PRINCETON – Russia’s current crisis, particularly the collapse of the ruble, reveals the fragility not only of the Russian economy, but also of the existing international order and the foundations of contemporary thinking about economic and political sustainability. Indeed, Russia’s crisis was never supposed to happen – and its growing isolation gives it little stake in existing mechanisms of global governance.
After the Latin American debt crisis of the 1980s and the Asian financial crisis of 1997-98 (which also affected Russia), emerging economies were determined to figure out how to avoid repeating that experience. They identified three keys to managing the perils of modern financial globalization: a large cushion of reserves to stave off speculative attacks; avoidance of large current-account deficits (with surpluses used to accumulate reserves); and low external public and private debt.
Moreover, the emerging economies took governance lessons, recognizing the imperative of improving transparency and reducing corruption. And policymakers and financial institutions devoted considerable attention to determining what might constitute warning indicators.
Before 2014, Russia was performing well by all of these criteria. There were no warning signs. In 2013, the public sector’s external debt amounted to a mere 3.8% of GDP, and private-sector external debt totaled a reasonable 30.2% of GDP. Last spring, the country’s foreign reserves amounted to a healthy $472 billion, helped by a substantial current-account surplus; and, according to the Central Bank of Russia, the country’s total foreign assets stood at $1.4 trillion, exceeding its liabilities of $1.2 trillion.
So what went wrong? One problem may be that assets are not easy to mobilize in a crisis. As economists at the Bank for International Settlements, especially Claudio Borio and Hyun Song Shin, recently highlighted, financial-asset balances often reflect the use of the foreign sector as a means of creating more intermediation – a system that enables large-scale capital flight. That seems especially true of Russia. In other words, Russian companies use capital that they raise abroad to accumulate assets, which they do not necessarily repatriate.
Under such circumstances, bad things can happen – even to countries with large reserves and current-account surpluses. After all, companies can quickly drain the reserves, instead of accessing their own overseas assets, if they need to make payments.
Economists are familiar with the classic macroeconomic policy “trilemma”: countries cannot have fixed exchange rates, open capital accounts, and an independent monetary policy at the same time. But there is also a financial-sector equivalent, in which capital flows are incompatible with financial-sector stability. And when international security issues become salient, such as during the current Russian crisis, free movement of capital generates even greater volatility.
Something similar occurred in the years preceding the outbreak of World War I. The close diplomatic relationship between France and Germany facilitated the movement of substantial amounts of capital; but moments of international tension, such as the 1911 Morocco crisis, brought about speculative attacks that highlighted Germany’s increasing isolation.
In the interwar years, and especially in the 1930s, when the global security order was disintegrating, speculative attacks became a tool for political manipulation. In particular, Nazi Germany hoped that, by placing financial pressure on France, it could induce credit and budgetary crises, thereby compelling the country to reduce military spending.
One of the hallmarks of the global order implemented after World War II was the interaction between economic and security governance systems, with the same five powers occupying permanent seats on the United Nations Security Council and, for the last generation, on the International Monetary Fund’s executive board. This helped stave off politically motivated speculative attacks and restore global financial and monetary stability.
The Soviet Union did not apply for IMF membership. But, in the 1990s, Russia did – and was awarded a seat on the executive board. Russia was subsequently integrated into the G-8 and the newly constituted G-20.
But the G-8 has suspended Russia, and the country was effectively downgraded to observer status at the latest G-20 meeting in Brisbane. In short, the world order is being recast – and Russia is losing its place.
The Russian political elite had hoped for the emergence of a new or alternative mechanism of global economic governance, underpinned by the major emerging economies – Brazil, Russia, India, China, and South Africa. The so-called BRICS were expected to challenge Western-dominated international institutions, especially the IMF, and the dollar-centric monetary system. And, to some extent, they have. But, so far, the effort’s impact has been limited.
For example, the large gas deal that Russia negotiated with China last May, on terms that favored the Chinese, is reported to include prices denominated in renminbi and rubles, rather than dollars. But, with the ruble’s collapse, these provisions are presumably being renegotiated.
Likewise, in July, the BRICS created a “contingent reserve arrangement” that would, it was claimed, “forestall short-term balance of payments pressures, provide mutual support, and further strengthen financial stability.” But Russia is unlikely to be able to draw upon this emergency credit line in the current crisis.
More recently, Chinese Foreign Minister Wang Yi pledged assistance to Russia. But his vague language reflected a larger hesitation that will probably persist until the crisis is over.
In short, both the Western-dominated governance mechanisms and the BRICS’ fledgling institutions have turned against Russia. At this point, Russia’s only hope is that the crisis triggers such serious instability and contagion that it unnerves investors and emerging economies – and ultimately blows up both global governance systems.