Monday, October 13, 2008

Icelandic-Russian Bailout

You may not have noticed but Iceland, a NATO member, had it's economic system collapse last week. Iceland has a population of approximately 350,000 and a per capita income of $35,000 (U.S. 41,000). It is now looking at a 5.4 billion dollar rescue from Russia.The implications are interesting to say the least. Jim Kunstler in Clusterfuck Nation sums it up nicely:

"Iceland is the poster-child du jour for this. The little island nation of about 320,000 souls (roughly half of Vermont's population) lately grew a banking sector that thrived on something-for-nothing finance. In little more than a month, its banks have imploded like mini death stars, leaving Iceland with a pariah currency. Since it has to import just about everything, and it suddenly finds itself unable to pay for imports, the people are stripping the grocery markets of whatever remains there now. You wonder what they will do in two weeks. Ten years from now there may be 32,000 of them left, subsisting on blubber sandwiches."

While the Russian stock market has taken even bigger hits than the U.S. the damage has been relatively contained as opposed to the melt down of the Russian economy under Yeltsin in 1998. The other aspects of new found Russian wealth are explored inthe "Moscow Times":

"The government is sitting on a giant pile of cash that it plans to invest in foreign assets. It began to flex its economic muscle this week, when the prime minister of Iceland announced that Russia may lend it 4 billion euros ($5.4 billion) to shore up its teetering financial system. Who would have thought that, given the chaotic Russia of the 1990s, a mere 10 years later it would be in the position to bail out a developed country and NATO member? Even more surprising is the fact that this helping hand for Iceland comes at a time when the domestic stock market is in a free fall and trading on the Moscow stock exchange is routinely halted.

The Kremlin thinks that now is the time to buy assets cheaply, using the current financial crisis to emerge as a powerful global economic player. As Prime Minister Vladimir Putin remarked at a recent meeting with the CEO of state-owned bank VTB, "Perhaps we should buy something [abroad]? Something that is up for grabs?" According to Arkady Dvorkovich, an economic aide to President Dmitry Medvedev, the government will support -- both diplomatically and financially -- the expansion of Russian companies abroad.

Following the Russian-Georgian war, the West is scared that the Kremlin will use its cash not just for economic purposes, but as an aggressive foreign policy tool as well. Should the West really consider blocking Russian investments abroad as a way to influence Russia?

Trying to erect an Iron Curtain around Russian funds and businesses will prove counterproductive. Indeed, a large-scale "invasion" of Russian business would be a positive development, because it would foster economic interdependence. This is true even if the economic expansion is led by state-owned companies and by Russian wealth funds. By investing in U.S. and European assets, Russia's government and business elites are buying a stake in the global economy. This should bring better mutual understanding and a more rational and accountable foreign policy.

Paradoxically, despite recent hits to the country's stock market, Russia remains awash in cash. The government just rolled out a $130 billion bailout plan for the country's ailing banking system. As a percentage of gross domestic product, this would be equivalent to about $1.3 trillion in the United States -- almost double the plan designed by U.S. Treasury Secretary Henry Paulson. Yet, even this package has not significantly eaten into Russia's wealth funds and the world's third-largest currency reserves.

The government's Reserve Fund, created to cushion the economy from a fall in oil prices, stands at $140 billion, and the National Welfare Fund, intended to invest in high-return vehicles, holds another $30 billion. Although the National Welfare Fund is not officially a "sovereign wealth fund," it is already among the 10 largest such funds, rivaling the Brunei Investment Agency.

The Reserve Fund and the National Welfare Fund combined rival Singapore's Temasek Holdings, currently sixth in the world, and lag just behind the China Investment Corporation. By design, this money is intended to be invested outside Russia. As today's financial crisis has made many Western assets cheap, they are now within reach of the country's government and leading companies.

Russian private and state-owned companies have already invested abroad extensively, often buying stakes in large foreign companies. Overall, the top 25 Russian companies hold $59 billion in foreign assets and are the third-largest investors in emerging economies, following Hong Kong and Brazil. Even though the financial crisis has wiped out the Russian stock market, some of the best-run companies have endured a softer blow than their Western counterparts and will therefore be shopping in the global market next year.

Russian corporations' foreign investments have already generated a heated debate in both the United States and Europe -- even when investment was made by a private company. The largest controversy surrounded a merger that Russian steel giant Severstal sought with Luxemburg-based Arcelor. Severstal was rejected in favor of Mittal Steel, with some commentators claiming that the decision was made on political grounds. But no investment by a private Russian company has, so far, been vetoed by Western governments."

If Russians were to buy the GM plant in Janesville WI I suspect the inhabitants would be glad to have an economic bailout of their locality. Unfortunately for them this will probably not happen.The question for many Americans is to look around at what is grown and eaten in your neighborhood and buy that up. It is what you will have in the long run.

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