September 3, 2000

The old ways are alive and well in Russia

Posted in International Economy ·
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The Bolsheviks pioneered `Total Propaganda’ or the `Art of the Big Lie’. Lenin distinguished between the high-powered, ideological propagandist who devised the strategy and the low-level agitator who put it into action. Thus agitprop or professional deceit was, and many argue still remains, at the heart of the Russian state.

Since Lenin, western opinion was skilfully and systematically duped. The total control of information combined with successful plants, well-timed leaks and high-profile sympathisers such as Bertholt Brecht and Anthony Blunt, enabled the Russians to feed the west with an endless stream of false impressions.

The great de-Stalinisation of the 1950s was really only a modified form of Stalinism. Moscow and Peking jointly engineered the Sino-Soviet split of 1960. “Romanian Independence” of the 1970s (which led to Nikolai Ceausescu’s notorious stay in Buckingham Palace) was a myth, as was Czechoslovakia’s “democratisation” in 1968.

Indeed, all the late 1980s revolutions in Eastern Europe were initiated as carefully orchestrated shams, organised by progressive elements in the KGB, which backfired badly.

The question for today’s Russia is whether professional deceivers will now stop deceiving. Events surrounding the Kursk submarine disaster and the ongoing war in Chechnya suggest that the government of Vladimir Putin has not answered this question.

The misinformation, lies and cover-ups stemming from the Russian navy in the past weeks are straight out of Brezhnev’s textbook. Given Putin’s KGB background it is probably not surprising that old habits die hard.

However, these days there are limits to this game. The Russian press is now freer than ever and Putin seems to be listening to it. In addition, a total absence of credit means Russia is now acutely dependent on western finance.

For investors, it may be a case of once bitten, twice shy. In the 1990s, investors were conned into believing that the so-called reform of Russia was proceeding apace. The IMF, the World Bank and the world’s most eminent investment banks poured money into Russia on the back of promises that the Russians were getting their act together.

In fact, the Russians were only borrowing from Peter to pay Paul. Worse still, the corruption was so extensive that even the central bank was in on a scam to gamble IMF loans on a pyramid scheme that the authorities themselves created. This Ponzy game involved the most senior officials in the land and succeeded in ensuring that at least $40 billion disappeared over a five-year period.

It began in 1993 when the west told the Russians that they would only be lent cash if they got the rate of inflation under control. Given that inflation was determined by the number of roubles in circulation, Moscow simply stopped printing money. Without money, prices can’t rise and, hey presto, in two years inflation came crashing down.

But without money, there is no credit and without credit, firms go to the wall. So firms started writing each other IOUs instead of paying. Very soon, huge internal debts began to build up between firms. Eventually, the firms had to write IOUs to their employees instead of wages. With no other jobs around, workers just had to accept delayed pay.

In order to stave off social and structural implosion, the Russian government had to act. As most companies were still owned by the state, this inter-company debt was another measure of the government’s budget deficit. With inflation apparently under control, the government went to the west and began to borrow in the very short-term, issuing three-month paper.

The Russians twigged that as long as you paid a certain small percentage of these loans back at maturity, greedy investors, thinking they had found a free lunch, would roll-over their loans and go again for a second time — and again and again.

A type of financial chain letter began to evolve with professional investors, hearing of someone getting 30 per cent return in three months, piled into short-term Russian debt. On paper, these investments looked fantastic and the fund managers involved saw their funds outshine the competition, attracting even more money. Thus, the pyramid began.

The Russian elite then proceeded to siphon off most of the foreigners’ dollars out of the country.

Granted, the government used a small fraction to pay some of the inter-company debts and salaries, but the vast majority of the cash found its way into offshore accounts. Some small domestic banks believed the free-lunch thesis and got involved themselves, providing the corrupt elite with a perfect smokescreen. These banks’ balance sheets, stuffed with worthless government IOUs, showed huge paper profits, driven by the promised 30 per cent interest rates. Western institutions, anxious to get a slice of the action, lined up lemming-like to buy these “virtual banks” (which had no business other than government debt) for vastly inflated prices.

By mid 1998, some investors began to smell a rat and started getting jittery. Many began to call in their loans and it became increasingly apparent that there was no cash in the coffers. Ultimately, Russia declared to the world that it couldn’t pay and the whole deck of cards came crashing down.

For the past two years, Russia has been a huge economy with no credit — in many ways the polar opposite to Ireland which is a tiny economy with too much credit. However, an economy without credit is like a bone without marrow and the recent high-profile disasters, involving the Kursk submarine and Moscow’s Telecom Tower, reveal the limits of trying to operate a country without the necessary credit to invest in basic infrastructure.

Now the new Russian government, following three years in financial purgatory, aims to begin borrowing again from the west. Large investment banks are again queuing up to lend on foot of increasing, but as yet unsubstantiated, evidence that certain parts of the Russian economy are showing life again.

This time, they’ll surely be more careful. And yet the past few weeks have shown that the Russians have not dispensed with their old ways. Mr Agitprop is alive and well, living in the Kremlin and spinning yarns as never before.