A change in strategy or uncontrollable consequences?

As was previously mentioned in my earlier blog, the trend of the rouble forced the government to introduce massive injections into financial system. After that did not work out, the central bank started to get rid of its dollar reserves in order to generate extra liquidity to finance its support policy. After a mo central bank was spending $1.6 billion every week to try to alter the currency trend. #


This however also proved to be ineffective and government is now claiming that this devaluation of rouble is planned and controlled. The rouble is undergoing a very difficult stage when oil prices collapse and foreign investors try to pull out its funds from the emerging economies. While the central bank along with Prime Minister Putin claims that is a first step of a series of technical decisions it is very unclear whether the government is still able to recover the currency afterwards. Significant injections lowered the government liquidity which is risky with the currency being under pressure.

Pumping in money is not enough…

Russian central bank has been injecting significant chunks of funds into the economy which by mid November added up to over $55 billion. This policy was forced by the general downturn in the economy beginning with the rouble followed by the decrease of RTS index. Devaluation of the currency meant that imports became much more expensive. Since the internal production has been suffering from the days of communism the country is very dependant on imports. Now the effects of that can be extremely felt by the SME’s.

A rapid change of plans by the central bank from the strong currency support position to its devaluation raised question marks whether it is still under control The initial injections into the economy limited further government actions to battle the crisis. Global way of fixing the situation proved to be decreasing interest rates to encourage public spending. Most of the European central banks including Britain chose this policy to help small businesses to recover from the global shock. In Russia, however things are a lot different. After the collapse of the currency and massive injections into the economy, public spending only increased. As the result the central bank was virtually the only one in the world to increase its interest rates in order to target rising inflation levels.

Tired battling the crisis? Here is a solution…

As we all already know the credit crisis affected not only the global banking sector but virtually paralysed economies in many countries around the world. With the recent significant reduction in interest rates adopted by the Bank of England last week it became clear that British government is now trying to encourage spending and borrowing to promote economic stabilisation. This reduction happened as a part of a rescue plan which incorporated a privatisation of risky assets by the government to “free up” the banking sector.

In other countries such as Russia things also went not so in favour of economic stability. The central bank also attempted to pursue various rescue measures like extra financial injections in the economy. However, due to lack credibility of the government and generally negative investor environment foreign and domestic investor chose to pull out funds from the Russian market. According to the report of Russian finance minister the outflow of cash reached just over 50 billion just over the past month. Here is a way to tackle the crisis according to the Russian Prime Minister Putin. Today he called for an unusual meeting of all the key figures in the finance sector alongside with the law enforcement officials. Prime Minister Putin order off to initiate a thorough check into “possible illegal activities” which could happen in the circumstances of crisis. His called for an immediate action from the law enforcement agencies such as FSB (former KGB) in case of a “suspicious” activity. He also pointed out the fact that transferring money abroad is perfectly legal transaction however later he added that financial institutions that transfer “significant” amounts abroad will not be granted the special low rate loans from the governmental banks. So how is this for a way to tackle cash outflows?

So who is responsible?

The former head of the Fed, Alan Greenspan, speaking at a hearing in the U.S. Congress, acknowledged that he is "partly" to blame for the shake of the world financial crisis. He confessed that he had underestimated the risk of rejection of strong regulation of derivatives and other risky financial instruments. In his forecast, the world after the crisis will live without them, and thus will have less risk of a giant soap bubbles to emerge. "

"We are middle of the credit tsunami, which occurs once a century" - the former head of the Federal Reserve System (FRS). Alan Greenspan began with a reminder that even in 2005, he warned that the prolonged underestimation of the risks would have "terrible consequences". "This crisis, however, was much broader than anything I could have predicted - he continued .- I do not see how we could prevent a substantial increase in unemployment." According to him, due reduced consumption, Americans are sending an increasing proportion of their income on savings. Indeed, because of falling stock market has dropped the amount of pension savings (401K plan), as well as the cost of homes - for U.S. citizens are usually the largest portion of savings.

What is happening to rouble?

The first signs of the devaluation of the rouble came to light in early September. After a massive government injection of $3.4 which followed after a decrease in rouble trends. The rouble, which has been strengthening against the dollar amid high oil prices for most of the year, came under pressure as foreign investors stepped up their exodus from Russian money markets amid a flight to US Treasuries and the dollar.

After the massive injection in the system by the central bank rouble is still showing bad results. This fact is exposed to the Russian public which starts to be increasingly worried. Falling rouble forces Russians to acquire more dollars which even worsens the situation. Moreover, central bank is starting to sell its dollar reserves to provide extra funds to support its falling currency. Although the government is trying all the possible means to stabilize rouble, it does not seem to be working.

Confidence weakens in the Russian financial sector as a result of the global crisis

By the end of the trading day the decline in RTS and MICEX Russian indices greatly accelerated. This happened as a result of the statement of international rating agency Standard & Poor's (S & P) on the revision of forecasts for Russia sovereign ratings from "stable" to "negative". As a result, the rating for Russia could be downgraded. According to S & P, this can be associated with the declining confidence in the financial system.

At the moment, long-term rating of Russia in the foreign currency remains at "BBB +" and short-term - at "A-2". Among the reasons which made S & P to take such a step was the uncertainty of economic policy and the impact of global financial crisis. In addition, if the active support of government banks will be further pursued, the country’s rating can be significantly decreased. In addition, analysts expect defaults in the financial and corporate sector in Russia. The situation maybe much worsened by the current trend on oil prices which is experiencing a significant decline lately.

The reaction to the statement by S & P followed immediately. By the end of the trading RTS index fell by 4.39% (636.54 points), and MICEX fell to 5.63% (592.75 points). The leaders among the declining companies were Gazprom, Rosneft, Tatneft, as well as Serbank Russia.

Who will come out “clean” from the crisis?

In the recent interview to the German newspaper Die Welt the American billionaire George Soros claimed that China will be the “winner” of the global financial crisis. He described that the origins of the crisis, that "mortgage bubble" was only a trigger that caused the collapse of the economy. It also explains why, despite all the measures taken, the administration of U.S. President has not yet been able to cope with the crisis.

"The key to understanding this crisis - the most serious crisis since the 1930's - is the recognition that it was created within the financial system. What we are experiencing today is not the effects of external shocks that disturb the equilibrium, as stated in the theory. In practice, it turns out that destabilize financial markets themselves, "- Soros explained.

According to him, "from time to time markets tend not to equilibrium, and the imbalance. My theory is different from the perception on two issues: first, financial markets do not reflect the fundamental economic indicators, they distorted the market. Secondly, this distortion in the financial markets may affect key indicators - as in the case of bubble or collapse. "
"Financial markets are functioning well indeed. Their instability affects the real economy, not vice versa. Now it is not only about the mortgage bubble. He was the only trigger that led to a major bubble burst. This super bubble, inflated increasing loans and debts, as well as the belief that markets correct themselves, grew in 25 years. And now it burst ", - explained Soros.

One of the main reasons for the crisis to grow to the present extent was the incorrect approach towards the problem by the Bush administration. The finance office failed to target the growing disaster at its very origin. In this view I agree with Mr. Soros on the basis that the finance office relied on the common perception of the financial market that is able to “fix” itself. No preventative and precautionary measures were developed after the fall of Bear Sterns and therefore American economy was absolutely not prepared for the strike. Moreover, if one was to monitor the actions the US finance minister Paulson one might notice that on every stage of the development of the crisis the office failed to introduce preventative measures.

Over the plan was not working. When the consequences of Lehman’s bankruptcy were obvious, Paulson urgently had to do something to save AIG. After a day the stock market was in ciaos. But he did not want there to take money. He wanted acquire bank’s illiquid assets "- Soros said.

So what is the way out of the crisis according to George Soros?
The billionaire suggests stages which should resolve the crisis and put the world economy back on its track:

1. Firstly, the administration is ought to recapitalise the financial system by acquiring bank assets.
2. The major process of inter bank loans must commence. This can only be encouraged by various government guarantees on transactions.
3. Thirdly, it is vital reform the U.S. mortgage system making sure that mortgage is not higher then the price of a house. This will encourage to slow down the decrease in mortgage prices.
4. Europe must ensure high position of euro.
5. Finally, it important to revitalise those world economies that suffered the most from the crisis which should be the job of the IMF.

Why China?

The main objective of the global financial policy is to prevent a worldwide recession. As a result of the crisis the US and Europe banks will be nationalised in the most part and will be having huge debts. Whereas, in peoples republic of china will become a new financial empire simply because it will be able to invest the markets worldwide and therefore acquire assets.

"The Chinese over time will have much of the world assets, as they transferred their dollar reserves and deposits in the U.S. into these assets. This will change the balance of power. The shift of power towards Asia will occur as a result of America over the past 25 years of sins" -- Soros concluded.