Around one-quarter of Russia's economic output is connected to the energy sector. So the 56% decline in the price of Brent oil (the international benchmark) in recent months has hurt the economy.
Sanctions imposed by the U.S. and the European Union on Russia over the conflict in Ukraine have also squeezed Russia's economy. And the perception of higher political risk in Russia is discouraging investment. And the worsening situation is causing people to lose what little faith they had in Russia. More from Kim…
Let's say you lose your job. Your 401(k) is in the dumps. You're spending your nest egg on groceries. Then your credit-card company tells you that since your financial situation has gone downhill, it's going to increase the interest rates on your credit card… And then your mortgage rate gets boosted for the same reason. That's kind of what's happening with Russia just now.
Russia's economy is in trouble. It's probably going to shrink more than 4% next year. One big bank went bust a few weeks ago. The whole bank sector is looking sick. The country's currency, the ruble, has weakened 18% versus the U.S. dollar over the past two weeks (and was weakened by 46% last year). Russia's stock market was the world's worst performing last year, falling 42%.
As Kim explained, it's normally a big deal to cut a country's sovereign credit rating… especially when it's going from investment grade to junk…
In December, ratings agency Standard & Poor's said it would likely cut Russia's credit rating from "investment grade" to "junk" within three months and is scheduled to announce a next step in mid-January. Ratings agency Fitch has Russia two notches above junk right now. It files its newest rating tomorrow.
A country's sovereign credit rating reflects its creditworthiness, or its risk of default. With $389 billion in foreign reserves (cash and other assets held by its central bank), Russia has a lot of cash on its balance sheet. But it blew through $88 billion in reserves last year trying to slow the depreciation of the ruble. The Russian government will need help keeping its banking sector afloat. It's also going to have to help heavily indebted state-controlled companies. Meanwhile, because of the decline in the price of oil, Russia's cash flows have collapsed.
The big question on everyone's mind is whether Russia will default like it did in 1998.
Financial expert Jim Rickards thinks so. He has seen this situation before. In fact, he was responsible for negotiating the bailout of Long Term Capital Management (LTCM) – a hugely leveraged hedge fund that collapsed in the midst of the Russian crisis – as the firm's general counsel.
Because LTCM had so much exposure to derivatives, it was viewed as a systemic risk. So Jim sat down with 14 of the world's biggest banks (like JPMorgan, Merrill Lynch, and Goldman Sachs) to arrange a $3.6 billion bailout for the hedge fund. The Federal Reserve supervised the entire deal.
Jim recently sent us an e-mail expressing his concerns over the current situation in Russia… and the similarities between what's happening today versus the late '90s.
In short, he thinks we'll see contagion. He's not worried about a sovereign default, because Russia has enough money to cover its dollar-denominated sovereign debt. But he says Russian corporations only have enough money to pay their debt until the end of this year.
Meanwhile, the largest European banks and emerging-market funds all hold loads of Russian corporate debt. So if you're invested in mutual funds or have a 401(k), your assets could be at risk. But when the banks start writing down the value of that debt, the problem will magnify.
Jim also noted that the Russian crisis actually started in Thailand, then spread to Indonesia and Korea before striking in Russia. LTCM's collapse took more than a year to play out. He thinks we're facing a similar timeline today.
But Jim isn't the only one who thinks we could see a replay of 1998. David Tepper, one of the wealthiest hedge-fund managers in the world, recently told CNBC, "This year rhymes with 1998. Russia goes bad. Easing [is] coming from Europe. Sets up 1999… I mean 2015."
Tepper wasn't calling the top. He was just warning people that things look similar to the Russian crisis… and that we should be prepared.
Luckily, Jim wrote the most important book out there for this kind of economic calamity. It's called The Death of Money. It's a must-read for anyone concerned about what's happening in the economy today – or who wants a better understanding of government currency manipulation and the potential outcomes.
