Book Review: Russian Currency and Finance: A Currency Board Approach to Reform by Steve H. Hanke, Lars Jonung, and Kurt Schuler
SEPTEMBER 01, 1994 by WILLIAM H. PETERSON
Routledge, 1993 • 238 pages • $49.95 cloth (also available from Laissez Faire Books at $21.95)
Once upon a time—in 1959—I propounded, in both Challenge and National Review, Peterson’s Law on inflation, as follows:
History shows that money will multiply in volume and divide in value over the long run. Or expressed differently, the purchasing power of currency will vary inversely with the magnitude of the public debt.
In the intervening 35 years, depending on the country, inflation has forged ahead relentlessly, sometimes quickly, sometimes slowly but always ahead—a 5,000-year-old story of multiplication of monetary volume and division in currency value. So currencies rot and governments rat on their citizens. That was my message.
Today virtually all currencies are unhealthy, but the sickest by far is the Russian ruble. Notwithstanding considerable financial help from Western governments and the International Monetary Fund, Russia suffers rapid inflation—some 15 percent a month since 1991 and recently 20 percent a month. Further acceleration is expected as the Yeltsin government, pressured by its statist parliament, increases lines of credit to its failing state industries.
The authors (Messrs. Hanke and Schuler are with the Johns Hopkins University, Mr. Jonung with the Stockholm School of Economics) worry. At some point, Russian industries will have to fire workers and consumers will have to pay higher real prices for formerly subsidized goods. Political upheaval is in prospect. Write the authors: “It is unclear whether the Russian public will blame the parliament, the executive branch or both for extreme inflation, but whatever the case, the result will be a new configuration of political forces.” Question: Is a new Stalin waiting in the wings?
Much depends on Russia’s coping realistically with inflation. Inflation is a structural as well as a quantitative problem—too much money chasing too few goods. A price, after all, is but a ratio of money to a particular good. Slow down or stop monetary growth, and you tend to at least slow down or stop the rate of price rise for a broad spectrum of goods.
The question for Russia is: How? Here’s where structure comes in. The authors, addressing the Russian authorities, advance a two-pronged program. First, realize that sustainable economic growth underwrites political stability and that such growth is only possible with predictable money, a sound currency that at least reasonably maintains its value from one period to another. Such a ruble would halt Russia’s “rush into goods” and “dollarization” of its economy. It would command both domestic and international respect. It would permit saving, investment, foreign trade, and economic growth to go forward.
Then second, with all deliberate speed, convert the Central Bank of Russia into a currency board such as prevails in Hong Kong. A currency board differs from a central bank in key ways. It supplies notes and coins only, while the central bank also supplies bank deposits, especially on behalf of the government. A currency board fixes an exchange rate with a reserve currency such as the U.S. dollar, while a central bank has a pegged or floating exchange rate. A currency board has foreign reserves of 100 percent and full convertibility, while the central bank has variable foreign reserves and limited convertibility.
The point of these and other differences spelled out in the book is that a currency board cannot create inflation while the central bank, usually a creature of a government, often cannot fight off political pressure for inflation. Short-run interests conquer long-run interests, as a painful rule.
And that’s probably when the history of currency boards—and dozens are listed in Appendix C in this important volume—shows them to be most helpful but of usually limited duration. The Philippines, for example, had three episodes with currency boards. Besides Hong Kong today, currency board countries include Bermuda, Gibraltar, and Lithuania, though Argentina and Estonia have currency board features. All these countries have relatively low inflation and good growth.
So Hartke, Jonung, and Schuler are unquestionably right and deserve credit. Russian salvation likely lies in sound money and a currency board. The problem is: Do the Russian authorities, for all their large gold deposits, have the vision and courage to adopt them? Peterson’s Law, foreboding though it may be, seems to prevail in the end. 
Dr. Peterson, an adjunct scholar with the Heritage Foundation, is completing a book on politics that broadens his original law; it’s called Peterson’s Law: Why Things Go Wrong.