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Moderator (Maxim Bratersky, Professor, Department of World Politics, State University-Higher School of Economics): Let me welcome at the World Political Economy Club our esteemed colleague Professor Martin Gilman, the Director of the Centre for Advanced Studies at our University. You all know of course that Martin is one of the best experts in the world finance. For quite a long time he occupied a number of very serious positions in the International Monetary Fund. The subject of todays master class is as follows: Russia: The Belated G-8 Member. Please, Martin, the floor is yours.

Martin Gilman: Thank you very much Maxim and Im sorry that Im going to be speaking in English in front of this group since my wife tells me that my Russian is okay for our children, but not quite yet in a setting like this. What I would like to do briefly is to address three points with you this afternoon. Two of them I believe may be rather provocative or controversial, the first one however, I hope will just be more or less a statement of fact that we can all agree upon, because what I would like to cover is first of all just the background of the G-8 and Russias participation in the G-8. Then I would like to go on to the question of, and Ill explain why were talking about this in a second, then to go on to the question of Is the dollar losing its role as the key International Reserve Currency?. And then the third and also controversial point along with that second one would be Can the Russian ruble become an International Reserve Currency?. Im not necessarily saying replacing the US dollar, but just an International Reserve Currency.

Both of the later notions, the inevitable decline of the US dollar and the possibility of the Russian ruble becoming an International Reserve Currency are both controversial, and the reason Im raising these two later issues is because I start with the question about Russias membership in the G-8. And you might say, whats the connection between the Russian ruble as a possible International Reserve Currency and Russias membership in the G-8? And here I would like to stress my first point, which is that its important to remember where the G-8 came from.

I assume that many of you are familiar with the history of the G-5, Ill just summarize briefly that when Richard Nixon in August of 1971 suspended the Dollars convertibility into gold, closed the gold window basically, he in a sense terminated the international monetary system, as it was known until that time. Shortly after Nixons closing of the gold window, you then had the collapse of the Bretton Woods system in Jamaica, they couldnt revive it, and so you had the collapse of the whole system of fixed exchange rates. You had shortly thereafter the first OPEC success in raising the oil prices after the Yom Kippur War in 1973. You had the first enlargement of the European Union when Britain and Denmark and Ireland joined, and then in 1974, you had a major international recession in OECD countries and the combination of these events, for the traditional international institutions and the mechanisms for resolving international tensions among the Western powers were not adequate. The International Monetary Fund, the OECD, the Bank for International Settlements were not able to create a forum in which serious discussion that could resolve the problems could take place. So, you may remember, some of you at least, the famous meeting in the White House Library of August of 1973 involving the finance ministers of the United States, Britain, Germany and France, and thats how they come to be called the Library Group. They were then joined shortly thereafter by the Japanese and that was really the origin of the G-5.

And why these particular five countries? Well, very simply, and this is the key point here, these were the five countries whose currencies were at the time the key International Reserve Currencies. And how do we know? Well, because it was these five currencies at that time that constituted the basket of the only internationally created asset, which was the Standard Drawing Rights, the SDR, which was created by the International Monetary Fund. The Finance Ministers and the Central Bank Governors were invited to join some of their meetings of the G-5. These five countries in a sense were the managers of the international monetary system. Yes, of course, working through the International Monetary Fund, but behind them, these five major shareholders, it was their currencies. And so, if they could coordinate among themselves as they did at the Plaza Hotel in New York, and engineer adjustments to international imbalances, then it was felt that the world could continue to grow and the world economy could prosper.

Now, you may also remember the history here, that then it was felt that these five countries, working at the finance minister level needed political cover from their principals, so the heads of State were invited by Giscar dEstaing to the Château at Rambouillet in November of 1975, and that started the summit process. Im not going to go into a long history on the G-5, G-8 at this point, because of what happened, its fairly well known, and I know that Marina is organizing a conference on this subject in June in which I am sure this will be thoroughly digested of what the G-7, G-8 have and have not done.

Suffice it to say though, that the agenda of the G-5 broadened very quickly, partly because they found out that trying to control international monetary flows was much more difficult than they thought, but also because just getting these five heads of government together, was actually quite useful in an informal setting. But the only problem is that there was a lot of pressure from those that were excluded from the club to get in. So the Italians were very upset and got themselves invited, actually to join the initial meeting at Rambouillet the following year in 1977, the Canadians were invited because if the Italians were there, why wasnt Canada there. The Netherlands almost got in because they were the next one on the list and they were very upset that they didnt get in. Anyway, the compromise was then that the President of the European Commission would be kind of invited to represent the other Europeans.

And it more or less stayed at that level, however, just once again briefly to recall the dramatic changes after the fall of the Berlin Wall, there were steps made to include the Soviet Union in some kind of association with the G-7. I guess that George Bush Snr. actually had suggested in Munich in 1992 that the newly independent Russia should be made a member of the G-7, the others thought that was certainly premature. But the formula of G-7+1 continued, in fact, at every future summit where Yeltsin was invited, and in 1997 in Denver, it was actually Clinton called it the Summit of the 8, which was a rather awkward name, and then the following year in Birmingham, England, Russia formally joined the G-8.

However, important remembering the origins of this as effectively the club controlling the international monetary system and representing the major economic powers, that there was to many observers, to put it mildly, a contradiction. A contradiction between certain sympathy for recognizing that the new Russia had made a major step in peacefully, as far as the rest of the world was concerned, in peacefully ending the Cold War and taking major and mature steps to join the international community. And so there was a feeling that this should be recognized politically, and it was important to secure Russias participation in this framework, from a political point of view. But the contradiction of course was, that the Russian economy, I mean here you had a country that in say 1998 had a rate of inflation of 84%, the Ruble was depreciating rapidly, foreign exchange reserves had been basically depleted, the fiscal deficit was not under control, and in fact shortly thereafter, there were also these, I guess you would call them financial scandals, like the accusations at least of money laundering through the Bank of New York and events that I had to live through personally which was the accusation of the theft of the 4.8 billion dollar IMF credit in July 1998. But to read more about that you have to wait until my book comes out. The point though is that in finance ministries, in central banks of the G-7, Russias membership, to put it mildly, at best, tolerated.

So, the point here was that Russia was systematically excluded from all discussions in the G-7 financial side. Russians were not invited to ministers meetings, meetings of finance ministers and central bank governors, even during Russias G-8 presidency last year. And despite, kind of, some face saving steps vis-à-vis Mr. Kudrin, who everybody kind of likes and respects in the G-7 framework, Russia was not invited to participate in the G-7 financial ministers part. There was one meeting in Moscow, I guess in February 2008 (yes, he said 2008) that they let Kudrin chair but that was really more for lets say, atmospherics, than for substance. So, the fact is that you have this G-8, and I guess that the point that I would want to make today, kind of skipping ahead now, is that and hence the title of my talk, belatedly it seems that in fact Russia may be a very appropriate member of the G-8. In fact, in 2007 Russias economy has not only overtaken Italy, but during the course of this year will no doubt in terms of GDP and purchasing power overtake the economy of Canada. So, just from the point of view of GDP, it would already be bigger than two of the other G-8 countries. Well come to some of the other characteristics of the ruble and what the Russian economy would need to acquire to be taken seriously as an International Reserve Currency member of the G-8.

But let me go on to my next theme, which is, if there is going to be another International Reserve Currency, or several new International Reserve Currencies, then what happens to the US dollar? All right, lets remember what an International Reserve Currency is. Very simply, since we dont have the power point, an International Reserve Currency is simply a currency which is used outside of its own country. Its a currency which is used by foreigners, by non-residents, just like the dollar is held outside the United States. So, that the dollar is used outside the United States, obviously the euro now has taken over the traditional role of the Deutsch mark in that regard, the yen is used outside of Japan. And the question is, if the dollar plays by far the dominant role as the International Reserve Currency, is it possible that the dollars role might decline or change entirely? Again, this would be the subject for a whole talk about whats happening in terms of the global imbalances, the kind of the triple deficits of the United States, as some economists call them, the budget deficit, the external deficit and then what you might call the internal savings deficit. The fact is that households that are highly indebted. And in the traditional view of most economists this situation, these deficits are unsustainable. They are the result of very particular, very particular circumstances that the Chinese and the Japanese would rather accumulate reserves and let their currencies appreciate. The same is true of the ruble. The Central Bank of Russia now holds, as of the end of April, almost 370 billion US dollars in reserves. Most of those are in dollars. Is it a good financial investment for Russia? Probably not, although if you werent doing that, it would mean that the ruble would be much more appreciated than it currently is. What effect that would have on the competitiveness of Russian industry, both in terms of imports substitution and the export of non-commodities? It could be pretty drastic. And in fact, I have great admiration for the macro-economic policy of the Russian authorities because this extremely unusual situation is unlikely to endure for many years. Already in its three-year projections, the Central Bank of Russia is showing that by 2010 the current account surplus will be gone. Unless you think that oil and energy prices are going to continue to go up very rapidly, but basically if they stay at their current levels, or even drop a little bit, the nominal value of exports is unlikely to be increasing, but you have imports that are almost rising at almost 40% per year. When that happens, if that continues, then the current account deficit is rapidly going to be reduced. So it probably doesnt make sense to have Russia go through a serious bought of Dutch Disease and then have to deal with the consequences of an industrial landscape, which has been basically destroyed by the expensive ruble. The point that I would want to make though, is that if the dollar is challenged as the International Reserve Currency, what does it really mean? Well, it means that these deficits in the United States eventually are going to have to be unwound or rebalanced or that the United States for instance, last year was borrowing, in net terms, the equivalent of two thirds of the total savings of the rest of the world to finance its external deficit. Two thirds of the savings of the rest of the world, that is the surpluses of China, Japan, the oil producers, including Russia, was all being recycled to finance the United States at the tune of almost 3 billion dollars net, every working day, because there were net foreign purchases of US assets last year of about 860 billion dollars. Now can that continue at that pace? As I say, most economists think it is highly unlikely. They dont know when this is going to change, but it will. However, in saying this, two important to be perfectly honest two important points, one is about timing the other is about substance.

In terms of timing, at the final dinner at the World Economic Forum in Davos just over two years ago, back in February 2005, you had in this room in Davos some of the worlds most famous economists, people like Stanley Fisher and Jacob Frankel, Mike Mussa, etc. And the discussion was whats going to happen to the dollar this year, in 2005? And you know what they all said, every single one of them? The dollar is going to drop. What happened? A month later, in March 2005, the dollar started to appreciate and in fact, the dollar ended 2005 stronger than when it started the year. Okay, but we also now understand the reasons for that, because the Federal Reserve was raising interest rates, the European Central Bank was leaving interest rates unchanged and so the interest rate differential in favor of the dollar, meant that short term, kind of hot money was coming into America. Thats changing. In fact, Triche, the Head of the European Central Bank, today just announced, just signaled, the way Central bankers do this, that another rate increase in Europe would be very likely next month. So, in fact I guess I have an article thats going to be published in Vremya Novostei tomorrow that talks about the inevitable decline of the dollar is starting but with a caveat about timing.

The second point is about substance, which is that the dollars is going to drop, while the traditional view of the majority of economists in the world is not the only view. There is a school of thought, more in academic circles, but shared by some very enthusiastic investment bankers, like in Morgan Stanley, who say that we are in a new paradigm. The new paradigm is that the world is changed fundamentally and therefore the old economic theories dont apply anymore. The United States can continue to borrow because the United States has the broadest, deepest and most stable financial markets. The cost of transactions are so low, the rule of law so secure that everybody, Europeans, Russians, Chinese, other Asians, Latin Americans will all continue to buy US dollar denominated assets. And that there is really no serious risk, there may be some cyclical problems but the new paradigm says that this situation can continue for quite some time. As I said, that is a minority view and the fact is that, well, well find out. Ill leave that point, but just to say here to conclude on the dollar, that it would be rather strange if the dollar were to come under sustained pressure over a period of time and still maintain its status as an International Reserve Currency. Because if you think about an International Reserve Currency, in other words a currency that other people are willing to hold, other countries, you can think of a reserve currency as having exactly the same attributes or characteristics of a national money. And money, to all economists, money has three basic attributes. It should be a medium of exchange, you can actually use it to make payments, it should be a store of value, youre willing to hold it to, for the future, delayed consumption and it should be a unit of account so that you can denominate your balance sheet, your profit and loss statement, your bank statements in it. So you have unit of account, you have store of value and you have a medium of exchange or for transactions. Well, if the dollar comes under sustained pressure it could become very difficult for people, banks, individuals and central banks, governments to be willing to keep their reserves all in dollars which are losing value. Because of all the characteristics of a reserve currency, probably the key one is that investors, including governments, have got to feel that the money is secure. That its value will not depreciate significantly. I mean if you think about it, traditionally it was thought, well, you have to be a very large country and a very large trading nation for your currency to be an International Reserve Currency. Like Great Britain with the pound sterling was. However, think about Switzerland. Switzerland is not a major trading nation, its certainly a trader, but its not a major trading nation and very few transactions are denominated in Swiss franks. However, the Swiss frank is certainly an International Reserve Currency, despite that its a very small country, it has a very small capital market, or financial market, but the main thing the Swiss have is credibility. So thats holding investors, central banks, and individuals feel secure in holding Swiss franks. So that if the dollar does start, at the margin, were not talking about a major change over night, although some of the literature on International Reserve diversification talks about the possibility of what is called a tipping point in English, and I have no idea how you would say tipping point in Russian, because its a fairly new term even in America. But tipping point means its the old analogy of the straw that breaks the camels back or the last drop that finally burst the dam, its that some, everything goes along fine and then suddenly one little extra marginal change and it all comes crumbling down. Why the pound sterling, even when Britain was no longer the major economic power in the first half of the twentieth century, was still maintained a major reserve currency role, at least into the 1960s? In fact, there is one of the authors that I was looking at was suggesting that was because Britain was the worlds largest creditor country. But thats not the situation of the United Stated today, the United States, , is the largest borrower, the largest debtor country in the world, so that if you view on the United States, the US dollar starts to change, it could be a tipping point. If people start to head for the exit, it could happen rather quickly. A different writer, thinking in a more politic economy context, was suggesting that the history of the next couple of decades, at least the politic economy of the next couple of decades that well be living through, will be about how the United States will use its residual political power to try to maintain its Reserve Currency status and try to force countries that hold dollars to prevent them from cashing them in. And its a very interesting hypothesis that perhaps can be explored at another time.

So let me go to my final point, which is about the possibilities of the Russian ruble. And here I can be relatively succinct in saying that if you think about it ten years ago, the idea that we could even be talking about the possibility of the Russian ruble becoming an International Reserve Currency would seem, frankly, crazy. In fact, a year ago, well last June, at the St. Petersburg Economic Forum when First Deputy Prime Minister Medvedev talked about the need to diversify away from the dollar and the possibility that the ruble could take on characteristics of a Reserve Currency, it seemed certainly premature at best. However, you may remember that a couple of weeks after Medvedevs speech at the Petersburg Economic Forum, on July 1, 2006, the final currency controls on the ruble were removed so that the Russian ruble became a totally convertible currency. The combination of total ruble convertibility that, of course as I understand talking to bankers, as well as individuals, no one really believes it, but the ruble is totally convertible, and there are indications that following that move to total convertibility that things are moving fairly quickly. There was a new securities law in 2003 that in conjunction with the removal of the final control of exchange controls meant that ruble denominated securities can be issued abroad and indeed, both the EBRD, the German KFW, the Nordic Investment Bank have all issued kind of Euro Rubles. In other words, they have issued ruble denominated securities outside of Russia for sale to non-residents. Youve got the fact that you now have a benchmark in the Moscow market called Mosprime, like Libor in London. Oleg Vyugin and his colleagues have made tremendous strides in trying to increase the transparencies, the idea of Central Registry, so that the Russian capital market starts to acquire characteristics that you see in what you would consider major Western or international financial markets. You start to see some of these characteristics and the question is really whether the ruble having achieved technically the basis for internationalization, whether there will be a demand on the part of non-residence to use rubles for their transactions. Now, there are ways that this can be, in a way, jump started, or manufactured. You may recall that also about a year ago, or maybe a little over a year ago, I guess in the 2006 speech to the Federal Assembly, President Putin talked about trading Urals crude in an oil exchange denominated in rubles. I think many of you know the history behind that, which was really that it was viewed that Urals crude was too heavily discounted vis-à-vis Brent and other crudes, like Dubai light, because of the high sulfur content of the Urals crude, but since this is being established by basically a London brokerage company that this discount was too big and so that if you forced trading in Urals crude on a Russian Exchange in rubles that you would get a smaller discount and the true value of the Urals crude would come out, it wouldnt be so heavily discounted. In fact, that story has now been, lets say, surpassed because now what theyre doing in Tatarstan is building scrubbers to get rid of the sulfur so to get rid of the need for a heavy discount. And so this oil exchange in rubles hasnt really started. And maybe its not really necessary to try to, through public policy, to try to force the use of the ruble. After all if you look at the use of other international currency, say like the Swiss frank, it wasnt through any government actions, it was simply because there was a view that the capital markets were stable, were secure and so the real question about the future of the ruble and whether it will become an International Reserve Currency depends, in my mind, on three things.

First, what happens to the role of the dollar? In other words, does the decline of the dollar, or confidence in the dollar, or lack of confidence in the dollar, create a scope or margin for other International Reserve Currencies? The second is, well what happens to, what are the alternatives, the ruble is one, what about the Chinese yuan? What about at the Indian rupee, the other members of the BRIC? Well, there is some thought that may be two or three decades from now that, if China is a very different country, the Chinese yuan may become an important International Reserve Currency. I guess my point would be that relative to, relative to the China and India right now that the Russian ruble is probably better placed, at least in the medium term, as an International Reserve Currency and that there could be, if the dollars role declines, there could be emerging a role for several currencies, perhaps regional currencies, to play a greater role and I would just conclude on this note that in the end I think it really depends on political and economic stability in Russia. If over the next few years, if the transition to the new Presidency, if economic policy stays as stable and as strong as it has been, then there is a very good basis for the ruble to become in greater demand for international transactions and for other central banks to want to hold some rubles in their reserves.

Anyway, I think Ill stop at that point and ask if there are some questions and comments.

Bratersky: Martin, thank you very much. Actually it was one of the most interesting opinions weve heard. You have said so many provocative and interesting things that almost everybody would like to say something about that.

Dmitry Suslov (Center for Comprehensive International and European Studies of the State University-Higher School of Economics): Frankly speaking I didnt find very much provocative in your presentation because it sounds so convincing, so clear, that it may provoke some questions, but its not provocative in terms of ordinance, its neat. And my question relates to the fundamental condition for any currency to become an International Reserve. There are, broadly, two economic factors: first, economic trust and second, political trust. And this component of political trust when we are speaking about the ruble is something that raises big question mark. As for the economy we are on the verge of another major crisis a course of which is looming. How do you relate your weight of political trust and economic trust in this situation and from that perspective, combination of characteristic of Russian economy and are there short to medium term prospects for Russian position in terms of political trust, and how it effects your assessment of the prospective of the ruble?

Bratersky: Martin, how do you prefer, to take all the questions and answer or

Gilman: No, one at a time, if you dont mind.

I think its a very good question. An answer may be in two parts. One is the kind of easy answer is that it depends I think on large part upon the international political context at the time. And I think that thats important because its always a question of what is the alternative to a particular Reserve Currency. If, imagine that the whole, just imagine abstractly that the whole world were dominated by, lets say, not very nice political regimes, dictatorships. There would still probably be some currency that would be used as a store of value in international transactions, but it would be within that political international, political context, so it partly depends on the kind of political context thats likely to develop, not necessarily the one that we have today, but the one that may exist a few years from now. And I made a reference earlier to the fact that if I and other more traditional economists are correct and that the dollars dominance in the international system is challenged, the United States is unlikely to accept this change without reacting and that those kinds of reactions could be politically significant, you know, in the same way that Americans unilateral action in Iraq had a very disturbing consequence for the whole international system. So when trying to imagine how Russias political evolution will effect the desirability of the Russian currency as an international store of value, you have to think, well, in what context, and to be perfectly honest, I guess I would have to leave it as more of a question mark than to give an answer because, first of all, I dont really know how the international context is going to develop and I certainly wouldnt pretend to know how the Russian political system is going to develop. But I do think that its important, the question youre asking. Yes, it does make a difference.

But the second part of the answer is that the juxtaposition or where politics and economics meet, they go very much jointly together. The reason I emphasize that: just imagine a hundred years ago, youre in 1907 and Britain is the dominant economic power, and the pound sterling is the International Reserve Currency. If a hundred years ago you would ask a London banker what do you think of the likelihood that the dollar will become a major International Reserve Currency? That banker would have looked at you like you were crazy. The dollar? The United States didnt even have the Federal Reserve System; it was only invented six years later in 1913. There was no Central Bank; the United States had just come out of a period where 20 years earlier there was major defaults on government bonds that had been issued during the American Civil War. In the 1880s there was major default on these bonds, so this was a country that also experienced major default. There have been all kinds of corruption scandals with the American equivalent of oligarchs, the robber barons. So if you think about a hundred years ago, the likelihood that the US dollar would become the dominant international currency, much less just one of them, hard to imagine. So I just make those two points that, yes, politics and economics do go hand in hand together here and, but therefore it was not predetermined that the US dollar would become the dominant currency in the international system. Politics made it happen, politics in the sense that political stability in the United States, the further development of financial markets, security of contracts.

Voice: And two World wars.

Gilman: And two World wars in Europe. Listen, I hesitate in this environment to sound too Marxist, but, you know, I guess to some extent Im a little bit of an economic determinist when it comes to politics, but not exclusively. So I would agree that the American role in the twentieth century, the political role that the Americans played was a key factor but it was the political decisions influencing the economy and the combination of those two that created the dynamic American economy and the strong currency.

Question: You have mentioned that the Russian ruble is better positioned now than the Chinese and Indian currency. Can you please expand this and to make some comments considering that the Russian economic power is based mainly on export in oil, gas and etc. Thank you.

Gilman: Good question. Maybe I would just start with the point that I think it unlikely that the ruble will start to play a role as a Reserve Currency until at least two things happen on the economic side, financial side. One is that inflation comes down to more normal European, American levels, in other words, where the currency is viewed as stable. I doubt that youre going to have much faith in the Russian ruble if inflation were to be at 7, 8, 9% a year. But if inflation comes down to European levels, then I think that that would be a prerequisite, a precondition for internationalization of the ruble. I guess the second part of it would be that the Russian ruble has got to be relatively free, a free float. See one of the problems right now with the ruble and this in the way of answering your question about the Indian Rupee and the Chinese yuan, is that, in even more in their cases, these are controlled currencies. Now, as I said earlier the Russian ruble is no longer subject to capital or exchange controls, but its controlled in the sense that the exchange rate itself is manipulated by the Central Bank of Russia and as I also said earlier, Im glad that it does because I think its important to avoid the symptoms of Dutch Disease in Russia, when the current account is likely to go into deficit sometime in the next few years anyway. I would hope, as the current account deficit is reduced and therefore the inflows of foreign money are reduced, that the Central Bank will then not need to intervene to try to keep the ruble down and I think that that would be an important precondition. And I think thats likely to happen and so my point about China and India is, I think, thats much more likely to happen in Russia sooner than it ever will in China or India because, and thats the link to oil and gas, because oil and gas production, unless in some major new fields are suddenly developed, and we know in the industry these things dont happen very quickly, that Russias export role is not likely to continue to increase significantly. Youre already a major exporter but just to maintain the level of exports and satisfy an increasingly energy hungry domestic economy will require a large increase in production. But, and then with the large increase in imports, Russia is likely to have a much more balanced balance of payments in the future. Whereas China, until is absorbs, Im not a China expert, but until it absorbs the rural population, its likely to keep the currency significantly undervalued to be able to absorb the excess labor into export, export related industry. So the Chinese not only manipulate the currency by buying reserves, but they also maintain exchange controls and youve got that combined with, at least in my view, a political system which is much more opaque than what you have in Russia, but thats a whole another subject. India is the worlds largest democracy, yes, India has progressed enormously in recent years, but in India while theres the potential that, particularly if the Chinese stumble, sometime in the next decade, if the Chinese start to stumble in their economic or political development, it could very well be that India will be the big major economy of the latter part of the twenty-first century. And the Indian rupee could very well become major International Reserve Currency, but the Indians will also have to get rid of their remaining capital controls, they will have to significantly improve their macro-economic management. Right now, India is running a major current account deficit. In fact, the current account deficit as a percentage of GDP in India is higher than in the United States. It could take a long time for the Indian economy and political system to mature that international investors would want to hold rupees. But I think as a longer-term proposition, its very, very likely that a world will no longer be so dominated by the Western Europeans and Americans.

Andrey (?): My question is also continuing this line of oil and gas. Basically I would like to hear your view of a possibility of selling Urals in dollars because for me it sounds simply irrelevant for both Western partners and Russians to trade Urals in dollars. First of all, because structurally the demand for Urals doesnt grow as fast as the demand for the high-octane oil. Second, Russian actors want to earn dollars first and they do not want really to bypass this tradition in earning dollars. So, what is your opinion on this? Thank you.

Gilman: Well, I dont disagree with you, I think that, its a little bit of a curiosity that one would talk about trying to set up an exchange to trade any commodity in local currency, when, by definition, the commodity is internationally traded. But that being said I can understand the initial motivation of the Russian Ministry of Fuel and Energy and Mr. Grefs ministry. But there really was this suspicion that the discount established in London on Urals blend, Urals relative to Brent, was too large to justify such a gap simply based on the sulfur content of the Tartarstan oil. But it was a bit of a curiosity that this step was taken to do that. So its normal that the international commodities, the basic metals groups, textiles, agricultural commodities are traded in relatively few, very liquid currencies that are internationally available. And one of the reasons is because the trading volumes in any of these commodities is very large and so therefore the market require a huge amount of liquidity and so the banks and the brokerages which are involved in those markets have got to have access to very large amounts of liquidity, either borrowed, bought on margin, from their own resources and the transactions cost in using those currencies got to be very low and therefore there are. Of course, most of the commodities are traded in and quoted now in dollars, there are also commodities which are more regionally quoted, say in yen, theres not very much in euros right now, but there is still, for traditional reasons, some quotes in sterling. But it doesnt mean that thats going to be true ten, fifteen, thirty years from now. Its very likely in fact, that as the major consumption of commodities switches from North America and Western Europe towards China and India and other Asian countries there will be good, sound economic and financial reasons for perhaps quoting the commodities in some other currency. In fact, one of the articles that I was reading lately was talking about well, given the fact that Russian commodities might be sold increasingly to an Asian market that you could bypass London altogether and create a Euro-Asian commodities market. It could still be in dollars, it could be in rupees, it could be in rubles, but there could be a diversion of major international trading away from the traditional international financial centers, now thats a whole another subject of international financial centers. Its a little bit like reserve currencies, from a different point of view. But I would agree with you that, it would seem somewhat artificial just to, to try to make that change by fiat or by orders.

Sergey Oznobischev (President, Institute for Strategic Assessments): Thank you very much, Mr. Gillman. Your presentation was extremely interesting, but there are a lot of ifs. You were saying that if this happen then there would have been so and so, and I understand this extremely professional approach but, still, upon your great and long experience can you tell us more definitely what is your assessment on two things. Say, economic stability in Russia, how deep and how long it will last. And China, how stable is it economically and what do you think about political stability in China? Thank you.

Gilman: Well the first question is relatively easy for me to answer without any buts and ifs. I believe that as long as you have people like Alexey Kudrin and Sergey Ignatiev running Russian macro-economic policy, there is no risk to the Russian economy. And the reason I say that, and its also people like Oleg Vyugin and others. I say that theres really no risk to the Russian economy because these are people who lived through the experience of the 98 financial crisis. They were in positions of responsibility during the 1998 financial crisis, they were both first deputy finance ministers and the experience of living through that crisis and managing the economic, the very swift economic decline that took place, I think has guaranteed them against any kind of relaxation of policies for life. And so I would say that as long as this President, or a future President keep them in their jobs, or jobs similar to what theyre doing now, and/or other people who have lived through the 98 crisis, I dont think theres any danger to Russian economic policy at all. Where I see some concern is later when a new generation who have, but this is true in all countries, when theres a generational change in Russia, when people who really dont remember, at least first hand, the 1998 crisis, when they take over, depending on circumstances at the time, theres obviously a risk that things could become extremely difficult. I would just recall the example of Africa, one doesnt like to talk about it too much, but if you think about the early 1970s after the Yom Kippur War when OPEC was successful in raising oil prices, the Western reaction was to avoid serious depression, or at least major recessions, and of course it was combined with the 1974 recession in the OECD countries, the reaction of Western central banks was to print money, okay? The printing presses, there was a lot of liquidity injected into Western economies and it created higher inflation that went up and up and up until Paul Volker was named as the Head of the Federal Reserve in 1979. The reason I mention this is because this huge injecting of liquidity into the international economy created a boom for all commodities, not just oil, cut it created a boom for coffee, cocoa, copper, all the metal groups, all the agricultural commodities. Well, the Africans were producing cocoa, coffee, copper, like in Zambia, cotton, etc. Their prices went very high, there were countries who had recently become independent and so they were living off of an export boom, the balance of payments were soaring and so government expenditure was increasing very rapidly. Well, what happened when Paul Volker came in and put on the brakes to monetary expansion in the United States? I just want to make a point: if people have not lived through the experience of what its like to go thorough an economic downturn, theres always a possibility of reliving what the Africans went through which is when you, when commodity prices drop, you think, oh, its just temporary, its not going to last, so well just borrow, well go to the banks, well borrow but the prices dont go up again and then you get into serious default debt situations. So it happened to many African countries, it happened in Latin America, it happened in East Asia, so yes, it can happen here, but I think this is, I believe, beyond the generation of those who are currently running economic policy in Russia.

And on China, I really dont know whats going to happen.

Question: Mr. Gillman, thank you very much for your lucid presentation. Especially point two and point three. I mean on the point one the overview was not as analytical as I expected, frankly, and the G-8 is a very specific creature and we started discussing it with you on the margins so, Im not going to dwell upon it because its too late, but my question has to do with this, how would you qualify Russias evolving role as a donor country? You know, it has to do with its status within the G-8, it has to do with its relationship with the IMF and the World Bank and you know how the relationship has evolved in recent years. Russias situation is changing now as far as its membership in the UN is concerned. Russia is already becoming a donor within several UN agencies. Russia, I guess, has already become a donor vis-à-vis the IMF, I mean the special rights, so what is your guess, what is your expectation, should Russia shift from the current situation in the UN? Its called a country with economy in transition, at times Russia is called developing country, in the IMF and World Bank language its middle income country, something like that, so how do you assess this trend?

Voice: As for Russian stance in international arena, my guess is that politics actually influence more the economics and I would like to invite you to come back to the first question of Mr. Oznobischev, and I would like to put it once again in a, I would say, tougher way. Do you believe it is possible for ruble to advance as International Reserve Currency within a confrontational international climate? I dont believe so. And secondly, do you see any possibility for Russia to be excluded from G-8? Having in mind the last developments in France, where Mr. Sarkozy has been elected, PM replacement in Britain and in the United States the expected coming of democrats and so on. Could this political factor influence the Russian stance, the Russian economics in international arena? Thank you.

Voice: Hello, Im Sergey, World Economics and International Affairs Faculty, second course. I would like to ask you as an expert on Russian long-term economic policy. You know that the receipts of oil and gas are tending to decline and youve said this, but on the other hand our government introduces some very ambitious programs, for example, national projects and these projects, these social responsibilities, are permanent, we wont be able to give up them and on the other hand we understand that we need them, that this modernization maybe is inevitable and we need it. So whats your point of view?

Gilman: Okay. I like these questions. Maybe Ill just take them a little bit in a different order in answering them if you dont mind, kind of going from the more technical to the more general. In this case I would take the last question first, which is the longer-term development. As you said, its normal that Russia, as it becomes a richer country should be able to afford a serious social safety net. I remember when I started working here in 1993 on IMF missions, the greatest shock that I had was that no one was interested in any kind of social safety net, because they said that after all these years of social experimentation weve had enough. So I think its normal, but given the oil and gas situation, youre right, that youre increasing permanently higher expenditure with uncertain revenue flows in the future. The only solution to that, speaking as an economist, is that youve got to make your economy more productive. Youve got to be able to produce higher levels of output per unit of capital, per unit of labor, people have got to become more productive which means there has got to be more targeted capital investment, much better education. I mean human capital is probably the most valuable asset that Russia has, I think even more than gas and oil, which gives you an enormous advantage over most other countries, including China and India. But, its an asset that requires constant improvement to increase productivity, so thats the longer-term solution there.

Maybe I would come back to the question about Russias changing role in the international system, and its a very big question and this role is certainly changing very rapidly. I was the IMF representative to the Paris Club when Russia both was rescheduling its debt and also when Russia finally paid back its Paris Club debt. This was a major event that Russia paid back its creditors, paid back prematurely the IMF, paid back all of its debts, that Russia not only was no longer a borrower from the International Monetary Fund but became what was called a designated currency. In other words, a creditor to the IMF, so that now the Russian authorities lend the IMF rubles, and the IMF uses those rubles internationally to finance other countries that have balance of payments needs. The fact that, as you mentioned, Russia is becoming a major donor, Russia has written off or forgiven much of the Soviet era claims on developing countries, particularly the poorest, what are called the heavily indebted poor countries (HIPC). Since this has happened in a very short period of time I must say that I have enormous sympathy for the officials in the Finance ministry and in other parts of the government, which have had to shift, mentally, their gears from being a debtor country and being hounded, being under pressure from creditors ten years ago to being sought after as a major donor and financier of the rest of the world. Is that something desirable? Thats really a politically question, because there are costs involved in becoming a major donor and creditor to the rest of the world.

Bratersky: Martin, in Russia its not a typical thing to talk of money and say its a problematic thing but the way you did it was quite rewarding. So Martin, if we had, if I am correct at the English grammar, if we had more people like you (laughter), we would have better knowledge of how we proceed today. (More laughter).

Gilman: Thank you Maxim. You actually used a subjunctive, it was very good, and many Americans do not actually use a subjunctive anymore. But could I come back, because I was really saving the one question to the end because its in some ways the most interesting. I certainly agree that if theres a very confrontational international atmosphere, that its going to be very difficult for the ruble to acquire any major international role. Its going to be difficult for the Russian economy, its going to be difficult for foreign direct investment in Russia, its going to be difficult for Russia and Russian investment in Europe and elsewhere.

Which leads to the question of, youve got this, youve got this enormous dichotomy, because here we are, and this was the theme in fact of the talk today, youve got, on the one hand Russia, which finally, ten years later, can claim to be a normal G-8 member from the economic point of view, at a time when theres a lot of talk in the other G-7 countries that on the political side, Russia should be forced out. And I have to say that Im very worried about it.

Because, I see it in my own country, in the United States, that criticizing Russia is basically costless, theres no domestic, political cost for criticizing Russia in the United States. Theres no big Russian constituency. Theres a Polish constituency, theres yea, Russian immigrants in the United States, not a cohesive group, so they have no lobby, so its not like the Jewish lobby, its not like the Polish lobby, in political terms its very cheap, it doesnt cost a politician anything to criticize Russia and if youre a Democrat and Im a Democrat, but I mean if you are a Democrat and running for office in the United States, and you want to show that youre strong on the US role in the world and because they dont really appreciate how much the world has changed and how much Russia has changed, its an easy target to score some political points to say that well be tough on Russia. I mean this ridiculous debate in the US Congress on Jackson-Vanick, its, in my mind, almost surreal at this point in 2007, it doesnt make any sense, unless you look at it in strictly US domestic political terms. Now, in France, Germany, maybe Britain under Gordon Brown, there may also be a tendency to say, well, look at Russia, you know, theyre dangerous, its a facile political trick, but a dangerous one and I would not know what to advise your authorities, I mean obviously having a little bit of a thick skin is probably useful. Not being too sensitive about this and understanding domestic politics.

Suslov: Thank you for a nice suggestion of how to integrate Russia fully into G-8, youre quite right that Russia is a semi-member still and doesnt participate in the financial issues which are key for the G-8, so your suggestion is really, and we are pleased to hear that suggestion, to integrate fully, to make Russia a full member of G-8. However, I have to make three short comments.

The first one is about the G-8 as such and Russias priorities in the G-8. You were quite right, the priorities have broadened; now it is not only about finance, it is about many issues, not even economic issues, but political issues like governance and even security issues. In this context I think that the Russian priorities, or the Russian chairmanship in the G-8 were quite smart, because Russia pushed forward energy in which it could play some part. In my understanding of the logic of Russian chairmanship, Russia was trying to preside over the long and fundamental process of energy transformation of global energy markets where the Western parts, the Western countries and Western companies are losing political control and where political control goes to developing countries, like Russia, to energy production countries. It would be not quiet logical, I think from a political point of view, for Russia to broaden its agenda too much to pursue financial aspects to strongly, but it would be logical for Russia to continue to push forward this sphere in which Russia is number one in the G-8 and will be number one rather than jumping into the train where Russia would be a vague number 5 or 4.

The second comment relates to the role of the US dollar. Of course, the dollar is declining, the dollar rate is declining, however, I think if we make a link between the pure financial sector and the real economy sector the picture wont be so gloomy. Im not very confident with the rate of the US dollar which is going to decline. By the way, I agree the US has the huge deficit, but if we compare the deficits with the size of the US GDP, it will be quite okay. And I think in the process, if we extrapolate the rise of the deficit and the rise of the US GDP, it will be quite okay. Im quiet confident with the US economy, with the US productivity, with the US rise of GDP, with the innovative nature of the US economy which is better than, for instance, Europe, and many others, well, the US is the most advanced economy in the developed world. If we compare that to the Asian countries, for instance, about 90% of the capitalization of China belongs to American companies. So you should not forget about that factor. So, what Im claiming, in order to make a reserve currency you have to trust. The key word is trust and you have to trust the economy, not only the pure financial sector, but to trust the economy. I do trust, to the American economy. I do not trust so much to the Chinese economy, to the Japanese economy and to the economy of the European Union. Why did the Bretton Woods system emerge? Because at that time, the US was about half of the worlds GDP, and today of course, the US is not half of the worlds GDP, but the American real economy is still far, far advanced against other world economies and in this sense I would not be that pessimistic about the role of the US dollar in international exchanges. I think it will be slowly, slowly, slowly decline but without any crucial disasters.

And point number three, very briefly, about Russia. I am not that confident with the Russian economy, sorry. And Im not that confident with the Russia financial situation, which is quite okay in the near-term prospects, but if you look at the middle and longer-term prospect, I think the situation might change. Even in energy, you see the Russian energy sector is highly underinvested. Russia, even now, has difficulties with maintaining its current obligations in terms of oil and gas export, thats why we buy much gas from Turkmenistan and essential Asian countries and re-sell it to Western Europe. If this situation does not change and Im pessimist about that, currently I do not see the prospects for change. There is much talk in the Kremlin and in the government, but lack of action in the right direction. So if the situation does not change, I think Russian economy will be tackled by troubles. Thank you.

Bratersky: Dmitry, thank you. So, why dont we end at this moment? I think weve had very productive discussion. Martin, thank you very much once again for the most interesting presentation. You are always welcome at our Club.

Gilman: Thank you.

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