Educating Clinton: Bosnia and Bonds Jude Wanniski May 17, 1993

A journalist friend, who is an otherwise ardent supporter of President Clinton, complained to me last week that he thinks it is a great mistake for the President to share his doubts about policy in public. "One day he thinks we should bomb Bosnia. The next day he's not so sure. Back and forth he goes, which makes him seem indecisive, unpresidential. He should be a leader. He should assemble his experts, get their considered opinions, make a decision, announce it to the people, and stick to it." Well, er, I observed, "Isn't that what he did in Waco?"

In fact, I prefer a young President Clinton who ventilates in public, sharing his policy doubts, allowing the American people to give him feedback before he proceeds with policies he might come to regret soon after he sets them in motion. As we suggested in "Boris and Bosnia," 4-28, the Waco disaster may have had at least this positive effect, demonstrating to Mr. Clinton that the ill-considered use of force can have unintended consequences. It is clear that by dithering on Bosnia he has permitted a flow of analysis and opinion to reach him in a way that has deflected the hurry-up-and-shoot appeals that were hustling him toward war. The situation in the Balkans remains incendiary, but now at least the President will open discussion on how the situation there might be solved without the use of force. This is a discussion that has not yet taken place.

In the U.S. press, the only item we have seen to date that suggests carrots rather than sticks was a commentary by Flora Lewis of The New York Times, 5-1, which throws out some ideas on how the region might be pacified through unifying economic projects. In his marvelous new book, Pandemonium, about the return of ethnic devolutions as a dangerous trend in a splintering world, Senator Daniel Patrick Moynihan does note that "affluence" is almost always a useful antidote to racial, religious or ethnic tensions. Did not the American experience demonstrate to the world the practicality of a melting pot, heated by the opportunities of entrepreneurial capitalism and grass roots democracy? Why not export these ideas to the Balkans, as well as to the splintered pieces of the former USSR, instead of the austerity schemes of the IMF?

Similarly, the President is now in the process of learning about monetary policy in a way that could be enormously beneficial to the nation and the world. We remain very nervous about the bond market, which could get mangled if the President doesn't learn these lessons quickly enough. The retreat of the bond market in recent weeks reflects growing doubts about the President's willingness to keep his nose out of the management of Fed policy. The Federal Open Market Committee meets tomorrow under a cloud as a result of the President's recent tendency to blurt out ill-considered views on interest rates, the dollar, and the Fed. As with Bosnia, though, the President's ventilations on monetary matters invites feedback that could fill the gaps in his knowledge. President Bush showed no interest in learning about the mechanisms of Fed policy, nor did Treasury Secretary Nick Brady. Bill Clinton, however, is a determined policy wonk, who is eager for education. Our continued long-term confidence in bonds rests on the ability of Federal Reserve Chairman Alan Greenspan to do the teaching.

In his press conference of last Friday, for example, the President was asked if he agreed with those who are now arguing for an increase in short-term interest rates, to combat growing signs of inflation. The President's answer revealed that he knows less than he should about monetary policy, as he argued against an increase in long-term interest rates on the grounds that renewed inflation is not yet clearly evident. In other words, the question was about short rates, over which the Fed has some control, and the answer was about long rates, which the Fed can only control if it makes the right decisions about short rates. This information disconnect exists in the minds of most politicians, and obviously exists to a large degree in the mind of Treasury Secretary Lloyd Bentsen, who was asked on "Meet the Press" yesterday about short rates, and answered as the President did on long rates.

To be sure, Greenspan is almost certainly aware of the disconnect, as well as the opportunity it provides for a lesson on monetary policy. There is nobody in the world who wants the yield on the 30-year bond to fall more than Alan Greenspan. The question that faces the FOMC, though, is which short-term path will cause those yields to fall -- easing, tightening, or no change at all. Another way of looking at the problem, from Greenspan's point of view, is this: How do you satisfy the creditors of the United States, who hold $4 trillion in government debt obligations, that they will not suffer capital losses by holding our debt? These losses, of course, would occur if the Fed makes the wrong decision on short rates.

At present, with the price of gold pushing $370 from $330 a few months ago, it seems clear enough that the gold market is betting the Fed will make the wrong decision. These gold bugs are throwing disinformation into the discussion by saying the rise in the gold price has nothing to do with inflation, but merely reflects supply and demand conditions in world markets for this particular commodity alone. Greenspan, of course, knows that all inflations, everywhere, are preceded by a rise in the price of gold, which is not only the most monetary of commodities, but also the most political. That is, it is the first commodity to which speculators retreat -- dumping dollars to acquire gold — when they suspect an inflationary error in government finance. The risk of holding dollar assets increases when the President or Treasury Secretary jawbones the Fed, as politicians rarely jawbone for deflation. In this case, damage is minimized because the discussion is about whether the Fed should or should not tighten. If the debate were about easing, the damage could be considerable.

Greenspan's relationship with Clinton and Bentsen is being tested this week on this issue. If he succeeds in keeping the confidence of the bond market, he will also succeed in keeping the confidence of the President. Educating Mr. Clinton on the workings of monetary policy presents an enormous opportunity as well. Once the President understands the utility of gold as a political commodity, Greenspan would be well on his way to moving the country back to a de jure use of the gold signal as the central means of satisfying America's creditors -- who are for the most part the American people, but also include Japan and other nations who hold U.S. debt as reserves. President Clinton is young enough to have avoided the brainwashing that older political leaders went through at the hands of the Keynesians and monetarists.

At the moment, the most decisive action the Clinton Administration could take to bring down long-term interest rates would be to sell a few bars of gold from U.S. reserves. That is, instead of selling bonds to mop up excessive liquidity from the banks, the Treasury could conduct an open market operation in gold, i.e., sell a small amount of gold for dollars -- an event that would be meant to convey the commitment of the administration to the peace of mind of America's creditors. The Fed could afford to sterilize the effect of such an open market operation on the money markets by simultaneously purchasing bonds. Because the present gold price embodies expectations that the U.S. will tend toward currency devaluation in the near future, an emphatic signal to the contrary would reduce the gold price to $350 or less, without any increase in short-term interest rates. The more peace of mind, the more long rates will fall. We can't know for sure, but would guess that Greenspan would like to be the man who gets the United States dollar relinked to gold. This would in itself go a long way to solving the U.S. deficit problem, as the $4 trillion national debt could be refinanced at less than 4%. It would also solve all the sovereignty problems that impede the integration of Europe.

Like my journalist friend, the newsweeklies this week are pounding the President and his Squish Factor, trying to persuade him to stop listening and simply redouble his efforts. We continue to believe this is a positive attribute in Mr. Clinton, who continues to feel his way in an unfamiliar job. Last fall, after the election, we advised that because he does not believe in anything in particular by way of dogma, he would be open to experiment, education and on-the-job training. We're delighted that he has permitted himself to be "rolled" by the Republicans on his stimulus plan, that he has been "squishy" on Bosnia, and that he shows no inclination to punish those who don't see eye to eye with him. If he can learn about money from Greenspan in the next few weeks, his second hundred days will be much better than his first.