Tumbling Tuesday – Russian Rubles In Free Fall

This is getting very ugly. 

This picture was from Moscow on Friday, with the sign offering 54 Rubles for $1 and offering to sell Dollars for 59 Rubles (nasty spread).  Today, just 4 days later, you need 80 Rubles to buy a Dollar with that currency dropping 45% (so far) in less than a week.  This is happening DESPITE the Russian Central Bank raising it’s overnight rates to 17% from 10.5% – up 62% overnight – AND IT DIDN’T HELP. 

This is bad, folks.  Russia isn’t Greece, Russia is a $2Tn economy with 143M people and very close ties to satellite nations that surround them so the contagion is likely to be fast and direct and can very easily spread quickly to Eastern Europe, which hasn’t been strong in the first place. In our Live Member Chat Room this morning, we discussed the impact of the Russian Rate increase:

Raising the rates makes (in theory) your notes more attractive so people use their relatively stable foreign currencies to buy your Ruble notes so they can benefit from the high interest rates.  The problem for Russia is that their currency is down 50% this year and 10% this week so it’s not that attractive to exchange $10,000 for 650,000 Rubles (at 65 to the Dollar) at 17% and get back 760,000 Rubles next year only to find out it’s now 100 Rubles to the Dollar and now you only have $7,600.  This is the kind of spiral that leads to hyperinflation.  

Don’t forget, you also have to believe that the country you are lending money to won’t default.  Russia did default in 1998, which was only 16 years ago and now oil is simply crushing their economy so why on Earth would you give them $10,000 to hold for 2-5 years – even with 17% interest.  The Credit Default Swap (insurance against bond default) on Russia is now 5% (per year) and rising fast, so your net “safe” return on investment is just 12% and, even then, you still get back Rubles and you still have the risk of the devaluing currency.  

That’s another Catch-22 in the currency game.  By raising the rate of interest they promise to pay, they make a default much more likely, so expect CDS rates to climb very quickly (was up 15% yesterday alone) and eat up a lot of that 12% spread.