And Still It Turns – Around Money
No. 1 2013 January/March
Sergey K. Dubinin

Doctor of Economics
Moscow State University, Russia
Faculty of Economics
Head of the Finances and Credit Department


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This article is based on a speech given by Sergei Dubinin at the international conference “Russia in the 21st-Century World of Power” held to mark the twentieth anniversary of the Council on Foreign and Defense Policy and the tenth anniversary of Russia in Global Affairs.

For more than 200 years since the beginning of the Industrial Revolution, the majority of countries incorporated in the European civilizational area set forth the creation of lucrative conditions for economic growth as a priority objective for their foreign policies. There exists an understanding that the national elites should struggle for access to resources and markets so that the economies of their own countries could develop dynamically and avoid crises and declines. However, methods and basic instruments for achieving this goal have changed drastically. The “power of arms” – “the last argument of kings” – for centuries was placed at the center of international life, but today the “power of money” has proven more efficacious in ensuring the needed results.


During the first 150 years of the industrial era, leading great powers would find it most beneficial to impose control on territories, markets and resources through the creation of empires. The imperial policy implied a seizure of and then administrative control over the territories and population of foreign countries. Aggression was targeted at the weakest states. Some of them had not yet taken shape as states, while others retained traditional feudal social and cultural systems. That is why countries that were frontrunners in a transition to industrial capitalism and in forming nation-states received long-term military and technological advantages.

European nations undertook global imperialist policy steps. The traditional empires, the rise of which was not linked to the industrial revolution – the Russian, Chinese and Ottoman empires, tried their best to keep up with the British Empire train. Britain and other countries that modeled themselves on it, including Russia, to some extent France, Germany and Italy – pursued an ideology of repartitioning foreign territories in their own favor. The two world wars were unleashed in pursuit of exactly this objective.

It is also true, though, that the wars taught the elites of both loser and winner countries that the costs of conducting those imperial policies were so huge and the hostilities among the leading world actors were so destructive that they simply could not be continued in those forms.

A war simply kills the very goal for the sake of which it was launched. What is the good of controlling territories that have been bombed out? When the hostilities were over, the governments would have to recover these territories from ruins, famine and epidemics. The elites and societies together brushed aside the policies of military aggression, which proved to be too dangerous and costly. At that point, ethical restrictions arose and “the power of ideas” went into action. The moral and ethical paradigms changed, and restrictions were introduced on the use of violence.

The same thing happened in the Soviet Union, too. The Soviet empire fell apart in the wake of a change of society’s understanding of what could be done by the use of force and what could not. I will not cite the numerous instances here but all of us realize that had the Soviet troops acted in Afghanistan in the same way in which all countries acted in Europe during World War II, they would have established control of some kind over that country eventually. NATO is faced with the same dilemma in Afghanistan right now. Out of purely ethical considerations it cannot anymore afford leading a war for the destruction of people and the scorching of territories.

The world has changed radically after World War II and the changes still go on. Globalization in the form of an imperialist division of the world into economic and political blocs opposing each other has receded into the past. Although the rivalry between the Soviet camp and the U.S.-led alliance of countries bore many similarities to a classical multilateral contention between great powers, this “competition of social systems” was a transition to a new form of globalization. The need to oppose the USSR provided a powerful stimulus for unification rather than division of the world markets of capitals, commodities, and informational/financial services. The leading players got new objectives for orientation and new boundaries of the admissible in their cooperation. Politicians kept reminding businessmen about the essentiality of depriving Socialism of arguments disfavoring the market economy based on private ownership, and the West’s victory in the Cold War confirmed the rationality of this strategy.


How then are rules of the game determined in this global system? How is access to markets and resources regulated, and how do modern states resolve their foreign policy tasks? The answer is simple: this is done with the power of money. Quite obviously, the case in hand is different in this situation from the monies accumulated in bank accounts or in securities, to say nothing of gold reserves, since gold is a precious metal falling into one category with other raw material commodities today. It is the common wealth, or the accumulated and permanently growing public wealth that has real significance. A growing national economy as such is a factor of attraction. Broadening markets promise lucrative contracts to any economic partner. For instance, a demand for resources from the so-called ‘golden billion’ countries made it possible to launch the production of these resources in countries with emerging economies. It is a growing economy and increasing wealth that matters, not the amount of money printed in any form.

That is why a growing national economy is the very force that dictates opportunities to others today, since the rules of the game are spelt out by those who are capable of aggregating investments – private investments first and foremost, not budgetary ones. The limitations of state budget resources are plainly visible today. Countries need only to convince investors to invest in their economies, not elsewhere.

Thus countries that have fast-growing economies or are considered to have low risks for business, that is, countries that are economically attractive to investors, dictate their own rules of the game.

Since the formation of the gross national demand, consumption (private and state one) and investments has turned out to be separate from the accumulation of savings in the national economy, every country has to compete on the global market for the right to turn national savings into investments. National savings get accumulated, enter the global market and are invested in transactions with financial instruments. The acquisition of rights to the shareholding capital or liabilities of companies operating in the real economy sector of one’s own country is just one of the options of placing funds in financial instruments, along with the acquisition of derivates, corporate sector shares, or government bonds issued in foreign countries.

The U.S. economy has created a highly sophisticated financial system which has provided the country with the world’s most powerful influx of financial resources. The use of the global financial market for investing in liabilities, for loans obtained by the U.S. private sector (corporations and households) and by the public sector has produced crucial instruments for financing consumption and investment in those sectors, in spite of a decline in savings accumulation to almost a zero mark.

The history of development of the current global financial system over the past four decades, as well as the history of a whole range of international financial crises, and attempts to devise international instruments for regulating and using supranational institutions offer a graphic instance of how the “power of money” works today.

The contemporary financial system arose out of two streams of innovations. On the one hand, information technologies created a web for transmitting data on financial transactions and the flows of that information acquired dimensions unseen before. On the other hand, new financial instruments came as a response to a growing demand for financial market services. A steady growth of the volumes of savings over several decades and their transformation into investments on the markets of securities produced a supply of financial innovations.

Investments in financial markets channeled huge financial flows and transformed savings into virtual values, which nonetheless brought revenues to investors. The filling of international channels of financial transactions with flows of liquidity in such amounts creates by itself an amassed payable demand for new issues of shares and fixed income bonds. Raising monies for investment projects has turned into a purely technical undertaking by and large. The servicing of new emissions of financial market instruments has become the main sphere of activity of global investment banks.

Meanwhile, the global economic slump of 2007 and 2008 started with a financial crisis. Discussions of a restructuring of the architecture of the global financial system have been on ever since then. The seven summits of the G20 that have been held in these years have focused on ways to reform the financial system. This issue will also take center place at the next summit on September 5-6, 2013 in Russia’s St Petersburg. However, neither new theoretical ideas nor specific proposals concerning organizational and/or regulatory measures have appeared so far.

It might seem that the global nature of today’s financial market and the global span of the crisis should predetermine the importance of imparting an international dimension to the regulation of this market. However, the crisis showed that, despite the global nature of the object of regulation (the world financial market), only national subjects (the governments of nation states) can take on the role of practical regulators.

International forums like the G20, summits of the G8 or BRICS, annual meetings of the IMF, the World Bank, the EBRD and numerous other organizations provide platforms for negotiations where the rules of the game can be discussed and endorsed provisionally. For instance, the WTO treaty says this organization has a right to monitor implementation of obligations, as well as to demand reviews and examination of violations that have been committed. As regards projects for setting up supranational agencies to regulate the global financial market, they are not even discussed.

Only the European Commission and the European Parliament claim the right to pass regulations mandatory for the member-states. Experience gained during the crisis shows that the entire set of supranational bodies of the EU is incapable of taking actions without coordination with national governments.

Although the agreement on the euro area contains a provision for a supranational regulator, the European Central Bank (ECB), the latter has never become such. The ECB issues the euro, establishes rates for loans granted to commercial banks, and has the right to buy out packages of securities from banks. However, it does not have a capability for direct operations on the financial market, and hence money supply and discount rates are the only regulatory levers available to it.

Attempts to impart the functions of supervision over and regulation of banking systems in the euro area to the ECB and to give it the power to introduce standards and procedures mandatory for commercial banks have received partial endorsement but remain unimplemented so far. The idea of a European Banking Union is far from being materialized, as well.

Failure of efforts to reliably assess the risks banks expose themselves to through their lending and investment practices has brought about the need to ensure that banks have enough capital to safeguard their solvency. The world banking community is trying to settle these issues through new standards (Basel II and Basel III), coordinated in the framework of the Basel Committee on Banking Supervision. The enactment of these requirements during the crisis revealed the presence of a serious capital deficit and excessive leverage. The Basel Committee introduced tighter capital requirements for commercial deposit banks, based on risk-weighted assets. This positive result arose from enduring multilateral negotiations.

If it is impossible to devise a mechanism of decision-making by a majority vote, only the principle of consensus happens to be functional, even if different rules are written on paper. The situation dooms the parties involved to endless talks (on how to help Greece, for instance). As a consequence, a mechanism of multilateral decision-making like this one is inefficient.

Practicable decisions are taken by countries – nation states – that have the capability to control the situation. Naturally enough, such decisions are taken on financial markets by the U.S. in the first place.

Forty years ago, in 1973, the U.S. Administration terminated the U.S. dollar’s gold convertibility. The move heralded an era of purely debt money that is backed up by the economic potential of the issuer nation. This approach was formalized in 1976 at an IMF conference. The so-called Jamaica monetary system came into being. Market-based methods of establishing rates of exchange proved to be quite successful. The global economy has demonstrated unprecedented growth over the several decades that have passed since then.

The paradox of the current financial crisis is that the U.S. dollar and the euro in the euro area have retained general trust and the role of major reserve currencies. Federal Reserve analysts estimated the total volume of money supply (M2) in the world economy, i.e. the volume of supply of freely convertible world currencies in the U.S. dollar equivalent, at around $20 trillion as of the beginning of 2011. Of that amount, the supply denominated in the U.S. dollars proper stood at over 9 trillion, and the supply denominated in euro, at over $2 trillion.

The U.S. dollar is the leading convertible currency in international settlements on financial markets, accounting for 70% of all settlements, while the euro and other convertible currencies account for less than 30%. The U.S. or, rather, its legislative and executive agencies of power and the Federal Reserve have therefore become the main players in the sphere of global financial regulation.

The Americans are resolving the tasks of eliminating the aftermath of the crisis and attaining steady development of the financial sector in the framework of the Dodd-Frank Act. Its main provisions are devoted to corporate governance, compliance, information transparency, and the rules of consolidated financial accountancy. One of the Act’s sections, the Volcker Rule, reduces the amount of speculative investments on banks’ balance sheets.

Another Act, the Foreign Account Tax Compliance Act (FATCA), goes into effect in the U.S. in 2013 and has extraterritorial reach. The same applies to the Foreign Corrupt Practices Act, whose application has expanded after the 2007-2009 crisis.

All major financial market players have followed in the footsteps of the U.S. For instance, the OECD member-states have attained agreements with offshore jurisdictions on full disclosure of information on the owners of assets and their revenues to counter offshore tax evasion.

Thus the efforts to reform the regulation of financial markets have become concentrated on several independent areas. First of all, it is the strengthening of the banking system and capital adequacy. The intra-bank system of accepted-risk assessment has particular significance in this sense. Another area is the reorganization of markets of derivative financial instruments. Apart from trade rules, the reform implies restrictions on financial institutions’ participation in transactions with these instruments. The third area is the discussion of taxation of financial transactions and revenues.


The development of the financial sector of Russia will have fundamental importance in the context of the country’s push for greater international influence. The position Russia is occupying today is somewhat ambiguous.

Russia’s securities market has gained a definite experience of operations over the past two decades but the scale of operations with shares and bonds remains limited. The market has chronic problems with demand and liquidity. Its capitalization versus the GDP stood at 71% at the end of 2010. This indicator was twice (or more) lower than in other BRICS countries, in particular India (142%) and China (209%). In developed economies, the “depth of financial markets” stands at over 400% of the GDP. Potential issuers of corporate securities prefer combining IPOs on the Moscow Exchange with IPOs in London or Hong Kong.

The Russian banking system has been developing fast enough over the past ten years and the crisis of 2008/2009 did not deal a blow to its steadiness. Government agencies and the Central Bank of Russia had to intervene at its acutest stage that fell on November and December 2008. Stabilization of the situation required state guarantees, the buyout of bankrupt commercial banks by government-run lending institutions, and the issuance of loans by the Central Bank to commercial banks against the pledge of low-quality assets.

The banking sector’s assets grew 10.6 times from 2001 through 2010 to reach 33.8 trillion rubles and the banks’ capital went up 9.4 times to 4.7 trillion rubles. The Central Bank says banking assets continued growing at a fast rate in the post-crisis period. The demand for loans among businessmen and private households resumed growth, although it was not as fast as before the 2008 slump. The annual increase in loans to households reached 25% to 30%, and loans to legal entities went up 20 or so percent. The year 2011 showed 23.1%, while the assessments for 2012 put it at 10.2%. The ratio of banking assets to the country’s GDP in the same year stood at 75%. The ratio of bank loans to the GDP went up 2.7 times to 40% in the post-crisis years.

Government-controlled banks are particularly active. Their loan portfolio grew 19.7% in 2012 in year-on-year assessments, while private banks increased the volume of lending by 11.9%. Lending to private borrowers (households) increased fast, reaching 47.9% in government-controlled banks and 36.2% in private banks.

Loans for three or more years make up about a third of all bank credits in Russia, but Russia’s largest corporate borrowers also draw resources on the global market. Russian big business regularly enters the world financial market to float bonds or turns to international banking groups for loans. The share of foreign lending institutions in the total volume of medium and long-term loans obtained by Russian borrowers exceeds 50%.

The international positions of Russian banks are getting stronger, too. Sixteen leading banking institutions in Russia have been included by The Banker magazine in its Top 1000 World Banks ranking. Of about 1,000 Russian banks, 356 banks have authorized capital exceeding 300 million rubles (36.6% of all banks). According to the Central Bank of Russia, foreign assets of Russian banks have exceeded $200 billion. Foreign investors control 50 or more percent of shareholders’ capital at 111 Russian banks. The global economic crisis obviously does not help the Russian economy’s growth. A steady post-crisis climb of crude oil prices from $40 to more than $100 at present is not accompanied by growing demand for energy resources. Exports of oil and gas have ceased to be a factor stimulating development and have turned into a tool only helping to level out the balance of payments. Not surprisingly, the picture evidenced in the Russian economy now is rather alarming.

Official estimates put the growth of the GDP at 3.6% in 2013. Stabilization and, more desirably, acceleration of economic growth will depend on growth in investments. Russia’s leaders will have to spell out clear-cut approaches to methods of stimulating investment activity as they plan the economic policy for the short term.

Given these conditions, assessment by investors of Russia’s country risks and the quality of functioning of its legislative and economic institutions is acquiring particular importance. The general opinion is that the investment climate in the Russian economy remains unattractive for private investors even on the background of continuing financial twists and turns in the euro area and the growing U.S. sovereign debt.

The Russian economy is naturally competing for investments, domestic and foreign ones, with these countries and, especially, with China, India and Brazil. The example of the latter countries makes Russia’s problems even more vivid, as they have succeeded in tapping resources of the global financial market and their own competitive advantages to ensure their high economic growth.

According to data provided by the UN Conference on Trade and Development (UNCTAD), Russia has made considerable progress over the past ten years in drawing foreign direct investment. This indicator includes investments in joint-stock capitals, reinvestment of profits, and intragroup loans. Russia’s share of global direct investment reached its peak before the crisis when it stood at 4%. Then it started shrinking – to 3.4% in 2011 and to 2.4% in 2012. Still this country has retained a place among the top ten countries of the world.

Over the past two decades, Russia’s economy has generated savings in volumes that overtop the size of internal investment. On the eve of the 2008 crisis, savings had a share of 31.5% in Russia’s GDP versus investment accounting for 21.0%. The accumulation of large-scale savings continues but they are little used in the national economy.

As a result, the net outflow of capital from Russia reached $80.5 billion in 2011 and was between $70 billion and $80 billion in 2012. Russia is thus playing the role of creditor in a global game of paying up deficits of state and private corporate budgets.

Capital outflow has been outmatching its influx over the past twenty years and it will obviously continue for several more years. Reverting this tendency towards a net inflow of loans and investments, preferably in the form of direct investments (which now make up no more than 10% of the entire capital inflow in Russia) is an important strategic task, which cannot be resolved by administrative methods. The government has imposed overly stringent control over FDI in the Russian economy. According to Russian law, a potential foreign investor seeking to invest in any of the 42 branches of the economy considered to be strategic should secure a prior endorsement of his participation in an investment project from a governmental commission if his share is to exceed 10%.

Still, the investor-unfriendly climate in Russia remains the biggest obstacle to direct investments in this country. The experience of development in many countries shows that foreign investors draw their assessments of country risks from the analysis of successes or failures of national businesses in a target country. Foreign investments will come here only when Russian companies start demonstrating success stories.

Russian businessmen show caution as they map out their investment policies. Statistics for 2012 show that the share of deposits, or liquid money, in aggregate assets of companies reached 47.2%. In October, their volume at deposit accounts grew 2.5%, making up a 14.1% year-on-year growth. Ruble balances at general current accounts of companies slid to 74.7% from 75.3%.

As an alternative to the investment climate’s improvement, some Russian economists have recommended issuing more and more money to produce cheap credit as a tool for financing investment. However, this recommendation seems to be highly risky and ineffective. According to the Ekspert magazine, Sergei Glazyev proposed the following ‘new monetary policy’. He suggests that the Central Bank of Russia should, first, establish a discount rate below the current inflation on short-term loans intended for commercial banks. Second, development institutions should loan money to the real sector of the economy for investment projects at 2% if the inflation rate exceeds 6%. Since the federal budget does not have the money necessary for this investment, Glazyev obviously proposes drawing it from the Central Bank through more money supply. Third, this pattern requires a “strategic planning system” that will specify the value of money, select target projects for discounted loans, and supervise their implementation. Fourth, Glazyev recommends dropping the free convertibility of the ruble and reviving the practices of currency control. He and other supporters of the idea of appointing interest rates by decree are reluctant to admit that the value of borrowed finances reflects a creditor’s assessment of the risks of one or another transaction and risks in a given economy rather than a mere addition of costs and operators’ margin (inflation plus net interest rate for a deposit plus an interest rate for the loan plus the bank’s expenses).

Obviously enough, these ideas are nothing new. One can recall an amassed money emission by Russia’s Central Bank in 1993 to enable manufacturers to pay off reciprocal debts. The move unleashed an inflation of over 1,500% annually on the consumer market. Also, there is the experience of increasing the money supply in the late 1920s-early 1930s to finance the “super-industrialization.” Joseph Stalin borrowed the idea from his rivals in the party – Leon Trotsky, Yevgeny Preobrazhensky and Georgy Pyatakov. It seems that none of them ever foresaw the consequences of that policy. In a situation where free price formation in the USSR had been renounced, the measure wiped out consumer goods from stores and brought about a system of rationing to ensure supplies of prime necessities to the population.

Viewed in this context, speculations about insufficient monetization (correlation of M2 to the GDP) in Russia compared with other countries need separate analysis. This correlation in the Russian economy stood at 45.3% in November 2012, revealing a marked contrast with the end of the 1990s when the indicator stood at 12%, while inflation in the consumer goods sector was running at 11.5%. This natural, rather than forced, growth of monetization is an encouraging factor. On this background, M2 increased by 28.5% in 2010 and by 15.8% in November 2012 versus November 2011, while prices grew by around 6% over the year. This means that the economy reveals a sufficient demand for money. Pushing the supply of and demand for money off balance does not produce anything but inflation.

References to the experience of monetary quantitative easing along with keeping inflation at a level below 2% a year are irrelevant, since they ignore the fundamental difference of the U.S. dollar’s role as the main currency of the global financial market. Besides, M2 was growing at 3.9% annually over the last two years.

In spite of three phases of quantitative easing (QE-1, 2, 3) in 2011, monetization in the U.S. amounted to 75%. The Federal Reserve’s assessment says there were more than 3 dollars invested in the so-called blue chips, denominated in the U.S. dollars, per one dollar included in M2. This means that the dollar liquidity will be insufficient in case of a mass discharge of these securities if the market collapses.

At present, the growth in the dollar and euro supply is largely absorbed by the replenishment by the U.S. banking system and that in the euro area of their capital. In using criteria of bank capital adequacy, introduced by the Basel III accords, with account taken of the quality of bank assets and risks involved, the banking systems of leading nations require a further considerable replenishment of their capital. There are scarcely any grounds in this situation to speak of an aggressive and excessive issue of the U.S. dollar or the euro.

*  *  *

Russian businesses and state regulatory agencies are facing the task of not only borrowing money on the international financial market and boosting the volume of available liquidity but also efficiently using complicated financial instruments for the purpose of integration into this market, which would be advantageous for the country and companies involved. Task number one is optimizing the already functional channels of integrating the Russian economy into the global financial context and then building up Russia’s potential as a world financial center. Russia’s regulatory and financial authorities should hold intensive talks to coordinate methods of integrating into global financial market mechanisms. This should be done with more energies than it was done before the financial crisis. Otherwise the Russian financial system may find itself sidelined due to inevitable higher risk ratings given to financial operations with Russian partners. Russian assets still fall into a high-risk category, even though the macroeconomic situation in this country is stable. Russia’s budget has had a surplus for three years in succession and the sovereign debt accounts for 11% of the GDP. At the same time, budgetary revenues still depend on oil and gas exports, and the non-oil deficit of the federal budget stands at 10% of the GDP.

There are many encouraging factors that can support GDP growth in Russia, among them the stability of the deficit-free federal budget in 2012 and the increased credit support for the national economy provided by Russian banks. The question is whether the country’s economic system is capable of ensuring the dynamics of economic growth and the international standing that will enhance the ability of the Russian elite to wield tangible influence on global markets and the rules of the game in the international arena.