Unlike other European countries, Russia was a backward agricultural society at the beginning of the eighteenth century. But change was in the air or, rather, on the road. In 1697, a tall, handsome Russian carpenter came to work in a Dutch shipyard in Zaandam. After a long day of sweating labor, he would return to his small hut and read everything from history to medicine, and most of all, books about manufacturing, the kind of material read by today's MBAs.

This remarkable carpenter was none other than Peter the Great, the seventeen-year-old who ascended to the throne of the Russian Empire. Determined to transform his backward nation into a modern European power, he first toured Europe incognito. Upon returning to his country, he launched a series of reforms to westernize Russia. To speed up the process, he lured 900 artists, craftsmen, and technical experts to Russia. Later he also sent young Russians abroad to learn Western crafts and trades. He established hospitals, built schools, and published scientific books. In order to force his people to make a clean break from the past, he even imposed fines for wearing oriental dress or growing beards. These reforms greatly sped up Russia's modernization process. By the turn of the twentieth century, Russia had been transformed from a weak state into a powerful empire.

The vastness of Russia's territory (roughly equal in size to the sum of the United States and China) and the richness of its natural resources remain unmatched by any other country in the world to this day. At the turn of the twentieth century, however, it also enjoyed another great advantage -- its labor costs were significantly below those of industrialized nations. With a population more than 50 percent greater than that of the U.S., it was clearly the largest emerging market of its time.

The industrial revolution and foreign investment further accelerated Russian development. Industrial production doubled during the 1890s, and then doubled again during the first decade of the 1900s. Productivity growth was especially impressive compared with the standards of the time. With increasing use of new technology, such as steam engines, Russia achieved a 75 percent increase in production with only a 27 percent increase in the workforce during the 1897-1908 period. Russia had the best steel production technology in Europe in 1914. It also ran an enormous trade surplus, and inflation was almost nonexistent.

Foreign money poured into Russia, much of it coming from the European and American bankers arriving first-class on ocean liners or railways. Impressed by St. Petersburg's elegant European buildings, beautiful Russian women wearing French perfumes, and the high cultural sophistication represented by the Russian ballet, these investment professionals saw unlimited potential.

The Russians obligingly created mechanisms for investors to realize that potential. Over a half-dozen organized securities exchanges boomed in their country. The most active was located in St. Petersburg and boasted a list of 612 securities in 1912. Russian stocks were also listed on the foreign securities exchanges in London, Paris, and Berlin to facilitate trading. Out of the total 5.2 billion rubles of Russian stocks and bonds issued during the 1908-1913 period, roughly a third were sold to foreign investors.

Of the many securities issued, British and French investors especially loved Russian railroad gold bonds. These were secured by Russian government guarantees, payable in gold, and free of currency risk. The eager financiers included many of the most prominent banks in the world, such as Barings and Rothschild of England, Credit Lyonnais and Societé Generale of France, and CitiBank (then National City Bank) of the United States. These banks helped finance the construction of a vast railroad transportation network, including the famous 5,786 mile-long Trans-Siberia Railway. The Russian government also sought foreign joint venture partners for some of its state-owned enterprises. Competition among foreign companies to join these ventures was no less intense than the situation in East Asia today. In 1907, when the Russian armament giant, Putilov, sought outside capital and technology, the French company, Schneider, and the German company, Krupp, fought an extremely nasty seven-year battle to participate. The French company eventually won by enlisting the diplomatic support of its government and by a massive infusion of new capital from French banks.

For a while in the early 1900s, everything seemed to be going well in Russia. Unfortunately, this prosperity was built on an active volcano. The country was led by the willful, autocratic Czar, Nicholas II. Disturbed by Japanese expansion in the Far East, he plunged his ill-prepared country into a disastrous Russo-Japanese war. Badly defeated, unwilling to undertake real political reform, and unable to improve the conditions of many Russian workers, the Czarist government was then dragged into World War I.

Few investors, however, noticed these early signs of looming disaster. In his book, The Global Bankers, Professor Roy Smith described the mentality of investors at the time:

The math was simple for these investors. The Russian five-year gold bonds yielded 6.75 percent compared with a yield of approximately six percent on Britain's bonds of similar maturity. The extra three-quarters of a percent interest appeared to make the risk worthwhile. Who could imagine that a large country like Russia, with its vast natural resources and huge gold reserves, could ever default on its debt!

History was about to teach investors an expensive lesson. Russia's poorly-organized involvement in World War I led to many humiliating defeats. In March 1917, the Bolsheviks, led by the master politician, Lenin, quickly seized the opportunity provided by the resulting chaos. In November, the first communist state in the world was established. Shortly after taking power, the Soviet government repudiated all international debt obligations and nationalized foreign companies without compensation. This was thrifty internal politics for Russia owed foreign governments and investors 13.8 billion rubles (US$7.1 billion) at the time. (Had investors put their money in a 6 percent interest account in the United States, these investments would now be worth US$700 billion.)