Suharto as model for Russia's coming financial collapse.

The financial world has seen this before. 

Political scientists have studied the political consequences of financial crises. In my 2009 book on the Asian financial crisis, I wrote about what happened to Indonesian dictator Suharto when it became clear that Indonesia’s banks were insolvent and the currency was in free-fall. Suharto’s struggles in 1998 suggest that Putin may face real economic difficulties in the coming days.

Putin’s options for how to address this problem are limited, as were Suharto’s. His choices boil down to the following: print lots of money on demand to cover all withdrawals; raise interest rates really high; or implement currency controls of some sort.

The first option generates inflation. It also does not really help to address the core problem: High inflation will give people with rubles an incentive to convert those rubles into dollars, gold or something else with a more stable value. That would push the value of the ruble even lower.

The second option seeks to keep money in banks (and rubles in Russia) by offering much more attractive returns for people holding ruble savings. But this is unattractive for many other reasons. With luck, it may eliminate inflation, but it may also put a sharp halt on spending and investment within Russia. It may avoid financial crisis, at the cost of a full-blown recession.

The third option would seem to be the most attractive. Indeed, this is an option that Prime Minister Mahathir Mohamad followed during Malaysia’s economic crisis in 1998. But it was very unpopular among Malaysia’s most wealthy elites, who were no longer able to move their savings and investments across borders. Moreover, in Russia today, such controls would have to be paired with controls on bank withdrawals to shore up the domestic financial system itself. Russia’s central bank is proclaiming that its financial system is liquid precisely to avoid having to do this.

It is hard to see how Russia’s domestic financial turmoil will end. The next 24 hours will be some of the most grimly interesting financial politics that Russia has seen since its two most recent financial crises, one of which (in 1998) ultimately paved the way for Putin’s rise to power.

In the meantime, however, Ukraine’s supporters in the international community may be thinking about how to leverage the threat of Russia’s financial collapse to their benefit. Giving oligarchs an exit option might provide the leverage they want to restrain Putin’s aggressive and destructive international behavior, by showing him its domestic consequences.