| Looking
At Russia ~ Investing In Russia ~ Page One |
| My
friend Pierre Lassonde, who runs Franco-Nevada and Euro-Nevada, toured
Russia extensively a few years ago, and wrote a well thought-out and lengthy
report (which he kindly made available to IS subscribers on a complimentary
basis at the time) on his assessment of the place. The bottom line was
that he wouldn't dream of putting a nickel in Russia for the indefinite
future. Approaching it from a completely different perspective, my friend
Rick Maybury considers Russia an integral part of a greater region for
which he coined the term Chaostan. I buy their basic reasoning. |
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| My
own attitude towards the place, based on innumerable points of input over
the years, was highly negative. I'd go so far as to say I had a real chip
on my shoulder when I got off the plane in Moscow a couple days before
the summer solstice in June. But, as Marx himself (actually, he took
the idea from Hegel) observed, if you take a thesis and confront it
with an antithesis, you arrive at a synthesis. And that's the subject of
the next pages. One thing I've learned in years of wandering around
the world, trying to figure out how things actually work, is that few things
are either as good or as bad as you might have been lead to believe, whether
it's an idyllic paradise or a war zone. |
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| Of
course that's partly just because of a cosmic reality: No matter where
you go, there you are. |
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| In the case
of Russia in 1998, it was pretty much as I expected in some ways, but much
better in others. Of course it's a huge country, and drawing conclusions
from just a weeks worth of travel in only two regions is dangerous, not
to mention that Russia is the home of the Potemkin Village, a Stalin-era
edifice constructed to make naïve foreigners think things were better
than they were. |
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| But since
the point of this exercise is to make money, let's first take a look at
what passes for an economy in Russia. |
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| THE RUSSIAN
ECONOMY |
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| From the very
earliest days of its history, when the Vikings sailed its rivers to trade
and loot, Russia has been only a source of raw materials— slaves, grain,
furs, lumber, and metals. Nothing has really changed in a thousand years,
except for "slaves" read "cheap labor". Grain production
has still to recover from the country's experiment in socialism, nor is
it likely to for some time. |
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| There's
no money in furs in these politically correct times. Metals and timber
are marginal at these prices. At the moment, oil and gas account for
about 45% of the Russian government's tax revenues; although I'm friendly
towards the sector at current prices, petroleum is where coal was 75 years
ago, and wood 150 years ago. There's no future in it, except as a crisis
hedge over maybe the next ten years. I'll get into both the short and long
term implications of that view more in the months to come. |
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| There's
very little the Russians manufacture that anybody else wants. The population
may be educated, but the vast majority of them suffer from a bad attitude
and worse work habits. Further, if you want a place to boom, it takes loads
of private capital—which will not be forthcoming. With no labor, and no
capital, this place is not likely to become the site of the next economic
miracle in our lifetimes. So what are they left with? The same drill as
the last thousand years: Producing raw materials, which are simple, not
terribly time or quality sensitive, and valuable only in bulk. |
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| Obviously,
raw materials are very necessary, but their real price has been in constant
decline throughout history. That process accelerated during the industrial
revolution, and will go hyperbolic over the next few decades with the unfolding
nanotech revolution. Commodity production was a great business in the 19th
century, a time of the choo-choo train economy. It can still be a good
business, cyclically, for short periods of time, in today's world; over
the long run it's a lousy business, and it's only going to get worse. |
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| Unfortunately,
Russia has nothing to offer but raw materials. That doesn't have to
be a problem in itself, but the presence of a lot of natural wealth actually
causes more problems than it cures. Countries with lots of wealth—Saudi,
Venezuela, Congo, Brazil, and Russia are just a few obvious examples—often
tend to develop dysfunctional societies, for much the same reasons spoiled
trust fund babies tend to wind up poor and unhappy. |
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| Being born
poor, like Hong Kong or Japan, paradoxically gives a country better odds
of long run success. But poverty is no cure for bad habits. Countries
are happy and successful in direct proportion to the level of capitalism,
property rights, and individual freedom they enjoy. End of story. |
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| In that
context, Russia's future doesn't look particularly bright. The place
has absolutely no tradition of capitalism, property rights, or individual
freedom. And although the place is radically improved from only a decade
ago, it takes a few generations, under the best of circumstances, to change
an ingrained national tradition. In addition, much more than in most places,
the Russian psyche has almost been hard wired to think in terms of a mass
economy. Unfortunately for them, the mass economy is as passe' as the choo-choo
train. So their only hope of muddling through the near future is to keep
producing raw materials as economically as possible. And the only way they
can do that is to induce foreign technology and capital to come and help
them. If Russia became a true free market economy, they could transform
themselves, and in 20 years have a standard of living like that in America.
But that seems unlikely to me. So far they've been total failures at doing
so—on the necessary scale—for reasons I'll try to make clear. |
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| It's true
that 1998 is the first year since 1991, when the USSR came unglued, that
Russia has shown positive economic growth. |
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| And before
the recent problems in the Orient, the 100% gains in its stock market were
making people quite optimistic on the future. But little attention has
ever been focused on the chronic structural problems of the Russian economy
I've just described. Instead, everyone is looking at the acute financial
problems of the Russian government. And those are very different things. |
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| THE BANKRUPTCY
OF THE RUSSIAN STATE |
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| The Russian
Government is not just technically bankrupt (like the US and many other
governments). It's really and truly bankrupt, which means it not only has
negative assets after paying off debt, but can't even pay its current bills
for simple lack of cash. That, however, is not necessarily the great calamity
portrayed by the media. In fact, it can be a very good thing, if the situation
is handled right—which it almost certainly won't be. |
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| The Russian
government owes about $70 billion of short term dollar debt, most due in
the next six months, but has only $15 billion in reserves. |
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| It's long
term dollar debt—of which I don't know how much is outstanding-- yields
about 15%, and short term ruble denominated debt—again I lack the current
number-- yields anywhere from 75-150%, depending on rapidly changing psychology. |
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| The Russian
government has already privatized almost all of its assets (except raw
land), and is keeping itself from collapse through debt. Right now that
means borrowing from the IMF, whose completely insane modus operandi
is to keep itself alive by consistently throwing good money after bad so
none of its earlier loans go into default. Although its not obvious to
the casual observer of its perverse lending policies, the first rule of
life for the IMF (like every entity) is to survive. So they actually want
that money back, including the latest $23 billion of emergency aid to Russia,
and with interest. To insure that, they are attaching some conditions to
the loans. Some of the conditions are constructive, such as further deregulation
of the markets and reduction of bureaucracy. But mainly they want the money
back, and they know the only way they're going to get it back is if the
Russian government extracts it from Russian society through higher taxes. |
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| TAXES |
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| Both the IMF
and the Russian government see their mutual salvation in the collection
of taxes. To facilitate that, the Russians have installed a new bureaucrat
named Boris Fyodorov, who seems to take pride in how aggressive he'll be
in squeezing blood from the workers and peasants. The Financial Times did
an interview with him while I was in Russia, characterizing the man as
"a tough-minded free-marketeer", and remarking that "Western investors
broke out the champagne (in May) when he was named head of the Federal
Tax Service". This makes me think that both the FT reporters and the Western
investors in question are blithering idiots. Here are a few things Fyodorov
had to say: |
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| "Once a couple
of important western businessmen who are resident here in Moscow are stopped
at the border and are told 'Hey, guys, you cannot leave, you are tax offenders,
probably you have to spend a couple of years in Siberia'. I think that
will make a very good example". |
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| "You guys"—addressing
the heads of Gazprom and United Energy Systems, two of Russia's very biggest
companies—"aren't paying taxes. We'll arrest you, we'll take your property,
we'll make your companies bankrupt". |
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| No need to
wonder why Russian companies are as cheap as they are. What's worse, he
plans on making sure the average citizen, who barely has enough to feed
and clothe himself, is caught in the dragnet, because at present individual
income taxes only amount to about 10% of State revenues, and less than
5% of Russian workers pay taxes. In particular, he's launched a campaign
to monitor the lifestyles and spending habits of at least 1000 of the countries
most prominent citizens. These are all tricks he's picked up from consultants
loaned to Russia from the IRS and various European tax agencies. There's
no way of telling to what degree this buffoon will succeed in doing what
he threatens, but the threat alone is enough to have a bad effect. |
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| As it stands,
Russian taxes are numerous, complicated, contradictory, and enforced very
differently by different people. This is probably to be expected, in that
the Duma (the Russian parliament) is populated almost entirely by political
hacks left over from the Soviet era. And trying to straighten out a tax
problem is even harder than in the US, because people are still used to
thinking in terms of Soviet law, which was really nothing but a criminal
fantasy given reality on a grand scale. The fact that the legal system
is a charade, leaving contracts and titles open to question, is another
problem. |
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| The natural
victims of heightened tax collection efforts are companies with fixed assets
(because they can't hide, and have something visible to attach), and foreign
companies (because they're known to have cash, and they're used to paying
taxes). Johnson & Johnson was the first foreign company hit, with $4
million in back taxes and $15 million in fines; the Russians have filed
criminal charges against two of their top executives. As in the US, the
fact J & J had already paid $28 million in tax over the last three
years means absolutely nothing. |
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| Most press
reports seem to hone in on the various mafias as the main danger to doing
business in Russia, but view the government as a necessary protector of
society, in desperate need of money to do its job. In fact, the mafias
present a danger, but it's trivial by comparison to that of the government
itself. I think it's worth looking at the subject a bit, since the government
is—by an order of magnitude—the biggest problem in Russia. |
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