All Commentary
Tuesday, January 1, 1991

A Note on Converting the Ruble

Dr. Wolfram is the George Munson Professor of Political Economy at Hillsdale College.

The 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 convertible 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 marketable to the rest of the world.

What Is Money?

In discussing the convertibility of the ruble, one must first determine what money is, and why anyone would wish to possess it. Ludwig von Mises established in The Theory of Money and Credit (1912) that money is simply a 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 will be established in the market as the good that trades for all other goods. This will occur naturally, without the need for government action.

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-Backed Ruble?

It has been suggested that backing the ruble with gold will make it a convertible currency. This, of course, will work after a fashion. But let us think for a moment about what we mean by backing the ruble with gold. It means that the Soviet government would be willing to exchange a certain amount of gold for a paper ruble. This means that rubles will have 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 produce 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 will run out of gold as its citizens 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 Only Solution: Free Markets

The only thing that will lead to long-run convertibility of the ruble is the production of goods and services in the Soviet Union that can be exchanged for goods and services produced in other 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 purpose 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 demonstrated over half a century ago that there is no method by which a socialist economy can determine the proper allocation of resources. 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 Economist will document the inability of the Soviet economy to function. The Soviet Union is having difficulty servicing its debts because the markets for its oil and arms, the only items that have a ready market in the rest of the world, are deteriorating.

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 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 currency is that it puts constraints on the issuing gov-eminent that disallow the debasing of the currency. 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 economy is the primary prerequisite to making the Soviet currency convertible.

Once a free market economic system is established, 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 conjunction 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. Most probably, the West German mark, the U.S. dollar, and the Swiss franc 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.

1.   For a nice discussion of Carl Menger’s theory of the origin of money, see Murray Rothbard, What Has Government Done To Our Money? (San Rafael, Ca.: Libertarian Publishers, 1985), or directly, Carl Menger Principles of Economics (Glencoe, Ill.: Free Press, 1950).

2.   See, for example, Murray Rothbard, “A Gold Standard for Russia,” The Free Market, January 1990, p. 3.

3.   Ludwig yon Mises, Socialism.’ An Economic and Sociological Analysis, 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-argued case for a free market in money can be found in Hans Sennholz, Money and Freedom (Spring Mills, Penn.: Libertarian Press, 1985).

  • Gary Wolfram is the William E. Simon Professor of Economics at Hillsdale College and President of Hillsdale Policy Group, a consulting firm specializing in taxation and policy analysis.