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An Open Letter to Alan Greenspan Jude Wanniski April 4, 1994 |
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Dr. Alan Greenspan
Chairman, Federal Reserve Board
Washington, D.C. 20551
Dear Alan:
Unless you see something I don't, you are rapidly running out of even poor options as you contemplate the parlous state of the financial markets. You can't take heart from the seemingly good news on the economic front because I think you know it is built on an inflationary foundation. The more than 10% rise in the price of gold since last summer has reintroduced the first clear sign of prospective stagflation since you were named Fed chairman seven years ago.
Other run-ups in gold occurred when markets speculated you would ease, and you didn't, which led to gold's decline to non-inflationary levels. This run-up occurred last fall when you allowed excess liquidity in the banking system to spill over into the gold market -- essentially accommodating the Clinton tax increases. This produced a temporary euphoria, as inflation always does in its early stages -- as consumers begin unloading currency at the margin, increasing the velocity of money.
The handsome GNP increase in the 4th Quarter and the rise in job creation (for temporary workers) reflects this monetary "high," which will have to be accompanied by "a morning after." The S&P 500 is now at levels it hasn't seen since last April and NASDAQ is at levels last reached in August. These excellent forecasters of future economic growth are seeing a bleak future. Considering that the broad market has to rise by at least 5% a year in order to forecast real economic expansion of 3%, we can say this monetary contretemps threatens to cost the United States a year's worth of economic growth.
President Clinton is still publicly indicating his affection for you, but you can see his confidence in your judgment has taken a beating along with the steady rise in long-term interest rates. The White House at the moment is already blaming you gently for the tailspin on Wall Street, backed by a Council of Economic Advisors that has not seen the inflationary signs of which you advised the President.
If you do nothing to restore the confidence of U.S. creditors in your management of the debt, you can be sure 1995 will unfold with the familiar, unpleasant signs of stagflation: The consumer price index will be rising along with wage pressures, finally catching up with gold, even as business and household bankruptcies multiply and unemployment lines lengthen. The President and Democratic leadership will be demanding that you lower interest rates to get the economy going again, even in the face of a rising CPI. Where will the gold price be a year from now? At $450? $500? At those levels, where would you expect to find bonds and stocks, especially the low-cap stocks that are most exposed to an unindexed capital gains tax?
This is the likeliest scenario you present to the bond market if you do nothing, as there is otherwise no reason to expect a rebound in stocks and bonds or a retreat from gold. This is why you have so few options and most of them are poor.
If you raise short-term interest rates again, by a quarter or half point, you will be resisting this scenario -- signaling further determination to prevent a rise in prices in general. This is a very inefficient way to accomplish your aim, because the financial markets will continue to assume that you are trying to prevent economic growth. This confusion has the effect of decreasing the demand for dollar liquidity, which puts upward pressure on the price of gold. You have to do a lot of damage to the financial markets in order to achieve small gains against future inflation, and there is no end in sight to the process.
This is why your best option may be to tell the nation's creditors that you will not permit the value of U.S. debt to fall further in terms of gold, and will drain dollar liquidity from the banking system whenever gold reaches $400 per ounce. This will also alert the markets that you will not react to other lagging indicators of economic activity so long as gold remains below $400 per ounce.
You have already advised the markets that, of all commodities, gold is the most important to you as an early-warning inflation indicator. But you have now twice presided over a monetary tightening with gold at $385 per ounce and have presided over a monetary easing with gold above $390 (by injecting liquidity via open market operations when the fed funds rate exceeded your announced target.)
You surely agree that if you were a bondholder instead of Fed chairman, you would not now know what the Fed or its chairman was up to. As long as this uncertainty exists, it will feed the financial markets and inevitably yield the stagflation scenario.
Could you do this without the support of President Clinton? Certainly your own statement of personal preference would have value in and of itself. It would also provide an anchor to the national debate over monetary policy that continues to swirl around you and your colleagues. Of course, it would be far better if the President and his Treasury Secretary would join you by explicitly asking you to stabilize the dollar value of the nation's gold reserves, with a ceiling at $400 and a floor at $350.
President Clinton and Secretary Bentsen should realize how little risk there is in this approach, and what great benefits there can be. By taking the inflation uncertainty out of government bonds by this degree of commitment, the value of all dollar assets would rise in tandem. The nation's creditors of course want the U.S. economy to grow as fast as it can without a monetary inflation that erodes the value of the debt's principle. Stabilization of the dollar value of U.S. gold reserves eliminates virtually all the monetary uncertainty from dollar assets, vastly increasing the efficiency of U.S. capital.
There are no monetary targets left that are more reliable than the gold price, I think you agree. The monetary aggregates can no longer serve as guideposts because the velocity of the money supply is so uncertain. The wholesale price indices are unreliable because they contain so many commodities that have little value as monetary signals, such as oil. Consumer price indices lag the early inflation impulses by many months, if not years. You have repeatedly argued correctly against the Phillips Curve tradeoff, which means you cannot target the real economy.
In the past 20 years, when we have discussed this precise issue before, you have agreed on the merits of gold's information content, but always wondered if an announced target price could be successfully defended. Today's markets are extremely sensitive to the Fed's intent, as you have advised congressional committees in recent years. The markets are practically waiting for you to give them this guarantee, that at least on your watch, the dollar will be as good as gold. A clear signal can only increase the demand for dollar liquidity and all dollar assets, which makes it easier, not harder, for you to persuade the markets of your intent.
Former Fed Governor Wayne Angell today publicly urged that you raise the federal funds rate to 4% from 3.5%, in order to demonstrate your resolve to prevent gold's inflationary rise. An announced ceiling price should accomplish the same objective, as long as you stick to your guns in defending it when necessary.
A dozen years ago, Professor Robert Mundell of Columbia predicted the government would eventually establish this kind of "gold-target standard," and that it would be initiated by having a ceiling and floor set. The markets would then guide you as to whether the floor should be raised or ceiling lowered, or both. There seems no better time than the present to begin this process.
Sincerely, as ever,
Jude Wanniski