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It was 20 years ago today...

by Kurt Schuler April 2nd, 2014 9:57 pm

...not that Sgt. Pepper taught the band to play, but that Lithuania adopted a quasi currency board. Actually, it was 20 years ago yesterday, when I meant to put up this post. The Lithuanians first heard about the currency board idea from George Selgin, Larry White, and me when a delegation of officials made a trip to the United States in 1990. Lithuania was still part of the Soviet Union but like many of the other Soviet republics was chafing at the bit, and Lithuanian officials were thinking about what policies to enact if and when Lithuania regained independence. Two of the places the delegation visited were Hillsdale College in Michigan, where George and Larry were attending a seminar, and George Mason University, where I was a graduate student. It was pure happenstance that George, Larry, and I were among the then very small number of people who knew anything about currency boards. In the fall of that year, George persuaded the George Edward Durrell Foundation to pay for us to visit Lithuania. We talked to the president, prime minister, and other officials, and wrote what I believe was the first detailed proposal about how to establish a currency board in the circumstances of an economy in transition from socialism. (Unknown to us until later, there had been one or two other recent proposals for a currency board in the Soviet Union, but with fewer specifics than we provided.) We visited again in 1991 with George's colleague at the University of Georgia, Joe Sinkey, an expert on banking,  just before the coup that ousted Mikhail Gorbachev and resulted in the collapse of the Soviet Union.

Lithuania did not immediately establish a currency board, opting instead for a conventional central bank. When it did not work as well as hoped, the government took a second look at the currency board idea. Within Lithuania, the Lithuanian Free Market Institute and especially its president Elena Leontjeva had kept the idea in the debate. Outside, Steve Hanke of Johns Hopkins University had become the best known advocate of currency boards and I had written a number of works with him on applying the currency board idea to other countries. Steve was named a state counselor (a position equal to cabinet rank, though unpaid) to the prime minister. Lithuania adopted not the strict currency board George, Steve, and I advocated, but a quasi currency board retaining some discretionary features the central bank already had. The system was much less discretionary than what it replaced, however.

Twenty years later Lithuania has been through more than one storm, but the currency has remained solid. As was the case with the similar system of Estonia, Lithuania's goal is to adopt the euro, which it expects to do in 2015.

George and I considered advocating free banking for Lithuania and made a case that bank regulation should be light. We lacked confidence in the capacity of Lithuanian bankers to achieve rapidly the stability that had made the best free banking systems elsewhere highly reliable, and it turned out that we were correct. It took a number of years for the banks to become stable, during which time most of the local banks failed or were absorbed by foreign banks. In the meantime, the currency gave one element of stability to the financial system. We had hoped that having taken one step away from central banking, the success of the system would lead people to consider that taking another step, to free banking, would likewise be advantageous, but it didn' t happen.

A reminiscence I wrote for the tenth anniversary of the system is here. An interview with Steve Hanke on the 15th anniversary is here.

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