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. 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. 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. 

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.

THE RUSSIAN ECONOMY

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. 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.

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. 

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. 

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. 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.

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.

 It's true that 1998 is the first year since 1991, when the USSR came unglued, that Russia has shown positive economic growth. 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.

THE BANKRUPTCY OF THE RUSSIAN STATE

 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. 

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. 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. 

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.

TAXES

 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:
"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".

"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".

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.

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.

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.

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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