Memo To: Alan Greenspan, Fed Chairman
From: Jude Wanniski
Re: Y2K Is All Yours
These are four letters that should concern you, Alan, letters about the Y2K "computer bug" problem you might miss if I did not bring them to your attention. The first, dated June 11, is from Jack Kemp to President Clinton. In it, he recommends a pegging of the dollar/gold rate as a temporary precaution as the domestic and world economy confronts the potential of financial disturbances because of unforeseen glitches related to Y2K. The second is a letter from Jack to the President dated August 11 on the same topic, when there had been no response to his first. I understand the letter actually was not sent until the 12th, and meanwhile a letter the President had written in response to the earlier letter had arrived at Empower America. The President rejected the advice, on the basis of findings of the 1982 Gold Commission, which occurred during the Reagan administration. The fourth letter is from former Vice President Dan Quayle to President Clinton, asking that he reconsider the Kemp proposal and that he specifically consult you before he makes a final, final decision. Treasury Secretary Lawrence Summers no doubt fielded the Kemp letters. Whether or not the President asks your opinion, which I think he will do, I believe you should take this opportunity to do something for the whole world -- even though you are technically responsible only for the 12 Fed districts.
As Quayle says in his letter to the President: "As disappointed as I was in your cursory rejection of Jack's proposal, it occurred to me you might reconsider if you asked Alan Greenspan to give it serious thought. As chairman of the most important central bank in the world, presiding over the management of the world's most important currency, he surely must worry about the issues we raise here. Your letter of rejection suggests you simply are prepared to wait for Y2K to see what happens before any precautions are taken in this most critical area."
First Kemp Letter to President Clinton
June 11, 1999
The White House
Dear Mr. President:
In six months and 19 days, computer clocks around the globe will click over to "00" and no one knows for sure what will happen. The predictions range from nothing more than a few minor disruptions to worldwide chaos. As a board member of Oracle and several Internet companies, I am convinced that we in the United States are technically well prepared but even so, significant disruptions in the economy may result if preventative steps are not taken.
One thing we do know for sure is that the behavior of individuals, business firms and governments is being affected by Y2K considerations. People are behaving differently than they otherwise would, and that change in behavior will have an effect on the global financial system that neither the Federal Reserve Board nor any other central bank is equipped to handle. All of these changes in behavior have a common effect: They alter the demand for liquidity. The problem is, under the Fed's current operating procedures, it does not receive adequate signals on how the demand for liquidity is changing so the central bank does not know when to increase or decrease liquidity or by how much.
In my opinion, there has been a considerable increase in the demand for dollar liquidity around the world, in part caused by Y2K considerations, that the Fed does not recognize it should be supplying. There is widespread evidence of a dollar liquidity dearth. The price of gold is down to $260, and commodity prices are weak (the CRB index is more than 20 percent below its levels a year ago). The price of oil has now receded to $18 a barrel from its spike up to $19 after the OPEC production cutback earlier this Spring.
What happens after the turn of the year? Even if Y2K effects are minimal, there may still be an economic slowdown as inventories are depleted. If the pessimists are correct, we may confront a genuine recession. In either case, the demand for liquidity likely will fall, perhaps precipitously, and excess liquidity may have to be soaked up to prevent an eruption of inflation. Under the Fed's current operating procedures it will not know what to do because it will not receive clear signals on the liquidity being demanded by the market. In fact, in the face of a weaker economy or recession, the Fed's current model will tell it to increase liquidity in order to stimulate economic growth, precisely the wrong thing to do.
Economists of every stripe understand that the modern world is held together electronically by trillions of bookkeeping entries that not too long ago were managed by pen and ink, on paper ledgers, with help from adding machines or desktop calculators. Most transactions involved the exchange of currency for goods and services. Now, high-powered computers keep track of most of the "promises" that make up local, regional and national economies. It was even simpler in the days of the Bretton Woods international monetary system, with the dollar linked to gold and all other currencies linked in one way or another to the dollar. High-powered computers were not needed to manage the daily adjustments in electronic debits and credits. In today's world of floating currencies, computers enable the world's banks to manage chaos.
I believe that what all of this means is that the burden is on the Presidency and the Treasury Department to take action now to ensure that the dollar remains rock solid throughout the upcoming period of uncertainty and possible turmoil. Throughout the coming year, on a monthly basis I believe, we will see extraordinary swings in the demand for liquidity. It is implausible that the standard interest-rate targeting mechanism currently employed by the Fed will work during this window of vulnerability. Moreover, when the clocks click us into the new century, many computers around the world may go down for some period of time, in which case there will be no way to conduct the $1 trillion of transactions required everyday by the current floating exchange rate regime.
With the stroke of your pen you can, temporarily at least, restore the simplicity of the Bretton Woods monetary system as an insurance policy against disruptions and guarantee a stable dollar throughout the Y2K window of vulnerability. Therefore, I want to urge you to issue an executive order immediately to stabilize the value of the dollar by instructing the Fed to conduct open market operations to add and subtract liquidity to keep the price of gold temporarily within a narrow band around the average gold price of the past 12 months. There would be no need of an international conference to discuss this. You need only fix the dollar/gold price as we did under Bretton Woods, and every country in the world could fix to the dollar.
This action would guarantee that, whatever the economic effects of Y2K, the Fed will continue to receive clear and unambiguous signals on the demand for liquidity and on what open market operations it must undertake to keep the dollar stable. We cannot know with any degree of certainty what the Y2K effects will be. However, with the value of the dollar temporarily anchored to gold, we can be sure of a rock-solid currency to see us through whatever Y2K might bring.
Is there a downside to this anchoring of the world's currencies to a single accounting unit? Perhaps it would prevent the Fed from raising or lowering the Fed funds rate to affect small changes in output and employment. But the risks of not anchoring the dollar are enormous and could invite the kind of recession or global depression that at least a few economists predict. I will be speaking about this issue in the weeks and months ahead, and I hope you will take the idea as seriously as I have in thinking it through. There are other areas of the federal government where simplicity would also help get the country through this unprecedented leap into the unknown. I'd be happy to discuss those with you as well, but because this one affects everyone on earth, I put it forward by itself.
Very sincerely yours,
Second Kemp Letter to President Clinton
August 10, 1999
The White House
Dear Mr. President:
In a letter dated June 11, 1999, I attempted to explain the virtue of issuing an executive order to stabilize the value of the dollar as a preventative measure against Y2K disruptions. You may recall that my suggestion was to instruct the Fed to use the price of gold temporarily as a target in conducting open market operations. This operating procedure would require the Fed to add and subtract liquidity to keep the price of gold temporarily within a narrow band around the average gold price of the past 12 months. Allow me to repeat my recommendation to emphasize just how serious I believe it is for the United States to maintain the dollar's stability, not just over the next few months, but over the long term as well.
The United States managed to escape the worst effects of the "Asian flu" but, without attempting to sound alarmist, we are not in clear waters yet. Nor am I alone in my belief that we should inoculate ourselves against unforeseen Y2K disruptions and potential financial turmoil as the year grows shorter. I call to your attention, for example, the July 23 New York Times article "Europe Rides Bumpy Computer Road to Year 2000" (attached), which called for immediate global action to ensure a safe and secure economic transition into the new millennium.
As I've said before, whatever the economic effects of Y2K, stabilizing the value of the dollar against the price of gold would guarantee that the Fed will continue to receive a clear and unambiguous signal on the demand for liquidity and on how it should conduct open market operations to keep the dollar stable. It's true that we cannot predict with any certainty the effects of Y2K, but with the value of the dollar temporarily anchored to gold, we can be sure that a rock-solid currency will see us through whatever the new millennium might bring.
I strongly urge you to take these preventive steps to protect the nation against significant disruptions in the economy. Mr. President, this is a matter of global consequence. We must prepare to face the unknown of the millennium on the best possible financial footing. Again, I'd be happy to discuss this issue further with you, Secretary Summers, and Mr. Podesta at a time that is mutually convenient and I look forward to your response.
President Clinton's Response to Kemp's First Letter
THE WHITE HOUSE
August 5, 1999
The Honorable Jack Kemp
1701 Pennsylvania Avenue, N.W.
Washington, D.C. 20006
Thank you for your very thoughtful letter regarding your concerns about dollar liquidity. I'm grateful for your careful analysis.
My advisors and I have reviewed your proposal to have the Federal Reserve fix the dollar/gold price via open market operations. While I share your concern that the Federal Reserve and other relevant authorities should be prepared to deal with any negative effects from Y2K, I do not believe that fixing the price of gold and the dollar would achieve the objective of stability in the event of Y2K problems. It is unlikely that the Federal Reserve could implement such a policy without risking substantial distortions in the U.S. money supply and the availability of credit. This conclusion is consistent with the 1982 Report of the Gold Commission, which addressed a broad range of issues related to gold and financial stability.
Although we have differing views on this issue, I hope that we can work together to prepare our nation for the year 2000. I do welcome your counsel. Please stay in touch. You have my best wishes.
Quayle Letter to President Clinton
The White House
Dear Mr. President:
Jack Kemp has shared with me his exchange of letters with you about the threat the Y2K computer bug poses to the domestic and global economy. Like Jack, I appreciate the efforts your administration is making to ensure that government computers are Y2K compliant. We are concerned, though, that your rejection of his June 11 recommendation may have been based on a misunderstanding, one that you may come to regret unless you give this issue closer scrutiny.
As I understand it, Mr. Kemp is simply suggesting we take precautionary measures to provide an anchor for our currency and all the world currencies that wish to link with the dollar in order to simplify financial transactions and record-keeping. The simple fact of the matter is that the global banking network, which not long ago relied on calculators and pen-and-ink ledgers, is now completely reliant on computers. "Money" is now largely electronic. Even if our financial markets are the most Y2K compliant in the world, a breakdown anywhere in this incredibly complex system may feed back to us in ways we cannot foresee or imagine. We need to think through what steps we can take right now to ensure the integrity of this system.
Jack Kemp's recommendation that you instruct the Federal Reserve by executive order to temporarily peg the price of gold -- as we did in the Bretton Woods system from 1944 to the early 1970s -- seems a credible one for this circumstance. The Fed's current attempt to manage the growth rate of the domestic economy should be briefly suspended in order to guarantee the stability of the dollar against commodities and other currencies as the world crosses the Y2K threshold.
As disappointed as I was in your cursory rejection of Jack's proposal, it occurred to me you might reconsider if you asked Alan Greenspan to give it serious thought. As chairman of the most important central bank in the world, presiding over the management of the world's most important currency, he surely must worry about the issues we raise here. Your letter of rejection suggests you are simply prepared to wait for Y2K to see what happens before any precautions are taken in this most critical area.
In your response to Jack Kemp, you dismiss this concern and address a much different issue: whether fixing the dollar/gold rate is the right long-term policy. That is an issue that can be debated at another time. For now, a short-term plan for dealing with potential disruptions deserves your closest consideration. If you are to act on the proposal, it should be done early enough to give the other governments of the world the opportunity to link into the system. No other country can provide this kind of currency umbrella to see us through a Y2K storm, should one occur.