Why Yeltsin Is Wrong
Jude Wanniski
March 24, 1993


Why is it that Russia's farmers cannot afford to buy fertilizer and will do the spring planting without it? When we can answer this question, we will understand why there is now a fearful crisis in Moscow:

On December 20, 1991, I wrote an op-ed for The Wall Street Journal warning against the imminent "floating of the ruble" by the Yeltsin government. I warned it would bring hyperinflation across Russia and the rest of the ruble bloc, wiping out ail the money capital of the population. As they have almost no physical capital -- this having been expropriated from the people by the state in the communist experiment commerce would grind to a halt, there would be nothing to tax, and the government would dissolve, giving way to anarchy. On January 1, 1992, the government of Yegor Gaidar, Yeltsin's vice premier and finance minister, lifted administered prices against a wide range of goods. It did not, however, float the ruble as I had feared. Most importantly, the government rejected the advice of Western economists at the IMF and in the Bush Administration, which wanted Yeltsin to allow the ruble price of oil to rise to the international level. The advice was tendered on textbook theory that Russia had to become competitive at this level and not cling to subsidized prices for its domestic economy.

The ruble price of a metric ton of oil was then R200. At the existing dollar/ruble exchange rate, this meant a price of $0.28 per barrel. To get the ruble price to the international level would have meant rocketing it to R 14,000. Instead, the price of a metric ton of oil was merely raised to R448. The government was essentially on an oil standard, still honoring its ruble debts to its most important creditors, its people, albeit at a fraction of the original value. Earlier that month, I was in Moscow with Professor Reuven Brenner of McGill, and had tried to persuade Minister Gaidar to go in the opposite direction, to restore the savings of the people instead of devaluing them. In January of 1991, for example, oil sold for R120, but insofar as the ruble was much stronger against the dollar, the equivalent dollar price was more like $1.50 than 28 cents. I told Gaidar I hoped I was wrong, but that I believed if he continued to take the advice of his friend and advisor, Harvard's Jeffrey Sachs, his economic plan would fail and so would his government. I told him that no government advised by Sachs had long remained in power, as his chief tool was always a currency devaluation that cheated the people out of their life savings. This, of course, is the standard IMF model as well.

Why did Yeltsin act so cautiously at the time, resisting the urgings of the IMF? In April of 1992, on another of my several trips to Moscow during this period, our ambassador to Russia, Robert Strauss, told me he had advised Yeltsin to ignore the urgings of the IMF. This of course meant Strauss was cutting against the advice of the U.S. Treasury and Secretary Nick Brady, which backed the IMF textbook plan. "I told Yeltsin that if he freed the price of oil, he would be thrown out of office in 48 hours," Strauss told me. "I told him to stay out of any deals with the IMF, as they will only make matters worse." Strauss recalled that advice yesterday in his law offices in Washington, D.C., as I paid a visit to discuss the parlous situation in Moscow. I offered my analysis of what has happened since he helped save Yeltsin early last year by his wise counsel.

First, we must understand that the Yeltsin government controls the administered price of oil, the most basic commodity in Russia's domestic and international commerce. The Congress, which is trying to strip Yeltsin of power and perhaps the presidency itself, controls the central bank. At the heart of the dispute between these two power centers is the currency issue. When the government raised the price of oil to R448 fifteen months ago, Russian industry was immediately faced with more than a doubling of its energy costs, which it could not meet without credits from the central bank. The bank had only two alternatives. It could supply the credits or shut down the entire economy. It supplied the credits and Professor Sachs denounced the bank for being inflationary, whereas the bank was simply validating the inflation that had occurred with the doubling of the oil price. Like a dog chasing its tail, the dollar value of the ruble sank, the ruble price of oil slipped further from the international market price, and the Yeltsin government decided it had to raise the ruble price again. In March of 1992, it announced the oil price would be brought up in stages to R2240 from R448. The central bank issued more credits and the IMF screamed inflation. In September, the government said the price would have to be raised yet again, to R4000, which would bring it to only 13% of the world price.

In November, immediately after the U.S. elections, Ambassador Strauss resigned his post and returned home to Washington. Soon after he left, Yeltsin was forced to oust Minister Gaidar from his post to appease the Congress. Yeltsin named a new prime minister, Mr. Viktor Chernomyrdin, the former energy minister. The new prime minister almost immediately announced the oil price would be raised to R6000 from R4000. By now, a dollar was buying 400 rubles, from 100 a year earlier. Enter the Clinton Administration. Who would be the new Treasury Secretary? Lloyd Bentsen. Who would be his Undersecretary for International Affairs? Lawrence Summers, formerly of Harvard, last year chief economist of the World Bank, a textbook economist with two Nobel prize-winning uncles, Paul Samuelson and Kenneth Arrow. And a pal of Jeffrey Sachs. Immediately, Summers demanded that the Yeltsin government drive the oil price to the world level. In February, it announced a new price of R12,000. More credits from the central bank. Earlier this month, with the oil industry in a shambles, its workers paid in worthless paper, the Yeltsin government responded again to the demands of the U.S. Treasury and IMF, with no U.S. Ambassador to help. The latest oil price is now R25,000 per metric ton, up from R200 only 15 months ago, remember. Dr. Summers is still unhappy, as at this level, with the ruble trading at 694 per dollar, a barrel of oil is still selling for only $5. Summers would have it at R100,000, which would match the $20 bbl. world price. Of course, the central bank would have to issue more credits, and the ruble would trade for 3000 or 5000 or 100,000 to the dollar. Back to school, Dr. Summers.

Just imagine what life would be like in the U.S. today if the price of gold, which was $350 in December of 1991, was $43,750 per ounce today, i.e., 125 times. Wouldn't we expect a power struggle between the President and the Fed? The U.S. Congress is now facing the prospect of raising energy taxes by 7% and is fearful of the wrath of the voters. Why do we assume the Russian Congress must be a hotbed of communists because they are unhappy with the performance of the Yeltsin government, which has increased energy taxes by 12,500%? The nation's farmers are unable to buy fertilizer, which is made from petroleum, and the oil is being sold abroad, the hard currency somehow disappearing. As the oil price has increased by 125 times, the average price level has gone up 26 times, the wage level has gone up 10 times. We can now smell the chaos approaching that we foresaw in December 1991. As I wrote then: "History repeats itself. The 1921-22 German inflation was the direct result of the Versailles Treaty, which Western bankers and politicians triggered by insisting that war reparations be paid in hard currencies; the government then flooded the country with marks to meet its domestic obligations. Hitler rose to power by denouncing the Versailles reparations."

The only people in Washington who have the slightest idea of what is going on here are at the Federal Reserve, and they have not been consulted on these issues by the Clinton Administration, Dr. Summers does not need any advice, except perhaps from Jeff Sachs. Oddly enough, the person who understands the situation best of all is another former Harvard Professor, Fed Vice Chairman David Mullins, whose specialty was not economics, but finance. If he were consulted by the White House, I'd sleep easier.

What should Yeltsin do? The only thing that will save him and save Russia from emergency rule, the equivalent of military occupation, is to reverse course on oil, lowering the spot price, which will enable the central bank to begin unwinding trade credits. Instead of collapsing in value, the ruble will strengthen. The government could then nail down the long term value of the ruble with the kind of Hamiltonian bond issue I've been recommending for four years. The Russian Congress, which now sees Yeltsin as a dupe of the West, which he is, would break out the vodka and toast his sudden change of direction, away from the cliff. So I'm told by my Russian friends, who doubt that anything like this is possible as long as Dr. Summers (who has not even been confirmed by Congress) is dictating policy to Yeltsin as the price of support from the Clinton Administration. If Yeltsin were to reverse course, he would make a lot of people in Washington mad, at the IMF, at the World Bank, and at Treasury. But not Bob Strauss.