Storm In A BVI Teacup

If you remember a couple of weeks ago, the Internet was rocked – for a total of about one or two days – by a wave of leaks from the ICIJ about the identities of offshore account holders in the British Virgin Islands. What juicy revelations did we have about the henchmen of the kleptocratic Putin regime?

Other high profile names identified in the offshore data include the wife of Russia’s deputy prime minister, Igor Shuvalov, and two top executives with Gazprom, the Russian government-owned corporate behemoth that is the world’s largest extractor of natural gas.

Shuvalov’s wife and the Gazprom officials had stakes in BVI companies, documents show. All three declined comment.

So that comes to one Minister who has always been open about the wealth which he made in the 1990’s as a law firm manager and then multiplied by leaving it in a blind trust invested into the Russian stockmarket; and a couple of top executives at one of the world’s biggest companies, are the two most prominent names that have been dredged up.

Rather underwhelming, TBH.

Incidentally, in most countries there is nothing particularly illegal about having offshore bank accounts. Morally questionable? Perhaps. For some, yes. And I can understand why countries like Germany (mistakenly, IMO) might not want to contribute to bailing out alleged tax havens like Cyprus, or why the US demands Switzerland reveal the identities of Swiss secret bank account holders to the IRS.

But is keeping money offshore illegal? No, it isn’t. Not in the US, not in Russia, not practically anywhere else. Not in any country that supports the principle of basically free movements of capital. Now if said money is suspected to have been laundered or otherwise acquired illegally then yes, investigations can follow. But the past few years of pressed government budgets have seen the big countries lean heavily on alleged tax shelters to reveal more information about their clients so it is arguably a much smaller problem than it was, say, a decade ago.

The non-illegal nature of offshore banking is the reason why Romney isn’t being prosecuted for his $250 million stash in the Cayman Islands, and why revelations that many wealthy Germans keep bank accounts in Panama has led to a lot of media noise but no legal proceedings. Is it because Germany is a kleptocracy in which the elites corruptly protect their own? To ask the question is to mock it.

But funnily enough whenever it comes to Russia even otherwise neoliberal or even Randian commentators start frothing at the mouth and demanding populist, Bolshevik reprisals against any Russian – that is, if he isn’t opposed to Putin – with money abroad.

Explaining Russia’s Economic Slowdown

The Russian economy is steadily converging on stagnation in the past few months. For real, this time. Businesses are becoming more pessimistic, and industrial production in the first two months of this year is 1.5% lower than for the corresponding period last year. What explains this? Alexander Mercouris explains:

Might this not be a good moment to discuss economic questions? … The reason growth has been so subdued is because monetary and fiscal policy is so tight.  This in turn is because ever since Russia came out of the post financial crash slump the Russian government and the Central Bank have been prioritising inflation reduction over growth.

Basically what was happening before the crisis was that the government focused on getting its own financial house

in order and building up its reserves whilst leaving businesses to sort out and fund their investment plans often by borrowing on the international money markets.  The financial crisis showed the danger of this approach so the priority since the crisis has been to strengthen the domestic financial system to the point where it is possible for it to sustain a long term investment programme by drawing on its own resources.  This is only possible in a low inflation environment.

Though the inflation has roughly halved from what it was before the crisis, there was a significant inflation spike last year, which has forced the Central Bank to raise interest rates and to take further measures to restrict monetary growth.  That inflationary spike was in turn caused by three factors (1) the poor harvest, with its effect on food prices  (2) the over rapid credit growth at the start of 2012 and (3) the delay in the annual tariff increases to mid year and the way in which these were staggered throughout the autumn and winter.

Of these three factors (2) and (3) were surely a consequence of the political needs of the election period.  It is a commonplace that governments seeking re election loosen the purse strings to create a “feelgood” factor with the bills being paid once the election is out of the way.  Russia has just seen a very pale example of this.

Anyway the result is that Russia not only has real interest rates, which by international standards are extraordinarily high (in most of the developed world interest rates are currently in negative territory) but, adding to the downward pressure, the government is also tightening fiscal policy by introducing its budget rule.

The result is that demand and investment and therefore growth are being choked off.  Not surprisingly the policy has its critics (Deripaska is being particularly outspoken) but it is a standard trade off that historically all advanced economies make.  Japan during its glory days in the 1950s and 1960s repeatedly experienced growth pauses as the Finance Ministry and the Central Bank regularly tightened fiscal and monetary policy to deal with periods of surging inflation.  Like Russia, Japanese policy in the 1950s and 1960s was haunted by recent memories of hyperinflation in the 1940s and early 1950s and of national dependence on foreign lenders.  Of course an even more famous example of tight monetary policies being used to choke off inflation at the expense of growth (in that case even at the price of outright recession) was the Volcker Shock in the US in the early 1980s.

I don’t think there is any serious possibility of Russia going through a contraction anything like as severe.  My own view is that with monetary and fiscal policy as tight as they are, all other things being equal, inflation should fall in the second half of the year.  The Central Bank has given itself a medium range target of 5-6% but with policy this tight I would not be surprised if it overshoots it. One way or the other, if inflation falls, interest rates will come down, monetary policy will loosen and growth will resume though this time in a much more subdued inflationary environment.  This ought over time to make it possible for businesses to borrow in order to invest and for banks to lend for the long term without concerns at both ends that the value of loans will be eroded.  It should also encourage saving fostering capital formation through deposit growth.

In other words far from being an indicator of weakness the growth pause shows that the economy is being intelligently and responsibly managed and is not being sacrificed to reckless notions of growth at all costs.  Without pointing any fingers, it is an altogether more responsible policy than what one sees in some other places.

I would finish by saying that this policy also makes a great deal of political sense.   Though the policy comes in for noisy criticism from the likes of Deripaska (who as an industrialist has an obvious interest in getting the cost of borrowing brought down) Mark Adomanis has posted a useful graph from Levada on his blog that shows that inflation is far and away the most serious issue of concern for Russians.

Anyway that is my take of the present position.  I’d be interested to know if anyone disagrees or thinks differently and of what those who actually live in Russia and who have more direct experience of the economic situation there think of all this.

On The Cyprus Deal

As a Greek with contacts in Cyprus, his opinion is one of the most valuable ones out there. Here it is:

We have now the latest bailout plan and contrary to the spin in parts of the western media it is COMPLETELY DIFFERENT from the plan we saw last week.

What was utterly outrageous about last week’s plan was its seizure of money from deposits held in every account in every bank across the entire island of Cyprus. This offends against every principle of banking, the rule of law and of private property I know of. By what logic, if solvent debtor A owes me money, am I required to lose money to bail out insolvent debtor B with whom I have no connection at all? The Cypriot government and the Troika compounded the outrage by extending it even to deposits that held less than 100,000 euros. This was blatantly illegal since it violated the EU’s own deposit insurance scheme. As I said, what all this managed to do was transform a problem of two Cypriot banks into a systemic problem of the entire Cypriot banking system.

Though you would not know it from the way it is being reported by the western media this morning, the entire calamitous idea of a deposit raid has been entirely dropped. There will be no raid on deposits whether above or below 100,000 euros. What is happening instead is what should have happened last week. The two insolvent banks, Laiki and Bank of Cyprus, are being merged and restructured. Since they will not be bailed out and since Laiki is being effectively liquidated, the bondholders of Laiki (one of whom is a Russian businessman) will be completely wiped out. The big deposit holders in both Laiki and Bank of Cyprus will also take a big loss. This is not because their deposits in Laiki and Bank of Cyprus are being raided as was proposed last week. It is because they will suffer a commercial loss (or “haircut” if you prefer) as creditors of debtors who have become insolvent.

What proves that the Cypriot authorities and the Troika were at all times aware of the blatant illegality of last week’s proposals, is that the statement setting out this week’s agreement that has been issued by the the eurogroup specifically says that deposits below 100,000 euros (including those in Laiki and Bank of Cyprus) will be fully protected in accordance with the EU’s deposit insurance scheme. What is that if not an admission that last week’s proposed raid on those deposits was illegal?

We now therefore have a bailout agreement that at least conforms with the law. What are its further implications?

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The Western Media’s War Against Cyprus And Russia

If you ever manage to get a troupe as diverse as Latynina, Mark Adomanis, the Cypriot Communist Party, virtually every financial analyst, Prokhorov, and Putin united in condemning your crass stupidity and cack-handedness, it’s probably time to stop and ponder. But it’s safe to say that’s not what the Troika – the European Commission, European Central Bank, and IMF – tasked with managing the European sovereign debt crisis is going to be doing any time soon. They seem to be living in la la land.

Here is the low-down. Contrary to German/ECB propaganda, Cypriot public finances, while nothing to write home about, are not in a catastrophic state. The debt to GDP ratio, far from ballooning out of control like Greece’s, was actually lower than Germany’s as late as 2011! This was despite Cyprus being steadily hammered by the global financial crisis and the massive explosion at a naval base in 2011 that cost it about 10% of its GDP.

cyprus-debt-dynamics The main problem was in its financial sector. Although it should have been safe on paper, Cypriot banks had the bad fortune to have had many operations in Greece – which hemorrhaged money as Greek debts were restructured under EU guidance. These involved painful austerity, but the principle that bank deposits would be inviolable held across the PIIGS. But for Cyprus, the Eurocrats – egged on by Schäuble in particular – decided to make an exception, demanding a “bail-in” as part of any financial rescue package. For the ultimately trifling sum of $6 billion, they were prepared to erode basic principles such as sanctity of property that the EU is founded on.

According to Edward Scicluna, the Maltese Finance Minister, his Cypriot counterpart Michalis Sarris was for all intents and purposes brow-beaten into accepting the deal – a 6.75% levy on deposits of less than 100,000 Euros, and 9.9% on everything above that – that the country’s parliament would later decisively reject. The Europeans, according to him, were dead-set on “downsizing” Cyprus’ supposedly overgrown financial sector and in particular its status as a tax haven and alleged center of Russian money laundering. After 10 grueling hours of discussions, Sarris finally conceded, and as soon as that happened, “Schäuble demanded that all wire transfers to and from the Cypriot banks would cease forthwith.”

In other words, they wished to destroy Cyprus’ financial system, and it seems certain that they have succeeded in this. As soon as the banks reopen (now delayed until at least May 26th), who exactly will continue to keep their deposits in a Cypriot bank?

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Blast From The Past: What Jim Rogers Said About Russia In 2003

This guy isn’t as clear-headed as Eric Kraus, is he? But does have company in the form of Andrew Miller, Jeffrey Tailer, “Streetwise Professor”, and Ed Lucas. H/t Mark Adomanis.

—– Original Message —– 
 Dmitry Alimov 
 [email protected] 
 Friday, September 12, 2003 11:28 PM 
 Conversation with Jim Rogers – HILARIOUS

Jim Rogers, a famous international investor and writer attended HBS this Wednesday. In his speech, he badmouthed Russia (in his usual style) and quoted several “facts” that were completely bogus. As you would expect, I could not let him get away with lying about our country and publicly disputed his factual claims. He basically told me I was a moron and left. In response, I sent an email to him with facts and references disputing his claims (sending a copy to my HBS classmates). What ensued is quite amazing – read attached emails. Start with the first email and read from the end (my original email), then read his response and finally my rebuttal in the second email. This will be worth your time I promise. This has already been circulated all over HBS, several other universities and in the investment community in New York. Since this is already in public domain, feel free to forward on.


Dear Mr. Rogers: I am the “lad” who disputed your factual claims with regard to Russia today. First of all, I would like to thank you for speaking to us at the Harvard Business School.  I think I speak for my fellow HBS students when I say that we enjoyed your original views and interesting stories today. However, I must address the unfortunate reality that your facts about Russia are plain wrong. You made three principal inaccurate claims today – I will deal with all of them in sequence.

Claim #1.  People are leaving Russia

Wrong.  In fact, according to Financial Times, your favorite newspaper, Russia turns out to be the second largest recipient of immigrants after the US (see attached FT article). Oops. While it is true that Russia’s population is declining but the reasons for that have nothing to do with people leaving the country, it is things like low birth rate (only 1.2 per woman), which is an issue that confronts many European states.

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The Race To Collapse

As readers of this blog know, I have long regarded the return of economic crisis as an inevitability (because the core energy and no-growth predicament facing the Western world wasn’t solved in 2008-9 but merely kicked further down the road by increasing debt and printing money). It looks like 2012 will be the crunch year, as a series of inter-related crises are rapidly converging: (1) The European sovereign debt crisis; (2) The continuation of the chronic US inability to balance its books, and of instability in the Middle East; (3) The probable onset of serious declines in global oil production, as new oil megaprojects are no longer able to compensate for accelerating decline from existing fields; (4) heightened risks of a war with Iran, as the narrow window opens between the start of US delivery of the next-generation bunker buster MOP (from November 2011) and the culmination of the Iranian nuclear weapons program and its hardening against air strikes (next year or two).

The European debt crisis dominates headlines, with the Anglo-Saxon media crowing about the lazy, shiftless Meds (as opposed to the diligent and careful Germans) and blaming socialism for their problems. This of course has a number of flaws within it. Greeks work the most hours in the EU – 2000 per year, relative to 1300 in Germany. And the only major EU nations without huge debt and fiscal problems are the Scandinavians, who are about as “socialist” as one gets nowadays.

But this is all sidestepping the fact that debt and fiscal crisis afflict the entire Western world, and it is just that – due to the special political weaknesses of the Eurozone – have manifested first and foremost in Greece, Italy, and Spain. However, a look at the actual statistics reveals that even the “serious” countries are in a great deal of trouble. For instance, in 2010 both the US and Britain had bigger primary deficits (cyclically adjusted) than “basketcase” Greece, whereas Italy’s was actually positive! The Meds’ total net government debt is larger, but on the other hand, if even France is beginning to experience perturbations – a country whose fiscal balances are better in every way than Britain’s or America’s – then it surely cannot be long before the crows come home to roost in the Anglo-Saxon world.

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Open Thread: The US Debt Crisis

As with the previous such post, this thread will primarily serve as a meeting ground where S/O readers can discuss the impending US fiscal crisis. As usual, I try to provide some context and avenues for discussion:

1. On August 2nd, give or take a few days, the US Treasury will run out of money. Some commitments will have to be broken. As this article explains, first in line will be Treasury bond holders; frankly, the US sovereign reputation is so valuable that it will not want to risk it at almost any cost. Nor does either party want to see SS recipients, veterans, and soldiers not getting their salary. Once these are accounted for, little else will remain (the US borrows $1.40 for every dollar it now spends). If a deal isn’t reached, there will be massive furloughs and a shutdown of most non-“essential” government functions.

2. Though the current deficit of 10%+ of GDP is patently unsustainable, the immediate drop in spending the failure to raise the debt limit will represent will instantly plunge the US into deep recession (if not depression, if sustained; i.e. a cumulative GDP drop of more than 10%). The economy is very weak, with recent revisions showing the post-2007 drop in output to have been deeper than thought, and the subsequent recovery much weaker. With consumer spending hurt by deleveraging and high commodity prices; it is only being propped up by government stimulus.

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OPEN DISCUSSION: Russia’s Economy In The Next Global Crisis

The response to the last global crisis only consisted of kicking the can further down the road, and the chickens are showing signs of coming home to roost. Of particular note: (1) the recent upwards spike on bond yields for Italy and Spain*; (2) The political paralysis in the US that may (conceivably, if unlikely) shut down government on August 2nd and send it into default; (3) oil prices are again inching up to the levels that coincided – and some argue significantly contributed to – the last recession; due to the realities of peak oil and rising Chinese demand, there is little to be done about this.

Question for consideration: How will Russia be affected by a possible Greece-style scenario unfolding in Italy, Spain, or even the US? (More generally, how do you think the next global financial and economic crisis is going to play out? What effects will it have on the Eurozone, US dollar’s status as reserve currency, etc?).

I don’t know the answers to any of these questions (if I did I’d be out there getting rich not writing this post). However, I can offer a provisional framework that may help you think about this issue.

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Some Updates on Russia’s Economy

There is a wide divergence of views on Russia’s economic future. The pessimists project near zero growth (e.g. SWP, Guriev & Zhuravskaya), or even a renewed collapse if Europe goes haywire. The inventor of the BRIC’s concept (and Russia bull) Jim O’Neill of Goldman Sachs believes it will manage to eke out growth of 7%, nearly recovering the output lost in 2009. The consensus seems to be around 4-5% (World Bank, bne). In this post I’ll describe developments in Russia’s economy since I last did it in a systematic way in December 2008 and give some indicators of what to expect in the next few months and years. Most of this post is based on the information in the World Bank’s Russian Economic Report #22: A Bumpy Recovery.

1. After the sharp -7.9% contraction in 2008, Russia has began to recover at a slower than expected rate, with GDP rising by 2.9% in Q1 relative to the same period last year (in comparison with China’s 11.9%, Turkey’s 11.7%, Brazil’s 9.0%, India’s 8.9% and Mexico’s 4.3%). However, there are indications it accelerated in Q2. The slowness and bumpiness of the recovery is presumed to be due to the waning of crisis stimulus spending and continuing low demand.

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Decoupling from the Unwinding

Three months ago I wrote an extensive analysis of Russia’s economy during the crisis in which I said that although it is going to be damaged by the shutdown of its traditional financing mechanism – cheap credit from the West – sovereign solvency will not be threatened and there will be a strong recovery in the second half. I was too optimistic, mostly because I misunderestimated the sheer severity of the global crash. That said, let us see how well its predictions stack up against reality more than three months on. I will also update my thoughts on the US and world economy, including for the more distant future.

Following the ruble correction, the trade balance was shifting back into positive territory. As of January, although resource exports fell by about a half the decline was less pronounced, with machines / equipment and chemicals falling 30% and consumer goods / agricultural products by 20% – this despite the internal credit crunch, shrinking foreign demand and increasing protectionism. Imports fell severely, especially for the biggest category – cars and equipment. This is not surprising – import tariffs were raised on cars and sales have plummeted, while there’s little need for new physical capital (machine tools, etc) when demand falls for the goods it is used to make.

In my essay, setting oil at 50$ per barrel and making some assumptions resulted in 2009 exports of 245bn $ and imports of 223bn $ – annualizing the January figures gives 204bn $ and 104bn $, respectively. Pretty much what I expected for exports, but imports will probably rise as inventories clear out and the ruble (perhaps) strengthens against the US dollar and the euro, which is quite possible since I expect oil to finish the year between 60$ and 80$ (PS. In the article I guessed that oil will average 50$ for 2009 – looks like its going to be significantly higher, as it is already hovering around 52$). Nonetheless, the current account will remain very much in the black. Keeping our capital account assumptions constant for next year, I stick with the “78bn $ in the medium scenario (50$ oil)” (that assumed a 100bn $ capital outflow in 2009 and higher imports – now, some economists are predicting capital outflow will be less than 83bn $), so really the capital account may turn out to be slightly pink instead of deep red).

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