What the Russian Revolution Can Teach Us About Bond Bubbles

missed that one. I mean, I don't think you should feel bad per se that you did it alone without me, because you know, it's sort of occasionally I'll do one solo, you do one solo, we pick up for each other. But I do like that topic a lot, and so yes, I wish I had been part of it. Well. As my personal gift to you, we are going to do a sort of Redux episode. We're not talking about defaults

or sovereign debt restructurings in general. We're going to talk about one very very specific instance of a debt default. In fact, it's probably one of the most famous of all time. It's certainly one of the biggest. In fact, depending on your definition of debt defaults and how you actually measure it, it is the biggest one of all time?

Do you know what it is? No, So I was just gonna say, this is really embarrassing to me because I know which one we're doing, And if someone had said, what is the biggest sovereign debt default of all time? You say, oh, this is the most famous one. I don't even know if this one would have occurred to me. So I'm kind of embarrassed by the fact that I apparently didn't even know in advance what the most famous of the category was. Yeah, I think most people would

probably you'd say Argentina, wouldn't you. I think you say, are Yeah, I might have said Russia in the late nineties. Oh yeah, okay, well that's closer. It is. It's Russia, but it's Russia in the early nineteen hundreds. So it's the famous uh nineteen eighteen repudiation of Russian debt once

the Russian Revolution happened. And it's a really interesting moment in time in international finance because it touches on all these themes that you and I like to talk about one of them is bubbles, right, Russia issued an incredible amount of debt in the run up to nineteen eighteen, loads of people bought it, and then suddenly the whole thing collapsed. But the other really interesting idea here is the sort of notion of a safe asset that suddenly

becomes not so safe. There's a moment in time when Russian sovereign debt was considered you know, really really pristine, almost like US treasuries today. And the other big theme has to be the politicization of it, or the ideology behind debt. And that's something that you and I have touched on at one point or another, in fact, maybe most recently with modern monetary theory. I'm I'm very excited about this for all of the reasons you laid out. So who are we talking to? So today's Odd Lots

guest is Hassan Malik. He is the author of Bankers and Bolsheviks, International Finance and the Russian Revolution, and he is also an emerging markets hedge fund analysts. So, Hassan, thank you so much for coming on. Thanks guys, thanks for having me. So this book was a really, really great read. I'm just wondering why did you decide to

focus on this particular episode of international finance. It goes back to my days working at an investment bank in Moscow and really living in the center of the Russian capital. I was walking around every day and struck by the degree to which banks from before the revolution are present in the built environment in the city center, be it the Lubyanka which is the former headquarters of the KGB, be its old bran bank branches that are repurposed as

modern retail or office space. And really, when I was in graduate school and studying financial history, what really struck me as the degree to which this financial past of Russia was largely unremarked in the histories that we we have of the of of that time period. Yeah, Tracy lead in with, oh, this is the most famous debt

default of all time. So I'm glad that there's at least some people who have, you know, forgotten about this period who I imagine, like me, this episode would not have been top of mind when thinking about debt default. But before we get to the default, obviously, what was it about Russia at the time that caused so much money to pour into their and for their government bonds to be seen as you know, a relative safe haven asset. So Russia was in many ways the emerging market boom

story of the time. The Russian government was actively tapping the international bond market to build up gold reserves so that it could go on to the goal standard, and also to help finance and industrialization drive, led principally by the railroad industry. It really was, in many ways, not unlike China today, both a massive player in the emerging markets markets finance story, as well as a geopolitically speaking, a great power at the center of European and indeed

global power politics. Right. So you mentioned the geopolitical aspect of all of this. Talk to us about who exactly was buying the debt that Russia was selling, because you know, obviously it's an emerging market play, lots of people want a piece of that. But you talk a lot about the political dimension of the foreign investors who were basically

funding the Russian government at this point. Right. So, basically what was happening at the time was Germany was rising, and this was a story that was complicating the European balance of power in diplomatic and geopolitical terms. Now, at the time, France had the highest savings rate in Europe, and France was threatened by a rising Germany, which had had fought a war with in the late nineteenth century.

Russia in in similar Vein was eyeing what was happening in Germany with some concern in various circles of the Russian government. And so this is really what under scored uh not only a diplomatic but a financial alliance between the Russian and French governments. And ultimately what this led to was a huge amount of retail money moving into Russian bonds that were perceived at the time to be

very safe, investment grade assets. And so that's in some ways one of the big contrasts with the present day emerging markets boom, insofar as it was really French individual savers and then over time their counterparts in Britain and elsewhere in the West, that we're investing in Russian government and corporate securities over the course of the late nineteenth and early twentieth centuries. I'm something that I'm interested in is the idea of government debt just or just this

idea of safe haven assets. It always kind of feels modern to me. And I think about the U. S Treasury market, and there's all kinds of very good reasons why we price everything or so many bonds, whether it's a foreign debt or private credit markets, there's a spread to US treasuries and that's a common way to sort of measure the perceived risky nous of any other asset class.

When did this concept of safe haven assets emerge? And you know, thinking back to retail investors in the early part of the twentieth century, when did these ideas like start to form about what was safe asset and how much part of one's portfolio one might want to allocate to them. Well, it's it's a great question, and it's fundamental to kind of this this story of the Russian

and other emerging markets booms. I suppose it goes back to the first times people started thinking about investing outside their own home markets. And in that sense, as emerging markets deepened in the late nineteenth and early twentieth centuries, a hierarchy began to form of which markets were perceived as riskier versus those which were perceived as closer to home, both physically and in terms of a risk profile. And in that sense, Russia was very much seen as a

quote unquote European great power country. It wasn't seen as some semi colonial domain out in Asia or Africa. It was seen very close both physically and in terms of the risk profile to core European economies such as Britain, France or Germany. So there are all these characters in your book that are strategically fueling what's eventually going to

become a Russian debt bubble. On the Russia side, there's a relatively well known finance minister, and then there are all these i guess lesser known bankers from London and Paris who are sort of deployed to start making these investments. Talk to us about the actual people, you call them gatekeepers,

the gatekeepers to Russian debt investment. Yeah. So this is a concept that I borrowed from a scholar and sovereign debt by the name of Mark Flandre, and I think he very aptly described the way capital markets worked, both in the past and the present. That is, even though you have debtors and and savers, the process of channeling those flows of capital happens, of course through the banks and the bankers and the and the investment managers that are present both in current markets as well as in

the past. And that to me was a very interesting nexus of people because they were ultimately individuals with all the biases and the prejudices and the imperfections of of of individual human beings. And that's really why I wrote this as a as a history book, as a story of people trying to feel their way through very difficult and imperfect markets at at really a pivotal moment in

world history. So one of the things that comes out, for example, is the degree to which national biases and patriotism at a time of geopolitical tension and ultimately war, fed through to investment decision making, and how this wasn't just a story of clinical analyzes of of balance sheets or of macroeconomic accounts, but rather also of humans trying to think their way through very confusing and fuzzy market environments.

You talk about these gatekeepers, but what specifically were the decisions that they made that we're so pivotal in getting flow funds to Russia. So there were several um In one instance in early nineteen o six, when the Russian government was really on the ropes financially aking, and on the verge of having to suspend convertibility of of rubles into gold, the bankers stepped in with a very key loan, which at the time was the largest ever recorded in history.

And this really happens because of two bankers, in particular in Paris and London respectively, who had cultivated relations with the Russian finance Ministry, which the ministry levered to great effects in nine six. Another example is the opening of the first branch of what is now City Group in Russia in early nineteen seventeen, the very year of the revolution.

And again reading the correspondence that the bank had internally, it's very evident that this was a decision that came to a large part because of the man on the ground and his feelings about Russia and its prospects, not only long term, but because of a sense of almost responsibility on the part of the US towards Russia and on the part of an American businessman to words his

Russian counterparts at a time of war. Yeah, I love that anecdote because it's just amazing to think that City was opening a branch on the eve of the Russian Revolution. On that note, you know, you just mentioned the loan that basically saved Russia in nineteen o five or nineteen o six. Why did investors hold on for so long and why didn't they push the Czarist government for more reform after they extended that loan. It's a great question,

and it's got a very complicated dynamic behind it. In one sense, there were conflicting arguments both in favor of and against extending loans. One argument, of course, is it's an anti democratic government and supporting them will just encourage bad behavior, and other arguments counter to that was that actually engagement is how one pushed development and ultimately a

better direction in Russian policymaking. The other story, of course here, and this is where the gatekeepers were not just bankers but also ministry officials in Russia itself, was that the Russian government became very adept at leveraging the exposure that foreign governments and banks had to the Russian economy to

great effects. So by the time the nineteen o six loan came up for discussion, the French had already invested so significantly into Russia that it really becomes a question of whether it was the creditors that had more power

over the debtor or vice versa. I love Tracy's question about why didn't the investors in these bonds pushed more reform because it seems like such a modern question, And I'm imagining like all the same reform talk we hear about in E M these days, about like like with the I M F. Yeah, and you know, cutting pension obligations and privatizing state owned power plants and all these

things that constitute reform these days. What does that mean though, Like what were the things that would have constituted reform in the early nine hundred, Like, what was it? What were the equivalent of those things? Well, it's funny you you make the comparison with today, because in many ways, a lot of the discussion points were very similar. The same things that we think about as problematic in Russia today and that are often ascribed to the Soviet past.

Things like corruption, bureaucracy, rule of law issues were things that investors at the time we're talking about in Russia

with respect to the Czaris regime. And indeed, at the time, as we got closer to nineteen seventeen, there was such a frustration in foreign investment circles with Bizarus regime on exactly these points, rule of law, bureaucracy, inefficient policy making, that there was almost a pining for some sort of change, and in some circles even an attraction towards the revolutionaries

because they promised something different. So in in the build up to nineteen seventeen, nine eighteen, what were the signs that trouble was brewing in the Russian debt market? What were the signs that the bubble was going to burst? Well, it's interesting because when the war breaks out in nineteen fourteen, there's actually kind of a rally in the Russian economy and financial markets, and this is partly because it kicked off an industrial boom because of wartime production increases and whatnot.

And so really the first couple of years of the war, you see the spreads the that is, the yields on Russian government bonds relative to the the investment grade benchmark, which was British treasuries at the time, shrink to multi year and even multi decade lows in just weeks and months before the the wheel really came off in Russia. And eventually what you started to see worth indicators in

the real economies start to turn over. If you look at the primary market data from when the Russian government was issuing new bonds into the market despite their attempts at financial repression, you start to see more onerous terms that the debt markets are inflicting on the on the Russian government. But really, until very very quite late in the game, bond market participants weren't really showing signs of alarm.

In fact, one of the things that I was shocked by was that even after the moment of default, when the yields explode, they explode quite dramatically, But when you compare them to relatively recent defaults that had happened in the time and in Argentina and Greece, the spreads hadn't been blown out to those levels, which indicated to me that investors still held out more hope in Russia even after the communists takeover than they had held out in

Greece and Argentina in the late nineteenth century. It is pretty remarkable I think back, you know, to some of

these more recent defaults. Like obviously, people, you know, we recognize the various political things that go on in these countries that precede the default, but there's a lot of focus still despite that, on sort of pure attempts to quantify debt sustainability within any of these countries, and they fixate on, you know, debt to GDP and primary surpluses or primary deficits or cyclically adjusted surpluses, these sort of attempts to, yeah, just put into numbers how sustainable a

country's debt is. And I'm always sort of skeptical about the value of those numbers in the modern situation. But I'm curious, like what the tensions and the lead up to the Russian default tells us about what indicators are actually of any use when trying to assess that the end game is NI. Yeah, that's that's a great question. I mean. One of the things that is different from in the past key versus today, is at the time, the macroeconomic accounts were both simpler and different in terms

of what investors would look at. So, for example, they didn't have access to statistics like GDP because they weren't really thought of in those terms back then. What they did look at, not unlike today, are things like export numbers and and a rough proxy for the current account position in a country. There was a consciousness about the level of debt, both in in absolute terms and in

relative terms. But I have to say the Russian finance ministry did a good number by shifting the the accounting around such that they created two different budgets, an ordinary quote unquote budget and extraordinary budget. And there was a lively debate in investment circles about which numbers investors should

be looking at. And also another complicating factor was at the time of war, investors that may have looked at hard nosed analyzes of raw numbers started also including in their thinking things like Russia's alliance with the West at the time of the war and the long term prospects of Russia, saying that even if right now things look rather stressed over the next hundred years, say, Russia still has a good future ahead of it, which brings to to mind the saying that every long term investment is

really a speculation gone bad. It's almost like an intangible asset for a company, right you're sort of factoring the sort of I guess, like aura around the country. Okay, So Hassan talked to us about the moment of debt repudiation. You know, we're building up to nineteen eighteen. What was the decision making process that went into, ultimately the decision to just repudiate all the debt that had been issued

under the Czar's government. So one of the things that really struck me when I was reading through all the archival material on this was the degree to which this was a a very complicated decision. There is a tendency in the histories that have come out on this period to just write this off as of course the Communists

came in and of course they defaulted. In reality, it was a very complicated decision because, yes, the communists hated the bankers and the financiers and the capitalists, but there were also some so there was, you know, this ideological backdrop to it, but there was also some very practical considerations. So one of the things was the revolutionaries basically had their support in urban centers, and many of them were really not representative of Russia as a whole, which was

still a very agrarian country. So coming in and talking about repudiating the debts was a very shrewd way of building support amongst the peasantry, which had run up mortgage debts in the process of land reform that had preceded the revolution. There's also the counter factual situation, which is that if the Bolshevik Revolution had not succeeded in late nineteen seventeen, and there's plenty of reason to argue that it could not have succeeded in a different scenario because

it was such a closely run thing. You have to ask yourself what would a different government have done. And one of the arguments that I make in the book is that if you look at the numbers, and if you look at the situation and how badly the Russian economy had started to perform by late nineteen seventeen, that even a more pro western, even a more liberal government at the time, would have had to default. And so it's, yes, partly a story of this ideology, but partly it's also

a story of practicality. And the other thing that I would say is that at the time that the Bolshicks came in, they really inherited the keys to essentially the largest country on Earth, and they were so taken up by the mechanics of running this large country that it took quite some time. Took a number of weeks before they were actually able to issue a decree repudiating the debts which also created its own levels of confusion and

and and uncertainty in the market. I know we talked about how big this was, but what are the numbers, like, how big was Russia, you know, in terms of the nominal amount of outstanding debt and how much of a slice of the credit markets or sovereign bond market were they at the time? Right, so they were the largest international debtor on a net basis on the eve of the war. The US was larger on a growth basis, but they would then re export a lot of the

capital elsewhere in frankly and emerging markets. If you look at default in roughly contemporary terms and sort of late sort of dollars, you're looking at at a default size

that can easily be put at three billion dollars. But really, given the size of Russia's economy and given the size of the debt at the time, if you translated to some other inflation metrics, you could easily make the argument that this was on the scale of a trillion dollar default, which underscores the gap between Russia nineteen eighteen and Greece

and Argentina more recently. What were then the knock on effect for the bag holders, so to speak, because even with Greece, which was, you know, so much smaller, there are all these fears about contagion throughout the entire financial system, and that the system couldn't handle an outright Greek default. What happened with the holders and who bore the brunt of it? Well, really, this is one of the tragic stories, is that a lot of the people that got hit

by this were ordinary savers in the West. I mean when I when I talked to my French colleagues in the markets today, many of them have stories of grandparents and great grandparents who are rendered destitute by the default. There's to this day internet for a of descendants of French bond holders that are still demanding restitution. There were a series of deals that were done, so in one deal that was consummated in six bondholders essentially got four

cents on the dollar um. None of this was inflation adjusted, and so really it was a story of individuals that lost out rather than the big institutions. And of course the biggest sufferers were people in Russia themselves, who entered this sort of monetary twilight zone of a collapsing real economy and hyper inflation. So, Hassan, what's the big takeaway

for emerging market debt? Can you say that all bonds are all debt is political or ideological or is that just exacerbated with this particular example in financial history because we're talking about you know, Bolsheviks versus capitalists. Basically, well, I think you're you hit the nail on the head and in talking about the political dimension, and that I think is the key takeaway is that all debt is

ultimately political. In fact, some historians have talked about debt markets being the crucible of of democracy in history really around the world. I think the lesson that I took away as as from an investment standpoint is that as important as the hard numbers analysis, thinking about balance of payments and GDP growth trajectories and whatnot, are the political dimension is so crucial, and in particular in emerging markets. Investing is not something that happens in a vacuum. It's

not just a clinical scientific process. When one is deploying capital in an emerging market, one is often taking, whether explicitly or implicitly, um sides in a in a political spectrum, and it's very important to be conscious of what those investments represent in that context. I'm afraid we're going to have to leave it there. But that was a really fascinating conversation that was Hasan Malik, the author of Bankers and Bolsheviks, thank you so much for coming on. Thank you,

thank you for having me. Yea so Joe. I really enjoyed that conversation, and I hope you did too. Oh, I love that conversation. The first thing we have to do is find one of these people that still holds some pre revolution Russian debt and do it a follow up episode on the ongoing legal fight to get remuneration that we have to do that. Hassan actually mentions this in the book, but there are internet forums for French holders of Russian debt still to this day. It's amazing.

There's gotta be like some lawyer involved with it. So let's let's try to book that person. Seriously. Yeah, But the reason I found that whole conversation so interesting is because, as I mentioned in the intro, it touches on a number of things that that you and I like to talk about, such as when bubbles burst and what the sort of turning point or warning signs are. But I think Hassan also does a really good job of talking about the sort of individual and personal decisions that go

into fueling, in this case, a sovereign debt bubble. Yeah, totally. I mean I think, you know, this is something that I know I talk about a lot, We've brought up a lot, but you know, we tend to just see all these assets as prices on the screen, you know, even with the debt today. But it's important to remember that it's like our actual human beings who have to make the decision to invest in something, or human being who has to go out and make the sales pitch.

And we still have that where we have you know, finance minister of some country will come to New York and meet with investors and explain why they should invest. And so understanding that a country is more than just the sum of its statistical parts, but that people actually have to go out and flog this stuff and make decisions and make deals is sort of an essential element

to this. And just in general, I always love when we talk about stories that remind us how things that we think of as sort of modern and finance really aren't that modern. So the idea of allocation to uh safe haven assets, or thinking about the spread of Russian debt to uh great a British debt at the time, just sort of all these things that feel extremely modern but have been around forever. Absolutely. So one other thing it really reminds you of is the sort of idea

of weaponizing debt as well. So, you know, bankers obviously go into a country and they're trying to make investments and make some money, but a lot of what went on with Russia took place among Russian politicians, who either use the debt to fund their various expansion plans, or in the case of the Bolsheviks, they basically weaponized debt by undermining the provisional government's attempts to sell it domestically. So they're all these sort of push and pull factors

that are just really really interesting. And I don't think you're right. We don't think about that enough. You know, in retrospect, it seems hard to believe, But I love that detail about how even after they came to power, there was still like a fair amount of confidence among the dead holders that that it would be okay, and

that spreads hadn't really winded that much. By historical standards, So you know, it seems absurd in retrospect that would have been the case, but it's just how you never know, and it was still worthwhile opening a city branch in Moscow. This has been another episode of the Odd Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway, and also like to send a thank you to our Bloomberg colleague who suggested we interview Hassan. That's

Gregor Stewart Hunter. You can follow him on Twitter at Gregor Hunter. And I'm Joe Why Isn't All? You can follow me on Twitter at the Stalwart, and you should definitely follow our guests on Twitter. Hassan Mollett, He's at h Malik h and be sure to follow our producers Toe for Foreheads He's at forehas T and Laura Carlson. She's at Laura M. Carlson. And don't forget to follow the Bloomberg head of podcast, Francesca Levy at Francesca Goodey. Thanks for listening.