Streetwise Professor

Michel and DR have a bet on the performance of the Russian economy in 2009.  I’m Shocked! Shocked! to see gambling at Craig’s Cafe SWP!

Russia Economy Watch has a very thorough description analysis of the subject of the bet.  Some highlights (lowlights?):

According to Deputy Economic Development Minister Andrei Klepach last week, Russia’s economy shrank by 7 percent year on year in the first quarter of 2009, a staggering turnaround for an economy which has just enjoyed eight years of solid oil-fueled growth.

“These figures are worse than we expected,” Klepach said at a press conference in Kiev,citing preliminary figures. Klepach also stated that net capital outflows reached $33 billion in the first quarter of 2009, following record outflows of $130 billion in the second half of last year.

. . . .

The Russian State Statistics Service have also released official gross domestic product figures for the fourth quarter of 2008. GDP was up 1.2 percent year on year, the worst reading for any quarter since the first quarter of 1999, and down from a revised 6 percent in the previous three months. The World bank are now suggesting that the present slump may be deeper than the one that followed the government debt default and ruble devaluation in 1998.

Certainly the data are bleak. Industrial production contracted for a fourth consecutive month in February – falling by 13.2% year on year – as the credit squeeze and falling incomes eroded demand for metals, cars and consumer goods. Retail sales contracted in February for the first time since February 1999. Unemployment was also up, at 8.5 percent in February, the highest level since January 2005.

Manufacturing output plunged with the collapse in demand in the last two months of 2008, and it is likely to contract further in 2009. According to Rosstat five of 14 major manufacturing industries reported outright output declines in 2008, with electronics, electrical, and optical equipment hardest hit (-7.9 percent), followed by textile and sewing (-4.5 percent) and by chemicals (-4.2 percent). Most of the dislocation took place in November and December 2008, when total manufacturing output respectively fell 10.3 and 13.2 percent (year-on-year). As credit continues to tighten and demand to fall, manufacturing is likely to contract further in 2009. According to recent statistics, manufacturing output dropped 24.1 percent in January 2009, compared with January 2008, and 18.3 percent in February 2009, compared with February 2008. In February 2009 the most significant declines were registered in the production of electro-technical and optical equipment (-46.6%), other non-metal products (-33.3%), and transport and transportation equipment (-31%).

. . . .
The latest data we have to hand confirm the ongoing character of the contraction. The Russian economy is thought to have declined by 5.4 percent in March compared with March 2008, according to the latest GDP indicator estimate provided by VTB Capital. The VTB GDP indicator also registered an average 4.4 percent contraction for the first three months of 2009, which would be the worst decline since the economy shrank 5.1 percent in the fourth quarter of 1998. The difference between the VTB estimate and the 7% estimate put forward by Klepach would lie in the fact that the VTB indicator does not include contstruction, and construction activity has declined sharply in recent months, so the two pieces of data are consistent with one another.

. . . .

As a result of this contraction in output and weakening in the labour market real incomes have declined substantially in Russia since the autumn of 2008. Rising unemployment and worsening enterprise finances (wage arrears have increased considerably) have meant that in the fourth quarter of 2008 alone, real disposable income dropped 5.8 percent year on year, and by 10.2 percent in January 2009 (again year-on-year). And unpaid wages as a share of total enterprise turnover tripled to 0.12 percent in December 2008, compared with August 2008. The stock of wage arrears as of March 1, 2009 (8 billion rubles or about USD 240 million) remains small but is likely to increase as the crisis grows. At the present time such arrears are thought to affect up to 450,000 people, significantly less than 1 percent of total employment. Growth in real wages came to a complete halt in January-February 2009, following double-digit increases in previous years.

. . . .

Inflation was spurred at the start of the year by the weakening ruble, which pushed up import prices, helping the annual rate jump to 13.9 percent in February from 13.4 the month before. The ruble has now lost 29 percent against the dollar since August. The most recent spike in inflation is evidently producing quite a headache for the Central Bank, since chairman Sergei Ignatiev last week that if April’s inflation is “significantly less” than it was a year ago, the central bank may consider cutting interest rates for the first time since 2007, giving some kind of monetary relief to an economy which is badly in need of it. Russia’s inflation rate went as high as 15.1 percent last June, and has since come down somewhat from that peak, but really the record of the central bank in containing inflation has been pretty abysmal.

Bank Rossii has been forced to raise its refinancing rate twice since last November, to the current level of 13 percent, in an attempt to limit the amount of rubles available to banks and companies and to slow the decline of the ruble against the dollar. On the other hand the central bank may be in danger of excessive optimism at this point, with Ignatiev telling journalists that his expectation was that the economy may pick up within “several months,” thus trying to offer hope that Russia’s banks won’t suffer that “second wave” of crisis that Finance Minister Alexei Kudrin said may hit as bad loans eat up capital. I am of the opinion that Kudrin is right to be cautious here.

Rising delinquency “is a serious problem, but I don’t share the opinion that a second phase of the crisis is unavoidable,” is Ignatiev’s view. Overdue retail loans rose to 4.4 percent as of 1 March from 3.2 percent on 1 September. “I believe the most serious phase of the economic crisis is over,” Ignatiev told journalists. Would that he were right, unfortunately I think he is wrong, the worst is still ahead.

Obviously the continuing inflation is a problem for Russia’s central bank since they would obviously like to offer monetary easing to the economy, just as the U.S. Federal Reserve, the European Central Bank and the Bank of England are doing by bringing their benchmark rates close to zero to bolster banks and pull their economies out of recessions. Bank Rossii last cut the refinancing rate in June 2007, and it has now increased the repurchase rate charged on central bank loans four times since November.

REW does note that various measures indicate that the rate of contraction in the Russian economy slowed in March; the economy was still contracting, but not as rapidly as in February, which in turn exhibited a lower rate of contraction than January.

To me, the most interesting aspect of all this is the policy dilemma.  The inflation issue mentioned above is a serious issue.  As I’ve mentioned before, Russia is in a stagflationary situation, which makes it very difficult to use an expansive monetary policy.  (Not that I think that US or UK policy is to be emulated.  We’re just facing a stagflation down the road.)  

A more severe contraction than forecast by the government also puts Russian government finances in a serious bind:

While the Organization for Economic Cooperation and Development and the World Bank are forecasting that the Russian economy will decline by 5.6 percent and a 4.5 percent, respectively, in 2009, the Russian government is still stubbornly holding fast to its official forecast of a 2.2 percent fall. Publicly government officials are sticking to their view, and diiging in around the idea that they expect a recovery in the final quarter. Deputy Economic Development Minister Klepach said that the government forecast takes into account a package of anti-crisis measures currently being debated by lawmakers that should bolster domestic demand and help boost GDP. Without it, the economy could contract by 4 percent to 5 percent, Klepach noted.

The Central Bank, on the other hand, continues to forecast a 4.5 percent contraction for the current year.

The Russian Cabinet approved last month a revised budget containing the first deficit in 10 years. The budget anticipates a deficit of 7.4 percent of projected gross domestic product, but since the current forecast is for a GDP contraction of only 2.2%, the final deficit may be considerably larger. The Finance Ministry is now transfering money from the Reserve Fund to cover the deficit, and anticipates using some 2.7 trillion rubles this year to help fund the budget gap.  

The Ministry of Finance has released the main parameters of its revised federal budget for 2009 which is based on lower oil prices (USD 41 a barrel, Urals) and a drop in budget revenues from the original 21.2 percent of GDP (under the old assumption of USD 95 a barrel) to 16.6 percent, or RUB 6.72 trillion. At the same time, expenditures will be increased by RUB 667.3 billion to RUB 9.69 trillion, to produce a deficit of RUB 2.98 trillion (about 7.4 percent of GDP), a massive reversal of the fiscal position from the 4.1 percent surplus in 2008.  

The total consolidated general government deficit is expected to be around 8 percent in 2009 deficit and will be financed largely from the Reserve Fund (7 percent of GDP) with modest domestic borrowing (up to 1 percent of GDP). With a large fiscal deficit, however, and the need to preserve some reserve fund resources for the uncertainty likely to extend into 2010, the space for more fiscal stimulus this year appears limited.

So the level of the contraction which the Russian economy undergoes in 2009 really is rather big beer, since it will condition the size of the eventual fiscal deficit, and the percentage of the Reserve Fund which will need to be used this year. If there is no rebound in oil prices in 2010 then Russia’s position can complicate on a number of fronts, since the Central Bank Reserves will be significantly depleted, the Reserve fund also, and there may be less room for fiscal easing in the face of potential credit rating downgrades, while monetary easing may also prove difficult given the need to support the currency, and protect Central Bank Reserves. All in all, 2010 could be a very hard year for Russia and its citizens.

Putin is touting the efficacy of his fiscal policy measures;

Prime Minister Vladimir Putin defended his handling of Russia’s economic crisis on Monday, telling lawmakers a 3 trillion-rouble ($90 billion) aid package would ensure the country survived a “very difficult 2009”.

“What should — and must — be said with all certainty is that Russia will overcome the crisis,” a confident Putin said in a 65-minute report to the State Duma (lower house), his first as prime minister.

“The country will beyond all doubt keep its position as one of the largest economies of the world.”

Amazingly, Putin also forecast that inflation would fall soon.  Right.  

I think a more realistic appraisal is that the likely prolonged economic downturn will put tremendous pressure on the Russian budget, thus draining the reserve funds, and putting tremendous pressure on the Central Bank to inflate.  

Russia’s fate depends now, more than ever, on a worldwide recovery.  Russia is a high beta country, due to its dependence on raw material exports.  The US Fed’s unprecedented loose monetary policy may also provide help to Russia by helping to prop up the prices of Russian exports.  But Russian policymakers have very few levers to pull.  They are at the mercy of the world economy.  And therefore, so are the betting men on SWP;-)

Last month Senator Maria Cantwell (Duh-W) announced two pieces of legislation to ”  help prevent future energy price bubbles and market manipulation“:

The first, S. 672, which she introduced on Mar. 24, would give the Federal Energy Regulatory Commission authority to issue cease-and-desist orders against manipulative schemes in progress. The US Securities and Exchange Commission and Commodity Futures Trading Commission already have this authority, she noted.

She said the bill also would make FERC able to freeze the assets of any entity suspected of market manipulation. It would give the commission authority to temporarily change or suspend power rates for up to 30 days during an energy emergency caused by market manipulation. And it would have any potential natural gas refund accrue from the time FERC brought a case (an approach currently used in electricity markets, according to Cantwell) instead of when it actually proves it.

“It will allow FERC to act more like a cop catching a robbery in progress instead of trying to piece together what happened at a crime scene after the fact,” she said.

Yes, we are expected to nod and trust the formulation of rules regarding the operation of our vast, and enormously complex financial markets to the likes of Senator Cantwell, who is apparently rather ill-informed about ordinary policing activities, let alone about the relevance of the possibility that cops may now and again interrupt an armed robbery at the Quickie Mart (Apu! Duck!) to the determination of the efficient way to reduce the frequency of manipulation and “excess speculation” in energy markets.  

First off, the premise of Cantwell’s analogy is wildly inaccurate.  Just how often do cops intervene while felonies are in progress?  Virtually all police work is done after the crime has been committed.  Cops respond to the calls of victims, or alarm calls, and in the vast majority of cases arrive after the perpetrators have fled.  Then begins the arduous process of “trying to piece together what happened at a crime scene after the fact.”  That’s exactly what cops spend most of their time doing.  Either Senator Cantwell watches way too much TV, or not enough.

Second, even if one were to grant that cops have the authority to intervene in crimes in process, and sometimes utilize that authority, that does NOT imply that this is the best way to fight market manipulation.  The law and economics of the trade-off of prevention vs. deterrence is very well understood.  (Steve Shavell wrote a very thorough article on the subject in the JLE in the early-90s.)  Deterrence–piecing together what happened after the fact, and imposing sanctions on those found to have committed harms–works best exactly in conditions like those that characterize a market manipulation.  Specifically, a real manipulation is readily detectable after the fact.  As Judge Easterbrook has written, “an undetected manipulation is an unsuccessful manipulation.”  Moreover, manipulators are typically not judgment proof.  That is, they are typically quite wealthy, and can afford to pay fines or other punishments equal to the harm they inflict.  Those that aren’t judgment proof are the firms whose manipulations failed spectacularly, and ruined the perps financially.  From a deterrence perspective, that isn’t a big deal, because fining successful manipulators can make the payoff to manipulation negative in every state of the world (fines when your manipulation succeeds; financial ruin when it doesn’t).  These are the conditions that make deterrence preferable to prevention.

Indeed, information considerations strongly favor ex post deterrence (as I argue in my 1996 book on manipulation).  Manipulations often unfold very quickly.  Moreover, the most distinctive effects of manipulation, such as the collapse in prices that follows the end of a corner (the “burying the corpse” effect), are virtually unmistakable after the fact, but cannot be observed while the corner is in progress. As a result of this fact, and others,  regulators necessarily have far less information about whether prices are distorted while a manipulation is in process, than after the fact.  Due to this information disadvantage, both “false positives” (intervening when a manipulation is not in reality occurring) and “false negatives” (failing to intervene in a real manipulation) are more likely when one attempts to act during an alleged manipulative event, than to wait and impose damaging sanctions after the manipulation is over.  Indeed, given that a mistaken intervention in a market would be extremely disruptive, false positive interventions are very costly.  That is, mistakes are much more likely, and the costs of mistakes are higher, when regulators attempt to intervene in real time, rather than to deter manipulation through the imposition of penalties.  (Moreover, private actions by those harmed by manipulation also have a strong deterrent effect, can rely on the superior information available after the fact, and can also fill the deterrence gap when regulators fail to act even after the end of a manipulation, as is too often the case.)  

Moreover, the costs of ex post deterrence only need be incurred when a manipulation has actually occurred, whereas maintaining a “police force” and surveilling every market is quite costly, and these costs must be incurred even when no manipulation is occurring.  

In other words, Cantwell is only 180 degrees off.  But it was one of her better days, I’m told.  

A couple of other entertaining thoughts.  First, the article states:

FERC would welcome this additional authority, according to one of the hearing’s witnesses, Anna Cochrane, acting director of the commission’s enforcement office. “Congressional action to give the commission cease-and-desist authority for violations of the [Federal Power Act] and [Natural Gas Act] and the ability to freeze assets of entities that violate the market manipulation rules would give the commission the same enforcement tools that both the SEC and CFTC have long possessed. In addition, authority to temporarily suspend market rules on file under the FPA when necessary to protect against potential abuse of market power could be useful,” she said in her written statement.

Imagine that.  A government agency that would “welcome . . . additional authority.”  Shocking.

Second, the article notes that CFTC and SEC have this authority.  With respect to market manipulation, it is seldom used.  

More humor:

Cantwell said the second legislation the hearing would examine would establish an office within EIA to collect and analyze information from physical and paper oil markets. This would improve EIA’s ability to predict future energy prices and help regulators police markets more effectively, she said.

In his written testimony, McCullough said no federal agency has been directed to investigate and explain last year’s extraordinary crude oil price changes despite oil’s arguably being the US economy’s most important commodity.

“The inability of the federal government to fully investigate oil price behavior in 2008 is fundamentally a data problem. Perhaps it is not a coincidence that oil is the most opaque of our nation’s energy supplies. The transparency legislation that you are discussing today is a step in the right direction because it will expand EIA’s ability to track oil inventories within the US by owner,” he said.

Sure.  EIA will be just dandy at forecasting energy prices.  And how is EIA, which has no enforcement authority, supposed to coordinate with CFTC and FERC (and perhaps soon, the FTC, when it puts its oil manipulation rule into effect), which do?  

“McCullough,” by the way, is Robert McCullough, Jr.  He is one of several people, e.g., Michael Masters, who routinely testifies before various House and Senate committees on energy market speculation and manipulation issues, and just as routinely parrots exactly what Cantwell, et al, want to hear.  The regular presence of this tiresome cast of courtiers, who IMO have little if any demonstrated expertise, and who routinely make idiotic arguments unsupported by logic or evidence, make the hearing process look like Kabuki theater, or a show trial.  It’s not intended to raise issues, find facts, sift evidence, or air serious disagreements.  Instead, it’s purely a theatrical production, with a pre-scripted outcome, intended to convey the impression of investigation, inquiry, and debate.

In the scheme of things, manipulation should be one of the easier things to regulate and deter in financial markets.  Nonetheless, Congress and various alphabet soup regulatory agencies (GFA, CEA, SEC, FERC, and probably soon, FTC) have made a complete botch of it for going on 87 years now.  (Yeah, I know.  But I’m feeling generous today.)  Yet we’re supposed to have confidence that that same Congress and same array of regulators (plus some more) have the knowledge, competence, and incentives to legislate and regulate much more complex and arcane aspects of the operation of the financial markets (e.g., clearing, “excess” speculation, product design).

Just remember the three big lies.  The check is in the mail.  I’ll respect you in the morning.  And the biggie: I’m from the government, and here to help you.

Several months ago, during a raging debate on the consequences of the world economic crisis for Russia, a commentator whom I’ll call BFC excoriated me for my pessimism.  He pointedly asked if things were so bad, why were reputable organizations, such as the World Bank, making much sunnier (though hardly great) forecasts for the 2009-2010 Russian economy.  

All good things come to those that wait, B.  The World Bank has released its Russian Economic Report 18.  (Links to report and a powerpoint presentation are to the right on the linked page.  You can read the entire report, but its main results are summarized in the ppt presentation.)

It’s full of I-told-you-so material for SWP.  Key sentences:

With a much worse global financial outlook and oil prices in the USD 45 a barrel range, Russia’s economy is likely to  contract by 4.5 percent in 2009, with further downside risks. This represents a major downward adjustment from our  forecast in November 2008, which saw growth at 3 percent, based on growth of the world economy and oil prices around  USD 75 a barrel. (Emphasis added.)

In other words, the WB was unduly optimistic last year, when the debate was raging here on SWP.  

The report makes frightening reading (not that there is a single economy out there for which 2009-2010 looks good).  I would direct attention to a chart on p. 12 of the World Bank report, in Box 2.1, which plots growth rate deceleration (vertical axis) against fiscal stimulus (horizontal axis).  Look at the point way down at the bottom.  The one labeled “Russia.”  It means that the WB forecasts that the growth rate for Russia will decelerate more than for any other G-20 economy.  I repeat.  The growth rate for Russia will decelerate more than for any other G-20 economy.  In other words, by one measure, the WB validates my assertion, contested so vigorously by BFC and a couple of others, that the world crisis would hit Russia harder than the US and most other industrialized economies.  

This measure is related to one I’ve mentioned in a couple of recent posts, namely the growth gap: the difference between growth potential and actual performance.  The combination of the facts that (a) Russia was growing fairly rapidly 2006-1H 2008, and (b) has contracted more than other G-20 economies, means that (c) the growth gap in Russia is very large indeed.  This is reflected in the rapid deceleration in Russian growth.

Another particularly interesting and revealing chart is Figure 1.1.  Compare the performance of Russia not so much to the developed economies, but its developing peers.  Note how much Russia has underperformed these nations in the crisis.  

The rest of the report is chock full of interesting details.  I’ll call out a couple.  First, investment in Russia (never high when compared to other rapidly growing economies, e.g., the “Asian Tigers”) has plummeted, down in the fourth quarter by 1.1 percent, down in the first two months of the year by almost 15 percent.T  This bodes ill for long term growth.  Second, consumption has also declined after dramatic growth in previous years.  Third, construction is down 18 percent.  Fourth, unemployment forecast to be 12 percent. Fifth, disposable income down sharply.  I could go on.

The adjectives in the report are also quite illuminating.  Phrases like “rapidly decelerating” and “collapsing domestic demand” are sprinkled throughout.  

The report pays special emphasis to how the crisis has seriously eroded the laudable progress made against poverty in the last several years.  The poverty, unemployment, disposable income, and consumption numbers all point to potential sources of popular discontent.  

Furthermore, the report repeatedly emphasizes that Russia’s policymakers face serious constraints that severely limit their choices.  Sound familiar?

And if you think the World Bank is gloomy, it is a starry-eyed optimist compared to the OECD.  The OECD’s report on the Russian economy forecasts a 5.6 percent decline of GDP in 2009, as compared to the World Bank forecast of -4.5 percent.  The OECD report notes that the Russian recovery is highly dependent on exogenous factors, especially the price of oil (another point BFC disputed vigorously).  

So, BFC, you asked for it . . . you got it.  

It should be noted that big organizations like WB, IMF, and OECD are frequently lagging indicators.  Prudence, and the fact that they are political bodies, dictate that they be very cautious in their assessments.  In contrast, mere bloggers can be more aggressive and opinionated.    

Oh, I have to mention just one other thing before closing this post.  It speaks volumes: “Russia Seeks to Carve Out Role in Crisis-Hit World Economy“:

“I think in general they see this crisis as a way to show the world that they have some answers and they’ve moved on,” said Tim Ash, head of CEEMEA research at RBS in London.

“It is a great opportunity for them to re-jig the global financial architecture and put themselves in a central place.”

Arguably Russia’s closest allies are the other BRIC nations, emerging market powerhouses Brazil, China and India. All have sizeable foreign currency reserves and are vulnerable to the global slowdown as they rely on exports.

This month the BRICs released their first communique at a G20 finance ministers’ meeting and joined the Financial Stability Forum, signaling a growing world role.

The communique reflected some of Russia’s campaigns, calling for “major reserve issuing economies…to ensure that the macroeconomic policy is more balanced” and for a reshuffle of country representation at the International Monetary Fund (IMF).

Russia followed that up with its own proposals for Thursday’s meeting of G20 leaders. Its suggestion to replace the dollar with a new international reserve currency quickly found support from China and sparked international debate.

Now, the first quote is the view of a certain Mr. Tim Ash, but if it is at all a reflection of Russian official thinking–and there is independent information that would tend to support that view–then they are delusional.  They have answers?  They have a Plan to Save the World?  

As the World Bank and OECD note, they have huge problems at home, and limited policy tools to deal with them.  They have more than enough on their hands at home even to think about saving the world.  Their reserves, shrunken as they are, are doubtfully sufficient to address their own pressing issues, let alone provide a meaningful prop to the world economy.  Their policy ideas are primarily aimed at weakening the US, rather than contributing to a meaningful improvement in the world financial system.  (When I read their proposals, or hear Lavrov or Medvedev speak of them, I am reminded of the punchline of the old joke about the Russian given a wish by a genie: “I wish that my neighbor’s cow dies.”)    

The entire world is hurting economically.  I stand by my previous forecast that due to the very structure of its economy and institutions, Russia is hurting, and continue to hurt, worse than most others.  The World Bank and OECD are coming around to that view.

The WSJ has a long article based on an exclusive interview with your fave and mine, Igor Sechin.  It is full of the usual his-lips-are-moving whoppers, but this one stunned even me, even as predisposed as I am to snort at pretty much anything old Eyegore has to say:

And he was quick to point out that Russia became a major oil exporter in the 1970s in response to demand in the West amid the Arab oil embargo. “Now they tell us, ‘You have Dutch disease, you’re a resource economy.’ But you yourselves asked us to be that way,” he said.

Sorry, but WTF is he talking about?  Yeah, the USSR was just eager to please the US and the West in the early-to-mid 1970s.  We said “jump”, and Brezhnev said “how high, boss?”  

Please.  The Soviets exported oil because (a) there was money in it, (b) they needed a lot of money, given that the rest of the economy was going to hell (especially the agricultural sector, which couldn’t feed the country), and (c) they had absolutely nothing else to sell that anybody wanted.  

What is it about Russians that they are responsible for absolutely nothing?  It’s always “The Devil (i.e., America) made me do it!”  They are wanna be Masters of the Universe, but everything is out of their control.  Sheesh.

Here’s another one from Putin’s Pinnochio:

Mr. Sechin is Moscow’s point man for warming relations with the Organization of Petroleum Exporting Countries. But he said Russia, the largest oil producer outside the cartel, isn’t ready to accept membership in the group, despite its pleas.

“It would be irresponsible for Russia to join OPEC because we can’t directly regulate the activity of our companies,” he said, as nearly all are privately owned.  (Emphasis added.)

Spare me.  

First, Russia taxes oil exports.  It is perfectly feasible for Russia to regulate the activities of its companies indirectly through the oil export duty mechanism.  Russia can achieve any level of exports it wants by adjusting the duty.  And it has been adjusting it–downwards, thereby encouraging oil exports.  (Maybe Sechin was quite deliberate in including the word “directly” in his answer, knowing quite well that this is an irrelevance, given the ability of the government to control exports via the tax mechanism, without directing companies to do anything.)  

Second, “nearly all are privately owned”–except the one that is by far the biggest, Sechin’s own Rosneft.  And, does he really expect us to believe, with Khodorkovsky in the dock, Mechel’s CEO Igor Zyuzin contemplating what Putin meant about “sending a doctor” (and given Russian healthcare, that is a frightening prospect), BP-TNK’s Dudley fleeing the country, etc., that if Putin or Medvedev told the owners/managers of these “privately owned” companies to cut exports, that they wouldn’t salute and ask “how much?”  

Sechin repeated his call to segment and “gasify” the oil market:

Mr. Sechin called for a gradual but major overhaul of the international oil trade, adding tight regulation and longer-term supply contracts, eliminating “economically unjustified intermediaries” and reducing speculation. Russia is the world’s No. 2 crude exporter.

Russia doesn’t like open markets and price discovery.  It likes market segmentation and backroom deals.  

In the add insult to injury category, Sechin uttered these Orwellianisms:

Mr. Sechin hailed  BP  PLC’s TNK-BP Ltd. joint venture in Russia as a sign of Russia’s openness to foreign investment in the sector. But he singled out secretive Siberian giant OAO Surgutneftegaz as “Russia’s best private oil company.”

Investors have criticized Surgut for refusing to release international-standard financial accounts or details of its ownership structure.

Surely, from Sechin’s perspective, black hole Surgutneftegaz is indeed the ideal energy company.  And yes, the whole BP-TNK fiasco is just a shining illustration of how an Investor’s Paradise has risen from the ashes of the former Worker’s Paradise.  Orwellian, like I say.

I actually appreciate the fact that Sechin has become much more open.  By speaking publicly, he reveals his utter mendacity, and in so doing, provides a revealing glimpse at the equally mendacious regime in which he serves.

The Russians keep playing that pleasing music, complaining about the Ukraine-Europe gas deal.  There are several reasons for this.  One is that it undermines the need for Nordstream and South Stream.  

Another important reason is that Europe will buy gas at the Russian border (taking title there), and pay transport fees to Ukraine directly, whereas previously Russia owned the gas in transit in Ukraine and paid the transit fees to the Ukrainians.  

This would seem to be beneficial for Russia, because this ensures the Russians get paid for any gas destined for Europe.  If (a) the Ukrainians don’t pay the Russians for their gas, (b) the Russians cut shipments to Ukraine in response, and (c) the Ukrainians siphon gas paid for by the Europeans to meet their needs, then (d) the Russians are whole, having passed title for cash before the gas gets onto Ukrainian territory,  (e) there is no ambiguity that the Ukrainians are at fault, and (f) the Ukrainians would have problems with the Europeans.

But, this arrangement could also reduce Russian leverage in negotiations with Ukraine.  Until now, Russia paid Ukraine a transit fee, and the negotiations over that fee were inevitably tangled up with the negotiations over the gas price.  Russia could use its control over gas as leverage over the transit fee.  Now, Ukraine can negotiate that separately with the Europeans.  Moreover, every cent of higher transit charge reduces the European’s derived demand for Russian gas, and reduces the amount that the Russians can charge for gas.  The Europeans care about the all-in price (transport plus gas), and really don’t care how that is split between the Russians and Ukrainians.  But the Russians care a great deal, and the reduced leverage is likely to reduce their share of the total pie.

But I think that the main reasons for Russia’s over-the-top rage are two.  First, it dramatically reduces the probability that they will be able to seize control of Ukraine’s gas transport system, either de facto or de jure.  Such control is clearly a major component of Putin’s long term plan to control both the gas upstream and midstream on virtually the entire Eurasian landmass.  (He has ambitions downstream too.)  

Second, and perhaps most importantly, it likely gives nosy Europeans a far better view into the murky world of the Ukrainian gas market, and hence the Russian role in it.  Or, more to the point, the role of particular Russians in it.  This has the potential to hit Putin, Medvedev (a former Gazprom chairman), and their cronies where it hurts.  This would explain their outraged howls.  

Now, with Timoshenko, one can never be too sure that this isn’t just a tactical move in her ongoing Good-Bad-Ugly standoff with rival Ukrainian politicians/parties.  But, it does raise the prospect for some improvement in the deeply corrupt Ukrainian gas trade.  And to the extent that the deeply corrupt Ukrainian gas trade is inextricably mixed with the deeply corrupt Russian gas trade, that could provide Putin and Medvedev with some very uncomfortably moments indeed.

Vlad is POd.  Seriously POd.  At the Ukrainians and the Euros, for having the audacity to modernize Ukraine’s shambolic gas pipelines without consulting HIM.  Can you imagine, the nerve.  Like Ukraine must think it is a sovereign country or something.

Here’s a glimpse at little Vlad’s foot stamping, hold-his-breath tantrum:

“It seems to me the document about which we are talking is, at a minimum, ill-considered and unprofessional because to discuss such issues without the basic supplier is simply not serious,” Putin said in the Black Sea resort of Sochi.

Just how the “basic supplier” would be harmed by measures that would improve the reliability and capacity of a major route linking its supplies to the ultimate consumer, Vlad didn’t say.

He’s so cute when he’s mad, dontcha think?  All I can say is, when he goes off like this, I know there is something right with the world.  For a change.

Loyal Putin creature Sergei Shmatko, the Energy Minister, chimed in:

Shmatko said the joint declaration touched on more sensitive issues than just gas and might damage EU energy security.

“It goes far beyond modernization of the Ukraine transit system and talks of the integration of Ukraine into the legal sphere of the European system as far as energy is concerned,” he told reporters.

Uhm, and what business is of yours, Sergei?  Ukraine and Europe have a perfect right to enter into such relations, even if it does involve some legal integration.  The concept is called “sovereignty.”  I’m sure you’ve heard about it.  After all, you and your cronies never tire of telling the rest of the world to f*ck off, and leave your “sovereign democracy” alone.  Goes both ways, dude.

Putin, gansta that he is and wants to be, sounds like one.  “Hey, Ukraine, you MY b*tch!  How dare you go out with somebody else.  Don’t make come over there and slap you around like I did that Georgia b*tch!”

This is all particularly rich in light of some of the things that Putin said during January’s gas war.  (Seems like years, not months, ago.)  At the time, Putin repeatedly denigrated the condition of Ukraine’s gas transport system, and called its reliability into question.  This was, in large part, an effort to pump up the prospects for Nordstream and South Stream, both of which would bypass Ukraine.

And that’s the real reason for Vlad’s pique.  He doesn’t want a reliable Ukrainian transportation network.  It undermines his goals, geopolitical and economic.

So, I say to Ukraine–You Go.  And to the EUnuchs–you surprise me, and in a good way.  (Though perhaps they didn’t foresee how Vlad would react.  It will be interesting to see whether they hang tough after Vlad’s outburst, and the inevitable follow on efforts to intimidate, and to play divide and conquer in an attempt to undermine this deal.  I’m sure that Schroeder will soon slouch to Moscow to get his orders to attempt to derail this deal.)

In other Russia news, Economy Minister Nabiullina has announced that the Russian economy contracted 8 percent year-on-year in February, and will likely contract 7 percent YOY for the first quarter. To put things in perspective, this collapse began in August, when GDP was probably on the order of 3-4 percent above its level as of February, 2008.  Thus, in 6 months, GDP has declined about 10-11 percent, a 20+ percent annual rate.

Economists often evaluate performance relative to growth potential.  Given a growth potential in Russia of 6-7 percent annualized, GDP should have been 7 percent higher, rather than 7 percent lower, than February 2008 as of the end of 2009.  This output gap of 14 percent compares with an approximate 8 percent gap in the US.

This is consistent with my view that the economic crisis has hit Russia harder than the US and Europe.  As is the fact that Russian economic indicators (e.g., the stock market, the ruble) have done better than their counterparts as of late.  The US market has turned around in recent weeks.  As I’ve noted, Russia is effectively a strongly procyclical economy (it’s “beta” to the world economy is greater than one) due to its dependence on highly procyclical energy and mineral industries.  With oil rallying 25 percent plus in recent weeks, in part due to the Fed’s apparent willingness to tolerate a lot of inflation to turn around the economy, and other commodity prices (e.g., copper) rallying too, Russia has benefited.

Though not so much as to justify this heady optimism by Deputy Prime Minister Igor Shuvalov (H/T R):

In comments to foreign media, First Deputy Prime Minister Igor Shuvalov said the government was increasingly upbeat about the Russian economy and hoped it would start growing again by the end of this year if the global economy doesn’t sharply deteriorate. As oil prices have risen above $50 a barrel, the ruble has steadied against the dollar and the Kremlin says there are tentative grounds for optimism, sounding an increasingly confident note about its handling of the financial downturn.

“The first phase is over,” said Mr. Shuvalov. “Most businesses have already adapted and the budget is not playing out according to the worse scenario.” Mr. Shuvalov confirmed that the Kremlin was no longer willing to offer large-scale bailouts to distressed corporations, something it did during the first stage of the crisis, but said that the government would help strategically important firms that had a genuine need. He stressed that commercial banks were now awash with cash, however, and could cover many of the lending requirements.

It is way too early to make such giddy pronouncements.  Russia is still highly dependent on the state of the world economy, which is anything but strong.  Kudrin is certainly not so ebullient.  He recently warned of a new wave of bad debts hitting Russian banks.

And Russia still faces its own home-grown curse: its legal nihilism, personified by Igor Sechin (will Marty Feldman play him in the movie?).  Sechin sent a letter to Norilsk Nickel, raising questions about some transactions, and in shades of the Mechel episode, Norilsk’s stock tanked immediately:

Norilsk slumped as much as 12 percent after the country’s biggest mining company said it received a letter from Deputy Prime Minister  Igor Sechin‘s office seeking information on transactions that were carried out last year.

. . . .

Norilsk sank 11 percent to 2,203.90 rubles on the Micex Stock Exchange, the biggest drop in a month. Sechin is seeking details on 86 billion rubles ($2.6 billion) of spending on share buybacks and asset purchases, and information on the sale of mining permits to a company owned by former Chief Executive Officer Mikhail Prokhorov, company spokeswoman  Erzhena Mintasova  said today.

Norilsk Nickel has complied with Russian law and the company’s own charter for all its transactions, Mintasova said.

Sechin, as chairman of  Rosneft, oversaw the state oil company’s acquisition of bigger rival  Yukos Oil Co.‘s largest assets at bankruptcy auctions after an investigation that led to the imprisonment of Yukos founder  Mikhail Khodorkovsky, once Russia’s richest man.

Meanwhile, the Telenor/Vimplecom farce continues:

Telenor said a Russian court rejected a motion to stay a ruling that found the Nordic region’s largest phone company liable for $1.7 billion in damages related to a dispute among OAO VimpelCom shareholders. VimpelCom sank as much as 11 percent in New York trading.

Wise words, these:

“The Norilsk and Telenor cases serve well to remind investors that Russia risk is a real phenomenon, which is the last thing Russia needs in this new, tighter-liquidity global market,” said  James Beadle, chief investment strategist at Moscow-based Pilgrim Asset Management.

The dispute is “an open demonstration of Russia’s aggressive business culture,” and is the same story as  OAO TNK- BP Holding, Beadle said.

So, in other words, la plus ca change.

The political uncertainty also continues.  A couple of interesting articles today, one by Pavel Baev in EDM, which noted:

Both Medvedev and Putin tried to perform as wise statesman meeting with Kissinger, but in reality for them global issues are just a public relations campaign of little importance compared with their real priorities of re-distributing money and property among servile but disloyal oligarchs (Grani.ru, March 20). This role of two-headed godfather is central for the regime’s survival in times of falling oil revenues when doubts in the irritated elites grow and spread under the surface of total obedience. Firing governors is apparently not enough to exterminate these mutinous doubts, so the second trial of Mikhail Khodorkovsky and Platon Lebedev is rolling towards the “guilty-as-charged” sentence (Novaya gazeta, March 18).

There is no way around the simple premise that in order to achieve a new positive start in U.S. relations, Russia has to begin a meaningful reformatting of its corrupt quasi-democratic regime. The Obama administration refrains from advocating any conditions of this sort, but Medvedev seems to be aware of the need to modernize the rigid system of “Putinism.” He remains reluctant, however, to deviate from the course set by his senior partner, who believes that the crisis hurts the U.S. more than Russia and will diminish its leadership, scorned as “uni-polarity.” Putin relies on the “fear factor” to keep the disgruntled elites under control and expects that demonstrative generosity towards pensioners and other “have-nots” would prevent an escalation of protest activity. His new anti-crisis plan unveiled last week does not envisage any new grants to struggling oligarchs, but gives first priority to social protection; it could, however, be overtaken by the unfolding disaster – as was the previous plan adopted last November (Kommersant, March 19). Such an emergency would require different kinds of measures, and forceful mobilization against an external threat is Putin’s fall-back option of choice; anti-Americanism, therefore, remains an important political resource – perhaps the very last refuge for a pair of scoundrels.

I particularly agree with Baev’s statement that the Khodorkovsky/Lebedev trial is intended to squelch “mutinous doubts.”

I found this paragraph entertaining:

Medvedev has personally explained to bankers that it would not be “fair” to demand money from the insolvent Rusal and its owner Oleg Deripaska; he also maintains that the International Monetary Fund should be governed by a board with a “fair” representation of contributors. Deputy Prime Minister Igor Sechin suggested at the recent OPEC meeting to establish a more “fair” system of regulating oil prices, which the gang of seasoned quota-fixers found only slightly amusing (Kommersant, March 16). This concern about “fairness” is not always driven by pragmatic calculations but betrays a grudge about the lost prosperity and stability that were perfectly on track until the U.S. made their economic problems everybody’s headache by provoking the global crisis.

The touching concern of Medvedev, Sechin et al for fairness brings to mind a spoiled child screaming “No FAIR!” when he doesn’t get what he wants.  Not that he earned it.

The other interesting article is from Goble’s WindowOnEurasia:

Even in other countries, he suggests, the notion that people are ready to sacrifice their rights to the state in exchange for economic well-being and will revolt if the government fails to provide it is overstated. Even in today’s severe economic crisis, the Moscow commentator says, “there are no signs in Europe of an 1848 or even of a 1968.”

In most cases, he argues, “the chief stabilizer is open political activity within a legal framework.” But in Russia, “our system is completely different, although it employs (for conspiracy!) the very same words,” an arrangement which includes the kaleidoscopic assertion that with Russians everything is exactly the same and at the same time entirely different.
This pattern has deep roots in Russian history and reflects a decision on the part of all those not intensely involved in political issues to focus on “their personal affairs and only on them” and to view politics as something alien to and apart from them and yet to see leaders as “symbiotically” involved in the survival of the state.

To this arrangement, Radzikhovsky says, a European would react with surprise: “They are DEPRIVING you (the people) of the rights to judge and decide and you (the people) nonetheless are still willing to support this arrangement!” But a Russian, he suggests, would understand the situation instantly, seeing it was being “a question of words.”

For the Russian it is not about deprivation, it is about “RELIEVING” the individual and society “of responsibility … and of the work involved in judging and deciding.” And as an example, to Radzikhovsky quotes Saltykov-Shchedrin’s observation that “the energy of the actions of fools opposes the energy of inaction.”

“The energy of societal inaction is the foundation of [the Russian] State,” he continues. “Therefore firmly or shakily, we stand by it.” Indeed, he says, “individualism (in individual affairs) plus humble fatalism (in common affairs) equals the ethnic Russian or better civic Russia (everyone in Russia, regardless of nationality acts that way) social-political SYSTEM.”
Given that set of attitudes – and Radzikhovsky insists that they can be called “sobornost,” “collectivism,” “apoliticalness,” or “alienation” – the relationship of those in power and everyone else is fundamentally different. Those in power have “a DIFFERENT function” and serve as “a shepherd” to the society.

Such a system, of course, has a dangerous tendency: the absolute power of the state in such circumstances tends to “corrupt absolutely, “both those who rule and those who are ruled.” But there is “a still more dangerous alternative: the absolute lack of rights on the part of the government and the absence of power [which can also] corrupt the people absolutely.”
The way out of this vicious circle would be a government with “LIMITED POWER,” but in Russia that has never been known and is not unknown now. “And with that is connected the completely SPECIAL role of the government in Russia,” one that is reflected in the very different attitude people have toward criticizing the government.

In most countries, Radzikhovsky continues, government is viewed as “only a superstructure’ over society” and thus as something from whose change the society does not think will change society. Consequently, any criticism of the powers that be for [such a] society is secure.”
But for Russians, “as is well known to all,” the picture is “different.” That is because criticism raises the question of leadership change, and “in the course of all Russian history up through today the main political question has not been resolved.” That is the question of the creation of mechanisms for a peaceful, regular and lawful change of the highest levels of power.”
Those in power, of course, “exploit this: destroy the powers that be and you will destroy Russia! This is a big EXAGGERATION. But it is only an EXAGGERATION” because the problematic situation it reflects is not invented but quite real. Russia has not succeeded in dividing “the powers that be” and “the country” just as it has not split power and property.

Consequently, the deference the population shows to the rulers is not so much “a slavish instinct” as an instinct for national SELF-PRESERVATION,” Radzikhovsky suggests, arguing that it rests on the notion that the powers and the population are linked together in “a biological symbiosis” whose violation by either side could lead to the death of the whole.
Thus “the real social compact [in Russia] is much more serious. It is not a trade off of independent sides,” and it is not about well-being “but about survival.” In this situation, the population will remain far more willing to defer to those in power because “the people DO NOT WANT” to do anything but “to AVOID being the opposite of humble.”

Understood in this way, Radzikhovsky concludes, the social compact in Russia has not yet been violated sufficiently to cause a revolt, especially given how great fears remain of “chaos.” And he reminds his readers that “one cannot free people externally more than they are ready for that internally.”

This is a very interesting commentary on the apathy of Russians.  It points out the fundamental lack of a civil society in Russia, the alienation between state and people (in spite of the allegedly organic relatonship between them) and reinforces a point that I made in my summer post On Russophobia, namely, that classical liberal limited government is an anathema in Russia.  (This, ironically, gave rise to charges that I was in fact a Russophobe projecting pejorative images of The Other.  But, as I noted at the time, this is considered a feature not a bug by many Russians, and many Russians like Radzikhovsky who think it is a bug acknowledge its existence nonetheless.  They have met The Other and it is Them.)

This is why, although I don’t discount the possibility of popular unrest, I believe that the main threat to the system comes from within, due to the “doubts in the irritated elites . . . spread under the surface of total obedience” (in Baev’s words).

Commodities have rallied strongly on the Fed’s surprise move to quantitative easing (“QE”) on steroids.  Gold and oil in particular have moved up substantially.

This is a big favor to commodity producers, and Russia in particular.  This will materially aid these countries, and help them address their severe economic challenges.

As to whether it’s good news for us in the US, color me skeptical.  Very skeptical.  This, to me, seems to be a recipe for stagflation, if not immediately, then in the near to medium term.

A couple of quick thoughts.

First, to me it suggests that the Fed is deeply concerned about the prospects for the economy, and the banking system.  This action was extreme, and unexpected.  I doubt the Fed would have acted in this fashion if it was confident that the economy was beginning to turn around.

Relatedly, it is very plausible that the Fed’s action reflects its view on the political situation, and in particular the efficacy of fiscal policy and the likelihood of a sane plan to fix the banking system.  In brief, it is a very big thumbs down on both.  That is probably a very astute judgment.  To say that Congress is a clown show is a deep insult to clowns.  The administration, and Treasury in particular, have so buggered the banking issue that it is unlikely that anything constructive will come out of its fire drill.  Indeed, the AIG fallout, and the colossal mishandling of that situation have so politicized the banking policy response that it will be a miracle just short of the Resurrection if anything positive develops on that front.

And Congress has made things infinitely worse.  Nancy Pelosi (please, has there ever been anybody dumber in a position of power?) today remarked that nobody would “be able to hide behind contracts.”  Great.  That’s sure to make anybody thinking of getting involved in TALF or TARP or any successor programs designed to attract private capital into the banking sector or the purchase of toxic assets to think once, twice, thrice–and then say “No thanks.”  These people are traders.  They are not going to enter into a position short a legislative put with Nancy and Obama and other demagogues in charge.

Second, the long term consequence of this are troubling, hence my stagflation forecast.  With a sober, constructive policy response to the banking process, and the normal equilibrating process of the economy, it is likely that later this year or next the economy would make solid improvement.  With a dysfunctional banking system, and huge/immense/gargantuan policy risks, I think that recovery is problematic.  But the injection of huge quantities of money will ultimately prove inflationary.

Moreover, it is extremely difficult to wring inflationary expectations from the economy once they become entrenched.  It basically took the entire decade of the 1980s–and a recession nearly as severe as the present one–to do that.   Moreover, there is considerable room for skepticism that a future Fed will have the political will to do this again.

Therefore, I think that there is a high probability that the coming decade will be one of low growth in output, and high growth in prices.  That’s why I’m buying more TIPS.

OPEC had another meeting over the weekend, and Igor Sechin reprised his role as Lucy with the football.  Sechin repeated his fulsome praise of OPEC, and his expressions of Russia’s undying support for the cartel’s actions.  As long as, you know, like, Russia doesn’t actually have to cut output or anything:

Hounded by a pack of journalists on his arrival, Russian deputy prime minister Igor Sechin led a parade of government officials to OPEC’s latest shindig in Vienna. He proposed a slew of things for Russia and OPEC ministers to work on together, such as coordinating (i.e., raising) taxes on foreign oil firms’ crude production and refining operations.

But Sechin, at his third OPEC meeting in six months, again signally failed to promise any big commitments to keep barrels out of the global crude market even as OPEC members said they’d push on with shoring up compliance with their own output cuts.

That’s obviously good news for consumers as Russia, the world’s top oil producer, and OPEC pump almost half the crude used daily globally. Any formal and disciplined coordination between the two could easily spell higher oil prices.

Mr. Sechin claimed Russia cut production and exports in recent months but most OPEC officials weren’t buying it. Exasperated, they say independent data show Russia boosted exports by almost 700,000 barrels a day the past six months, even as OPEC members shaved their own production.

But Russia is still flirting with OPEC and may yet consummate a more formal relationship with the group. For its part, OPEC is still open to the courtship. Mr. Sechin said Sunday that Russia wants, among other things, a “permanent representative” stationed at the OPEC secretariat.

Mr. Sechin said that doesn’t mean Russian OPEC membership but a deeper and wider exchange of data, information, and ideas.

“Flirting.”  Interesting choice of words.  “Exchange of data, information, and ideas.”  In other words, you let us in on your information flow, and we’ll use that to optimize our decisions.  

Sechin claims that Russia will stimulate domestic consumption, as part of a strategy to curb exports:

Russia will cut oil exports and increase domestic oil consumption in a bid to stabilize world oil prices amid the ongoing financial crisis, Deputy Prime Minister Igor Sechin said on Sunday.

“We will be cutting oil exports through the expansion of domestic consumption. In particular, we plan to transfer 2 million tons of fuel to agricultural producers and also increase oil refining inside the country,” Sechin said.

And pray tell how will the government expand domestic consumption in an economy that is continuing to hemorrhage, especially in its energy intensive manufacturing and transport sectors?  And, the best way to divert oil from export to the domestic market would be, as I’ve said numerous times before, to raise substantially export duties.  But those have just been cut again.  And insofar as domestic oil refining is concerned, it has long been a Russian policy objective to encourage Russian refining of domestically produced oil.  Indeed, the duty structure was designed in part to encourage the export of value added refined products in place of crude.  And note that Russia also just cut its duty on refined products too.  Exporting refined products puts as much downward pressure on international prices as exports of crude.

In other words, pay no attention to Sechin as long as his lips are moving.  And never take your eyes off of his hands.    

OPEC seems to be catching on, at long last:

OPEC officials have said privately that Russia — which sees itself as a leader on the world stage — is unlikely to give up its energy independence by joining OPEC. In an apparent allusion to Russia, el Badri on Monday urged “the larger producers” outside OPEC not “to take advantage” while his organization tries to manage crude supply and demand.

Russia “take advantage” of OPEC?  Go on!  Or should that be “что Ñ‚Ñ‹!”?  

Sechin did make one revealing comment.  He suggested greater use of long term contracts in the oil market.  These contracts could be effective in facilitating a division of the market.  They also play into the traditional divide-and-rule strategy.

Sechin framed his proposal as a means of taming those eeeevvvviiiiilllll oil speculators:

The price that the producers would charge under these long-term contracts would take into account the rising costs of lifting and delivering crude, ensuring future investment, he said.  

A system of such contracts would not allow financial institutions to “unreasonably rock the boat,” Sechin said.  

It is clear, however, that as always, Russia sees benefits in reducing transparency and flexibility as means of exerting market power.  In other words, Sechin (and Russia) would like to remake the oil market into something similar to the gas market.  

This is something to be avoided if at all possible.  The nat gas market–especially the LNG sector–is evolving to support more spot trade.  The “gas OPEC” Russia has proposed can be seen as a method to throttle spot trading in gas, and to keep the market relying on opaque, long term contracting relationships that subject the buyers especially to holdup, and reduced competition at times of contract renegotiation (because supplies from other sources are locked in via long term contracts, leaving the original buyer and original seller in a small-numbers bargaining situation.)  Russia’s ability to exploit a fragmented buyers side of the market in such circumstances is well known.  The last thing we need is the oil market to adopt the same dysfunctional structure.  I hope that policy makers in consuming nations are alive to this possibility, and will fight it tooth and nail.  Experience (especially in the European gas market) suggests, however, that my hopes may be in vain.

Both the WSJ and NYT ran articles to the effect that Russia had decided not to extend additional bailouts to various oligarchs drowning in a sea of debt.  Some are interpreting this shift in policy as evidence that (a) Russian resources are dwindling, and the government needs to conserve them to bolster the real economy, and (b) the government is backing away from exploiting the crisis to re-nationalize “strategic” sectors of the Russian economy.

I do not believe that the evidence supports either conclusion.  I wrote some months ago that it would be foolish for the Russian government to, in essence, assume the obligations of the oligarchs to the Western banks.  The loans, even taking into account any haircut on the shares the oligarchs provided as collateral, reflect the values of the borrowers’ companies when they took out the loans.  These values are now far in excess of the current market values of the collateral.  Sure, if the government lent money to the oligarchs, who paid the banks, and took the shares in collateral, it would probably end up owning the companies.  But it would obtain this ownership by paying the old, higher values.  This would make the Western banks very happy.

But there is a far cheaper way for the government to achieve the same end.  Just let the oligarchs default on their debt to the Western banks.  I doubt, under current circumstances, the banks have much of a desire to hold the equity they would receive in this event.  The government could buy it back at current market value, far below the amount the oligarchs owe the banks.  Moreover, the government would be in a very strong negotiating position.  It could always threaten to nationalize the companies, a la Chavez, leaving the banks with zip.

So, by letting the oligarchs fail, the state–and those who control the state–can pick up control of their companies for a small fraction of what it would cost to bail out the oligarchs, and then seize the companies when the oligarchs almost inevitably would default.

My only question is: why didn’t Putin et al do this earlier, instead of giving Derispaska and others billions?  My earlier conjecture was that Putin and the siloviki were loath to allow prying Western eyes inside these companies even for a short period of time.  Maybe they are still reluctant to do that, but compared to the alternative (bailout and vastly overpay) this is a problem they are willing to deal with.  Indeed, they may have used the intervening period to sanitize records and clean up embarrassing trails, thereby minimizing this problem.

The WSJ interview with Arkady Dvorkovich provides a hint that nationalization is still on the table:

“The authorities don’t have any plans to take things away from people and nationalize them,” Mr. Dvorkovich says. “But that doesn’t mean that one shareholder can’t sell to another investor. It doesn’t mean that the state won’t wind up owning some assets that were held as collateral.”

The government needn’t take anything away from anybody under current circumstances.  It can let the Western banks do that for it, and then scoop up the assets for a pittance as compared to the cost of bailing out the oligarchs–and the Western banks.  This is a three-fer for the government: no oligarchic threat; a blow at the Western banks and the West; and the extension of control over Russia’s strategic industries.

This course would put the oligarchs in a situation where they would have far less to lose by openly opposing the government.  They still have resources at their disposal, and could conceivably make things more difficult for Putin.  Perhaps they would avoid outright rebellion, but they could help fund opponents in the regions, for instance.

Perhaps this is the real reason why Khodorkovsky and Lebed are on trial again.  They provide a living demonstration of the hell that Putin can dish out to those who dare buck the power vertical.  In the current environment, any “liberal” gesture towards the Yukos defendants could send a very dangerous message to the other oligarchs.  Therefore, despite all the yammering about how Medvedev needs to show leniency to Khodorkovsky in order to establish his independence, and his liberal bona fides, this is not going to happen.  Especially now.  The political situation is too explosive in Russia.  The oligarchs face financial extinction, and the only thing that can reasonably keep them from open resistance is the threat of legal extinction–or literal extinction.

In other words, Khodorkovsky is on trial pour encourager les autres.  To keep them from getting any funny ideas.  To ensure that they realize there are far worse things than going broke–like being broken.

There are other indications that fears of intra-elite conflict pervade the Kremlin and the White House.  Governors, including powerful, long serving ones, are being sacked.  The governor of Bashkorostan is supposedly on the way out–though he denies it (they’re always the last to know).  (H/T-R).  Medvedev just fired Orel Oblast’s venerable Yegor Stroyev, and he has been subjected to intense questioning on corruption charges.  He’s lucky (for now)–his son-in-law was recently died from 9mm lead poisoning.

Echoing Russian sources, the FT is rife with rumors about a panicky elite, and the prospect for brutal intra-elite infighting.  Clearly, the objective conditions for such infighting are in place.  The personalized, a-institutional, natural state nature of the Russian polity makes such conflict highly likely in periods of acute economic stress, especially when the rents that hold it together have all but disappeared.  The crackdowns–against Khodorkovsky, the governors, not to mention dissenters–provide tantalizing suggestions that such conflicts are taking place.  So does the public squabbling between Kudrin and his allies on the one hand, and made capos like Yakunin on the other.

In other Russian economic news, inflation continues apace, running 2.4 percent in January and 1.7 percent in February.  (Interestingly, a time when China and other nations experienced deflation, and US inflation was relatively tame–for now.)  This is further evidence that, as I opined in an earlier piece, Russians are exchanging rubles for goods at a rapid pace, reflecting their pessimism about the future value of the currency.

As Dvorkovich mentions in his interview, Russia is suffering stagflation (as I pointed out to Michel a couple of weeks ago).  Stagflation is a severe policy challenge: fight inflation, and risk strangling the real economy; stimulate the economy, and fuel inflation.

Given these monthly figures, the government’s forecast of inflation for 2009 in the 14 percent range seem extremely optimistic.  The potential for a continued hemorrhaging deficit similarly makes such a rosy outcome–less than a percent higher inflation than in 2008–highly unlikely.  (Note that the government has announced another cut in the oil export tariff.  That’s less money coming into the government’s coffers.)

The stagflation problem is just another reason why I believe that Russia faces more acute policy dilemmas than virtually any other large nation.  This places tremendous strain on the political/governing structure.  Thus, expect to see more crackdowns, especially on regional governors who might be getting ideas about opposing the Kremlin/White House, and on any oligarch that gets the least bit uppity.

Jules Crittenden has a caustically funny take on the Obama Message to Garcia . . . I mean Medvedev.   This missive is being spun so many different ways that it’s difficult to figure out just what’s going on.   Obama’s new line is that it was just a re-statement of his publicly announced position.   So then why all the drama of a secret, hand-carried letter?   His people also claim that the letter made it clear that this was not a “best efforts” thing: i.e., the Russians just couldn’t say “well, we tried, but. . . ” and expect us to shut down the missile defense program when Iran proceeds full speed ahead with its nuclear program; instead, the missile defense system would be eliminated only if the Iranians stop.   Maybe: let’s see the letter so we can judge on our own.   The newest spin is that this was a fiendishly clever plot to put the Russians in an awkward spot, forcing them to utter an embarrassing Gromyko-esque “Nyet!” Well, they said “Nyet,” but don’t seem the least bit embarrassed about it.

Crittenden hits the nail on the head when he skewers this negotiating ploy.   After all, it’s the Russians who have been venting over the Czech and Polish bases for an ABM system.   The intensity of their rhetoric suggests that it’s really important to them.   So, if it’s such a big deal to them, let them make the first offer.   Don’t like the bases?   What are you going to offer us?  

In other words, Obama should have taken a lesson from Kyrgyzstan.

Moreover, this is the only way to determine the credibility of Russia’s opposition to the bases.   It is very possible that all the hyperventilating is just an act, intended to gull credulous Europeans, and latterly Americans, into being nice to the Russians, and unilaterally make concessions on this and a variety of issues in order to assuage hurt Russian pride.   That is, it is just another part of the tiresome narrative about how badly the West treats Russia, and that the Russians reasonably expect that if they make a big enough stink they’ll get this–and much more–in exchange for exactly nothing but words.   If those; Putin in particular seems to relish adding rhetorical insult to practical injury.   The specific idea floated by the Russians as their idea of a quid pro quo–the non-deployment of mobile Iskander missiles to Kaliningrad–is a joke because (a) the missiles aren’t even built yet, and are unlikely to be built for some time, and (b) whereas any decision not to deploy an ABM system is likely irreversible, but any Iskander decision is easily reversible because they are, er, mobile.

The palpable anxiousness to please and appease the Russians, and others (e.g., the Syrians) reflects a fundamental leftist trope: that all of America’s international disputes are at root the result of Bush’s cowboy foreign policy and brusqueness.   Well, the brusqueness didn’t help, but there are objective sources of disagreement between nations in general, and between the US and Russia in particular, that are persistent, and which are immune to sweet talk.   This view also reflects a sort of infantile narcissism and magical thinking that perceives the US as so uniquely powerful that everything that goes wrong must be our fault.   Not that we’re faultless, but it takes two to have a dispute.

A little more realism, and a little more poker savvy, would be welcome in dealing with Russia.  Russia has smacked Obama several times–on the day of his inauguration, with the threat regarding the Iskanders, with Kyrgyzstan, and with this letter.  How many cheeks is it necessary to turn?  How many hints do we need?  

I’m not suggesting anything overtly hostile.  Just studied indifference.  Which would drive Putin et al nuts, but which wouldn’t feed his agitprop machine.  And steely resolve in resisting Russian pressure in the “former Soviet space.”  A consistent message that “spheres of privileged influence” are so 19th century.  

It’s not as if Putin and Medvedev are going to be genuinely cooperative.  They perceive us as their primary adversary, and are obsessed with denying us victory even when this leads them to cut of their noses to spite their faces (e.g., Afghanistan, Iran).  Don’t get played.  Don’t be Charlie Brown.  Just let Putin and Medvedev and Lavrov stew in their own juices–and their own economic crisis and demographic decline.