Russia’s unsound ruble has suffered high and variable inflation leading to high interest rates. Unlike the dollar, the ruble cannot be legally traded for some purposes without special permission. In particular, Russians cannot lawfully send capital abroad. However, restrictions have not prevented a massive illegal flight of capital, estimated by some sources to exceed $100 billion. The instability of the ruble has prompted Russians to use the dollar despite the government’s efforts to discourage it. Officially, all payments within Russia are supposed to be in rubles — but it is estimated that Russians hold at least $40 billion in U.S. dollar notes.
Another cause of the current crisis is that banks have behaved as agents of the government. The largest banks are not mobilizing savings for productive activities; rather, they are conduits through which the government redistributes public funds to favored firms.
Finally, unlike central banks in the West, which generally only influence overall conditions in credit markets, the Central Bank of Russia directs credits to particular favored firms through the banking system. The selected firms’ ability to obtain credit from the central bank has enabled them to avoid the discipline of profit and loss, so they behave in the same inefficient ways as when the state owned them.
Russia has modified rather than dismantled the centralized control that the Communists established. The shaky finances of the Russian government and the spillover from the Asian currency crisis also precipitated the current financial crisis. The government was unable to repay its accumulated debt from current revenue because it was running substantial budget deficits. Very high interest rates further increased the burden of refinancing its ever‐increasing debt. On August 17, 1998, the central bank gave up supporting the ruble at the then‐current rate of 6.3 per dollar. The devaluation and default in effect bankrupted many of the largest Russian banks.
Although the August financial crisis seems to make Russia’s prospects for economic reform dimmer than ever, the crisis creates a fresh opportunity for change. Fortunately, the necessary institutions already exist in Russia or can be imported. A capitalist monetary system requires a sound currency, yet Russia’s currency crisis stems from the government’s attempt to force Russians to use only rubles. To promote a capitalist monetary system, the government should remove in all transactions the barriers to using dollars or other foreign currencies. Intensifying dollarization of the Russian economy will reduce the demand for rubles. The less people use the ruble, the less ability the Central Bank of Russia will have to finance government spending by printing more rubles. Formerly subsidized businesses will have to stop wasting resources or go out of business.
A sound currency needs to be complemented by good banks. Foreign banks, which have the confidence of consumers, can function as genuine gatherers of savings and allocators of investment. To enable them to do so, the Russian government should liberalize its restriction on foreign banks. The Russian financial system is also plagued by an inefficient payments system, which could be improved by the privatization of the central bank’s clearinghouse and the establishment of other clearinghouses.
To acknowledge that Russia is not a good producer of monetary policy need not be shameful or imply a violation of national sovereignty or pride. If the Russian government really wants something to be proud of, let it establish an open monetary system that allows Russians unfettered access not only to the best currencies and the best banks in the world but also to the prosperity that such a system will foster. Other former socialist countries, most notably Estonia, Lithuania and Bulgaria, have already undertaken some of the reforms suggested here and have enjoyed success.
It is grotesque to blame laissez faire for the current financial crisis and for Russia’s wider economic problems since the Soviet Union dissolved. The most effective step that foreign governments and international financial institutions can take is to stop supporting both the Central Bank of Russia and attempts to reform Russian banks from within.