At a ridiculous charade called the "St. Petersburg Economic Forum" over the weekend Goldman Sachs Group Inc. Chief Economist Jim "Mr. Bric" O'Neill stunned the host nation by laying Russia low.

O'Neill said: "Oil prices will definitely not do what they've done the past 10 years, and that's not going to be great news for Russia" because it "doesn't have the same advantages over the next decade' as China and India, which will benefit from larger workforces and greater productivity. Russia's gross domestic product will likely grow 3.3 percent a year from 2010 to 2015 and 2.9 percent a year during the following five years."

It would actually be even worse for Russia if oil prices did continue to rise just as they have over the past decade. If that happened, crude oil would become far to expensive for the market to support, and the market would be obliterated, as would the global economy. But left on it's own, with no help from world oil prices, the Russian economy is quite simply doomed to failure, because Vladimir Putin has done nothing to reform or improve it. Instead, just like his Soviet ancestors, he's chosen to devote Russia's resources to a new cold war with the hated United States, hoping to get it right this time. This was illustrated nicely over the weekend when Sberbank head German Gref stated that "Russia's lack of infrastructure, high income growth and shortage of skilled labor indicated the economy is already in the process of overheating." Medvedev's Economics Minister quickly denounced this statement. And demographics are not the only problem. The Russian workforce has always been far less efficient on a per capita basis than those in the West, and this is due not only to laziness but also to corruption. A senior Russian prosecutor claimed last week that corrupt government officials steal as much as $120 billion from the Russian budget each year. So much for Russian patriotism!

A story in the New York Times about the Forum began: "The lineup told it all about Russia’s importance today. There, on one stage, sat the leaders of BP, Royal Dutch Shell, Chevron, Exxon Mobil, ConocoPhillips, Total, Schlumberger and Dow Chemical, as well as the chairman of the Russian energy giant Gazprom and the president of the Russian oil company Lukoil." Indeed, it does tell all. And "all" is that Western oil companies have lots of ready cash due to the spike in oil prices, and they're looking for any means possible to expand capacity -- including even plonking some money down in the gambling casino known as the Russian economy. Not one of these views Russia as being a responsible economy or political system. Each one knows, like any casino gambler, that at any moment they can lose their entire investment to any manner of bizarre arbitrary political event. But the simply don't care. An economy that takes pride in generating investment of this kind is an economy not long for this world.

The Times also reports:

In a speech on Sunday that was keenly awaited by liberals in Russia’s business elite, a first deputy prime minister, Igor Shuvalov, listed the “many hurdles” on this path: an over-reliance on energy exports, a falling population, a lack of modern skills, an unhealthy way of life and a state apparatus with a tendency to meddle. “Russia should be a country that people want to live in,” Mr. Shuvalov said in remarks that seemed uncharacteristically self-deprecating for a top Russian official these days.

Mr. Shuvalov’s audience filled less than half of the hall. It had been packed on Saturday when the new president, Dmitri A. Medvedev, took subtle aim at the United States, suggesting that the world might be in the worst economic crisis since the Great Depression and that a revived Russia could offer solutions to problems that have underscored America’s shortcomings.

So let's see if we understand. Medvedev, a so-called liberal, uses his first major exposure to the West to attack it. And an actual liberal speaks to half-empty room. That pretty much sums up the value of what we've heard from the Russophile collaborators, that Russia now has new leadership we can make progress with, now doesn't it?

Russia isn’t immune from the business cycle, nor is it immune from the consequences of being governed by a clan of KGB spies with no more idea of economics or how to run a business than of brain surgery. Russians routinely claim that their nation can’t be governed as a democracy, but the example of India proves how ridiculous that claim really is. With nearly ten times as many people and a much more vibrant and diverse socioeconomic landscape, India nonetheless manages to maintain democracy and promote a vibrant economy — even stepping all over Russia in the area of computer science, where Russians supposedly excel. With its massive workforce and willingness to embrace pluralism and hard work, India is on track to rocket past Russia in terms of development and obliterate it as an economic competitor on the world stage.

And yet it is Russia, not India, that sits on the G-8. History will view this outrage — which not only slights India but encourages a crazed regime in Russia to maintain the malignant status quo — as one of the great errors of this century. Republican John McCain is precisely correct to call for Russia’s ouster and replacement by India. One can only hope he prevails in the fall, or that his rival Barack Obama will adopt the same policy.

The Moscow Times reports on the specter of inflation looming above Vladimir Putin's Russia:

It's early evening at the upscale Scandinavia restaurant, and its courtyard a few meters off Tverskaya Ulitsa is starting to fill up with customers.

Bustling servers bring out plates piled high with beef burgers, while diners indoors tuck into the pricier steaks and fish.

But behind the scenes, the Swedish restaurant is starting to feel the pinch.

"We haven't marked up the prices on some of the favorite dishes for six years," said Marina Averchenkova, the restaurant's public relations director. "But as long as we work a lot with imported products such as meat and wine, prices in Europe have put us in the situation where we have had to raise our prices."

With the state expecting inflation to top 15 percent in May, rising costs are forcing thousands of enterprises to hike prices even as they struggle to keep costs down.

Prime Minister Vladimir Putin says Russians can live with double-digit inflation for years, but it is a claim that may be put to the test if the government does not act urgently to contain soaring costs.

After eight years as president, Putin has passed on to Dmitry Medvedev stewardship of a booming economy. But it could prove to be a poisoned chalice. The country is facing sky-high inflation — driven by food prices — that threatens to undermine many of the Putin-era successes.

It is not a Russian phenomenon, of course. Across the globe, food costs have escalated on the back of years of underinvestment in agriculture, poor harvests and higher demand for grain from emerging economies, such as China. Tens of thousands of people across the world marched on May 1 against the rising cost of food and falling wages and pensions. In Russia, too, there are signs of growing unrest as inflation starts to bite.

Real inflation is believed to be higher than the official figures, and a recent poll indicated that about 67 percent of Russians identify inflation as the most urgent issue facing the country today.

Inflation rose for the first time in years in 2007, hitting 11.9 percent. The Economic Development Ministry remains hopeful that inflation will be contained at 10.5 percent this year, while economists say it could reach 11.5 percent to 14 percent. Even the figure of 14 percent is arguably optimistic, given that consumer prices have risen by 7.5 percent so far this year.

While prices have risen rapidly for some time now, particularly in higher-end segments of the economy, such as property, it was only last fall that the specter of inflation truly reared its head. With State Duma and presidential elections fast appearing, the authorities got down to work fast on growing food prices.

But their efforts — which included price caps on food and hikes on several import and export tariffs — have been widely derided by economists as populist and cosmetic. With a new government installed this month, hopes have been kindled that the bureaucrats will now start to take substantive steps to tackle inflation.

For sure, the government is taking inflation seriously. But officials have shown a deep-rooted disinclination to do anything that would alienate the population and threaten economic expansion.

Over the past 18 months, the country has seen a significant increase in money supply; the ruble has depreciated against the euro and the yen, and the government has pursued an aggressive spending program as it seeks to uphold economic growth, which has averaged at more than 7 percent in the last eight years.

It is no coincidence that inflation has struck in the middle of a debilitating international financial crisis that has rocked confidence in the global financial sector and brought the United States to the brink of recession.

Faced by the prospect of tougher lending conditions for banks and, in turn, their consumers, the Central Bank responded by printing more rubles — a decision that released liquidity into the system to shore up the financial sector but further fueled inflation.

But there is good news, too. Central Bank chief Sergei Ignatyev said Wednesday that the money supply has risen by a mere 0.7 percent in the year to April, compared with 11.2 percent over the same period last year, giving the Central Bank the confidence to predict slowing inflation over the rest of the year.

Nevertheless, there is no easy solution, and policymakers remain divided on how to tackle the problem, which has a real potential to undo the government's popularity.

Problem No. 1: Overheating Economy

Liberal members of government have warned repeatedly that the state's aggressive appetite for spending — on wages, infrastructure and other national projects — is fueling inflation.

"Real budgetary expenditure rose by 26 percent last year. It's too much and is greater than the total growth of our economy," Deputy Finance Minister Dmitry Pankin said at a forum this week. "This is influencing inflation."

It is a point made by his boss, Finance Minister Alexei Kudrin, time and time again. The keeper of the country's purse strings, Kudrin has navigated the country through eight years of prosperity and has fiercely opposed the government's tendency to support big-spending programs, which would ensure continued high growth. The government has also poured money into pensions and state sector salaries, further measures that fuel inflation.

With global growth under threat because of the financial crisis, Russia is selling itself to foreign investors as a place where the rewards are still rich. It is a silver lining that many believe the country can ill afford to ignore.

Indeed, economists are already predicting that Russia's growth will slow this year, although the effect will be much less than in the West, as banks see overseas funding dry up, resulting in fewer loans.

A split in the government on the pace of growth spilled into the public in April when Kudrin and Economic Development Minister Elvira Nabiullina squared off over whether the economy was overheating, the state at which growth becomes unsustainable. Kudrin's conclusion, that the economy is overheating, is shared by many economists.

"Inflation has really been able to run away … because the economy is simply growing too fast," said Rory MacFarquhar, chief economist and a managing director at Goldman Sachs.

He said the economic growth could be slowed to a more sustainable rate by reining in government spending and curbing credit growth.

But it appears that Kudrin is fighting a losing battle. Putin has outlined massive investment for transportation infrastructure this month, and more is to come. Oil, meanwhile, has soared to more than $135 per barrel, delivering windfall profits for the state.

"As long as the price of oil is so high, this is an argument that Kudrin cannot win," said Martin Gilman, former representative of the International Monetary Fund in Russia.

If inflation cannot be contained, however, the economy faces a very real risk of slowdown.

Problems will arise if inflation reaches 15 percent to 20 percent, the level at which it could start to dent investor confidence, said Oleg Vyugin, chairman of MDM Bank and the former head of the Federal Service for Financial Markets.

"If inflation is kept under current limits and it is manageable, then it is possible to avoid [damaging the economy]," Vyugin said. "But if businesses see that the government is not in a position to control inflation, then there will be serious damage."

Problem No. 2: Monopolies

The many monopolies have also been a major contributor to inflation by introducing aggressive price hikes for services.

The government regulates prices in a range of sectors, from electricity and gas to telecommunication services. The prices are usually set at the beginning of the year and in some sectors are subject to reforms and liberalization, which implies double-digit growth in prices in many cases.

"I think the government has to come up with a reasonable plan on how to regulate these tariffs taking into account the [current level of] inflation," Vyugin said.

In addition, anti-monopoly rules should be enforced against companies that try to regulate prices, he said.

Earlier this year, Putin sought to blame monopolies for high food prices, claiming that they effectively created a cartel to keep costs high. It is a theme he took up again in his candidacy speech for prime minister, calling for tougher implementation of the anti-monopoly policy.

But he also ruled out curbing the power of the country's natural monopolies, which include companies such as Gazprom and Transneft, arguing that the money for reform and upgrading of the country's infrastructure had to come from somewhere.

Solution No. 1: Appreciation

One way to bring down costs would be to allow the ruble to strengthen against other currencies, namely the euro and the dollar. For example, a liter of German orange juice that sells for 2 euros at home costs 74 rubles to import at the current exchange rate of about 37 rubles to the euro. But the same liter would cost only 72 rubles if the ruble appreciated to 36 to the euro.

This difference is potentially significant because food is a main driver of inflation in Russia and, Putin said recently, big Russian cities import up to 70 percent of their food.

The Central Bank tightly controls the ruble's exchange rate by buying and selling rubles to keep the ruble steady against major foreign currencies.

Until the government relinquishes control of the ruble, it will not be able to target inflation in the long-term, some economists said.

"They really do need to let go of the exchange rate," MacFarquhar said. "But there is a very deep-seated reluctance to get into the position of overvaluation after 1998," the year of the Russian financial crisis.

Vyugin said the Central Bank should have let go of the ruble months ago, given the money pouring into the economy in the shape of investment flows, on the one hand, and services and trading boosted by high oil prices on the other.

"When the economy experiences this kind of double inflow, the currency has to be appreciated," Vyugin said.

Many major investment houses are banking on exactly that. Goldman Sachs, Deutsche Bank and Merrill Lynch recently advised clients to buy rubles in anticipation of a policy change on the currency. They predicted that the currency could appreciate by as much as 4 percent in the next six months.

But to rein in inflation for good, the ruble would need to be appreciated by about 20 percent, some economists said. Politically, such a measure would face stiff opposition. Domestic exporters, which make up a powerful lobby in the government, benefit from a weaker ruble, which adds to their competitiveness abroad. On the flipside, domestic exporters, particularly in the oil industry, are also seeing inflation eat into their competitive advantage by increasing their costs.

The Central Bank is reluctant to appreciate the ruble. Fearing ruble speculation that would result in greater inflows of money, the bank said last year that it no longer considered the exchange rate policy to be an effective way to battle inflation.

In a speech to the Duma before his confirmation as prime minister early this month, Putin dismayed many economists by saying the government's anti-inflationary efforts would focus on boosting investment in agriculture, enterprise and curbing the power of monopolies. He made no mention of ruble appreciation and suggested that the state's goal was to return to single-digit inflation "within the next few years" — an indication that the prospect of ruble appreciation had been shelved.
A few weeks later, the Central Bank muddied the picture further, saying it would conduct daily interventions in the local forex market to head off speculators and make the exchange rate more flexible. In doing so, the bank introduces greater volatility into the market, making it harder for dealers to predict the bank's next move. It is also a first step toward an inflation-targeting regime.

But perhaps the biggest turnabout came this week, when the Central Bank indicated that it would start to broaden the ruble's traded range on a very gradual basis and might let the currency appreciate within months. Nevertheless, the bank has made clear its determination to pursue every other available avenue first.

Gilman, who teaches at Moscow's Higher School of Economics, argued that a drastic ruble appreciation was not the answer. "Firstly, it would be a signal to investors that the ruble is a safe one-way bet," he said. "But the longer-term problem is that Russia is not going to be running a current account surplus for very much longer. Do you want the ruble appreciating by 20 percent if Russia is going to be running [a] deficit? Is that really an intelligent policy?"

Solution No. 2: Monetary Tightening

The Central Bank's primary tool to fight inflation so far has been to tighten monetary policy by raising interest rates.

Interest rates have been hiked twice this year, and more increases are expected. But economists call this measure ineffective in a climate where the exchange rate is tightly managed. Higher interest rates combined with a weaker ruble would encourage investors to pour more money into Russia, negating the effect of such a move in the first place.

"Whenever you have interest rates hikes in a fixed exchange system, it generates capital inflows and monetary expansion rather than monetary contraction," said Vladimir Osokovsky, chief economist at UniCredit Aton. "For example, in the U.S., you cut interest rates and the dollar depreciates, [which leads to] monetary expansion. … Here, the monetary expansion and contraction is driven by capital inflows and outflows rather than the efforts of the Central Bank."

Raising interest rates will work only when the ruble is allowed to float freely, he said.

Of secondary importance is that consumer credit is a relatively nascent phenomenon in Russia, where only a minority of the population hold credit cards and mortgages account for a mere 2 percent of gross domestic product, compared with 40 to 50 percent in the West. While higher interest rates in the West would discourage spending, in Russia the effect of such a move is minimal.

"The Russian authorities are between a rock and a hard place," Gilman said. "There is very little that monetary policy can do to change this situation."

In the meantime, the Central Bank has announced that it will raise bank reserve requirements aggressively from July 1, forcing banks to set more money aside and thereby slow lending growth. Corporate lending has grown at a phenomenal rate, up by 70 percent in the first quarter alone, and banks have historically been able to capitalize on cheap interest rates abroad to lend at a higher cost at home.

Solution No. 3: A Coordinated Policy

The Central Bank is inching toward an inflation-targeting regime, but it has indicated that this will only start to happen toward the end of this year. Inflation targeting would effectively imply a relaxation of control over the exchange-rate mechanism and a tightening of control over capital inflows. "That's what the Central Bank is doing, and that is what they have to be doing from a macroeconomic viewpoint," said Osokovsky, of UniCredit.

But it is a long-term solution, and there would be a significant time lag before it would begin to have an impact on inflation.

The U.S. economy, meanwhile, is playing a significant role in fueling Russian inflation. With the ruble tied closely to the dollar, the key international reserve currency, Russia is effectively importing loose U.S. monetary policy. Since the beginning of the year, the U.S. Federal Exchange has desperately tried to inject dynamism into its flagging economy by dropping interest rates to just 2 percent. This has led to an avalanche of dollars into the economy, which feeds into countries such as Russia that tie their currencies to the dollar. It is unlikely that the Fed will tighten its monetary policy before the U.S. economy starts to pick up.

"U.S. monetary policy is very soft today, and a lot of funds in the Middle East and Asian countries have accumulated dollars and are now trying to spend them," Vyugin said. "It's a source of inflation."

There is little Russia can do to influence U.S. monetary policy, but Gilman suggested that Russia could build an informal coalition of countries to put pressure on the United States.

How that pressure would be applied is another matter entirely. Both Russia and Saudi Arabia have enormous dollar reserves and would be in the strongest position to threaten gently to sell off dollars and even diversify into other currencies.

The United States, however, would most likely think Russia was bluffing, Gilman said. If Russia then went ahead and sold a few billion dollars, the value of the dollar might plunge or U.S. bond prices might drop like a lead balloon, which would hurt the housing market as interest rates rise, he said.

"It is kind of like an atomic bomb. It is a very dangerous weapon," he said.

We wonder how many explicit warnings from prominent Western business publications like the Economist and the Wall Street Journal foreign investors will have to read before their interest in Russia dries up completely. It will certainly be quite difficult indeed to feel any sympathy for anyone foolish enough to put funds in to Russia when those funds slip down the rathole of nationalization. Forbes magazine reports:

Russia's former president Vladimir Putin has spent the last few years expanding the state's interest in industries ranging from diamonds to aviation. A new fund for the construction of much needed roads and bridges will be largely funded and overseen by the state. Rosoboronexport, the massive arms-trading entity owned by the government, bought the country's largest titanium concern and has taken control of a carmaker that has a joint venture with General Motors.

In Russia, entrepreneurs don't just compete with each other, they have to watch that the government isn't lurking around the corner, planning to seize the fruits of their hard work. Many large natural-resources companies are partly owned by the government--or at the very least, are vulnerable to the government's whims. But there is a separate sector, made up of fast-growing consumer products companies, telecoms, pharmaceuticals and others, that operates mostly without government interference.

The danger, though, is that this divided economy could result in stagnation. There is an ever-present fear that the government will arbitrarily choose another sector to sink its teeth into. As the newly minted president, Dmitry Medvedev, takes over from Putin, many in Russia are anxious about which way the economic and political winds are blowing.

This all has its roots not in the gangland crony capitalism of the 1990s, but in the latter years of communism. At the time of the Soviet Union's collapse in 1991, there were no companies as we understand them, and there was no competition. In the late 1980s, Mikhail Gorbachev introduced glasnost and perestroika to loosen controls on society and commerce. This move resulted in well-connected people (such as those who had been active in communist groups or the Party) forming semi-private companies, many of which were simply auxiliaries of state-owned companies and were used to siphon profits into their owners' pockets.

After 1991, state enterprises, which before had received orders concerning how much steel to produce, how much coke and iron to requisition and where to send products or materials, were abruptly left without customers, suppliers or distributors.

As these companies began to go bankrupt, a few canny people, such as Mikhail Fridman and Vladimir Potanin, saw opportunity. They seized the chance to buy shares of privatizing companies on the cheap. Some provided a market for Soviet-era factories' products or convinced company managers to turn control over to them. And some hired armed guards and simply took the companies with force.

These men and dozens of others (including government officials), benefited from the chaos that ensued in the early 1990s and quickly became the country's richest people.

By the mid-1990s, most of Russia's prime assets had been claimed and divvied up. Suddenly, the tycoons realized that to grow these businesses, they needed to introduce Western accounting practices, corporate governance and personnel management. And they also wanted to monetize the assets they had grabbed. Hello, capital markets.

Mikhail Khodorkovsky, who acquired oil giant Yukos from the state for just $350 million, restructured the company and began to comply with generally accepted accounting principles. He actively lobbied members of the Russian legislature and reportedly met with U.S. officials about a merger with an American oil major. In 2003, just as Yukos was becoming globally competitive, Khodorkovsky was arrested for tax evasion, money laundering and fraud. But perhaps his biggest sin: nearly embarrassing Russia by pursuing a partnership with a big foreign company. Khodorkovsky lingers in prison to this day.

As other large Russian companies flourish thanks to rising oil prices, their major shareholders--mostly tycoons who made a name for themselves in the early 1990s--have been mindful of Khodorkovsky's fate. The billionaire Russian shareholders of TNK-BP, a joint venture with BP (nyse: BP - news - people ), are said to be negotiating the sale of their share to Gazprom or Rosneft, both government-controlled concerns. Billionaires Vladimir Potanin and Mikhail Prokhorov recently split up their holdings in nickel and diamond companies, probably out of fear of government harassment.

Putin, angered by these men's seizure of state assets for nothing, has implemented his own plan--a new (old) economy, reminiscent of the Soviet era. Certain sectors, though benefiting financially from the capital markets, would be "nurtured" by government oversight. Other sectors could operate freely--at least for now.

The result? An economy divided into two classes: massive, government controlled natural-resources companies and scrappy private-sector consumer-focused ones.

The larger companies are aware that the state could--as with titanium--suddenly decide that a particular industry is "strategic" or remiss in obeying environmental rules or taxes. So, management often consults the Kremlin before pursuing a big merger. To hedge their political risk many, like the steel giant Mechel, list their shares in London and on the New York Stock Exchange.

Still, companies find themselves in the Kremlin's cross hairs. Russneft, founded by billionaire Mikhail Gutseriyev, had been one of Russia's few independent oil companies. But Gutseriyev, faced with a claim that he owed millions of dollars in back taxes, sold out to a Kremlin favorite, metals billionaire Oleg Deripaska--and fled the country.

Below this layer of massive, billionaire-controlled concerns are newer companies, focused on consumer goods, real estate, pharmaceuticals and technology. Some are publicly traded, while others have managed to access foreign and domestic private equity.

New York Stock Exchange-listed beverage maker Wimm-Bill-Dann Foods (nyse: WBD - news - people ), formed by entrepreneurs in the early 1990s (now billionaires) and led by former Coca-Cola (nyse: KO - news - people ) exec Tony Maher, is feverishly developing new products and cutting costs. Sergey Petrov, owner of Rolf, the country's largest chain of imported-car dealerships, has become a billionaire.

But it the fun-house world of Russian capitalism, Petrov doesn't need to fear his nominative competitors as much as he needs to fear his own government.