Worried about the U.S.S.R. Jude Wanniski December 12, 1990

The winter is getting deeper in the Soviet Union, the shelves are bare, and practically every political leader in the Western world is worried about food riots, civil strife, a political crisis and police crackdown by Mikhail Gorbachev. Already overburdened, Germany, Finland and Poland are now bracing for the possibility of hundreds of thousands of refugees streaming westward from Russia. Just about the time when the Bush Administration expects to be getting down to serious business with Saddam Hussein, it has to contemplate the possibility that the critical center of political gravity will shift to the U.S.S.R. The coalition that President Bush and Secretary of State Jim Baker have so painstakingly put together at the United Nations may no longer have sufficient energy or attention to deal with Iraq. Baker is now arranging for direct food aid to Moscow, which President Bush is scheduled to announce later this afternoon, but this will not be enough to avert a crisis. I spent three days in Washington last week meeting with officials at the White House, State Department, and Federal Reserve to revive the idea of a monetary reform to avert political crisis in the nick of time, in the same way Ludwig Erhard's 1948 monetary reform swiftly turned the potential of economic and political collapse into West Germany's "miracle."

In September of 1989, when Federal Reserve Gov. Wayne Angell and I visited Moscow and Leningrad under the auspices of the USSR's state bank (Gosbank), we warned that the forces at work would soon tear apart the Soviet Union, and that the only thing that would work to prevent this would be monetary reform. After I returned from Moscow from a second trip this year, again under the auspices of Gosbank, I wrote an outline of a reform proposal for The Wall Street Journal, "Save Perestroika With Monetary Deflation," 5-16, warning of "a growing food crisis" caused in part "because farmers expect prices to soar in the coming inflation [and are thus] withholding their surpluses from the market. As many as 30 million tons of grain are in storage or are being fed to animals while the state pays hard currency to import grain."

At the time, the idea was generally dismissed here because the favored idea of the U.S. Establishment was that Gorbachev should simply follow the example of Poland's "big bang." The state would lift price controls and allow the ruble to seek its "free market" level. This absolutely terrible idea, communicated relentlessly to Soviet officials by U.S. economists, businessmen and politicians, but resisted by Gorbachev, has been one of the main reasons for the current food crisis. It would in fact mean a serious inflation wiping out the savings and pensions of the people. The fact that one year after the Polish "big bang" the distressed people of Poland pitched out its political architect, Prime Minister Tadeusz Mazowiecki, has proven to Gorbachev that he was correct. But he doesn't know what to do instead.

As I argued in May, what he should do is the exact opposite of inflation: Deflation -- make the ruble worth more, not less. If he would announce on Christmas Day a bond issue of $15 billion, denominated in gold rubles at, say, 1000 rubles per ounce of gold, where the ruble is now black marketed at closer to 3000 per ounce, he would pleasantly shock the citizens of the USSR with this Christmas gift, as pleasantly as Helmut Kohl shocked the East Germans this spring when he offered to give them Deutschemarks for their near worthless Ostmarks. If fear of inflation causes hoarding, the fact of deflation causes dishoarding! For starters, people will want to sell gold to get rubles to buy gold bonds, thus driving down the blackmarket price of gold from 3000 toward 1000. They'll also sell hoarded food to get rubles to buy gold bonds, and once credibility sinks in, they will unload hoards to get rubles to buy private issues of debt and equity.

This would work if the people of the USSR actually believe in the gold bonds. This could be achieved if the government transfers sufficient gold to trusteeship in Switzerland or New York to back the bonds, and the bonds were traded in New York and London, etc. The added twist that I presented in Washington last week was the following: The Soviet Union wants trade normalized with the United States, and the U.S. would now like to grant most-favored-nation treatment to Gorbachev, especially for his behavior these past years as a respected citizen of the world. But one condition that must be met requires Moscow to clear up its old debts to the United States, regarding czarist bonds and WWII lend-lease loans. The amount has been agreed upon, roughly $600 million, but the Soviets do not have it. Why doesn't the U.S. agree to accept $600 million worth of gold ruble bonds of the $15 billion issued?

The whole point of the exercise is to persuade the Soviet citizens that for at least the period of the bond issue, say 10 or 15 years, the ruble will be worth more, not less. They will be protected against inflationary cheating by their government not only by the gold bullion held in trusteeship, but also because the United States would collect a portion of the gold. Simply put,  if the United States believes the ruble is good as gold, it will also be as good as gold in the minds of the Soviet citizens. When the ruble has value, not only as a circulating medium, but also as a store of value, people will work like hell to get their hands on it. This, Wayne Angell insisted with our hosts in Moscow, is the prerequisite to a successful perestroika. Nothing else Gorbachev does can substitute. By getting the U.S. to accept bonds to clear up his arrears, Gorbachev also gets normalized trade and access to the U.S. financial markets now denied the USSR. Not least, a successful monetary reform works to pull together the Soviet federation, removing one of the biggest complaints of the republics. There would be no need for crackdowns and the West could focus all its attention on Saddam Hussein.

In the absence of any other ideas on how to avert anarchy or oppression in the USSR, this one is now circulating at high levels in Moscow and Washington. Nobody can find anything wrong with it so far, except that Wayne Angell and I are the only folks who continue to offer it. So far.