Again, Approaching $350 Gold Jude Wanniski April 19, 1991

When Saddam Hussein moved into Kuwait last August 2, one of the side effects was the interruption of gold's glacial slide toward $350. Only a few dollars above that level on that day, the gold price then climbed by leaps and bounds to more than $410, as world markets expected the Fed to inflate --as it always did when the price of oil shot up during a Middle East distress. Keynesian economists parroted the old song that the oil price increase was "like a tax" which reduced the purchasing power of consumers by taking money out of their pockets, and it was up to the central bank to expand the reserves of the banking system by printing dollars, which would then find their way into the pockets of those overtaxed consumers. This time, the Fed refused to play along. Short-term interest rates moved lower as the economy weakened, but the Fed was restrained in its buying of bonds with printing-press money. The gold price crept back down as world markets were relieved to see a new inflation would be avoided.

Had Saddam not invaded Kuwait, we assume the price of gold would have continued its creep last August and eventually found itself below $350. Why is this an especially important price? Because Federal Reserve Gov. Wayne Angell says so. Of all the governors and regional presidents of the Fed, Angell is most identified with the concept of Price Level Targeting (PLT). The other governors have their own "targets" that signal them when to ease and when to tighten. Because they are not quite sure their targets are right, they all have several that they use from one month to the next: monetary aggregates, credit volumes, GNP, the unemployment rate, the positions of the stars and the moon. Angell, though, is certain he is right with his PLT target, and over the course of the last four-plus years he has gradually made an impression on his colleagues with the accuracy of his forecasts. And as they all know, $350 gold is at the heart of his PLT. Who are they to suggest $375 or $200? When the Fed thinks PLT, it thinks $350 gold.

Why does Angell pick $350 as his equilibrium price? Maybe because that's what it was when he was sworn in as governor. Maybe because over the years he has observed that the bond markets don't like gold going toward $400 and don't like it going toward $300. It's a midpoint. Maybe because it is ten times the old official gold price of $35, and the prices of things in general have gone up about that much since the mid-50s, the last time the U.S. was willing to automatically exchange gold for dollars at $35. He isn't sure $350 is the right price, but it's well within the ballpark, and since one number has to be picked and adhered to, let's go with $350. Until Angell came along, my number was $400, but I don't get to sit at FOMC meetings and vote. Once I understood that Angell was fixed on $350, I threw in with him.

I never, ever, discuss monetary policy with any of the Fed governors, but I do discuss monetary philosophy with all of them. When the bond markets jumped around earlier this month, with gold bouncing back up over $360, the only way I could explain the disturbance was the stories attributed to former Fed Vice Chairman Manuel Johnson that the FOMC was wracked by dissension, and that a split had developed between Chairman Greenspan and the other Fed governors on one side, with Angell and the regional presidents on the other. When the disturbance erupted last week, I was in Tokyo. I counseled a few dozen Japanese financial institutions holding a mountain of U.S. Treasury securities that this was not a serious problem. When the unemployment rate rose in February, Greenspan probably should have waited a day before pushing down the fed funds rate, as it threw off too heavy a signal that he was willing to combat unemployment with inflation. The fact that he didn't consult the regional presidents irritated them. But in the end, Greenspan no doubt realized his error, and when the unemployment rate rose again on April 5, the Fed passed.

Having slogged all this way toward $350, it stands to reason Angell would not wish to see the Fed ease before gold got below $350. It also stands to reason that having gotten this close, his colleagues will, out of deference to his PLT, give him his shot. I don't know that any of this is true. But this is elementary group dynamics. If gold gets below $350 and Angell's signal tells him it is time to ease, and he can persuade his colleagues they should do so, they will observe the actions in the bond market. If the bond market likes the gesture in a big way, he will have scored. The bond market, in fact, should outperform the stock market for a bit, catching up with the recent stock market rally. If not, Angell's colleagues will wonder why he went wrong and fuss again about their own targets. Back to the drawing board.

Meanwhile, all the yelling and screaming for the Fed to ease from the Treasury Department, by Secretary Brady and Deputy Secretary John Robson, is acting to keep gold from getting below $350. If they would just keep quiet for a few days, we'd get a lot closer to their objective of lower interest rates. On the assumption that Saddam Hussein will not invade Kuwait in the next few weeks, we are betting on the bond market.