It was inevitable that the Ponzi-like scheme the Russian Treasury was running—where each day it had to find more and more new lenders so it could pay off earlier lenders—could not endure. By August 17, 1998, the Treasury and Central Bank were forced to announce that they could no longer redeem the country’s bonds and pay back its lenders. This collapse was precipitated and made even more serious by the financial upheaval that hit Southeast Asia earlier in 1997. As Thailand and what had seemed to be the other dynamic economies of Southeast Asia fell into recession, commodity prices collapsed. Since most of what Russia exported was commodities, this hurt Russian export revenues. When speculators around the world sensed that Russia might also be vulnerable, they began to sell off their Russian stocks and bonds, thereby anticipating and precipitating such a collapse. This increased the hesitancy among those investors and governments who might otherwise have been willing to provide additional financial support. The IMF did provide a last-minute loan, as did Goldman Sachs, but both loans proved to be inadequate and controversial. Because Russian officials met with the owners of some of the oligarch-run banks before the government publicly announced the debt and a foreign currency exchange moratorium, some of the private Russian bankers used their insider information to sell their government securities and cash out their ruble holdings for the dollars sent in by the IMF and Goldman Sachs before outsiders could seek similar protection. This further undermined confidence in both the government and public officials.
The consequences of such domestic and international economic and financial mismanagement were far-reaching. Since government securities (that is, bonds and short-term securities called GKOs) were the main assets on the balance sheets of most of the country’s banks, and since these securities were now all but worthless, most Russian banks were no longer viable. In all but a few banks, liabilities exceeded assets. Many of the oligarchs who had only recently been at the top of Russia’s income pyramid found their banks were worthless. For a time it looked as if as many as 1,500 Russian banks would have to close their doors.3 In effect, Russia found itself in the midst of a bank holiday similar to the one Franklin D. Roosevelt declared in the United States in the early 1930s. Some bankers, like Khodorkovsky, managed to survive because before his bank Menatep went bankrupt, Khodorkovsky used it to finance the purchase of properties such as the oil company Yukos, which he bought through the Loans for Shares auctions. While most of those companies were not wildly profitable, they made enough to sustain Khodorkovsky’s other operations. But like Menatep, most other banks simply had to close. It did not make Menatep depositors very happy to learn that Khodorkovsky had arranged to transfer the few viable assets that remained out of his Menatep Bank into another financial entity that he operated in St. Petersburg. There they were beyond the reach of all the helpless depositors who had put their money into Menatep.
Russian industrial output and the stock market also took direct hits. The gross domestic product was 5 percent lower in 1998 than 1997. The impact on the Russian stock market was much more far-reaching. By October 1998, just a year after the October 1997 record RTS high of 571, the index fell to a mere 39. For all intents and purposes, the Russian stock market had disappeared.
The impact was not restricted only to those who had invested in the Russian stock market or to Russians. Western banks that had been lending so eagerly to Russian borrowers found themselves with worthless bonds. Some had to write off several hundred million dollars’ worth of loans. Credit Suisse First Boston, for example, lost $1.3 billion and Barclay’s Bank in England lost $400 million.4 In the United States, Bankers Trust wrote off a comparable amount to that lost by Barclay’s Bank.5 More than that, there were fears that the whole U.S. financial world would be similarly affected when the monster hedge fund, Long Term Capital Management (LTCM), in Greenwich, Connecticut, acknowledged that it had lost $1.86 billion of its capital and was insolvent. It was not that the Fund itself had invested in Russia. Rather, it had lent money to other investors who were affected by the moratorium on Russian debt and the collapse of the ruble, none of whom could now repay their loans. Were it not for the timely intervention of the U.S. Federal Reserve Bank, it was likely that the LTCM collapse would have triggered a cascade of other defaults throughout the financial system. Out of concern over the impact of LTCM, the Dow Jones Index dropped by over 20 percent.
Banks and the Dow Jones Index were not the only ones affected. In the panic that followed, many foreign investors who had already set up operations in Russia—not the least of which was Pizza Hut—and imported what they sold were forced to close down. Many decided it was best simply to walk away from investments worth tens of millions of dollars. Others who were thinking of investing simply went elsewhere. Simultaneously, the price of petroleum, Russia’s most important export product, fell from $26 a barrel in 1996 to almost $15 a barrel (see Table 2.1). With its banks closed, its credit worthless, and its main export product earning only 60 percent of what it had two years earlier, Russia saw many of its businesses close or come to the verge of closing, and the prospects for the Russian economy were bleak.
The drop in oil prices in the early and mid-1990s had a devastating impact on oil production. With oil prices so low, by the time the petroleum producers allowed for production costs, taxes, and transportation expenses, there was little and often nothing left over for profit. So the new owners (many of whom were now private entities) not only halted exploration for new fields, they also cut back production in existing fields.6 As a result, Russian crude oil output fell nearly 40 percent from 1990 to 1998.
A QUICK RECOVERY
But sooner than might have been expected, the world economy began to recover. Led by an increase in commodity prices in southeastern Asia, where the recession began a year earlier, energy prices also began a quick recovery. By 2000, oil prices hit $33 a barrel, double what they had been only two years earlier (see Table 2.1). What had been a glutted market almost overnight turned into a tight market.
Much of the impetus for this change was due not only to a recovery in Europe and the United States but an ever larger increase in demand for oil and gas in India and China. Whereas China was actually a net exporter of petroleum in 1993, by 2005 it had become a major importer, forced to import 40 percent of its petroleum.7 In 2006, it imported 138 million tons of crude oil and 24 million tons of refined petroleum.8 Only the United States imports more. As the Chinese economy grew, this new wealth brought with it an even higher demand for petroleum. Chinese consumers’ increasing use of cars and air conditioners, machines that are particularly heavy users of energy, was especially important in driving up demand. Simultaneously, China continued making massive investments in heavy industries such as steel, aluminum, and cement plants, all of which require very intense input of energy.9 So in 2004, while China’s GDP rose about 9 percent, oil consumption rose 16 percent. Overall, from 2001 to 2006 China’s energy consumption rose an average of 11.4 percent annually, which was greater than the 10 percent annual growth of its GDP during similar years.10 Oil consumption did not increase as much in the years immediately following, but still by 2006 China consumed about 7.5 million barrels of petroleum per day (350 million tons), 6–8 percent of the world’s total and second only to the United States, which consumed about 20 million barrels per day (940 million tons).11 Some Chinese economists project that energy consumption in China will more than double between 2006 and 2020 and triple by 2030.12 This would mean China will be importing 500 million tons of petroleum a year, which approximates Saudi Arabia’s entire production. (Some of this would come from countries that no longer need to consume as much because they have become more efficient in using what they have. But that would not free up enough to satisfy China’s need. Who the suppliers will be for the additional coal, oil, and gas needed to feed China’s voracious energy consumption is not clear.)