Fixing Russia with Gold Jude Wanniski September 9, 1998

Memo To: Website browsers, fans.
From: Jude Wanniski
Re: A Gold Ruble

On Friday afternoon, I became alarmed about the financial collapse in Russia and called Bob Bartley, my old boss at The Wall Street Journal editorial page, offering to write a piece on how to fix Russia right away, before it was in complete chaos. We were told he would not be in until Tuesday, but within minutes, we got a call from Mike Gonzalez, deputy editor of the edit page of The Wall Street Journal's European edition. I'd never spoken to him before, but he accidentally had run across some Internet comments of mine on how to fix Russia with gold and asked if I would write a piece for his Monday page — as the WSJ publishes in Europe on Labor Day. Quite a coincidence, I thought, unless a Higher Power had taken a hand in directing Gonzalez to me. I wrote the following piece on Saturday and with some minor editorial changes, it ran in both the European and Asian editions of the Journal on Monday. What may have helped was Bob Novak's syndicated column last Thursday, which mentioned a letter Jack Kemp sent to President Clinton while he was in Moscow last week. The column mentioned me several times (except in the New York Post, where the editor cut out all the references to me). Here's the op-ed as it appeared in the WSJ:

* * * * *

Reinventing the Ruble:
...Or Make the Ruble As Good As Gold

In September 1989, the Soviet government of Mikhail Gorbachev invited me to Moscow for nine days to discuss my unorthodox views on how the U.S.S.R. could make the conversion to a market economy. I'd been arguing that the process had to begin by fixing the ruble price of gold at a credible rate of exchange, which I believed then would be a relatively easy thing to do. I still believe that.

When Gueorgui Markossov of the Soviet Embassy in Washington first heard me out in early March of 1989, he asked who else shared that opinion. So it was that then Federal Reserve Board Governor Wayne Angell and I traveled together to Moscow that September to discuss how to build a financial structure for a market economy around a gold ruble. We found an attentive audience.

Mr. Angell, who is now chief economist at Bear Stearns, astonished our hosts by declaring they should not even think of fixing the ruble to a foreign currency — only gold would do. Only after the country had established its people's confidence in the ruble as the monetary standard by keeping it as good as gold might it join the world of floating currencies that revolve around the dollar.

Again and again, Mr. Angell predicted that the U.S.S.R. would fall apart politically without a gold money to hold it together financially. Instead, Western academics persuaded the Gorbachev government to remove the system of price controls before a market economy could develop around a reliable unit of account, which we believed had to be gold.

The current global financial crisis which ended the valiant attempt by the government of President Boris Yeltsin to keep the ruble tied to the dollar had another component, however: it took place during a period of drastic dollar deflation. Eighteen months ago, the dollar price of gold vas $385 and today it is $285. In essence, Russia imported the Fed's deflation and could not manage the turbulence, which is what Mr. Angell meant when he told the Soviet Gosbank in 1989 that it could not join the world floating regime without what he called "a full-bodied money."

Last week, the former U.S. vice-presidential candidate for the Republican Party, Jack Kemp, wrote a letter to President Bill Clinton. In it he urged him to ask Mr. Yeltsin and his prime-minister nominee, Viktor Chernomyrdin, to consider the gold solution as the quickest and easiest way to end the financial crisis without more suffering by the Russian people.

The ruble, which traded at 6.2 to the dollar a month ago, traded Friday 17 to one, implying a complete collapse of the economy and a hyperinflation just ahead. Even The New York Times on Saturday acknowledged that only a currency board or gold may prevent collapse.

But gold is preferable in this situation because the Russian government could announce that it will defend the ruble in terms of gold at a rate of 2,000 rubles per ounce and because it has control of the ruble but not the foreign currencies of a currency board. That is, Russia need not have gold ingots backing every last ruble in circulation in order to keep the gold-ruble price stable. It can do so by managing the supply of ruble liquidity, which the government can do easily by buying and selling ruble interest-bearing bonds to Russian banks. It should also make an unlimited amount of the gold-ruble bonds available to ordinary people.

This is how Alexander Hamilton solved the financial crisis that faced the administration of George Washington in 1791. America's first Treasury Secretary fixed the dollar to gold and promised creditors they would be paid all they were owed at par, with interest. In 1947, West German Finance Minister Ludwig Erhard ended a similar financial crisis by pegging the Deutschemark to gold. At these times, neither the U.S. nor the German government had any gold. The gold promise worked because their own people understood that their governments were not insolvent, but simply faced a short-term cash crisis. In the same way, the Russian state today has small liabilities, perhaps $200 billion, compared to the assets it possesses, which easily amount to $10 trillion. The state, after all, owns almost everything in 11 time zones, which it acquired in the 1917 revolution. All of these assets can be used to back up the exchange rate by converting them at the ruble price of gold.

On hearing that their government promises to pay ruble debt at a 2,000-to-one gold price -- which implies a dollar/gold rate of 7 to 1 at the moment — the Russian people would have to decide if the promise was credible. Would they rather have a gold-ruble bond paying interest at a hard rate of 7 to 1, or a ruble note paying no interest at a collapsing rate of 17 to 1? The question suggests the people would rush to convert ruble notes into ruble bonds.

As it is, the Russian people are transacting among themselves using $40 billion in U.S. currency, while the value of the ruble money supply implodes toward zero. A government gold/ruble peg would quickly bring the people to their banks with dollars, asking for the now more valuable rubles. In short order, the government would have enough dollars to pay Western banks the interest they are owed. As the Russian government creates new ruble liquidity to meet increased demand, the problems with insolvency at Russian banks also are resolved. And as domestic commerce now would flow through ruble tax gates instead of dollar barter, Mr. Yeltsin would be able to pay all back wages in tax rubles instead of fiat money. By fixing to gold instead of a currency-board basket, Russia would be able to collect a bonanza in seigniorage.

If President Clinton wished to follow through on his promise to help President Yeltsin, he could ask his Treasury department to buy $3 billion to $4 billion of the gold-ruble bonds from its Exchange Stabilization Fund. If this happened tomorrow, Russia could meet its dollar obligations this week. If there were any further doubts among Russians about the credibility of a gold ruble, they would dissolve upon seeing the U.S. government actually buying their sovereign ruble debt.

The Russian government would soon be able to hasten an economic expansion through supply-side tax reforms. But first things first. A ruble as good as gold is what Dr. Angell ordered in 1989 and it is what the doctor orders now.

Mr. Wanniski is president of Polyconomics Inc., an economic consulting firm in Morristown, NJ.