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You may have seen an influx of
content lately about how Russia
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is on the verge of a banking crisis—
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specifically, that banks have been
quietly subsidizing the Russian war
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machine now for the past two years,
both saddling those banks with risky
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assets and also putting the Russian war
economy on an unsustainable trajectory.
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Well, today is going to be
a bit of a meta-discussion
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because we need to talk about
the origin of this theory,
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why it would not be surprising if
Russia pursued this funding strategy
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despite the issues that I am
going to raise in the first bit,
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and then we will talk about how exactly the
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Russian economy could fall
apart due to all of this.
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And, as ever, all of these things are complicated.
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Let’s start with the origin of the discussion.
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It all traces back to this substack post called
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“Russia’s Hidden War Debt,”
published on January 11.
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The basic argument is that the
Kremlin has forced major Russian
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banks to issue loans to the war
industry at under-market rates,
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to the tune of $210 to $250 billion.
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These contractors are credit risks, meaning
that the Kremlin has shifted a large portion
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of the implicit cost of the war away from the
federal budget and to privately-owned banks.
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This has a ton of implications
about the sustainability of the war,
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which we will get to later. For now,
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I want to focus on the stubstack post and have
a meta-conversation about its dissemination.
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Now, I saw the post on January 11,
the day it that came out. And I
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also thought that it had a very interesting claim.
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Moreover, I had a looong flight the next
day. One the things that I prepared to do
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on the plane was to write a script for a
video that would go in-depth the subject.
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But I stopped outlining after about ten minutes.
Why you may ask?
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Because this is not a report.
It is an executive summary of a report that,
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as of the timing of this writing,
has not yet come out.
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And until there is an actual report,
we cannot really engage with the claims
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that are being made. In the interim,
though, this thing has snowballed,
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getting quite a bit of media attention—
28 articles by one well-Grounded measure.
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And within those articles, it is
tending to be presented as a report—
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which, again, it is not. It is a substack post
that is an executive summary of a report.
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It also caught quite a following on
Western social media because—well,
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not surprisingly—it is intriguing
and would be bad news for Russia.
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Now, I, for one, am very interested
in reading more about it.
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I am also interested in seeing what others
make of how the report was constructed.
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For now, though, I think it would be best
if the media ecosphere reined it in a bit.
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Oh, also, I would be shocked if Western
intelligence did not know all of this
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already. So while it is very interesting for
us in the open source circles to discuss it,
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we keyboard warriors should always be humble
and cleanse ourselves of the notion that we
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found the one true secret of the war. The
fact is, we are usually eight steps behind
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what is being discussed within the inner sanctum.
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You know, I want to go back to those
twenty-eight articles for a second.
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It is a decent chunk of the media ecosphere,
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and it was a problem across
the political spectrum,
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with some of coverage coming
from each the ideological wings.
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But the upshot is that only a handful of major
outlets covered it, and the distribution was not
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as massive as, say, two-hundred something sources.
That is how many covered Trump’s comments during
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his inauguration that Putin was destroying Russia.
It also does not touch the three-hundred something
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sources covering Trump’s appointment of Keith
Kellogg as special envoy to Ukraine. Start
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reading those articles now, because we are
going to be hearing a lot about him soon.
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Anyway, how do I know this?
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Well, it is all thanks today’s returning sponsor
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Ground News. Did you catch that
well-grounded pun from earlier, hmm?
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Regardless, Ground News has you
covered with its Vantage Plan,
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which is how I stay up to
date with what is going on.
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And, with my special link ground.news/linesonmaps,
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all while supporting this
channel. Isn’t that great?
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What is also great is the
analysis that you are about
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to get on why Russia might pursue such a strategy—
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because even if we cannot yet evaluate the report,
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we can still discuss why Russia’s alleged
methods would be a plausible choice.
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The knee-jerk answer is obviously “the war
is expensive, and so more funding is better
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than less.” The banking sector has a lot of
money, so soaking them is not a bad idea.
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And, no, there is nothing wrong with that take.
But there a couple of subtleties here too.
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One is signaling to the opposing
Western coalition. I think I have
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spilt enough digital ink telling you
that, in bargaining, convincing your
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opponent that you are strong is almost
as important as actually being strong.
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Well, if Russia can continue the war to the
degree that we have seen while only spending
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about 6.3% of GDP on defense, think about
what would happen if Russia really bore down.
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For a comparison, the United States spent about
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40% of GDP on its military
at the peak of World War II.
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Whereas the West has learned to ignore
Russia’s alleged red lines, actual movement
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of the front lines with only a modest
military investment speaks volumes.
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Remember, don’t listen to what
leaders say. Watch what they do—
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and this is a lot of doing.
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Of course, there are questions
about the physical toll of the
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war on Russia. But the point here is
that the Kremlin wants to promote the
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idea that it is capable of pushing a
lot harder, regardless of the truth.
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Then again, I should circle back
to the caveat about intelligence.
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This operation might have flown
under the public’s radar for a while,
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but it ought not go two years without
setting off some alarm bells inside of
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Langley. Understanding how Russia’s war
machine works is a top priority there.
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So, once more, this almost certainly has
already been priced-in to how Western
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governments have been reacting
to the war for a long time now.
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The other benefit is what goes on
inside of Russia. Inflation can be
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self-reinforcing. That is, expectations that
prices will rise can cause prices to rise,
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as consumers rush to stores to make
purchases before everything costs more.
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But that increases demand,
and so prices go up.
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In that light, public defense spending
is a public metric. It may very well be
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suppressed behind closed doors to
some degree. But whatever hedging
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or obfuscating goes on there
ultimately gives way to some number.
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So the lower you that can make that number,
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the more that you mitigate inflation
fears. The end result is less panic buying.
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And you can see where this is an
active problem for Russia right now.
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Reports indicate a growing unease within
the Kremlin about the Russian economy.
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To fight inflation,
the Central Bank has increased interest rates.
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But higher interest rates mean less investment,
and that is going to reduce the long-term
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quantities of consumer goods available.
Thus the need to hide inflation.
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Of course, this is no silver bullet.
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In the long run, consumers are going to
feel how abundant rubles are in the economy,
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and that is going to increase
inflation one way or another.
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Meat prices are going to go
up, same with the produce,
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and let’s not even begin to discuss eggs.
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But if you are the Kremlin,
the longer that you can delay it,
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the better.
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As for where this creates problems
for Russian economic stability,
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the answers there again are subtle.
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It is tempting to default to a
headline problem that risky loans
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risk bankrupting banks, and that would
cause the entire sector to meltdown.
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Those of us who lived through the Great Recession
understand the basics of that problem well.
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I feel like he is pointing to me right now.
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But that ignores what the Russian
government can do to mitigate the problem,
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and Russia has a fantastic head
of the Central Bank. It seems
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like 2025 is going to be the year of Elvira
Nabiullina, for better or worse for Russia.
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Indeed, ignoring Russia’s agency on this front has
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been one of the central fallacies
in Western analysis of the war.
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I am sure you have heard it a hundred times:
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“Do this simple step, and Russia
will be bankrupt in six months.”
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Well, yes, if Russia continues to do
the exactly same thing and ignores
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the simple step that you have taken.
However, Russia is a strategic actor
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and will adapt to the circumstances placed
in front of it. Sometimes it takes a bit,
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but eventually the information
filters up, and Kremlin reacts.
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Now, some interventions will not be
necessary. If a loan or two goes belly up,
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a single bank might not be in financial danger,
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nor will it pose domino problems to the sector.
The bank will just have to absorb the loss—
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and the Kremlin can smile as
it successfully shifted some
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portion of the cost of the war to private banks.
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Not too long ago, we discussed how
the real losers of the war currently
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are Russia’s oligarchs. Well, this is just
another way that they are paying the price.
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Where things get more interesting is with
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bigger losses—the types that the
banks cannot absorb on their own.
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Absent a government intervention, this
is where the economy can fall apart.
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Again, think back to the Great Recession.
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But even with a government intervention,
the Kremlin still comes out ahead here:
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it essentially received an interest
free loan in the affair. The banks
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acted as a silent creditor to the government.
It is not a great outcome for the Kremlin,
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but it is still better than
fronting the costs from the start.
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The real problem is the meta-problem.
No, I am not talking about this guy.
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I am referring to if Russians become worried about
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the stability of the banking
sector and initiate a bank run—
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either because they do not trust
the Kremlin to make the banks whole,
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or they think that the whole
process will take too long.
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Then you have a systemic problem on your hands
once again. And the perverse thing about a bank
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run is that there need not be any fundamental
problems with the sector for one to start.
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Consider this.
Imagine that everyone else is
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withdrawing their funds. Generally speaking,
banks do not have enough
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liquidity to pay everyone at once.
I do not want to be the one left holding the bag,
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and so I too race to withdraw mine.
But that justifies everyone else’s
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decision to withdraw their funds.
And thus, the cycle begins anew.
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It is a self-reinforcing behavior,
which again gives the Kremlin all
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the reason in the world to stay silent
about this alternative funding strategy.
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To repeat: governments can take
measures to mitigate such a problem,
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and Russia is no different.
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They certainly are going to
try to insure those deposits,
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just as the FDIC does in the United States.
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By doing so, depositors will eventually get their
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money from the government even
if the bank cannot pay them.
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They can place caps on withdrawals
to limit the total money removed.
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They can raise interest rates to
incentivize people to not touch their funds—
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though Russia is maxing out
on that strategy already.
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But all of those distort the banking sector in
some other way and thus are not free solutions.
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As a final note, this system creates
a further problem with ending the war.
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A risky loan can still pay off
for the bank as long as the
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business stays afloat. However, once the war ends,
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all of those manufacturers are
going to go out of business.
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At that point, the Kremlin will have to
step in to rescue the banking sector.
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Looking at the flow of payments,
it is not an impossible problem—
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it will essentially be cutting out
the middleman of the payment system.
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But it also does not make the post-war
situation look very good for Moscow.
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Add that to the list of difficult but not
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impossible peacetime challenges
that we have covered before.
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Meanwhile, what is an impossible
problem is how to decide between
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two excellent books about the war. I guess
you will just have to read both of them.
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Check the video description for
more information about those two.
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And if you enjoyed this video, please
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like, share, and subscribe, and I
will see you next time. Take care.
