Spinning Gold into Dross Jude Wanniski December 29, 1997

Memo To: Richard W. Stevenson, NYTimes
From: Jude Wanniski
Re: ‘Spinning Gold Into Dross’

Your Sunday “Week in Review” report on the “declining” role of gold in the international monetary system was better than any of the others I’ve seen in recent months. You still make the mistake of concluding that “whatever its other enduring qualities, its economic role is in decline.” There is nothing in your piece to support that view, except a collection of assertions to that effect. It is true that gold’s role as a central bank reserve asset is not what it was a century ago, but that was the story when the dollar was floated in 1973 away from our gold reserves. Why write about that in 1997? I’m of course pleased that you were good enough to call and quote me in the piece, not only because I take the opposite position, but also because you got my central argument correct: “Indeed, supply-side economists say the decline of gold’s role has been vastly exaggerated and that the world still operates in some ways on a gold standard, with gold serving an informal but critical role as a gauge with which to measure the underlying soundness of currencies. ‘People still use gold as a way of assessing the problems of governments in dealing with their debt,’ said Jude Wanniski, a supply-side economist who is one of the most outspoken defenders of gold.”

If you keep asking the right questions, you will get to deeper levels of abstraction and understanding. There are, after all, several monetary roles that gold has had through the millenia. The role of gold as “money” first declined when governments began using their debt as money, in much the same way that goldsmiths began to serve as banks by issuing warehouse receipts that served as circulating media. Paper replaced the specie itself as a medium of exchange and there is no place on earth that has used gold for that purpose since the beginning of this century. What was left was gold’s monetary use as a store of value, a final settlement asset, a unit of account, and as a numeraire -- by which we mean a proxy for everything that has a price which is not gold.

Gold is still used everywhere as a monetary store of value, both by governments and private citizens. This is because history demonstrates that paper assets can quickly collapse in value, if equity markets collapse, or if the underlying confidence in the government accounting unit devalues. This use of gold as wealth is relatively small. If the net worth of the whole world is $100-$125 trillion, gold represents a bit less than 1% of that. A century ago, my guess is that the percentage was more like 2%.

Gold is no longer used as a final settlement asset because of the international decision to float with the dollar in 1973. Governments still hold a third of all the gold as monetary reserve assets, and would probably hold roughly that amount when an international monetary reform restores gold’s role as an official numeraire, but the percentage would steadily decline into the 21st century as long as the dollar/gold link held up.

Gold was indirectly the unit of account under the various monetary regimes of this century, in that the dollar was legally defined as a specified weight of gold. In 1934, the government dissolved the private gold contracts while prohibiting private holdings of bullion. Under the international agreement at Bretton Woods, the United States pledged to keep the dollar defined as a specified weight of gold, but Nixon broke that agreement with an executive order in August 1971. Switzerland maintained gold as an accounting unit for a short period after the dollar floated in 1973, but was finally forced to float the franc, being much too small a country to provide an anchor in the turbulent world of floating exchange rates.

The role of gold as numeraire is what remains, and that role will remain as far as the eye can see. Ordinary people, as opposed to government, must have a numeraire which enables them to accurately price present goods against future goods against foreign goods and foreign future goods. In your piece, you noted that the dollar price of gold has declined in the last year, but the baht price of gold has increased, as has that of the Indonesian, Malaysian, Philippine, Taiwan and Korean currencies. The dollar price of gold has fallen as much as it has because the Federal Reserve has appreciated the value of U.S. government debt by making the dollar scarce relative to gold and everything that has a dollar price which is not gold. Look at the European currencies and you will see they sidestepped the Fed’s dollar deflation, the DM price of gold has not fallen as much as the dollar price.

The Fed seems to be doing okay because our financial markets have performed well, but that is because the budget deal produced a lower capital gains tax this year. It was this increased reward to risk-taking that produced the decline in the gold price -- as the Fed made dollars scarce by not supplying the liquidity needed by an expanding economy. This is what confuses most analysts, because it is not easy to see the intersection of monetary and fiscal policy changes. Journalists never discuss this intersection, because their readers would find it even more complex. When you add in progressive tax rates, the variables become even more complex.

What I think you have begun to understand better than most is that the world will not be able to live with a dollar that floats against one set of variables while every other country, each with its own set of variables, must be guided by the floating dollar. If you watched "Fox News Sunday," you saw Jack Kemp making the argument that if Greenspan had pegged the gold price at $350, which is where Kemp had argued it should be pegged, the Asian crisis would not have occurred. If gold had been alone in declining in price this past year, it would have forced me to admit error in my assumption about its value as a true signal of incipient monetary inflation or deflation. The decline in the dollar price of oil and other commodities was predictable only in my analytical framework. It is this true signal that has not diminished in the economic value of gold. Kemp also noted that Greenspan is essentially the chairman of the world central bank and it is our responsibility to maintain the dollar’s global value as a unit of account. If we do not, that role will have to be filled by a European currency bloc or an Asian bloc that recognizes the essential nature of gold as a numeraire.

Robert Mundell taught me 20 years ago that the gains to be had to world commerce from a common currency are so great that civilization will always find a way to get one. The Euro cannot provide a common currency without a numeraire to hold the system together, given Europe’s myriad variables of tax and regulatory policies. It was this insight which enabled me to predict in 1977 -- in my book -- that the Europeans could not develop a common currency without gold at the center or a unified tax system to eliminate those variables. This remains the flaw in the Euro, although nobody in the world writes about it except Polyconomics. Being alone does not make me wrong. The fact that I make my living by advising global asset managers and that I overwhelm my opposition in forecasting should mean something. Observing the universe of asset prices from the perspective of the dollar/gold price is the biggest -- but by no means the only -- reason for this success. If I were greedy, I would not attempt to persuade the press corps that this idea should be made national policy, because it eliminates one of the advantages I have as an analyst. The reason I do this is that I know a dollar/gold link would make life nicer for six billion people, our own people included. Keep at it, Rick, and you’ll see it too.