8 min read

Sino The Times

Sino The Times

For twenty years, Russian policymakers have been threatening Europe with assurances that Gazprom, Rosneft, and the broader array of SOEs and large corporates across the economy could always pivot to China and Asian markets if their western counterparts didn't play ball. In 2002, early talks over the Eastern Siberia-Pacific Ocean pipeline (ESPO) were held with Japanese counterparts selling Moscow the idea seaborne crude exports would allow them greater flexibility. By 2003, the context had shifted thanks to the likes of Mikhail Khodorkovsky and Yukos closing supply deals with Chinese firms. Next thing you know, Yukos is being devoured by Rosneft with the help of Chinese financing and a branch pipeline has been added to ESPO to serve the Chinese market. The Power of Siberia eventually repeated this logic in the wake of the Eastern Gas Program. At least as far as energy is concerned, that was always the idea. Nothing comparable made sense for exports of aluminum, steel, or other refined metals. Coal fit into this matrix as well.

Russia's rhetorically persistent promises to the West that it could look east hinged on a particular growth regime that emerged in East Asia broadly, and accelerated in China specifically, in the wake of the Asian Financial Crisis that helped set off Russia's default in 1998. There are two big picture components to grasp here. First, the perpetuation of global imbalances whereby Asian exporters ran up large current account surpluses with China acting as the "factory of the world." Second, China's voracious appetite for commodities of all stripes – fueled in part by its role as a goods exporter – exploded with its growing reliance on investment (namely into property and infrastructure) to generate GDP growth in an increasingly ineffective matter by the time we arrive at 2008-2009. These dynamics then overlap fuel exporters (such as Russia and Saudi Arabia) running up current account surpluses as nominal prices for oil and gas rose during the 2003-2013 commodity supercycle only to be squeezed by the rise of US tight oil production unleashed by cheap credit.

Let's start with the goods story. Thanks to Brad Setser for these fantastic charts:

I raised the Asian Financial Crisis of 1997 because it was a chain reaction triggered by a currency crisis – the devaluation of Thai baht. As the baht was floated because Thailand lacked the FX reserves to maintain its peg to the US dollar, the IMF and global economic institutions were caught offguard because it turned out that cautious fiscal policy wasn't enough to stop a currency from rapidly devaluing due to loss of foreign reserves. 'Hot money' flows, inflows and outflows of capital making short-term speculative bets on the short-run value of an asset could rapidly pull out in the event they lost confidence in a currency, pegged or otherwise, leaving countries with weaker currencies in a difficult position if they owed foreign creditors dollars, Euros, or yen. One can imagine a hypothetical investor taking out low-interest rate debt in US dollars and parking it in a bank deposit earning a high interest rate abroad or in property and so on enjoying the ability to profit off the arbitrage if, like the baht, the currency was pegged the US dollar or otherwise traded in a tight band against it.

After 1997, the regional economies with open capital accounts learned that running large trade surpluses was the safest way to ensure that would never happen again. But running those surpluses means they had to acquire foreign claims (US Treasury bonds, bonds in the Eurozone, other assets abroad) and effectively repress domestic consumption to ensure the continuation of said surpluses. China is the extreme case, though not a perfect one since it maintained capital controls to avoid precisely this kind of emergency situation. On the flipside of the equation, you have the Eurozone which does not run a current account surplus collectively when energy prices rise, but is dominated by a German export machine that has depended on the repression of domestic wages and consumption to maintain large surpluses that then filter into the entire bloc's exchange rate and growth woes. Russia learned a similar lesson from its 1998 crisis, though the political mechanics of it were different and the country's fiscal balance was a mess. So we see that Russia was balancing east and west with its energy exports as part of the empire of US dollar accumulation powered by fuel exporters:

LHS = millions bpd oil of consumpion/production RHS = % Share of consumption/production

I pulled this just cause I find it funny that while Russia increased its share of global output – driven primarily by the huge recovery in production led by Yukos and other firms reviving old fields with western expertise from 1999-2005 – the surplus countries' share of global oil consumption has been fairly steady. Turns out that goods exporters whose growth engines depend on external demand track global growth. And this sidesteps the loss of output from Venezuela and Iran and does not include 2022 data where Russia's output would be down while China's current account surplus has risen to new record highs thanks to lockdowns and its underconsumption. The natural gas side of the consumption ledger shows as well how Russia missed its window even before the current cutoffs because of the likelihood of falling demand in Europe:

LHS = bcm

2008 and 2009 represent the peak of gas demand in Europe (barring some later recovery) thanks in no small part to austerity and the slow burn effect of renewables investment and efficiency gains. While new fields were developed and Novatek successfully launched more LNG capacity under sanctions, to this day there is no physical link between the Power of Siberia complex and Russia's Europe-facing natural gas pipeline infrastructure. Worse still, the Chayanda field that supplies China has experienced repeated technical challenges and by some estimates has cost an extra $20 billion due to corruption, poor quality, lack of oversight, and mismanagement. And that's where they're trying to increase exports mind you.

Equally important now is the reality that China's growth engine has finally sputtered to a crawl. Huge investments into building new roads, bridges, railways, and buildings of all stripes for the purpose of speculation recycled into local and regional budgets through the taxation of land and property sales no longer lift consumption much. Consumption's share of GDP remains too low. Export-led growth is also increasingly unsustainable given China's rising per capita income levels and wealth. Thanks to Brad Setser again:

At some point, China's got to consume more and that means redistributing more wealth into the hands of households, reforming labor market policies to grant workers more leverage with their employers, and providing a stronger safety net for an aging population. Mortgage takeup in China was down 25%ish y-o-y for July, construction activity have registered y-o-y contractions starting in May which hasn't happened in the datasets those figures are attached to in BBG before, and property investment is falling. For years now, Putin has been making reference to the size of China's economy in PPP adjusted terms overtaking the US, to growing strength of Asian economies in a multipolar world, and so on. But the entire time, he never seemed bothered to look under the hood at what was actually driving China's growth – and the scope for Russia to maintain its own current account surplus which has proved detrimental to net growth, investment, and per capita incomes since about 2008.

A world where China's growth weakens considerably because it can't manage the process of structural adjustment swiftly is net deflationary across a lot of commodities given it's now the world's largest oil importer (and single EV market) and consumes 30-60% of any given non-energy commodity input in the metals complex leaving lithium and similar inputs aside. The global economy has been rebalancing since 2012. Not fast enough and with incredible political dislocations, but rebalancing all the same. The ghosts of 1998 continue to haunt Russian policy and the prospects of its eternally broken export-led growth model, especially in current conditions. Domestic consumption is all that can reasonably drive growth now, and that's not going to recover for years.


  1. As of now, immigration data shows that 419,000 people have left the country so far this year (368,000 to CIS countries) and 294,000 have returned from the CIS. At first glance, the stronger ruble is sucking in more migrant labor which is keeping figures in net positive territory, but not by a lot. Only about 20-22,000 people have received status as refugees so whenever you hear or see someone posting about ending tourist visas for Russians while assuring us there'll be a pathway for asylum etc., they have no clue what the numbers tell us (hint: it's not easy).
  2. Oil & gas revenues fell to 672 billion rubles in July, the lowest level in nominal terms since June 2021 and 3.4% lower y-o-y nominally compared to last August. A stronger ruble means lower revenues. These figures are particularly worrying given that the budget rule is currently suspended and a new one is likely to come back, though the additional revenues did beat expectations by 85.9 billion rubles.
  3. After some signs of stabilization for May-July, economic indicators are turning more negative again. Though industrial PMIs were in growth for August, services began to contract, and consumer demand was down 9-9.5% overall for the month with no evidence of recovery in September likely as consumers beg off expensive purchases. Things are likelier to get worse now than better with short-term measures like furloughs losing their effectiveness.
  4. Roman Shamolin wrote a nice reflection on the regime's adaptation to stagnation and current circumstances using Pelevin's "Generation P" as a framing device to capture the turn away from promoting a Russian sort of Homo Economicus towards the current generation and growing reliance on non-material values. To me, it goes beyond the classic matter of providing enough bread and circuses to keep the regime going. There are nascent competing ideological preferences at play among different elites now pursued through the codification of the "Russian world" and all of them intersect the growing pressure on the regime to generate rents in economic conditions undermining the traditional current account surplus rent machine Russia has relied on since 1998.

Like what you read? Pass it around to your friends! If anyone you know is a student or professor and is interested, hit me up at @ntrickett16 on Twitter or email me at nbtrickett@gmail.com. Always happy to look at any freelance opportunities pertaining to Russia, Eurasia, energy and commodities, or my old love foreign policy.

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