OK, but what's in it for George?
Friday 14 August 1998
In a letter published in the Financial Times yesterday, Mr Soros said the Russian crisis could be solved if the authorities were to devalue the rouble by 15 to 25 per cent and then peg the beleaguered Russian currency to the euro or the dollar.
So is Mr Soros right? What weight can we put on the arguments of a man unless we know whether he stands to gain were the rouble to fall?
The official Russian reaction to Mr Soros's analysis of their predicament was, unsurprisingly, to rubbish it. The authorities are unlikely to do much else - the surest way to precipitate a devaluation is to hint at currency weakness. Suggestions from any prominent figure that a currency is weak substantially heightens the risk of devaluation.
All of which begins to raise questions. Is Mr Soros simply offering the Russian government a piece of free advice, or has he already placed a bet that the rouble will fall? Or, given the market reaction yesterday, that world stock markets will fall?
Hungarian-born Mr Soros has made his fortune by betting on currency - and occasionally commodity - movements. A well-known philanthropist, he shot to fame in the late 1980s when he bet that the Tokyo market would fall further than New York, a prediction that, eventually, turned out to be true.
Mr Soros, 67, became a household name in the UK in 1992 when he made $1bn (pounds 610m)or so by predicting that sterling would fall out of the ERM. By the 1990s the name Soros only had to be vaguely linked to a currency, or commodity, for there to be a marked market reaction.
Thanks to his mythical status, Mr Soros now - at least in theory - can engineer win-win situations. Bet correctly on a currency, and you are hailed a hero, and this simply adds to your reputation. Bet incorrectly, and let it be known that you believe a currency will fall. This is precisely the reason why the markets greeted Mr Soros's FT letter with such scepticism.
His motives aside, is his analysis of the Russian problem correct? The most immediate problem facing the Russian government is a liquidity crisis. The state has insufficient revenues to service its short-term debt. As Marc Chandler from Deutsche Bank in New York explained, the most recent IMF loan to Russia totalled $4.8bn. Russia needs an estimated $3.3bn to service this month's debt alone, and after that, it needs reserves to prop up its troubled currency.
Russia is caught in a vicious circle - it has insufficient funds, so investors bail out of the country. This puts downward pressure on the rouble - meaning the central bank has to squander valuable resources to defend the currency - and makes it harder for Russia to raise funds by selling long-term bonds.
As Mr Soros suggests in his letter, without drastic measures Russia will print money to service its debt - a move which could lead to hyperinflation - or Russia could default. Mr Soros says either of these options would have "devastating financial and political consequences". Most experts believe he is probably right.
To avoid this, Mr Soros recommends devaluation. But devaluation brings new problems. First, says Stephen Lewis, chief economist at Monument Derivatives in London, many Russian banks have outstanding forward contracts, meaning that they have agreed to buy back dollars at an agreed point in the future at a specified dollar/rouble exchange rate. If there were a devaluation, then the banks would have to lay out proportionately more roubles to meet contractual obligations. So a fall in the rouble may alleviate one type of liquidity crisis, but could well cause another.
Another problem is the effect on confidence, both of residents and of foreign investors. A sharp fall in the rouble would render the savings of many Russians almost worthless in foreign currency terms.
Mr Soros says a modest devaluation should be followed by pegging currency to the euro or dollar. But the problem with this, to borrow a phrase from Margaret1 Thatcher,is that "you can't buck the markets".
Mr Soros's diagnosis of the problem in Russia is undoubtedly correct. His cure is more questionable - most independent experts seem to agree there is no quick fix to Russia's problems, and the long-term solution lies in structural and political reform, not devaluation. And as for Mr Soros's motives - his track record, it is probably fair to say, speaks for itself.
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