General Confusion on Economic Policies Jude Wanniski October 15, 2003

It isn’t enough that President Bush has a national security team that has consistently misled him on Iraq. Now he seems surrounded by advisors intent on putting silly stuff into his speeches on economic policy, exemplified by his statements yesterday poking Japan and China to appreciate their currencies to help U.S. manufacturers export more goods. It’s no wonder, when there is so much confusion about domestic and international monetary policies among some of the best economists and financial journalists.

In this morning’s Wall Street Journal, Glenn Hubbard of Columbia University writes about the yen in an op-ed titled "Currency Kabuki.” Hubbard was the President’s chief economic advisor until he decided to return to academia last spring after helping design the marvelous tax package that is now working its magic on the stock market and the economy. While still in the administration, he had been shuttling back and forth to Japan, counseling measures to lift its stagnant economy out of the deflation it has suffered for years. His essay begins with this statement: “[Japan] is spending tens of billions of dollars to avoid letting its currency appreciate against [the U.S.], which eschews intervention.” Hubbard’s heart is in the right place, as he argues Japanese monetary policy is “too tight,” which means he must oppose the President’s call for an even stronger yen. In trying to be nice, he resorts to fudging instead of simply making his case. If President Bush read the piece, he might easily think Hubbard was agreeing with him.

Worse yet, Hubbard begins his piece with the gross error that Japan has been “spending tens of billions of dollars” to delay the yen’s appreciation. Indeed, it has been “buying” tens of billions of dollar assets with yen created by the Bank of Japan for that purpose. That’s how Japan lifted itself out of the monetary deflation that was strangling it; the unsterilized portion of those new yen did go into the expansion of the Bank of Japan’s monetary base. The yen price of gold is now a relatively healthy ¥41,000 per ounce. It would really be in the pink at ¥45,000, its optimal level based on its track record over the past 15 to 20 years.  It was below ¥30,000/oz. during 2000, which led to the deepening deflation. Hubbard isn’t alone in his confusion. In today’s NYTimes account of President Bush’s two-day visit to Tokyo, reporter Ken Belson writes in paragraph four that “Japanese authorities have been selling dollars to prevent the yen from rising too quickly,” and in the tenth graph says “Japan has spent a record 13 trillion yen ($119 billion) buying dollars this year.” He gets it right the second time but still does not make it clear that these are not taxpayer yen being spent, but printing press yen created by the BoJ. 

Most of this is sterilized by the sale of yen bonds and the purchase of U.S. Treasury bills. Enough liquidity has leaked out to relieve deflationary pressures, though. Treasury Secretary John Snow, who is as clueless on these issues as he is proficient on fiscal matters, doesn’t seem to understand that he and the President are trying to bully Japan into another deflation crisis. Glenn Hubbard knows what’s going on, but until he is prepared to bring gold into his analysis almost nobody reading his op-eds in the Journal will know what he really thinks. He should say both the U.S. and the Asian economies would benefit the most by economic growth at least partly conditioned by getting their respective currencies at optimal levels. This means $350 gold for the dollar and ¥45,000 for the yen. Because China is pegged to the dollar, the yuan also will become optimal when the dollar gets to where it should be. There are folks in the administration who understand this, but none at a level where their opinion counts.

There is even less understanding of these currency issues in the Democratic Party. Its leaders and presidential contenders continue to rely upon the neo-Keynesians who think a cheaper dollar is almost invariably good for job creation. The reasoning: if a million Japanese widgets trade for a million American gadgets when the dollar equals ¥360, a 10% depreciation of the dollar buys only ¥324; therefore, Japan will buy an extra 100,000 gadgets from us and we will buy 100,000 fewer widgets from Japan! What a great deal! We will get less for more! But where is the advantage to us? It is in the form of MORE JOBS. We will have to employ 10% more people to make the gadgets for export and also have to employ 10% more people to make widgets we are no longer importing. Fred Bergsten of the Institute for International Economics in Washington actually sold this idea to then Treasury Secretary John Connally, who sold it to Nixon. Here we are 32 years later and we have Bergsten still making the same arguments, but now getting Secretary Snow and President Bush to bite, with the NAM and unions in the background egging them on. 

Fortunately, the Asian central banks are not going along with this pestering and the Democratic political leaders are standing aside, totally confused. The political world seems to have been turned upside down in only six months. In March, Mr. Bush thought he would be in great shape as Commander-in-Chief going into the 2004 elections and would have to pray the economy would be in an expansion mode. He must now worry that Iraq will drag him down in a continuing series of “humiligrating developments,” as Jimmy Durante would put it. With every passing week, though, the news gets better on the economy and on Wall Street. Even the deficit projections at the federal and state levels are being adjusted downward as the exchange economy perks up and tax coffers begin to fill. 

The Democrats mapped out their 2004 political strategy in March on the assumption the President would be home free on Iraq and foreign policy but would remain vulnerable on the economy. If the tax cuts of 2001 did not work, why should the tax cuts of 2003? The leadership and each of the presidential contenders bought the notion that President Clinton succeeded by raising taxes and balancing the budget. California Governor Gray Davis also thought he could succeed along that policy track and now has demonstrated how ugly the result could be. This morning’s <i>Wall Street Journal</i> has an illuminating article by Jacob Schlesinger on how “tax reform” has suddenly become the policy <i>du jour</i> for the Democratic presidential candidates. As they feel the economic ground rising under them, they must try to wriggle out of their pledges to raise taxes if elected President. Raising taxes is now a no-no, except if you can tag the richest of the richest as Senator Lieberman proposes in his “tax reform.” The idea is to reform and simplify the tax system. There are few specifics to date, but we will see more as the primaries approach amid a rising stock market and good holiday sales.

There may soon be a test as the tax legislation now cooking in Congress comes to a boil. This is the legislation we have been watching since July, to offset the end of the Foreign Sales Corporation. It still holds the possibility of supply-side tax cuts. Something has to happen soon in the Ways and Means Committee to clear up the confusion on the House side. The net result should be a positive for the financial markets and the economy and a bill should get to the President before Congress adjourns. If there is no action, the World Trade Organization would almost certainly follow through on its warning to penalize American companies. Two of the biggest hits would be Caterpillar and Boeing, both in House Speaker Denny Hastert’s Illinois. This leads tax-watchers on the Hill to expect the game of chicken House Ways and Means Chairman Bill Thomas is playing with the Democrats on his committee will soon come to an end, with Hastert leaning on Thomas to cut a deal. This would get the Dow Jones Industrials back above 10,000. 

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