Washington’s Secret Trump Card

An exclusive interview with Sergei Nikolaevich Grinyaev, the General Director of the Institute for the Development of Financial Markets (in Russia).

– Sergei Nikolaevich, several Russian leaders have said that the peak of the crisis is still ahead of us. What can Russian people expect, and for what should they be preparing? In general, how do you expect the situation to develop?

– First of all, we believe that the word “crisis” should be put in quotes. In reality, this “crisis” is aimed at solving the United States’ debt problems, primarily with respect to its foreign debt, which is more than $13 trillion.

Experts from the Institute for the Development of Financial Markets believe that the current situation in many ways resembles the one in the ‘80s. Back then, the manipulation of oil prices and dollar exchange rates enabled the U.S. to solve a number of its strategic problems. Most importantly, it helped the U.S. destroy the USSR. Just like in 1980, in 2008 oil prices increased dramatically, which made it cost-effective for the U.S. to drill for oil and put into operation new oil wells. In 1980 to 1985, the increased oil supply reduced oil prices in the world market, and contributed to increased investment in the dollar, thereby quickly making it more valuable. The same thing is happening now. Of course, those who managed the process were able to prepare in advance for what was to follow, and thus came out winners from this organized “crisis.”

Today, the Soviet Union and its oil ties no longer exist, but there are other unfriendly-to-the-U.S. oil-producing countries: Venezuela and Iran. The U.S.’s excessive debt is a separate problem. If events similar to the ones that happened in the ’80s happen now, then the “crisis” might last about ten years. But on the other hand, lower oil prices are beneficial to China, which is America’s most important potential ally/competitor. That means the U.S. will avoid prolonging this benefit and quickly end the “crisis,” particularly since it’s having a serious negative impact on the rest of the world.

After comparing several variations, we believe that this phase of the “crisis” will last three to five years. Of course, this is assuming that the U.S. Federal Reserve (the Fed) does not lose control of the situation. If it does, then the Fed will have to urgently declare that the U.S. dollar is in default and use a backup plan, such as introducing a new currency (e.g. something like the amero, a North American currency).

Russians should be prepared for a weaker labor market (e.g. rising unemployment, lower wages, and delayed wages), higher tariffs, social problems in the regions, problems with bank loans, and protests. As always, much will be determined by Russia’s leaders and their self-preservation instinct. The situation could get more dramatic and unpredictable if (just like during previous years) billions of dollars leave the country under the guise of creating foreign exchange reserves and sovereign funds, higher-level officials actively participate in property redistribution, medium- and low-level officials continue bleeding people, and political parties impose their very controversial positions in the regions.

– As the oil prices continue to decline, is there a lower-bound “pain threshold” that would be catastrophic for Russia? What can be done to avoid this?

– Most likely, oil prices in the coming years will be in the $30-70/barrel range. Although OPEC is primarily managed by the U.S., in the long run, it will not be able to forego reducing production levels. Otherwise, the organization will simply cease to exist. Therefore, due to the supply reduction, oil prices will rise a little. But after a few years, due to the decrease in easily-accessible oil reserves, oil prices could climb above $100/barrel and even beat 2008’s historic high.

Now, let’s turn to the “pain threshold” topic. Due to the forecasted drop in oil prices from $95/barrel to $41/barrel, Russia’s federal budget lost 56.16 percent of its income, or 4.2 billion rubles. If the year’s average oil price drops to $20/barrel, the budget will decline by another 2 billion rubles. Primarily, this will have an impact on social programs and national defense.

What should be done? First, we should start properly managing our oil reserves, based not on corporate, but national interests. Oil extraction levels should be brought up to at least what they used to be in the former USSR. We should also pass the long-suffering subsoil law. Perhaps we should consider establishing oil reserves, although this measure would stabilize oil prices only in the short run (for up to 2 months). It’s time to stop talking while doing practically nothing, especially since in the oil refining area the power has already deteriorated by 75-80 percent. By the way, this is a good investment. We should spend our oil money here, instead of investing it in the American economy.

As a stock market expert, I’m also interested in how the oil is brought to market. It’s time we stop the strange (to put it mildly) practice of selling “cash-settled” futures while still handling the actual delivery the old-fashioned way – through separate contracts in each region. We need to put the oil on the market and get a real fair market value. Maybe then we won’t lose $2-4 on each barrel, caused by price differences between Russia’s Urals and foreign Brent.

– The ruble/dollar and ruble/euro rates seem unpredictable. What is the likelihood that the U.S. will introduce a new currency, amero? How realistic is Kazakhstan President Nursultan Nazarbayev’s proposal to change Russia’s, Kazakhstan’s, and several other countries’ currency to the yevraz?

– In December of 2008, the Institute for the Development of Financial Markets made a forecast for the dollar/ruble and euro/ruble exchange rates for the end of 2009. It predicted that the dollar would equal 30.5-31 rubles. The forecast was based on the assumption that the degree of the Russian economy’s competitiveness would be the same as during the prosperous 2007. But now, the government’s projected rate is one dollar to 35.1 rubles. In other words, the government decided to win back its pre-2007 position and make a competitive reserve that roughly corresponds to 1999-2000. We’re not sure this is the right approach because it may create import problems. And currently, almost everything is imported, even medicine and agricultural products. Russia can’t develop its own production on a short notice; it’s well-known that it takes a whole generation to “grow” a competent farmer.

At the end of the year, the euro’s exchange rate will be determined based on the dollar’s value and the euro/dollar exchange rate on the world markets. Most likely, by 2010 the euro will regain its position (if the U.S. lets it) at the rate of 1.3-1.4 dollars per euro. These forecasts depend on the Fed having full control over the dollar’s development. If not, then the switch to a new currency like amero is possible, and it will cause major problems for the rest of the world. Obviously, it will result in a loss of trust in the U.S. financial system. It will take a long time to rebuild that trust. Therefore, such actions will only be taken as a last resort. An interim option could be the conversion of other countries’ dollar-denominated assets into the amero, probably along with a delay in payment due dates. This option could also be used during the next stage of the man-made “crisis,” when the real oil resources start getting exhausted.

Nazarbayev’s suggestion is very timely. It’s a realistic and logical way to modernize the world’s financial system. Indeed, if country A wants to import goods and services from country B, naturally, it should first get that country’s currency, which then becomes its reserve. It works the other way, too. Everything becomes clear and simple as long as a few guidelines are followed. First, central banks should not be involved in the process of establishing currency exchange rates. They shouldn’t handle commercial operations. Their job is to unconditionally fill the money channels while minimizing inflation. Currently, several countries’ central banks are acting as IMF’s agents (i.e. practically speaking, as agents of the Fed).

Second, if countries want their money to be a reserve currency, the currency should be tied to real (as opposed to virtual) assets. For example, the currency should be tied to gold, metals, oil, etc. Otherwise, sooner or later it will be diluted by other foreign currencies. And thirdly, the price of every single real base asset must be determined on either global or regional exchange markets. Naturally, under this approach, there’s nothing stopping several countries in a region from establishing a common currency, such as yevraz.

This is how the global financial system will most likely develop, since nothing fundamentally new will be proposed on April 2nd at the G20 summit. By merely monitoring rating agencies and hedge funds, as well as improving operating standards for financial institutions, we’ll only treat the symptoms and not the underlying cause. The Fed isn’t planning to stop the printing presses any time soon, so it will continue printing dollars that aren’t secured by any real assets.

It should be noted that introducing new regional currencies could lead to increased military threats. The U.S. will not put up with this kind of willfulness. Recall what happened to Yugoslavia after the introduction of the euro, or to South Ossetia after Dmitry Medvedev mentioned the plan to make the ruble its regional currency. Finally, recall what happened in the Persian Gulf area (proposed regional currency – the Gulf dinar), which led to major issues in Iraq and Iran. In each of these cases, the U.S. carried out sanctions under the pretext of promoting democracy in its American sense.

The obvious question is whether Russia has enough power to deter this possible military aggression, especially after the latest stage of the so-called “military reform” practically destroyed the remnants of Russia’s most capable military units.