Russia's New Premier, A Defeat for the IMF Jude Wanniski December 16, 1992

The Western press corps without exception has uniformly asserted that the defeat of Boris Yeltsin's architect of economic reform, Yegor Gaidar, is a victory of the hardline communists in the Russian Congress and a blow to the forces of democracy. This is uniform baloney. In fact, this was a stupendous defeat for the poisonous economic policies that Gaidar has been forcing upon Russia at the behest of the International Monetary Fund. It is the best news out of Moscow all year. We have been rooting for the defeat of Gaidar ever since it became absolutely clear he had painted himself into an austerity corner with the thoroughly inept IMF economists, as well as his personal advisor, Harvard's Jeffrey Sachs. A modern day Dr. Frankenstein, Sach's tried to create a market economy for Russia out of spare parts and "shock therapy" lightning bolts. Viktor Chernomyrdin, the new Prime Minister who replaces Gaidar, has been a key opponent of Gaidar's so-called "price liberalization" strategy. From his post as oil and gas minister, he has steadily fought the IMF demand that oil and gas prices be freed to world market levels.

I'd actually been an advisor to Gaidar's Finance Ministry until it was clear my counsel was being trumped by the IMF and Sachs, whereupon I simply withdrew and kept my silence. A year ago, on the assumption that Gaidar would do exactly that, I met with him in Moscow and warned of a hyperinflation that would bring all formal economic activity on January 1, 1992, to a halt, and would cause the dissolution of the central government. To dynamite the old system of capital all location, before a new system has been put in place, would throw 300 million people into the jungle. This simple idea has thus far eluded the Western economics profession and its Nobel Prize winners. Because of the resistance of industrialists like Chernomyrdin, who understand the colossal stupidity of the IMF economists, Gaidar was constrained to raise the controlled price of oil by increments, producing a steady decline in the value of the Ruble, from 75 per dollar a year ago, to roughly 420 today. This has produced a 25% per month inflation that has been accelerating this fall since, Gaidar on September 1, pushed up the oil price from R2000 to R5200 per metric ton-- an almost $2 increase at the current exchange rate. This practice has been steadily destroying the value of the Ruble in terms of the people's savings, pensions, wages and industrial inputs. The only benefit is to Western carpetbaggers and local gangsters who can buy the country with their hard currency. This is what has been justifiably infuriating the parliamentarians who have finally ousted Gaidar.

Think of the Ruble as being on an oil standard, with the government willing to sell oil from its vast reserves for an extremely low price in Rubles. This was the linchpin of the old system, which preserved the purchasing power of the currency -- the non-interest bearing debt of the state in the hands of its people. To quadruple the price of oil in Rubles is the equivalent of Alan Greenspan announcing that he will henceforth target the price of gold at $1,400 per ounce. To get the price to that level quickly he would have to madly shovel reserves into the banking system, in essence printing money. The general price level would rapidly follow in that direction and, in short order, the dollar price of oil would be pushing $80 instead of $20. When the IMF last spring tried to get Yeltsin to free price controls on oil completely, setting the sky as the limit, it had the backing of the U.S. Treasury Department, Secretary Brady and Undersecretary David Mulford. U.S. Ambassador Bob Strauss, however, privately told Yeltsin that if he followed the IMF advice he would not stay in power for another 48 hours. Yeltsin pulled back from that cliff.

Once you devalue the Ruble price of oil, the only way to keep the old system of commerce and industry functioning is to create lots of Rubles through the extension of Ruble trade credits -- the equivalent of Greenspan shoveling reserves into the banking system. Unless you relish the idea of 100% unemployment, there is no other choice. Yet the IMF, along with Sachs and Swedish economist Anders Aslund, another Gaidar pal, protested the creation of these massive trade credits as being inflationary. The Western press, including even The Wall Street Journal's editorial page, joined in this criticism, which is simply monetarist claptrap. How is it possible for the state to charge its industrial components four times more for its energy purchases without allowing them to borrow from the central bank for those purchases until they can recover them in the sale price of their goods? Once this process begins, the prices of all factors of production have to quadruple, including land, capital and wages. Without the extension of trade credits, the only buyers who could afford the oil would be foreigners and the black marketeers with hard currency. The machinery of Russian industry, already clunking along in obsolescence, would grind to an immediate halt. So what?, says Jeffrey Sachs. "Russia doesn't need more MIGs or submarines or steel. It needs shops and kiosks." Arrrgh.

According to this morning's reports, Chernomyrdin is trying to figure out a way to halt the inflation without damaging commerce and adding to the suffering of the population (except, of course, those who runs shops and kiosks.) If he were to ask me, I'd tell him the first thing he should do is to cut back the price of oil to R2000 per metric ton. This will halt the inflation in its tracks by collapsing the demand for trade credit. It's like Alan Greenspan deciding he has had a change of heart, and instead of quadrupling the gold price to $1,400, only doubling it to $700. The folks who are selling the Ruble short would be stung, and its exchange value would be cut at least in two, probably more, as they might correctly suspect I'd soon be announcing another cut in the oil price. Then, I would advise the Prime Minister to have a mammoth domestic Ruble bond issue, with the bond payable in Rubles with interest at maturity, or in gold without interest. The dollar equivalent exchange rate at maturity should be no greater than 20 rubles per dollar. The purpose is to offer interest-bearing government debt that will extend the government's determination to fix the value of the ruble into the future. The bonds will be bought because of their obvious potential for capital gains, and in that sense act more like equity in the government. By deflating the Ruble, the government rewards the people -- its most important creditors -- instead of cheating them.

Will the Russians do this or something like it? Not if the Western establishment has anything to say about it. But we find it interesting that no sooner had Yeltsin announced the sacking of Gaidar (and the defeat of the IMF) than it was announced that he will be going to China, tomorrow, and that his first stop will be in the South China industrial zone. Indeed, the "communist" faction in the Congress has been urging a shift to China and the East, insofar as Beijing has been getting better advice from the Hong Kong Chinese on how to convert to capitalism, than Moscow has been getting from the IMF and the Charles River crowd. China has been making the conversion to democratic capitalism rationally, building a new system from the bottom up alongside the old system, which will not be torn down completely until the new superstructure is in place. Yeltsin has a lot to learn from Beijing.

It could be that the Clinton team is taking note of these developments, as both the President-elect and his nominee for Treasury Secretary, Lloyd Bentsen, have been saying nice things about the Chinese in the last few days. Clinton has gone so far as to say he supports continuation of Most Favored Nation treatment for China. The Hang-Seng index is back on the upswing, up 100 points last night on the news from Little Rock,  at its highest since December 1. There also seems to be less frenzy among the Clinton people on the departure of Yegor Gaidar than we found in the press corps. It could be that Bob Strauss, a Democrat in good standing, is back in Washington to stay and has given his friends on the Clinton team a better reading on what's happening in Moscow than they have been able to get by reading the papers.