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January 30, 2001
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Its the Dollar

by Michael S. Bernstam and Alvin Rabushka

Since the dissolution of the Soviet Union, the Russian ruble has had a bumpy ride. It has suffered periodic devaluations. In 1991, the last year of the Soviet Union, the midyear exchange rate of the ruble was R42 to $1. It subsequently fell from R180:$1 in January 1992 to R4,640:$1 at the end of 1995, by which time chronic inflation totaled 200,000%. The dollar had become an alternative currency to the ruble as a result of its chronic depreciation. The ruble attained a measure of relative stability during 19961997. On that basis, in 1997, the government officially de-dollarized the economy, requiring that all legal payments be made in rubles. It redenominated the ruble on January 1, 1998, at a rate of one new ruble to one thousand old rubles, lopping off three zeros. The ruble remained relatively stable, trading at about R6:$1, until August 17, 1998, when it was again devalued, falling to about R10:$1. It now trades at R28.4:$1.

To protect themselves from inflation, Russians accumulate dollars, so much so that they reportedly hold the largest stock of U.S. currency in any country outside the United States, under mattresses and in cookie jars. Estimates run at $4050 billion. When newly-designed U.S. banknotes were first issued in 1996, especially hundred-dollar bills, Treasury officials went to great lengths to explain their features to Russians, and reassure them that existing notes would not be demonetized.

Rubles remain Russias sole official legal tender. However, Russians are free to buy dollars on the open market inside Russia. Dollars can be used in unofficial transactions, but not as legal tender. This restriction means that owners of dollars do earn interest and do not lend them to enterprises as a source of finance.

Meanwhile, there is endless hand wringing, both inside and outside Russia, on the correct value of the ruble. Some express concern that the ruble is overvalued, because Russian inflation has outpaced that of the country's main trading partners. An overvalued ruble is seen to place Russian exports at a competitive disadvantage. An overvalued ruble is also seen to cheapen imports, thus reducing the domestic competitiveness of Russian industry. Overvaluation due to large dollar inflows and their Central Bank purchases inflate the ruble money supply and the price level and elicits calls for sterilization (withdrawal of rubles from circulation by fiscal and other means). On rare occasion, there is concern that the ruble may be undervalued, which means that Russia would be importing inflation and investors stay away from holding ruble-denominated assets. The Central Bank is cognizant of this controversy. It routinely states that it will try to maintain the ruble within a narrow trading range against the dollar in order to insure ruble price stability.

Most concerns center on financial stability, ever fragile. But there is a ready solution to the matter.

With the stroke of a pen, the Russian government can end the controversy, once and for all. All that is required is to issue a single order, taken from the face of U.S. currency, which states: The U.S. dollar is legal tender for all debts, public and private. This means that taxes, salaries, and all invoices can be paid in dollars.

Such an order does not constitute dollarization, which would replace rubles with dollars, as exists in Panama, the British Virgin Islands, and the Turks and Caicos Islands, has recently happened in Ecuador and El Salvador, is scheduled for Guatemala on May 1, 2001, and is debated for Argentina. Nor is it the equivalent of establishing a currency board, such as in Hong Kong or Argentina, in which dollars constitute backing for ruble banknotes on a 100% basis at a chosen fixed exchange rate, and which the board guarantees to exchange at this fixed rate.

The ruble would also remain legal tender. Both currencies would circulate freely inside Russia.1 There would be no stipulated level of foreign reserves that the Central Bank must maintain as backing for the ruble. Both currencies would compete on the market for the choice of enterprises and consumers.

With the U.S. dollar as legal tender in Russia, the issue of an overvalued ruble disappears. Price stability ceases to be an issue. The stability of the dollar, preserved by the Federal Reserve Board, solves the problem of inflation. The exchange rate between the ruble and dollar would be determined by market forces.

Liberalization, stabilization, etc. would become utterly unnecessary. Exporters who earn foreign currency would no longer have to convert the proceeds into rubles to pay taxes, or invoices, salaries, and other expenses. The government would no longer have to go through the process of buying dollars with rubles to repay foreign debt. Households would be free to use dollars for domestic and foreign purchases. Since Russian exports are largely priced in dollars, the balance of payments would take care of itself automatically.

In short, the holy grail of ruble macroeconomic stability would cease to matter. Perhaps, too, the IMF?

1. How it would work in general and in the banking sector in particular is discussed in Fixing Russias Bank: A Proposal for Growth, pp. 9698.