More Than Money, What Yeltsin Needs Is Inflation Medicine

April 18, 1993|By STEVE H. HANKE and KURT SCHULER

The backdrop for the seven-nation summit in Tokyo last week is clear. Russian President Boris Yeltsin is locked in a bitter power struggle with the Russian parliament. Western leaders are sympathetic to Mr. Yeltsin and are attempting to tilt the political balance in his favor.

Unlike the Russian and Western leaders, the Russian people are cool to Russia's internal politics. Polls show that fewer than half of the voters would participate in next Sunday's national referendum to decide who should rule Russia. The Russian people's principal concern is inflation, which is running at a faster pace than last year's 2,000-plus percent. If the West wants boost Mr. Yeltsin's popularity, which would allow him to prevail over the rather boorish parliament, the West should provide Mr. Yeltsin with the means to lick inflation rapidly.

Unfortunately, most Western leaders don't appreciate the significance of the inflation problem. Even those who recognize the problem aren't aware that the anti-inflation medicine is within reach.

Russia's inflation is caused by the Central Bank of Russia, which is controlled by the Russian parliament. The parliament approves large, politically popular subsidies to unprofitable state enterprises. The subsidies cannot be financed from taxes, nor by government borrowing. Consequently, the parliament orders the central bank to finance the subsidies by printing rubles.

To stop the inflation, which is jeopardizing all economic and political reforms in Russia, the central bank must either be replaced by a monetary regime that is protected from the politicians or the central bank must be made irrelevant. That conclusion rests on a careful reading of Russian history. Since czarist times, central banking in Russia has always been highly politicized and unable to sustain anti-inflationary policies.

The currency-board system is the only monetary regime that has the requisites to stop inflation in Russia. A currency board, an alternative to a central bank, is a monetary authority that issues notes and coins fully convertible -- at a fixed exchange rate and on demand -- into a stable foreign currency. A currency board holds reserves in the foreign currency equivalent to 100 per cent of its notes and coins in circulation.

The most notable example of a currency-board system today is Hong Kong. In the past, though, currency boards have existed in about 70 countries. They have an excellent record. No currency board has ever failed to maintain full convertibility into the foreign currency with which it had a fixed exchange rate.

The appeal of such a system for Russia today is that it is simple and rigidly bound by rules that would inspire confidence by the Russian people. The rule-bound nature of a currency board tends to protect it from political pressure for inflation. A currency board is a type of monetary constitution that protects economic freedom in the same way a well-designed political constitution protects political freedoms.

To replace the central bank with a currency board would be difficult. Indeed, it would probably make the recent confrontation between Mr. Yeltsin and the Russian parliament look like child's play.

Fortunately, Russian history suggests another way of reforming the currency; one that would make the central bank irrelevant. That alternative, too, has been successful in the past. It would require the establishment of a currency board as the issuer of a parallel currency. Currency-board rubles would then circulate alongside central bank rubles at a floating exchange rate just as dollars now circulate alongside rubles.

Russians would then have a choice between using inconvertible, rapidly depreciating central bank rubles or using fully convertible, stable currency-board rubles. Most Russians would quickly switch to using currency-board rubles. Thus protected from the ravages of inflation, market prices could start to be meaningful and the Russian economy could cease its free-fall.

A parallel-currency approach to establishing a stable currency has been used twice before in this century in Russia, both times successfully. The first time was during the Russian civil war. The anti-Bolshevik government of the region around Archangel and Murmansk established a currency board in cooperation with its ally the British government. Rubles issued by the North Russian currency board were backed by British pounds sterling and had a fixed exchange rate with the British pound. As its initial foreign reserves, the currency board held a deposit in British pounds sterling at the Bank of England. The British government provided the deposit as a gift to establish the currency board.

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