Russia's Achilles Heels (Plural)

Whenever the horrifyingly precarious fundamentals of the Russian economy are pointed out to its apologists, the response is always the same.  “Russia has low debt and high reserves, so it can weather any storm,” they chant, and the melody of the anthem of the USSR can be heard in the background.

This is the opposite of the truth.  Far from being a strength, debt and reserves are Russia’s main Achilles heels.  In Ukraine, they may prove Russia’s undoing.

Russia came under withering economic fire last week as it geared up for a broader war of aggression in Ukraine.  Its stock market lost over 5% of its value, crashing through the 1300 barrier on the MICEX exchange, and the U.S. treasury secretary boldly stated that the U.S. would target Vladimir Putin’s personal assets if he launched an attack.  S&P downgraded Russia’s credit rating due to massive capital flight, and every day that passed brought new revelations about measures at U.S. disposal to wreck havoc in the Russian banking sector. 

World leaders piled on Putin with genuine zeal.  The secretary-general of the Parliamentary Assembly of the Organization for Security and Co-operation called Putin a “ridiculous hypocrite,” and the U.S. secretary of state called Putin a liar and a cheat who had “refused to take a single step” to de-escalate the Ukraine crisis.  Russia found itself in the world’s financial cross hairs, with few defensive measures available in response.  The Russian Central Bank panicked at the prospect of runaway inflation and clamped down hard, risking putting the economy into a death spiral as loans dry up and growth peters out.

As the Russia economics guru Anders Aslund points out, it’s simply mythology to imagine that Russia’s currency reserves are squirreled away in some impregnable fortress deep within the bowels of the Kremlin, to be trundled out whenever the cold winds of recession blow.  They’re not even in Russia.  These funds, arising from international fossil fuel transactions, are mostly abroad in foreign banks, and they are subject to being frozen via economic sanctions.

Aslund writes:

In its March report on the Russian economy, the World Bank showed that the country's total foreign debt at the end of January was $732 billion. The distribution between public and private debt is only available from October last year. Then, state banks had $128 billion and nonfinancial state corporations $164 billion of foreign debt. Adding $80 billion of government foreign debt, Russia's total public foreign debt was $372 billion, while its international currency reserves are $477 billion, but much of those can be frozen as well.

Russia, in other words, is rapidly approaching the time when foreign debt will exceed reserves, even assuming it can access 100% of the reserves – which soon may not be the case.

Even if sanctions don’t target the reserves directly, they can still wipe them out.  Determined sanctions can radically reduce Russia’s national income, forcing it to incur more debt, and, by placing the Russian economy under pressure, can force the Kremlin to spend billions defending the value of Russian equities and the ruble.

And Western nations can also cut off Russia’s access to credit, meaning that it simply won’t be able to solve its problems by incurring more.  That would create a fierce financial crisis similar to what Russia saw when the USSR collapsed.

What’s more, regardless of sanctions, we have already seen the bloodletting that can occur in the Russian economy when the price of oil drops precipitously, as it did in 2008-2009.  The bottom fell out of the Russian currency and stock market when that happened.  Had it not been for its reserves, Russia as a nation would have flatlined.

In fact, at present, the only thing keeping Russia from being cast into this abyss is the West’s fear of the chaos that might result if Russia did collapse.  Aslund writes: “One month ago, the Western discussion on possible sanctions against Russia focused on whether they could be effective. During the spring meeting of the International Monetary Fund in Washington April 12 to 13, the question was turned around: Do we really want to destroy Russia that fast?”

Russia is choosing to face off against a NATO alliance whose combined GDP is ten times greater than Russia’s, and which spends ten times more on military capabilities.  It is choosing to do so at a time when, prior to any sanctions, its economy was already on the brink of a breathtaking recession.  These are the same sorts of missteps taken by the USSR – steps that led to national collapse.

And indeed, Aslund points out that the Russian security counsel, the only source of consultation Putin has turned to in regard to his aggression against Ukraine, consists almost entirely of former KGB agents like Putin and does not have a single member qualified to assess the economic ramifications of military actions.  As in Soviet times, Putin does not engage in real deliberations, but rather utilizes rubber-stamp façades to cover up what are really dictatorial edicts.

Thus, while Putin claimed that opinion polls in Russia strongly favored seizing Ukraine, those polls don’t reflect the views of a public that has been properly informed about the likely economic consequences of an invasion.

Even the Russians are starting to ask inconvenient questions.

Writing in leading Russian newspaper Vedemosti,  economist Yevsey Gurevich points out that in its desperate bid to vie with the West, Russia is spending nearly five times more on its military as a share of GPD than does the average NATO member, and is planning even more dramatic increases.  What this means is that just as in Soviet times, Russians are shouldering a far greater burden in the guns-or-butter tradeoff than those nations they are competing against.  Gurevich warns: “[O]nly a highly developed country can act as a super power without harm to itself.”  Russia isn’t a highly developed country, but rather one that relies on exports of raw materials to such countries in order to sustain itself.

Gurevich is worried because his country is already feeling the heat.  Both Ford and Renault have announced major rollbacks on the their business operations in Russia, and McDonald's has totally shut down in Crimea.  In the first quarter of this year, Russia has lost between $50 and $75 billion in capital flight, as nervous investors have sought the exits after seeing the neo-Soviet Putin regime unsheathe its claws.

And some Russians have already had enough.  Russia’s Mark Zuckerburg, founder of the Russian version of Facebook called Vkontakte, has fled the country, never to return, becoming the poster boy for Russia’s neo-Soviet brain drain.  And Putin has responded by imposing  (Russian-language links) Soviet-style restrictions on government officials traveling abroad, in what may be the first step on a wider ban designed to staunch the flow of talent.  Indeed, a group of Russian physicists just resigned from a major academic council to protest the firing of a colleague who dared to travel abroad without state approval.

Where just months ago commentators were hoping to see Russia do more to develop the rule of law, now they just want to see bare rationality, something that’s been in short supply of late.  Russian military analyst Alexander Golts says that Russia simply doesn’t have the type of military force that would be necessary to occupy, administer, and hold Eastern Ukraine, but he doesn’t believe that this fact will necessarily stop Putin from trying.  Needless to say, even if Russia did have such a force, it certainly does not have the economic power to support it indefinitely.

The signs of warlike intention are clear.  Russia has been sputtering with warlike rhetoric and backing it up with repeated threats to NATO airspace with military attack aircraft.  The rashness of these actions, which could spark a global war by accident, clearly recalls the worst of Soviet misconduct, such as the Cuban missile crisis.

Russia sent nuclear missiles to Cuba because a new, young, untried president had been installed, and Russia believed that his weakness offered an opportunity.  America’s current steward presents an equally sophomoric image to the world, and has no doubt encouraged Russian aggression in the same manner.  Then, ultimately, Russian missiles were blocked from our hemisphere.  What will historians say happened on Obama’s watch in Eastern Europe?

Follow Kim Zigfeld on Twitter @larussophobe.

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