The Perestroika Watch Jude Wanniski February 7, 1990

When Fed Governor Wayne Angell and I were in Moscow last September, everywhere we went our warning was the same: The limited economic reforms put into effect by President Gorbachev's perestroika were having the unintended effect of tearing apart the USSR and its Eastern Empire. We had thought prior to our arrival in Moscow that they had a year or two to make the necessary adjustments, but we advised that they had only three to six months. Angell and I did not recommend that they go immediately to a gold-convertible ruble. We predicted that if they did not do so, the empire would splinter in that period. As Angell put it in a long discussion we had with members of the Communist Party central committee, as I recall his words: "The forces of private commerce that have been loosed by perestroika must have a banking system that does not now exist. If Moscow does not provide one soon, Eastern Europe will split away to gain the advantages of the banking system in Western Europe. It will be drawn to the West German Deutschemark." Once Eastern Europe spins off, we asserted, it would not be long before the Baltic states, already yearning for an independent currency, will follow, and thence Armenia and Azerbaijan, and the national republics to the east. In my September 14 report, "Mission to Moscow," I noted:

In a speech Gorbachev delivered Saturday, September 9, which we read about upon our return, he himself warned of the prospect of civil war in the Soviet Union should the ethnic regions persist in pressing for independence. We addressed this specifically in our Soviet audiences, pointing out that the one economic tool a central government cannot decentralize is the value of its money. A gold ruble would set up centripetal forces, binding the outlying regions to Moscow, offsetting the centrifugal forces now working to tear the Soviet Union apart.

Having made these predictions in no uncertain terms, Angell and I were also under no illusions that they would heed our advice, at least at first. The dominant advice Moscow and Eastern Europe has been getting from Western economists is quite the opposite; to boldly tear off all price controls, let the painful adjustment process take place, and when the smoke clears in several years, peg the drastically devalued ruble to Western currencies. Poland has embarked on this course, destructive at worst, unnecessary at best. Somehow our Ivy League economists believe their bold reforms will soon transform Poland into Illinois, Hungary into Oklahoma, East Germany into Minnesota. These are the same economists who have been advising Peru, Argentina, Brazil and Zimbabwe.

The first sensible economic proposal we've seen thus far came yesterday, with West German Chancellor Helmut Kohl's proposal to hold immediate talks with East Germany on creating a single German currency. Officials said the modest aim was to get a common currency within two years, although we think it should be more like two months. Even so, Bundesbank President Karl Otto Pohl, a man of limited vision, denounced the idea as "very fantastic," as did East German Economics Minister Christa Luft, who insists what East Germany really needs is a big bag of money from Bonn. In this case, the economists have to be brushed aside by the politicians. Wolfgang Berghofer, the Dresden mayor who has quit the Communist Party, called for monetary union yesterday, as did Gregor Gysi, the East German Communist Party leader. The economists who are jumping up and down about the "inflation" that would result in West Germany if the currencies would integrate, including the president of the Bundesbank, assume the absence of a bond market! The whole point of creating a unit of account that has predictable value for East Germany, for goodness sakes, is so that it can issue notes and bonds in a way that capitalizes the potential of its people and considerable resources. Politicians seem to know this while their economic advisers shrink from it. Angell and I found in Moscow that the political people we met with at the CPSU central committee were the most receptive to a gold ruble, the most emphatic in agreeing with our idea that the banking question was central. The economists, trained on Western schoolbooks, were usually dumbfounded that Americans would be giving them such advice.

In the same way, Gorbachev was roundly criticized by U.S. economists in December when he rejected the "bold" proposals from his Economics Minister, Leonid Abalkin. But he was quite right to do so, as they did not address the banking question and would simply have sent the USSR over a cliff. Gorbachev is now maneuvering brilliantly to strengthen his political hold, even as the centrifugal forces we warned of are tearing at the cohesion of the USSR. But all his brilliance can't overcome the weakness in his economic policies absent a convertible ruble. Quentin Peel, Moscow bureau chief of the Financial Times, in a commentary February 5, "What's to Be Done After Bankruptcy?" observed:

The Soviet leader faces the classic dilemma that the economic austerity essential for genuine reform, including a radical reform of the subsidized price system, is incompatible with the explosion of popular debate. Every attempt by the government to liberalise, to raise some prices to become more realistic, or allow enterprises and co-operatives to charge what the market will bear, runs into hysterical popular opposition.

And quite rightly. The solution to the government's monetary problem is to drive prices down, not up, by a sharp deflation of the ruble. Because economists have never before encountered an economy without private property or private debt, it has not occurred to any of them that a monetary deflation in the USSR would shift all of the burden of adjustment to the state, which is where the burden should lie. Deflation is only harmful to individuals in an economy that has private debt. A Soviet deflation would free individuals to use their accumulated capital, their life savings, for the beginnings of a market economy. Similarly, East Germany should deflate the street value of the Ostmark to bring it into line with the Deutschemark. This would preserve the hard-earned value of the life savings of the people of the USSR and East Germany instead of wiping these out with a deep devaluation. A sharp rise in prices wipes out this accumulated capital, and puts the entire burden on individuals, none on the state. This is a foolish thing to do, as the state is vast, at the moment possessing all the country's resources in 11 time zones, resources that can be capitalized in the monetary reform Governor Angell and I envisioned for them.

I've urged my friend Gueorgui Markossov, economics counselor in the USSR Embassy in Washington, to remind Soviet officials that the country is extremely rich, not poor. The amount of ruble "overhang" that Western economists constantly bleat about, like the sheep they are, is trivial compared to the incalculable riches of Mother Russia and the Soviet republics. The government at the moment owns practically everything on one-sixth of the planet's land mass. The surface value alone has to exceed $15 trillion, not to mention the stupendous treasure of minerals beneath the surface. It should be child's play for economists to figure out how to cross this divide from poverty to wealth. Yet all they can counsel is fiscal austerity and inflation. Peel, a marvelous reporter, nonetheless reflects this intellectual bankruptcy among demand-side economists when he says "economic austerity is essential for economic reform." Quite the contrary. The reforms should bring instantaneous relief, or they are bogus. What the economists of the West are currently doing to Poland is a tragedy of monumental proportions.

Gorbachev deserves better advice from the West, from Washington, and the Bush Administration than he's been getting. It should be clearer than ever this week that the man is not only a visionary, he's a democrat. I was persuaded of this last spring, in an excerpt from a speech Gorbachev delivered before the Supreme Soviet ("The Debate in the Soviet Congress," The New York Times, 5-26): "I assure you, comrades, I want to dispel the illusion that information doesn't get to me and that I don't know what goes on in the country...May be I know more than you. I know less than all of you put together, but more than each of you individually." This is the essence of democracy, I think, not it's morality, but its advantage! Gorbachev clearly understands that political reform in the Soviet Union must produce a mechanism that can tap this broader wisdom of the electorate. His maneuvers to diminish the power of the CPSU and increase the strength of the presidency can be read in that light, and I can now imagine him winning a national presidential election in his country.

At least, whatever is left of it after he finally addresses the central banking question. As it is, the centrifugal forces are still at work, with nothing in sight to pull his people back toward the center.