A Monetary Moment of Truth Jude Wanniski June 18, 1990

With the price of gold finally trading a bit below $350, the Fed has another opportunity to stabilize the dollar at this level when the Federal Open Market Committee meets July 3. It could do so by gently easing, lowering the fed funds rate a smidgeon to 8 and an eighth or 8 and a quarter from the current 8 and three eighths. If the Fed does so, with Governor Wayne Angell almost surely taking the lead in arguing such a move, we would expect a robust July rally in bonds and stocks.

The importance of $350 gold is that it is Angell's target, one he has used as a lodestar during his four years at the Fed. It was $350 when he was sworn in, February 7, 1986. At the time, he told the Senate Banking Committee he would consider his tenure a failure if he could not hold the commodity purchasing power of the dollar within 10% of the range he found on taking office. From 1983-85 I had used $400 gold as the optimum price ~ one that balances the interests of dollar debtors and creditors. But I was persuaded that $350 -- exactly ten times the official price abandoned in 1971 --was a more appropriate level.

In August of 1986, with gold at $350, Angell argued unsuccessfully against an aggressive easing of policy. Gold ballooned over $400 and the bond market sagged. In October of 1987, with gold snugged back down to $370, he unsuccessfully argued against devaluation of the dollar, and watched the stock market crash when Treasury devaluationists won that argument. Last December, with gold at $413, Angell was again unsuccessful in arguing against ease, correctly predicting that the bond market would not appreciate the inflationary implications of easing. Angell's December dissenting vote was crucial, in that he put at risk his Price-Level Targeting Model. If he'd been wrong, he would have had egg all over his face for a long, long time, and so would we. The Fed's resistance early this year to the continued pressures for easy money from the Treasury and White House is a tribute to Angell's enhanced stature and the positive influence he has had on Chairman Alan Greenspan and other Fed governors. Around the White House and Treasury, which has been consistently wrong on monetary policy, Angell is viewed as being "erratic," "inconsistent," and even "flaky," while in fact he has been a rock of consistency. The whispering campaign against him of course comes from Keynesians and monetarists who are horrified at his resolve and effectiveness.

It helps to bear in mind that the timing of the July 3 FOMC meeting is critical to the continuing conflict between supply-siders and demand-siders. From an intellectual standpoint, it would be least helpful if the Administration concluded a budget agreement with the Democratic leadership in Congress in the next two weeks. For the Fed to then follow with an easing of policy would be seen as proof of a deal involving fiscal austerity and monetary ease. In fact, no budget deal is possible without a cut in the capital gains tax. The White House has made this quite clear. This means the deal would be fiscally expansive, not austere. And the apparent shift to an easy money policy would in fact represent a tightening of the dollar toward gold at $350, ending a deflation rather than beginning an inflation.

By this reasoning, the optimum scenario would be continued administration difficulty in reaching an agreement with the Democrats until after the July 3 FOMC meeting. Then, a moderate easing by the Fed would still be reported by the financial press as having stemmed from fears of recession, but with no connection to the budget summit. Angell, though, would be seen by the financial markets as being dominant with his P-LT Model. It makes all the difference in the world to the markets whether the United States is going to use monetary policy to goose the economy along or maintain the purchasing power of the dollar. Clear signals are better than conflicting signals, and interest rates would come down much faster with the optimum scenario.

The clearest signal of all would be the President's nomination of Angell to be the new Vice Chairman of the Fed. The resignation of Manuel Johnson is a setback for the supply-side, but it is not as great as it would have been without Angell's December gamble. This is because Johnson always put more emphasis on the yield curve, as Alan Reynolds pointed out. Simply put, in December, Angell bet on gold and Johnson on the yield curve, and gold won. Whoever comes to the Fed to take the open seat will now have the benefit of Angell's record. As long as the nominee is not an ideologue who simply rejects evidence, chances are that the Fed will not be weakened.

CEA Chairman Michael Boskin would probably like John Taylor named to the Fed. Taylor, who Boskin brought to the CEA from Stanford, was at the top of the list of names floated. It would be marvelous if this would happen, as Taylor is as open-minded as he is competent. For Taylor to be named Vice Chairman from his junior slot at the CEA, though, would immediately be read by the financial press and the markets as a Presidential slap at both Alan Greenspan and Angell, for refusing to do the White House bidding earlier this year. Naming Angell to the Vice Chairmanship and Taylor to the open seat would be optimum, a vote of confidence in Greenspan and Angell's commodity targeting, plus a direct White House link to the Fed in Taylor. The newest Fed Governor, David W. Mullins Jr., is a Brady protege and Treasury link. Like Taylor, Mullins is bright, open-minded and even less ideological. It must be assumed that the White House gets this "pick," not Treasury, which elevates Taylor's chances.

As we approach this monetary moment of truth, the worst possible scenario would have Angell taking the lead for a shift toward ease and being outvoted by an FOMC determined to get the consumer price index down by having a national going-out-of-business sale. This is the painful anti-inflation "strategy" being followed by the Bank of Canada, which I am convinced is one of the chief irritants now threatening the breakup of the Canadian federation. It's also the strategy that Margaret Thatcher has employed in the last two years, which has kept interest rates and unemployment high in the U.K., with Conservative popularity on the skids. Fiscal "responsibility" does not require paying off the real national debt. Monetary responsibility does not require bankrupting debtors via deflation.

The Wall Street Journal's Alan Murray this morning reports that administration officials privately hope the Fed "would give a boost to the economy by easing credit and bringing down short-term interest rates. But with few signs of a recession, and inflation unchanged, the Fed is unlikely to change its policy soon. Fed officials say that before easing, they would like to see convincing evidence that the inflation rate has started to drop." The report hit the financial markets today like a bucket of ice water.

The evidence is there, in $350 gold. If Angell can make the case that this is convincing evidence, with Greenspan the man to convince, we will get a serious rally going. I'm convinced he can.