The Oligarchs (73 page)

Chubais also believed in the rock-hard stability of the ruble. The “corridor” of 1995—in which the Central Bank pledged to keep the ruble exchange rate with the dollar within a narrow, defined limit and
succeeded in doing so—led to his proudest accomplishment, the decline of inflation. This was more than an economic goal. For Chubais and a generation of young Russian politicians and businessmen, the stable ruble was an icon of their long quest for normalcy. They were criticized as harsh “monetarists” and “Chicago boys” in the mold of the University of Chicago's Milton Friedman, but they had no regrets—they had slain the awful inflation of the early 1990s.
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The ruble corridor, which originally was an experiment, became a fact of life. In November 1997, the Central Bank went further and announced it would keep the ruble stable, within a 15 percent “band,” until the year 2000. The average exchange rate for the coming years was to be 6.3 rubles to the dollar. This promise was a signal to the tycoons: the Central Bank would
not
devalue the ruble.

Even as the Central Bank pledged stability, the outside world was not standing still. The decline in oil prices began to be felt in Russia's balance of trade. Previously Russia had a strong trade surplus because, with massive reserves of oil and gas, it was exporting far more than it imported. The country could afford imports for many things it wanted but did not have—it was deluged with imported food, cosmetics, and electronics. The oil and gas went out, and Oreo cookies, L'Oreal shampoo, and Sony video recorders came in. In Moscow and other big cities, half the food supply was imported, much of it expensive and favored by the nascent middle class. As long as Russia had a strong trade surplus, the arrangement was fine and the ruble stable. However, when the value of oil exports fell, the trade surplus shrank. To defend the ruble at the same level, the Central Bank had to use up its reserves, week after week. Global sentiment was changing about emerging markets, of which Russia was one. Foreign investors were less willing to bring their money to Russia, so the Central Bank had to offer higher interest rates to attract it, which also drained its reserves. If the ruble were allowed to devalue, say, to seven or eight rubles per dollar, the pressure would ease. Russia could cope with the shifting winds of the global economy if it was flexible.

But for the economic and political elite in Russia in early 1998, the idea of ruble devaluation ran against everything they had worked for. Chubais and the Central Bank chairman, Sergei Dubinin, as well as his deputy, Aleksashenko, were deathly afraid that devaluation could lead to panic and political upheaval. A devaluation would probably cost them all their jobs. For some of the oligarchs who had oil and minerals
to export, it would be salutary, since they could sell oil abroad for dollars, while their ruble costs at home, such as wages at the refinery, would drop. But a far more worrisome consideration was that devaluation would wreck the banks with big portfolios of Western loans and dollar-forward contracts. Their financial obligations were in dollars, but their assets were in rubles. If the ruble assets plunged in value, they would be hard-pressed to pay back the dollar debts.

Devaluation was the second dragon, and the elite—especially Chubais, the Central Bank, and some of the tycoons—were dead set against it. That is what they told Andrei Illarionov in early 1998.

Illarionov was a maverick economist, a radical free marketeer who had once been an adviser to Chernomyrdin. Director of a small think tank, the Institute of Economic Analysis, he worked out of a narrow, document-stuffed, two-room office in central Moscow. Illarionov had a reputation for being a prickly contrarian. He scolded Russian politicians, frequently lambasted the Central Bank, and was a thorn in the side of the reformers because of his constant harping that Russia had really not accomplished liberal reform; there was too much leftover socialism for his taste. As early as 1994, he declared there had never been “shock therapy.” It was a reminder that the young reformers did not like to hear.

They also did not like to hear what Illarionov had to say in the spring of 1998. He studied the numbers: import and export statistics, the Central Bank's reserves, and the monetary base. He was especially alarmed by the decline in the Central Bank's currency reserves, made up of gold as well as foreign currency such as dollars. Illarionov used a simple criterion to judge whether the ruble would be stable. He compared the size of the Central Bank's reserves to the overall monetary base, a broad measure of the money supply. When the reserves declined, it was a warning, a flag, that the ruble could become unstable.
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Illarionov first mentioned possible ruble instability in his institute's November 1997 newsletter; by spring, he was growing alarmed. He decided—in his own stubborn way—that devaluation was inevitable, and it would be easier to do it sooner, gradually, rather than later, abruptly. It was like letting the steam out of a pressure cooker—better to do it slowly than with a rush of explosive force.

Illarionov knew devaluation was a sensitive subject, given Russia's history of currency panic. He gingerly began trying to persuade government officials that they needed to consider it. He visited deputy
finance ministers, bureaucrats, the Kremlin. He sometimes used charts but usually liked to just sketch his ideas on a sheet of blank white paper. “And the reaction, the first reaction was absolutely stupid, complete stupidity,” he said. The officials all told him: there will be no devaluation. Why? “Because we decided that there will be no devaluation.”

“It was so strange,” Illarionov told me later, “because all these people are so young, advanced, so open to the new ideas, to the West—to everything. And there was such ignorance and pride; they felt that they knew everything.” Illarionov was twenty minutes into his presentation when the officials interjected: but the Central Bank promised there would be no devaluation. After another twenty minutes, they would nod. Perhaps he was right.

“And they would be sitting there, saying okay, maybe, but we have only one request for you,” Illarionov recalled. The request was always the same: “Please don't tell the journalists!” The Russian officials feared a panic. “Don't attract public attention,” they warned him.
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The Central Bank was particularly loath to listen to Illarionov. Dubinin, the chairman, had presided over the end of hyperinflation, and he just finished the successful redenomination of the ruble, without panic. Why create unnecessary trouble? One Finance Ministry official told me that talk of devaluation left Dubinin paralyzed. “He was extremely scared of doing anything of this sort. He just couldn't do it.”

Chubais generally trusted Dubinin and Aleksashenko, and he misjudged the economy completely in the first months of 1998. Illarionov gave a presentation calling for devaluation to a small club of liberal economists led by Gaidar. When Illarionov made his case, Pyotr Aven recalled, “Gaidar and Chubais just laughed.”
⁴²
(Chubais said he did not attend.)

Chubais was blinded by signs of growth in the economy. Growth meant a “qualitative” change for the better was coming. There would come “a different standard of living, a different relationship between rich and poor, a different dynamic of investment, a different foundation for growth, a different situation with nonpayment of taxes. Generally—everything is different.”
⁴³

Chubais proudly surveyed what had already been accomplished: Russia was admitted to global financial markets; Russian companies were making deals with Goldman Sachs; inflation, the great threat of the last five years, was tamed. Chubais could hardly see a reason to
throw it all away for devaluation. He simply did not believe devaluation was inevitable, and he feared the damage would be enormous—especially to the banks, to the oligarchs, and to Yeltsin. “At that time, what did it really mean to conduct devaluation?” Chubais told me later. “A devaluation of even 20 percent or 25 percent meant a total, mass bankruptcy of the country's banking system.” What Chubais really feared was the political fallout. “We would have gotten mass discontent of the population,” he said. “The protests, the lack of understanding, the lack of acceptance of that decision would have been absolutely terrible.”

But the twin dragons—debt and devaluation—could not be wished away.

 

On taking office May 12, Kiriyenko vowed to keep his distance from the tycoons. He said his government would show them no favor. “There are interests of the state, and they will be ensured at all costs,” he announced. Fastidiously, perhaps a little too enthusiastically, Kiriyenko refused to meet with the oligarchs. He refused to play by their rules.

But Kiriyenko was in trouble. On the day he finally named his cabinet, coal miners went on a nationwide strike, blocking key Siberian rail routes. They also came to Moscow and noisily banged their hats on the pavement outside the White House in protest. In another harbinger of difficulty, the parliament in May passed legislation to limit foreign investment in Unified Energy Systems, the huge Russian electricity monopoly, which was already a favorite of foreign portfolio investors. Chubais had just been appointed president of the company. The bill sent the worst possible message to skeptical overseas markets—foreign investment in Russia was not secure. On May 27, Khodorkovsky's megadeal, the proposed merger of Yukos and Sibneft, fell apart. On the same day came still more bad news. The government announced it could not find a bidder for Rosneft, one of the last big vertically integrated oil companies to be privatized. This blew a $2.1 billion hole in the budget. After months of political instability, investors saw that Russia would be that much further behind in the weekly race to pay off the GKOs. According to Aleksashenko, foreign investors were already fleeing and had yanked between $500 million and $700 million out of the government bond market in two weeks
prior to the Rosneft disclosure. The stock market, which had been sliding all year, took a plunge on the Rosneft news, and the Central Bank was forced to raise interest rates to an extraordinary 150 percent. The Central Bank, which had reserves of $23.1 billion the previous October, was down to $14.6 billion. The bank spent about $900 million supporting the ruble on May 26 and May 27 alone.
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Dubinin insisted the Central Bank would not devalue the ruble and said the high interest rates were intended as a “cold shower” to “prevent currency speculators from making quick money by playing games with the Russian ruble.” Chubais quickly made a trip to Washington to meet with U.S. officials, including Deputy Secretary of State Strobe Talbott, Deputy Treasury Secretary Lawrence Summers, and Stanley Fischer, deputy managing director of the International Monetary Fund. President Clinton issued a written statement suggesting conditional support for further financial aid for Russia. The Chubais message to the administration in Washington was, Russia urgently needs help. But Clinton's statement contained no specific promises and no numbers, and no package was forthcoming. Kiriyenko was losing time but didn't seem to realize it.

On June 2, Yeltsin summoned the oligarchs to the Kremlin. The meeting was held in the same green room with a huge white marble table where Yeltsin had, the previous fall, implored them to stop quarreling over Svyazinvest. Smolensky looked thin and was chewing gum; Gusinsky was smartly outfitted in a double-breasted blazer. Chubais came, Berezovsky did not. At a time when foreign investors were fleeing, Yeltsin wagged his finger at the businessmen, insisting they not pull their money out of the Russian markets. “If you want foreign investors to invest, you should invest your own money as well,” Yeltsin said. In fact, most of those at the table were rooted in Russia. They probably wished they could escape, but they could not. “All our money is in Russia,” Gusinsky protested. After the meeting, Alexander Livshitz, Yeltsin's economic adviser, suggested that the market jitters could be calmed if a large sum were simply deposited for Russia at the IMF headquarters in Washington. Yeltsin sat quietly for a long time, then said, “No, we need to take the money. Otherwise we'll fail for sure.”
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Back in Moscow after his visit to Washington, Chubais expressed hope for a calm GKO auction on June 4, the first after the market slump the previous week. But it was not to be. The debt dragon roared
again—the Finance Ministry raised only 5.8 billion rubles in new securities, compared to the 8.4 billion that came due. The government had to dip into its accounts to pay off the rest. Kiriyenko was still sanguine. “I am absolutely certain the situation is under control,” he said. Gaidar, who was working closely with Kiriyenko, said that “only illiterate half-wits” would want to see a controlled devaluation of the ruble. In fact, Russia was facing a crisis of confidence in the markets and pretending it did not exist. Chubais, the most experienced of the Russian economic reformers, missed the turning point. He was out of touch with the trading-floor sentiment, which was growing bearish day by day. This was not just another Russian government financial “crisis,” like those of recent years. This was a storm. This was Meltdown.

Bernie Sucher was on that trading floor, and he felt like a prizefighter getting slugged every few minutes. Sucher, then thirty-eight, was a veteran of Wall Street who had spent a few years in Russia and took a long break before the peak of the speculative bubble in 1997. He returned to Moscow in March 1998 just in time to see the crisis unfolding. He was a tall, powerfully built man, who looked like a high school football lineman. When he came to Moscow, he couldn't get a decent steak, so he opened his own steak house. Later he opened a pair of popular American 1950s-style diners. One of them was a stone's throw from the statue of Lenin atop of the Oktyabrskaya Metro station. Milkshakes, hamburgers, equities, GKOs—Sucher knew them all. He was managing director of Troika Dialog, a stock brokerage that at the time was owned by Bank of Moscow, part of Luzhkov's empire.