Checkpoint Asia

With Global Recession Looming, Unleveraged and Debt-Free Russia Looks Strong

Russia is among the world’s countries best placed to cope with the coming bust

Suddenly, the floodgates have been opened and even mainstream business media is admitting that the threat of a global recession is very real. When exactly it will all come down is still open for debate, but otherwise it seems pretty much ordained.

In a global recession, no country is safe, but Russia looks to have quite a lot going for it in terms of economic advantages. Russia’s national balance sheet is next to none with by far the lowest debt of all major countries.

All economic actors, the government, corporations and households are economically solid and minimally leveraged. Not only is the government virtually debtless, but it has again replenished its spectacular forex and sovereign wealth fund reserves. On top of that comes a hefty budget surplus. – Yes, you heard that right, surplus. In a time when all Western countries are in a chronic fight against deficits, you rarely even hear the term budget surplus.

And more, Russia runs the world’s third biggest trade surplus. Add to that the current account surplus, and there’s the hat trick in form of your classic triple surpluses. Russia has a lot more going for it, too. We’ll look at that and the figures to back up the talk further down in this report.

Central bank fueled asset bubbles

Russia is low in debt, but you can’t say the same about the US and other Western nations. And that debt really is what got the world in the present mess and brought it teetering on the brink of financial collapse. Since the late 80s, the US central bank, the Federal Reserve under Alan Greenspan developed an addiction to cure any downward tick on Wall Street with easy credit, eventually requiring after every downturn ever bigger central bank liquidity injections to keep the stock indices on a growth curve. Greenspan was experimenting with a policy aimed at creating a “wealth effect” aka “trickle-down.” The idea being that Wall Street bankers and big corporations be stuffed with all the free money they can swallow for the purpose of keeping stock and bond prices high. The theoretical frame told that doing so something would eventually trickle down to the real economy, and everybody would live happily ever after. After stocks and bonds, Greenspan’s wealth effect policy was addressed to inflate home prices and all real estate with that. That was the road that eventually led to the 2008 subprime loan crisis, which took down Lehman Brothers and then all of Wall Street and the whole global economy.

But Wall Street recovered soon, because Greenspan’s successor Ben Bernanke had set forth to blow up an even bigger asset bubble. And the Europeans followed suit. The Fed fueled the market frenzy with creating money out of thin air (aka quantitative easing) in favor of governments, banks and corporations to the tune of $3.5 trillion in the decade following the 2008 collapse.

The European Central Bank has done the same for Europe in volumes more than 2.5 trillion euro to date. All the other Western central banks joined the gambling by flooding the markets with fiat money at same levels relatively speaking.

But anyway this astronomic leverage and the humongous budget deficits of the Western countries didn’t get the real economy anywhere. They have blown up asset bubbles of phantasmagorical proportions with preciously little trickle down. Since the pre-crash peak in October 2007, the broadest US stock index (Wilshire 5000) has gained 95% (on top of covering the nearly 60% crash from in between). In the same 12-year period industrial production (manufacturing, mining, energy, utilities) has grown only 5% combined over all those years.[1] Deduct – the in itself lossmaking – shale oil and gas and there is barely no growth left in the 12 years. In fact, the US manufacturing sector was in June still 1.6% below the pre-crisis peak in December 2007.[2] So we have a 5% gain in the most important part of the real economy vs. 95% in stock market gambling. The absurdity of the stock market growth is further evidenced by the gap between growth of real final sales and stock valuations since 2007 peak. Since then, the former has grown on an average 1.6% per year, while the stock market has delivered annualized growth at levels of 15%.

Trickle-down, anyone?

It would be false to claim there has not been any trickle-down at all. Millions of people have kept their jobs because of it. But at the same time they have had their real wages squeezed and the overwhelming majority have seen their standards of living drop. Only massive loads of consumer credits and ultra-cheap mortgages have kept up an illusion of superficial prosperity among the middle classes. This debt-fueled prosperity and it’s cursory result, the artificial real estate asset bubble will prove a wolf in sheep’s clothing when the everything-bubble bursts.

There’s been another form of trickle-down, too, a much more real and actually beneficial one. By creating the debt-fueled illusion of prosperity, the Western central banks have actually subsidized China, Russia and all of the emerging world as they have flushed their export goods on the global markets where the Western nations have picked it all up on borrowed money. Thanks for that, though. At the same time, that has driven production costs up in the West with the consequence that their own industries have been priced out.

The humongous borrowings fail to produce GDP growth

Every year since the last bout of the crisis in 2008, growth of debt in the national economies of each Western country has far exceeded the growth of economic output measured as GDP. Below chart shows just how bad it has been in the US.

The debt and GDP growth curves started to diverge in the late 70s, but from 2000 debt has spiraled out of control delivering preciously little incremental GDP. Deduct the wasteful debt and wasteful spending and there would be no growth whatsoever.

Not only has there been no real GDP growth but even the nominal growth has to a crucial extent been provided for by means of the enormous government borrowings. We see from below table that that in each year from 2008 to 2017 even the nominal GDP growth has been less than the growth of government debt, with 2015 and 2015 as the only exceptions when they were on par.

In the peak crisis years 2008 and 2009, debt growth was a staggering 5.7 and 6.3 times that of GDP growth.

The debt game has been equally miserable all over the West, perhaps with the only exception of Germany, who has wisely refrained from participating, even when egged on by liberal economists calling Germany’s more prudent policy unfair to the gambling nations. Below chart shows how much more the Western governments have borrowed than produced economic growth. The chart covers years 2004 to 2013, but the trend has been the same ever since. GDP growth has been vastly less than the growth of the colossal debtberg.

Note, Russia there as the shining exception.

Below chart ranks countries according to their debt burden relative to GDP. Again you see how debtless Russia is compared with the squandering nations.

These charts concerned only government debt, when we add private debt to it, the picture is doubly worse. From the point of view of a national economy it really doesn’t matter in which form the excess debt expands, public or private. In fact, on an average in the West the situation with household debt is equally dire. Below chart tells you just how bad. And again note Russia as the one shining exception.

And it’s no better with corporations, which have throughout the last decade been enjoying mindboggling levels of central bank largesse in form of virtually unlimited interest-free financing. For example, compared to earnings, US bond issuers are about 50% more leveraged now than in 2007.[3]

Finally, there is the black hole containing trillions and trillions of bankers derivative risks. Deutsche Bank – which was recently placed in emergency care – alone is said to have 49 trillion dollars in exposure to derivatives. These risks alone could take down the whole global financial system.[4]

First no real interest, then negative yields

One of the many deadly side effects of the central bankers’ practice on gambling with the national economies is that they first eliminated real interest rates (pushed rates below inflation) and then doubled down on the destruction of sound economic principles by cooking up a system with negative yielding bonds (bonds which yield below zero). By now $30 trillion of the $60 trillion US bond market yield below inflation (no real interest) and nearly $17 trillion worth of bonds are in negative yield territory. That’s mostly made up by sovereign debt of Japan and European governments (12 at the moment) but recently the mass of negative yielding corporate bonds has also doubled to $1.2 trillion. Half of the $5 trillion worth of European government bonds sport a negative yield as well as 20% of European investment grade corporate bonds.

Inflation risk

Normally, this kind of excess liquidity artificially put on the market (aka money printing) would have led to high inflation if not hyperinflation. Several factors have helped to keep prices in check. First, it needs to be pointed out, though, that inflation is actually a lot higher than what the government reports. This has been pretty convincingly proven in the case of the United States.[5] Official statistics may not see it, but people sure feel it.

Secondly, the asset price bubbles in real estate and financial markets in fact represent inflation, it’s just not officially recorded as such. As it is only the 10% (and increasingly, the 1%) who get the money, they spend it on the stuff that counts for them, stocks and real estate. Keeping their loot offshore also helps to dampen inflation at home. The squeeze on the middle classes and stagnating wages, is sadly an important factor in keeping inflation down. Ordinary people just can’t afford to buy.

One should also note, that resulting from the illusionary debt-fueled prosperity and its effect on keeping the local Western currencies artificially high, there has actually been an inflation in wages and production costs, but only in relative terms in comparison with the emerging world. This in turn has led to further offshoring of manufacturing jobs.

A crucial factor, which in the crazy money printing environment has kept consumer goods from hyperinflating has been imports from the emerging Asia and especially China. Huge growth of the Chinese manufacturing industry coupled with massive influx of cheap labor from the rural countryside into the cities enabled China for a couple of decades to constantly increase its exports to the US and Europe and these countries to keep prices down. (Including by domestic industries having to lower prices in competition). With the Trump trade wars and dramatically increasing protectionism, this will change. And it could get very ugly.

Finally, there is an important consideration that few if anyone seem to understand. That is the fact that the US and other Western countries have been able to print the stupendous amounts of money while keeping rates down and without the currency values crashing only because they enjoy local currency monopolies in their respective territories. The USD has of course been enjoying a global monopoly, but that is fast fading. All the other factors mentioned above (and several other ones), have enabled to prop up and prolong these currency monopolies, but there is a limit to everything. In the coming recession, I would expect some of the lesser currencies to lose their monopoly trust and that would shatter the position of the bigger currencies USD and Euro and force them to raise interest rates. I have earlier written more in detail about this in a report titled How the Dollar and Euro Monopolies Destroyed the Real Market Economy.

The below chart suggests that the Western countries are already on the way to lose their respective currency monopolies. The BRICS countries (Brazil, Russia, India, China, South Africa) now have a combined GDP (measured in PPP, which is the only correct way to measure the relative size of national economies) larger than not only the G7 countries, but the US and Eurozone economies combined.

At its foundation in 1973, the G7 countries had a combined 50% share of the world GDP PPP, by today it is down to 30%. In the same time their nominal GDP as a share of the world economy has crashed from 80% to 40%. The currency monopolies came with the economic superiority, it is therefore only natural that with the economic domination goes the currency domination, too. If we haven’t reached the tipping point yet, then that will happen within 5 to 10 years.

In summary, everything else unchanged, the risk of inflation picking up with just a few percentage points could have the entire Western financial systems coming crashing down due to the pressure on interest rates growing. The Fed and the ECB are continuously speaking about their inflation targets and how they want to pump the markets with more liquidity to raise inflation. There could yet be a big surprise in store for them. Interest rates as such could also be the primary trigger (even without inflation first rising), as nations would have to protect their currencies and attract financing for their colossal debtbergs.

Must add as a P.S. that the incipient flight to gold might well be one of the trigger events for those currencies to lose their monopolies. (Gold price is up 20% since May).

Deleveraging will come

These massive borrowings have delivered nothing of tangible value. Now, when the party is nearly over all there is left are the debt bubbles that have hit the roof. The real values of all the assets below bear no relation to the money that went into inflating the balloons. What’s left is economic hardship for 80% of the people, a crumbling infrastructure and simmering social tensions.

The debt saturation point has been reached, therefore this time it will be different, the central bankers have lost their magic wand and won’t be able to renew the debt binge and extend it with one more decade. Instead, there will be a day of reckoning. Governments and corporations will have to put their act together and let the market weed out the failed entities. Those who cannot carry the debt, will have to shed it. There will be bloodbath with defaults, bankruptcies and massive unemployment. – Perhaps a revolution here and there. – There will be no choice, deleveraging must happen.

Now, whether this system will come crashing down or just slowly die as it trundles downhill will not matter all that much. It will eventually die either way. Most people would prefer the slow motion option, but only with the crash would a cure come. Whatever, it has become increasingly difficult to stave off the crash and this time around, the financial markets would take the real economy down with them big time.

The impressive figures on Russia

The question then is, who would be left standing? Naturally, those who are less leveraged. Now, scroll back to have a new look at the above charts on government and household debt. Find the position of Russia there? That’s right. Russia is the country with – by far – the least debt, both public and private. Having after 2014 following sanctions been cut off from the Western debt orgy, even Russian corporations are shielded against a possible Western debt apocalypse.

Let’s look at Russia’s present financial health report.

Thanks to import substitution (domestic production instead of imports to neutralize sanctions) Russia’s industrial production rose 2.6% year-on-year in June. (USA +1.1%, UK +0.8%, Japan -2.4%, Germany -5.9%). Above, we mentioned that US industrial production was up with as little as a cumulative 5% since 2008 to date. In the same period Russia’s industry grew 18% notwithstanding the hardships of sanctions and sharp drop in oil price. In fact, since 2014 when the sanctions were first imposed, Russia’s industry has grown 12%.

Russia’s merchandise trade surplus for the first half of 2019 was $93 billion, ranking third in the world after China and Germany and before South Korea. Imports were down by 3%, the other side of the coin of growing domestic manufacturing. Even when exports also were slightly down, lower imports will keep the surplus on track to reach levels near $200 billion for the full year, just under last year’s record $212 billion.

Q1 current account surplus clocked in at $33 billion, up 10% over the year.

In this connection, it might be helpful to remind that Russia’s economy is nowhere near as dependent on fossil fuels extraction as it is habitually believed in the West. In fact, oil & gas only account for 10% of Russia’s GDP according to World Bank statistics. (In 2017, total natural resources share of GDP was 10.7%, but that includes minerals and forest, too).

We also need to point out that Russia has an enormous strength by way of being the world’s most self-sufficient major country. Russia has the by far lowest level of imports relative to GDP of all countries, as evidenced by below table. It shows that Russia’s imports as a share of GDP was as low as 7.2%, while the corresponding level for Western European countries was between 30 to 40%. The extraordinary low levels of imports in a global comparison obviously signifies that Russia produces domestically a much higher share of all that it consumes (and invests), this in turn means that the economy is superbly diversified contrary to the claims of most so-called Russia experts.

Despite initial scares, inflation has remained low even when the VAT rate was from the new year raised from 18% to 20%. The rolling 12-month inflation runs at 4.6% but with the declining trend the full year inflation is expected to hit the central bank’s target 4%.

The job market continues strong with record low unemployment levels, while the job participation rate has not deteriorated (so no tricks here). The July reading of 4.6% translates to 3.4 million unemployed, which is low for a country with a population of 146 million. The strength of the labor market was underscored by an increase of real salaries by 3.5% by July. This while disposable income otherwise has remained subdued.

Whereas the US is combating persistent budget deficits (latest reading, a deficit of 4.5% of GDP) – likewise the EU countries – Russia mustered a huge budget surplus equal to 3.4% of the GDP by July this year.

Russia’s foreign exchange and gold reserves have also done a spectacular comeback reaching $520 billion.

The Russia sovereign wealth fund surged in July to reach a value equal to 7.2% of GDP.

Despite the wholesome macroeconomic environment and impressive figures, Russia’s GDP growth has been less than 1% so far this year (year-on-year 0.6% in Q1 and 0.9% in Q2). However, by the looks of it the fundamental economy seems to be growing and modernizing, while the drag on the growth comes from depressed household consumption. What’s more important, though, is that while Russia’s growth is hovering around the 1%, so is that of all of the Western world. (Accuse me of whataboutism if you will, but these things need to be put in perspective). Q2 growth in the Eurozone was 1.1%, with Germany even about to slide into recession. UK clocked in at 1.2% and Japan at 0.4%. (All figures, year-on-year). The US showed only 2.1% even when fueled by a mountainous budget deficit set to reach $1 trillion for the fiscal year and despite all that easy money the Fed keeps pumping out. Only China remained firmly in growth territory with 6.2%.

One more piece of background information is needed to fully understand the strength of the Russian economy. That is the difference between GDP nominal and GDP PPP, the GDP adjusted for purchasing power parity. The financial media prefers to refer to the nominal GDP, either out of habit, stupidity or to prop up its narratives. The thing is that GDP nominal is biased in favor of the Western nations and makes them look more solid than they are. But in fact, the nominal GDP merely expresses the relative cost level in a country, how expensive things are in one country compared with others. Quite the contrary, the PPP method measures the real economic output in a country, how much goods are actually produced. A simplified example: 2 countries don’t produce anything but tomatoes. Country A produces 2 kilos of them which sell at 1 dollar. Country B produces 1 kilo which sells at 3 dollars. According to GDP nominal, country B would be the bigger economy, because its economy was worth 3 dollars. But according to GDP PPP country A is rightfully the bigger one, because it produced double the amount of tomatoes.

This is precisely the case of Russia. The GDP measured in PPP shows its true position among the world’s largest economy. The below table shows the 15 largest economies based on GDP PPP in 2018. You can see, that Russia is there 6th just after and practically on par with Germany. Not that it matters so much – because this is not a beauty nor a sports contest – Russia is on track to supersede Germany this year to become the 5th largest economy. Whatever, they will still be practically the same size. Other thing, that according to the trend in 10 years, Russia could be much bigger than Germany and even compete with Japan for 4th place.

Read more about GDP nominal and GDP PPP here.

The big disadvantage Russia has compared with the Western countries is the exorbitant real interest rate that the central bank maintains. The steering rate is presently 7.25%, with inflation predicted to be 4%, that translates into a primary real interest of 3.25%. Compare that with the negative real interest – and even negative yields – of competitor countries. As, the Russian central bank has failed to create a real banking sector which would lend according to international standards to the country’s businesses, the ones that are lucky to get a loan at all would look to pay interest at the level of 15% of more (save the largest corporations). The Governor of the Russian Central Bank Ms. Nabiullina does not see this as a problem, though. She has said that instead she would pin her hopes on improving the countries investment climate (sic!). (She calls for improvement of corporate governance, development of human capital, and all kinds of nice things. That would sure do it).[6]

So, then actually the conundrum is, how can Russia produce the same GDP as all the Western countries with their seemingly limitless injections of give-away money? How is it possible that all those trillions and trillions that the Western central bankers have thrown on the economy do not produce any real incremental economic output?

In conclusion, we are not saying that Russia would not be hurt by the coming recession, we merely express our confidence that Russia is among the world’s countries best placed to cope with it.

Source: Awara Group





[5] See, for example,