The Soviet "Monetary Reform"/
Good News on Capital Gains
Jude Wanniski
January 23, 1991


THE SOVIET "MONETARY REFORM:" The announcement in Moscow yesterday that the 250 billion ruble "overhang" would be shrunk simply through a partial confiscation of personal savings is a monumental and tragic blunder by President Gorbachev -- one that destroys almost any chance that the Soviet Union can survive without massive repression. By diktat, Gorbachev ordered all 50- and 100-ruble notes turned in to the state bank for smaller denominations within the next three days, but with a maximum of 1000 rubles per person. The move will not only cause an acceleration of ruble inflation and deepen the economic crisis, but also destroys the remaining shreds of public respect for Gorbachev and confidence in his leadership.

Ironically, this direct confiscation of government debt was clearly designed to "solve the overhang problem" that Western economists have posed for Gorbachev. The 250 billion rubles in circulation and in savings accounts are said to be potentially inflationary if all wage and price controls were lifted as a necessary step to a market economy. Poland simply devalued its currency by 90% in its "big bang" solution, which of course meant that 90% of all zloty savings was instantly confiscated by inflation. The "liberals" in the Soviet government more or less clustered around the 500-day plan advanced by Stanislav Shatalin, which would have spread an inflationary confiscation over that many days instead of all at once. Gorbachev killed the plan, on the advice of his then-Finance Minister Valentin S. Pavlov, who was correctly fearful of the political consequences of the Shatalin plan. Pavlov, who Is now Prime Minister, obviously reckoned there would be less of a political outcry if only the "richest" citizens those with more than 1000 rubles in higher denominated notes -- were ripped off. His official rationale, though, was that most 50- and 100-ruble notes circulate in the black market, a dubious assertion. The New York Times cites a 62-year-old woman bursting into tears on hearing the news, explaining her 3,000-ruble life savings had been carefully stashed in large bills. The Times also quotes a young black marketeer who boasts he wouldn't be affected as he keeps all his money in hard currency.

It's important to note that any of the plans officially considered in Moscow would have reduced the woman's 3,000 rubles in savings -- which now buys 3,000 loaves of bread at controlled prices to a purchasing power of not more than 100 loaves. The inflation route would at least have masked the government theft, as Mexico, for example, did in its myriad peso devaluations since 1976. Shatalin would at least have sold off state assets to absorb the "overhang," but his plan still did not contain the ingredients necessary to prevent inflation. The Pavlov reform more closely approximates Brazil's recent confiscation of savings by freezing financial assets while paying interest, but is even more blatant in its destruction of capital by outright theft. Gorbachev could never get this reform approved by a democratic parliament. The only plan unofficially considered in Moscow which would not involve capital thievery was that which I advanced with Federal Reserve Governor Wayne Angell in September 1989. We argued even then that it was the only way President Gorbachev could keep the federation together without the use of force. Ironically, both Shatalin and the Soviet Foreign Ministry had expressed interest in reviving our ideas of a deflated gold ruble in recent weeks, and I will again meet with Deputy Foreign Minister Obminski in early February at his request. But with this latest move following the discouraging political developments in the Baltics, it is difficult to see how the situation can be rescued. The population must now be thoroughly demoralized and on the edge of chaos.

GOOD NEWS ON CAPITAL GAINS: Evans & Novak reported this morning that the President's new budget message will contain a proposed capital gains tax cut. This is extremely important, even though at the moment it is considered a pro forma move at the White House. There isn't even much chance the President will mention it in his State of the Union address next Tuesday, but as long as it is officially in the budget it can be brought to the front burner when the Gulf War is behind us. White House Chief of Staff John Sununu and Budget Director Richard Darman continue to show more enthusiasm for the issue and, as Evans & Novak report, the President's political advisors, Roger Ailes and Bob Teeter, are now behind the issue.

In another important development today, Fed Chairman Alan Greenspan finally went public with support for a zero percent capgains tax, in testimony before the Senate Banking Committee. He asserted that a lower rate would undoubtedly raise real estate values and relieve pressure on the thrift and banking industry. Treasury Secretary Brady said if the rate could be cut without raising other taxes he would be the first in line. He also said the President has not yet made a decision on capital gains, but that only means he had not read Evans & Novak this morning.