Two oil-dependent economies

Sept. 22, 2008
As financial crises rock two globally important, oil-dependent economies, a question looms for anyone with capital to expose to risk: Which is likelier to emerge from this turmoil as a promising and safe place to invest money—the US or Russia?

As financial crises rock two globally important, oil-dependent economies, a question looms for anyone with capital to expose to risk: Which is likelier to emerge from this turmoil as a promising and safe place to invest money—the US or Russia?

Both countries depend on oil—the US on purchases and Russia on sales. The US worries too much about its oil dependency, Russia not enough. And both countries bleed from deep financial wounds.

Giants succumb

In rapid succession, three US financial giants have succumbed to a credit crunch. Lehman Bros. Holdings Inc. declared bankruptcy. Merrill Lynch & Co. agreed to be bought by Bank of America Inc. A beleaguered American International Group Inc. submitted to government control after receiving an emergency loan of $85 billion. This all came after the government rescued mortgage behemoths Fannie Mae and Freddie Mac on Sept. 6 and the investment bank Bear Sterns in March.

It has become painfully clear that a rebalancing of national accounts and purge of credit-market excesses were inevitable, even necessary. Equally clear is the need for better, though not necessarily more, regulation. Those processes will be difficult. But they will end.

The adjustment, moreover, will have help from oil prices falling not only from a weakening of market fundamentals but also from financial side effects. This year’s surge of investment money into commodities, including oil, already was receding when the newly aggravated financial crisis slashed the ability of oil traders to buy on credit. Also, the Federal Reserve has resisted new pressure to cut interest rates and weaken the dollar. Leverage limits and dollar strength should add downward momentum to oil prices.

While falling oil prices are economic health food in the US, they’re poison in Russia. There, an arrogant government has squandered its oil boom. Instead of promoting foreign investment and economic diversification, it has exploited nationalism and momentary public comfort to fatten its authority. It has raised taxes capriciously, expropriated the assets of large companies, thrown leaders of private corporations into jail or out of the country, and handed large segments of the Russian economy back to state-owned enterprises. Then it invaded Georgia.

Business seems to have lost confidence. Last week trading had to be halted on Russian stock markets, where plummeting share prices pushed aggregate losses since May to more than 40%. The rout followed publication in the Sept. 3 Moscow Times of an essay by Anders Aslund of the Peterson Institute for International Economics entitled, “Ten reasons why the Russian economy will falter.”

Aslund’s pessimism hinges on the Aug. 8 invasion of Georgia. “Russia’s foreign aggression has strengthened the authoritarian regime, and this has ended all hopes for substantial reforms at a time when they are needed the most,” he wrote. Russia, he said, has profited from a surge in private enterprise, an economic “catch-up” effect and credit boom during the transition away from communism, and high oil prices. But those sources of growth “will soon be exhausted.”

Corruption and risk

As the global economy weakens, Russia remains plagued by “enormous corruption” and the inability to carry out major infrastructure projects, Aslund wrote. The government’s bullying of private businesses has raised political risk. Investment as a share of economic growth is low by international standards. Russian efforts to join the World Trade Organization probably are doomed. Poor public services increasingly hamper economic growth. With oil prices falling and production stagnant, Russia’s external accounts “are bound to deteriorate quickly.” The banking system is poor. And the inflation rate is 15%/year. “In short,” said Aslund, “Russia is set for a sudden and sharp fall in its economic growth.”

Two economies, each dependent in its own way on oil, thus have turned stormy. One remains subject to the rule of law; the other subordinates law to raw power. One will respond to current troubles with systemic changes, good or bad; the other won’t. One, if its systemic changes are constructive, will stabilize; the other will unravel, weakening the political regime, until oil prices rebound. One will attract investment; the other….