Download Extra Credit Assignment: The Ukrainian Crisis and Economics April

AP Economics:
Extra Credit Assignment: The Ukrainian Crisis and Economics
April, 2014
(10 questions total)
Why Russia Can’t Afford Another Cold War
MARCH 7, 2014
A Soviet tank on a street in Budapest, Hungary, in 1958. The old Soviet Union was all but impervious to foreign economic
or business pressure. Credit Agence France-Presse — Getty Images
By JAMES B. STEWART
Russian troops pour over a border. An autocratic Russian leader blames the United States and
unspecified “radicals and nationalists” for meddling. A puppet leader pledges fealty to Moscow.
It’s no wonder the crisis in Ukraine this week drew comparisons to Hungary in 1956 and
Czechoslovakia in 1968 or that a chorus of pundits proclaimed the re-emergence of the Cold War.
But there’s at least one major difference between then and now: Moscow has a stock market.
Under the autocratic grip of President Vladimir Putin, Russia may be a democracy in name only, but
the gyrations of the Moscow stock exchange provided a minute-by-minute referendum on his military
and diplomatic actions. On Monday, the Russian stock market index, the RTSI, fell more than 12
percent, in what a Russian official called panic selling. The plunge wiped out nearly $60 billion in
asset value — more than the exorbitant cost of the Sochi Olympics. The ruble plunged on currency
markets, forcing the Russian central bank to raise interest rates by one and a half percentage points to
defend the currency.
A bank in Kiev. Ukraine’s central bank imposed limits on bank withdrawals last month. Credit Yuriy Dyachyshyn/Agence
France-Presse — Getty Images
Mr. Putin “seems to have stopped a potential invasion of Eastern Ukraine because the RTS index
slumped by 12 percent” on Monday, said Anders Aslund, a senior fellow at the Peterson Institute for
International Economics in Washington.
On Tuesday, as soon as Mr. Putin said he saw no need for further Russian military intervention, the
Russian market rebounded by 6 percent. With tensions on the rise once more on Friday, the Russian
market may again gyrate when it opens on Monday.
Mr. Putin seems to be “following the old Soviet playbook,” in Ukraine, Strobe Talbott, an expert on
the history of the Cold War, told me this week. “But back then, there was no concern about what
would happen to the Soviet stock market. If, in fact, Putin is cooling his jets and might even blink, it’s
probably because of rising concern about the price Russia would have to pay.” Mr. Talbott is the
president of the Brookings Institution, a former ambassador at large who oversaw the breakup of the
former Soviet Union during the Clinton administration and the author of “The Russia Hand.”
Russia is far more exposed to market fluctuations than many countries, since it owns a majority stake
in a number of the country’s largest companies. Gazprom, the energy concern that is Russia’s largest
company by market capitalization, is majority-owned by the Russian Federation. At the same time,
Gazprom’s shares are listed on the London stock exchange and are traded over the counter as
American depositary receipts in the United States as well as on the Berlin and Paris exchanges. Over
half of its shareholders are American, according to J. P. Morgan Securities. And the custodian bank for
its depository receipts is the Bank of New York Mellon.
Many Russian companies and banks are fully integrated into the global financial system. This week,
Glencore Xstrata, the mining giant based in Switzerland, was in the middle of a roughly $1 billion
debt-to-equity refinancing deal with the Russian oil company Russneft. Glencore said it expected to
complete the deal despite the crisis. Glencore’s revenue last year was substantially larger than the
entire gross domestic product of Ukraine, which was $176 billion, according to the World Bank.
The old Soviet Union, in stark contrast, was all but impervious to foreign economic or business
pressure, thanks in part to an ideological commitment to self-sufficiency. As recently as 1985, foreign
trade amounted to just 4 percent of the country’s gross domestic product, and nearly all that was with
the communist satellite countries of Eastern Europe. But the Soviet Union’s economic insularity and
resulting economic stagnation was a major cause of the Soviet Union’s collapse. According to Mr.
Talbott, the Soviet Union’s president at the time, Mikhail Gorbachev, was heavily influenced by
Soviet economists and other academics who warned that by the turn of the century in 2000, the Soviet
economy would be smaller than South Korea’s if it did not introduce major economic reforms and
participate in the global economy.
To attract investment capital, Mr. Gorbachev created the Moscow stock exchange in 1990 and issued
an order permitting Soviet citizens to own and trade stocks, bonds and other securities for the first time
since the 1917 Bolshevik revolution. (Before then, Russia had a flourishing stock exchange in St.
Petersburg, established by order of Peter the Great. It was housed in an elegant neoclassical building
directly across the waterfront from the Winter Palace. As a symbol of wealth and capitalism, it was
one of the earliest casualties of the revolution.)
Soviet tanks in Prague in 1968. Credit Libor Hajsky/Agence France-Presse
Even before this week’s gyrations, the Russian stock market index had dropped near 8 percent last
year, and it and the Russian economy have been suffering from low commodity prices and investor
concerns about the Federal Reserve’s tapering of bond purchases — factors of little significance
during the Cold War.
By contrast, today “Russia is too weak and vulnerable economically to go to war,” Mr. Aslund said.
“The Kremlin’s fundamental mistake has been to ignore its economic weakness and dependence on
Europe. Almost half of Russia’s exports go to Europe, and three-quarters of its total exports consist of
oil and gas. The energy boom is over, and Europe can turn the tables on Russia after its prior gas
supply cuts in 2006 and 2009. Europe can replace this gas with liquefied natural gas, gas from Norway
and shale gas. If the European Union sanctioned Russia’s gas supply to Europe, Russia would lose
$100 billion or one-fifth of its export revenues, and the Russian economy would be in rampant crisis.”
Mr. Putin may be “living in another world,” as the German chancellor, Angela Merkel, put it this
week, but surely even he recognizes that the world has changed drastically since 1956 or 1968. He has
no doubt been getting an earful from his wealthy oligarch friends, many of whom run Russia’s largest
companies and have stashed their personal assets in places like London and New York. The oligarchs
“would not dare to challenge him,” a prominent Russian economist told me. (He asked not to be
named for fear of retribution.) “But they would say something like they would have to lay off workers
and reduce tax payments.”
During the Cold War, there were few, if any, Russian billionaires. Today, there are 111, according to
Forbes magazine’s latest rankings, and Russia ranks third in the number of billionaires, behind the
United States and China. The economist noted that the billionaire Russian elite — who are pretty
much synonymous with Mr. Putin’s friends and allies — are the ones who would be severely affected
by visa bans, which were imposed by President Obama on Thursday. Other penalties might include
asset freezes. Many Russian oligarchs have real estate and other assets in Europe and the United
States, like the Central Park West penthouse a trust set up by the Russian tycoon Dmitry Rybolovlev
bought for $88 million. “This is what may have already forced Putin to retreat,” the Russian economist
said.
And while the Cold War was a global contest between Marxism and capitalism, there is today “no real
ideological component to the conflict except that Putin has become the personification of rejecting the
West as a model,” Mr. Talbott said. “He wants to promote a Eurasian community dominated by
Moscow, but that’s not an ideology. Russia’s economy may be an example of crony capitalism, but it
is capitalism. There’s not even a shadow of Marxism-Leninism now.”
What brought down the old Soviet Union and ended the Cold War “was the economic imperative to
make Russia into a modern, efficient, normal state, a player in the international economy, not because
of military power but because of a strong economy,” Mr. Talbott continued. But “to have a modern
economy, you need the rule of law and a free press.” Mr. Putin, he said, “isn’t advancing Russia’s
progress.”
The Russian economist agreed. “The pre-2008 social compact was that Putin would rule Russia while
Russians would see growing incomes,” he said. “Now, the growth has stalled, and he needs ideology,
coupled with propaganda and repressions. Apparently, the Soviet restoration is the only ideology he
can come up with.”
Russia does have uniquely strong ties to Ukraine. “Of all the former provinces of the old Soviet Union,
it’s the most painful to have lost and the one many Russians would most want to have back,” Mr.
Talbott said. “The ties between Kiev and Moscow go back over 300 years. Ukraine is the heart of
Russian culture.” With Russian troops entrenched in the Crimean peninsula and some Russian
Ukrainians clamoring for annexation, there may be little the United States or its allies can do to restore
the status quo. “Containment, in a muted and modified way, will once again be the strategy of the
West and the mission of NATO,” Mr. Talbott predicted.
But not another Cold War, which is surely a good thing. “A propaganda war is completely feasible,”
the Russian economist said. “The recent events were completely irrational, angering the West for no
reason. This is what is most scary, especially for businesses. Instead of reforming the stagnating
economy, Putin scared everybody for no reason and with no gain in sight. So it is hard to predict his
next actions. But I think a real Cold War is unlikely.”
http://www.nytimes.com/2014/03/08/business/why-russia-cant-afford-another-cold-war.html?_r=0
1. The old Soviet Union failed primarily because of its flawed economic policies.
a. One was a desire for self-sufficiency, perhaps due to its Cold War rivalry with the
West. Refer to Krugman Module 1 and define Opportunity Costs.
b. Now refer to Krugman Module 4’s discussion of Opportunity Costs and Production
Possibilities Curves and describe how the citizens of nations who do not seek trade
based on competitive advantage will suffer a lower standard of living.
2. It is said that the Cold War was ended by economics.
a. By increasing spending on the national defense, President Reagan’s administration
increased what component of Aggregate Demand?
b. Would this cause a move toward larger government deficits or surpluses?
c. Would this cause an increase or decrease in the crowding out effect?
d. Refer to APE Macro Activities 5-6 and 7-5. How would this affect the demand and
supply for loanable funds and how would it affect real interest rates?
e. Based on your answer to (e), how would this affect Aggregate Demand? What
portion of Aggregate Demand would be particularly affected?
f. Who was better able to withstand the cumulative effects described above, the
Communist bloc or the West?
(continue on following page)
from Bloomberg.com 4/25
3. RTSI is index of 50 leading Russian companies, sort of their version of the S&P 500.
a. How much has the index declined since the Ukrainian crisis unfolded in mid February
2014 (in percent)?
b. If you are a Russian oligarch owning $3b in stock in a major Russian company or
companies, what is the average decline in your wealth since mid February 2014?
c. How will the decline in the RTSI affect the Aggregate Demand in the Russian economy?
___________ What term do Economists use for this effect? ________
(continue on following page)
from Bloomberg.com on 4/25
4. BNO is an ETF (Exchange Traded Fund) which holds futures contracts on barrels of Brent
(European) Oil.
a. Describe how expectations of an interruption of Russian supply would affect oil
prices?
b. Has oil risen since the Ukrainian crisis began?
c. Does market believe Russia will restrict supply?
d. In your opinion, why or why not?
(continue on following page)
from Bloomberg.com on 4/25
5. Above is a chart of the price of Russia’s currency, the Ruble, displayed as Rubles per US
Dollar.
a. Has the value of the Ruble appreciated or depreciated versus the US Dollar since the
crisis began? By how much (in percent)?
b. If a Russian individual or business wished to buy a Microsoft software package
priced at $100, how many Rubles would be needed in January, and how many
today?
c. Since Russia does not have the ability to produce quality products such as Microsoft
software, they must import them. How does the change in the value of the Ruble
affect inflation in Russia?
d. What do we call the combination of slow or no real GDP growth and inflation?
e. Does expansionary policy address both slow growth and inflation?
f. Does contractionary policy address both slow growth and inflation?
g. What can Russian policy makers do (you can refer to Krugman Module 20)?
6. Go to the Business Administration and Management class webpage and read the Business
Academy homework reading for March 13 entitled “Iran, Hyperinflation and Economic
Warfare”.
a. America and it allies enacted laws making it difficult for Iranians to conduct foreign
exchange transactions needed for trade. How did this affect the value of their
currency, the rial? Explain.
b. Explain how the change in the value of the rial created inflation in Iran.
c. Do you believe it is ethical for nations to enact regulations designed to create
economic problems for other nations?
7. Read “Russia Unexpectedly Raises Interest Rates”: http://rt.com/business/154840-russiarates-cbr-ukraine/
a. What is the name of the head of Russia’s Central Bank?
b. Why do you think Russia is raising interest rates? Discuss the depreciation of the
Ruble and how it affects inflation in Russia.
c. Where were Russian benchmark rates before the Ukrainian crisis? (See chart within
story)
d. How will this affect their GDP?
8. “Russia’s Bond Market Return Aborted as Yields Surpass 9%”:
http://www.bloomberg.com/news/2014-04-23/russia-s-bond-market-return-aborted-asyields-surpass-9-.html
a. Why did the attempted auction of Russian government bonds fail?
b. Can political instability cause capital outflows, even if real interest rates are higher
than rates in more stable countries?
c. Capital outflows cause the Supply of Loanable Funds to ___________.
d. This causes Real Interest Rates to _____________.
e. The Russian government and its corporate cronies have ~$700b in debt outstanding,
primarily in state-owned or state-dominated corporations. A real rate increase of
2% will cost them $_________________ per year.
9. Now that we have examined the facts, based on Economics, its time to make some
predictions.
a. If you were Putin, and your people saw their standard of living drop from a
sustained period of stagflation, how would you explain your leadership plans?
b. How long do you think the stagflation would need to persist before your popularity
with citizens declined significantly?
c. Would you blame an outside influence or would you tell voters you accept the
consequences of your decisions?
d. Do you think the Russian citizens will believe him?
e. Do you see a compromise in the near future?
10. Do you think our leaders are consulting with their senior economists before making
decisions on how to deal with the Ukrainian crisis?
a. See http://www.whitehouse.gov/administration/eop/cea/about
b. What is the name of the agency where economic advisors to the president work?
c. Who is the current chairman of this group?
d. Where did he earn his PhD in Economics?____________ Where did he earn his MSc
in Economics?________________And where has he served as visiting scholar?_____
(hint: someone in our class will be studying there next fall…hint 2: its not
Brookdale…)