The Russian Bear Awakens: A Global Macro View

by: Paul Legato posted on: March 25, 2008 | about stocks: CEE / JRS / RSX    

Investing in Russia seems like one of the best bets available today. The Russians are determined to rebuild their economic power, and the political will to do so has just recently congealed. Dmitry Medvedev’s selection as Vladimir Putin’s successor marks the final end of political uncertainty, and assurance of continuity in policy. A well-educated workforce, vast untapped energy and commodity reserves, and record high prices for both will amply fund the current economic restructuring. Meanwhile, Russia is slowly rebuilding its considerable international influence, setting up partners around the world to compete with the United States on its own turf, in the arena of global capitalism.

In a speech last week, President Putin stated bluntly that Russia does not plan to remain reliant on its status as a commodity supplier for long. He said that Russia must build an:

innovative, science-based economy … Either we become a raw material appendage to the global economy, which can eventually jeopardize Russia’s very existence, or we become a world leader and the best country to live in.

I do not doubt that they will succeed, now that there is no further question of who is in charge of navigating the nation.

Russian scientists are among the best in the world; due to years of free higher education under the Soviet Union, the country has a disproportionately large number of highly educated and skilled people ready to build. How will this economic restructuring be paid for? Russian oil reserves make the Persian Gulf look like a puddle of spit. Just the known proven oil reserves in Russia are the eighth largest in the world, and Russia is already the world’s second largest producer of oil. Speculation abounds that actual extractable reserves are far larger, and are either not proven or are deliberately kept secret by the Russian government. In any case, Russia has a lot of oil by any standards. Natural gas resources are comparable. Putin has made it clear what he’s going to do with this money, and he has the human resources to make it happen.

Russian Nationalism

Russian nationalism should not be underestimated as a potent force in the future of the Russian (and world) economy. We can find evidence for this on every level, from the historic actions of Russian rulers centuries ago to the recent popular surge of National Bolshevism and various other hyper-nationalist movements (in spite of the government’s not-so-lighthanded repression of the more extreme factions) to the very words of President Putin himself. The internal economic and social chaos following the collapse of the Soviet Union, and concomitant loss of economic and military might on the international stage, was deeply embarrassing for a certain segment of Russia, led openly by Vladimir Putin. They have successfully wrested control from the oligarchs and the Russian mafias, consolidated their power, and in the past few years have been setting about the reconstruction of Russia’s formidable production machinery with the avowed goal of restoring Russia to what they see as its rightful place on the world stage.

Russia has been an extremely powerful country for a very long time. It is accustomed to getting what it wants (no replies on reification, please) on its own terms and being in absolute charge of its own fate. The Russian people will not accept anything resembling a subordinate role in the globalized economy for long. Russian politicians are usually refreshingly honest and direct about their power-oriented motives and goals, compared to oily Western politicians who are much the same but attempt to dress their efforts up in flowery language. We don’t even need to peel back layers of subterfuge and innuendo as we would with a Western president; we just have to listen to what Putin is saying (unspun and unfiltered by the Western media and their nationalistic biases.)

As Putin said, Russia is acutely aware that simply exporting energy as its primary economic activity is not a good long-term strategy. This would leave Russia vulnerable to the vagaries of supply and demand, and at best produce a highly volatile and unstable economy subject to boom and bust cycles. Right now, they’re in a boom, with real GDP growth averaging over 6% lately and projected to continue growing. They have been investing the windfall in fully modernizing the Russian economy, a proposition that will take years to accomplish and longer to begin to pay off.

The Chaos of the 1990s is over. Putin won.

The Soviet-era economy was hobbled by the vast inefficiencies of the bureaucracy. Despite this handicap, the Soviets were able to produce technology and economic output comparable to that of the United States. The restrictions of central planning have long since been swept away and replaced with efficient market forces, and the internal infighting for power seems to have ended with a clear victor, Putin and his group.

The USSR’s formidable economic machine tripped and fell in 1991 in the wake of the political collapse. The ’shock therapy’ privatization of the Soviet government’s assets was an unmitigated disaster. Graft and corruption ruled the process, brokered by the force of the Russian mafia, and the famed Russian oligarchs took over as the public face of the country (inasmuch as anyone did.) Yeltsin proved either unwilling or unable to exercise effective control, and sat by as the state’s coffers were pillaged by “businessmen” and their gangster allies under the banner of capitalism.

The 1998 Russian financial crisis proved a tipping point of sorts. Vladimir Putin appeared from nowhere to become Yeltsin’s successor as president in 1999. His dramatic catapulting from obscure KGB spook to president of the largest country in the world indicates that powerful forces within Russia were very unhappy with the gangsters and cowboy capitalists running things. Putin quickly set about breaking the political power of the oligarchs and gangsters and reappropriating assets he regards as having been stolen from the Russian state, and he has succeeded. Every oligarch either fled into exile, came to terms with Putin and brought their business interests in line with government goals, or wound up in jail and had their assets repossessed by force.

There is no question that Putin’s ally and handpicked successor, Gazprom director Dmitry Medvedev, will win the upcoming “election” and become the next president of Russia. This represents continuity and signals conclusively that the power vacuum is filled and the era of any wildcards in public policy has ended. This means that Putin’s economic plans will assuredly be carried out, and there is little to no chance of any interlocutors stepping in to distract from the official policy dialogue.

Foreign Influence

Russia still eagerly absorbs foreign capital, though never in a way that would allow foreigners to control strategically important operations. Western oil companies are accustomed to bullying weak third world governments into submission by force and bribery (witness Shell in Nigeria, BP in Shah-era Iran, Chevron in Burma, and a long litany of other abuses, historical and present, that digress from today’s topic.) BP and Shell learned the hard way that trying to use their typical hardball tactics in Russia leads to disaster. Despite The Economist’s whining about how awful it is to finally be given a taste of one’s own medicine, it is very unlikely that Russia will desist and allow any significant fraction of its energy boom to accumulate in foreign hands. Among other things, this guarantees that the economic redevelopment in Russia will be amply funded.

The final puzzle piece for now is Russian arms sales, which both provide welcome hard cash inflows into the Russian economy and help to bolster Russia’s friends, notably Iran and Venezuela, and stave off any regional instability. Many in the United States seem to have been lulled into a sense of complacency and smug superiority by the collapse of the Soviet Union, and believe that the United States is now invincible. Nothing could be farther from the truth. Though nowhere near its peak strength under the USSR, the Russian military is certainly beyond any direct challenge from the United States, and remains a source of advanced weaponry for countries who can’t or won’t buy from the United States and Europe. This has allowed Russia to begin to recover a base of client states and allies as part of a long term strategic initiative to recreate its own power bloc in opposition to NATO and the United States.

Russia has been selling advanced air defense systems to Iran. They’ve made no effort to hide these deals and indeed seem quite proud of them (many of these links are to the official state news agency, RIA Novosti.) Russia has invested enormous sums in the Iranian nuclear program, and they are not about to sit idly by and watch billions of dollars of their capital be destroyed in a war between Iran and the United States.

Moreover, and a far more subtle threat, is the longer challenge to the hegemony of the US dollar as the world’s reserve currency, an effort spearheaded by Iran. Oil, engine of the world economy, has traditionally been traded exclusively in US dollars, requiring any country that wants to buy it to purchase dollars to pay for it. This has been changing, and is a big factor in the recent decline of the US dollar. Putin openly discusses the benefits of trading oil in Euros. Putin also advocates ruble-denominated oil futures. Venezuela is considering selling oil in Euros, bartering oil rather than using dollars, and disgorging dollar-denominated assets from state accounts. Iran is building an exchange for non-dollar oil trading, and claims to have stopped accepting dollars for oil altogether in December of 2007. Some claim that Saddam Hussein’s decision to sell oil in Euros was one major factor prompting the US invasion. While I don’t believe it was the only reason, it was certainly a factor.

A similar invasion of Iran and Venezuela seems very unlikely, in no small part because of Russia’s open support for them. (Hussein was instrumental in the end of Soviet influence in Iraq, leaving Russia with little motive to help him.) The obvious beneficiary of petroEuros will be Russia, inasmuch as the ruble is linked to a Euro-tilted basket, and they are investing heavily in terms of both money and arms in the main OPEC countries moving to Euro sales.

Russia has strong growth prospects: ample funding, vast untapped energy reserves at a time when the rest of the world is talking about peak oil, a plan to quickly fully modernize its economy and soon become competitive in high technology, newfound political stability and absolute political control, and a stable of allies and client states that is growing once more to help it along. Contrast this with the United States: politics driven by corporate greed and self-interest at the expense of the nation as a whole; 8 years of disastrous neoconservative policy aimed squarely at the personal economic benefit of the neoconservatives and their friends, at the expense of the nation as a whole; a long since declining industrial base; and a consumer spending driven economy fuelled by consumer debt.

In Europe, the problems are similar, with the addition of even higher labor costs, fewer available resources, and little open land relative even to the US. In both, we have a high finance industry that resembles nothing so much as a vast shell game designed to funnel money upwards at the expense of our own national interests, which has given us a looming recession as this all comes to a head. Asian growth has been running insanely fast for many years, and appears to be inextricably linked to the economic health of the United States and Europe. In the short and medium term, Russia looks like a much better bet.

Disclosure: Author is invested in Russia through some of the above-mentioned securities.

This article has 10 comments! Add yours below...

Paul Legato

About this author:
Become a Contributor Submit an Article

This article has 10 comments:

  •  
    xander
    Mar 25 04:55 AM
    i hope many our liberals agree with your assessment and move to russia.we could use the relief.
  •  
    otis the
    impaler
    Mar 25 01:00 PM
    according to the data you submitted, Russia has six years of oil
  •  
    drbenway
    Mar 25 01:08 PM
    Oh great..now we know that US invaded Iraq because Saddam wanted to sell oil denominated in Euros...thanks for enlightening us!

    Just because Putin replaced Yeltsin's gangsters with his own gangsters (of ex-KGB kind) does not make Russia less corrupt. As a matter of fact, check out en.wikipedia.org/wiki/....

    Russia has steadily slipped every year in the rankings and catching up quickly to such bastions of honesty as Nigeria (hey still 0.1 ahead!)...

    Russia will still go as far as Oil and commodities prices go and has no other industry that is growing outside of the service sector.

    While I think short-term Russia is a good investment (just valuation-based it seems cheaper than other emerging markets), long-term prospects are dim. Population is rapidly aging, the population is very poor outside of a few large cities and oil producing centers, private enterprise is being nationalized...

    Dear Paul, please do some research before writing your Communist manifesto...

    P.S. I have lived in Russia most of my life...
  •  
    anvor
    Mar 25 03:29 PM
    Although the article have some obvious mistakes and seems rather dated (Medvedev was elected almost a month ago), its argument is not as bad as the comments above would lead you to believe.

    As anti-corruption researcher and consultant I agree that corruption in Russia is as omni-present as in Brazil, India and China, but that is the risk you have to mitigate and there are numerous free and effective ways to do so.

    Compared to the USA Russia has many strategic advantages and the continuation of the Putin's line combined with the clean balance sheet and high commodity prices will inevitably lead to it to further economic and political prominence.

    Although indeed outside of natural resource-based industries it is the service sector, consumer finance and housing that lead the way in Russian economic development, given that they start so low and have an immense internal demand to satisfy, the growth of those sectors is sure to sustain Russia for decades to come. In the end Russia has all the signs of moving towards the path of countries like Canada, where vast natural resources sustain the rest of the sectors and thus ensure decent economic life of its small, comparing to its territorial span, population. But, as Russian and Canadian citizen permanently living in the US, I think it’s a good thing prospects:-).

    Besides, Russia's positive national balance sheet and ever-growing foreign currency reserves allow them to make mistakes along the way and not to fall into the ditch the way the US is ready to do.

    Finally, these days Russia is much less Communist that America in virtually every way. Actually, while I was a research professor at one American university, I felt as if I was back in the Soviet Union again: so thick was the bureaucratic thinking, so little entrepreneurship was there. Alas, the state legislators think in exactly the same terms as our university bureaucrats and, to my dismay, I found that most states legislators across America are acting in the same mode, wasting your and my money on the things that have little pay-off or will not pay in the short-to-medium term. But in the long term we are all dead, eh? :-( Tell me if I am wrong. anvor@yahoo.com
  •  
    DJP
    Mar 25 04:00 PM
    Clearly the Anglo/American alliance is in decline and Russia is on the rise. This is actually good for the whole world as it will lead to stability and discourage military adventures. Russia resources are immense and no president in modern history has done more than Putin for his people. - A true democrat(unlike Bush and Blair). According to BP estimate Russia has about 120billion barrels in reserves. Artic and East Siberia are barely explored. Russia is becoming an industrial powerhouse - auto manufacturing, agriculture - grains/Potash, building materials and in the near future will likely add to its territory and population voluntarily - Crimea,East Ukraine and Northern Kazakhstan and Belarus. The future does indeed like bright for the Russia people and they deserve this after the inhumanities inflicted on them in the 90's by Russian politicians and neocon economists Jeffrey Sachs and Anders Aslund. In addition to all this they have their culture - immensely superior to any in the west. The only wild card is peak oil and the unstable financial system in the west.
  •  
    User 167988
    Mar 25 04:01 PM
    Dear Paul (or is it Pavel?),
    For the sake of Russia's 90% of impoverished and neglected population outside of Moscow, St.Petersburg and few other large cities, I hope Mr. Putin and Mr. Medvedev read your wishful thinking and invest even miserly 1% of their oil and gas riches to spread the wealth.
    Let's remember: it was oil at $9 a barrel that toppled Soviet Union more than any other factor. And now it the oil at $100 a barrel that keeps few thousand Russians being crowned as the richest individuals in the world. Moscow with population over 12 million people officialy became the most expensive city in the world. For most natural of Muscovites it is unaffordable and unwelcoming city.
    And this is nothing new, for if you now Russian history, Russia has always been a Great banana emporium. Where very few owned the country riches and the rest of population served those few.
    And recently we have witnessed the formation of second generation of "The Have Dynasties" who becoming the new Russian aristocracy with birthrights.
    But as long as we are willing to invest in Gasprom and the world industry (outside Russia) keeps producing, we can make few bucks or euroes.
  •  
    Paul Legato
    Mar 26 03:37 PM
    My Website
    Hello all,

    Thanks for sharing your thoughts.

    I'd like to clarify one thing. It doesn't seem to be clear to some posters that I was not conducting a moral analysis of whether the Russian government and Putin's actions are good or bad; I was conducting an investment analysis of whether they will produce favorable investment conditions. This is not a political philosophy website, and a full exploration of the moral dimensions of the current Russian system would require many, many pages of work. While that may be worthwhile, it is beyond the scope of this article. The focus here is whether it is a good idea to invest money in Russia, not whether you personally like Putin or the Russian government.

    For the benefit of all the jingoists who are still fighting the Cold War, and the Russian expatriates eager to demonstrate their devotion to their new homeland by publicly renouncing Russia, this view is not, and is not intended as, a threat to other countries, just as an observation about the economy of one country. I believe that Russia's economic success will only increase global economic activity for all, by providing new trading opportunities and researching new technologies that will benefit all.

    While the Russian government is perhaps no less corrupt than before (and the article does not claim that it is), it is certainly far more stable than during the 1990s, and conditions now exist to allow profitable investment. I have tried to elucidate them. I would love to hear any comments on that topic.

    Russia's long-term prospects indeed depend highly on how the current windfall from commodities is invested; specifically, on whether it is invested in modernizing infrastructure and expanding higher education. Putin has said he will do these things, and as of now, I believe him. I could be wrong; time will tell. If they do invest wisely in these kinds of improvements, the long-term prospects for the Russian economy are excellent.

    Paul (neither a Communist nor a Pavel)
  •  
    cmonbulls
    Mar 30 11:10 AM
    Interesting reading! I found the comments both enlightening and humorous.
    Westerners, particularly Americans are so caught up in the cold war and the fact that Russia if finally getting it together, that we can't see past are noses. I just read a blog the other day from Cramer that when asked if a company in Russia was a good investment, he said, "Russia can be no longer trusted". What a joke that is! As if the larger corporate American banks can be trusted. Not to mention that an impressible change of government will occur in May.
    The argument about whether Russia is a good investment. will surely involve more about politics (for years) then the fundamentals of a given company or sector in Russia.
    I too have spent alot of time in Russia and eastern Europe to find out there are many, many myths that still surround that part of the world. It took me some time to get over my cold war attitude having spent many years in the military and having grown up with bomb alerts in grade school. I used to hate the "commies" but isn't that our history for the past 80 years? It's a hard habit to break for both sides isn't it? Like it or not, time will tell all and for my money, I'm betting on the Russian people and Mededev to continue to build thier economy. While many citizens may be embarassed, (because they were lied to for 80 years) many are over it and moving on to bigger and better things - I want on that train and having been there, I beleive the Russians will give the world more competition than we are prepared to compete with. Go ahead and keep your heads in the sand. It just gives me more time to make more a significant investment.
    The only dangerous things you have to consider in Russia are the ladies and the traffic!
    ps. there is much more opportunity in Russia than just their resources. Good Luck and take a look at the world once in a while from "outside the box!"
  •  
    cmonbulls
    Mar 30 11:31 AM
    Furthermore, I have to agree with most of what P.L. says. You want to hear something funny and ironic? Germany, the biggest player in Europe is making much of it's money in Russia! I couldn't help but be struck when I first went to Russia (2004) and noticed how many German businessmen and European businessmen in general there were. While America is busy in the middle east and southwest Asia, the Europeans are busy doing business in eastern Europe making friends and lots of money!
    Even President Bush suggested that the next American President ought to spend more time getting to know the Russians. It's a little late for Bush but I agree that for our future investers and ordinary citizens to trust Russia, WE NEED TO SPEND MORE TIME THERE and do more business there. This is the chance of a lifetime for investors and our countries to have no more cold war and this is where I differ most with P.Legato.
    "Na zdorovie" To your health!
  •  
    Bakerloo
    Bill
    Apr 22 05:55 PM
    Your pitch sounded pretty good until I got to the part about corporate greed and self interest. You might try reading a little Adam Smith along with your Karl Marx.

Loading...
Symbols:
Authors:
Quick Links:

ETFs In Focus

  • Long Ideas

  • Short Ideas

  • Cramer's Picks