Potential Positives With Putin

Recent indications from Russian President Vladimir Putin that he may run in the 2008 parliamentary elections to possibly stand in as a candidate for Prime Minister is spurring discussion in the Western press about the demise of Russian democracy. We think that is a misreading of the situation. In our view, Putin's continued presence on the Russian political stage is more likely to be a positive, stabilizing influence for Russia's political and economic outlook insofar as it safeguards the country's sound economic reforms instituted since 2001. Indeed, we think investors would face greater uncertainty if Putin, the man who pulled Russia up from the ashes of the post-1998 devaluation disaster, were to suddenly drop off into obscurity.

Today, President Putin is hugely popular in his own land, enjoying a reported 70–80% approval rating. Were it not for the Russian constitution, which prohibits a president from serving three consecutive four-year terms, Putin could safely win reelection if he were allowed to run. But to understand why Putin is so wildly popular, one should remember what happened to Russia under Putin's predecessor Boris Yeltsin. As Anne Williamson, author and Western journalist covering post-Cold War Russia, put it earlier this year:

In the course of Yeltsin's rule, the Russians lost their savings in the great inflation of 1992–93 Harvard advisers engineered by having Yeltsin free prices in a monopolistic economy, their jobs, or well, their jobs' paychecks anyway. The population was halved literally overnight, and the nation's boundaries pushed back to what they had been 300 years earlier.

Russians lived through the loss of their chance at becoming owners of a piece of their national estate and the public humiliation of social collapse and national insolvency. The psychological burden on the Russian people, citizens of what was for centuries a great and powerful country, was a heavy one. Each man, each woman was robbed and swindled several times over by street rackets, by lotteries, by government failure and stupidity operating under the banner of "reform." Deaths from accidents, suicides, sudden illness, drunkenness and violence skyrocketed. More died than were born.
And then in 1998, they got to do it all again!

When Putin assumed power on December 31, 1999 Russia's status as a world power had collapsed to the level of basically a third-world, oil-exporting, nuclear armed country with a weak central government, suffering political instability within its own borders in Chechnya. Under Putin, however, Russia underwent nothing short of a "miraculous" transformation with a much stronger economy and enhanced international profile. Today, unemployment is 5.7% as of August and GDP has grown an average of 6.6% during the last five years.

The conventional understanding of Russia's recent economic success attributes the country's growth as largely the by-product of rising oil prices, especially since 2002. But if Russia's growth story were simply about the rising price of crude, then other oil-exporting countries, such as Venezuela would be able to boast similar successes. But that's not the case.

The difference between Russia and Venezuela is readily explainable when one looks at the fiscal and monetary differences and the important lasting effects of the truly supply-side fiscal reforms instituted under President Putin almost six years ago. In 2001 Putin instituted a 13% flat tax rate on personal income along with a 9% rate applied to dividends. And capital gains, which are taxed as ordinary income, enjoy today a slightly better treatment in Russia than in the United States. What's more, according to PricewaterhouseCoopers (PWC) there is a full capital gains tax exemption on the sale of a primary residence that is held for more than three years. The American exemption is good only up to $500,000 for a married couple for the same term. In 2006, Russia effectively eliminated its inheritance tax and taxing estates between 5–40%. Additionally, according to PWC, Russia's corporate tax rate was also reduced during Putin's tenure. It now ranges between 24% and 20% in most Russian regions.

Venezuela's tax system, on the other hand, is rife with obstacles to capital formation. It boasts a 34% top marginal rate on income over $93,000; a 34% tax on dividend income; and capital gains are taxed as part of ordinary income. Taxes on estates and inheritances run from 1% to 55%. The corporate tax rate is 34%; while for some industries, such as oil, the rate is as high as 50%.

Monetarily, the differences between Russia and Venezuela are even more apparent. At around 24.5 rubles per dollar today, the ruble is now stronger against the greenback than it was when Putin became president in 1999. What's more, monetary officials are correctly recognizing an anti-inflationary benefit in allowing the ruble to strengthen against the globally weak dollar. The Venezuelan bolivar, by contrast, suffered orchestrated devaluations in 2004 and 2005. On December 31, 1999 the Venezuelan bolivar-dollar exchange rate was 648.5. Today, it is nearly three times that number at 2,147 bolivars per dollar. It is on the back of these positive fiscal and monetary developments that Russia's capital formation has really outshined other oil producers. While the Caracas stock exchange under Chavez's redistributionist policies has still managed to gain 108% in U.S. dollar terms since January 1, 2002, Putin's supply-side revolution has catapulted the Russian Trading System Index, which is up more than 645% over the same period!

Understandably, investors long in Russian equities do not wish to see any backsliding on Russia's pro-growth policies. And to some extent, we've already seen measures put in place by Putin to keep out the influence of those forces widely considered in Russia to have contributed to the economic mess of the Yeltsin days, such as the prohibition against foreign-funded non-governmental organizations.

Last month, Putin nominated Viktor Zubkov to become Prime Minister. Zubkov, a colorless apparatchik, has nowhere near the popular base of Putin or his charisma. But Zubkov, with his experience as head of the Federal Financial Monitoring Service (similar to the U.S. Treasury's Financial Crimes Enforcement Network) which has targeted the shady money dealings of Russia's "oligarchs" in the past, may serve as a political defense against Russia's business elites from meddling too heavily in the country's political system, as they did during the Yeltsin days.

Should Putin become Prime Minister in 2008, there is speculation that such a move would lead to a stronger parliament relative to the president. Mark Ames, editor of the ex-pat journal Exile, points out that the irony of such a move is that a stronger parliamentary democracy is precisely what fierce Putin critics Garry Kasparov and post-Soviet oligarch Mikhail Khodorkovsky (who remains in jail) have been pining for. But a stronger parliamentary democracy would also likely make new legislation a more deliberative process, with it being far easier to kill bills than to pass them, thus preserving much of the critical tax work implemented during Putin's tenure. As Prime Minister, Putin would likely nonetheless command significant powers and this would allow him to continue pushing pro-growth reforms.

With fiscal policy on a superb footing, Putin's future attention may turn to monetary matters and trade. During a business summit in St. Petersburg this past June, Putin offered a wringing indictment of the global financial system and its inability to meet the needs of developing nations that are struggling to participate on fair terms with first world powers. As Putin put it:

"Today, the protectionism the WTO was set up to combat is often implemented by the developed economies that founded the organisation. It is in these economies that we see the greatest concentration of state support for business. It is not coincidence that a parallel system of regional alliances and agreements is taking shape, essentially giving the global market a new structure. And the trade liberalisation process is now taking place more and more through these new agreements. It is worth thinking about creating regional Eurasian free trade institutions in order to encourage trade and investment."

The idea is clear: global free trade has become a difficult proposition practically, but it is a much easier game regionally. And despite the lack of progress with the Doha trade talks, it is clear that the U.S. has nonetheless pursued bilateral trade agreements with a number of countries, along with regional trade deals such as CAFTA. Putin is simply giving notice that it is probably in Russia's best interest to consider the same approach.

Additionally, Putin's discussion of the global monetary environment suggests that thirty-five years of floating exchange rates have been more than enough. In other words, for Russia to fairly honor free trade agreement with its partners, currency stability is a necessity. In the same St. Petersburg's speech, he said:

"An international financial system based around just one or two currencies and a limited number of financial centres no longer reflects the global economy's strategic demands. Fluctuations in these currencies' exchange rates have a negative impact on the financial reserves of entire countries and on the development of different economic sectors around the entire world.
There can be only one answer to this challenge and that is the emergence of several reserve currencies and several financial centres..."

Given the dollar's pronounced weakness in foreign exchange markets and its inability to function as a reliable unit of account for international commerce in recent years, Putin's clamor for an alternative to the unstable dollar, euro and yen likely resonates with the developing world. Not only with China, which is being pressured by Washington to 'float' their currency, but also with a slew of commodity producing nations, especially the oil-producing countries around the Persian Gulf, who themselves are struggling with the rapid rise of inflation under their dollar-linked currencies. The thrust of Putin's speech even splashed into the op-ed pages of the Wall Street Journal, where the editors still appreciate the truth that free trade works best when currencies are stable.

Does this mean a future Ruble bloc? Not necessarily. But Putin's suggestion of a new financial architecture with stable exchange rates at its base, is a compelling foundation by which Russia's sovereign trading partners can find mutual benefit in scrapping floating exchange rates and adopting a single unit of account. Indeed, this is basically the same premise behind the creation of the euro, which will soon expand to 15 European economies that worry not a whit about currency fluctuations between them. Such a direction would be positive for Russia's economic future.

There may also be mutual interest between Russia and its trading partners in agreeing on a stable monetary anchor, i.e. gold, to which to tie their currencies. This approach would be a much more radical maneuver to remake a system comparable to the Bretton Woods global monetary architecture.

Politically, Putin is acutely aware that right now his country's political system is too dependent on one man. At the Valdai Discussion Club last month, he said:

"I am very concerned that today in Russia so much depends on only one person. And I want to change this. But when I said that both groups were right [one group saying Putin will leave the political scene and one group saying he will stay on the political scene], I meant that I am not planning to disappear altogether. I am not planning to emigrate, to take up permanent residence in another country. I love my country, I am Russian…It's absolutely clear: my activities will have an influence. But I say again, I am not planning to use it to destabilise or weaken the authorities. My goal is to ensure that power in Russia remains stable".

The idea that President Putin is looking to retain power and become a Stalinesque dictator sounds utterly misplaced. Still, it does seem reasonable that Putin could end up in a situation where he might retain a good deal of power and influence once he steps down as president and continues his career as a parliamentarian and possibly Prime Minister. But it is also clear that even as Putin's successful presidency draws to a close, there is still work to be done. He is attempting to establish political safeguards that would preserve his positive contribution on taxes and allow the continuation of the country's renewed prosperity. With that part of his legacy secure, Putin would then be free to lead Russian legislators in pursuit of positive initiatives such as improving trade ties and currency stability between trading partners.

October 16, 2007

Vlad Signorelli [send him mail] covers international markets and is the executive editor of Bretton Woods Research, LLC, a supply-side macroeconomic forecasting firm. Before Bretton Woods Research, Mr. Signorelli was the Director of Global Research at Jude Wanniski's Polyconomics, Inc. Disclosure: Bretton Woods Research is currently bullish on Russian related ETFs (exchange traded funds) such as RSX and CEE.

Back to LewRockwell.com Home Page