I’m a Russophile, and have been since grade school. I majored in Soviet Studies at West Point. I had dreams of parachuting into the Eastern Bloc at night. My contact, a sexy concert pianist turned dissident would brief me on the ground. Together we would fight the oppressors of liberty. Later as a financier when the Soviet Union was no more, I desperately tried to find a way to invest in a changing Russia.
In the nearly twenty years since I first traveled to Moscow, I have returned time and again in search of an opportunity where I would feel comfortable risking capital. So far I have never been able to get comfortable with the risk/reward paradigm.
Others have made and lost fortunes in Russia in the last two decades. Friends Bob Smith and Bill Browder have made, lost and made again millions of dollars, from St. Petersburg to Vladayvostok, but I was always a coward. I would have been keen to HALO behind the iron curtain, but I’ve always been a coward when it comes to my capital.
We have touched on Russia a time or two in our subscriber-only newsletter, Without Borders, but never really talked about Russia as a place to invest or a place to live; for good reason – lots of good reasons. I started my career in the ‘Soviet business’. My degree from West Point was in Soviet Studies. At least I thought it was. Years later when I needed a copy of my transcript I noticed that my major had been changed to geopolitics and cultural geography. Someone must have decided on my behalf that Soviet Studies was no longer marketable.
In retrospect it is intuitively obvious even to the casual observer that I majored in buggy whips and minored in typewriters. Within a few years of graduating there was no Soviet Union and my final project, a database programmed in Ada (and probably still classified), had about one fiftieth the functionality of the first generation of Lotus 123 spreadsheets. But, at least for a while people thought I was a Russia and computer ‘expert’. Remember in those days both were obscure niche fields and the bar was set very, very low.
My first jobs in investment banking and fund management were as a direct result of my Russian ‘expertise’. I spoke German, could understand more Russian than most westerners and could build a fire without a match; so I was put to work on privatization projects for Polish sewer plants and Ukrainian steel mills. Don’t question the logic, just accept it. I spent a good amount of time looking at Russian investments and always came away with the same conclusion; bad idea.
I had good friends who made and lost fortunes in Russia and others who learned the hard way how violent the culture can still be. I have Russian clients who remain good friends. We have done deals together on several continents and they think foreigners are nuts to invest in Russia. Over the years the contrarian in me wanted – no, needed to prove them wrong so I followed Russian economics and politics closely for a decade in search of an angle. Yet the more I learned the more I came to the conclusion they were right. So I simply retired my expertise that never really was and moved on to much more compelling opportunities.
However, in the last few days my phone has rung off of the hook with calls from friends from my previous lives. About mid week the calls were from friends in the fund management world and investment banking world. President Medvedev’s trip to the US was the cause for the questioning. “Do you think the Russian Silicon Valley idea has legs?” “We need to increase our
BRIC allocation and need advice on Russia, can you help?” “How do we source venture capital opportunities in Russia?”
So I thought it was about time to write about Russia. Then the “Spy Ring” story broke and my phone really started ringing. Now I KNEW it was time to write about Russia. So I penned a dispatch in our subscriber publication, Without Borders, put together a blog post on Globalspeculations.com and finally decided it warranted its own Special Report.
Fascinating, Romantic Russia
I am enamored with the idea of Russia. I have always been fascinated by the romantic notion of
Russian aristocrats straddling the eastern and western worlds. As a teenager I read everything I could get my hands on about Russia. The allure was almost irresistible. In my mind it was a land populated by strong men equally divided into the two categories: the oppressors and the oppressed; and women divided into two categories: beautiful ballet dancing, violin playing nuclear physicists, and three hundred pound gulag grey wearing babushkas.
I grew up during the Cold War, and through adolescence I thought knowing about Russia was the ticket to an exciting life of adventure. It would be peppered with intrigue and spiced with lithe and nubile ballerinas that wrote poetry and knew secrets of the east that kids from New England could only fantasize about. Then I read Eastern Approaches and I knew my future would be tied to Russia. Reading about the real Fitzroy McLean’s adventures with beautiful White Russian aristocrats in exile, and his exploration of the far flung outposts of the Soviet Union changed my life. I was a plebe, and with the certainty only possible to achieve as an 18 year old trying to survive the first semester at a military academy, I had solidified my destiny.
Ever since then I have been trying to understand Russia and I have failed. As many far greater thinkers before me have concluded; understanding Russia is impossible. Understanding Russians, however, is not impossible. It is just really damn complicated and not surprisingly, an exercise in frustration.
I once sat through a brown bag lunch seminar hosted by a former CIA Moscow station chief. The setting was the back room of what is known internally as Russia House. This is the small task force within the Central Eurasia division of the Directorate of Operations. The luncheon was for newly minted clandestine service officers about to be stationed in the Russian sphere of influence. The topic was neither trade craft nor intelligence gathering in general. The topic was Russians.
I was admittedly awed by our host, as he was a living legend within the service, having served four tours inside the Soviet Union and had been responsible for recruiting some of the most sensitive agents within the Soviet apparatus. I will never forget how he opened the meeting, “The greatest understanding I ever had of the Russian people was on my first day in Moscow in
1963. It has been in steady decline ever since.”
Serious scholars have tried to delve into the Russian psyche and soul and left the task unfinished after a thousand pages. There is no categorical way to define or even summarize a diverse culture, even if you were to try to do it by age, sex, ethnic group, social standing or any other sub category. Yet there are some lessons learned and rules of thumb that are helpful when thinking about the modern Russians that are mostly derived from the shared recent cultural history of Russia and the surrounding areas.
Modern Russian history and cultural identity can be traced back to the end of Tsarist rule, somewhat in the way Brits go back to the industrial revolution, rather than feudal times, when they talk about the class system. Likewise, American’s talk about the Great Depression and World War II more often than the Civil War when talking about their modern cultural identity.
Although admittedly reductionist and oversimplified, for most Russians the recent history that most defines their society starts in 1905 with a clash between Tsarist troops and workers in St. Petersburg. A general strike ensued and the next five years were marked by Tsarist concessions and social unrest, until WWI temporarily diverted the nation’s attention from internal strife to external threat. Then in 1917 the real action started.
In March of 1917 Tsar Nicolas II was forced to abdicate. The Russian people were already agitated by years of social and economic immobility. A lack of private property rights, and being forced into military service to fight for an unpopular ruler only exacerbated the resentment.
The crafty Germans sent Lenin to Russia from Switzerland by train, in hope that he would cause internal havoc. He obliged in spades. Lenin led the Bolshevik’s to power and White Russians who had been nominally in control of the interim government either fled or were killed. The Bolshevek’s soon after signed the treaty of Brest- Litovsk, ending Russia’s involvement in World War I.
Soon after that came civil war, followed by war with Poland, followed by Stalin’s purges, followed by World War II. Between 1905 and 1945 at least one third of the males who made it to age 14 died a violent death. The numbers are far from accurate but if you were born in this era there was a one in three chance you would die – violently. Pick the revolution, world war, civil war or purge period of your choice and the statistics would be similar. Greater Russia was not a safe place. Violence was the norm for generations, and that has a lasting effect on the psyche. It fosters a stoic and fatalistic approach to life that is hard to imagine until you experience it first-hand. It also fosters apathy towards life that stifles ambition in most, and imbibes many with the notion that survival is the ultimate form of success. In my limited experience, these characteristics, borne of this era, are still the dominant forces in Russian life.
The Cold War
After WWII, the Cold War era Soviet Union, that frightened American and European school kids into hiding under classroom desks while monkeys blasted into space, came into being. Despite all the show trials, executions, gulags and small wars in neighboring lands, in the cold war era the chances of violent death decreased dramatically. You were less likely to be sent off to war or tossed into a mass grave, but that does not mean life was safer or easier. Suspicions and paranoia ruled the day and Soviet citizens were always afraid of their neighbor.
The ruling bureaucracy was dangerous in a different way than a Tsar or even a Supreme Soviet leader. The bureaucrat could make your life miserable, or disrupt your life without cause or merit. The threat shifted subtlety from being caught up in a mass movement of either war, purge or revolution to being singled out by an angry neighbor or a misanthropic apparatchik.
If there is one characteristic that lingers today, borne of the cold war era, it is suspicion and cynicism. Even today many of my Russian friends are cynical to the point of being unable to actually enjoy any good fortune, or relax in any way other than short, intense bursts of hedonism or drunkenness. Naturally this is a generalization but it is a more common characteristic in Russia than any other place I know well.
Yeltsin and Privatization
Every once in a while a chance to create massive, multi-generational wealth comes along. When it does there are those that will grab at the chance. The early days of privatization in Russia and the former Soviet bloc was one of those times. There has been lots of coverage of the ‘raping’ of the Russian economy or the ‘theft’ of assets. Having taken the time to study it on the ground and watch it unfold, my basic premise is that the early days of privatization were more a matter of incompetence, ignorance, apathy, and suspicion on the part of government and the masses, contrasted by pure social Darwinism on the part of those who walked away with the riches. Here is the basic overview of the early days of post Soviet Russia.
First, Gorbachev had to go for no other reason than he was a legacy leader from a dead system; too controversial for all. He was the guy who ‘gave up’ according to the hardliners, and he was ‘a Communist dinosaur’ according to the so-called reformers. Yeltsin just happened to be the guy in the right place at the right time. Powerful people inside and outside of the government wanted a weak leader during the transition period, and Yeltsin fit the bill.
The privatization plans were well-intended and were designed to distribute the wealth of the nation to the Russian people. The basic program was thus: The new government would attempt to value the state-owned enterprises, and then each Russian citizen would receive vouchers worth a small percentage of Russian enterprise. Through a somewhat complicated process thee voucher holders could exchange their vouchers for equity shares in various enterprises, or they could sell their vouchers on the open market.
Sounds great, but there were two problems; the first was that Russian industry was never run properly, and one result of that was that state-owned companies were very hard to value. The law of supply and demand had been suspended for fifty years and ‘sales’ were based on production. Production was determined by bartering agreements arranged by government ministries. The infamous five year plans determined that factory A would produce fifty thousand pairs of ankle length leather boots in return for twenty tons of corn. When crops failed then the shoes were shipped off to the satellite states or another country as government aid; tough to figure out a proper multiple to attach to a business that way.
The second problem was Russians. Add up the characteristics mentioned above and you would not be surprised that the average man in the street did not quite understand the voucher process, and even if they did, they were suspicious of these new ideas and wanted nothing to do with it. People traded vouchers, eventually worth hundreds of dollars each, for a loaf of bread or bottle of vodka. Many people never bothered to even claim their vouchers, despite radio, television and newspaper campaigns designed to explain the system. This created an opportunity for clever or cunning men to purchase major stakes in Russian industry for kopeks on the ruble.
Everyone knows about the oil and gas concerns that were sold off at a fraction of their value, but for every Gazprom or Lukoil, there were fifty shoe factories or bakeries or sewage pipe factories or agricultural collectives that were sold for many multiples of what they were really worth because no one realized that there was absolutely zero demand for their products, or that they could not be produced economically.
We have met with managers of factories that put all they had into buying equity in the companies they knew so well, only to learn that what they made could be bought in Taiwan and shipped to Moscow for half the price it cost for them to produce it. Some later discovered that their shares had value by virtue of the real estate the worthless factory sat on, or they dug deep and retooled their operations, thereby adding value. Sadly however, many lost everything.
Oligarch’s and the ¨Vorovskoy Mir¨
The period between 1991 and 2001 is generally thought of as a free-for-all that spawned a new breed of Russian Oligarch, and simultaneously the Russian Mafia. There was nothing new to it. The Vorovskoy Mir, or “Thieves World” in English, was a not-so-secret society that traces its roots back to Tsarist times. In those days, the Tsar owned everything and the only way to protest was to become an outlaw. The Vorovskoy Mir became a brotherhood of thieves who banded together to rebel against the Tsar. Early folk tales about the Vorovskoy Mir sound like a mixture of Robin Hood and Libertarian fiction. They shared a code of honor and a code of silence and took a vow never to cooperate with the government until the “chains of slavery were broken”.
When Lenin came to power, the brotherhood found that the new power was no less autocratic than the Tsar, and shortly after taking power, Lenin was robbed by members of the Thieves World in St. Petersburg. During the World Wars the brotherhood survived, but not without periods of infighting and brutal bloodletting. After WWII Stalin made it a priority to stamp out the criminal brotherhood and anyone thought to be a member of the Vorovskoy Mir was either imprisoned or killed.
After Stalin died 8,000 prisoners were released. Many of these hardened criminals had learned about the organization of the old brotherhood, and took with them the tactics but not the original ethos. All semblance of the original anti-state and pro-freedom ideology was gone, and what was left was a ruthless but organized criminal organization. This new breed of Russian gangster was presented with a real opportunity when Leonid Brezhnev came to power.
By the mid 1960s the economic and social fallacies of communism became clear. The system did not work, and government corruption became first a survival mechanism and then later a path to relative prosperity. The crime boss and the party bosses were natural partners in the looting of the Soviet system from at least the early 1970s. The black market was the only functioning market in the Soviet Union, and those that operated illegal businesses had to pay protection money to the gangsters. When Gorbachev came to power he legalized much of the black market economy, but the crime syndicates not only continued to charge their cut, but also decided to open businesses of their own. Think Joe Kennedy in the back bay of Boston after prohibition.
The CIA and the White House may have been surprised by the collapse of the Soviet Union, but the crime bosses had been planning for it for at least three years. There were open meetings amongst crime groups debating how to handle the coming collapse. However, they were not alone. A new breed of up-and-coming reformers inside the government, and in the universities, was also able to read the writing on the wall, and they too were beginning to plan. In their thirties and forties these newcomers had been on the path to success as defined by the old system, and they intended to stay on the path to success regardless of what came next.
Chaos came next – economic and social chaos. The government officials running the country were so out of their depth that the newly opened economy took on too much debt, and the ruble collapsed. Parliament was suspended. The Army was called in. It was madness. To cling to power, Yeltsin offered loans to the first generation of Oligarchs in exchange for their political support. Meanwhile, the crime bosses spent most of their time either branching out beyond their borders in places like the US and Europe, or ensuring their traditional rackets kept growing. The new group of up-and-comers, on the other hand, had their eyes set on Russian industry.
Some of the young guns grabbed at the low hanging fruit by selling military hardware on the black market. Many of these entrepreneurial ‘black marketeers’ came from the KGB, and prior to the collapse of the Soviet Union would have never considered criminal activity or known any of the crime syndicate members. Yet the KGB veterans understanding of the inner-workings of the old system and language skills was an attractive asset for the organized crime groups that had a ready-made criminal network of Russian emigres around the world. While gun running was profitable, it paled in comparison to what came next.
Other young former government and academic stars started to see opportunities. Some were sharp managers inside ministries, others were professors, and some were even shift supervisors in factories. While people were giving away their privatization vouchers to anyone who asked, they were trying to organize investment syndicates to gain control of assets they knew to be valuable. The problem was most people would not listen, and those who did listen had no money. So sometimes they went where the money was; in the hands of the crime boss. More often they got their funding from legitimate sources ranging from foreign banks to the Russian expatriate Jewish community. These entrepreneurs were the next generation oligarchs, and their association with the Russian mafia is the stuff of legend; some deserved but mostly exaggerated.
During this period there were real opportunities for legitimate entrepreneurs. As long as you did not get too big, or poke your finger in the wrong eye, you were more or less left alone. We have friends who built successful businesses in Russia between 1993 and 2000. But then things started to change when Putin came to power.
This concludes Part 1 of this report. In Part 2, I discuss the Putin years and Russia today.
About The Author
Without Borders is a monthly newsletter dedicated to finding the best global investment opportunities and the most beautiful places to live and do business.
If you are interested in specific strategies for moving money overseas and diversifying out of the dollar –whether it’s overseas bank accounts, real estate purchases, commodity currencies, or offshore brokerages — Fitzroy tells you the safest and most robust places to park your dollars while they’re still strong and widely accepted… places that will keep your personal economy strong even as the dollar and the U.S. economy suffer. He investigates outstanding investment opportunities, companies, and stocks you won’t hear about on CNBC as well as lucrative overseas deals that they themselves scope out and test.
If you want to think, invest, and live outside the box, test Without Borders now risk-free – with a 30 day, 100% money-back guarantee. Click here to learn more.
To learn more about Without Borders CLICK HERE