BusinessWeek: February 4, 1991

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AND NOW, A CRACKDOWN ON CASH

Within hours of the stunning announcement, massive lines had formed in the bitter, early-morning cold, waiting for banks to open. "People are afraid," says Vladimir Kuzmichov, a retired engineer nervously fingering his cash notes outside a Moscow bank. The Soviet state bank had just proclaimed that all 50- and 100-ruble notes would be banned and saving accounts would be partly frozen. Each person could exchange up to 1,000 rubles, the equivalent of less than four months' average pay, for small-denomination notes. Although the move was supposed to be aimed at dealing a blow to black-market operators, who hold huge sums of cash, its real effect will be to wipe out the savings of millions of ordinary Soviets such as Kuzmichov, who have stashed away billions of rubles in mattresses and coffee cans. Many of the wily black-market operators had converted their rubles into dollars long before.

Ruble confiscation is the most draconian fiscal measure taken in decades and another demonstration of Soviet President Mikhail Gorbachev's turn to the right. It may also signal the end of attempts to liberalize the economy. Instead of continuing to promote individual initiative with material rewards, Gorbachev is reasserting a traditional taboo: Having a lot of cash is a crime.

MASS RESIGNATIONS. Gorbachev is beset by an economy near collapse and open rebellion throughout his country. Just two days before the new cash policy, he had expanded his bloody crackdown on the Baltics. That touched off mass resignations of his progressive advisers, who had guided the country toward greater democracy and a market economy. Now, there are signs that the newly empowered KGB, military, and Communist Party bureaucrats could also reverse the "new thinking" foreign policy that has won the Soviets world acclaim and provided support for the U. S. war against Iraq. "Foreign policy is changing dramatically because of the internal situation," says Oleg Bogomolov, a onetime Gorbachev adviser and currently director of Moscow's Institute for International Economic & Political Studies.

Besides curbing the black market, the monetary policy--the first act of new Prime Minister Valentin Pavlov--was aimed at reducing some 300 billion rubles that resulted partly from the vast expansion of the money supply under Gorbachev. Some of those rubles also lie unused in homes and factories because there are too few goods to buy. Gorbachev's radical economic advisers had urged him to diminish the ruble oversupply by selling off state property. Instead, Gorbachev decided to seize individual savings.

Rather than quashing inflation, the policy appears to be merely compounding the chaos in the economy. Confusion ruled on the streets of Moscow as the decree caught citizens and bankers by surprise. At the central telegraph office on Gorky Street, crowds of angry people tried to change their larger bills. Clerks ignored them. Leonid S. Abakhyan, visiting from Armenia, banged on the window in frustration. Just 90 minutes before the decree was made public, the telegraph office had given him three 50 ruble notes. Now, he can't get change to head home. "The railway office won't take it," he complained. "You might as well wrap chocolates in it."

Indeed, the cash policy is almost certain to touch off a backlash among the long-suffering population. Families stand to lose their life savings, while prices for ordinary consumer goods have shot sky-high. Since state stores with cheaper goods are empty, the black market performed a useful function, delivering goods and services. An early Gorbachev reform allowed cooperatives, or small private businesses, to begin replacing the black market in delivering market-priced goods. But they, too, will be badly hurt by the new cash policy.

The monetary move also hints of something more sinister: a widespread KGB crackdown on the economy. To change money, individuals must go to their workplaces and sign documents revealing their incomes. These could lead to KGB and police probes if assets greatly exceed salaries. Some radicals who openly criticized Gorbachev under glasnost now worry about a return to a terror campaign with mass arrests.

COLLAPSE? Ruling the economy by force may be tricky, though. Gorbachev's policies of glasnost and demokratizatzia have stirred up profound yearnings among the Soviet people for free expression and personal material gain--along with nationalist hatreds. The new repression will not encourage hard work and fresh ideas, says Nikolai Petrakov, who quit as Gorbachev's personal economic adviser on Jan. 16. "There are card and rationing systems for both individuals and enterprises," he says. "It's an example of the totalitarian methods where everything is distributed by the center."

He and many other economists believe that the Soviet economy will completely collapse this spring. In addition to the clampdown on the money supply, the government has yet to settle the socially explosive issue of prices. Wholesale prices have been raised nationwide while retail-price hikes are being held in check. Already, a textile factory in the city of Ivanovo has closed its doors because cotton costs have quadrupled. But the factory must still sell products for the same low retail price. This raises the specter of factory closings and unemployment while shop shelves remain bare.

The government faces a dangerous Catch 22. Without retail-price hikes, many levels of the Soviet government will run out of money (page 66). "We can only last until the end of February," says Sergey Tsyplakov, a senior international expert at the Russian parliament. Yet republics from Estonia to Kazakhstan have suspended price hikes because of outcries. Meanwhile, Boris N. Yeltsin, president of the Russian Republic, is pressuring Gorbachev to give in to the republics rather than the Kremlin power structure. Yeltsin won mass support Jan. 20 at a rally outside the Kremlin that drew 300,000 people. They deplored the crackdowns and demanded Gorbachev's resignation. Also in the Russian republic, political parties and environmentalists are trying to form a

movement modeled after Poland's Solidarity.

By early February, the four largest republics--Russia, the Ukraine, Kazakhstan, and Byelorussia--are expected to sign a four-way treaty that could be the basis for a new Soviet Union. Since Gorbachev's government is yet to be included, the pact will be a direct challenge to central authority. The threat would be formidable: The four republics control 82% of industrial production and make up 90% of the people.

LOST GROUND? Gorbachev's shift to the right could have profound implications for U. S. security and world diplomacy. Already, from Washington to Tokyo, diplomats and politicians are growing more worried that the Soviet military mindset is replacing the diplomacy developed by Gorbachev and his former Foreign Minister, Eduard A. Shevardnadze.

Some Moscow observers, such as Bogomolov, believe that the Foreign Ministry has already lost considerable ground to the military--an assertion ministry spokespeople vigorously deny. Shevardnadze quit, Bogomolov speculates, because of disagreements with top military officers last fall over the Soviet acceptance of U. S. policy against Saddam Hussein, a longtime Soviet arms client.

Western diplomats have detected a shift in the atmosphere. For example, the Conventional Forces in Europe treaty signed by Bush and Gorbachev in November in Paris faces a rough ride for ratification in the U. S. Senate. The main reason: Moscow's decision, just before the treaty was signed, to declare three army divisions in Europe as part of its naval forces, and thus not subject to the treaty's reduction provisions.

Similarly, the nearly completed Strategic Arms Reduction Treaty (START) that could be signed at a planned summit in Moscow on Feb. 11-13 needs a final push. But with Shevardnadze gone, "the question is whether the Foreign Ministry is an equal partner in this debate anymore," says a Washington official.

Probably not. The new hardliners will also soon find that they won't be able to save a collapsing economy through sleight-of-hand tricks with the money supply. And ordinary citizens, not black marketeers, will pay the price.

Rose Brady, with Rosemarie Boyle, in Moscow, Bill Javetski in Washington, and Peter Galuszka in New York
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