Policy Analysis No. 348

Replacing Potemkin Capitalism: Russia’s Need for a Free-Market Financial System

Executive Summary

On August 17, 1998, Russia devalued the ruble and stopped payment on its government debt, creating a financial crisis that continues today. Some observers have blamed the financial crisis, and the poor performance of the Russian economy generally, on government policies that they claim are rigidly laissez faire. However, a closer look at the Russian financial system reveals that it remains fundamentally socialist, though it has superficial capitalist features.

Attempts to preserve the value of the ruble and to prop up Russia’s ailing banking system are misguided. The ruble is a currency of socialism; the government uses it as a tool for making forced transfers of wealth from the Russian people to inefficient enterprises that are holdovers from the socialist era. Russian banks likewise have been mainly vehicles for subsidizing enterprises.

Russia needs a genuinely capitalist monetary system. The system should have two pillars: the U.S. dollar, Russia’s de facto free-enterprise money, and sound banks. Foreign banks should be allowed to compete on equal terms with Russian banks. The central bank should be eliminated, and with it the privileged access of some Russian banks to the resources of the Russian government. Similar reforms have been implemented at least in part in other former socialist countries with good results. In addition to fostering economic growth, the reforms have been politically popular. The U.S. government and international institutions should learn from the experience of those countries and stop supporting Russia’s current monetary institutions.

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Kurt Schuler is a senior economist with the Joint Economic Committee of the U.S. Congress and author, with Steve H. Hanke and Lars Jonung, of Russian Currency and Finance: A Currency Board Approach to Reform (1993). He participated in writing this paper before assuming his current position, and the views expressed here are his own. George A. Selgin is an associate professor at the University of Georgia and an adjunct scholar of the Cato Institute. He is the author of The Theory of Free Banking (1988) and Bank Deregulation and Monetary Order (1996).