Asian Dominoes
Jude Wanniski
August 5, 1998


Memo To:  Rep: Barney Frank [D-MA]
From: Jude Wanniski
Re: Asian Crisis

Do you remember our conversations last fall when we spoke several times about the Fed's monetary deflation as evidenced by the long decline in the price of gold? You also may recall I said you might be my only hope at the House Banking Committee to understand the dreadful implications of what we have done to Asia and the problems we would create at home. I'd hoped you could at least grasp the essence of the problem, but I'll grant you it is awfully difficult. I'm writing again with the passage of time — and the decline in the stock market — in hopes you might see how inexorably a monetary deflation works and how it now is steadily creeping into our economy.

As far as I can tell, there is not a single member of Congress who has the slightest clue to what is going on, nor can I find staff members anywhere who appreciate its nature. There is almost nothing in the economics textbooks about it, and what little there is wrong. Ludwig von Mises got it right in his book, Human Action, published in 1949, when he said that it occurs so seldom in the history of civilization that almost nobody knows what it is when it appears. ("The statesmen who were responsible for the deflationary policy were not aware of the import of their action...Debt aggravation was merely the unintentional outcome of a policy aiming at other ends.") Almost all monetary errors are inflationary, which is what happens when governments devalue their currencies against gold and thereby repudiate a portion of government debt. It is unnatural for governments to wish to add to their debts by going in the opposite direction, which is why it only happens at the end of "greenback" periods that accompany wars.

In the first phase of deflation, it is an enjoyable experience to societies that are net consumers of commodities. This is because when the currency price of gold falls, the currency prices of all other commodities must fall as well — to get the commodities back into alignment with each other. You can see this more easily if we were on an apple standard, and a dollar was first one apple and then became worth two apples. If a dollar were worth an apple it also would be worth an orange, as they have traded side by side through history. So if a dollar deflates and is now worth twice as much in terms of apples, the price of oranges must fall as well. This is called the Law of One Price. Get it?

In the second phase of deflation, the problems associated with commodity producers come home to haunt those who have enjoyed the lower prices. This is because the commodity producers can't pay their debts. They had contracted to pay a debt of $1 million when apples were $1 each. When apples now are 50 cents each, they must pay 2 million apples to pay the debt. When they can't, they go bankrupt and the creditor does not get paid. In this second phase, creditors get crushed, which we first see in the small banks that serve commodity producers, then in the large banks that serve the small banks. You see, Barney, these are issues of banking, yet no member of either banking committee of Congress understands them. Rep. Ron Paul of Texas is the only fan of gold on the banking committee, but not because he understands these mechanisms. There are people who had been taught by their fathers or grandfathers or by a favored teacher to appreciate the power of gold, and Paul is one of these. Most educated men laugh at the idea of a gold standard, but are unable to tell you what it is. They have been taught to laugh at the power of gold the same way Congressman Paul has been taught to appreciate it. In these times, it is necessary to teach yourself the powers ah4 limitations of gold, because there are no schools left that teach it at all) I've done this for the last 25 years, Barney, which is why I'm a rare old bird who is in a position to warn you, and through you warn the House Banking Committee and maybe the government of the United States.

The nasty wrinkle we see in this particular monetary deflation is that it is occurring at a time when tax cuts in our country have offset the downside pressures of monetary policy with upside pressures of a more favorable capital gains tax. We're doing better than the Indonesians and Koreans and Thailanders, etc., who were first pulled down by our dollar deflation, then pulled down farther by recommendations of the IMF to RAISE TAXES! A double whammy, if you know what I mean. That's why the economic erosion is occurring more slowly here. It can be seen in the tremendous increase in the number of personal bankruptcies, and individuals realize they owe more than the collateral is worth, so they walk away from it. It can be seen in the small farms and small banks and small mills and mines.

It is also getting worse, as the price of gold declines further. People around the world who contracted to pay their debts in dollars are demanding dollar liquidity, but the Federal Reserve will not supply it to he degree necessary, which is the cause of the decline in the gold price. When the gold price declines again and again, commodity prices fall again and again. Eventually things will get bad enough here that Greenspan will say, now is the time to lower interest rates, and the dollar price of gold will rise. Think of all the wreckage that occurs in he meantime, wreckage that cannot be restored to its original condition. People around the world are dying because of this deflation, 'hey are starving and at times they are killing each other for what's left  to fight over. They are far away from our blessed land, so we only read about this in the papers. But I guess I'm cursed with the knowledge of how it has happened, and how easy it is to stop, if only people like you would understand and get excited about it as I am.

Anyway, I thought it was time for an update, and here you have it. Let me know when you have time to learn more about this, and I will happily do what I can to help.