My Five Days in Washington Jude Wanniski March 30, 2001

In early January, I discussed the monetary deflation with several incoming members of the Bush administration. I drew circles and arrows to illustrate my thesis that the pure monetary deflation, which has our financial markets and economy in its grip, cannot be overcome by tax cuts, interest rate cuts, or regulatory relief -- the three areas where the administration, the Congress and the Fed are concentrating their efforts. The most important presentation I made was to Vice President Dick Cheney on January 7. I advised him the problem easily could be corrected by increasing the price of gold by having the Fed add sufficient liquidity, but that because I was alone in making the argument, nothing could be done until enough damage had been done to Wall Street to force policymakers, out of fear, to take it seriously. Last Saturday, I returned to Washington and a broader audience indeed had been made attentive by the interim convulsions on Wall Street -- plus the client letters and memos I’ve sent out since the January meeting. Here are the folks to whom I made presentations; their reaction was uniformly respectful, with great interest in the different methods I thought might be considered to solve the problem:

§ Sen. Trent Lott [R-MS], Senate Majority Leader, member of Senate Finance;
§ Sen. Chuck Grassley [R-IA], chairman of Senate Finance;
§ Sen. Don Nickles [R-OK], assistant Senate majority leader;
§ Sen. Robert Torricelli [D-NJ], member of Senate Finance;
§ Paul O’Neill, U.S. Treasury Secretary;
§ Kenneth Dam, Deputy Treasury Secretary (nominee);
§ Tim Adams, chief of staff, U.S. Treasury;
§ Dean McGrath, deputy chief of staff, office of the Vice President;
§ Cesar Conda, director of domestic policy, office of Vice President;
§ Ronald Christie, assistant director, office of Vice President;
§ Jim Carter, assistant to the director of the White House National Economic Council;
§ Brian Reardon, chief economist, Senate Republican Policy Committee;
§ Richard Ribbentrop, legis. dir. Sen. Phil Gramm [R-TX], chair of Sen. Banking Comm;
§ Steve Robinson, staff director, Senate Finance Committee;
§ Wayne Boyles, III, legis.asst., Sen. Jesse Helms [R-NC];
§ Jon Shiner, asst. Rep. Charles Rangel [D-NY], ranking Dem. House Ways&Means;
§ Chris Frenze, staff director, Joint Economic Committee of Congress;
§ Robert Kelleher, chief macroeconomist, Joint Economic Committee;
§ David Hoppe, chief of staff to Senate Majority Leader Lott;
§ Larry Hunter, chief economist, Empower America;
§ Grover Norquist, director, Americans for Tax Reform;
§ Jacob Schlesinger, Wall Street Journal Treasury correspondent;
§ Hugh Sidey, Time;
§ Tony Blankley, nationally synd. columnist/former press sec’y to House Speaker Gingrich;
§ Armstrong Williams, TV talk show host (hour long interview).
§ Herb Klein, publisher, San Diego Union;
§ Bob Novak, syndicated columnist.

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My basic argument to each began with the assertion that the events we have been witnessing since the deflation began in November 1996 demonstrate that global capitalism cannot function satisfactorily with a floating unit of account. They must begin planning, for an international monetary reform of the kind the Reagan administration tried but aborted in 1987, when Treasury Secretary James Baker III told the International Monetary Fund in Washington that the major exchange rates had to be stabilized, using a commodity basket including gold as a reference point. I put it more bluntly: We have to return to a gold standard or continue to face inflationary and deflationary crises -- which stem from errors by the world’s central bankers in their matching of liquidity supply to liquidity demand.

The main point I made was that deflations are caused by monetary errors by the Fed, signaled by a falling gold price. Deflations can only be corrected by inflationary adjustments, which bring debtor/creditor relationships back into balance, reducing the bankruptcies that would otherwise have to occur to equilibrate with a lower general price level. An end to deflation is signaled by a rise in the gold price to an appropriate level, in this case to between $325 and $350 from its current $258 level. Deeper tax cuts, as some supply-siders advocate, would increase incentives for production and exchange, but also worsen the deflation. It is like feeding a skinny teenager until he is robust, while expecting him to wear the same suit of clothes. Liquidity must expand to fit the bigger economy or each dollar of liquidity must cover more of the body economic.

A contraction -- such as the Great Depression -- occurs when tax rates and tariffs climb to unnecessarily high levels. Producers who were planning to export part of their production and receive imports of foreign surpluses in exchange will be unable to export as much if tariffs rise because foreigners will not be able to get their exports across our higher tariff wall. Inventories will rise on both sides of the tariff wall and prices will fall as the inventories are cleared. The same is true when domestic producers suddenly face a higher tax rate, which is a “higher wall” between them and other domestic producers. Inventories rise and prices fall until the inventories are cleared. These kinds of economic episodes cannot be “solved” by devaluing the unit of account, as was evident when President Roosevelt devalued the dollar in 1933-34. The Depression only deepened because Roosevelt also added tax increases on top of President Hoover’s tariff and tax increases.

Everyone asked how to solve the problem, of course, and if it could be done without returning to a gold standard. There could be temporary relief, I said, if the government followed the pattern established by the Reagan administration in 1985, when the second round of Reagan tax cuts were expanding the demand for liquidity and the Fed was not responding, as it would have had to do automatically if the dollar were linked to gold. Our Treasury and Fed officials met at the Plaza Hotel in NYC with counterparts from Germany and Japan. They agreed to keep exchange rates between their currencies stable, which put the Fed on a slightly inflationary footing at the time. The gold price rose gradually from $300 to an excessive $400 before settling back to $350 in early 1986. There it stabilized until the economy encountered the Clinton tax increase of 1993, which reduced the demand for liquidity and sent gold higher. Because my analytical framework became clear to those I met, they were then able to see how the Fed’s errors since 1996 caused the Asian crisis and the energy crisis that persists to this day. I can’t say how much they agreed with my thesis or how they would respond if asked about it. I told them I was only the “doctor” diagnosing the illness in the economy and warning that the economy will get worse and worse unless they take the gold signal seriously -- as it is a sure sign that the four-year accumulation of small deflationary errors has turned into one big golden snowball.