Letter to Baker Jude Wanniski December 12, 1991

December 12, 1991

The Hon. James A. Baker III
Secretary
U. S. Department of State
Washington, D.C. 20520

Dear Jim:

I got back from Moscow last night after two and a half days of meetings with the relevant folks in the Government, most particularly Finance Minister Yegor Gaidar and First Deputy Foreign Minister of Russia Theodore Shelov-Kovedyaev. There is not a speck of confidence anywhere on the "liberalization" plan, only the sense that they have to "do something" to satisfy the demands for action, which are chiefly coming from the West: G-7, IMF, The New York Times, Jeff Sachs, etc. Gaidar hopes that maybe it won't be much worse than Poland and that at least food will reappear on the shelves when the ruble is floated, although he acknowledges there will not be much purchasing power to buy what appears. I told him I believe a hyperinflation is inevitable, that all commerce will cease, and that I worry the nukes will somehow come into play. The day I talked to him Latvia "liberalized prices" and nothing appeared on the shelves! Gaidar, who I like, seems trapped by political forces and is almost certain to be the fall guy for the reform failure.

As a result of my meeting, I'm now an official advisor to the Russian Government, with a letter from Gaidar committing the Finance Ministry to a joint economic reform project with Polyconomics and the WEFA Group. We're going to raise $2 million from western businesses and develop a growth strategy instead of a chaos plan. We're going to put together a team of the best people we can find around the world -- and get the new Commonwealth on a fast growth track, which is the only way the western creditors are ever going to get paid off on old loans.

I was very blunt in telling Gaidar that, although I wish him well, his current reform plan will fail, and he did not argue with me or Prof. Reuven Brenner of McGill University, who accompanied me. Gaidar is not happy with the idea of floating the ruble January 1, saying they could not come up with anything better. They are fascinated with my action plan, the idea of a bond issue, which I also presented to the Supreme Economic Council of the Russian Parliament (which is preparing a team to take over when Gaidar's failure becomes evident). My plan is now being officially translated and circulated through the government and parliament, so there is still some hope. I urged a delay to February 1 in the price liberalization, which would give us the time we need to fix the ruble. Anything you can do to urge delay would be helpful; I'm planning another trip in late January, with some Wall Street finance people to help show them the way.

My understanding is you've put Larry Eagleberger on the case instead of Bob Zoellick. I'm afraid he's likely to be part of the jump-over-the-cliff crowd, but if you'd like, I'll brief him on how I see things shaping up. He should have my point of view anyway. I can appreciate the move if it's in line with the objective of getting power out of the hands of the western creditors and the Treasury crowd. Global security interests are best served by postponing the ruble float, I think you must surely agree.
To remind you of how awful it will be, here is what I told Gaidar: The "inflation" that has occurred so far is a de facto inflation, which is the people's expectation that the Government will repudiate its debts to its own people. That can be reversed if the Government announces it will honor its debts, instead of going through with the float January 1. The float makes the inflation de jure, and instantly wipes out all future purchasing power of the people's ruble savings.

At the same time, it wipes out the purchasing power of the wages of the people. Even in the "best case" which they present, the average wage will amount to $10 a month. Prof. Brenner asked what incentive is there for business to produce anything when consumers only have $10 per month per household to spend. Nechaev said they never thought of that! Nothing will appear on the shelves. The fact that a banking system does not exist means people are unable to borrow against their future earnings. If a banking system did exist, people still have no private assets to collateralize. The IMF economists have tightened the noose to a maximum, and the Bush Administration has helped at every step of the way via the role Mulford has played. If the float goes ahead, it will be "something much more destructive than an atomic bomb," says Georgy Matykhin, chairman of the Russian Central Bank, who I met with in Moscow. Matykhin is excellent, but acknowledges he has no power as long as the Government goes ahead with its plan. It will be extremely difficult to pick up the pieces after January 1.

I warned Gaidar and his chief deputy, Andrei Nechaev (with whom I spent almost three hours), that Yeltsin will be extremely vulnerable if he goes ahead with the plan — as it is very rare to find a political leader who devalues a currency and survives. I was also blunt in telling him I knew of no government advised by Jeffrey Sachs that is still in power. (Sachs met with Gaidar yesterday and is quoted in the NYT today on the wonderful plan that Gaidar has arranged! Sachs is utterly incompetent in this matter. To wipe out all the savings of the people in a twinkle makes it realistically impossible for Yeltsin to survive in the political convulsions that will follow. The ruble/dollar rate, which I understand is now up to 120/$, is the foreign community's bet that the government will fail, the odds being 120-to-l against success. To get the ruble down to 1/1 would make Yeltsin .a hero. You'd probably be surprised at how many people in Moscow loved my idea of a one-to-one rate, including the academics I addressed at the Supreme Economic Council. Stanislav Shatalin told me he would call Gaidar with support for my plan! Shatalin, remember, is identified with the Yavlinsky 500-day-plan. He was a Gorbachev crony and Gorbachev is now totally out of the picture, it seems. But Shatalin was also one of Gaidar's economics professors.

If Gaidar would fix the ruble along the lines of our plan, though, the new Commonwealth would stand every chance of success. All the Islamic republics will join up, having little choice. We'd avoid having to deal with a string of fundamentalist Ayatollahs. The Russians I spoke to about this tell me the biggest concern they have vis a vis nuclear weapons is an Islamic ICBM aimed at Israel. By restoring the savings of all the people, Slavs and Moslems, the Commonwealth Government would have a solid foundation not only for economic prosperity via market capitalism, but for pacific democratic rule.

Good luck to you on your trip to Minsk. If they bring up the plan I presented, the key to which is U.S. acceptance of ruble bonds in payment of lend lease debts, all you really need to do is comment on its creativeness and indicate if the Commonwealth Government offers such a deal, it would get the most serious consideration. You should know I flew to Moscow on the Forbes "Capitalist Tool," to inaugurate the Radio Free Europe station there. On the flight, I sat next to the AFL-CIO's Lane Kirkland for about four hours. He told me he "had no problem" with the U.S. accepting ruble bonds to clear the old debts. Even if the government can't redeem the bonds at maturity, because of economic ineptness, the old debts would at least be guaranteed in gold, not paper dollars. Eventually, Russia will get its act together and the bonds will be redeemed, with no loss of purchasing power. The only way Yeltsin/Gaidar will get off the track they are on, though, is if we can get the banks off their backs.

If you have a moment to spare, please give me a call, especially if there are any loose ends you'd like to clear up on the proposal I've made to Moscow. It's important that you know there is an alternative to the disastrous course the country is now set upon.
 
Sincerely, as ever,

Jude


cc: Vice President Quayle
Richard Cheney
Robert Gates
Brent Scowcroft