Powell Is a Duck Dressed In a Tattered, Old Bear Costume

Powell Is a Duck Dressed In a Tattered, Old Bear Costume
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He was a bear who was surrounded by ducks, and so one day he decided to slaughter some ducks to show he was still a bear. That was how one Russian political analyst put the March 1998 sackings. The bear was President Boris Yeltsin who while nominally still in charge had long since been a shell of his former self. Outwardly aging and taking off for long stretches, much had been left to his Prime Minister Viktor Chernomyrdin.

Chernomyrdin was an old style apparatchik. He survived the fall of the Soviet Union in Yeltsin’s orbit and would serve him faithfully, some said well, out from the one desperate crisis until the doorstep of another. The early nineties transition from Communism was a disaster for the Russian people and the economy, and with financial noises plaguing much of Asia beginning in the fall of 1997 there were growing fears Russia could slide back into the abyss.

President Yeltsin fired his entire cabinet one day in March 1998. No warnings, no consultations. On a national television broadcast, Boris gave Russians few specifics, saying only that his ministers were, “lacking in dynamism and initiative, fresh approaches and ideas.”

Initially, Yeltsin had simply absorbed the role of Prime Minister. His time as that particular officeholder lasted but a few hours. Later that same day, he changed his mind and appointed Sergei Kiriyenko who had just been fired from his position as Minister of Fuel and Energy.

“The offer came as a complete surprise, I learned about it this morning,” the new head of Russia’s government admitted.

Was it reforms being spearheaded by First Deputy Prime Minister Anatoly Chubais that had caught Yeltin’s disapproval? There were rumors the President was displeased, to put it mildly, with Chernomyrdin for meeting with the head of Ukraine and treating him as an equal, a fellow head of state. Or was it more basic and fundamental?

Global oil prices had been falling steadily, and as the global economy seriously cooled prices would only fall further.  The US benchmark for crude, WTI, had been around $27 in January 1997. By March 24, 1998, as the bear was arranging his marked ducks, oil prices were in the midst of a sharp rebound if only to around $16 (WTI) from a low of $13 reached just a week before.

And it was a temporary one. Crude would continue to sink for all of 1998, below $11 at the bottom.

When the market price of your country’s key export commodity, the very thing upon which your whole economy relies, plummets by nearly two-thirds even a Communist can see what’s in store. Stores will become increasingly empty as shoppers will quickly disappear once the economy grinds to a halt.

The vicious cycle, procyclicality, whatever you want to call it. Something bad happens, seemingly a small or unrelated distant spark, then funding markets turn pessimistic and before you know it the currency you need to keep everything going becomes increasingly hard, if not impossible, to acquire. The more difficult it is to source funding the worse the economy gets - turning markets even more against you. And round and round it goes, this self-reinforcing death spiral.

In Russia in 1998 that currency wasn’t the ruble.

Chernomyrdin had come to be seen as stability, the guy who, despite his many obvious flaws, was able to chart and maintain a steady course. No small feat in a transitioning place like Russia and Moscow. But if the country was on course for another disaster, steadiness may not have been the optimum signal to send.

Chaos is, of course, its own danger. For while Sergei Kiriyenko was young – only 36 at the time – energetic and engaging, everything Chernomyrdin wasn’t, he was also untested and, as many would claim, a bit too much of a sycophantic duck kissing up to the bear. His time at the top of the Russian government would come to a close in August…1998.

Russia’s situation had only grown worse. So much worse. The ruble was in deep trouble, plummeting against the dollar. In June 1998, Kiriyenko’s government had hit upon a debt swap as their ticket out of the hole. Investors were given the option to exchange GKO’s, short-term government debt securities, into Eurobonds.

The Russians wanted to avoid having to rollover short-term government debt, which the government knew in June 1998 it wasn’t going to be able to do. The only other option was default, which was not an option officials were willing to concede (at the time). Foreign appetite for ruble-denominated debt had crashed along with the ruble, and domestic sources of funds were already being decimated by the fallout.

The Finance Ministry had been active in Eurobonds, issuing two worth a combined $3.75 billion just before the swap. Thus, having re-established itself in the global dollar market, there were several older Eurobond floats still out there, the Russian government was attempting to “pay back” short-term obligations in a currency nobody wanted, rubles, with promises for a more distant future delivery of the currency everyone requires, dollars.

Any GKO’s maturing between July 1, 1998 and June 30, 1999 were eligible to be swapped into seven- or twenty-year Eurobonds. The incentive was the rates: 14.9% for the 7s, and 15.2% for the 20s for a spread over comparable UST’s better than 900 bps.

Yet, only 15% of eligible GKO’s were ever swapped, amounting to about $6 billion out of ~$40 billion outstanding (you can see why Russian authorities were panicking with so much debt coming due and the currency they might be tempted to print in order to pay it off more and more unusable).

The IMF had just come in with an enormous rescue package, the usual tranches of credit lines and debt mixture ($22.6 billion) along with forced local concessions about reform platitudes. Since the price of GKO’s had plummeted on debt markets, many Russian investors (evil speculators?) were willing to buy up and hold the ruble debt already at pennies on the dollar betting on the IMF to pull it off.

And if not the IMF alone, then the whole of the West and its endless bounty of bailouts, the true products of the godlike central bankers as far as the markets were concerned. It was a far more profitable scenario for GKO holders than 15% coupon Eurobonds.

But it was just a scenario, the usual assumption that international authorities when committed to a cause would be successful in that cause. The legend what became Alan Greenspan. So much of the perceived international order seemed to depend as much on this ideal, the whatever of last resort.

Russia’s debt swap was in trouble from the start, however. The government wasn’t the only group of Russians seeking refuge and space in the global dollar market. Banks in the country especially those who had swapped GKO’s for Eurobonds had obtained in their possession a government note for repayment in dollars paying handsome interest.

And these Russian banks had billions in syndicated debts coming due in 1998, too. Unlike the Russian government, those credits were outstanding not in rubles but dollars. With the ruble in crisis and largely non-negotiable, the dollar market also rejected them for rolling over those dollar debts (too risky).

Kiriyenko’s government had just handed them one (partial) way out of their fix. They could, and did, sell their Eurobonds in order to raise the dollars needed to pay off some of their maturing obligations.

Which had the effect of tanking the price of Russia’s Eurobonds, as well as the economy, which then made another GKO swap impossible. And another was needed, or seemed to be needed, because the ruble price of government debt was still falling as the pressure on the Russian economy just would not abate.

With Russia’s Eurobond issues in turmoil, haircuts and margin calls followed in very 2007-esque fashion. Russian banks tried to meet them by selling their GKO’s and OFZ’s (another form of government debt) and swapping the rubles to the central bank for dollars under standing liquidity agreements which quickly depleted the country’s foreign reserves.

On August 17, not even two months into the swap and the rescue, the game was already over. Russian authorities erased the exchange rate regime, de facto devaluation. GKO and OFZ’s would be restructured, meaning a limited default. Various capital controls would be imposed to try to stem the tide of dollar “flight.”

Six days later, the bear slaughtered a few more of his ducks in favor of resuscitating his old one. In typical Yeltsin style, no one saw it coming. One contemporary LA Times article adeptly described the scene. “The report of the firing of Prime Minister Sergei V. Kiriyenko was read at the end of the 7 p.m. television news, after the sports report, by a baffled presenter.”

More surprising still was on August 24 when Viktor Chernomyrdin was brought back ostensibly to stabilize the spiraling situation. Andrei Kortunov, president of the Russian Science Foundation, said of the President’s odd maneuvering:

“In short, this means that Yeltsin has capitulated; that is, he admitted committing a grave mistake by staking too much on Kiriyenko and his government. By appointing Chernomyrdin, he takes the situation back to square one; that is, he tries to take the country back…months and start again with the very same people who had been building up the economic problems that have now become so acute. It is an act of desperation on the president’s part.”

But how was this possible? I mean, the IMF. An enormous, historic rescue package and commitment – that blew up in its face almost from the start. Something is missing. Something still is missing, as the IMF’s recent, very recognizable mission in Argentina shows.

A contemporaneous account in the New York Times begins to get at it, by describing the Russian currency crisis this way:

“The lunge for dollars was driven mostly by Russian banks scrambling to trade rubles for dollars and other foreign currencies. The moves reflected a pessimism by bankers and investors about the outlook for the ruble as well as the uncertainty over whether Mr. Chernomyrdin can halt the crisis.”

From this conventional perspective you are left with the sense the ruble as the dollar is nothing but a flat, two-dimensional price. Russian banks saw the price of the Russian currency as a bad bet and therefore, as the New York Times told it, began trading out of rubles and into the safety of the dollar. An investment choice drawn from tangential “pessimism.”

But that’s not it. Currency is a three-dimensional object which includes price as well as volume. It may not be physical notes as we might think about it from time to time, but quantities of something nonetheless – even if nothing more than numbers on bank computer screens.

The third dimension is this thing we call the dollar short. Everyone needs dollars because the world runs on them. You cannot separate globalization from the currency which financed it. That currency, however, is some variation of financial product (Alan Greenspan’s June 2000 monetary admission) which ultimately means everyone is dependent upon the global banking system to keep them flowing (credit-based).

The eurodollar system.

Russia had experienced a modern dollar shortage, a mismatch between the shrinking quantity (shortage) it could reasonably acquire from those global banks balanced against an unflinching need for it (short).

And it wasn’t alone. The Asian Financial Crisis, the Asian flu, had ravaged other parts of the region in a very similar fashion. Even the Japanese had to beg the Federal Reserve for dollar swaps whose parameters are, to this very day, undisclosed.

Just six years before Russia and Asia, the British pound underwent much the same currency crisis – only it didn’t lead to the catastrophic consequences of those later versions. As I so often dig back up, the New York Times was spot on with its summation of that one:

“The world’s currency markets, it seems, are no longer governed by central bankers in Washington and Bonn, but by traders and investors in Tokyo, London and New York, as the chaos in the currency markets this past week has shown.”

Traders and investors who work at eurodollar banks trading eurodollar financial products. The British were lucky this was 1992.

To bring us up to the current day, just a few days ago the G-20 was briefed on a terrifying-sounding vulnerability. A new-ish development for the world’s monetary stewards, so called, to chew on.

 “Central banks have lost control of global liquidity. The dollarised international financial system has become treacherously unstable and vulnerable to a sudden reversal in capital flows.

“Yet the International Monetary Fund is a diminished force and no longer has the firepower to act as the world’s lender of last resort in an emergency. That is the stark conclusion of a G20 task-force of leading currency experts.”

The report was prepared by the Robert Triffin International Forum but wasn’t at all what you might be thinking. It begins by noticing all the footnote dollars whizzing around the world at the speed of light. Once again, not dollars as in physical notes but virtual currency made by banks. Financial products.

However, these genuinely good folks who are only now starting to peer behind the global currency curtain have intentionally or not made it sound like this is some new problem. Worse, they pile on with the belief that the Fed is the only potential backstop available when all available historical evidence proves, beyond any honest doubt, that it is not and has not been.

The IMF gets the axe in this one. It won’t be much longer before the Fed does, too.  

The entire exercise of the 2008 crisis was more than enough of a demonstration, including the $600 billion in dollar swaps drawn during only one part of it – the economic and financial damage would continue for half a year beyond them and therefore forever show just how ineffective all the world’s responses really are under the tremendous weight of “global liquidity” in reverse.

Besides, as we can see by going back to Russia in the late nineties, the whole arrangement has been this way for quite a very long time. Maybe this is officialdom’s way of being softened up in order to finally, at long last hear the Great Truth – the monetary system is not what you’ve been told it was.

And it’s been that way for a very long time.

If they make it sound like this is some new development rather than something that arose in the sixties and seventies, when, ironically, people like Robert Triffin were warning the world about the offshore dollar explosion and the potential downsides of it, then perhaps the public won’t be too harsh in its backlash.

Should the people of the world realize that the financial products of the global eurodollar system have actually been in charge for decades, not central bankers as they’ve been led to believe, they might, after all, look at 2008 and its aftermath in an entirely different way. I think that would be a good thing just to head off the fragmenting of politics and society at large, a legitimate answer to this search for answers where the people are getting none and seeking out more extremes in the absence.  

You might imagine as I do, however, just how those in charge during 2008 who also happen to have somehow avoided accountability (subprime mortgages!!) and remained in charge twelve years later, twelve among some of the worst economic periods in global history, would attempt to explain themselves more carefully in light of how things really work.

The offshore eurodollar world is beginning to come further into focus. Halleluiah! Except, it’s being left in the wrong hands. The official world being tired of having no answers for what Federal Reserve Vice Chairman Richard Clarida recently called global disinflationary headwinds. Gee, what are those, exactly, Mr. Vice Chairman? To the rest of us they are Ben Bernanke’s false dawns.

They sure weren’t subprime mortgages. It was never subprime mortgages. And if 2008 wasn’t really about them, then what it means for 2020 is that global affairs are still all about “dollars.” Not the Fed. Jay Powell is a duck dressed in Alan Greenspan’s tattered, old bear costume.

The only real bear is the rising dollar. 

Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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