The Controversy Over Money

In October 1997 the Bank of Lithuania celebrated a memorable date-the seventy fifth anniversary of itself and the litas. On this occasion people were recalling-with nostalgia and pride-a strong inter-war litas. Its stability was sealed by law-each litas was backed with 0.150462 grams of gold.
Introduced in 1993, the new litas could boast no gold anchor. It had no safeguards against instability, except for the central bank’s good will. We still remember our wallets pulsating because of fluctuations in exchange rates, which were triggered neither by supernatural phenomena nor by objective market forces. They were a typical consequence of central bank interventions. The Bank of Lithuania pursued discretionary, back-door policies. It was an active interventionist and commander.
Many argued, and some still do, that there was no need to introduce a currency board in Lithuania. This issue of The Free Market presents a document of the Bank of Lithuania illustrating what monetary policies the central bank pursued prior to the installment of the currency board. The document in question announces an auction purchase of foreign currency by the central bank. It shows that the Bank of Lithuania exercised coercive interference by ordering commercial banks where to use their assets, “The proceeds received from the auction sale of foreign currency shall be used to credit agriculture.” Further, the upcoming auction was announced merely two hours before it. The general feeling and tone of the document reflects the spontaneity of the then monetary policies and an extempore performance of “classical” functions.
Under such circumstances the credibility of currency was out of the question. Little wonder concerted efforts were made to devise a monetary arrangement that would lay the foundations for sustained economic reforms and private sector growth. Adopted in 1994, the Law on Litas Credibility enforced currency board principles, by which Lithuania renounced discretionary monetary policy in favour of strict rules. However, central bank functions were not repealed but integrated with automatic rules of the issue of notes and coins. This inconsistent approach and run-of-the-mill compromises made the Lithuanian currency board fall short of classical precepts. Eventually, it came to be safeguarded not so much by Lithuanian law but by a memorandum with the International Monetary Fund. Upon signing it, Lithuania pledged to suspend the Bank of Lithuania’s functions and not to abandon the currency board. The memorandum expired in October this year.
The unrelenting battle of the Lithuanian authorities against the currency board, crowned with the newly introduced Monetary Policy Programme, planted the seeds of distrust of the litas. Its symptoms are many in number. The recent policy debates on the legalisation of credits in foreign currency by commercial banks are one of them. Unprotected by law, people are forced to resort to all kinds of precautions against the dilution of money. For this reason business transactions now tend to comprise the condition “provided the litas exchange rate does not change….”
It is regrettable, though understandable, that people are beginning to lose confidence in domestic money. Shortly, it will be backed not with gold-as in the inter-war period-nor with foreign currency and gold reserves-as over the past few years, but with the good will of those in power. This issue of The Free Market provides insight into the politics of money.