RUSSIAN ECONOMY IN DEATH SPIRAL

After World War 2, our near neighbors over in The Netherlands, whose country had been pillaged and mistreated by the Nazi occupation, then ravaged by their retreat in 1944/45, had the luck to discover significant quantities of natural gas. Its extraction, domestic use and export helped catapult the country out of the post-war doldrums and for the next 30 years drove rapid economic change.

However it came at a price, that has since been coined ‘Dutch Disease’, a term for an an economic situation caused by a specific set of circumstances. The gas extraction business was not a minor enterprise. It drew in huge numbers of workers who were better paid, and they abandoned their old jobs in manufacturing, agriculture and general industry. A new type of service industry blossomed – retail, restaurants, housing, car dealers and the like. The problem being that the well paid jobs accidentally destroyed the creation jobs, causing industry to flounder and the country quickly shift to being dependent on gas extraction.

In The Netherlands the problem was eventually realized as dangerously terminal, because the vast amount of gas was finite and exporting of it would inevitably run down, leaving the country with no replacement. Democratic governments worked hard to remedy the situation so that gas extraction became another part of the portfolio of industries, not its sole business on which all else relied. Today the country is a mixed industry economy still extracting gas.

Russia, as a command economy had its ups and downs as the Soviet Union, doing well when energy prices were sky high (relatively speaking) in the 1970’s and early 1980’s, while conversely those same high energy prices undermined western economies and caused a recession. Other than rudimentary low quality industries, only armaments were Russia’s primary production, financed by the energy they exported. When the US & Saudi Arabia deliberately concocted a plan to undermine the Soviet Union by crashing oil prices, by the mid-late 1980’s Russia’s economy was in crisis and the result was the collapse of the Soviet Union.

As Russia re-assembled itself from the collapse, minus much of its former empire, the model it chose as the quickest way to get back in the game was the worst one it could have sought out. Oligarchy certainly saved many industries from total extinction – the obvious ones were oil, gas and resource extraction. These are globally salable and demand never really goes away. Wealthy and not so wealthy businessmen took gambles, often with other peoples money, and bought up vast tracts of Russia’s formerly state owned enterprises. They became fabulously wealthy and immensely powerful almost over night.

The problem was that the system was based on resources and their extraction and sale. Nobody was rushing too manufacture anything, money lay in the get rich quick business and as a result, Russia quickly acquired a dose of Dutch Disease. Everything, including almost half the states income, became dependent on the oil/gas and mining sectors.

Despite their power and wealth they never reckoned on Putin and his approach to governance. At first he was entirely happy for them to finance him in return for being able to just do more or less what they liked. Then he started to turn the tables, making it clear he called the shots and they would do what he wanted as and when he called. Most were willing to accept it, those who didn’t ended up in prison and exiled or dead, or the state used taxation laws and the like to steal their businesses.

Russia used its state income to build what appeared to be a fearsome multi-level military machine that the collective West was universally afraid of. There was plenty to suggest it wasn’t as wondrous as they might think, but they were blinded by the Russians potential, when they had slashed their defence expenditures so far they could only look embarrassingly at their own inadequacies. Nobody saw that the Putin regimes inherent corruption had permeated so deep and so far that the military was as riddled with it as general society and business.

The decision to attack Ukraine was the result of western failure to make Russia pay for the 2014 Crimea annexation and the moves into the Donbas. Reliance on cheap Russian energy, lack of military preparedness and especially German reluctance to endanger its energy supply convinced Putin he could get away with it. Nobody saw Russia and its military as especially corrupt, yet Western attitudes and intelligence reporting described Ukraine as something of a basket case because of corruption. It could never last, it could not defend itself and there was no point in wasting aid – General Mark Milley, Head of the Joint Chiefs at the time, pretty much told Congress that in a closed session.

Putin played his hand, and it went monumentally catastrophically wrong. The West was wrong, the Russian army was a disaster in the opening stages, by September Ukraine mounted a shocking counter attack in Kherson and the North East that had the Russians in retreat and considering nuclear weapons use to slow the Ukrainians down.

Yet the Russian oil and gas income was roaring – no matter what they said the Europeans were buying its energy at the highest prices for years – and that was being invested in expanded Russian weapons production – the start of a long cycle that’s led it to disaster.

As the realization that the war was in fact not going to be over in a year let alone a week, the Russians had to start thinking how long it might go on. Sanctions quickly followed and the Europeans spent the summer of 2022 securing alternate energy supplies. It was made easier by a relatively mild winter. With Russian exports starting to tumble and gas and oil prices falling the Kremlin upped their war hoping to break Ukraine. They did not.

Meanwhile the states investment in weapons and arms manufacturing started to mount and during 2023-4 reached new levels. The states savings account – which Putin had largely kept abroad and unbelievably didn’t try and repatriate before starting his war, was big enough to cover maybe two years of deficit spending. It lasted around 18 months before gas income was virtually reduced to zero and oil income dropped precipitously. Again, Russia’s own duplicity came home to hurt it. It promised to slash oil output by 800,000bpd to force up prices with its Opec+ counterparts slashing another 3,000,000bpd. They did, Putin did not. Saudi Arabia was not amused and reversed it within a year, pushing prices ever downward since. Russia’s income plunged, at the very time its savings ran out.

Meanwhile the military industries had been absorbing every available source of manpower that the army hadn’t already taken up. Pay skyrocketed, yet still even now there is a massive 400,000+ workforce shortage.

The defence industries, drew people away from ordinary manufacturing and what we would call domestic industries, from food processing to TV manufacturing. Dozens of businesses were failing every week until its now become a tsunami – Dutch Disease – but this is terminal.

The Netherlands is a democracy and the people and government knew they had to do something – Russia is not and its only concern is to manufacture weapons to win a war it’s clearly never going to. The result has been the rapid destruction of what was already a weak domestic industrial base. The oil and gas industry are on their knees, the Ukrainians are hammering the oil refineries and the country is trying to import refined fuels with neither the means of transport or infrastructure to do it.

As the government has used inflation and printing money, increased taxation, tinkered with interest rates and used bizarre economic instruments to borrow back the money it printed for itself, the defense industries are themselves stretched to breaking point.

They cannot produce enough, they don’t have a skilled workforce, the government is cutting back what it pays, wages in the industry are no longer record breaking but still higher than average, so they are still draining domestic industries of workers and close peace time domestic businesses, which in turn forces up imported goods costs from China, and requires payment out of Russia’s Yuan reserves, which they can’t use for buying drone components. And the Chinese are taking the Russians for a ride on pricing.

The problem now lies with Putin. He must end the war if he has a hope of saving the Russian economy, because there’s just about enough private business left to provide a catalyst for recovery. But it’s a thin line and within a couple of months at the scale of Russian business closures, it will be too late.

Now imagine he gets removed say, in May next year. The war is quickly terminated.

Russian military industry will come to a screaming halt almost overnight as the government scrambles to rein in impossible expenditure. The army will be scaled back fast.

The well paid workers will have no-one to employ them. Local businesses are gone, domestic industry squeezed out of existence.

The death payments economy which has sustained so many small villages and towns across Russia as the casualty lists mount, will dry up instantly. The oil and gas industry will take years to recover the refineries and oil exports, even if sanctions are lifted it won’t have so easy a market when customers aren’t getting discounted oil. Even if it recovers within a year, it’s not going to rebuild a domestic industrial base over night. China likes having Russia over a barrel and is more than capable of stepping in and exploiting its position – I suspect they’re just waiting for it to happen. The Russian economy is going to go into a horrendous recession that will make the 1990’s look like a picnic.

Even if Ukraine stopped attacking the refineries, Russia’s fuel distribution system is collapsing now. 58% of Russian gas stations are privately owned and they’re operating on paper thin margins. They are closing down at unprecedented rates – permanently – because they simply cannot cope with the cash flow disruption. As fuel prices soar, I noticed that they were at 95 rubles a liter – it’s obvious that nobody ever considered they were going to be so high. Not one Russian petrol station has a fourth digit display to show numbers over 99.9. They have lived for so long in a world of guaranteed cheap fuel, it was beyond comprehension.

This is Putin’s legacy, a country facing unprecedented economic circumstances driven by a war he cannot bring himself to stop, and if he did will see a terrifying economic collapse. Let alone 700,000 miserable unemployed and unpaid troops with guns.

If Ukraine carries on crippling the fuel distribution system via refinery and rail strikes, then hammers the electrical power generation system, especially around Moscow, while attacking military industries – and its going to be able to do this in early 2026 at the latest, Russia is going down next year.

Russia has no real allies who don’t want to profit from its demise or gain influence over its regions. That has always made it weak. Ukraine has the most powerful European alliance and industrial and financial muscle behind it that’s simply not there for Russia. Ukraine is seen as a valuable future member of that economic and military alliance. It has real friends, nations who believe in it and trust it, who support it and will help it overcome the post war challenges as well as the current military and economic ones. Yes it took time for Europe to gather itself together, but it has. What does Russia have? Nothing it can truly trust.

Russia’s command economy has doomed it to destruction. This war has and will continue to be a catastrophe for it. It’s really just a matter of what miserable way it ends for them.

The Analyst

militaryanalyst@bluesky.social