Mr. Kurt Schuler is Senior Economist to the Vice Chairman of the Joint Economic Committee of the U.S. Congress. More than a decade ago he and other prominent economists took an active part in making the case for the currency board reform in Lithuania. 070-463
In the following article Mr. Shuler gives reminiscences on how the Law on Litas Credibility, which established the currency board system in Lithuania, saw the day-light in the country.
The ideas ultimately embodied in the Law on Litas Credibility of April 1, 1994 began with a visit by a delegation of Lithuanian government officials and others to the United States in April 1990. The group was gathering ideas potentially useful for advancing Lithuania’s economy and the cause of independence from the Soviet Union. The delegation visited George Mason University in Virginia, where I was a graduate student in economics. I was unable to meet with the group that day, but I wrote a short memorandum suggesting that the simplicity and robustness of a currency board would make it a good monetary system for an independent Lithuania. The memorandum was later translated into Lithuanian and published in the newspaper Permainos.
The delegation also visited Hillsdale College in Michigan. Coincidentally, the college was hosting a conference of economists of the Austrian School of economic thought. Among the participants was George Selgin, then an assistant professor at the University of Georgia. Selgin talked to the group and also suggested a currency board as an appropriate monetary system.
Hearing a currency board proposed independently by two people made a sufficiently strong impression on the delegation that in the summer of 1990 Selgin and I were invited to visit Lithuania. What the delegation did not know was that perhaps only half a dozen people in the United States knew much about currency boards at the time. Selgin and I were both influenced by our study of Hong Kong. In 1987, when he was an assistant professor at George Mason University, Selgin had received a fellowship from the mutual fund company G.T. Management. The fellowship paid the expenses of summer study in Hong Kong under the guidance of the firm’s chief economist, John Greenwood. During the 1988-89 academic years Selgin returned to Hong Kong as a lecturer at the University of Hong Kong. In 1989, I received the G.T. Management summer fellowship. John Greenwood was then, as he remains today, probably the most knowledgeable person about Hong Kong’s somewhat peculiar version of a currency board. He had been instrumental in returning Hong Kong to the currency board system in 1983, as a way of ending a severe currency crisis.
During the summer of 1990, Selgin arranged financing for our trip from the George Edward Durrell Foundation, an organization devoted to the study of monetary questions, and the Atlas Economic Research Foundation. Together, we wrote a draft paper containing ideas on monetary reform as well as some other topics. I presented it to a seminar at George Mason University, while Selgin solicited comments from a few economists around the United States. Milton Friedman gave a characteristic reply, politely but firmly pointing out some defects with the draft.
We visited Vilnius in late October 1990 for a week or so as guests of the Bank for Industry and Construction (Promstroibank). We met with a number of officials, including the bank’s president, Romualdas Visokavicius (later president of the Bank of Lithuania); the Prime Minister, Kazimiera Prunskiene; and the Chairman of the Supreme Council, Vytautas Landsbergis. George Selgin also spoke at the Institute of Economic Science. We were helped during our visit by Mr. Visokavicius, his wife, and a small group of other persons that included Kestutis Glaveckas, Elena Leontjeva, Petras Austrevicius, Vytenis Aleskaitis, and Remigijus Bartaska. The first three members of this group would later found the Lithuanian Free Market Institute (LFMI).
My impression of the centrally planned Soviet economy was that upon close inspection almost everything was shoddy and second-rate. The stores had displayed in the window but few goods on the shelf; restaurants had extensive menus but only actually served a few dishes, usually not prepared well; large apartment buildings had no sidewalks connecting them and no working elevators. The system was rotten, but most Lithuanians knew it was rotten, and they were preparing for the day they would no longer have to live under it. However, because the Soviet system had so long isolated Lithuania, the economic ideas of policymakers were heavily influenced by Soviet examples. We considered it a bad idea simply to imitate the Soviet central bank, for instance, with a Lithuanian central bank based on similar principles, and we expressed our doubts in an interview with the newspaper Respublika.
After returning to the United States, Selgin and I used the balance-sheet data and other information about the workings of the monetary system that we had gathered during our trip to refine our earlier ideas. The resulting paper that was, I believe, the first detailed proposal for a currency board in any centrally planned economy. We explained how Lithuania might generate the foreign reserves for a currency board. We suggested that the most appropriate anchor currency would be the German mark, since after Soviet rule ended, Lithuania’s trade would turn increasingly toward Western Europe. Finally, we proposed how to handle some potential problems with the banking system.
We could not get our proposal published in the United States because it seemed too novel at the time. It was, however, translated into Lithuanian and circulated in Vilnius in photocopied form. We did not know then but later found out that another American economist, Joe Cobb, also recommended a currency board as a possibility for establishing an independent currency in Lithuania at a conference in Vilnius in November 1990. In March 1991, Prime Minister Gediminas Vagnorius invited us to follow up our previous visit, apparently as a result of reading our proposal. On our second trip, Mr. Vagnorius requested George Selgin to return to Lithuania and to bring colleagues if Selgin wished. Selgin therefore asked Joseph Sinkey, Jr., a professor of finance at the University of Georgia, and me to accompany him. Sinkey was the author of an authoritative and widely used textbook on the financial management of commercial banks. We arrived in Vilnius on July 30 and stayed a little more than a week. During our visit we were again helped by some of the same people who had been so hospitable the previous year, especially Elena Leontjeva. Ruta Vitkeviciute (now Vainiene) served as our translator on a few occasions.
Our impression from talking to government officials and observing the policies the Lithuanian government was enacting was that, as in 1990, the government and people knew central planning did not work, but lacked a clear alternative vision. The Bank of Lithuania was just translating Soviet regulations into Lithuanian and enforcing them. It had no plan for making an independent Lithuanian currency convertible. Its officials refused to meet with us. We expressed our scepticism of the bank’s policy and of the coupon rationing scheme that had recently begun. After returning to the United States, we wrote a paper summarizing our ideas, which was published by the Cato Institute in Washington.
The Soviet Union ended sooner than we dared hope. The abortive coup against President Mikhail Gorbachev occurred later in August 1991 and Russia recognized Lithuania’s independence in early September. Given the opportunity to pursue a monetary policy different from that of the Soviet Union, though, Lithuania did not establish a currency board. A central bank had support both within Lithuania and from the International Monetary Fund, which only had a few staff who knew much about currency boards. At a conference in Indianapolis, Indiana in October 1991, sponsored by a group called the International Baltic Commission, two IMF officials told me they thought currency boards were not appropriate and not likely for the Baltic States.
In June 1992 Estonia established a currency board-like monetary system – not an orthodox currency board, but a combination of currency board and central banking elements. The Estonian system was influenced by a short book that I wrote with Steve Hanke and Lars Jonung. Jonung, who suggested the project, was at the time chief economic adviser to the prime minister of Sweden. As such, he was involved in Sweden’s effort to help its Baltic neighbours in their transition to a market economy. Hanke was (and still is) a professor of applied economics at Johns Hopkins University in Baltimore, Maryland. He had learned about currency boards from Sir Alan Walters, a fellow professor and sometime economic adviser to British Prime Minister Margaret Thatcher. I had begun working with Hanke in the summer of 1990 because of our shared interest in currency boards. Hanke visited Estonia in May 1992 to discuss the currency board idea with members of the Estonian parliament. Jonung also visited Estonia and had contact with Estonian government officials and economists.
The success of Estonia’s monetary reform combined with some problems under the original monetary policy of the Bank of Lithuania allowed creating renewed interest in a currency board. Without the untiring efforts of LFMI the idea of a currency board would not have received a second chance. The institute, especially Elena Leontjeva, wrote and talked frequently about the idea to many different audiences. When the time came that the idea was ripe to be reconsidered, LFMI asked Steve Hanke and me to write a short book as we had done in the case of Estonia. It was translated by Ruta Vainiene and published in February 1994. Like the proposal Selgin and I had made, it suggested that the German mark would be the most appropriate anchor currency.
During the debate about reforming the Bank of Lithuania’s monetary policy, Steve Hanke visited Lithuania. He received an appointment as an official but unpaid economic adviser to President Algirdas Brazauskas and kept in contact with the president’s office during the time the Law on Litas Credibility was being drafted. I had frequent opportunities to watch the progress of the drafting while working with Hanke in his office as he received frequent faxes and telephone calls from Vilnius. Hanke and I advocated an orthodox currency board. LFMI gave valuable support and advice to Hanke on the politics involved. Prime Minister Adolfas Slezevicius seemed inclined in our favour, but the Ministry of Finance, the Bank of Lithuania, and the resident representative of the International Monetary Fund were opposed, and tried to retain as much discretionary power for the Bank of Lithuania as they could. The final result was a currency board-like system somewhat like that of Estonia.
In many writings, such as a 1993 book proposing a currency board for Russia, Hanke and I have warned of the dangers of currency board-like systems. They contain incompatible elements, because the discretionary power characteristic of a central bank is opposed to the rules characteristic of a currency board. The problem is one of economic logic as well as politics. Argentina’s currency board-like system came to a bad end in January 2002. Lithuania’s system endured strains in during the banking crisis of 1995 and again after Russia’s financial crisis of 1998. Fortunately, the government chose to adhere mainly to the discipline fostered by the exchange rate rather than to follow the more typical central banking path of devaluation. Again, the Free Market Institute played a key role, by making the case to the government and the public not to return to the policies that had already been tried before 1994 and been unsatisfactory.
The exchange rate of 4 litas per U.S. dollar survived. The switch from the U.S. dollar to the euro as the anchor on February 2, 2002 in a sense fulfilled the recommendations Selgin, Hanke and I had made years earlier to use the German mark. Lithuania will soon become part of the European Union, and it is on track to become a member of the European Central Bank with fewer exchange-rate problems that Poland, for example, may experience because of the difficulty a “pure” central bank has in maintaining a pegged exchange rate.
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The Law on Litas Credibility, while not perfect, was considerably better than the policy it replaced, and over the last ten years it has helped Lithuania develop into an increasingly prosperous market economy.
The ideas expressed in the article represent his personal views only.
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References
Cobb, Joe. 1990. “The True Achievement of State Sovereignty: A Currency for Lithuania.” Unpublished paper presented at a conference in Vilnius, November 28.
Godunavičiaus, Arūno. 1990. “Nepritariame jūsų banko reformai.” Respublika, 26 October, p. 2.
Hanke, Steve H., Lars Jonung, and Kurt Schuler. 1992. Monetary Reform for a Free Estonia: A Currency Board Solution. Stockholm: SNS Förlag. Estonian translation by Avo Viiol Rahareform vabale eestile: valuutafondi lahendus. Tartu, Estonia: Tartu Ülikool, 1992.
Hanke, Steve H., and Kurt Schuler. 1993. Russian Currency and Finance: A Currency Board Approach to Reform. London: Routledge.
Hanke, Steve H., and Kurt Schuler. 1994. Valiutų taryba: pasiūlymai Lietuvai. Translated by Rūta Vainienė. Vilnius: Lietuvos laisvosios rinkos institutas.
Schuler, Kurt. 1990. “Litas nereikalingas iš viso.” [Translated by Vytennis Aleškaitis.] Permainos, September.
Schuler, Kurt 1991. “Currency Board System Urged.” Durrell Journal of Money and Banking, v. 3, no. 1, February, pp. 30-1.
Schuler, Kurt, George Selgin, and Joseph Sinkey, Jr.1991. “Replacing the Rubble in Lithuania: Real Change versus Pseudoreform.” Cato Institute Policy Analysis no. 163, 28 October. http://www.cato.org/pubs/pas/pa-163.html
Selgin, George A. 1991. “Questing for Currency Reform in Lithuania.” Durrell Journal of Money and Banking, v. 3, no. 1, February, pp. 30-1.
Selgin, George A., and Kurt Schuler. 1990b.“Memorandum on Lithuanian Currency Reform.” Proposal submitted to the president and prime minister of Lithuania, November 1990.
