July 1, 1999    
This Date's Issues: 3371 • 3372 •3373 

Johnson's Russia List
#3372
1 July 1999
davidjohnson@erols.com

[Note from David Johnson:
1. Itar-Tass: Russian Security Service To Oversee Dec Duma Elections.
2. Moscow Times EDITORIAL: Leave Voting To Citizens, Not Chekists.
3. Radiostantsiya Ekho Moskvy: Governor Ayatskov on Center-Right Coalition.
4. Andrew Meier: The Russian Market from start to crash. (Background to
PBS Frontline program, The Crash).
5. Financial Times: Martin Wolf, CAPITALISM: Caught in the transition trap.]

*******

#1
Russian Security Service To Oversee Dec Duma Elections 

MOSCOW, June 29 (Itar-Tass) - Russia's security 
agencies will play an important part in the run-up to parliamentary 
elections due in December, the director of the Federal Security Service 
(FSB), Vladimir Putin, said on Tuesday. 

Putin was speaking at a session of regional security chiefs, which was 
attended by Prime Minister Sergei Stepashin, who made a speech. 

"They (the elections) must take place in terms defined by the 
Constitution, in full compliance with the norms of election legislature. 

They must be free, equal, and democratic," Putin said. 
Security agents will control capital flows during the election campaign and 
dig up information about illegalities, he said. 

"Our main task is to prevent criminals from penetrating into power. A 
breakthrough has appeared in public opinion, and people are feeling the 
necessity for the law enforcement agencies, and the security services in 
particular, to work efficiently," he said. 

Meanwhile, Putin declared, the FSB is not going to exert pressure on voters 
or violate human rights in any way. 

"A throwback to the past is out of the question," he told reporters, 
adding that the FSB "will perform no unconstitutional functions." 

Meanwhile, "the necessity for discipline and order is ripe in society," he 
said. "I believe the state should create conditions for the upcoming 
elections to the lower house of the Federal Assembly (parliament) to be 
as transparent and open as possible," he said.

*******

#2
Moscow Times
July 1, 1999 
EDITORIAL: Leave Voting To Citizens, Not Chekists 

On Tuesday, Prime Minister Sergei Stepashin addressed a meeting of the 
Federal Security Service. His message: FSB agents have a crucial role to play 
this winter in keeping undesirable elements from being elected to the 
parliament. 

We would disagree with the prime minister's assertion entirely. Let the 
voters decide who should be in the parliament. 

It's hard to imagine a situation in any democracy where the security services 
should be encouraged to place their own political judgments above those of 
the electorate. But it's even harder when that security service is the 
not-so-reformed former KGB. This is the same organization that in April 
offered parliament its cheeky and unsolicited opinion that the Duma's drive 
to impeach President Boris Yeltsin was illegal. 

Stepashin told his Chekists that "criminals" are about to slip into the Duma 
through the December elections and called for vigilance. Now, again, this is 
the same FSB that earlier this year was torn between two camps f each of them 
accusing the other of running organized crime rings within the agency. 
Alexander Litvinenko and two other former FSB agents told a national 
television audience they had been instructed by superiors to assassinate 
Russia's best-known political intriguer, tycoon Boris Berezovsky. Amid 
giggles and criminal slang, the three also bragged of their own exploits, 
which included kidnapping, torture and killings. 

So no matter how one parses this, it seems that the FSB is having a problem 
keeping contract killers out of its ranks. How is it going to keep more 
run-of-the-mill criminals out of the entire national political scene? 

For that matter, why should we trust Stepashin when he publicly wrings his 
hands about organized crime creeping into politics? Isn't this the same 
Stepashin who, as interior minister, airily announced he would ignore an 
arrest order for Berezovsky issued by the prosecutor general? We are not 
making a commentary here on Berezovsky, only on Stepashin's sense of duty f 
here was the nation's No. 1 police officer, defiantly brushing aside orders 
from the prosecutor. Berezovsky will come in his own good time and "explain 
matters," was how Stepashin put it. (After this performance f to say nothing 
of Chechnya f how could self-described "democrats" applaud Stepashin as prime 
minister?) 

Stepashin has been vague about how FSB vigilance might translate into action. 
However, he has put forward one concrete task: to keep these elections 
"clean" of kompromat, compromising materials. But what is kompromat f except 
evidence of criminal wrongdoing on the part of government officials that 
finds its way into the news media? And what can the FSB do to stop this, 
except muzzle the media? 

********

#3
Governor Ayatskov on Center-Right Coalition 

Radiostantsiya Ekho Moskvy
29 June 1999
[translation for personal use only]

[Presenter] It's 1418 in Moscow, this is Marina 
Starostina and our studio guest is the governor of Saratov Region, 
Dmitriy Ayatskov. Good day, Dmitriy Fedorovich. [Ayatskov] Good day. 
[Question] We'll try to discuss the forthcoming parliamentary and 
presidential 
elections first of all, which leads to the first question as follows. 
There's a lot of talk about the chances of setting up a right-wing bloc 
for the elections. As far as I know, you're one of the people behind the 
idea. 
[Answer] You're absolutely right. There is a lot of talk about, although I 
don't want to claim that I am the only person behind the idea of setting 
up a right-wing bloc. It's also being worked on by our leader, [Viktor 
Chernomyrdin]. He's involved in some intensive negotiations. I'm also 
involved with this issue, on Viktor Stepanovich's instructions, and I'm 
talking to [Samara Region Governor] Konstantin Titov, [Kemerovo Region 
Governor Aman] Tuleyev and [Sergey] Kiriyenko, and I think that we all 
understand that if we help the left-wingers by not organizing the 
right-wingers we'll be in for a crushing defeat. [omitted: general 
prediction that the idea will catch on]. 
[Q] Do we need such a bloc? A lot of people are saying that the left 
wing is not so strong now. Tuleyev has broken away from the Communist 
Party, for example. 
[A] In any event, we mustn't fragment ourselves. We must do all we can 
to not only clear the five-per-cent threshold but to make sure as well 
that the right wing forms an overwhelming majority in the next Duma, the 
1999 one. [omitted: the right wing could then push through its agenda and 
do away with the legacy of Soviet legislation; jokes that elections 
should be held, annulled and then held again as many times as needed to 
soak up all loose money in the country; after that proper and equal 
elections can be held] 
[Q] Let's go into this in more detail. Who in your opinion could join a 
right-wing-orientated electoral coalition? 
[A] I think that All Russia, Voice of Russia, New Force, all political 
forces... [Q, interrupting] What about Fatherland? 
[A] Including Fatherland. Yuriy Mikhaylovich Luzhkov is a level-headed 
man and the type of Russia he wants is not one with a bright past but 
with a great future. 
[Q] But how could Kiriyenko's New Force coexist with Luzhkov's Fatherland? 
[A] I think that we're talking about a theatre here, in which there are 
lots of actors and each plays his own role. And in the end, behind the 
scenes, they sometimes embrace each other. No matter who's the star, no 
matter what role each is playing, they can say what they like to the 
cameras. But what's best for them? I'm sure that Kiriyenko could find a 
common language with Luzhkov. And [Boris] Nemtsov, who doesn't really 
like Chernomyrdin, could find a common language with him, and so forth. 
They shouldn't place their own personal vanities above the public's best 
interests. Sometimes you have to shelve these vanities, maybe for several 
years. 
[Q] What role is the Kremlin playing in setting up this electoral 
coalition? 
[A] The fact that a political directorate has been set up is very good 
news. The fact that we're putting ideological differences to one side is 
also very good news. The Kremlin is concerned about the future. If we 
again say that the Duma is transitional, then we'll enter the next 
century still in transition. The public won't put up with that, and the 
economy won't withstand it either. And we'll disgrace ourselves not only 
in the eyes of our neighbours but of the international community as well. 
[omitted: general ruminations on the relationship between political 
parties and power and parties' desire to win power, citing situation in 
other countries as examples] 
[Q] Dmitriy Fedorovich, another question is who should lead the 
right-wing coalition. Stepashin's name often crops up. 
[A] That's an important question, because whoever becomes the leader of 
the right-wing majority, the leader of Rossiya, will probably be a future 
contender for the presidency. Who should lead the bloc? I've said in the 
past, and repeat again now, that there is no single name emerging from 
the ratings published in 'Novaya Gazeta', 'Nezavisimaya Gazeta' and 
elsewhere in the media. But a name will emerge closer to the elections, 
somewhere around October or November, so I won't speculate at the moment. 
[Q] What about [Yevgeniy] Primakov's chances? 
[A] Yevgeniy Maksimovich is a very cautious and diplomatic man. I don't 
think he'll jump boldly to either Fatherland or the All Russia right-wing 
movement. He'll tread his own road. This is my own opinion, and I don't 
seek to impose it on Yevgeniy Maksimovich. But I think that wherever he 
decided to run for parliament in the future... 
[Q, interrupting] I remember that you once said you wanted him to run 
for a constituency in Saratov Region. 
[A] Unfortunately, Ekho doesn't reach as far as Switzerland [where 
Primakov is now] and he probably can't hear us. 
[Q] But you are in touch with him? 
[A] He'll be back soon after his treatment, and I think he'll hear what 
I'm saying. I would like him to do exactly that - run in a single-seat 
constituency and then head the lower house of parliament. [omitted: 
Primakov would be a good speaker of parliament; predicts a tough and 
sometimes dirty election campaign for December; says Russia's voters are 
becoming more discerning] 

********

#4
Frontline
PBS television series
The Crash
broadcast June 29, 1999
Background information and interviews at
www.pbs.org

The Russian Market from start to crash 
Memo to Sherry Jones from Andrew Meier/Moscow, 2/2/99 (meier@glas.apc.org)
(Meier works in Time's Moscow bureau and is the author of "Russia in the 
Red,"Harper's, June 1999. Sherry Jones is the producer of FRONTLINE 's 
documentary, "The Crash.")

Sherry,
Over all, it seems to me that the most interesting questions to cover, which 
no one has yet covered in much detail, are:

a. the role of the oligarchs in all this
b. the White House & US Treasury
c. the IMF 
These are the chief parties who exerted muscle in encouraging ex-prime 
minister Sergei Kiriyenko to pull the trigger. One idea for us might be to 
fill in the trans-Atlantic dialogue that transpired from the spring of last 
year to August 17, 1998. 

To start

Make it easy. Begin by taking a look at the graph of the life of the Russian 
Trading System (the RTS) on their web page. It looks like a child's drawing 
of a fairy-tale mountain. It goes perfectly steep up one side and just as 
steep down the other. 

The stock market here didn't last long. But while it did, boy did it boom. In 
its first post-Soviet experiment with the markets, the Russian government 
raised about $45 billion from 1994-98 by selling securities (GKOs, Eurobonds, 
MinFins), Russian commercial banks and companies ran up debts of an estimated 
$20 billion more. Anywhere from $60 - $100 billion left Russia over the same 
period. In short: contrary to conventional wisdom, Russia didn't crash for 
lack of money.

Russia's brief experiment with the free market began with pain.

There was price liberalization, hyperinflation, massive un/underemployment. 
Here you may wish to remind Strobe Talbott of his own words--to 
paraphrase--"There was too much shock, not enough therapy." A brief refresher 
of the elemental phases:

1992: On Jan 2, Yegor Gaidar ends price controls - arguably the most 
important decision of the post-Soviet era. Gorbachev's talk of the coming of 
'market socialism' ends. Foreign exchange controls are abolished, too. The 
market would come, all right. (Western governments, by April, gave the first 
big cash infusion--$24 b. aid package) 

June 15: Yeltsin names Gaidar acting pm (he is never approved) 

August 15: Yeltsin announces the voucher program. But there was a problem: 
the economy had no competitive levers - no invisible hand to control supply 
and demand. What resulted? Hyperinflation--some 2,600 percent in 1992. Life 
savings and pensions were inflated away--by the day. The masses were not so 
irate last August about the banks' folding because many had lost their 
savings in '92.

Gaidar then set about dismantling the Soviet command economy--stripping the 
state of its immense property holdings. This phase is best seen through the 
history of one "organization"--the GKI, the State Property Committee. From 
Chubais through Boyko to Kokh. What began as an inspired, Thatcheresque 
ideology of de-politicizing the state's assets ended up with Kokh--as a sales 
quota. ($1 billion per annum, is what Kokh told me bluntly). Just like in the 
Soviet days--a plan to fulfill.

Vouchers

Thanks to a scheme planned and paid for in large part by U.S. taxpayers--145 
million Russians received vouchers for shares in some 15,000 large state 
enterprises. But before long, it all started to go bad--really bad. 
Privatization began with the vouchers--but who would get the factories and 
mines was more often than not understood long beforehand. In many regions, 
the so-called Red Directors would retain the controlling stakes in their old 
enterprises. No one bothered to explain the need for direct foreign 
investment and transparency and efficiency and so forth. Taxes started to go 
uncollected, regional budgets broke down, profits flowed off-shore and barter 
began to spread like a cancer.

Only in 1994 did the then-prime minister, Viktor Chernomyrdin, understand 
that printing money was not the right answer. This brought Gaidar's infamous 
quip on the end of "the most expensive education in history."

Privatization's second phase 

1995 and 1996: The reign of Chubais-shchina. Chubais in short order became 
the darling of D.C. The WH, Treasury, State Dept seemed to back him from the 
get-go. Why? A number of good reasons. But in short: Chubais got things done. 
By 1995, everyone knew that if you had to get something done, some document 
signed etc--see Chubais. Moreover, he looked like a Westerner--tall, wore 
good European suits, carried his own laptop, etc. Russians may not have 
trusted him, but Western diplomats and businessmen sure did.

Under Chubais, two dark currents ran strong and deep: the sell-off of state 
industries and the development of "authorized banks"--banks, or rather 
financial vehicles, that were given carte blanche with budgetary funds--for 
financing state enterprises, arms production, taxes, you name it--they got it.

How the giants were sold

The auctions, simply put, were imperfect. (We can do detail on this, if need 
be.) A series of privatization "auctions"--whose results were determined 
beforehandówere held by the GKI. (There are books out on this phase, but in 
essence, they held the firesale of the century. ) The engines of Soviet 
industry --oil companies, metals plants, utilities-- were sold for a song. 
Russia is among the world's richest countries in terms of natural 
resources--(The Natural Resources Minister, Viktor Orlov, can run down the 
list of gold, nickel, silver, timber, oil and of course natural 
gas--one-third of the world's reserves--for you.). And in short order, the 
riches were exported by the shipload east and west.

Theft

Ever wonder how Estonia, a country that produces no aluminum, became one of 
the world's top aluminum exporters? This was the market's main cancer: theft. 
The greed that motivated it (and still does) was impressive. But the theft 
will go down in history. Economists now talk about state corruption, and of 
course graft was a contributing cause of the market's death, but pure and 
simple robbery played the leading role. The rape of Russia's riches in its 
first decade of "independence" will doubtless be remembered in a century's 
time as unprecedented.

The locals had plenty of help

The gold-diggers flew in from Wall Street and Washington, London and Tokyo. 
By 1995, much of Wall Street was sold on Russia. "Bullish on the Bear," was 
the title of one Salomon Brothers' breathless report on the new market. In 
1996, an economist from LSE joined a former Moscow correspondent from The 
Economist to write a book (unfortunately) entitled The Coming Russian Boom. 
The Western bankers played eager pilgrims. The auditors too. One US 
accountant--from a Big 8 firm--once told me: "We don't practice creative 
accounting in Moscow, but we often have to create new ways of accounting." Go 
figure. 

Politics (or Yeltsin's ego)

You can never leave out Yeltsin's easily offended ego when it comes to 
Russia's market experiment. Think of it this way: Before the '96 election, 
Boris was weak. He was, if you remember, all but ruled out. He needed the 
cash. He needed the new financial elite on his side. Now it has become 
fashionable to downplay the role of the oligarchs in reelecting Yeltsin. I do 
not agree. Those who attended the financial "strategy" sessions say that it 
was never a question of whether or not to give to Yeltsin's campaign; it was 
a question of How Much. And give they did.

The mythical banking sector 

Russia, we are told ad nauseam, had at one point as many as 5,000 banks. But 
most were flimsy shells. Ever wonder why there were so many armored cars 
circling Moscow? Most companies could never get more than, say, ten thousand 
dollars in cash from a bank.

The reason: there was never a real, functioning banking sector. No credits, 
no small-biz loans, no credit cards. And certainly no multiplier effect. The 
banks were parasites, not catalysts for growth. The financial sector grew 
fast in the early 1990s--some 45 percent from 1992 to 1995, even as GDP 
plummeted. But why did Russia need so many banks? (New ones appeared by the 
week, on every corner) The biggest banks speculated against the ruble using 
the state funds entrusted to them. (In large part the fault for this lies 
with the government itself, for it never developed a treasury system.)

The debt

The biggest banks--Unexim, Menatep, Inkombank, Rossiisky Kredit, SBS-Agro, 
Nationalny Reservny (Gazprom), MOST--grew into "powerhouses." By 1995, 
however, the government faced a new problem. (Rather, an old problem that 
everyone had quietly ignored.) The state debt. To cover yawning gaps in the 
budget, the govt. was forced to find a new way to come up with the cash. As 
the unpaid masses began to protest, demanding their months --for some, 
years--of back wages, the masters of the state's finances realized they had 
to do something. Russia had already borrowed billions in the first 
post-Soviet years--from the West, mostly through the IMF (I have the stats, 
if needed.) But now they tried a new trick--they created a cash channel. They 
would sell short-term, ruble-denominated treasury bills, known as GKOs (not 
pronounced GECKOS, as some would have you believe, but GAYKAYOOS). At first, 
the idea, blessed by the US advisors, seemed swell. Western and Asian 
investors had liquidity. Emerging markets were hot. And Russia needed cash. 
Moreover, Russia had 30,000 nukes and some 147 million consumers. "It can't 
crash" was the refrain. The GKOs, moreover, as anyone who went big in them 
will now tell you, were to be guaranteed by the Central Bank.

Was it a pyramid scheme, an international ponzi scam? To a good degree, yes. 
But at first, the bonds made great sense. And they worked--they delivered 
billions to the Central Bank. Did that money go to the budget? To pay 
pensions, the army, social services etc? Some of it did--the finance minister 
Mikhail Zadornov and others insist. But most of it went right back out--to 
pay off the debt that they couldn't roll over. Obviously, the process had 
momentum--the higher the yields soared, the more people bought the GKOs. Up 
to a point. At triple-digits returns, even the deep-deep-pockets started to 
worry about the state's ability to pay off the bonds. 

The state started to have a new trouble: moving the paper at its weekly 
auctions. Then during the spring and summer, it started canceling the 
auctions altogether. This was not, to put it mildly, a good sign. The debt, 
all the while, compounded.

Sirens should have sounded. It was not just the bond market. (We can't forget 
MinFins, Eurobonds too.) It was also the stock market, an experiment that 
soon grew into a cash cow for Russian and foreigner high-risk investors 
alike. The stock market looked like good value, even with its high risk. 
(Hedge funds--the monsters that helped eat up the promise of 
globalization---mushroomed in the Russian market). But market cap was never 
high. Even at its peak, the stock market never held more than $127 
billion--about four times Amazon.com.'s stock value (as of this writing).

1997

The market's big year. It grew beyond anyone's dreams. As returns on some of 
the top stocks hit 1,500 percent, the market became the world's hottest 
emerging market. The fault-lines were obvious. The blue chips were 90 percent 
oil and gas. Moreover, with their brazen dealings, the leaders of the Russian 
market put Boesky and Milken to shame. Insider trading was not the exception 
- it is said to have been the coin of the realm. An American corps of 
advisors and consultants tried to bring financial law and order to the 
market. They even helped to establish a Russian-style Securities and 
Exchanges Commission. But enforcement was rare.

So was real, direct investment. Very few foreigners put a dollar or a DM in 
the decaying Russian factories and mines. At the same time, they had good 
reason not to. Tax men, hit men and old-guard industrial captains (the 
infamous "Red Directors") conspired to discourage foreign investors from 
trying more than a brief fling with "the new Russia." It was a dance, a 
flirtation--but never a long-term relationship. Investors went bullish, but 
never committed.

In the weeks before Yeltsin's '96 reelection, annualized yields on GKOs 
climbed over 150 percent. The triple-digit yields should have caused the IMF 
to reconsider its policy. But by then, the big boys of the emerging market 
sandlot had gone long on Russia-- Mark Mobius and George Soros. Inflation 
(which had bloomed famously under Gaidar) had flattened off into single 
digits and stocks boomed. Traders from Texas and London and Omsk squared off 
in the fight to discover the best finds on the RTS - the stock market.

Forwards

Even though the tight ruble corridor was holding and inflation had come 
dramatically down, given the history of hyperinflation, the Western houses 
that went big into GKOs all started to sign dollar-forward-contracts. (We can 
do detail on this, should you desire.) In essence, the foreign banks were 
smart; they wanted to hedge themselves against a fall in the ruble. These 
deals were signed in quiet--as the Russian banks didn't really have the cash 
to cover the contracts (a point that has now become painfully obvious.) I 
remember well the day last spring as the ruble came under attack and the 
devaluation rumors gained weight, when I asked one of the top bankers, 
Vladimir Potanin, about the dollar-forwards--news of which had only just 
spread. (Reports had surfaced suggesting that the forwards could amount to as 
much as several billion dollars worth of contracts.) Potanin simply replied 
that "I don't think anyone bought GKOs without signing forwards on them." 
(The Russian banks, in turn, had hedged their contracts, naturally, to guard 
their own positions.) And so the GKO market was not only soaring, the higher 
it went the more weight it put on the hollow banking system. The bomb went 
off in my mind: a devaluation would destroy the banks.

When things started to go seriously wrong

First: Svyazinvest. Soros and Potanin broke the "gentlemen's agreement" on 
the privatization auctions. They paid a competitive price--at the time--for 
the goods. Second: At the same time, the 'bankers' war" broke out. In part 
because of Svyazinvest. But more because the oligarchs had let their egos get 
the better of them. They began to believe that Chubais & Company were in 
their employ, that they should do their bidding, and if they failed to--they 
should be fired.

Soon enough, in the fall of 1997 the first waves of the Asian contagion hit. 
The world price for crude--Russia's primary hard currency export--had already 
begun its fall. Indonesia went. Japan foundered. The Asians dumped their 
GKOs. Those ministering to Russia's finances yet again doubled GKOs yields. 
As 1998 opened, the sharks swarmed. The ruble came under attack--again and 
again. With the GKO market soaring, the stock market--by the inverse nature 
of their relation--tanked.

Still, Chubais, who had shuffled so often between the cabinet and Kremlin in 
recent years, repeated his mantra that Russia would soon see growth. The 
Asian flu, Chubais insisted, was good news for Russia. "It proves that at 
last we've joined the global economy." As the ruble fell prey to attacks, the 
Central Bank mounted a costly defense. "A stable ruble," Chubais chanted, "is 
our pride, proof that the reforms are working."

The Central Bank, however, soon burned billions in hard currency reserves 
propping up the ruble. During a June visit, World Bank head James Wolfensohn, 
ever the affable Australian, was saturnine: "A bump in the road to be sure," 
he told Russian reporters. "But you've been through crises before."

A note on George Bush's cameo: You may wish to get footage of Bush's speech 
at the Goldman Sachs' gala in early June. It was a classic. Ranks up there 
with his famous Chicken Kiev speech. Goldman flew him in to open up their 
Moscow office. As the signs of impending doom swirled and the dire diagnosis 
of Mobius ("This is meltdown time folks") lingered in the Moscow air, Bush 
declared his faith in "the power of freedom and free markets." "I am 
optimistic," he told the gathering in the elegant House of Columns (where 
Stalin had lain in state). "I believe Russia is going to thrive." Coming as 
Russia's stock market hit a new low and GKO yields soared, his speech sounded 
more like a half-time pep talk to the Christians in the Coliseum.

In July, after long weeks of suspense, The Bailout arrived.

Chubais joined IMF and World Bank officials in the Russian White House to 
unveil a complex package of $22.6 billion in credits. (Japan also pledged a 
small slice of that--to feed hungry coal miners in the far eastern regions 
that have critical exports for the Japanese market.) But no one knew how much 
Russia really had received. Previous credits were thrown in to pad the total. 
Billions more depended on the Duma approving liberalizing economic measures, 
while the World Bank tagged its credits to vague "structural reforms."

And so, the headlines around the world the next day gave varying figures for 
the total credits. The Bailout, we were assured, would return confidence to 
the market. The IMF team left town. Chubais went on holiday. Potanin went to 
Europe, to enjoy his yacht. The IMF delivered the bailout's first tranche, 
$4.8 billion. But John Odling-Smee--the IMF's top man for Russia who helped 
Chubais announce the Bailout--is said to have told fellow passengers on the 
flight from Moscow that "there's no way they'll ever get all the cash." 
Within days, no one believed in the package. The markets, meanwhile, kept 
staggering--down one day, up a bit the next. But the confidence in Russia's 
ability to steady itself never came.

By late July the rumors of a devaluation, first floated before May Day, hit 
fever pitch. The Central Banker, Sergei Dubinin, instructed his compatriots 
"to spit in the eye" of anyone who dared to call devaluation inevitable. (He 
had in mind the liberal, provocative, economist Andrei Illarionov--who had 
been making daily press statements that the devaluation was inevitable.) 
Pressure on the ruble mounted, as investors ran for shelter in dollars. The 
Central Bank had just $12 billion in its coffers, with some $4 billion of 
that in demonetized gold bouillon. The GKOs were coming due with accelerated 
regularity. Several of Russia's biggest banks, the plush lairs of the 
once-flush oligarchs, failed to meet margin calls on loans from Western 
banks. The state faced darkness: it could not cover its debts.

The chronology (sketched in brief)

On August 13, 1998, after blue chips fell more than 20 percent in the first 
hour of trading, the Moscow stock exchange shut down as the RTS fell 6.5 
percent overall and yields on GKOs soared above 200 percent. The cause this 
time is not just the sinking Yen: Soros also did his part. One of the biggest 
players on the Russian market, in an August 13 letter to the Financial Times, 
Soros called for devaluing the ruble, tagging it to the dollar or euro and 
establishing a G-7 backed, $50 billion currency board. (Had such a board been 
created, Russia's Central Bank would have had to guarantee all rubles in 
circulation with dollars or euros at the established peg level. Soros in his 
FT letter kindly added that Russia's meltdown had reached "a terminal phase."

Friday, Aug. 14, the rulers of Russia's finances convened in the White House. 
It was late in the night when they ran down the figuresótrying to tally CB 
reserves versus debt coming due. Zadornov and Dubinin were in charge. 
Kiriyenko listened. The Soros FT letter was discussed at length. Yeltsin's 
"no devaluation" promise still resounded on the TV news--he'd said it only 
hours earlier on a visit to a sausage factory in Novgorod. There was a sense 
of panic. In large part because the IMF top advisors were out of town. And 
because Chubais, the mastermind of the post-Soviet political economy, whom 
millions of Russians consider an agent of Washington, World Zionism and 
Deutsche Bank, was still on holiday in Ireland. But all agreed that if they 
were going to devalue it had to be done immediately--on the weekend moreover, 
so as to limit the hemorrhaging. (Or so they thought).

Early on Saturday, Aug. 15, Kiriyenko called a conclave at his government 
dacha outside Moscow. Kiriyenko and Gaidar ran the meeting, which lasted for 
hours. Chubais--according to my interviews--had made it back by then. He and 
Dubinin and Gaidar assured Kiriyenko the IMF would back them up, and they 
were right--in part. Over the weekend there would be more meetings.
The IMF's top Russia hand, Odling-Smee, would also fly back that Saturday 
morning. Handmaidens from Washington would sit in on the meetings in the 
Russian White House, compounding the hand wringing.

At least two participants of those White House deliberations say the decision 
to devalue was made by a small circle: Kiriyenko, Chubais, Dubinin, Zadornov, 
Vyugin and Gaidar. Boris Fyodorov, the former finance minister and erstwhile 
tax czar, says that after the dacha gathering, when he first learned of the 
planned default on GKOs, he rushed to the Metropol Hotel near the Kremlin to 
tell the IMF delegation. "I warned them of the coming suicide," Fyodorov 
would later say. "I tried to get them to stop Kiriyenko. But I realized right 
away--they knew, they were in on it and they decided to keep quiet about it."

Later on Saturday, the usually restrained, unflappable Kiriyenko was on the 
verge of panic. During the night, as people came and went through the White 
House, it was Chubais who held court. He had not had his best year. Embroiled 
in a scandal over an unseemly book advance from a Swiss company tied to 
Potanin, Chubais had spent much of 1998 in political exile. In delivering The 
Bailout, however, he had returned to savor the limelight. It was late at 
night when he laid out the state's emergency exit plan to the assembled 
ministers and bankers, uttering almost in passing, the fateful words, 
"controlled devaluation." "I knew right then," said one of those present, "we 
were fucked."

Chubais standing at the window in the White House that night in mid-August, 
almost 7 years to the day after the 1991 coup against Gorbachev, uttering, 
for the first time, the words "controlled devaluation." The moment may well 
deserve a special place in Russian history--alongside the passing of a 
General Secretary, the beginning of a purge, the end of an era. The pain, 
Chubais said blithely, would be minimized. By Sunday, however, the oligarchs 
had camped out at the White House.

Sunday afternoon the cabinet took a straw vote in the White House. All were 
in favor. Sunday evening, Kiriyenko decided the time had come to tell 
Yeltsin. The PM and Chubais and Kremlin chief of staff Yumashev choppered out 
to Yeltsin's country residence in Zavidovo--known as Rus. "Grandpa," as 
Nemtsov calls Yeltsin, gave his blessing. (All the subsequent talk that 
Yeltsin knew nothing about the coming devaluation was shameless spin).

While Kiriyenko and Co. were at Rus, the oligarchs agitated for a total debt 
freeze--both domestic and foreign. They'd get most of what they demanded. 
They'd get a 3-month freeze. NB: In the wake of The Deval, some would say the 
barons of Russia's nascent financial- industrial empires had little to gain 
from a devalued ruble, and everything to lose. Others would note that when 
your debts are big, and getting bigger all the time, devaluation never hurts. 
(Especially when your chief commodity is oil.) A debt moratorium, however, 
would give all players a precious time-out--time enough to channel equity 
abroad.

Late Sunday night, the PM broke the good news: there would be the 
"controlled" devaluation and a debt freeze--but only temporary while the debt 
restructuring was worked out. Early Monday morning, just a few hours before 
the world would find out the news, the IMF gave Chubais and Gaidar its OK. 
"They were in on the discussions all along," insists Gaidar. "The IMF knew 
what our idea was and they supported it. All attempts to say otherwise now 
are simply cowardice."

Monday, Aug. 17: And so the deed was done. "It's over," came the calls--one 
after another, from the distraught bankers and brokers. Russia defaulted on 
$40 billion in GKOs and cut its umbilical cord to the capital markets. Many 
of Russia's fattest banks would cave in. Hardest hit, of course, was the 
infant middle class. The stock market tanked. By October 6, 1998, one year 
after hitting a high of 571, the RTS hit a new low, at 37.

"Kto vinovat?"-who's to blame?

The political witchhunt--"Kto vinovat?" being the first instinctive question 
on many Russian minds--began right away. The Communists cried for arrests, 
the Central Bank came under attack. The IMF hid. Soon Dubinin resigned (and 
went back to Gazprom). By now all the contenders for Yeltsin's throne have 
cried for the guilty, those behind the GKO "pyramid" and the "criminal 
privatization," to be tried. In Strasbourg not long ago, Interior Minister 
Sergei Stepashin told the Council of Europe that $1 to $2 billion was 
smuggled out of Russia each month. The prosecutor general's men seized the 
databases of the Moscow Interbank Currency Exchange, investigating money 
laundering by state officials. The data, prosecutor general Yuri Skuratov 
promised, would reveal the activity of the accounts of those who had been 
deepest in GKOs. In November, the business daily Kommersant reported, citing 
"operational information" from the Interior Ministry, that in the days before 
August 17, "high officials of the government and the Central Bank warned 
certain participants in the GKO market about a default." Those fortunate few, 
of course, could then dump their GKOs. By now, the oligarchs have taken a big 
hit--for some, the fall has been fatal. (Sidanko this week will go into 
bankruptcy). Boris Nemtsov, the former deputy prime minister, was blunt, 
telling me, "Now there's only one oligarch left--[Moscow Mayor Yuri] Luzhkov."

The irony

Nearly a decade after the fall of The Wall, life in Lenin's old land was 
supposed to be better than this. 1998, as Chubais had promised every 
journalist who would listen, would be the year that Russia turned the corner, 
that the Motherland enjoyed real economic growth at long last. Instead, the 
crash came and Chubais was history. 

Yeltsin had decreed 1997 the "Year of Reconciliation and Accord." There was 
little evidence of either, however. And in 1998, political crises became the 
norm, as Yeltsin fired two prime ministers and as many governments. And 
brought in a third--Primakov--only after the toughest political standoff 
since October 1993. By the fall, the reformers were out in the cold. One day 
in October, Nemtsov was summoned to the Kremlin to meet with Yeltsin--(when 
Yeltsin named him to his present volunteer job on some little-known Kremlin 
committee). After a long lunch in the Kremlin, Yeltsin invited Nemtsov out to 
Gorky-9 for tea and a stroll. As they walked in the woods --in Nemtsov's 
telling--Yeltsin turned to him and asked after "the boys" (i.e. the young 
reformers he had so praised only months before.) Nemtsov demurely explained 
that they'd known better days. (He didn't have the nerve to ask why the 
president had fired them all) In response, Yeltsin simply shook his head, and 
sighed: "So the old guys have come back?" 

As the year closed, Russia faced its darkest winter in years. The bankers and 
brokers, traders and importer/exporters were all badly wounded. So too were 
the political "liberals"--the Molodiye Reformatory who had sullied words like 
Democracy and the Free Market. Now they would have to bear the blame for the 
so-called "reforms." And then before long, came the murder of one of their 
own--the Duma deputy Galina Starovoitova, who had long demanded genuine 
reform that developed genuinely democratic institutions.

Just before New Year's, Russia failed to make a $362 million payment on 
Soviet debt. By then the point had grown obvious to all: Russia will soon 
have to default on its external debt as well. As one top banker put it to me 
in early January of 1999 : "We are now living on the good will and patience 
of the Western bankers." 

********

#5
Financial Times
30 June 1999
[for personal use only]
CAPITALISM: Caught in the transition trap 
By Martin Wolf (Martin.Wolf@ft.com)

The nomenklatura capitalism that has evolved in many former communist states, 
including Russia and Ukraine, is to blame for the failure of reform

How are the mighty fallen! This year, according to World Bank forecasts, 
Russia's gross national product will be a mere $167bn, which would make it 
considerably smaller than Belgium's and only 25 per cent bigger than 
Poland's. This contrast with Poland defines a decade of transition. Turning a 
socialist dictatorship into a market democracy was feasible, but hard. Some 
have managed; others have failed.

Just under a decade ago the Poles elected their first non-communist 
government. Then, at the end of September 1989, Leszek Balcerowicz, the new 
finance minister, went to Washington. His aim was to tell the policymakers 
gathered at the annual meetings of the World Bank and International Monetary 
Fund of his government's plans to give his country a market economy. He 
spoke; they listened; then, in 1990, the transformation began.

It was a long and difficult road. But last year Poland's real gross domestic 
product was 17 per cent higher than when transition began. Its economy has 
grown at between 5 and 7 per cent a year in every one of the last five years 
(except 1998, when growth was still 4.8 per cent). Russia, by contrast, has 
lost close to half its output and has experienced negative economic growth in 
every year of its transition (except 1997, when output expanded by a mere 0.8 
per cent).

The contrast between Poland and Russia is part of a wider divergence between 
central Europe and the Baltics, on the one hand, and the rest of the former 
Soviet Union, on the other. In essence, the former, which have reformed with 
relatively greater determination and consistency, experienced substantial 
initial declines in GDP, but then recovery. But the latter have suffered 
sustained declines, with no reversal.

The most recent forecasts for 1999 from the European Bank for Reconstruction 
and Development show that the biggest declines in GDP in central and eastern 
Europe and the Baltic states were in Latvia, down 40 per cent since 1989, 
Macedonia, down 40 per cent, Lithuania, down 35 per cent, and Bulgaria, down 
34 per cent. Many have managed several years of consistent growth - not just 
Poland, but also Croatia, Estonia, Hungary, Latvia, Lithuania, the Slovak 
Republic and Slovenia.

The contrast with the Commonwealth of Independent States could hardly be more 
stark. Nine out of 12 countries have lost more than 40 per cent of their 
pre-reform output. The worst performers - Georgia and Ukraine - have lost 
some two-thirds of their initial output. Strong and steady growth has been 
registered in recent years only by Armenia, Azerbaijan, Georgia and 
Kyrgyzstan.

The big question is why this sharp divergence has occurred. Some intriguing 
answers emerged from a conference on 10 years of transition that was 
sponsored by the Croatian National Bank and held in Dubrovnik last week.

The conclusion of Johannes Linn, the World Bank's vice-president for the 
region, was simply that "market-oriented reforms, combined with social 
reforms and institutional strengthening have worked to turn former socialist, 
centrally planned economies around and can put them on a sustainable path of 
economic growth and social inclusion".

Moreover, while institutional reforms matter, macro-economic stabilisation 
and price liberalisation matter even more. A paper by Oleh Havrylyshyn and 
Ron van Rooden of the IMF concludes, on the basis of an - admittedly heroic - 
econometric exercise, that the addition of indicators of institutional change 
to standard economic policies adds something to explanations of economic 
growth, but not all that much.

If economic policy and institutional reform determine outcomes, one would 
expect differences in such efforts to lie behind the gaps in performance. So, 
indeed, they do. The EBRD has constructed a transition indicator, which 
averages scores (from 1 to 4+) over a range of policies and institutional 
actions (see chart). These include: privatisation; enterprise restructuring; 
price liberalisation, trade liberalisation, introduction of competition 
policy, banking reform; and development of securities markets. By and large, 
the further a country is from Berlin, the fewer of these reforms it has been 
prepared to undertake, with few exceptions.

Here then is a simple explanation for the geographical pattern of 
performance. Determined stabilisation, liberalisation, structural reform and 
institutional development work. But differences in effort have tended to 
correspond to a country's location.

There are, however, three reasons why this story, with its emphasis on 
effort, is too simple. The first is that the ability to implement reforms 
depends on a country's human resources and level of development. Some 
countries are more backward in this regard than others.

The second is that the dislocation involved in the fragmentation of the 
Soviet Union was much greater than anything that happened in central and 
eastern Europe, except former Yugoslavia. This is why the Baltic countries 
suffered quite deep output losses, despite vigorous reforms. For this reason, 
the countries of the former Soviet Union were bound to suffer traumatic 
transitions.

The third reason is the most fundamental. The story so far does not explain 
why some countries persisted with reform and others did not. The answer is 
that if a country was to persist, it needed a supportive political culture. 
Yet long experience of socialism was bound to militate against just that. The 
longer the experience and the more ruthless the regime, the greater the 
damage. To understand transition, one must also understand the legacy of 
socialism.

Under socialism everything belonged to a state that destroyed all non-state 
institutions. Since everything was forbidden, unless authorised, the winners 
in society were those who enjoyed enforcing prohibitions and those skilled at 
evading them. The ideology of the state also preached that whatever furthered 
the cause of the party was good. Thus were justified some of the greatest 
crimes in the history of humanity. The more deeply entrenched was the 
socialist ideology, the more those at the top tended to be both ruthless and 
corrupt. Inevitably, they saw the collapse of the coercive state as a superb 
opportunity for private gain. It was - and they grabbed.

Yegor Gaidar, a leading Russian reformer, explained why this legacy was so 
baleful. The collapse of the socialist state left both a monetary overhang 
and a breakdown of economic co-ordination. The first effort of reformers was, 
therefore, to limit inflation and liberalise prices. But this was only 
possible if they could impose hard budget constraints on enterprises. The 
more politically powerful the bosses were, the better they were able to 
resist the government, by accumulating arrears both to one another and to the 
state. As arrears grew and output collapsed, they demanded monetary 
expansion. Repetition of this cycle explains the damagingly slow achievement 
of monetary stability in countries such as Ukraine and Russia.

Unfortunately, it was never politically possible to force enterprises to pay 
their taxes. So monetary stability could only be achieved if the government 
either refused to pay its contractual obligations, or borrowed. The Russian 
government did both. The first of these two options made it impossible to 
establish a culture of honest dealing: who would meet his contractual 
obligations if the government failed to do so? The second led to the default 
of last August.

Meanwhile, the ruthless and amoral sought, successfully, to privatise as much 
of the wealth and income of the country as they could. Much blame is placed - 
rightly - on the privatisation of valuable assets at risibly low prices. One 
estimate is that in Russia assets worth between $50bn and $60bn were 
privatised for just $1.5bn. But such privatisation was the icing on the cake. 
The exploitation of positions of influence to obtain valuable licences, 
privileges or access to streams of income was pervasive. Privatisation often 
legitimised theft rather than caused it.

The resulting symbiosis of property with illegal power has a host of malign 
consequences: it starves the state of resources for essential purposes; it 
allows inefficient enterprises to monopolise resources, at the expense of 
truly private business; it permits managers to steal property from companies 
they run; it allows established business to exclude competition; it 
encourages a culture of lawlessness; it undermines the legitimacy of private 
property; it encourages capital flight; and it discourages long-term 
investment.

Today, alas, quite a few countries have ended up in such a transition trap, 
among them Russia and Ukraine. Their regimes can be called "nomenklatura 
capitalism". This halfway house between reform and reaction seems to be worse 
than either extreme. Poland and the other central and eastern European states 
avoided this trap because they were so determined to become western and free. 
Their relatively brief periods under communist rule also did less damage and 
they benefited from the presence of alternative sources of moral authority 
and political legitimacy.

Unhappily, the core countries of the old Russian empire seem, for now, to be 
doomed to a more bitter fate. More than 80 years ago they suffered a ruthless 
revolution intended to create, by force, a selfless human being. Lenin's 
insane ambition has ended up in its opposite - in a capitalist economy more 
ruthless, more corrupt and more unequal than anything even he could have 
imagined.

******