A Note on Converting the Ruble; G. Wolfram

22 A Note on Converting the Ruble by Gary Wolfram T he Soviet Union is beset with a myriad of problems as the final collapse of socialism approaches. One of these is how to make the ruble freely convertible with Western currencies. What seems to be missing in the discussion about convertibility is that this problem cannot be solved in isolation. It is impossible to create a con vertible currency without establishing property rights and a system of free exchange such as exists under a market economy. Recent proposals to establish a gold standard or to back the ruble with a basket of commodities will fail in the long run if the economy can't produce goods that are mar ketable to the rest of the world. WhatIs Money? In discussing the convertibility of the ruble, one must first determine what money is, and why any one would wish to possess it. Ludwig von Mises established in The Theory of Money and Credit (1912)that money is simplya medium of exchange.

It is a good that is desired not primarily for direct use, but because it can later be traded for a good that the consumer wishes to use. Money allows indirect exchange, not only in the present time and place, but across time periods and locations. Mises pointed out that the advantages of indirect exchange of goods, and the specialization of labor that this allows, are sufficiently strong that some commodity willbe established in the market as the good that trades for all other goods. This willoccur naturally, without the need for government action.1 Dr. Wolfram is the George Munson Professorof Political Economy at HillsdaleCollege. Thus, someone would want to possess rubles only because he or she hopes to exchange them at a future date for goods or services. When we say we want to make the ruble convertible, what we really mean is that we hope individuals will accept it as a medium of exchange, without being required by their government to do so. They will either trade goods and services for rubles, or they will exchange other mediums of exchange for rubles.

In other words, the ruble will be convertible when the market accepts it as money. A Gold-BackedRuble? It has been suggested that backing the ruble with gold will make it a convertible currency.2 This, of course, willwork after a fashion. But let us think for a moment about what we mean by back ing the ruble with gold. It means that the Soviet government would be willingto exchange a certain amount of gold for a paper ruble. This means that rubles willhave become certificates that are claims to gold. Why would anyone want a gold-backed ruble? Only because one wished to exchange it for goods or services, or for gold, and later to use the gold to exchange for goods or services. Suppose that the Soviet economy remains in disarray, unable to pro duce goods and services that are competitive with the rest of the world. This means that Soviet citizens will find their rubles are convertible all right, in the sense that producers in other countries will accept the Soviet rubles in exchange for goods and services. But the rubles that are accepted won't be traded for Soviet goods and services.

Instead, they will be exchanged for gold. Eventually,the Soviet Union willrun out of gold as its cit izens exchange the gold-backed ruble for foreign goods and foreigners exchange the ruble for Soviet gold. When this happens, the ruble will no longer be convertible, and the Soviets will have traded their stockpile of gold for a basket of Western goods and services. The OnlySolution:FreeMarkets The only thing that will lead to long-run con vertibility of the ruble is the production of goods and services in the Soviet Union that can be exchanged for goods and services produced in oth er countries. And this can only occur through the institution of a free market system of production with full private property rights. It is not the pur pose of this note to argue the efficacy of the free market system. This has been argued elegantly by the Austrian school of economists and within the pages of this journal over the years. Mises demon strated over half a century ago that there is no method by which a socialist economy can deter mine the proper allocation of resources.3 Without free market pricing, value cannot be assigned to the outputs of the system, and thus one has no way of knowing how much to produce of any good or service, what resources should be used in the pro duction of goods or services, how much to produce of intermediate goods, and so on.

Clearly this century's experiment in state-run economies provides ample evidence of the failure of the socialist system, in any form, to produce goods and services that meet the standards of a capitalist economy. Any recent issue of The Economistwilldocument the inability of the Sovi et economy to function. The Soviet Union is hav ing difficulty servicing its debts because the mar kets for its oil and arms, the only items that have a ready market in the rest of the world, are deterio rating.4 Institution of a market economy is the only method by which the Soviet Union can become a sufficiently efficient producer so that there will be a demand for its goods and services from the rest 23 of the world. This is really what the Soviets are after, since they wish access to Western goods and services, with currency convertibility being only the means by which that will be accomplished. This is not to say that the ruble shouldn't be gold-backed. As Mises and others have pointed out, the primary advantage of a gold-backed cur rency is that it puts constraints on the issuing gov ernment that disallow the debasing of the curren cy.5 This makes the currency more useful as a medium of exchange over time and would aid in establishing the long-run convertibility of the ruble. But the institution of a free market econo my is the primary prerequisite to making the Sovi et·currency convertible.

Once a free market economic system is estab lished, a gold-backed ruble would certainly trade in world markets for goods and services as well as exchange for foreign currency. But why not move further into the realm of free markets? In conjunc tion with a gold-backed ruble and a free market economy, allow the Soviet citizens to transact in any currency they choose. Those currencies that were most useful as a medium of exchange would dominate the market. 6 Most probably, the West German mark, the U.S. dollar, and the Swissfranc would be the primary competitors of a gold backed ruble within the Soviet Union. The effect would be to make the ruble convertible in the Soviet Union as well as abroad. D 1. For a nice discussion of Carl Menger's theory of the ori gin of money, see Murray Rothbard, What Has Govern ment Done To Our Money? (San Rafael, Ca.: Libertarian Publishers, 1985), or directly, Carl Menger Principlesof Economics(Glencoe, Ill.: Free Press, 1950).

2. See, for example, Murray Rothbard, "A Gold Stan dard for Russia," The Free Market,January 1990, p. 3. 3. Ludwig von Mises, Socialism:An Economicand Soci ologicalAnalysis,German editions in 1922 and 1932, (latest edition: Indianapolis: Liberty Press/Liberty Classics, 1981). 4. "Russia's latest queue: for creditors," The Economist, May 19-25, 1990,p. 76. 5. See, for example, Mises, The Theory of Money and Credit, (Irvington, N.Y.: FEE, 1971), p. 438. 6. A well-arguedcase for a free marketin moneycan be found in Hans Sennholz, MoneyandFreedom(Spring Mills, Penn.: Libertarian Press, 1985).