The Price Of Failure

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If you think you had a tough week last week--and who didn't, with the Dow off 482 points?--you might perk up after a chat with Stanley Druckenmiller. A six-footer with deep-set eyes and a grin that creeps sideways across his face like a stock ticker, he has been labeled the world's brightest currency trader, an Einstein of the pits. Druckenmiller's paycheck is signed by George Soros, for whom he oversees $22 billion. Uh, make that a little less. Last week Druckenmiller watched helplessly as the Russian debt market vaporized into fiscal neutrinos, taking the last of $2 billion of Soros' Russia-invested money into hyperspace. Fessing up on CNBC, the crestfallen trader blinked at the camera and softly explained that the Moscow meltdown had turned "a very good year into a mediocre one."

The $2 billion markdown is small change compared with the devastation that the Russian collapse inflicted on central banks and stock markets in other countries, even those seemingly out of harm's way. Venezuelans stumbled through a valiant, painful defense of their bond market, Brazilians scrambled to save their currency, and Americans watched a nervous stock market plummet, pause and plummet again. Russia's slide was a reminder that every investment is at heart a bet on the future. Last week the future looked awful.

The chaos started two weeks ago, when the Yeltsin government effectively devalued the Russian ruble by about 34%. To some folks, this limited devaluation appeared to be a wise move that might strengthen Russia's exhausted central bank. Since the Russian economy had been quietly improving last year, a small relaxation of the currency could have helped boost demand for Russian exports, which would have pushed the recovery along. From an Economics 101 perspective, the approach was a sensible--if risky--way to help Russia through a tough patch. Even Soros argued that a small devaluation, linked with other measures, was prudent.

The problem was that Russia's banking system was a mess, which meant the well-intentioned devaluation quickly turned into a free-for-all. The particular dilemma was that Russia's banks were loaded down with foreign-currency debt, which meant that a decrease in the value of the ruble made repayment more expensive. This made the temptation to default almost irresistible--especially since Russian banks are generally seen as checkbooks for a new class of oligarchs. As the soon to be departed Russian government heads huddled in Moscow to figure a way out of this crisis and to consider how to deal with the devaluation, the halls of their offices began to fill with very worried, very powerful bankers. They had come to deliver a lethal message: they would no longer pay their debts.