A Job Only Gold Can Do Jude Wanniski March 27, 2004

Memo To: Website Fans, Browsers, Clients
From: Jude Wanniski
Re: An Op-Ed Flashback to 1981

Can you imagine an op-ed commentary written in the New York Times of August 27, 1981, that is still relevant today? Here is one I wrote back then, "A Job Only Gold Can Do," still in the early stages of the Reagan Revolution. It was at a point when it looked like supply-side economics would go down the drain as the Reagan tax cuts had been signed into law and the economy kept sliding into recession. As you will see, I argued that the incentive effects of the tax cuts were being swamped by the Federal Reserve's tight monetary policy, which could easily be identified by the steady decline in the dollar price of gold. I'd been an advisor to Reagan Gipper during the '80 campaign and knew how much he wanted to again make the dollar as good as gold, to correct the error President Nixon made in 1971 when he broke the link between the two and set off the inflation -that followed. The Times was good enough to run my piece, which I hoped to make it clear not all supply-siders were ignoring monetary policy. (Some had sided with Milton Friedman, who had helped talked Nixon into going off gold.) How nice if the Gipper could have gotten his wish back then. We would have avoided 23 years of continuous turmoil in the world economy due to the wild swings in the dollar from then to now. The principles are the same now as they were then... and there is still a job only gold can do.

By Jude Wanniski
The New York Times
Thursday, August 27, 1981

Morristown, N.J. – When President Reagan returns to Washington he will have no choice but to turn the attention of the White House to the abysmal state of the credit markets.

Vague hopes that his stunning budget victories would buoy the bond market, bring down interest rates and signal economic recovery have been dashed. There is growing apprehension among the political figures in the White House that the monetarists who control Federal Reserve Board policy will not be able to brake inflationary expectations with high interest rates. The vision Republican candidates for the Senate and House have of trying to defend 20 percent interest rates in 1982 is too awful to contemplate.

The supply-siders, who predicted this situation, are girding for a different kind of battle. The fight with Democrats and Speaker Thomas P. O’Neill Jr. is over. Now there will surely be civil war among Republicans over monetary policy, a struggle held in abeyance as supply-siders and monetarists united behind the tax and spending programs.

It cannot be avoided. At the outset of the Reagan Administration the die was cast when it was arranged that the supply-siders would dominate the fiscal side of the Treasury and the monetarists would get the monetary side. These forces are basically incompatible: the economy cannot advance as the forces pull it in different directions. By letting people keep more of their earnings after taxes, the fiscal changes are encouraging them to increase their production. But the Fed and the Treasury monetarists see this as an inflationary impulse and try to choke off economic activity with higher interest rates.

The aim of the supply-siders is nothing less than a commitment from the Reagan Administration -- and the Federal Reserve – to move toward a dollar that is convertible into gold. The objective is to win this commitment to a gold standard by the end of 1981, and designing a modern international gold standard would no doubt take a year or so. As unlikely as it may seem that this objective can be met, the chances for gold increase dramatically as the failure of the monetarists continues. Gold is the only answer.

Aug. 15 was the 10th anniversary of President Nixon’s closing of the gold window, which formally opened the experiment with monetarism, a “paper standard.” To the classical, supply-side economists, the attempt to manage the currency through academic formulas and bureaucratic operating techniques was always doomed to failure. The chief reason is that bureaucrats are no match for the marketplace in determining the correct amount of money and credit to be supplied by the central bank at any given moment.

With a gold standard, the bureaucrats have it easy. They simply watch the gold window, and when individuals line up with dollars to buy gold, the Fed knows it has supplied more money and credit than the market requires for transaction purposes. When individuals line up with gold asking for dollars, the Fed knows it has not met the demand. In either case, the Fed uses its instruments that regulate the flow of money into the system. At the end of each day, the net effect of its actions satisfy all comers at the gold window, buyers and sellers, and over time maintain the gold-stock level so that it neither rises nor falls. In this way, the marketplace acts as a vast computer, with all transactors satisfied with the level of money and credit except the man on the margin, who appears with surplus money or surplus gold.

Milton Friedman has acknowledged that a gold standard is an ideal system but says politicians will not live by its “discipline” as if it causes pain. But is not discipline that Paul A. Volcker, chairman of the Federal Reserve Board, needs. It is the kind of information that gold signals. In the current environment, it is inefficiency that is destroying the currency. Here is how Alexander Hamilton expressed the efficiency argument in 1786:

Among other material differences between a paper currency, issued by mere authority of Government, and one issued by a bank, payable in gold, is this: That, in the first case, there is no standard to which an appeal can be made, as to the quantity which will only satisfy, or which will surcharge the circulation; in the last, that standard results from the demand. If more should be issued than necessary, it will return upon the bank.

To monetarists, money is an instrument that works on the economy through consumer demand; increasing the quantity decreases spending, decreasing the quantity reduces the upward pressure on consumer prices. To the classical, supply-side economist, money is a medium of exchange, a unit of account that works on the economy through the individual producer.

Here is what is happening in the United States economy now. Carpenters would dearly love to buy new automobiles and would eagerly supply new houses in exchange with the terms of trade being, say, 10 autos for one house. Auto workers would dearly love new homes and would willingly trade new automobiles. The problem, though, is that the dollar as a unit of account is so unreliable that the carpenters and the auto workers must pay enormous premiums to the financial intermediaries and the savers, who take all the risk. That is, over the 5 years a carpenter works to finance his auto, or the 30 years an auto worker works to finance his home, a devaluation of the dollar means that they each pay back less in real goods than they originally agreed upon in the terms of trade. The banker, or the person who deposited savings in the bank, is stuck.

The governors of the Fed don’t think of the marketplace in this fashion. They see themselves as regulators, not bankers; regulators of an arbitrary “money supply” that bears no relationship to a demand for money. The economy is still functioning, but only because the Fed is not consciously trying to destroy the dollar; its value ebbs gradually. The accidental effect of current policy is to permit banking of goods and services that are quickly exchanged. Bakers and dairies do all right; their products are produced and consumed within 24 hours. Home builders, auto makers and the savings and loan industry that books exchanges of homes and autos suffer most.

The goal of the Reagan Administration at its outset was a broad, deep bond rally, which the supply-siders see coming through growth and monetarists see coming through austerity. The problem is to persuade one investor, here or abroad, to part with, say, $10,000 in resources in exchange for a 30-year bond at less than 10 percent interest. The Administration monetarists are urging new management techniques on the Fed, contending that a few more tinkerings will do the trick.

They probably have until year’s end to succeed and they will fail. Tinkering with money, one day at a time, will not restore its credibility in the eyes of our 30-year investor.

No, it has to come down to gold. It is not a liberal issue or a conservative issue. No individual of any political bent would now be so foolish as to buy a 30-year bond at 5 percent, on the pledge that the “paper bugs,” or monetarists, will do better in the decades ahead compared with the decades past. Only by advising our mythical investor that Fort Knox is committed to the fight against inflation can it be whipped now.

The Government of the whole people must pledge to the individual bond buyer that a bond today will have as much purchasing power 30 years from now as it has today – and back that pledge with a restored dollar-gold link – or interest rates will spiral higher, dipping only during recessions. The supply-siders are supremely confident that this will happen sooner rather than later because there are no more options when the monetarists run out of time.

When it’s done, our central bank will be a bank again instead of a regulator. Nothing bad will happen. Interest rates will plummet, and the $106 billion cost of financing the national debt will plummet too, balancing the budget. Auto workers and carpenters will exchange with each other again, and the savings and loan institutions will be saved. The third world will be able to refinance its stupefying debt at low rates as interest rates tumble worldwide, keying on the dollar. The financial crisis we are now going through will be ended. The dollar will be as good as gold.

Jude Wanniski is president of Polyconomics, Inc. and author of “The Way the World Works – How Economies Fail and Succeed.”