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RUSSIAN ECONOMIC CRISIS OF 1990S.
Term Paper ID:25963
Essay Subject:
Examines causes, domestic & global effects, threat of debt default, politics, reform, trade, foreign investment, ruble, banking, hedge funds.... More...
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Paper Abstract:
Examines causes, domestic & global effects, threat of debt default, politics, reform, trade, foreign investment, ruble, banking, hedge funds.
Paper Introduction:
INTRODUCTION
The possible default of Russia on her debt has precipitated a crisis around the world, and coming at the same time as the Asian crisis, this may be a devastating second-tier of financial woe with effects far from Moscow. The Russian crisis has already affected investment in certain hedge funds and has frightened a number of analysts who realize what more could happen if the crisis is not resolved. Many Americans see Russia as far away and not related to American interests since the downfall of the Soviet threat, but this is not the case. The Russian crisis has already had an effect on the American economy and may have an even greater one. This may or may not be an argument for bailing Russia out, but it is certainly cause for some concern.
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The issueis more complex when specific reforms are examined rather than merely theidea of reform as such. Little progress in terms of economic reforms had been accomplished bythe end of the Gorbachev era, and the success or failure of any reformafter that time would be linked to the level of popular support that couldbe garnered for that policy. Recent losses in hedgefunds can be attributed in part to the Russian economic crisis (Sesit andJereski, February 28, 1994). If Russia is not able toraise fresh money or delay payments, analysts expect that Russia willdefault on as much as $2 billion in foreign debt in 199, making this thelargest default by any government in history. As these losses were reported, Chernomyrdin insisted thatRussia herself was under control and that the situation would not have anylong-term consequences ("Russian Crisis Hits World Markets"). Boris Yeltsin in the election in the fall of 1996 promised tohelp disadvantaged members of Russian society, those suffering the mostduring the changeover, but he has yet to follow through on that promise.While the economy has been improving, it has not yet achieved a level thatwould attract foreign investment, which remains relatively low compared tocountries such as China and Hungary. Russian Economic Reform. Each of the Western models is sufficientlysimilar, though, that the path taken by the Russian socialist system willbe clearly in a new direction (Leitzel 1). New political alliances produced new tensionsuntil Russia was declared independent and withdrew from the Soviet Union(McKay, Hill, and Buckler 1115-1116). . The Russian crisis has already affected investment in certain hedge fundsand has frightened a number of analysts who realize what more could happenif the crisis is not resolved. Russia achieved a visible foreigntrade surplus over $2 billion in 1995, and this was partially offset bynet imports of services at something over $8 billion. The standard of living has improved in Moscow and St.Petersburg for most people, but life has worsened for those who are old andon a pension ("Russia: What's Next" 22). Long-Term Capital has a portfolioworth $9 billion and is one of the best-known hedge funds, financialinvestments catering to the rich and making big and often risky investmentbets with the hope of spectacular returns. The effects werenot confined to Long-Term Capital or its investors. Thornhill notes that there is much blame to go around, with one issuebeing raised as to whether or not more aid should have been provided tohelp solve the problem before it became such a crisis: "Supporters of moreaid say that, expensive though it might have been, the cost of dealing withan unstable Russia could be much higher . . "Who Lost Russia?" London Financial Times (August 28, 1998), 16. bailout costing $3.5 billion wasmade of a risky investment fund verging on collapse. [and that] the failure of July 1998lay at Russia's door, not at that of the international community"(Thornhill 16). For the timebeing, most western investment is likely to be channeled into the rawmaterials sector. Russian exports are dominated by raw materials such as oil, gas,timber, metals, and ores, and this is likely to continue for the mediumterm. This problem was of concern toEuropean and Japanese monetary authorities as well. They then found that they wereholding piles of worthless securities. But most western policymakersreject criticism of the G7's role . The fund was once so impressive that it garnered billions of dollars from some of the biggest names in finance. Russia has only $12.3billion in cash reserves in the treasury, and with Russian companies arelargely broke. The ripple effectspread out to UBS A.G. RUSSIAN DEBT The level of the Russian economic crisis can be seen in projections asto what will happen within the next year or so. The ruble crashed just thesame, leaving the economy and the political leadership in disarray andrenewing fears that the government will default what is owed to foreigncreditors. A History of World Societies: Volume II. The largest number of people in all republics favoredcontinuing the stable, government-set prices for all goods. Dubinin has defended his regime, stating: "Under my leadership, theCentral Bank did not print worthless money . and Joseph Kahn. However, Russia has alreadydamaged its credibility with foreign creditors by imposing the debtmoratorium, making it doubtful that any new solution will involveadditional money. The financial world remains concerned about what impact this willhave on worldwide bond markets, which have already been badly shaken byevents in emerging markets in the last two months: "Fear of a pullback inlending by major financial institutions also grew yesterday as banks wereawakened to the risks in their previous easy-money attitudes towardborrowers. OfficialRussian statistics indicate that there has been a decline in production instate-run industries, but there has also been a rise in private-sectoractivities. "Fed Chief Defends U.S. . There have beenmore changes since as more respondents accept private ownership (White,Gill, and Slider 188-189). Monetary policies cannotforever compensate for weaknesses in tax collection and the management ofnational debt, both internal and external" (O'Brien, September 8, 1998).Russian politicians are typically quick to allocate blame for the country'sills, and they have been satisfied to blame Dubinin. In August1992, respondents were asked if they thought the economic reforms shouldcontinue or be stopped, and 53 percent supported the reforms while only 2 percent wanted them stopped. Boston: Houghton Mifflin, 1996.Morgenson, Gretchen. Worry set in as members of Congress called for an inquiryinto what went wrong. Even those respondents unhappy with their ownsituation believed that further reforms would improve matters. This may or may notbe an argument for bailing Russia out, but it is certainly cause for someconcern. In any case, about$2 billion in debt comes due by the end of this year, and another $17billion is due in 1999. . Many Americans see Russia as far away andnot related to American interests since the downfall of the Soviet threat,but this is not the case. The fund had spread its bets among many markets in various countries around the world. Russia currently must face the problems of a staggering debt and adevastated economy scarred by skyrocketing prices, unpaid wages, dwindlingfood supplies, and the threat of even worse to come as winter approaches.This comes as a new prime minister takes control and tries to find a way tocope with these issues. . Late in 1989, nearly half of all respondents disapproved ofthe new businesses, and only 25 percent approved. The Russian economy is in a shambles. . "Hedge Fund Bailout Rattles Investors and Markets." New York Times (September 25, 1998).O'Brien, Timothy L. The Central Bank also failed torigorously supervise the often profligate bankers. Instead ofdoing so, these banks ran up huge piles of bad loans to industrial concernsin which the bankers held interests. . "A New Economic Plan?" The World & I (September 1996), 3 - 37.Henriques, Diana B. The questionindicated that market-based pricing was the main element in the transitionto the market. A survey in June 199 examined the specific issueof market-based pricing, or prices based on supply and demand, which mostpeople correctly interpreted as meaning higher prices. Works CitedBush, Keith. Hill, and John Buckler. In addition, some1 , Soviet citizens engaged legally in small-scale crafts and trades.The rest of the Soviet market economy was technically illegal and so hiddenand described as the "underground economy" (Leitzel 27). and Laura Jereski. Margot Jacobs, a banking analyst with United Financial Group, states,"Right now, Central Bank policy is completely confused . The great human resource in Russia is a highlyeducated and well-trained workforce, with wages a mere fraction of worldlevels. The world then asked whether the Soviets wouldfollow their satellites. It is notclear how Yeltsin intends to treat these industries, whether he will shieldthem behind protective tariffs or try to stimulate their development withpreferential tax rates and the attraction of external resources (Bush 37). Hedge funds use large lever aged borrowingsin order to boost the size of the investments they make, and when the valueof their securities falls rapidly, the finds may be obliged to find moremoney to cover their positions (Lewis 1). Dubinin didn'tdo a bad job of monetary policy for the past couple of years, but he did alousy job of preparing banks for what they're going through now" (O'Brien,September 8, 1998). INTRODUCTION The possible default of Russia on her debt has precipitated a crisisaround the world, and coming at the same time as the Asian crisis, this maybe a devastating second-tier of financial woe with effects far from Moscow. . The only Russian manufactured goods that can compete on the worldmarket are products of the military-industrial complex and the space andnuclear energy industries. "Hedge Funds Face Hard Scrutiny of Trading by Key Central Banks." The Wall Street Journal (February 28, 1994).Stevenson, Richard W. The Russian crisis has already had an effect onthe American economy and may have an even greater one. Blame was being spread around in the United States as well over thequestion of whether or not the hedge fund should have been bailed out bythe government. HEDGE FUNDS Hedge funds were seen as a problem as early as 1994 when it wasindicated that the Federal Reserve and other major central banks weretaking a hard look at hedge funds' trading activities, seeing theiraggressive practices as in need of control. Since these bankers had politicalinfluence, funds that could have been used to strengthen the Central Bank'sreserves were used to support failing banks. Financial markets around the worldhave been affected adversely in recent weeks by the turmoil in Russia, andPresident Clinton recently called for the world's industrial powers toconfront "the biggest financial challenge facing the world in a half-century" (O'Brien, September 15, 1998). Finger-pointing began as different groups charged that one or another entity wasresponsible for what had happened in Russia and so for the consequences ofit. There have been better-founded criticisms of Dubinin's decisions,and he has been faulted for easing reserve requirements for banks as theirloans went sour, which many considered to be a signal that he was willingto bail out banks rather than let them fail. "Back from the Brink: Learning from the Market Meltdown." New York Times (December 6, 1998).Leitzel, Jim. Observers note that Russia has been moving toward a market economy,though they wonder if the people will continue on this road. Resentment increased at the fact that an elite firmwas saved from a disaster of its own making with unusual help from theFederal Reserve, which orchestrated the rescue effort. The latter haveoperated their companies more like speculative ventures than institutionsthat could have helped lay the groundwork for a modern economy. marketsdirectly, but it had a major effect on those markets just the same. There has been an increase in the number andfrequency of public opinion surveys in Russia in recent years. Dubinin was well regarded by those who valued his efforts torein in the money supply over in recent years, a policy that had kept theruble stable before the recent debacle. Progress in developing a Western-style market economy in Russia hasbeen uneven. "Had the failure of LTCM triggered the seizing up of markets, substantial damage could have been inflicted on many market participants, including some not directly involved in the firm, and could have potentially impaired the economies of many nations, including our own," Greenspan said (Stevenson, 1998). But the strategy did not protect it from the chain reaction that hit global markets in August (Henriques and Kahn, 1998).The Russian crisis may seem distant and not to involve U.S. At the end of September, the U.S. "Hedge funds Hit hard by Market Turmoil." London Financial Times (September 3, 1998), 1.McKay, John P., Bennett D. He may also be chastised fornot defending the ruble early and consistently, and later for wastingprecious reserves and international financial assistance when he decided tosupport the currency much too late. Itwas then that the Duma, the lower house of parliament, rejectedChernomyrdin again as President Boris Yeltsin's choice to be primeminister. CONCLUSION The hedge fund case also shows that international markets are moretightly linked than some may believe: But the larger lessons of Long-Term Capital's crisis may not be as fleeting as the recent dip in the Dow. Federal Reserve Chairman Alan Greenspan defended thecentral bank's role in averting the collapse of Long-Term CapitalManagement LP by saying that the Fed had acted out of concern for thestability of the financial markets rather than a desire to assist theinvestment firm's wealthy owners. "Central Banker's Resignation Deepens Financial Chasm." New York Times (September 8, 1998).O'Brien, Timothy L. Sergei Aleksashenko, Dubinin'sformer deputy, immediately became acting chairman of the Central Bank. A survey conducted sixmonths later, though, showed that 54 percent were willing to work for aprivate employer while only 27 percent refused to do so. Russia has already missed $247 million in interestpayments. Analysts believe that how the Russian governmenttries to revive the economy will have a profound effect on its ability toget lenders to agree to restructure its debt. New York: Routledge, 1995.Lewis, William. Yeltsin, whohas been largely absent during this economic crisis, received the news ofDubinin's resignation coolly, indicating that the decision should have beenmade earlier. Attention has focused on two candidates,Viktor Gerashchenko, a central banker from the Soviet era who is a favoriteof the Communists, and Aleksandr Shokhin, a moderate who leads ViktorChernomyrdin's faction in parliament. Russia has a market economy andhas included capitalist-style behavior for as much as 25 percent of alleconomic activity in the pre-reform USSR, some of which was even legal.The legal portion was dominated by collective farm markets (Leitzel 27).Prices at these markets were more or less unregulated. The mostimportant reform is the shift from state to private ownership, and this isalso the reform that most went against decades of state indoctrination.The cooperative movement in 1988 and 1989 was the first attempt at legalprivate enterprise in the Soviet Union, and it met with considerableopposition. of Switzerland, Europe's largest bank, which said ithad lost as much as $721.6 million in the third quarter, partly because ofits risky investments with Long-Term Capital, and its stock fell 1 .8percent. Since the time of the failed coup attempt in 1991, the Russian economyhas been in a transition to a Western-style capitalist country. Greenspan said that it was the centralbank's responsibility to play a role in addressing a crisis which couldhave effects extending far beyond the fate of this one fund: "Financial market participants were already unsettled by recent global events," Greenspan said, referring to the spread into Russia and Latin America of the financial crisis that began last year in Asia. DEVELOPMENTS IN RUSSIA IN THE 199 S Gorbachev brought about many changes in Soviet politics and society.In 1989 changes occurred throughout eastern Europe through a series ofpeaceful revolutions. Role in Saving Giant Hedge Fund." New York Times (October 2, 1998).Thornhill, John. Another loss reported was that of High Risk Opportunities (HRO), "thehighest profile hedge fund casualty of the Russian economic crisis so far"(Lewis 1). This has produced an imbalance in Russia's export structure thatwill one day change, though not in the immediate future. "In Russia, Horrific Debt, Devastated Economy." New York Times (September 15, 1998)."Russia: What's Next." The World & I (September 1996), 22-23."Russian Crisis Hits World Markets." London Financial Times (August 28, 1998).Sesit, Michael R. The transitionhas built on both the legal and the illegal market economy. The new regime's economic advisers want to preserve the strengths ofthe market while imposing tighter regulatory controls, and they furtheradvocate reversing the government's move to effectively devalue the rubleand impose a debt moratorium, noting that these decisions precipitated theeconomic crisis in the first place. When it almost collapsed, it tested some fundamental assumptions of the investment world--and found them severely flawed: Diversification, the elementary precaution of not putting all of one's eggs in a single basket, failed utterly. Chernomyrdin accusedDubinin weeks ago of being responsible for devaluing the ruble, even thougha much broader and more powerful coterie of politicians, advisers, bankersand international lending agencies had roles in the decision. Only weeks ago the ruble was trading at about 16 cents, but thatwas before the government announced a devaluation that it then hoped wouldlet the ruble fall no lower than 1 cents. The recent turmoil in financialmarkets, particularly the collapse in Russia, produced huge losses for Long-Term Capital. Market purists are also reacting with scorn to theascendance of Soviet-era economic advisers as Prime Minister YevgenyPrimakov tries to assemble a new Cabinet, and these observes characterizeRussia's new stewards as "Stalinist retreads who desire a larger role forthe state in managing the economy and are ready to print money to ease thecash crisis" (O'Brien, September 15, 1998). Russia would like togain membership in the World Trade Organization (WTO) and the Organizationfor Economic Cooperation and Development (OECD), but this is likely to takeseveral years (Bush 32). Central bankers aresupposed to regulate bank exposures from the standpoint of lender's riskand credit risk, and hedge funds are in effect borrowing from banks.Market management is another concern to see if these funds make marketsmore unstable than would otherwise be the case. The real problem has come not from government policies "nor even thenotorious machinations of the plutocrats that have deprived the Russianeconomy of its advantages" (Luttwak 19), but rather from chronic deficitsin services and a reliance on imported food in the cities has continuedalong with a steady decline in the value of Russian exports: "A balance ofexternal payments that had always been in surplus thus started to generatedeficits" (Luttwak 19). Peter Boone, an analyst with Brunswick Warburg, states, "Theappointment of the next central banker is going to be incrediblyimportant." It was the resignation of Dubinin of the Central Bank thatprecipitated the current level of crisis, and speculation is already underway about possible replacements. There is a debt moratorium in place temporarily, but theexpanses only continue to mount up. In truth, though, the areas most in need of Westerninvestment and technology transfers are the consumer goods and food-processing industries, both of which have been long neglected. If difficulty in borrowing money lasted more than a few weeks,it could cause a significant slowdown in the United States economy"(Morgensen, 1998). This onlypartially identifies the goal, since there are several different types ofWestern capitalist country. This had a rippleeffect on markets around the world.
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