- - Friday, July 10, 2015

On Friday, the Russian news agency TASS reported President Vladimir Putin called China the “locomotive of the world economy” at the annual meeting of the Shanghai Cooperation Organization and the BRICs Summit in Ufa, a city centered in the Volga region of Russia. The fact that Mr. Putin considered it necessary to make this statement is telling and could show the Kremlin’s concern about its recent pivot to the East and China specifically.

With Western sanctions on Russia continuing to have a negative effect on its economy and the price of crude oil back in the doldrums, it seems the economic contraction in Russia could be worse than anyone expected only a few short weeks ago. Social services have been cut, including medical care and education, but the Kremlin maintains above average military spending as the priority continues to be modernization and rearmament.

The crash of the Chinese equity market comes at a bad time and it remains to be seen how much the loss of trillions of dollars in wealth will impact the real economy. Perhaps the most significant consequence of the rout on Chinese exchanges is the obvious, desperate attempts by the Chinese government to overtly manipulate the stock market. As China continues to push for the yuan’s inclusion in the International Monetary Fund’s Special Drawing Rights (SDR) reserve currency basket, this manipulation must be taken into account. How can a country that openly intimidates sellers (actually threatening to put them in jail) on its markets be included in a global reserve currency regime? This question remains unanswered even in the light of decades of Chinese currency manipulation as well.

China is also experiencing a major slowdown in growth. So much so that you are starting to see articles in the press warning of revolution if the government can’t uphold its end of the bargain with its population — prosperity for the loss of freedom and civil rights. The attempts by the Chinese to stimulate domestic spending as an alternative for its historical export prominence have been a dismal failure. It seems the Chinese economic model could be broken.

Recently, there was a huge uproar in Moscow about the long-term lease of Russian farmland to China on the Siberian border. The old fears of Chinese territorial expansion raised their ugly head. The fact that the many energy deals cut by Moscow with Beijing were closed with an obvious price advantage to China has also raised the fear in Moscow that the Chinese are taking Russia for an economic ride, exploiting their time of weakness.

The ruble is also losing value again against the dollar, slowly making its way back to the psychological import level of 60/1. The Russian central bank maintains it has plenty of reserves to defend the currency in the future. This is true, but there are many demands on Russian foreign currency reserves at the moment as Russian corporations and banks attempt to roll over dollar-denominated debt as they are shut out of Western capital markets.

Individually, these issues are not that disconcerting, but taken together one could be forgiven for wondering about the wisdom of Russia turning from West to East in search of economic progress.

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