Crashed
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Clearly, the dollar-based financial system had experienced an existential crisis. For avowed skeptics and critics of American power it was an unmissable opportunity to score points against Anglo-Saxon finance. But given the extraordinarily heavy dependence of both individual banks, such as Deutsche and Paribas, on Fed support and the huge swap line facility provided to the ECB, it is hard to see how either Steinbrück or Sarkozy could have been more out of touch with reality. By the early twenty-first century, the dollar’s dominance did not rest on the Bretton Woods Agreement of 1944 or the institutions, like the IMF, that issued from it. The foundation of the global dollar was the private banking and financial market network, materialized in the Wall Street–City of London nexus. This was a cocreation of American and European finance, deliberately erected beyond state control. What happened in the fall of 2008 was not the relativization of the dollar, but the reverse, a dramatic reassertion of the pivotal role of America’s central bank. Far from withering away, the Fed’s response gave an entirely new dimension to the global dollar.
Steinbrück and Sarkozy may perhaps be forgiven for failing to recognize the significance of the moment, because the Fed had acted without fanfare and without seeking public legitimacy either at home or abroad. The sporadic global debate about alternatives to the dollar was the price that the Fed paid for keeping its stabilization campaign below the radar. On Capitol Hill, while controversy swirled around TARP, there was silence about the Fed’s gigantic global liquidity effort. As one senior New York Fed official remarked, it was as if a “guardian angel was watching over us.”37 If some members of Congress understood what was going on, they thought better of discussing the Fed’s actions openly. The reality of global financial policy disappeared in a “spiral of silence,” in which it suited both the Fed and its collaborators to bury the reality of massive and explicitly hierarchical interdependence.
Chapter 9
EUROPE’S FORGOTTEN CRISIS: EASTERN EUROPE
By October 2008 the Fed’s swap line facilities defined a relationship of dependence and interdependence between the US central bank and an exclusive club of privileged central bank counterparties. But that posed a question. Who was in and who was out? What were the criteria of membership in the swap line club?1 On October 28, 2008, Nathan Sheets, the director of the Division of International Finance at the Fed, set out a short list of three criteria.2 The recipients of swap lines must be:
Of significant economic and financial mass so that there can be spillover to the US.
Well-managed with ‘prudent’ policies so that the problems they have encountered are clearly the result of contagion from US and ‘other advanced economies’ and therefore warrant US assistance.
The problem faced by local banks should be one of dollar funding stress so that swap lines would actually make a difference.”
Ultimately, the Fed had to justify its measures in terms of benefits to the US economy. There were economies that were too small to warrant action. There were countries that were experiencing stress as a result of a collapse of trade or commodity prices that could not be helped by swap lines. But it was point 2, with its stress on “prudent policy,” that offered the scope for political discrimination. What was a prudent policy was very much in the eye of the beholder. As two US analysts attached to the National Intelligence Council remarked at the end of 2009: “Artificial divisions between ‘economic’ and ‘foreign’ policy present a false dichotomy. To whom one extends swap lines” is as much a “foreign policy as economic decisions.”3 The Fed was well aware that with the swap lines it was treading onto the terrain of geopolitics. Each of the fourteen European, Latin American and Asian central banks included in the swap network was approved by the Treasury and the State Department. They were clearly safe bets. The Fed did everything it could to dissuade further applications. Nevertheless, two further countries did apply and were denied. Their identities are shrouded in secrecy. But there were clearly some countries that were never going to make it onto the Fed’s list, no matter how large or hard hit by the crisis they were.
I
On November 14, 2008, Sarkozy hosted President Medvedev of Russia, who was en route to the first leader-level G20 summit in Washington. Sarkozy and Medvedev exchanged congratulations over the peace settlement that Sarkozy had brokered in Georgia in August. But this was not the only topic of Franco-Russian backslapping. Sarkozy also expressed his agreement with recent initiatives from Moscow on the currency question.4 Over the summer, with the price of oil at all-time highs, Medvedev had been pushing for a diversification of reserve currencies and a greater use of the ruble. Days before arriving in France, Medvedev had given a speech to the Russian parliament in which he drew parallels between the crisis in Georgia and the global financial debacle. They were “two very different problems,” as Medvedev told the Federal Assembly in November 2008, but they had “common features” and a “common origin”: the presumption of an American government that “refuse[d] to accept criticism and prefer[red] unilateral decisions.”5 This played well with the nationalist gallery in Russia, but there was not much dissent from the European side either. At their summit in Nice, Medvedev noted that on currency issues “the Russian and European positions were practically the same.” What he did not mention was that whereas France’s banks could count on limitless dollar liquidity from the Fed, the Russians were on their own.
If Moscow’s increasing assertiveness had been buoyed by oil prices surging to $145 per barrel, the crisis was a severe setback. By the end of 2008 oil prices had plunged, reaching their nadir at $34 on December 21. With natural resource rents accounting for 20 percent of Russian GDP, the impact of the commodity price crash was devastating. Tax revenue per metric ton of oil fell by 80 percent.6 But the Russian state had the resources to cope. Unlike in 1998, by 2008 Moscow had accumulated enough financial reserves to withstand the pressure of the global crisis. At their peak, Russia’s foreign currency holdings were estimated at $600 billion. It was not the state but Russia’s globalized business sector that was in trouble.
Russian Stock Market and Oil Prices, 2008
Source: World Bank in Russia, Russian Economic Report 17 (November 2008), figure 2.1. Data: RTS, Thomson Datastream.
As oil prices plunged, so did the Russian stock market. By September 15 the Russian market was already 54 percent off its peak in May 2008. In the days after Lehman, trading was so jumpy that Moscow regulators took the decision to suspend trading. When the markets reopened on September 19, jitters continued, with October 6 seeing a single-day fall of 18 percent.7 According to one widely quoted estimate, Russia’s oligarchs saw their combined wealth slashed from $520 billion at the beginning of 2008 to a mere $148 billion by early 2009.8 What was spooking investors, apart from oil, was the likely impact of a sharp ruble devaluation on Russian balance sheets. It was the private, not the public, sector that was in danger.
By the third quarter of 2008, Russia’s banks, raw material producers and industrial conglomerates had run up external debts of $540 billion, half owed by Russian industrial corporations and the rest by banks. This debt mountain matched Russia’s official reserves and was roughly equivalent to Lehman’s balance sheet. A substantial fraction was short-term debt. Having adopted the market-based banking model, Russia’s banks were particularly at risk, needing to refinance as much as $72 billion due by the end of 2008.9 Apart from the banks, the list of stressed dollar borrowers included all the major Russian oligopolies: Gazprom ($55 billion), Rosneft ($23 billion), Rusal ($11.2 billion), TNK-BP ($7.5 billion), Evraz ($6.4 billion), Norilsk ($6.3 billion) and Lukoil ($6 billion). Collapsing commodity prices slashed their revenues and a slide in the ruble would put even heavier pressure on those that billed in local currency rather than dollars—a major issue for Gazprom, Russia’s largest gas supplier.
As in the West, the crisis and the terms of the bailout opened the question of the balance o
f power. To some it seemed that the Kremlin was bent only on saving the skins of its cronies at the expense of the Russian taxpayer.10 On this reading, the Russian story was an even more corrupt and brutal version of the drama played out in America.11 Like the barons of Wall Street, Russia’s oligarchs needed state aid and the regime came to their rescue. It is certainly true that Russia avoided dramatic bankruptcies, and considerable state resources were deployed to make sure of that. But putting events in Russia side by side with those in the United States or Europe, one is struck less by the self-dealing of Russian crisis management than by the frankness with which the question of power was ventilated in Russia and the obvious willingness of President Medvedev and Prime Minister Putin to use the occasion to shift the balance in their favor. Since the breakup of oil conglomerate Yukos in 2003, none of the oligarchs had dared to challenge the Kremlin. Now Medvedev and Putin were turning the screw. They offered financial protection, but they exacted a price.
The cornerstone of the Kremlin’s crisis-fighting strategy was to prevent a death spiral of devaluation and bankruptcy. In the first phase of the crisis, the central bank deployed its ample foreign currency reserves to stem the fall in the ruble. As a result, as oil prices plunged by 64 percent between October and December 2008, the ruble lost only 6 percent against the dollar.12 Only in January did Moscow let the ruble go, allowing it to devalue by 34 percent before stabilizing in February. Like any successful rearguard action, it came at a price. The central bank burned $212 billion of its reserves, 35 percent of the total, to slow the slide. But by so doing it bought time, allowing dollar-exposed borrowers to pull in their horns and giving the state some time to launch its own response.13
A key element of this program was a demand from the Kremlin that the oligarchs sink a large part of their fortunes into stabilizing the stock market. There were rumors of an “all-night mandatory meeting held in the Kremlin” on September 16, the day of the AIG rescue, at which “oligarchs were ordered to plunge cash into their own faltering stocks, buy collapsing financial institutions directly, or simply fork over the cash and/or shares.”14 Following this “bail-in” of the oligarchs, the government targeted takeovers and bailouts at the smallest and weakest Russian banks. Coordination was provided by state-owned Vneshekonombank (VEB), where Putin, as Russian prime minister, served as chairman of the board. Five billion dollars was used to take over Sviaz Bank, Globex bank and Sobinbank. Then the deposit insurance fund was recapitalized and the insurance limit raised to $28,000. A $50 billion central bank facility put VEB bank in a position to act as the backstop, with a further $35.4 billion in subordinated debt available at tough rates for troubled oligarch enterprises. The loans would be repayable within a year and otherwise convertible into controlling shares.15 It was not a government takeover, but a conditional threat and a stark demonstration of where power lay.
VEB pumped $4.5 billion into Rusal, the aluminum company majority owned by Oleg Deripaska, to allow it to unwind foreign financing, which it had used to buy a 25 percent stake in mining giant Norilsk Nickel. VEB also put $2 billion into Mikhail Fridman’s Alfa Group to help it to pay off Deutsche Bank and rescue Alfa’s large stake in Russia’s number two mobile phone firm, VimpelCom, which might otherwise have been forfeited as collateral. As investment plunged and domestic economic activity began to spiral downward, unemployment rates doubled. This was particularly worrying in the so-called monotowns—the urban legacy of Stalinist industrialization.16 On October 16, 2008, Igor Sechin, Putin’s right hand, convened an industrywide brainstorming session on the car industry at Togliatti, the company town of AvtoVAZ, the bankrupt inheritor of the Soviet car industry. He announced an immediate $1 billion loan for AvtoVAZ from VEB that would keep the factory and its staff of 100,000 working.17 By the end of the crisis, $1.7 billion would be pumped into the Russian auto bailout.
In the wake of the oil price shock, the Russian federal budget was reset on the assumption of an average oil price of $41 per barrel by contrast with the June 2008 budget, which had assumed $95 per barrel. With tax revenues plunging, Putin, as prime minister, took credit for a large fiscal stimulus. A quarter of the government’s 9.7 trillion ruble budget was dedicated to crisis spending on work creation, industrial subsidies and tax cuts. Relative to the size of its economy, commonly compared with that of Spain and roughly comparable to that of Texas, the Russian crisis response was one of the largest in the world, dwarfing those undertaken by West European governments.18 It was heavily skewed toward the largest, best-connected corporations that were included in a list of 295 nationally important corporations and 1,148 regionally important firms. It was a top-down, corporatist stimulus, and Moscow made clear that it expected the oligarchs to reciprocate. Indeed, it was unafraid to call them out by name. On one notable occasion, Putin singled out four of them as follows: “Vladimir Potanin (Interros Holding), Leonid Lebedev (Sintez Group), Mikhail Prokhorov (Onexim Group), and Viktor Vekselberg (Renova Group) . . . I have known all of you for many years; in essence, we have been working jointly. Let me repeat that during the difficult conditions of the crisis we have made every effort to support you in the various directions of your business. The crisis is waning. It’s not yet over, but it’s on its way.” Now Putin expected them to make good on their commitments. “We agreed to meet you half-way in this area as well. We postponed the deadlines for investments. There will be no more such adjustments of schedules. Please focus your utmost attention on meeting your commitments.”19 What would happen if an oligarch failed in his responsibilities was demonstrated in June 2009 when Putin descended on Pikalevo, a small town south of St. Petersburg dominated by the metallurgical empire of Oleg Deripaska. Deripaska, who had once been listed as the richest man in Russia, with a fortune estimated at $28 billion, had seen it reduced to $3.5 billion. But that was no excuse for not paying wages.20 Indignant workers were blockading the Moscow highway, causing a 250-mile traffic jam. In front of the TV cameras Putin upbraided Deripaska. Tossing him a pen, the premier demanded that the oligarch sign the paychecks there and then. It was economic management by personal intimidation of the telegenic tub-thumping variety.21 The message was clear. Ten years on from the humiliation of 1998, there were men in charge who would see to it that things “got done.”
In its way, it was effective. It demonstrated leadership. It humbled the oligarchs. It rallied Russian social interests around the state that provided for them. It kept Prime Minister Putin in the limelight. But was it a long-term strategy for growth? Liberal economists were skeptical. So too was Medvedev, who had succeeded Putin as president in 2008. Even before the crisis, the expert advisers that Medvedev cultivated in his personal entourage had been calling for a new course.22 In the wake of the crisis their message was even louder. What had made Russia so vulnerable in 2008 was its lopsided integration into the world economy: on the one hand, its excessive reliance on oil and gas; on the other hand, the corrupt culture of capital flight, in which Russian oligarchs sluiced money in and out of the country through the off-shore banking system. How else could one account for the bizarre anomaly that made tiny Cyprus into one of Russia’s main sources of foreign investment? What Russia needed was modernization. As Medvedev remarked on September 10, 2009: “Can a primitive economy based on raw materials and economic corruption lead us into the future?”23 Two-fisted crisis fighting was not enough. A mere recovery from the shock of 2008 would lead “nowhere. We need to get out of the crisis by reforming our own economy.”24 What Russia needed was economic transformation, and for that it needed not less but more interaction with the world economy, and above all with its technological leaders. And this had wider implications. After the shocking confrontation with the West in August 2008, Moscow needed to change course. With the crushing of Georgia, the Kremlin had made its point. In the future, Medvedev asserted, the success or failure of Russian foreign policy should be judged by a single criterion: “whether it contributes to improving living standards in our country.” Rather tha
n “puffing out its cheeks” to threaten others, Russia should concentrate on attracting foreign technology and capital.25 It was a message of modernization and partnership that was eagerly taken up both in European capitals and by the new administration in Washington.
II
It might be tempting to conclude that by taming Russia, the effect of the crisis was to calm international relations. And in the short run this was surely true. But in the international sphere, power is judged by relative standards. And if Russia was hard hit by the 2008 crisis, the impact on Eastern Europe was even worse. The shock to the most highly leveraged transition states of the former Communist bloc was staggering. If we compare the forecasts for 2010 made in October 2007 with the expected outturn two years later, we see how radically the crisis changed the outlook for the worst-hit countries in the region.
The most extreme case was Latvia. One year into the crisis, in October 2009, the IMF’s forecast for Latvia’s GDP in 2010 was 39 percent lower than it had been in October 2007. Over the same two-year period, Estonia’s and Lithuania’s GDP expectations were revised downward by a whopping one-third. Slovenia, the Czech Republic, Slovakia, Hungary, Bulgaria and Romania all experienced downward shocks of between 15 and 18 percent, more than twice that suffered by the United States. In the adjoining post-Soviet Commonwealth of Independent States (CIS), the downward revision of growth expectations ranged from 18 percent for Russia to 32 percent for Armenia. The pattern was not uniform. Poland, notably, escaped largely unscathed.26 But all the most severe casualties of the 2008–2009 crisis are to be found among the transition economies of the former Eastern bloc.