Russian Default or a New World Order?

September 30, 2014  

Several months ago I wrote about a possible default of Ukraine which was aggressively but lamely prepared for us by Russia. The Fifth Column and our idiotic leaders have strangely helped and, in fact, are still helping Russia in this endeavor. However, everything has changed over the past few months, especially in light of the Malaysian flight downed by Russian terrorists.

Frankly speaking, there is only one careless step by Vladimir Putin remaining prior to a quick default of Russia. This fact should be understood and admitted by both Vladimir Putin and his circle. Unfortunately, I cannot appeal to Russia’s civil society, because there is none.

What is my confidence based on? It is based on an understanding of the mechanisms of the global currency and financial system. I will try to briefly and concisely explain its foundations. The transfer from the gold currency standard to the dollar gave birth to the dependence of the entire world on the financial system of the US and became the cause of globalization, because it resulted in the opportunity for exporting countries to grow much quicker than was possible under the gold currency standard. Alas, the gold reserves in importing countries were always limited, but the dollar reserves, at least in the US, were unlimited…

China and the oil and gas exporting countries – Russia, Arabian and Latin American countries – became the main beneficiaries of the dollar standard. These countries are confident that there will always be enough dollars in the world to pay for oil and gas in the first priority at any price level. This unlimited dollar reserve not only corrupts the US but it mainly corrupts oil and gas exporters, in the first place, as it encourages them to receive excessive profits at outrageous prices. The prices for energy resources has grown over the last decade at unbelievable rates to the delight of oil and gas producers, but the US has been printing the dollar at even more stunning rates in order to pay for these irrationally expensive resources. Just who is smarter in this crazy competition? Obviously, it is easier to print money than to extract oil and gas. But even such an ingenious country as the United States could not fully protect itself, other countries and the entire world from the imbalance caused by the price wars on energy resources. Moreover, the US and the EU did not “notice” that Russia “quietly” spent more and more oil dollars on the weapons race and already in 2013 became a military country.

The Americans created the global financial system, first and foremost, as a convenience for themselves. Its essence is that the net exporting countries are forced to create vast gold reserves for their stable development. We are talking about trillions of dollars. For example, the gold reserves of China reached 3.95 trillion dollars, while Japan’s reached 1.28 trillion and Russia’s reached 494.6 billion dollars. This system allows the US to receive back these dollar financial resources at the lowest interest rates in the world. Americans pay for short-term bonds approximately 1% and, for example, 2.6% for 10-year long-term bonds. What’s more, sooner or later all of these dollars return home.

Having returned to the US, these dollars help resolve a vast amount of economic problems. For example, they help to balance the payment balance. The US’s deficit of the current account of the payment balance (clean import of goods and services) is enormous. Over the last twenty months it has reached more than 400 billion dollars and almost always equals to the net surplus of the financial account (i.e., the flow of foreign investments from abroad).

It is quite important to understand that nearly everything that China, Russia and other countries have earned from exports must be repaid to the US in the form of credits and investments with practically zero profitability. These countries not only finance the trade deficit, but they also finance the budget deficit of the US, which in 2014 is expected to be at the level of 3% of the country’s GDP.

Central or national banks usually have an alternative to investing in American assets: the holding of dollars in cash or the sale of dollars on cash markets to commercial banks. However, if central banks will sell a lot of dollars, then the exchange rate of national currencies will begin to increase, and this will decrease their export potential and lead to a deficit of external trade, which will mean a crisis for the economies of such countries as China, Russia, etc. Certainly, in addition to the US other countries, such as Japan, England and Switzerland, have created analogous systems. However, size matters here. Only the EU has become a real financial power, but not an alternative to the dollar.

I have painted a very simple picture of the global financial and credit system based on the dollar standard. Nevertheless, this allows us to simulate the situation, which Russia has been in fear of over the last months. Specifically, I am speaking about the US and EU sanctions on Russia. The first and second level of sanctions were most likely a symbolic, disruptive force for the economy and finances of Russia – an insignificant devaluation of the Ruble, an inconsiderable fall of the stock markets, and the acceleration of capital flight (approximately 100 billion dollars per year), which is traditional over the past years. However, the “2.5 level” of sanctions stings a substantial sector of the economy (“Rosneft”, the gas company “Novatek”), weapons traders (the corporations “Almaz-Antey” and “Izhmash”, the concern “Kalashnikov”, the State Research and Production Enterprise “Bazalt”, “Uralvagonzavod”, the KBP Instrument and Design Bureau (developer of high-precision weapons), NPO Mashinostroyeniya (rocket design bureau), the Concern Radio-Electronic Technologies (KRET) and the Concern “Sozvezdie” (electronics)) and the financial sector.

In fact, the banks against which sanctions have been imposed are very interesting. VAB bank is the most powerful bank in Russia, where Vladimir Putin is the Chairman of the Supervisory Board, and Gazprombank, whose main shareholders are within the closest circle of friends of the President of Russia. The sanctions also apply to their subsidiary organizations, as follows:

Subsidiary Organizations of Gazprombank:

•          “Gazprom-Media Holding” – 100%;

•          “Association of Machine Engineering Factories” – 97.8%;

•          “GPB-Ipoteka” – 90.1%;

•          Credit Ural Bank – 100%;

•          Areximbank – 100%;

•          Gazprombank Switzerland Ltd. – 100%;

•          GPB International SA – 100%;

•          “GPB-Faktoring” – 100%;

•          Gazprombank Leasing – 100%;

•          GPB-DI Holdings Limited GPB Global Resources B.V. – 100%;

•          “Gazprombank – Upravleniye Aktivami” (Asset Management) – 100%;

•          “Gazkardservice” – 100%;

•          “Forpost-Holding” – 100%;

•          “Izhorskiye Zavody” – 83.9%;

•          OMZ-Spetsstal” – 97.8%.

Subsidiary Organizations of VAB Bank:

•          Rosexminbank – 100%;

•          MSP Bank – 100%;

•          Svyaz-bank – 99.5%;

•          Prominvestbank – 98.6%;

•          Globexbank – 99.9%;

•          “VAB Kapital” – 100%;

•          OJSC “Federalniy Tsentr Proektnogo Financierovaniya” – 100%;

•          OJSC “Korporatsiya Razvitiya Severnogo Kavkaza” – 100%;

•          Management Company RFPI – 100%;

•          EKSAR – 100%;

•          OJSC “Fund Razvitiya Dalnego Vostoka i Baikalskogo Regiona” – 100%;

•          VAB Asia Limited – 100%;

•          ZPIF Long-term Direct Investments RFPI – 100%.

I will say that the US imposed very humane sanctions in relation to these enterprises and banks. They can work as before, but they cannot lend long-term credit in dollars for development. The Americans have not yet used their monopoly right as the issuer of the dollar.

In order to make things clear, let’s look at the example of banks that fell under these US sanctions. All of Gazprom’s borrowings on external markets currently equal approximately 16 billion dollars, and already this year it needs to extinguish 2 billion dollars of debt. VAB’s indebtedness for Euro bonds is 10 billion dollars, but it does not need to extinguish any of this debt this year. Obviously, the problems with dollar liquidity can be easily resolved on the Russian domestic market or at the expense of significant gold reserves of the Bank of Russia. By my calculations, these sanctions will lead to stagnation of the credit potential of Russian banks and will cost the economy 1% of GDP (no growth in 2014 and 1.5% in 2015).

This raises the question of whether the US sanctions are actually lenient. My response is that these are not yet sanctions; it is the last warning to Russia. Based on the facts set forth in the beginning of this article regarding the functioning of the current global currency and financial system, it becomes clear that only one decision of the US, for example, completely banning these banks and enterprises from using dollars for settlements, would lead to Russia’s default on the very next day. Within one to one and a half months there would be a complete collapse of Russia’s economy and even its disintegration. Of course, such a decision by the US would lead to the default of all Russian enterprises and banks with borrowings in dollars and euros. The indebtedness of Russian banks before US and EU banks is currently 182 billion dollars. Consequently, these defaults would injure American and European banks. If this were to be the case, then the West’s response would be to freeze all of Russia’s sovereign assets in dollars and euros to compensate for the losses from default. This would simply be the last step.

Needless to say, Vladimir Putin is desperately searching for a way out of the trap into which he or his advisors have driven Russia. Let’s look at the most unprofessional plan for escaping this trap. This plan was developed by Vladimir Putin’s advisor, Sergei Glazev, PhD, and can be named “The Great De-Dollarization of the Economy of Russia”. Mr. Glazev proposes that the Russian government extract all assets and accounts in dollars and euros from the NATO countries and put them into neutral countries. He also proposes to hold a preemptive sale of bonds of NATO members and those countries that supported sanctions against Russia. Further, Russian banks would have to create 100% reserves for debt obligations of non-residents, and the state corporations and banks would have to substitute credits from Western banks with Ruble credits from Russian banks. Glazev suggests that commercial banks should not repay (i.e., freeze) currency obligations. This plan, in my opinion, would hurt the Russian economy even more quickly than the US and EU sanctions.

The unprofessionalism of this advisor does not have any boundaries and, therefore, it is not worthy of criticism. Suffice it is to say that the above plan is just as insane as the recommendation of Glazev’s colleague, Vladislav Inozemtsev, the director of the Center for Research of Post-Industrial Society. For example, Mr. Inozemtsev recommends agreeing upon a conversion of debts of Western countries into assets in these countries, which could remove any barriers towards investments from BRICS members into Europe and the US. I can only say one thing about this recommendation: “Blessed Na?vet?”. However, it is a serious enough plan to get rid of the hegemony of the US and the EU in the global currency and financial system (I am referring to the 2014 BRICS Summit, where an agreement was reached to create a development bank with headquarters in Shanghai and an authorized capital of 100 billion dollars and a currency reserve fund). In truth, this is about creating an alternative structure to the IMF and World Bank. Moreover, Russia conceded that the role of the US in such structures will be played by China and the role of the EU will be played by India, while Russia will act as a secondary player (at least in an economic aspect).

As an expert in international finance, I will admit that such structures can actually be created within two years, provided that the US and the EU do not interfere. However, such a step will in time lead to a collapse not only of Russia, but of India and China, not even mentioning Brazil. Alas, international trade with the US and the EU is the driving mechanism of these countries’ development. At the same time, trade operations between the BRICS members in exchange for their independence from the US and the EU do not bear a significant meaning. The trade turnover between Russia and Brazil is only 6.5 billion dollars. The question that arises is why would they need a currency reserve fund (alternative to the IMF)? This amounts to building a castle in the air.

Over the next five years there is no alternative to the dominance of the US, EU and Japan in the global currency and financial system. In time, China and India will join the upper echelon, but not the BRICS members. It is no wonder that the Prime Minister of India, Narendra Modi, failed to find time to meet with Vladimir Putin in Brazil at the BRICS Summit, as the latter was in an interesting conversation with the President of South Africa, Jacob Zuma, whose four wives all bear the status of First Lady.

Of Counsel, Frishberg & Partners

Professor Alexander Savchenko




Frishberg & Partners 2012