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21 January 2015

Who's Demonising Whom?




Political leadership has at least as much to do with illusion as reality; what the adage about fooling people really means is as long as you can fool some of the people some of the time, you stand a fighting chance of keeping your head above water. And when things at home start to go wrong, then the smart move is to point at an outside enemy to draw the people’s attention from your own shortcomings. Last week, in his article on here, Richard Horswill presented that as the current US policy towards Russia, a policy developed to deflect criticism of the current state of the US. Now, I’m not going to say that there may not be some truth in that view, but I would suggest that it works at least as strongly in the other direction. In other words, the Russian leader is just as keen to to present his problems as being created by external forces. 

Resource Economy

Just look at Russia for a moment; it’s a resource economy - manufacturing doesn’t register and although technology knowledge is undoubtedly there, it is not in a position to compete on a global scale. What it has is mineral wealth - energy and metals, principally. Up until relatively recently, that wealth has stood it in good stead and has enabled Vladimir Putin to a) hold on to power and b) appear to have parts of the west at his fingertips. In reality, it’s a one-product economy (oil and gas - in other words, energy) and that makes it very vulnerable to the movements in the market for that one product. Now, the origin of the oil price drop lies on the demand side - weakening Chinese economic growth has meant demand is not at the predicted level. What has exacerbated the fall in price, though, has been the reaction - or rather, the lack of reaction - from the supply side. Whereas the expected behaviour of suppliers in times of weakening demand is to reduce supply, that is not what is happening. The producers at the bottom end of the cost curve (Saudi being the most significant) have elected not to help out those with higher costs by bearing a share of production cuts. Instead, they have adopted the perfectly reasonable approach in a commodity market of continuing to pump at previous levels because they can. If you can produce cheaper than anybody else, then let them bear the pain - it’s not your problem. The days of cosy, protective behaviour amongst producers are over, at least for the moment.

The US - and Shale

The extra factor, which has led to this change in behaviour - and I accept there may be other arguments here, but to me it seems clear - is the emergence of the US once again as a major producer. It’s difficult to over-estimate the effect of shale oil and gas extraction in the US; and that is the real target of the Saudi pressure. Shale is higher cost, but as long as it is economic, it threatens demand for other producers. So, the logic goes, let’s get the price down to render it uneconomic. (As a non oil expert, I believe there are two flaws in that logic. First, history tells us that over time, technology becomes cheaper - just look at electronics - so it’s at least an arguable case to assume that the cost of extracting shale oil will also do over time. Secondly, as I understand it, that extraction is more like an industrial process than it is like a mining operation; shuttering a shale production facility is more like switching off something that can be switched on again, whereas closing an offshore field is on the whole terminal. In other words, if necessary, shale production can be closely linked to the ups and downs of prices. That suggests it’s an ever-present threat to supply.)

Collateral Damage

There is collateral damage to this, of course. Producing countries like, for example, Venezuela, Iran - and Russia. As I commented above, Russia is a one-product economy. Unfortunately, it is not amongst the cheapest producers of that product, and is therefore not in control of its own destiny. Two facts get bandied around here. Russia has around $400 billion of reserves; yes, but at the beginning of 2014, it had more than $500 billion. Twenty percent has gone, used in an attempt to protect the rouble; that went well, didn’t it? Look at the rouble rate in January 2014 versus where it is now. Secondly, Russia has a lower level of sovereign debt than lots of others, significantly, for the purposes of this discussion, than the US. Again, that’s true, but it only tells half the story. Since oil underpins pretty much everything about the Russian economy, the fact that its ‘privatised’ oil companies (as well as the state-owned ones) have huge debt in international currency is, logically, of equal importance. Add all that lot up and then think about potential debt problems, and bear in mind that that debt is not in devalued roubles. It’s true that on a purely rouble level, Russian oil producers see a benefit from the weakening currency; but the debt outweighs that.

Napoleon - and Obama

Contrast that with the US; there, the picture looks rosier. For sure, unemployment is worse than the headline six per cent-odd figure would suggest (taking into account the ‘discouraged’ unemployed brings it to a level somewhere above ten percent) and the political picture is murky, with a president and legislature seemingly unable to agree on anything. But the stories of exporting manufacturing and low oil price led layoffs in the oil sector are exaggerated. In fact, US manufacturing is strong and healthy and the consumer benefits gained from low oil prices outweigh the problems for some parts of the sector - and, as I say above, the shale doesn’t go away; it’s a resource that remains available to be exploited. What the current price really does is transfer wealth from foreign oil producers to US consumers, as the impact of lower prices feeds through the system. In the end, it’s because the US is a far more broadly based economy than Russia and is not dependent on one sector for such large proportion of it’s wealth. That doesn’t mean everything is perfect; the US is over-indebted, it does still appear to have unresolved social and racial issues, but Obama (who wouldn’t win any contests looking for a good president: let’s face it - despite the euphoria that greeted his election, he has frankly been an indecisive  disappointment) seems to be what Napoleon would have looked for. Shale oil and gas and the action taken by the Saudis in the market on the back of that and the weakening of global demand is his good fortune - and Napoleon realised one of the lasting truths of human behaviour: “I’d rather have a lucky general than a good one”. That’s a sentiment echoed by generations, including, incidentally, those who employ copper traders, for example.

History

So, back to the theme of the demonisation of the outsider. I would argue that Putin has a greater need than Obama to create the shadow of an external threat. Faced with a weakening economy, a crashing currency and no control over the price of its major resource, it’s surely the time to point to others for blame. The grab for Ukraine seems to me to epitomise that, because it was almost inevitable that, after the break-up of the Soviet Union, Ukraine would begin moving closer to the west. History is important, and three generations is not enough to blot out the communal memory of Russian actions in the early 1930s - the Holodomor killed countless millions, and its author was Russian. The fact that both sides evoke the 1940s and call each other fascists and nazis is unedifying but can’t conceal that it’s been Russia pushing Ukraine more than the west pulling it.

A Simple Question

Without forgetting that the world is no longer the competition between two superpowers that it was after the Second World War and that China has a big voice in this these days, if you’re looking at which of the two economies looks the more stable and successful, ask yourself this simple question: how many Westerners, having made their fortune, immediately head off to Moscow to buy themselves property and security? And then turn the question round. In the end, what people do with their own money is a pretty fair indicator of what they think. The reaction to western sanctions is telling; preventing the import of some western consumer goods is a way of hiding how the weakening rouble would have inflated their prices. Much better to do it this way, putting the blame on the foreigners rather than have to recognise the truth of the weakening economy. 




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