The International Monetary Fund has promised Moscow another $4.5 billion, supposedly to promote market reforms. That's too bad, since such a promise bolsters the views of those Russians who blame their current financial crisis on their government's allegedly rigid laissez-faire reforms. Despite having the illusion of reform, Russia's financial system today is in a chaotic state that might be called "Potemkin capitalism." Superficially, the financial system looks market based; however, closer inspection reveals that it remains fundamentally socialist.
Russia's unsound ruble has suffered high and variable inflation leading tohigh interest rates. Unlike the dollar, the ruble cannot be legally tradedfor some purposes without special permission. In particular, Russianscannot lawfully send capital abroad. However, restrictions have notprevented a massive illegal flight of capital, estimated by some sources toexceed $100 billion. The instability of the ruble has prompted Russians touse the dollar despite the government's efforts to discourage it.Officially, all payments within Russia are supposed to be in rubles -- butit is estimated that Russians hold at least $40 billion in U.S. dollarnotes.
Another cause of the current crisis is that banks have behaved as agentsofthe government. The largest banks are not mobilizing savings forproductiveactivities; rather, they are conduits through which the governmentredistributes public funds to favored firms.
Finally, unlike central banks in the West, which generally only influenceoverall conditions in credit markets, the Central Bank of Russia directscredits to particular favored firms through the banking system. Theselected firms' ability to obtain credit from the central bank has enabledthem to avoid the discipline of profit and loss, so they behave in the sameinefficient ways as when the state owned them.
Russia has modified rather than dismantled the centralized control thattheCommunists established. The shaky finances of the Russian government andthe spillover from the Asian currency crisis also precipitated the currentfinancial crisis. The government was unable to repay its accumulated debtfrom current revenue because it was running substantial budget deficits.Very high interest rates further increased the burden of refinancing itsever-increasing debt. On August 17, 1998, the central bank gave upsupporting the ruble at the then-current rate of 6.3 per dollar. Thedevaluation and default in effect bankrupted many of the largest Russianbanks.
Although the August financial crisis seems to make Russia's prospects foreconomic reform dimmer than ever, the crisis creates a fresh opportunityforchange. Fortunately, the necessary institutions already exist in Russia orcan be imported. A capitalist monetary system requires a sound currency,yet Russia's currency crisis stems from the government's attempt to forceRussians to use only rubles. To promote a capitalist monetary system, thegovernment should remove in all transactions the barriers to using dollarsor other foreign currencies. Intensifying dollarization of the Russianeconomy will reduce the demand for rubles. The less people use the ruble,the less ability the Central Bank of Russia will have to finance governmentspending by printing more rubles. Formerly subsidized businesses will haveto 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 gatherersofsavings and allocators of investment. To enable them to do so, the Russiangovernment should liberalize its restriction on foreign banks. The Russianfinancial system is also plagued by an inefficient payments system, whichcould be improved by the privatization of the central bank's clearinghouseand the establishment of other clearinghouses.
To acknowledge that Russia is not a good producer of monetary policy neednot be shameful or imply a violation of national sovereignty or pride. Ifthe Russian government really wants something to be proud of, let itestablish an open monetary system that allows Russians unfettered accessnotonly to the best currencies and the best banks in the world but also to theprosperity that such a system will foster. Other former socialistcountries, most notably Estonia, Lithuania and Bulgaria, have alreadyundertaken some of the reforms suggested here and have enjoyed success.
It is grotesque to blame laissez faire for the current financial crisis andfor Russia's wider economic problems since the Soviet Union dissolved. Themost effective step that foreign governments and international financialinstitutions can take is to stop supporting both the Central Bank of Russiaand attempts to reform Russian banks from within.