Greenspan's Golden Smoking Gun
Jude Wanniski
October 14, 1997


Memo To: Louis Uchitelle, New York Times
From: Jude Wanniski
Re: Disinflation/Deflation

Your news analysis piece on page one of the Sunday “Week in Review” section, "Two Cheers for Inflation, Given the Alternative," makes the legitimate argument that a little inflation is a better option than a little recession. Here at Polyconomics, we have been making the argument since the beginning of the year that with the price of gold well below $350, any tightening of monetary policy by Alan Greenspan’s Fed would be deflationary and would unnecessarily damage the economy. Don’t you think this is a deficiency in your analysis, Lou? Why is it that you (and the other Times reporters) refuse to discuss the price of gold as a relevant factor in understanding the continuous debate over monetary policy, the economy, interest rates, the bond market and Fed policy? You may think gold is irrelevant, but I know you know Greenspan himself is a gold advocate, and has many times told Congress that he views the gold price as the best single indicator of inflationary pressures in the economy. Am I right, Lou? If so, how then can you explain taking up the topic for the Sunday Times and failing to note that at $325, the gold price is now $25 below where it was when Greenspan was appointed to the Fed in 1987, ten years ago. If he is serious about inflation being on the horizon, why is the gold price $50 below where it was a year ago?  It looks to me like a smoking gun, at least as far as Greenspan is concerned, in the sense that there is no reason for him to be even hinting at an increase in interest rates to halt a coming inflation. Tell me why you don’t think so?

I was happy at least to see you introduce the discussion about “disinflation” and “deflation.” For years and years I’ve watched financial reporters struggle with the concept of “disinflation.” The concept appears in no economics textbook prior to the last 15 years. It had to be invented to cope with the regime of the floating dollar. When the dollar was floated in 1971-73, the gold price climbed as high as $850 in early 1980, from the original $35. This was the primary inflation period. It was accompanied by a rise in the price of oil and other commodities and the price of labor as well. In the period from 1980 to the spring of 1982, the dollar deflated against gold, to $300. It was in this period that it became necessary to come up with the idea of “disinflation,” because while many prices continued to rise, to reflect the gold rise to $300 from $35, other prices began to fall with the decline in the gold price -- particularly the price of oil. The averaging of some rising prices with some falling prices thus produced a slowing increase in the producer and consumer price indices. Do you understand what I’m talking about here?

It is critical if you are to understand where we are today, because from that $300 level of 1982, there began another, secondary inflation of the gold price, as the Volcker Fed allowed gold to rise as high as $500 in 1982 before allowing it to settle at $425 for the next two years. The price of oil once again turned up. All the while, the dollar price of labor continued to advance in order to catch up with the inflation that began with gold’s rise from $35. The tightening that began in 1984 brought the dollar below $350 by the spring of 1985, which you may recall was also the dollar’s strongest point relative to many of the European currencies. It was at the beginning of 1986 that we can say gold finally settled at around $350, although it has for brief periods since then risen toward $400 and for other periods fallen closer to $300. In the last decade, we have seen all other dollar prices finally catch up with gold at $350. It took that long for the general price level to adjust because long-term dollar contracts, leases, bonds and mortgages had to unwind. My colleague David Gitlitz this summer found a way of demonstrating that the “catch-up” was finally complete. This means that any decline of the gold price below $350 now has to be accompanied by a decline of the general price level -- a process that has always been recognized as a deflation. If you would like to see David’s work, we would be happy to share it with you. Its implications are of great significance, we think, because it means we could now lock onto $350 gold and not worry about residual inflation (or deflation).

By the way, David Hale of Zurich Kemper, who you quote in your article, understands what I’m saying here. Kemper has been a client of Polyconomics for at least 10 years.