Memo To: SSU Students
From: Jude Wanniski
Re: Trying to Help the Russians
In 1989, the Soviet government invited me to come to Moscow to explain my ideas on how it could successfully transform their communist "command economy" to a market-based economy. I agreed to go, at my own expense, and asked my hosts at the Gosbank, the Soviet central bank, to also invite Federal Reserve Gov. Wayne Angell, a good friend, who shared my views on why the first step they should take would be to fix the ruble to gold and establish it as a reliable unit of account around which a market could form to price goods and allocate capital. Today's lesson is the transcript of an interview I gave to Keith Bush, who collected a few dozen interviews and published them in a book "From the Command Economy to the Market," 1991, the FRE/RL Research Insititute."
At the time of the interview, the ruble was trading at a rate of about 4 rubles per dollar on the black market. The official rate was $1 = R1.35. Obviously our advice was rejected by the Gorbachev government in favor of "shock therapy." This meant freeing prices without a fixed ruble/gold price, and the hyper-inflation Angell and I predicted soon followed, along with the fragmentation of the USSR, with political upheavals, as in Chechnaya, that persist to this day.
An Interview with
Jude Wanniski is an influential analyst of US and global political economics. Formerly an Associate Editor of The Wall Street Journal, he founded Polycoromics, Inc., in 1978 to advise corporate and financial clients on the emerging "Supply-Side Economics. " He has advised ex-President Ronald Reagan and President George Bush. This interview was recorded on 7 June 1990.
You are well known in the West, but your name is not so familiar to our audiences in the Soviet Union and Eastern Europe. How did your interest in Soviet-type economies arise?
A large part of it comes from my family background. My father's parents came from Ukraine a hundred years ago to work in the coal mines in central Pennsylvania. And my mother's parents arrived from Lithuania a century ago, also to work in the Pennsylvanian coal mines. My mother's side of the family were communists and helped organize mineworkers in Pennsylvania for the Communist party in the 1920s. So the family was politically very active. As a young man, I considered myself to be a Marxist, a socialist, and belonged to the Young People's Socialist League. But then I went through my own personal perestroika in my middle years and wound up as associate editor of The Wall Street Journal.
You coined the term "Supply Side Economics." Would you please explain it for our listeners?
This is a revival of classical economic theory in the United States that had died out in the 1930s after the Great Depression; it is a brand of economics that Ronald Reagan had studied when he was a young man. I became an adviser to Ronald Reagan in 1979 and 1980 on how to get the US economy, which was in trouble in the years of Presidents Nixon, Ford, and Carter, onto a noninflationary growth track. There are fundamentally two kinds of economics that have been prevalent in the world in the last two centuries. One starts with the proposition that the consumer is the central actor in the system, the demander of goods. That's the demand theory. And the other, the classical theory, is that the producer of goods is at the center of the system. So it's almost like the Copernicus and Ptolemaic theories, and it was the supply-siders who revived the growth ideas in the administration of Ronald Reagan with the revival of supply theory.
What, in your view, is the primary cause of the current economic crisis in the USSR?
Let's use a metaphor: It comes down to a country being like a computer. In a command economy, you have a relatively small number of bureaucrats trying to allocate resources and credit for some 285 million people. In the United States you have a very large number of people making those decisions through the political process and through the market economy. Everyone is engaged in feeding and signaling the markets both politically and economically as to what the preferences are and how to put capital to its highest and best uses. So our observation here in the West was that eventually the higher computer power of the United States and the Western market economies would submerge the bureaucratic economies of the socialist system.
You have visited Moscow on more than one occasion during the past few months and have consulted with Abalkin and other leading officials. What advice have you been giving them?
I think the central problem in the Soviet Union -- and this is the advice I gave them in my trip last September  and then again in April  -- is the fact that they do not have a banking system. That they need, first and foremost, a currency, a unit of account, a ruble that is convertible and defined and recognizable in all parts of the realm, and also has sufficient integrity that it will be recognized as being creditworthy outside of the Soviet Union. So the first object is: how do you get a convertible ruble? The way I put it to the Russians I met with in September is that it's like building a house without a commonly understood unit of measure. If the meter stick were understood to be of one length to the architect and another to the carpenters and engineers, the house that would be constructed could not stand. In the same way, if you're going to build an economy, you have to have a currency that has precise definition internally and externally before you can begin to think the rest of the process.
You have spoken with many top decision makers in Moscow. You will agree, I think, that they are fully aware of the necessity for a convertible ruble. And yet the present plan, as outlined by Premier Ryzhkov in May 1990, again provides for a period of stabilization while the massive monetary overhang is being mopped up. Are they on the right track?
This course of action, as proposed by Ryzhkov and Abalkin, is in error, in my judgment. It goes against my argument that, before they have a price reform, they should have a monetary reform. In other words, before they lift controls on wages and on the prices of goods and services that have been in existence for all these many years, they should first have a monetary deflation. The Soviet Union has an advantage over Western economies in that its authorities can deflate their currency while we cannot. Western economies cannot have monetary deflations because we have private debt, and in a deflation private debtors are crushed. In the Soviet Union, because there are no private debtors, the only debtor is the state itself, the state can easily deflate the ruble back to the original controlled price levels. So that, if the ruble were very hard, backed by gold at a very hard exchange rate, then if price controls were lifted, prices would not rise. I use the price of tomatoes as an example. The controlled price of tomatoes in Moscow is three rubles per kilogram. The market price that you'll find in the kolkhoz market is fifteen rubles per kilogram. The economists who advise lifting the prices first, as happened during the Polish "big bang," say: "Well, if they lift the price controls, all the prices will go to fifteen rubles per kilogram of tomatoes." But this would represent a major political decision for the Gorbachev administration: it would mean that the value of the savings, wages, and pensions in the Soviet Union would all be cut down to only 20 percent of their previous levels. The people would not stand for this kind of dilution of the purchasing power of their hard-earned savings, which now amount to up to 500 billion rubles. So I suggest that the government deflate the ruble and back it with gold to the extent that, when prices are freed, the gold price equilibrates with tomatoes at three rubles per kilogram. This way the purchasing power of the pensions and the wages and the savings arc all kept intact. It means that the state takes the major burden of the adjustment, and the individual citizens take the least. This is a politically feasible way to convert from where they are to where they want to go, and the next steps in the process then become much easier.
Many of our listeners will not understand how you back the ruble with gold if the monetary overhang is estimated at up to 500 billion rubles and yet their stocks of gold are believed to be equivalent to about twenty seven billion dollars at the world market price. Therefore, they say, there is insufficient gold to back the ruble. Would you explain that?
All you have to do is establish credit. The establishing of credit means that transactors inside and outside the Soviet Union will come to believe that it will not devalue the currency once the gold ruble exchange rate has been established. On my last trip, when I met with the Director of the State Bank, Viktor Gerashchenko, we focused on the bond issue that the Soviet Union is now planning. They're planning a bond issue of seventy billion rubles. Sixty billion rubles will be taken up by the state enterprises, and ten billion rubles will be offered to the public at large. Now, the terms of this bond issue, which will have a sixteen-year maturity, include a 5 percent interest rate. I advised the State Bank that I thought the bond issue would fail. The private citizens would not buy ten-billion-ruble bond issues with such a long maturity and such low interest rates on the eve of what the government is saying will be a doubling of prices, a big inflation. The bonds will immediately become worthless. I proposed instead that the Soviet government offer all or part of the ten billion rubles for sale internationally, in London and New York, and do so at an exchange rate of roughly 500 rubles per ounce of gold. At the same time, they could take, say, five billion dollars worth of that twenty-seven billion dollars worth of gold reserves and deposit it in New York or in Switzerland so that they would have credibility for that fraction of the bonds that would be taken up by foreign investors.
Many Soviet citizens have told me that they would have no faith in any gold backing of the ruble, because the present ruble notes claim that they are redeemable against gold -- which is obviously a fiction. But they assured me that they might alter their skepticism if they were to see foreigners buying these bonds. I wrote up this proposal in The Wall Street Journal, and I have discussed it with top officials of the Bush Administration, with the President's chief economic advisers, and with specialists at the Department of State. None of them could find any flaw with my argument, and they believe that this would be sufficient to begin the credit process. Almost all countries launched their monetary systems, as the United States did in 1791, without large amounts of gold. We had a very tiny amount of gold when we started the United States of America. Alexander Hamilton, our first Treasury Secretary, put us on a gold standard with a trivial amount of reserves. The Soviet Union has much more gold than is necessary for beginning this process.
Your proposals were contained in the interview with Federal Reserve Governor Wayne Angell, that appeared in the central press last September. How did they go down with the Soviet authorities?
I understand that they have been circulated in top government circles. I discussed them with Abalkin, Shatalin, and Milner. And I'm told that President Gorbachev read the interview. From the Soviet embassy in Washington, I gather that the proposals are still under discussion, but the thrust of our program was undercut by the decision, a few weeks ago, to double retail prices for some foodstuffs. This struck me as running contrary to Gorbachev’s pledge not to use “shock therapy.”
It sounds as if you are not in favor of "shock therapy?"
Absolutely not. There's no reason to have the Soviet economy get worse before it gets better: it can get better immediately by embracing the policies that I've advanced. This is why I've put forward the idea of a monetary deflation, and this is why I was invited to Moscow twice. They told me that I am the only Western economist they have talked to who believes that things do not have to get worse before they get better.
Some Soviet officials, and many of our listeners, may be suffering from a surfeit of -- albeit well-meaning --Western advice on how to put their economy in order. The more skeptical ones might ask: "if he is advocating the gold standard for us, then why did the Western industrialized nations go off it?"
Our demand theorists persuaded President Nixon in 1971 that we would be better off without a gold standard. And they thought our interest rates, our production, our employment would be much better if we could devalue our currency. Well, exactly the opposite happened. And so, for the past twenty years, we have experienced tremendous turbulence in the Western banking system. We've now had a collapse of our thrift institutions. Almost all of these problems derived from our leaving gold, and we're now groping our way back to a gold standard along with the European economies. In 1987, when Jim Baker, currently our Secretary of State, was Ronald Reagan's Treasury Secretary, he spoke to the IMF and said that we had to move towards a system whereby we once again would make use of the gold reserves. When we were in Moscow last September, Governor Angell told the Russians that if they went to a gold ruble, they would no doubt force the Western economies back on a gold standard, because the Soviets would be able to command the lowest interest rates in the world.
Let us suppose that President Gorbachev has appointed you to be his economic adviser. How would you outline to him, and to the Soviet population, the course of action to be followed?
As I explained to the Soviet officials when they asked this question of me in April, the first thing I would do would be to instruct Soviet officials not to tell the population that it will be necessary to have price increases in order to move towards a market economy. Because the people are smart enough to know that, if the prices will be going up, they had better buy as much as they can now; get rid of the rubles as fast as they can, in order to hoard goods in advance of the inflation. And those farmers who have foodstuffs to sell will withhold their goods from the market, knowing that they will then get a better price.
If the Soviet government were to deflate, people would be smart enough to get their goods to market. The farmers would move their foodstuffs to the stores as quickly as possible before the prices start to fall. The problem was very similar in Germany, in 1948, when the Reichsmark had lost all credibility and the common currency in Germany was American cigarettes and nylon stockings. Ludwig Erhardt exchanged ten Reichsmark for one Deutschemark and guaranteed the Deutschemark in terms of dollars. This also had the effect of lowering the effective tax rate: whereas before Germans paid a 90 percent tax rate on the equivalent of $900, after the conversion they encountered that punitive tax rate at the equivalent of $9,000 a year. In other words, an enormous tax cut accompanied the monetary reform. So, in a matter of days, the empty shelves of West Germany were filled with goods, and the German economic miracle had begun. I think a similar economic miracle is ready and waiting for the Soviet Union, with its vast resources and its highly trained and intelligent population and work force. All it requires is a restoration of faith in their currency -- a belief that it is better to hold money than goods.
But the goods and services are not available in the Soviet Union at the moment.
Governor Angell had the best answer when this question was put to him at the USSR Gosbank last September. He said that when the currency has value, when people really believe that the currency has more value than the goods that they can produce, then the way to get that currency is to work like hell -- to become as productive as you can, to find ways to produce goods and services in order to get your hands on these rubles that are now worth something instead of not being worth anything. The whole thrust of our argument is: instead of worrying about there being too many rubles, think of ways to increase the demand for them. And the best way to increase the demand for them is to pledge, in terms of gold, that once this system is established, there will be no devaluations in the future. The people will then trust the government if they see that in the event of an inflation, the government is going to lose all its gold. Once the people know that the government is going to lose its gold, then they will trust the government to not devalue.
Paul Craig Roberts and other distinguished observers, argue that the acceptance of private property rights is a prerequisite for any meaningful reform.
I think that property rights are very important, and the topic will increasingly come to the forefront, but they are secondary to the banking issue. After all, the private property rights come down to the value of the labor, the savings of individuals, and how much integrity those will have. So the first question of the convertible ruble is tied up with the question of private property. Yet some progress could be made on a basis of leasing rather than property. I don't agree with Paul Craig Roberts that the first order of business is to privatize property, and then move on to other questions. My first preference is to create the banking system and then tackle the secondary issues.
One of the promising measures that has been adopted -- in principle at least -- is the sale to tenants of state housing. Most of the Soviet economists who have discussed this course of action have recommended that the prices of apartments be fixed at a high level in order to mop up as much of the monetary overhang as possible. I gather that you would disagree with their advocacy?
Yes, very much so. In fact, I argued that the Soviet government would itself benefit the most by getting the housing stock as rapidly as possible into the hands of the people. And to make this easy, I would discount them at as low as 10 percent on the ruble. If people knew they were getting a good deal, they would work very hard to acquire the rubles in order to get the properties, and then fix them up. When they come to sell those properties to others, the government would then be in a position to tax the gain through property taxes, and thereby benefit. I explained to my Soviet hosts that this was essentially an argument made over the issue of our public lands at the formation of the United States. One faction in our government said we should hold on to the Western public lands, or sell them at very high prices, but Thomas Jefferson argued that we should sell them at the cheapest possible prices, and even throw in the mineral rights. First we were selling at two and a half dollars an acre, and the land wasn't selling fast enough. So Jefferson made it a dollar and a quarter an acre. The moral for the Soviet and East European governments is not to go for short-term gains, but to aim at getting property and resources that are now state-owned into the hands of individuals who will work on them and give them added value.
Would you open this market to foreigners? They might well snap up enormous tracts of land or much of the available housing.
As far as housing is concerned, the tenants should have the first rights to purchase the property. In fact, I would recommend that people who have been living for, say, ten or more years in an apartment be given the property outright, while those who have occupied an apartment for one year be given 10 percent equity. The Soviet people should have the first crack at the wealth of the country. However, the country could also benefit from any influx of capital and expertise from abroad. I feel that properties should be auctioned, rather than be sold at fixed prices. But this and other decisions will be easier to take once the ruble is convertible.
In your writings and in your advice to Soviet officials, you have laid great emphasis -- after banking and monetary reform -- upon taxation reform. Since nearly all of our listeners pay taxes, they would probably like to hear more about your proposals.
Well, this was the essence of the Reagan revolution in the United States. After we had so many years of inflation in the 1970s, in the administrations of Presidents Nixon, Ford, and Carter, our citizens were pushed into very high tax brackets that were originally meant only for very rich people. And this discouraged production, and productivity, and incentives. Because the government was taking so much of their earnings, the people were left with too little, and therefore were not producing.
This could become a problem in the Soviet Union and Eastern Europe. Indeed, it is a problem right now in Poland, where they are moving to a market system. In freeing price controls, they devalued their currency excessively, and they've left themselves with a tax system that is suboptimal. The tax system in Poland now makes it almost impossible for entrepreneurial activity to take place. It's very difficult for the economy to get off the ground when high tax rates form barriers to human initiative, productivity, and commerce.
Thus, in the Soviet Union, the first order of business is monetary reform with a convertible ruble. The second priority is to set tax rates that are reasonable and that permit the people who are out there producing to keep enough of their output so that they're encouraged to produce more. Excessive tax rates are the easiest way to shut off economic growth.
Until now, for most Soviet workers and employees, a flat rate of 13 percent has been levied on incomes over 100 rubles a month. With effect from 1 July , incomes of over 700 rubles a month will be subject to steeply progressive tax rates. I imagine that you would disapprove of this?
Absolutely. In fact, I discussed this with President Bush at Camp David, a year ago, in April 1989, when I read in the Financial Times of the Soviet proposals to introduce tax rates that would really smother all economic activity. We agreed that the Soviet government should be advised that this is not the way to move towards a robust economy. It was also agreed that the United States should recommend those precepts that had proved successful for us in the past, and discourage those ideas that had failed for us. So the recent Soviet moves on taxation are alarming, as is the failure to implement a monetary reform.
You evidently don't think much of the new income tax provisions. What about corporation tax? In the latest version of his economic reform program that was unveiled in May, Premier Ryzhkov proposed an "excess profits tax." To quote: "It is expedient to limit the upper level of profitability in industry to 30 percent and in agricultural enterprises to 40 percent." Would you approve?
I feel that when you set rates like those, you are in fact telling workers that you want them to produce only up to those levels. Yet the situation in the Soviet Union is such that workers must be given incentives to work flat out, to produce as much as possible. Indeed, on the contrary, I believe that once they have reached a certain level of output, the workers should be permitted to keep everything they produce, to be exempt from taxation on earnings above a specified limit. Then they'll be flooded with goods. I suspect that President Gorbachev's advisers favor high rates of taxation in the misguided belief that the Soviet people demand this on egalitarian grounds. I submit that the Soviet people can well understand that low tax rates would stimulate productivity.
In the third edition of your The Way the World Works, published in 1989, you were optimistic about the growth prospects of the Soviet Union. In the light of your recent visits to Moscow and your talks with decision makers there, has your assessment changed? And, finally, could you sum up your prescription for the Soviet economy.
I believe that the natural resources of the Soviet Union will provide the basis for rapid economic development between now and the end of the century. I do not know how long it will take for the political leadership to find its way to the path to growth, but I have been extremely discouraged and frustrated to observe, during the past few months, the absence of any coherent sense of direction within that leadership, as shown principally by Prime Minister Ryzhkov and by Leonid Abalkin. Unless they find a way to arrest the decline, there is every chance of the country breaking down into civil unrest before the summer is out, with strikes and food riots as people become more and more desperate over the deteriorating situation. Eventually, a leadership will emerge with the right answers: it may be Yeltsin, or it may be Gorbachev with a new team of advisers. And I suggest that this new team will take our advice and will acknowledge the need for a new banking and monetary system, and a convertible currency.