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Sanctions and the Rise of Putin’s Russia

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There’s been a great deal of discussion in the press, in Congress, and in business circles about the impact of international sanctions imposed on Russian entities and individuals as a result of Russian policies in Ukraine, Syria, and of course, Russia’s concomitant interference in the conduct of U.S. elections.

One problem in understanding the discourse is there seems to be a muddled perception about the status and origins of the Russian actors in this unfolding drama. Terms like ‘oligarchs’ and ‘siloviki’ are often used as being virtually interchangeable. Further, a true understanding of the critical transition period from the Soviet state to modern Russia is often garbled or missing altogether. There exists a gap in understanding the balance of political and economic forces that constrain Russian policy, with or without sanctions.

Central to that balance is, of course, Vladimir Vladimirovich Putin. Ascending to the Presidency in 2000, he was determined to change the structure of the Russian economy. Unhappy with the rise of the oligarchs and the increasing power of the capitalists, Putin could not stand the idea that the economy of Russia would be in private hands. Along with his Chekist comrades (basically the security apparatus of the former Soviet state), Putin would isolate and remove the oligarchs who had taken effective economic control of the Russian economy, and install new and powerful ‘siloviki’ into the corridors of power. These siloviki would become the heads of state organizations like the railroads, banks, insurance companies, finance and investment corporations, state committees, and the media.

In the most recent round of sanctions, the name which comes up most frequently is billionaire oligarch Oleg Deripaska. Head of aluminum giant RUSAL and Basic Element, one of the largest diversified industrial groups in Russia, Deripaska is a special case. Unlike many other oligarchs, Deripaska has managed to survive the winds of change.

Yet, with the current sanctions in place, and the recent offer by the U.S. Department of the Treasury to relax pressure on RUSAL, Putin stands under a great deal of pressure to remove Deripaska. The US use of sanctions has proven to be a considerable burden for Putin and the Russian economy. It represents the hardest ‘soft power’ available and seems likely to produce the effect it seeks.

As the web of interrelationships between Deripaska and the Kremlin make many options unsavoury, Russia’s president faces a tough choice.

Today’s Russia is a unique place and the rules, yardsticks and economic successes in Russia are very different than the traditional ‘developed’ and ‘underdeveloped’ shorthand terms which often pose as analysis. There are many countries of the world which are economically underdeveloped. There are almost none which are politically underdeveloped; a political structure emerges over time which fills the needs of that society.

The restructuring of the Russian state from the failures of the Soviet state is a journey which should be explored if an understanding of its current state can be reliably discerned and evaluated.

Back in the USSR

The Soviet Union was never efficient. It had built-in inefficiencies. There were at least three people for every important job in the USSR; one from the civil administration; one from the party organisation, and one from the control agencies. The power was not divided equally among them. This was even more complicated in the regions with local party and civil administrators participating and offering advice.

This was monumentally inefficient. No one had sufficient individual responsibility to run anything. There were phantom factories, phantom workers and phantom transport links. These were sufficiently well documented that they passed for reality and got their budget allocations and requisitions. In one year in the 1970s, the most efficient and productive facility in the USSR was a shoe factory near Lake Ladoga which had never been built. It did so well because there was no real factory and no real workers, so it thus avoided the shortfalls and quota delivery problems which plagued existing companies.

The USSR economy was capable of producing the same quantities of aluminium, steel, coal, aircraft, oil, natural gas and even grain as Russia produces so profitably today. However, they didn’t achieve anything like these levels of production. The system was skewed, corrupt and inefficient; primarily lacking in investment capital. The people who were running the USSR economy were incapable of making it fit the needs of the twentieth century.

If it weren’t for the Afghan War the USSR might well have crumbled six years earlier. It was a command economy with the inmates of the asylum in command. What did function was the military with its ability to annihilate the world. Russia was a Great Power but only militarily. It would have had a hard time competing economically with several Third World countries.

Communism contained the seeds of its own destruction. Even if there were competent people in charge of key ministries or state trading companies, the fabric of the economy was threadbare. They had no resources or systems to make the needed changes. So, they did their best to try to fit reality into an unreal system.

This internal system was facilitated by the use of a central bank clearance system in which internal accounts were calculated in rouble credit and debits across an industry, a ministry, or a state trading organisation. The accounts were all paid into and out of the ‘centre’. There they were allocated by the ‘Gosplan’ planning committees as part of a ‘plan’ for the needs of the industries and matched by establishing quotas for production. External payments in hard currencies and hard currency sales were conducted only by the central banking system without regard or reward to the importer, exporter or producer. As long as the ‘centre’ existed and functioned this planning model creaked on.

Shocks to the System

This system functioned in Russia from about 1964 to 1988. Then there were three crises which occurred. The first was Gorbachev’s order to disband Gosplan (the centralized state planning organisation); over 60,000 people lost their jobs. They didn’t go quietly. They set about sabotaging the system, so they would be needed to restore it to order.

The next shock was the order to close up the state trading companies. This was an enormous wrench to the system, not only because people lost their jobs and control of industries, but because these state trading companies had joint ventures around the world which suddenly were also out of business. Who was able to market Soviet products on the world market when these trading companies disappeared? No one had a clue as to how the goods should be priced, as no one had an idea of the real costs (including transport, wages, etc.).

The other shock was the removal of the Communist Party from its place of monopoly in the political system. This had many political ramifications, but the economic effects were devastating. As the Party made up a third of the triumvirate of power in every factory or shop or agency, the vacuum was created into which no one dared enter.

This system broke down in an effort to establish ‘perestroika’. The first people to lose their jobs were the planners at ‘Gosplan’. The Yeltsin victory and the introduction of Gaidar’s and later Chernomyrdin’s reforms sought to decentralise the control of the CIS and later the Russian economy. This was a positive step towards establishing a market economy but a dreadful wrench for the existing manufacturing sector.

Capitalism without the capital

Because all purchases and sales were made through the ‘centre’ there was no aggregation of capital which belonged to any factory or ministry or trading company. There had been no ‘profits’ so there were no accrued earnings. Productive enterprises owed goods to the system and requisitioned materials from the system. There were no real cash transactions among the enterprises, nor was there an accounting system which measured who owed what to whom, for how long or why it owed it. The introduction of reforms made life terribly difficult for state enterprises and trading companies.

For example, in the aluminium industry the aluminium smelters were obliged to produce and deliver finished aluminium. Yet they had no means of paying for alumina, coke, cryolite or any of the other materials needed to make aluminium. They had not ‘sold’ aluminium previously, merely delivering it as the state determined. They could not ‘buy’ alumina from the alumina producers because they had no money to do so. In any event no one knew what the price for alumina should be. The alumina producers could not sell the smelters alumina anyway as they had no money to buy bauxite from Africa, neither in roubles or in dollars, to make the alumina.

Equally as problematic was arranging the internal transport of these goods within Russia. If there was no means of exchange how would these companies pay the railroads for handling their goods? What price should they pay? To whom should they pay it? Who would pay for the coal to the power stations? How would the power stations charge for electricity? Reform, in short, however small, brought chaos.

Just as the Russian workers woke up one day to find that they had been moved from the state sector to the private sector, Soviet business found that the same stroke of the pen had moved them from state capitalism to private capitalism. In both cases there was little preparation for such a shift and certainly no guidelines or infrastructural changes introduced to prepare or equip them for the move.

Simply put, the companies couldn’t pay the workers from accumulated earnings because there weren’t any. They could not continue producing goods because they had no money to buy raw materials. They couldn’t ship these goods to and from the factories because no one knew who was financially responsible for supplying the railroads with coal, diesel, rolling stock or electrical power. The regional governments had no funds to invest to shelter the costs of the transition phase and no one was collecting taxes which could allow the state to set up transitional funds.

There were also no Russian banks in 1990-1991 which were equipped to handle the requirements of Russia’s trade. The Bank for Foreign Trade (Vneshtorgbank) was established in October 1990 with support of the State Bank of the RSFSR and the Ministry of Finance of the RSFSR to service Russia’s foreign economic transactions and encourage the country’s integration in the world economy. It was the first and most successful bank for foreign trade. It didn’t get its foreign exchange license until January 1991. Vneshtorgbank (‘VTB’) was able to take over some of the larger, state, trading deals and spread its offices across the globe. VTB was put in charge of handling important government tasks.

All you need is cash

The Russians were in a dilemma. They needed to buy, in hard currency, the raw materials it needed from abroad. It didn’t have reserves or the mechanism to guarantee the purchases. The individual factories, however large, had no cash reserves to fund the purchase of needed resources, nor did they have a line of credit established at any bank which could give them the working capital to produce the goods. As a result of this, their offers of finished products to the world market were not believed; the buyers and traders knew that if they agreed to purchase the finished goods and put letters of credit in place the Russian factories could not perform, nor could they issue Performance Guarantees as compensation. Still less could they arrange the shipment of the goods from the factory to a port as they couldn’t pay the railroad.

In addition to the reforms needed to cope with introducing price and cost into business transactions the enterprises could not keep up with their social responsibilities as well.

There was a tradition in the Soviet system that many of the needs of the workforce for consumer goods, foodstuffs and services (police, fire, education, health, etc.) were provided by the enterprise itself as part of the compensation package offered its workers. Workers were able to get food parcels, clothing, etc. from the place of work. This stopped them having to leave work to join the endless queues and offered an ‘on the spot’ system of distribution. The state arranged a minimum standard of living for all and was responsible for delivering sufficient food, clothing and services to even the most remote areas to permit a difficult but not impossible life.

One of the immediate consequences of the reforms was that the production planning function was divorced from the distribution function. It was very difficult for the new state and regional bodies, as well as the enterprises themselves, to purchase and take delivery of the quantity and quality of these consumer items and services formerly provided by the State. Wages were largely unpaid or delayed. Largely because of this there was a massive depopulation of rural areas, particularly in Siberia, where a newly mobile population left the challenging life on the edge of the tundra for a more secure, if impoverished, life nearer the big cities.

In the vast areas of rural Russia, as in between Bratsk and Komsomolsk-on-Amur on the Baikal-Amur Railway line, population dropped in eighteen months by almost thirty percent. Towns and factories stood deserted. Houses lay empty alongside roads with no traffic. Industries just closed their doors. The state proved unable to provide food and supplies sufficient to maintain the population levels, so the areas shrunk in size to serve a diminishing population. The companies had no resources to do it on their own.

Go to Plan C

The Soviet leadership was persuaded to act. Under Yeltsin, Russian Prime Minister Silayev, Deputy Prime Minister Oleg Soskovets, presidential aide Aleksandr Korzhakov and Speaker Ruslan Kasbulatov, and the leaders of the First, Fifth and Sixth Directorates of the KGB developed a two-pronged plan.

The first part of the plan included inviting in foreign capitalists to prepay the expenses of the factories to get production moving. Using a model developed by Marc Rich, these capitalists would be asked to pay for raw materials, pay for transport, pay for production, and would then earn the right to sell the completed goods on the world market. They would pay, in addition, a fee or ‘toll’ to the factory for producing the goods.

Secondly, this system of tolling would only work if there was an internal currency which could be used to start the payment system and establish prices. President Boris Yeltsin signed a decree on March 7, 1992, allowing foreign tolling. Yet there was no state mechanism capable of handling this. So, the planners decided on an ambitious, if risky, system. They would make an alliance with the small and disorganised criminal groups in Russia to develop a parallel system to the government’s currency business. They opened up the floodgates on a massive hemorrhage of roubles onto the world markets to get hard currency and to prime the rouble pump inside Russia.

The money began to flow out of Russia. Ordinary roubles became ‘gold roubles’ when they passed the border. These were gold roubles because they were backed by gold held in the Russian Treasury.

Between 1990 and 1992 the Russian gold reserves then mysteriously disappeared. When Gregori Yavlinsky, the reformer, went to the September 1992 G-7 meeting in Bangkok, he reported that of the 2,000 tons of gold in the Russian reserve, only 240 tons were left. In November even these were gone. In a little over a year over US $22 billion in gold left Russia at a heavy discount to cover the massive rouble river costs. Europe was full of stories of this group or that offering to place $140 million with one bank or the other. What did happen is that most of this money, in roubles, eventually returned to Moscow.

The Rise of the Oligarchs

When this money returned to Moscow it had to be used to provide a capital market for Russian factories and the ‘Red Generals’ of the factories who remained at their posts. This required setting up domestic banks and analogous financial entities.

The KGB and its allies set up a system in which loyal and trusted members of the Komsomol system and friendly businessmen could form their own banks in Russia. Men like Mikhail Khodorkovsky, Pyotr Aven, Mischa Fridman and others were chosen and set up in the money business; later developing into giant banks like Menatep or Alfa. These were talented and educated university graduates who were the link between the government and the growing Mafias who were developing nationally to handle the international transfers of funds.

With the success of tolling and the liquidising of the rouble, prosperity began to return to Russia as the funds were repatriated. As this system worked and metals and oil were produced and sold, these companies retained a part of the hard currency earnings.

The foundations of Russian capitalism were laid.

As these banks and investment trusts prospered, Russia became less and less dependent on the Mafia for its business. They also became less and less dependent on Western capitalists to introduce them to commodity trading. The Russians brought the rubles home and, in the various stages of privatisation, they invested these in taking control of Russian businesses.

Quite often this privatization was a sham but that wasn’t the point. The point was to bring the money home and take over the shares and the businesses. An open tender for these might otherwise have attracted Western investment interest. A great deal of the money used to pay for the fake privatisations was money squirreled away in overseas banks by those in power and returned through the new ‘oligarchs’ to take over the shares in Russian companies.

The new oligarchs had access to the funds being returned to Russia and used them to buy shares in the Russian enterprises moving into the private sector. They then turned these companies into thriving businesses with them at the helm. However, they were still responsible and vulnerable to the political leaders and the KGB which had empowered them.

One might well ask on what basis these oligarchs were chosen. The main reason, in addition to their competence, is that they were mainly Jews or outsiders (Potanin’s father was a trade official and he lived outside Russia for years). Others, like Kakha Bendukidze or Vadri Patarkashvil were Georgians. As Jews or outsiders, they were without a political base. No Russian member of the Duma would dare stand up to protect a ‘rich Jew’, as Berezovsky and Gusinsky soon found out.

These oligarchs were initially dependent on their KGB bosses. As they took control of these businesses they began to operate as real entrepreneurs. They sought modernisation, a Western-style management, and integration in the world economy. These financial oligarchs were joined by others with technical and entrepreneurial skills, like Vladimir Lisin and Iskander Machmudov. They began to create large functioning companies which were generating substantial profits in international trading. They often worked in concert with the new Mafia families who had organised in recognised ‘gangs’ and played a role in maintaining the liquidity of the rouble.

The Liquidity of Rossiyskaya Mafiya

The positive role of the Russian Mafias in the modernisation of Russia is crucial to understanding how the system flourished.

Since there were no functioning local banks across the broad expanse of Russia there was enormous difficulty in getting access to cash to pay the workers and to pay the bills. If a company needed cash to pay the workers, it could petition the bank in Moscow to send the cash. Often this would take months.

However, the Mafia was selling cigarettes and vodka and a variety of imported goods for cash across the country. In many cases these large companies, and their overseas partners, would take some of the ‘tolling’ money and use it to pay Western suppliers of cigarettes and vodka who delivered these to the Mafias and the Mafias would pay the roubles inside the country to the companies for their wage bills, etc.

Simply, the Mafias had rouble liquidity and they played an important role in keeping the financial system lubricated. Moreover, the Mafias were also the providers of ‘middle management’ in the oligarchs’ plants and factories across Russia. It was a working symbiotic system.

The new oligarchs thrived under Yeltsin and grew extremely wealthy. They set up financial institutions in the West. They sold shares in their companies to Western investors. They buried their money in banks in Cyprus and the Caribbean and they moved many of their assets to offshore havens. They moved their children to England to get an education. They, or at least their money, were welcomed into British and European banks and polite society.

They also distanced themselves from the Mafia as much as possible as they no longer needed them. However, some of the oligarchs’ accumulated wealth belonged to the Mafias who were unwilling to abandon the money or the control, as they needed these sums and international companies owned or controlled by the oligarchs to finance and shelter their international criminal activities. As the oligarchs, particularly those settled in the West, began to accumulate wealth legitimately there was additional friction with the Mafias.

Yeltsin’s Slide

By the end of 1995 it had become clear that Yeltsin’s efforts to reform the Soviet economy was less than fully successful. He was worried and in desperate need of cash. He was not collecting sufficient tax revenue to pay the state bills. His war in Chechnya was a heavy drain on the state purse. His economic policies had damaged the national economy and impoverished many of the poorest in the country and destroyed their savings.

Equally as important as Yeltsin’s impotence was the fact that Russian business had emerged from its stunted state at the passing of power from Gorbachev. There were very rich Russians. There were powerful businessmen, and these had emerged despite the actions of the state, rather than because of these actions and policies.

In the immediate post-Gorbachev period there were two emerging types of Russian entrepreneurs. The first group were the Soviet-era factory directors of small and middle-size factories who continued to operate in the vacuum of governmental control with the passing of the Soviet Union. They just kept control of their factories in a de facto privatisation, often making deals with the local criminal gangs who helped them with raw materials and distribution. An important part of this relationship was access by these factory directors to the liquidity provided by these criminal organisations, their banks and their close working relationships with the local and regional civil services and elected leaders. They acquired their shares in their companies by buying them from their employees or extorting the shares from them in a bargain for job security. These were the ‘New Russians’ who were famous for flaunting their new wealth in a feast of nouveau riche excess.

The second type of entrepreneurs were the people like Chernomyrdin; members of the Soviet nomenklatura (the elite) who had become the owners of major national businesses; e.g. Gazprom. Many of these were the Red Generals who had co-operated with the KGB organisers in the schemes developed by Andropov to prepare for the collapse of the Soviet system and who moved the state assets out of the country; the program initially supervised by Arkady Volsky. These evolved into the Union of Industrialists and Entrepreneurs. These were not just large Russian companies with major businesses to run. They became international businesses as the nomenklatura capitalists set up overseas facilities to hide their shares and influence and to diminish their reliance on solely Russian capital.

Russian companies began an accelerated movement towards privatisation. The first company to be privatised was the Bolshevik Biscuit Company on December 8, 1992. There were several soon after. Yeltsin had succeeded in creating a neo-capitalist system in Russia, but one which was badly led and badly funded. It finally reached its climax in the 1998 bank collapse, when the government changed, and Vladimir Putin became President of Russia.

Vladimir Vladimirovich Putin was a different character than Yeltsin. On 25 July 1998 Yeltsin appointed Vladimir Putin head of the FSB, the successor agency to the KGB and, in August 1999 he was named a Deputy Vice President of Russia. Later that same month he was elected Prime Minister of Russia. On New Year’s Eve 1999, Yeltsin resigned his post as President which left Putin as Acting President. Putin’s first decree as Acting President was to issue a ‘Get Out of Jail Free’ card to the Yeltsin ‘Family’; a ‘ukase’ which granted immunity to the wider Yeltsin Family.

During his rise to power, Putin had briefly been in counter-intelligence (Second Department) before moving on to the Fifth Directorate where he monitored Soviet dissent. He transferred to the First Department (International) only when he was offered a post in East Germany where he spent five years essentially monitoring the opinions and actions of fellow Soviet officers and officials. When the Soviet Union collapsed he was transferred to Leningrad where he spied on student movements and dissidents. Putin joined forces with Anatoly Sobchak, the mayor of Leningrad as Sobchak’s international adviser. He became head of the Leningrad committee to promote investments and foreign commerce.

Within one year of his appointment, a local commission investigated Putin for understating the prices paid for permits for the export of non-ferrous metals and the missing food aid that never reached the city (a total of US$93 million). No case was ever proved against Putin and he remained in his job. He survived and prospered in his posts even as Sobchak and his assistants suffered terminal heart attacks almost simultaneously.

When Putin rose to the Presidency he was determined to change the structure of the Russian economy. He, and his Chekist friends, were unhappy with the rise of the oligarchs and the increasing power of the capitalists over what they believed the Russian economy should look like.

Despite the notion that Communism died with the fall of the Soviet Union, the state, its agencies and its companies are now populated by the Undead; the unreconstructed nomenklatura of the failed communist system.

In his book, Capital, Marx wrote that ‘capital is dead labour which, vampire-like, lives only by sucking living labour’. He coined the term ‘Vampire Capitalism’; of corporations whose exploitations ‘only slightly quench[ ] the vampire thirst for the living blood of labour’, and that ‘the vampire will not let go while there remains a single muscle, sinew or drop of blood to be exploited’.

What Putin created is a society of Vampire Communism – where the Undead suck the life blood from private corporations and government agencies, leaving drained and powerless structures behind them. He achieved this by co-opting into governmental and corporate posts his former colleagues in the security services, the Chekists.

A ‘Chekist’ is a general, if pejorative, term for those who are or once were employed in the security operations of the Soviet state – the KGB, GRU, MVD, FSB, etc. (the ‘Organs’). Dzerzhinsky’s original agency was the Cheka; hence Chekists. Russia’s new and powerful people (‘siloviki’) have been almost exclusively drawn from the ranks of the ‘Chekists’. Under Putin, these ‘siloviki’ have been firmly installed in the corridors of power.

With Putin’s direction, the Chekists, primarily the St. Petersburg flavour of Chekist, openly took power as ministers, government advisors, governors, bankers and politicians. There may be as many as six thousand of these Chekists in powerful positions in the Russian state. There is no mystery about who they might be. Nikolai Patrushev, Igor Sechin, Yuriy Zaostrovtsev, Viktor Ivanov, Nikolai Patrushev, Boris Gryzlov, Sergei Ivanov, Vladimir Ustinov, Sergei Stepashin, Sergei Pugachov, Nikolai Negodov, Vladimir Yakunin, Konstantin Romodanovsky, Viktor Cherkesov – to name but a few. They became heads of state organisations like the railroads, standing state committees, chairmen of banks, insurance companies; finance and investment corporations, and the media.

These are mainly economic actors rather than representatives of a political ideology. There is little unity in the ‘siloviki’ position. There is no one united plan that they follow. These ‘siloviki’ are in competition with each other and form cliques, alliances and temporary groupings to further their aims. In doing so, they often attack other members of the clan and do serious damage to Russia. There are more factions of siloviki than there are factions of Trotskyites.

As Putin rose to prominence these siloviki were empowered. Their first task was the isolation and removal of the oligarchs who had taken effective economic control of the Russian economy. Putin and the siloviki could not stand the idea that the economy of Russia could be in private hands. They set about the removal of the oligarchs from power. Some, like Berezovsky and Gusinsky could be forced into exile, relinquishing their holdings at a deep discount before they left. Others were forced out by imposing phantom taxes on their businesses.

Putin and the Siloviki Clean House

One of the first battles, a kind of test case, was the effort to prise the railways from the grasp of Nikolay Asenenko, the Railways Minister. Asenenko was a long-serving Minister, associated with the Yeltsin Family, who was active in instituting reforms in the aging and poorly maintained Russian railroad system. After a long period of resistance, the railway system agreed to be reformed. After long debate, the government agreed to Asenenko’s plan to split the railway into two entities, a managerial state-run system and a private operating railway business. As soon as this was agreed the ‘siloviki’ moved in to prevent Asenenko from carrying on the reforms and putting himself at the head of the railway monopoly. The then Prosecutor General, Vladimir Ustinov (himself once a Yeltsin man) began to find ‘tax errors’ and underpayments by the Railways. He purported to find almost seventy million rubles in unpaid taxes. Asenenko prepared his resignation and Putin fired him (3 January 2002). The new people who were moved into the railways were ‘siloviki’, led by Vladimir Yakunin.

Having succeeded so well with Asenenko, the siloviki turned their sights on a much more powerful figure, Mikhail Borisovich Khordokovsky of Menetep Bank and the large Yukos oil complex. Yukos was one of the world’s largest non-state oil companies, producing 20% of Russian oil—about 2% of world production. In July 2004, Yukos was charged with tax evasion, for an amount of over US $7 billion. In short, the siloviki used their power in the tax office and the Procurator’s office to issue grossly inflated tax demands on Yukos and effectively put the company into bankruptcy.

Putin’s vampires then sucked the cash out of Yukos, arrested Khordokovsky, threatened his partner Nevzlin with a trial for attempted murder and stole the company in a fake auction which left the assets with Rosneft (I. Sechin, proprietor). They tried to do the same with several successful companies, including Alfa Bank. In the meantime, the siloviki were busy milking the Yukos cow through insider trading and depriving any Western investors of their stakes in Yukos shares.

“Greed is good”

The real question is why these ‘siloviki’ are so determined to move into business and take over control of public companies and take others back into quasi-public ownership. The answer is very simple – greed.

Putin actively promoted the creation of the ‘oligarchs in epaulets’. There were phenomenal sums of money being earned in Russia as a consequence of the Yukos case. There are no laws against insider trading in Russia which prevent this. The government knew when it was going to make an announcement about Yukos; an announcement that would send its shares up or down dramatically. It knew when it would announce news about stopping or starting oil flows; an announcement that would send oil prices up or down.

There is a principle, known as Occam’s Razor to guide us. This is a logical principle attributed to the mediaeval philosopher William of Occam. The principle states that one should not make more assumptions than the minimum needed. There is increasing evidence that foreknowledge of government intentions led to trades in Yukos shares and oil futures, betting on a ‘sure thing’, by the same groups of people who were making the decisions, the siloviki. They were milking the Yukos cash cow for months.

What is important about Putin and the siloviki is that they have created a system of governance in Russia which, once again, effectively removes the linkage between the individual performances of a private company, a parastatal or an industry from the funds it generates. Because of the configuration of the siloviki economy the profits from the various producing entities and service industries are not kept in the name of the generating company or service but effectively put into a central pot (like the ‘obschak’ of the Mafia) for distribution by the political leadership.

This divorce from a direct line between earnings and capital accumulation makes corporate planning a subject of political discussion and debate. This is inimical to the notion of ploughing back profits towards R&D, maintenance and the renewal of plant and equipment. This is the central weakness of the Russian economy and a powerful reason for the stranglehold of the siloviki on the direction of the economy.

Most of the former oligarchs are still in business, but they have virtually no political power. They, and their Mafia partners, have to stick with making money and avoiding Russian politics. Most live abroad if they can.

Putin has succeeded in returning much of Russian commerce, especially the heavy industries, into the hands of the state through the siloviki. This is why the Western targets for sanctions are aimed at the ‘oligarchs in epaulets’ and the parasitic siloviki who live on their companies. Even more important for Putin is that he is the decider of who and for how much the competing siloviki access the common pot.

This is, ultimately, his source of power.

In discussions and debates about Russia sanctions, a name which comes up most frequently is Oleg Vladimirovich Deripaska, the head of RUSAL Aluminium and Basic Element.

Once Russia’s richest man, Deripaska is an oligarch and has never been a Chekist. He was an assistant in the office of Mischa Chernoy for years. He survived being sent to Sayansk Aluminium plant during the Aluminium Wars by hiring bodyguards who followed him everywhere. Most traders assumed he would be killed there but he managed to survive.

Deripaska was not an oligarch on his own. The shares he owned in the various aluminium plants were widely believed to be actually owned by Mischa Chernoy. Because of Mischa’s legal problems, he needed a ‘beard’ for several projects. Oleg was one of the beards. Iskander Makhmudov did the same in copper. Arik Kislin was the chap who handled the cash for them.

Oleg, however, had something special that no one else had. In the last years of Yeltsin, the Chernoy brothers (then partners in TransWorld Metals), worked closely with Berezovsky, a close confidante of Yeltsin. A meeting took place in Berezovsky’s country house, Chateau La Garou, in the Cote d’Azure attended by Berezovsky, Tatyana Dyachenko-Yumasheva (Yeltsin’s daughter and political guru and fixer), Valentin Yumashev and Dmitry Bosov (a representative of Trans World and right-hand man to Lev Chernoy). They discussed the political situation in Russia and possible personnel changes in the government and presidential administration.

Tatyana would suggest that they establish closer ties. She suggested arranging the marriage of Oleg Deripaska to the daughter of Valentin Yumashev (whom she had married), Polina Valentinova. They married in 2001. This was important because Deripaska then became one of Yeltsin’s extended family and benefited from the ukase which exempted Yeltsin’s family from any legal proceedings. This made Deripaska a valuable partner to have if even Putin couldn’t touch him.

An Aluminium Empire

The largest regrouping of forces in the Russian metallurgical industry occurred almost immediately after Vladimir Putin came to power. Within several months of his inauguration, a new pattern of forces had formed in the aluminum industry.

Instead of going to war as expected, Roman Abramovich (who was a ‘beard’ for Berezovsky) and Oleg Deripaska ( ‘beard’ for Mischa Chenoy) joined forces and set up the Russian Aluminum (Rusal), which included the Krasnoyarsk, Bratsk, Sayansk, and Irkutsk aluminum smelters and the Achinsk Alumina Refinery. In the course of these grandiose deals, the former giants of the aluminum market left the industry – including the brothers Mikhail and Lev Chernoy; the head of the Bratsk Aluminum Smelter (BrAZ), Yury Shlyafshtein; entrepreneur Anatoly Bykov; and Krasnoyarsk Aluminum Smelter (KrAZ) co-owner Vasily Anisimov.

With this newly established entity, RUSAL and Deripaska had their first run-in with the U.S. authorities in a RICO suit.

In December 2000, a group of metals trading firms filed a US $2.7 billion RICO suit in US District Court for the Southern District of New York against Russian Aluminium, Sibirsky Aluminium, key controlling individuals Oleg Deripaska and Mikhail Chernoy, and other affiliated entities (Base Metal Trading, et al. v. Russian Aluminum, et al.). The suit alleged that the defendants conspired in a range of criminal activities, perpetrated on US soil to the detriment of US economic and business interests, designed to aid the defendants in illegally seizing control of the Russian aluminium industry overall, and of the Novokuznetz Aluminium (NKAZ) plant in particular. Deripaska, Chernoy and Sibirsky Aluminium are part of the Russian Aluminium group, which controls more than 70% of Russia’s primary aluminium output and ranks among the world’s largest aluminium companies. The suit was filed on behalf of Base Metal Trading, SA, Base Metal Trading, Ltd. and Alucoal, Ltd. by former New York State Attorney General Robert Abrams, of the law firm Stroock & Stroock & Lavan, and supporting attorneys.

The complaint enumerated specific allegations of murder, extortion, and mail and wire fraud, among other criminal acts orchestrated by the defendants and carried out in some cases by the notorious Izmailovo Russian-American Mafia. It sought US $900 million in compensatory damages, treble damages under the RICO statutes, and unspecified punitive damages. The core claim of the suit was that when the defendants were unable to negotiate a legal purchase of the NKAZ plant, they resorted to extortion to seize control of the plant and a greater portion of its trading profits.

The judge denied relief on the grounds that these acts were perpetrated in Russia, not the US, so the court lacked jurisdiction. RUSAL made a cash deal with the plaintiffs and the case was closed. There was no ruling on the merits of the case.

There were a number of other cases in Australia and elsewhere where the actual ownership of the RUSAL shares by Deripaska was questioned. Mischa Chernoy sued Deripaska in London and they arranged a settlement. Deripaska lost his U.S. visa in 2006 and, despite a great deal of lobbying, still doesn’t have one.

Applied Sanctions

Lima Charlie News has reported on the impact that Russia sanctions have had on RUSAL and the aluminium market worldwide. With recent announcements by U.S. Treasury Secretary Mnuchin that the US would take a more lenient view of RUSAL with Deripaska out, Putin faces an uneasy choice of how to deal with the situation. To get Oleg out of RUSAL means to untangle the intricate web between Deripaska and the Kremlin.

The use of sanctions against the siloviki and ‘oligarch in epaulets’ represents the hardest ‘soft power’ available to the US and has proven to cause real pressure on Putin and Russia’s economy. For now, it seems likely such sanctions will produce the effect it seeks.

 

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