Pawns On the Chessboard of Europe

STOCKHOLM - For years since the fall of the Berlin Wall, Europe and Asia watchers have urged me to invest in Russia. Surely, the Slavik talent, finally unleashed by the defeat of the czars and the collapse of communism, is primed to take its place as a world economic power, those proponents argue.

Because these countries are so similar, a review of geographic and population highlights is helpful.

And what of these countries economic strength and opportunities for strife?

Since prosperity eases a lot of political problems, can these states export their way to wealth? Let's look at what they need to import and what they sell each other and their trading partners -- Russia, Poland, Germany, Finland, and Sweden.

Not only do these four countries have tiny GDPs, but all four have a balance-of-payments problem. The goods they do export are not of high quality and cannot command a premium on the world market.

Belarus

For centuries Byelorussia was fought over, devastated, and partitioned among Russia, Poland, Lithuania, and in World Wars I and II, Germany. Geographically, Belarus is little more than a landlocked great plain. Over the centuries, it's been a large field over which the great armies of Europe have marched, a buffer zone between Europe and Russia. After seven miserable decades as a Soviet republic, the newly named Belarus declared its independence in August 1991.

Chiefly Slavic, Belarus has retained closer political ties to Russia than any of the other former Soviet republics, and both Yeltsin and its President Alexander Lukashenka, have made a career of promising to link up again. Indeed, in December 1998, the two signed agreements intended to provide greater political, economic, and social integration while preserving both states' sovereignty.

This agreement suits both politicians’ political agendas. To ensure he remains in power, Lukashenka wants to bring back the "glory years" of the "prosperity" of the Soviet Union, and Yeltsin wants to show he's starting to rebuild the Soviet empire. No sooner than Yeltsin appoints a new prime minister than he hotfoots it to Belarus to promise that yes, the two are going to hook up again. Actually, both politicians are grandstanding, something successful politicians do well. Hooking up with Belarus will suit Yeltsin's plans big time. He can say this addition requires a new constitution, maybe even a special meeting of the Duma, before there can be another Russian election, and the result will be a silent political coup.

As soon as we entered Belarus, I knew trouble was afoot. On the toll road coming in, the collector refused to take the Belarusian ruble, his own country's currency, and insisted we pay in a hard currency like the dollar, mark, etc.

Any time a government's minions refuse to accept its own currency you know the country's in economic distress. The last place this happened to us was Yugoslavia in February.

Today Belarus is falling apart even fastere than Russia, which is saying a lot. While it exports food to its neighbors and military aircraft to Africa, it has little else to sell, meaning it has a difficult time obtaining hard currency, with which it could purchase the sorts of goods -- industrial, electronic, and telephonic -- to make its people's lives less harsh and more productive.

Belarus is in no better shape politically. President Lukashenka has been in office since July 1994. New elections were promised several years ago but like the thug he is, Lukashenka has refused to order them, clinging to power by hook or crook. Instead of a modern democracy, the bleak political climate in Belarus reminds me all too much of the USSR in Stalin's days. The former head of the central bank, Tamara Vinnikova, and a former interior minister, Yury Zakharenko, disappeared earlier this year. On Sept. 16, Viktar Hanchar, deputy speaker of the parliament disbanded by Lukashenka in 1996, also disappeared. Except for the Economist, little of these disappearances has been noticed in the Western or the Russian press.

To "save" the economy, Lukashenka’s been printing money like mad. Whereas in Russia the ruble is worth about 26 to a dollar, the Belarus ruble has fallen to about 500,000 to the dollar and plummets by the day. The treasury is preparing to issue 5-million ruble notes, as mere 1-million notes are no longer large enough for everyday transactions. In a useless attempt to keep the rapidly rising inflation in check, the government placed strict price controls on food and consumer products, which naturally resulted in food shortages. Long lines for dairy products, chicken, and pork became common.

Just how bad -- and fast -- has the currency collapsed?

One Sunday as we barreled along the Belarus autobahn, we saw a sign that said "40 kph, Workmen Ahead." Being Sunday and with no workmen in sight, we continued on at 101 kph. A Belarus policeman flagged us down. He demanded 5,000,000 rubles on the spot. Then, as if the sum seemed gigantic, he recanted, asking only 1,000,000 or about $2.00. He had not yet comprehended how much his own currency had collapsed.

Indeed, when you buy even a hamburger at a kiosk, you're told the price is three 'units' which then have to be multiplied by an exchange rate that goes up every day. You'd think such an unstable market would accept dollars, as Cuba's does, but Belarus is too far away from the US. A babushka selling onions or bread doesn't trust such strange money, plus Belarus has made it illegal.

Having little to sell to Russians or anybody else, Belarus really has offered only a geographical and political buffer zone, serving over the centuries as little more than a weak pawn. And since geography is destiny, there's no reason to believe anything else is in store for this small country any time soon.

Sadly, Belarus has seen little structural reform since 1995, when Lukashenka launched the country on the path of something called 'market socialism,' an oxymoron if there ever was one. In 1997, in an effort to slow the devaluation of the Belarusian ruble, Lukashenka introduced a complex system of legal buying and selling of hard currencies. But you can't have it both ways -- control a market and have it work freely. Naturally, the new system proved unworkable and resulted in galloping devaluation.

Now his only hope is to rejoin Russia, where he hopes the army will keep him in power and the Russian ruble will provide a stable currency or at least one more stable than his. All that's in it for the Russians is renewed imperialistic glory, but that may be enough to make it happen since that so-called glory would bolster Moscow's politicians.

If it does take place, it won't last. The people we met in Belarus have no interest in Moscow. They are struggling for survival and blame many of their present problems on Moscow and the USSR.

Lithuania

To our surprise, we learned the beautiful church across from our hotel in Vilnius was a grain warehouse under the Russian occupation as well as occupations by the Germans, Swedes and Poles before them. The building was a perfect example of occupation mentality -- suppress the local culture while taking supplies for its own needs.

Like Belarus, Lithuania has been a crossroads for armies marching back and forth across Europe. But instead of printing money to escape the nation's economic troubles. Lithuania's leaders borrowed heavily, which produced a different kind of problem. Like its Baltic neighbors, Lithuania has little to sell the West.

Reducing its high deficit is Lithuania's immediate economic challenge, one I don't see it solving easily. Its major neighbors keep deprecating their currencies making it difficult, if not impossible, for Lithuania to compete. Lithuania depends on Russian oil, giving the Russians yet another hold on their small neighbor, a hold Lithuanian leaders are discovering during current refinery negotiations.

Eighty-seven percent of Lithuania's electric power is furnished by a Chernobyl-type plant called Ignalina. In addition to contamination of soil and ground water with petroleum products and chemicals at military bases, the nuclear plant at Ignalina leaks, making Lithuania's future even bleaker.

In the U.S., we don't normally think of Russia as part of the European continent, but that part west of the Urals certainly is. To my surprise, a spot right outside Vilna, Lithuania is Europe's geographical center. Thus, these four states are smack dab in the heart of geographic Europe, and if they were more disciplined they might turn themselves into another Switzerland. However, each of their populations is declining, with more deaths than births. That, combined with a brain drain, is another part of the recipe for their economies to falter.

To my further surprise, I found Lithuania has an American president, a former EPA bureaucrat in his seventies who has come back to run his country -- a politician who was everybody's second choice.

 Latvia

Like most of the other small European nations, Latvia often has been invaded by its neighbors, Sweden, Poland, Germany, and Russia. Today, Russians comprise 30 percent of the population and Latvians 57 percent, a mix prime for intense ethnic strife.

Naturally the Russians want to continue to speak Russian, which was made the official language when Stalin took over in the 1940s. The Latvians are having no more of it. With the upper hand now, they insist the state language be Lettish. Indeed, wherever we went, our Russian translator wasn't liked, only for his nationality, not his personality. In fact, he needed a visa, while we Americans needed no papers. The Latvians are getting back at a people who for decades made them present papers at every turn.

They too, have a 'foreign' president -- a Canadian-Latvian, a woman, and a retired professor, in her sixties. So fast and unexpected was her election that she had to send back to Canada for her clothes so she could stay and govern. To her credit, she has refused to sign a law saying only Latvian can be spoken in Latvia. Certainly a Canadian ought to be an expert in understanding the mischief linguistic restrictions can cause!

A depressing and unhealthy haze smothers Latvia, a result of some deposits of shale oil, peat, and phosphorus being burned. The country has some ship building, but nothing spectacular.

Pipelines cross Latvia, transporting hydrocarbons from Lithuania to Russia, but this is not enough to produce much income. Latvia, too, has the same over-valued currency as Lithuania. I kept finding myself paying developed country prices in what is clearly a developing country. Something has to give.

Estonia

Estonia is in the best economic position of all the Baltic countries. While Lithuania and Latvia have little to sell the outside world and don’t run a tight ship, Estonia has not only run a government surplus, but also has more to sell. Its relative success has put it on a fast track to be the first to join the European Union, a goal all these countries share.

Estonian, the language, is similar to Finnish. The Finns see the Estonians as their cousins, and often visit here. As are Latvia and Lithuania, Estonia is participating in the NATO military radar system called Air Sovereignty and Operations Center (ASOC) which is to ring Russia with spy stations. Still NATO isn't likely to admit any of these small countries into its defense network because they'd have to be supported by the rest of NATO, like Greece.

In and out of Swedish and Russian control over the centuries, this tiny state was re-incorporated into the USSR after the German occupation ended in World War II. Independence came with the collapse of the USSR in 1991; the last Russian troops left in 1994. Estonia then became free to develop economic and political ties with Western Europe. Again, the number of ethnic Russians, 28 percent of the population, remains a concern of Moscow.

But some bright spots shine. Estonia has reformed its markets, maintained disciplined fiscal and monetary politics, and liberalized its trade. Not surprisingly, its GDP grew, but then dropped under the weight of the Russian and Asian financial crisis. The country began talking to the EU about joining and to its credit, its banks are consolidating and strengthening. Its national telephone system has been restructured, and the government hopes to join the WTO.

If any of the four makes it, Estonia will be the one, but it's still a tiny country with an over-valued currency. Only about a million Estonians live in Estonia. The EU may well take it in since it won't be a great burden, but what then? Is Estonia being consumed by yet another larger neighbor just as it has been since the beginning of time?

All Together Now

All four states are desperately eager to become part of Europe and to convert their feeble currencies into real money.

However, it won't happen for a long time. They badly need more people, but they have aging populations, low birth rates, high emigration, and high divorce rates. Unfortunately, their long-term fate is the same as their long-term history: to be absorbed by some larger and stronger entity. Geography and their people's background mean they will continue to be, in one fashion or another, supported by someone else. Their centuries-old legacy of being pawns isn't likely to change. Mongolia is a good analogy, always a poor cousin to China and Russia, because its geography blocks it from establishing itself as an independent power.

These four countries have severe economic problems that cannot easily be cured. If they worked at it, really worked at it, they might turn themselves into the Singapore of Europe, but such discipline and dedication is not likely to occur and would take many years. After all, Switzerland, too, was once overrun constantly by its neighbors, but it disciplined itself and put a stop to it. So it's possible, just not likely. That two of the four need North Americans as presidents highlights the region's political instability, suggesting the countries had no better candidates. Even the head of the Lithuanian military is a retired American army colonel.

After the Berlin wall fell, Latvia, Estonia, and Lithuania each established a public stock market. Naturally the companies listed were local banks, industries, and transportation companies, infrastructure companies that are always the first to go onto developing countries' stock markets. Sometimes these can be terrific investments, as the infrastructure usually grows as fast as the country develops, but since these countries haven't done all that well, these shares aren't likely to do well either. We just could not find the strong, vibrant economies which are necessary for surging capital markets.

Not that it's impossible to do well here. We met Benita, 31, a tall slender brunette with a 5-year-old child. Her husband had died two or three years ago, and she's now the Mercedes dealer for all of Latvia. Next to the Canadian president, Benita is the most famous woman in the country. She also owns a major perfume company, the Chanel distributorship, and has expanded both businesses successfully.

Catty rumors say Benita fired all the beautiful women on taking over the Mercedes dealership; we certainly saw enough good-looking female employees there to tell us those rumors are only mischievous gossip.

Whether the success story of a single-parent, a woman or both, Benita has remained a major player despite the 1998 economic collapse. Although Benita is proof one can prosper here, I don't see how any outsider can manage it. Those who do are going to be on the ground fighting with the wind slashing against their face, not a passive overseas investor.

In tootling around this part of the world we came across a particularly odd political anomaly -- Kaliningrad. Formerly the Prussian city and province of Konigsberg, and now separated from Germany, Kaliningrad sits atop Poland and is both a province of Russia and a city. Its most famous son is Imanuel Kant, the philosopher who was born, lived, and died here.

Today Kaliningrad is not only (still) Russian but unattached by land to Russia. Just as Alaska is not part of the contiguous United States, Kaliningrad is not part of contiguous Russia. Lithuania stands between the two. Kaliningrad has turned itself into the Uruguay of the Baltics, the home of serious smugglers. Many Russians have built huge houses here with their new prosperity. I suspect they know this will not always be a part of Russia so they feel somewhat secure building on the shores of the Baltic. Whichever neighbor absorbs Kaliningrad will be better than Moscow.

When Stalin took Konigsberg over, he sent the German people back to Germany, but we saw many signs the Germans are returning to this formerly Prussian state. At the same time, many Russians remain, as the Russian troops in Lithuania all were sent here, not back to Russia, in 1993 and 1994. As a result, Lithuania has the smallest Russian problem of any of the three Baltic states, but it also has the Russian army at its doorstep if Moscow ever decides to use it.

Over the long haul, these four states face a difficult fight to remain independent. Prosperity is an even greater challenge. Those who urge me to get involved here in any way are flat wrong. I see little reason for optimism, even though these states are European and can now look west instead of east. Nor can I see a reason for any Westerner looking for a decent return from an accommodating economic climate to consider an investment.

Updates are available at www.jimrogers.com.

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