from Follow the Money

And the money keeps rolling in …

May 2, 2006

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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To Russia.

In 1998, Russia was very short on cash.  It went to the IMF and got a $15 billion credit line.  When it didn’t hold up its end of the bargain – taking steps to collect a bit of revenue – then Treasury Secretary Rubin pulled the plug on the program after only $5 billion had been disbursed.   He argued that there was no point in throwing more good money after bad.

$5b.   Chump change.   That is less than ½ of what Russia added to its reserves in the first three weeks of April.  Russia’s reserves were $217.1b on April 21, up from $205.9b at the end of March.  For the full month, Russia’s reserves will probably grow by $15 billion. 

By the end of the year, Russia will likely have as many reserves – around $300b – as the IMF has on deposit.  Talk about a reversal of fortune.

Some of the $15b or so April increase comes from the rising dollar value of Russia’s euro-denominated reserves in April.  If Russia has 40% of its reserves in euros (at the high-end of the possible), the rising dollar value of its euro reserves added maybe $3b to its April total.

But that still leaves a monthly increase of say $12b, depending on the size of Russia’s take in the last week.   In April, Russia and Saudi Arabia together may add more to their reserves than China.  

Nothing like oil at $75.

No wonder the Russians are taking over London, oil money’s new Switzerland.   Hedge funds instead of private bankers, but better parties and no taxes -- at least no taxes that cannot be avoided by offshore investors. Yes, I am a bit cynical about London’s rise as the global financial center, but I will grant one thing: London, unlike New York, truly does export financial services -- not just debt.

By my very rough estimates, the combined current account surplus of the world’s oil exporters could approach $600b this year.   It should top $500b fairly easily if oil stays above $70.   I  assume that the oil exporters will continue to increase their imports at their 2005 pace – i.e. their current spending on imports of goods, services and the transfer payments the expat workforce in many Gulf states send home would increase by $100b plus.  Export revenues would just increase by more. 

The foreign reserves of Russia and the foreign assets of Saudi Arabia’s central bank both could increase by well over $100b in 2006.  Each added almost $25b or so in the first quarter, back when oil wasn’t worth all that much.  Some of that came from the dollar/ euro, but not all that much. 

Which brings me to the real point of this post – 

All the money that we pay to our oil producing friends has to go somewhere.  And a big fraction never actually flows into the domestic economy of the oil states.   The governments of oil states often get their cut of the country’s oil revenues in dollars, and just hold their take abroad.   They don’t ever convert the dollars (or euros) into the local currency. 

Parking the oil windfall in government accounts abroad may not increase Russia's standard of living much, but it certainly makes life a lot easier for the central bank.  If export proceeds are not converted into domestic currency, the central bank doesn’t need to take offsetting steps to withdraw the currency from circulation.   So called sterilization – the sale of central bank bills to withdraw domestic currency created when export revenues are converted into the local currency – isn’t necessary.

Karen Johnson of the Federal Reserve noted in a recent speech:

“Payments for oil exports are generally received directly in foreign exchange—usually dollars—and may go directly into official holdings without passing through the private sector and the foreign exchange market” 

That is a big difference between Saudi Arabia and China.  China may get paid in dollars, but its firms convert their dollars to RMB – forcing the central bank to sell sterilization bills to prevent base money from growing.

But keeping the government’s take of the country’s exports revenues abroad means  that the government sits on a huge pile of cash. For Russia, I can use the term cash almost literally.   According to the available data, the Russian’s hold a very conservative portfolio – almost all short-term treasuries and bank deposits.  Very few long-term bonds.  

That is not an accident.  The World Bank’s Russian office noted that the law currently requires Russia’s central bank to be conservative.  The government’s oil stabilization fund holds its money in ruble deposits with the Bank of Russia, and the Bank of Russia holds safe foreign assets against those liabilities –

“The stabilization fund is currently held as a ruble account at the Central Bank.  … current law permits only investment in safe and highly liquid foreign bonds”

The World Bank thinks Russia should have a slightly more adventurous portfolio, since the government is now managing a large share of Russia’s financial wealth – not just a large share of its mineral wealth. 

Whatever happened to the state’s retreat from the economy’s commanding heights?

More stocks, more risky bonds, more property – and fewer T-bills.  If oil stays at $70 plus, that means that Russia – the Government of Russia – would own a big chunk of something.    

One of the great ironies of the post-Cold War world – at least the post cold-war, post tech boom, W world – is how former Communists turned bureaucratic capitalists have emerged as the United States biggest creditors. Get ready for Red Square property management and Kremlin asset management …

That brings me to my final point.  W’s foreign policy was meant to put freedom on the march.  No compromise with despots.   No sacrifice of moral clarity.

Yet it is hard to see how W’s energy policies (no efforts to curb US demand; conservation is nothing more than a personal virtue) and the United States’ continued inability to bring Iraq’s production up to its Saddam-era levels have helped freedom's march.  OK -- they have provided the rulers of the oil states (and gas states) with a lot more freedom of action.  They hold the high card – access to oil and gas. And freed them from budget constraints.  But I don’t think that is quite what W had in mind.

If oil stays at $70 plus, the oil states collectively will have about twice as much money to invest in global markets this year as the People’s Bank of China.  High oil prices have helped make Putin and his clique, King Abdullah and his family, various Gulf emirs, the Iranian mullahs and a host of others very, very rich.

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