The economic systems of both the United States and Russia are rooted in geography. The United States boasts a large number of interconnecting navigable rivers draining massive tracts of arable land and a variety of coastal regions blessed with multiple harbors ideal for trade and city-building. A long series of barrier islands on the East Coast greatly simplifies local ocean shipping, while a series of geographic features on the West Coast — California's Central Valley, for example — encourages development on that coast even without any linkages to the rest of the country. All that was necessary to make the United States a well-developed country were a few transport links — road and rail — crossing the Rocky and Appalachian mountains. Transporting goods around the country is pretty simple, especially for Midwestern farmers who just need to get to a river. Wealth begets wealth, and private enterprise faces very few barriers to growth. In short, economic advancement is a breeze in the United States, and that has shaped how the economy — even the financial system — has developed. Americans tend to prefer a laissez-faire system, with the government keeping fairly well out of business simply because government is not needed very much. Americans debate what to do with their wealth after it is earned — not how to generate it in the first place.
In contrast, Russia's rivers for the most part neither interconnect nor flow to places where it is logical to site cities. Most drain to the Arctic Ocean, while the largest that does not — the Volga — drains into the landlocked Caspian Sea. Russia's useful coastline is also very small, and where it does have some coastline (the Black and White sea regions), it is not situated near major population centers. Because Russia's growing season is so short, foodstuffs are produced in seasonal surges rather than year-round, making transport of produce a once-a-year nightmare that cannot be ameliorated by the use of rivers or maritime shipping. Russians are dependent on shipping everything along whatever road and rail network the government has been able to build. The result is an economic culture that is almost a perfect inverse of the United States. Whereas economic development in America is child's play, mass starvation in Russia can be avoided only with strict and careful central planning. Transport infrastructure is a convenient unifying factor in the United States — according to some perspectives almost a luxury — but it is a life-and-death issue in Russia. So while Americans expect their government to stay out of their business, Russians fully expect the government to play an active role in anything that involves the economy. This backdrop does much to explain how market events of the past few days have turned out. In the United States, the two big events were the bankruptcy of Lehman Brothers and the government intervention to salvage American International Group (AIG), both of which found themselves on the financial rocks after gorging on subprime mortgage
assets. Questionable lending practices created a massive amount of mortgages being granted to people who in truth could not afford to make payments. But since the conventional wisdom in investment is — make that was
— that mortgages are the safest, most reliable category of securities, many investment houses bought up such subprime mortgages in bulk and developed their own lending arms to create more subprime mortgages directly. Eventually, the housing bubble popped and the combination of a recession in housing and all these subprime mortgages going bust — some 20 percent are in delinquency — forced an industry-wide write-down of assets. For Lehman Brothers and AIG both, the process of rationalizing their books proved too expensive, threatening their ability to operate. In the case of Lehman, the government attempted to matchmake them with a healthier firm to allow an orderly transition; but, in the end, the government was willing to step aside and simply let the firm die by its own mistakes. The AIG situation is a touch more complicated. Here the Federal Reserve granted an $85 billion loan to take control of 80 percent of the group's stock. Many saw this as a bailout and heckled the decision, but the reality could not be further from the truth. The Fed's conditions were simple: We will grant you this loan so that you do not need to worry about stockholders' demands (there will be no dividends) or liquidity ($85 billion should be plenty to keep AIG's internal operations running no matter what happens in the wider market). In exchange, you will sell off the entire company within two years. The Fed intervened only to ensure that AIG's massive insurance policies would not be abandoned (the group controls a half-trillion dollars' worth of financial protection that it provides Wall Street firms and the biggest companies of Europe and Asia). The price for its assistance was the group’s utter liquidation. AIG, in effect, ceased to exist the day the "bailout" was announced. The Fed action simply keeps the body on life support until all of the body's organs can be harvested. The markets are still roiled, and it is unclear whether Wall Street has fully absorbed the fact that AIG was not saved but was put down like a horse with a broken leg. The point remains that this sort of intervention is done reluctantly, with only two thoughts in mind: Intervene only when the stability of the system itself may be in danger and not simply to save any particular private enterprise; and get the government out of the business of business as quickly as possible. Now contrast this with what is going on in Russia. Troubles in the Russian markets are not new. Earlier this year, the government began taking a much more interventionist tack in dealing with foreign investors; and in May, foreign money began to flee. Many things contributed to the change, but the biggest would have to be a growing feeling within the Russian government that rule of law and property rights — never very strong in Russia in the first place — could be interpreted creatively by officials to serve the government's tactical needs. The biggest example of this was the government encouraging the fleecing of the BP half of oil firm TNK-BP
. In August, Russia invaded Georgia, adding a layer of political risk and making investors with longer memories think back to the geopolitical hostility and financial volatility of the Cold War era. The outflow increased. Finally, the Western credit crunch that claimed Lehman Brothers and AIG has triggered a global flight to quality assets. Considering the Russian view of property and the Georgia war, Russian assets are no longer considered a safe bet. Add the fact that oil prices have dropped by a third in the past three months, and energy-exporting Russia suddenly looks like the place not to be. So, on Sept. 16, the Russian markets plunged, forcing the government to suspend trading in its final hour. Overnight strategy sessions to prevent a repeat failed, and trading was suspended in the first hour Sept. 17 for the entire day. It remained suspended Sept. 18, and the system was switched back on Sept. 19 but halted again after a couple of hours. The rout is so uncompromising that Surgutneftegaz, one of Russia's oil majors, now suffers from a market capitalization that is only slightly more than the amount of cash it holds in the bank. The Russian government held a series of crisis meetings in which it was decided that it would directly recapitalize the three largest state banks — Sberbank, VTB and Gazprombank — to the tune of $44 billion. Additionally, the government will sink 500 billion rubles ($19.6 billion) directly into the stock markets and another 60 billion rubles indirectly via those same state banks. Direct intervention in a stock market is generally frowned upon for the inefficiencies it creates — investors never know whether they will find themselves on the wrong side of government action — but announcing that you are going to do it ahead of time allows speculators time to line up bets against the government action. If the plan goes ahead as announced, the Kremlin will in effect be burning over $20 billion to achieve very little except perhaps the perception of getting things back on track. Neither of these are major concerns for the government. Unlike the Americans, its goal is not to protect the economic system; the Kremlin's goal is to control the system as one would control a domesticated animal. The difference in mindset from the U.S. Federal Reserve could not be more stark. The Fed does not even pretend to think that it could manage the entire system by itself — and it wouldn't want to even if it could. The Russian system, however, is predicated on government control born out of political and economic necessity. There is no allergic response to the idea of centralization. In fact, many in the top ranks see centralization as a good in and of itself. But even the most laissez-faire among them realize that, at times, a firm guiding hand is necessary — especially in Russia. The argument is not over whether to intervene but how deeply and for how long. The Kremlin knows it needs more money in the system, plain and simple. It also knows that, despite its $750 billion in reserve funds, it does not have the managerial skills or even the cash necessary to manage the entire economy itself. It has to get hold of more resources. As a stopgap measure, the Kremlin is in the process of drawing up a short list of critical firms that cannot be allowed to go under. These firms will be given some sort of access to government funding. Those not on the list are left to fend for themselves. One result is that the firms that can gain access to financing will gobble up many who cannot — massive consolidation is definitely looming on the near horizon in Russia. Since the government is far more likely to grant lifelines to government companies, this consolidation will also be a centralization of economic power under the Kremlin. The government's next step will be to address the funds shortage. Its goal is to prevent more money from fleeing — the trading suspensions are only the start of that; capital controls and perhaps even limits on the ruble's convertibility will follow. After that, the government will rustle up additional resources to augment its reserves. Since the first step will make foreign money avoid Russia like a plague, the Kremlin will need to look to another source. And it looks as if the Kremlin has already found one: Russia's oligarchs. The oligarchs were originally a group of men who robbed the Russian state blind in the early days of the Soviet collapse. Using everything from fraud to theft to armed seizure, they amassed massive, if somewhat Frankensteined, corporate empires that ruled Russian economic — and even political — life for years. Their membership would change as new oligarchs would rise (sometimes violently) to replace the old, but they seemed to be a permanent feature of the Russian system until the rise of Vladimir Putin. He laid out new ground rules to lash their economic power to the Kremlin's goals, and punished those who did not obey. Yet not all of the oligarchs are private citizens anymore. The assets of many of the oligarchs who fell have since been transferred to the state and placed under the aegis of Putin's allies. So now the oligarchs can be split into four neat groups: the nominally subservient yet still independent, those with government offices, the exiled or imprisoned, and the dead. This second group warrants some exposition, since its existence is woven tightly into the Russian predilection for centralization. It is not merely that these "state oligarchs" happen to control major firms for the state, but also that they are government ministers who directly control the firms. They include such august personages as Deputy Prime Minister Igor Sechin (also president of Rosneft) and First Deputy Prime Minister Viktor Zubkov (chairman of Gazprom). New President Dmitri Medvedev previously held both of Zubkov's offices. The point is that Russia's economic centralization is already deeply under way. One of the strategy sessions held Sept. 16-17 was not simply a gathering of government economic personnel. Putin ordered that the major oligarchs — all of them — fly to Moscow. The attendance list was so thorough that it even included Roman Abramovich
, an oligarch who not only has divested himself of many of his Russian assets but who is now living in London — he flew in late the night of Sept. 16. The Russian oligarchs represent the greatest pool of capital — foreign or otherwise — in Russia, and all have a reputation for putting their own financial interests first. The fact that the markets crashed in the first hour of opening after this meeting indicates that if there was a plan for the oligarchs to provide ballast, that plan was not very enthusiastically implemented. That will not be forgotten. The oligarchs — especially the private oligarchs — have the money. The Kremlin needs the money. Centralization is the word of the day. Connecting those dots is ultimately what STRATFOR sees as the main event in the Russian economy in the weeks ahead. In the American system, the emphasis is on system preservation; whereas in the Kremlin, the emphasis is on power preservation. In the United States, the events of the past week — while certainly noteworthy — do not represent any fundamental breach of the existing economic system. In Russia, it appears we are entering the final stage of struggle between the oligarchs and the state for control over the economy itself.