Continued Slide in Moscow
Jude Wanniski
April 15, 1991


I traveled to Moscow this month at the invitation of the government, my third visit in the past two years. This time the feeling of hopelessness was palpable, a sense of continued drift toward a dark unknown. The only hope I heard expressed was pure fantasy, built around a sudden miraculous rescue. In advance of Gorbachev's trip to Japan this week, one Moscow rumor had it that he would sell the Northern Territories to Japan for either $28 billion cash or a commitment of $200 billion in foreign investment. As it happened, I left Moscow for a week in Tokyo, where I found only amusement at the idea. In one poll of Japanese businessmen, 95% said they would not invest in the USSR under present conditions no matter what the disposition of the Territories.

The only progress the Soviet government has made since I visited in September 1989 with Federal Reserve Governor Wayne Angell is that the sense of desperation has focused the government's attention on action. The new prime minister, Valentin Pavlov, is at least a man of action, and I came away with the small hope he will finally act on my proposal to assist the government to get on track.

Each time I've visited Moscow I've insisted that the central problem of the Soviet Union's transition to a market economy from a command economy demands a convertible ruble, without which a banking system cannot exist. In a command economy, capital is allocated by central planners and there is no need for banks, i.e., a financial services industry. Once President Gorbachev introduced the first elements of a free market four years ago, a banking system became essential, but banking cannot exist, even at the curbstone level, without a unit of account. A currency that is inconvertible has no value as a unit of account. The ruble's utility at the moment only applies for spot transactions, with no utility over time for contract purposes. No debt or equity can be issued in rubles that has any future meaning. Exactly a year ago in Moscow, I advised the chairman of the state bank of the USSR (Gosbank) that I did not believe their citizens would take up the bond issue of R60 billion then being planned. It went unsold. I've been the only consultant who has advised the government to begin with a monetary reform that would deflate the ruble to restore its purchasing power, with an issue of ruble bonds guaranteed in gold. The collapse of the Soviet economy and political decline of Gorbachev flows from the failure of the government to deal with this issue. The last remnants of the people's confidence in the government are swiftly headed toward a vanishing point.

On arriving at Moscow Airport in the late morning of April 2,1 was met by a representative of the Foreign Ministry and taken to the Mir ("Peace") Hotel. A late lunch at 4 p.m. was scheduled with the Deputy Prime Minister, Steban Sitarian, and the Deputy Foreign Minister, Ernst Obminski, two of the highest ranking officials on economic policy. Meanwhile, I sought a bottle of mineral water at the hotel buffet and was advised it cost 90 kopecks, just under a ruble. At the currency exchange in the lobby I proffered a $5 bill, expecting 30 rubles in exchange, at the tourist rate that applied last April. Instead I was handed 138 rubles, at the new official commercial/tourist rate that had taken effect that day. I now had enough rubles to buy 150 bottles of mineral water, or 200 loaves of bread, or 100 quarts of milk. On the advice of the Gosbank, the government had moved in the direction of the "free market," by accepting the speculative rate as the new official rate. I could smell the International Monetary Fund behind the move, a disastrous one for the country.

At my 4 p.m. lunch, which went on until 7 p.m., I so advised the Deputy Prime Minister. This is exactly how all the hyperinflations of Latin America have begun, I told him, and said it was my guess this would cause grave problems within the next two months. Even as we met, the coal miners were meeting with Gorbachev, demanding a doubling of wages, which they got. I advised Mr. Sitarian the coal miners didn't really want double the wages, they simply wanted their rubles to buy twice as much. Workers all over the country would have to get double or triple or quadruple the wages to keep up with the devaluation and the government would be invited to devalue again. The USSR is getting further away from a convertible ruble, closer to economic chaos.

Both Keynesians and monetarists have argued for more than a generation that in a country with capital controls, the black market rate is a good indicator of what the true value of the country's currency should be. By allowing speculators to fix the value of the ruble, I said, the government was abandoning its responsibilities to its people. "If you observe two people on a street corner in Moscow changing 27 rubles for $1, this only means the person giving the rubles is betting against the government's policies and the person giving the dollar is betting he can get rid of the rubles faster than a further erosion of their value takes place. Next thing you know, you'll be seeing people on the same street corner changing 54 rubles for $1."
In a Latin American country with a hyperinflation, at least private assets inflate as the spot rate devalues. If your property is worth a billion cruzeiros at the beginning of the year, you can sell it at the end of the year for a zillion cruzeiros. In the USSR, there are no private assets. The government owns 95% of the nation's assets and the people own 5%, in the form of claims against the state, their life savings held in state depositories.

In my three days in Moscow, I met with Gorbachev people and Boris Yeltsin people, explaining that the problem confronting them was to figure out how to get at least half the state assets into private hands. Instead, by listening to western economists who don't know what they are doing, the government is unwittingly cheating the people out of their life savings. Instead of the government owning 95% of the assets, it will soon own 99.9%. Is it any wonder President Gorbachev's popularity is nil, with demands for his resignation erupting across all eleven time zones of the USSR's land mass?

The reformers who are backing Yeltsin have more or less fixed on the 500-day Plan ascribed to Stanislav Shatalin, who quit the Gorbachev cabinet early this year when Gorbachev rejected it. A "500-Day Club" has formed in Moscow to promote it. I explained to the Yeltsin people that none of the plans cooked up in the last three years address the banking issue correctly. The three main blueprints all begin the process of reform by cheating the Soviet people out of their life savings. This includes the recently published IMF-World Bank three-volume study of the Soviet economy that had been commissioned by the G-7 heads of state at the Houston Summit last year. Each of the approaches is driven by demand theory, which is all our Nobel Prize Winning economists understand, and the USSR problem is one of supply.

As I explained to both the Gorbachev people and the Yeltsin people I met with, there is no logical reason why they could not agree with my general approach, as they all wish to avoid the inflation they are told by the IMF is necessary, and they all know they must solve the banking question. Whether the market economy that emerges is more capitalistic or more socialistic is a matter that will be up to them, after they arrange a convertible ruble and a banking system that are required in any case. Possible movement toward a coalition government in Moscow, which would include the Yeltsin people, should rest on this keystone. Only this would promise that the psyche of the Soviet people could be quickly turned around. There is plenty for Gorbachev and Yeltsin to argue about, I said, without arguing about this. Even the debate over private property has been settled, Deputy Foreign Minister Sitarian assured me. I got no sense from him, from Mr. Obminsky, or from other high level economic officials of the Gorbachev government that I met with, that there is any interest in returning to a command system.

I did not get to meet with Prime Minister Pavlov, as I'd hoped, but was assured that he is aware of my proposal and would soon focus on it, probably this week. One of the questions he asked Mr. Sitarian was about who would be the principle audience of our study. I said Mr. Pavlov and President Gorbachev were the only audience of importance at the moment, the only people who could turn things around. If they don't, the federation would fly apart. Then there would be 15 economies and the problem would be the same. Each would need a banking system and a convertible currency, and if they took the advice of the IMF on how to proceed, they would soon divide around ethnic and religious differences into 45 economies. The breakup of Iraq provides some idea of what sort of disasters would attend the ethnic splintering of the Soviet Union. The world would be a lot better off if the union could be preserved in an expanding economy.