Larry Lindsey, Harvard Keynesian
Jude Wanniski
January 8, 2001


Memo To: Bob Novak (CNN)
From: Jude Wanniski
Re: GWBís Economic Advisor

With great interest, I watched your Saturday interview with Larry Lindsey on CNNís Evans&Novak. He was so awful I could not believe he has the ear of the President-elect. The man is totally incompetent, a hard-wired, old-fashioned Harvard Keynesian who has not the slightest idea of what is happening to the economy. All he knows is that we must somehow get more money into the pockets of the people through the kind of tax cuts he cooked up for GWB. He was serious when he said: "The key is to keep up demand." The economy is crumbling under the weight of Alan Greenspanís monetary deflation and while Lindsey sees economic weakness, the things he proposes to deal with them are truly feeble measures. Worse, his insistence that Greenspan is a mastermind tells me Lindsey isnít paying attention. As we all saw last week, the half point cut in the funds rate had one day of applause on Wall Street before the market began booing again. Cutting the funds rate will do nothing to arrest the monetary deflation nor will another half point cut. Neither will the Bush tax rate cuts, "putting money into people's pockets." Only an increase in the gold price will do that, but deflation is not even on Lindseyís radar scope.

Frankly, Bob, I still do not think you quite understand that. The "capital crunch" you talked about on the show is the result of the monetary deflation. As the risks to the returns on capital investment increase, capital will not even form. Think of it this way: Gold began its decline in 1997 because the supply-side tax cuts that required more liquidity from the Fed did not get it. Just as inflations always begin with a rise in the gold price, deflations always begin with a decline in gold when the central bank makes liquidity scarce. As I warned everyone I could think of at the time, the fall in the gold price would be followed by a decline in the oil price, then by other commodities. When the price of oil then sank to $10 from $25, capital stopped flowing to the oil industry and the industry had no reason to look for it or to develop proven reserves. A tax cut or an interest-rate cut would not have solved the problem. Greenspan needed to see the decline in the gold price as a deflationary error, but after a lifetime of touting gold as the best monetary signal, he then ignored it. The energy problems of today are the result of the oil industry's inaction. It is not too extreme to call this the Greenspan Deflation. Alan, though, is in denial, or he would not be able to sleep at night.

What we have is a crisis in market capitalism, which cannot function efficiently without a "unit of account," a "price" anchored to reality (gold). Capitalism must be able to direct capital to where it is needed and where it will produce a profitable return on its investment. As the monetary deflation continues, dollar earnings are shrinking as dollar earnings from oil did in 1997-98. The Federal Reserve cannot halt the deflation with cuts in the funds rate, as the lower rates do not cause debt to be monetized faster than it is being demanded. The only measure that can solve the problem is a devaluation of the dollar relative to gold. That is, a weaker dollar that relieves the problems of dollar debtors caused by Greenspan's errors in recent years. When asked about the dollar by Brit Hume on FoxNewsSunday, Lindsey said he favored "a strong dollar." He does not have an inkling of what is going on around him. On your show, he simply said he would not criticize Greenspan. When I say Lindsey is a "hard-wired Harvard Keynesian," I mean it is clear he would find it impossible to even understand what I am talking about here.

We do not have to go back to the 19th century and the deflation of the 1870's to realize how great a problem this is. We saw it before in the first years of the Reagan administration, when the dollar deflation produced the weakest economy since the Great Depression, with unemployment rates in double digits. That deflation was only solved by the banking crisis which surfaced when Mexico told its creditors in the U.S. that it could not pay. Gold had dropped from $600 to $300 as the Fed starved the economy of liquidity which the Reagan tax cuts needed to be effective. When Paul Volcker was forced to monetize $3 billion in Mexican peso bonds, the fresh liquidity sent gold soaring above $400. The stock market and the bond market both boomed, embarrassing the monetarists who said an easing would cause a collapse of the bond market. No such "Mexico" crisis is on the horizon, which means this deflation will continue until it runs its course, a process that will undermine the Bush administration as it proves hapless in dealing with it. You did not mention gold in your interview of Lindsey, only "a credit crunch." I wish there were other journalists around who knew how to deal with this issue, but once again you seem to be alone. There are several people around who understand monetary deflation. Former Fed Chairman Paul Volcker was in the middle of the last one. He should appreciate the threat the deflation poses to the commonweal. Maybe he could explain it to Larry Lindsey.