It can be difficult to separate the important from unimportant on any given day.
Reflections mean to do exactly that — by thinking about what happened today, we can consider
what might happen tomorrow.
The Russian markets plunged on Tuesday before government authorities halted trading on the exchange an hour early; the Moscow Interbank Currency Exchange fell 17 percent, and the dollar-denominated Russian Trading System (RTS) fell 12 percent. The carnage built upon ongoing losses in the Russian economy that have now seen the RTS fall by nearly 60 percent since its mid-May highs. The Russian ruble has recently become the world's worst-performing major currency. Russian government officials insist that this is simply a passing storm that has nothing to do with the August invasion of Georgia. While obviously an overstatement, there is something to the claim. Western financial institutions — and investment houses specifically — currently are engaged in a flight to quality investments. Russia, despite its ongoing impressive energy and minerals exports, simply never made the list of the top tier of reliable assets. But the fact remains that investors — and especially foreign investors — are scared. They were already nervous about the Kremlin's flagrant targeting of foreign assets, and now the Russian willingness to invade its neighbors is most certainly a factor, as is the falling price of oil (Brent crude pushed below $90 a barrel Tuesday). Yet while the Russian stock markets are suffering because of the uncertainty, Russia is not necessarily suffering. Most states measure their economic development plans by the amount of foreign direct investment (FDI) that they attract, because FDI brings in not only money, but also technology and managerial skills. But in Russia, FDI is not so important. Most FDI into Russia is cash that is actually Russian in origin: Russian businessmen send their earnings abroad to evade taxes, and then repatriate it as tax-free "foreign" money as they need it. A similar logic holds true for the relative unimportance of the Russian stock market. Most of the Russian firms who issued breathless initial public offerings in the past five years never went to the next step and allowed stockholders to take a peek at the books. This lack of transparency acted as an anchor on long-term interest in those stocks, so Russian firms did not become dependent on such sources of capital. Should the bulk of the Russian stock markets dry up, few Russians will care much. But the same cannot be said of bonds. The same things that dissuade people from investing in Russian stocks — weak rule of law, little respect for private property, shady business practices — do not impact the bond market, since bondholders do not expect input into how a company is run. They only want a return. Thus, bonds have long been not only the primary means that foreigners use to invest in the Russian economy, but also the primary means by which Russian firms fund major expansions (the Russian financial system is as complex as it is unable to facilitate such activities). So the real shock to the Russian system will come not when FDI crashes, or when the stock markets wither or the ruble falls — all of which seem to be happening — but instead when bond investors get scared. Such developments, however, do not have an immediate impact. Bonds that become unpopular now do not hurt the borrower — the borrower gets the money from a bond tranche upon issuing — until he attempts to issue a new tranche of debt. So it will be several weeks before we can fully gauge the damage to the bond market (we have to wait until firms attempt to roll over some large debt). The most obvious sign of the damage will be when sizable efforts to increase energy output start to shut down for lack of funding, as bonds are how most of those projects will be financed. But even on an aggressive timeframe, that will not translate into lost output for a year at least. In the meantime, the Russians are sure to boast that they are fine regardless of what the West does, while the West is sure that by wielding its investment power, it is hurting the Russians where it counts. Both, of course, will not quite be on point.