Bulgaria and Bosnia After Ten Years

This article appeared in the September 2007 issue of Globe Asia.

In 1997, bulgaria and bosnia and herzegovina, which iscommonly known as Bosnia, introduced currency board systemson July 1 and August 11 respectively. With a currency boardsystem, a monetary authority issues a domestic currency that isconvertible into an anchor currency at a fixed rate. Confidence inthe domestic currency is established because the monetary authoritymust hold foreign reserves to fully cover the domestic currency thatis issued.

Prior to the introduction of their currency board systems, bothBulgaria and Bosnia were in bad shape. Bulgaria had defaulted onits international debt, narrowly escaped a revolution in late 1996, andwas battling hyperinflation (a rate of inflation per month that exceeded50%) that had virtually wiped out its banking system and sent thereal economy into a free fall. It is worth noting that hyperinflationsare rather rare. There have only been 30 in history, with Bulgaria's1997 hyperinflation being the last one in the twentieth century andZimbabwe's current hyperinflation being the first in this century.

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The newly independent Bosnia and Herzegovina had just comeout of a bloody civil war, one that had disrupted and displaced mostof the population, destroyed 18% and damaged 60% of the housingstock, and covered much of the territory with land mines. Its economywas in shambles, declining to about 20% of the 1990 level. With theexception of the deutschemark, the other three currencies in circulation—the Bosnia and Herzegovina dinar, the Croatian kuna, and theYugoslav dinar—were either unstable or very unstable.

In both Bulgaria and Bosnia, I had an opportunity to play a rolein designing and implementing their currency reforms. In 1991, Ico-authored with Kurt Schuler a monograph Teeth for the BulgarianLev: A Currency Board Solution. After its publication, I began to visitSofia to introduce the currency board idea to government officialsand the public.

In particular, I can recall my meetings over the years with TodorVulchev who served as Governor of the Bulgarian National Bank fromJanuary 1991 to January 1996. He had studied my proposal carefullyand understood it. Indeed, during our meetings, he required no staffprompting. From our first meeting until the last, Vulchev's positionremained the same: "We at the BNB are in full control and can't envisiona scenario in which that wouldn't be the case. In consequence, wehave no need for currency board rules."

These conclusions were echoed in official circles until late 1996.Faced with a hyperinflation and an economic collapse, the official resistanceto the currency board idea began to crumble. What forced itto completely collapse was a turn in public opinion as well as a revoltcarried out in the streets of Sofia.

The public had lost all confidence in the government and theBNB. Instead, it embraced the currency board idea. As an indicator of the public's support for the currency board idea, consider that oneof my books, Currency Boards for Developing Countries, had beentranslated into Bulgarian and reached the top of Sofia's bestseller listin early 1997.

In March 1997, President Petar Stoyanov appointed me as his economicadvisor. My immediate task was to draft a currency board lawand assist in implementing it. On July 1, 1997, Bulgaria introduced acurrency board law to govern the BNB.

Among other things, this episode is further evidence to confirma conclusion made by Milton Friedman in his memoirs: "I have longbelieved that we do not influence the course of events by persuadingpeople that we are right when we make what they regard as radicalproposals. Rather, we exert influence by keeping options availablewhen something has to be done at a time of crisis."

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In Bosnia, the currency board system was mandated in the Dayton/Paris Treaty (December 1995) ending the civil war. To assist inthe implementation of the new currency board system, I was invitedto Sarajevo in December of 1996. And what a trip it was: militarytransport flights, armored cars, bodyguards and other local oddities.

At the time of their installation, critics claimed that neither currencyboard would succeed because Bulgaria and Bosnia didn't meetpreconditions required for a successful currency reform. Those whopeddle this precondition notion claim that a currency board is unlikelyto be successful without the solid fundamentals of adequatereserves, fiscal discipline and a strong and well-managed financialsystem, in addition to the rule of law.

The preconditions argument falls into what I term the "95%Rule":95% of what is written about economics is either wrong or irrelevant.Just look at the accompanying two tables. In the last decade,Bulgaria and Bosnia have experienced sustained economic growth,stable prices and a rapid increase in the demand (as reflected in thegrowth in foreign reserves) for the currencies produced by their currencyboard systems.

I dare say that Indonesia's economy would be in better shape todayif it had followed the sound money path taken by Bulgaria andBosnia ten years ago.