Source Pravda.Ru

The Other Piece of the Economic Puzzle

The secret to explosive economic growth is laughably simple: low taxes, stable money. Of all of Vladimir Putin's reforms, by far the most important has been the radical reduction of tax rates. Once the VAT and social taxes are lowered, preferably to single-digit levels, that great project will be nearly complete. Now the Russian leadership must consider the next step - creating a stable currency that will serve as the foundation for all the economic developments that will follow.

After a decade of truly disastrous experiences, Russians are now aware that although a stable currency is not everything, everything is nothing without a stable currency. No matter how much reform, investment, development and education take place, it will all collapse if the currency collapses. If you build on sand you should not be surprised if your house crumbles. Vladimir Lenin reportedly said that the surest way to undermine a society is to debauch the currency. Whether the currency is debauched on purpose or by accident, the effect is the same. Lenin put his principles into action: with the Russian economy collapsing into hyperinflation, in 1921 Lenin introduced the chevronets, a new currency fixed to gold. The reform was a success and Lenin was wildly popular. Russia has a number of monetary options before it today. It can join the Eurozone, for example, but that would mean subservience to the neglected bureaucrats in Brussels, who have an Old World distaste for the kind of low-tax, high-growth policies that are now powering the Russian economy. Also, the European Central Bank does not appear to be a particularly competent institution.

Russia could create a currency board or dollarize, like some countries in Latin America. Dollarization has many advantages, but it would mean leaving the Russian economy at the whims of an unelected Fed governor in Washington, who you can be sure is not looking out for Russia's interests. Alan Greenspan's record is spotty, and his successor will surely be worse. In any case, I think Russia has greater ambitions than to become a monetary vassal to the United States. Russia could create its own central bank in the mold of the Fed or the ECB. Yet what would be gained by this? Unless the Russians can manage a floating currency better than the Fed or ECB (which is extremely unlikely), then Russia might as well use dollars or euros. The Fed, ECB and Bank of Japan struggle constantly with monetary systems that, frankly, don't work very well. Dozens of smaller countries have tried using the same techniques, with results ranging from poor to disastrous.

That leaves one solution, by far the best and the most ambitious of them all: the gold standard. When Karl Marx said in Kapital that gold is money "par excellence," the very best of all the available monetary options, he was merely reflecting conventional wisdom distilled from centuries of experience. After Amsterdam adopted the gold standard in the 17th century, it quickly rose to become Europe's economic and financial powerhouse. Britain's empire, and its financial system, did not circle the globe until Britain dropped its floating currency and adopted a gold standard at the beginning of the 18th century. The United States, which suffered a hyperinflation after the Revolutionary War, established a gold standard in 1792 and stuck to it until 1971. It too became a superpower, and the dollar eventually reigned supreme. Japan had two great eras of growth, which coincide perfectly with the country's two great gold standards: first, from the 1870s to World War I; and second, from 1949 to 1971. The growth of the 1950s and 1960s was later called "miraculous." Germany's own "postwar miracle" began when the great finance minister Ludwig Erhard established the gold-linked deutschemark in 1949, replacing the worthless reichmark. Mao Zedong ended hyperinflation in China when he pegged the yuan to gold in 1950. Julius Caesar pulled Rome out of economic decline by establishing a gold standard. Napoleon put France on a gold standard in 1801, ending the hyperinflation of the 1790s.

A gold standard is very simple to operate. When the free market ruble-gold exchange rate (now displayed on the Bank of Russia's homepage) rises above the specified value, the central bank must sell assets, thus reducing the supply of outstanding rubles, known technically as "base money." By reducing supply, the value of the ruble is supported. When the ruble market price of gold falls below the official parity, the central bank must buy assets, thus increasing the supply of rubles. The increased supply depresses the ruble's value. This is how all the successful gold standards of the last 200 years have operated. The mechanism is essentially identical to a currency board, but the peg is with gold instead of another currency. Like a currency board, the operation of a gold standard is automatic and there is no need for discretionary monetary policy. Note that it is not at all necessary (though it might be desirable) for the central bank to exchange gold and rubles, or even hold any gold at all. Gold coins are not necessary. The great economist David Ricardo, who helped redesign Britain's gold standard in the early 19th century, made exactly this point.

One of the great advantages of a gold standard is that it produces extraordinarily low interest rates. It is common for a government to be able to issue long-term bonds at 3% under a gold standard, and for corporations to borrow at 4%. Amsterdam borrowed at 3% in the 17th century, Britain in the 18th and 19th. During the late 1940s and 1950s, the United States (still on a gold standard at that time) borrowed at least than 3%. At this very moment, gold market interest rates (loans of bullion, repaid in bullion) are below 2% for 1-year loans. The implications for economic development and government finances are obvious.

The U.S. finally eclipsed Britain as the economic and political leader of the world when Britain left the gold standard in September 1931. The U.S., which left the gold standard on August 15, 1971 and promptly fell into monetary disarray, would have been eclipsed itself (perhaps by the Soviet Union) had not every other country in the world followed the U.S. into the inflationary morass. If Putin's tax reforms continue and are paired with monetary reform and the establishment of a golden ruble, Russia would eventually pose a serious challenge to the United States. Do not be surprised if advisors from the U.S. insist that a gold standard would be "impossible." It was not impossible two thousand years ago and it was not impossible in 1965, when the Russian ruble traded at 0.987412 grams of gold. Just this month, Malaysia has proposed the establishment of a gold dinar for trade between Islamic countries.

A challenge, not a threat, for the U.S. would lose nothing if Russia is successful. Indeed, Russia might finally shake the U.S. out of its complacency and help return that increasingly flabby nation to the high ideals of its founders. It might seem incredible to think that Russia could one day surpass the U.S. in global stature, and it would take at least fifty years or a century to do so. But the U.S. didn't look like much in 1792, either.

Nathan Lewis Economist Polyconomics Inc.

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