Gold and Poverty Jude Wanniski June 2, 2000

Unless there are interesting questions posed as a result of this lesson, I am going to make it the last of the spring semester and our concentration on money and banking. As in the past, summer school will be devoted to random topics, to help those of you who fell behind in our earlier lecture series. For this lesson, I chose the topic of "Gold and Poverty," to help you REALLY, REALLY understand why I spend so much time on monetary policy in general and a gold standard in particular.

On June 17, I will be 64 years old, which suggests I am on my last laps as an active participant in the debates over public policy. Of all the things I have learned in these years, the importance of money as a unit of account is very near the top of my list. If you were to ask me what I worry about most in the world these days, I will readily say Black Africa. I worry too about India and the rest of the Asian subcontinent as well as Islamic Africa, but these are down a few notches, along with my persistent concerns about Black America. Of the 1800 SSU students registered here, I suspect not one of you puts Black Africa at the top of your list of worries, but don't worry about that. Remember that Aristotle was comforted by the fact that the masses of ordinary people worried about so many different things from so many different angles. It also is good to remember that you should never worry about anything which you cannot do anything about. It is only because I am in a position to do something about the things I worry about that I spend so much time at it. There is also my fervent hope that SSU will produce students who some day may be in a position to effect change in these areas.

Why Black Africa? Because it is now that part of the organic BODY we call "mankind" which has a cancer, a malignancy that is spreading throughout the continent, and which as it metastasizes will infect the rest of our global Body Politic. If you read my 1978 book, The Way the World Works, you will find similar expressions of concern for Black Africa. My concerns, by the way, have never been racist or patronizing in any way. Those of you who have followed my teachings here will accept the fact that I objectively look over the whole of the Body Politic and find it healthy to one degree or another, and the Black Africa is the least healthy. If you have your doubts, I recommend you read The Ends of the Earth. It is a book by Robert D. Kaplan, a young man and editor of the Atlantic Monthly who devoted several years of his life in the early 1990's traveling to the poorest countries of the world, with a knapsack on his back. It is a grim first hand account of the depth and breadth of poverty that afflicts the greater part of humanity. As I noted recently on this website, in a memo to UN Ambassador Richard Holbrook, I have little doubt that the diseases of the Black African part of our Body Politic will spread to the rest of us unless we figure out how to arrest the economic decline.

The original title of my book was The Way the World Works: How Economies Fail, and Succeed. With the help of Canadian economist Robert Mundell -- who now has a Nobel Prize -- and his protégé Arthur Laffer, I provided the serum that Ronald Reagan and Jack Kemp injected into our national body politic. The U.S. economy now enjoys a 17-year expansion which should be credited to the revival of supply theory and the policies they engendered. The apportioning of credit only concerns me when it distracts political leaders around the world from the original insights of Mundell & Laffer, Reagan & Kemp. For the most part, global political leaders now understand that high marginal income-tax rates are self-defeating and most countries that had top rates of 70% or 80% in the pre-Reagan years have now brought them down to below 40%. These are still too high, especially when reached at very low income thresholds, but the direction is a hopeful one. Monetary policy here and around the world remains stuck in the demand model, though, and is a primary source of the world's poverty. It is useful here to recall the quote of John Maynard Keynes who wrote in Essays in Persuasion (1931): "Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of Society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner in which not one man in a million is able to diagnose."

So let me return to the topic today, which is really about how a dollar as good as gold will help end the poverty of Africa and the Asian subcontinent. Simply put, it is because people of even limited wealth can manage nicely with a floating unit of account, but the poorest people cannot. Having a portfolio of investment assets means you have a cushion to protect you and your family from the effects of inflationary and deflationary swings. By definition, being poor means you have no cushion of financial capital to provide food, clothing and shelter. You must rely upon the benevolence of society in downturns, either private charity or government welfare. The process of climbing out of poverty means you must rely upon your labor to provide not only enough for your immediate needs, but enough to save for a rainy day.

In the barter economy where there is no "money" involved, face-to-face trades are made on the spot market and through face-to-face contracts. When a specific amount of bread is produced and exchanged for a specific amount of cheese, there is no risk of inflation or deflation in the contract. Poverty occurs when nature spoils a crop through drought or pestilence or when an invading army carries off your stores and kills your young men who produce. In a modern economy, living standards are as high as they are in the developed world because there are large stores of surplus, efficient means of matching surplus capital with investment opportunities, welfare networks, and security against invading armies or internal insurrection. Even in modern economies, though, for the poor to become unpoor requires the ability to produce enough so there is a surplus that can be saved. The surplus could be used first as a cushion, perhaps cash saved in a cookie jar, and then accumulated with a goal of buying educational skills that would have higher marketable value, or acquiring physical capital that could produce at a higher rate of return.

Consider a man who decides he is going to cut himself loose from a wage that barely covers his daily needs and go into business for himself. He has the idea that he will take his intellectual skills -- in and of themselves an important form of capital -- and try to make a living by selling goods from a pushcart. If only he can provide for himself and his family out of his 70-hour-weeks peddling, he might be able to put away $1 a week, so that at some point in the not-so-distant future, he will be able to buy a wagon.

As soon as he has the $100 for the wagon, the government decides to devalue the dollar by 50% in order to "make exports cheaper." Suddenly, our pushcart entrepreneur must work an extra year to earn the money he needs to buy the wagon. But he slogs on and in another year, he has the money, but the government devalues again! What is the use of continuing? This is what Lenin was talking about when he spoke of the ill effects of debauching the currency. At this point I'd like you to look at a graph of the Indian rupee over the last 27 years. It shows that in 1973, it took roughly 500 rupees to buy and ounce of gold and today requires 12,000 rupees for an ounce. In that span of time, the population of India has risen from 550 million to almost one billion, and except for a few islands of prosperity, the poverty of the world's biggest democracy is greater today than it was before Nixon broke the dollar's link to gold. A similar chart for the United States would show the 1973 dollar gold price rising from $120 per gold ounce to $275 today. The percentage rise of the gold price in British sterling is roughly the same as that of the United States. The difference is that Ronald Reagan arrested the decline of the dollar with his Mundellian policies of supply-side tax cuts, which increased the demand for dollar liquidity, and a tight-money policy that not only ended the inflation but now has deflated the unit of account. In Britain, Margaret Thatcher followed suit, bringing an end to what once was called "the British disease," that combination of stagnation and inflation which neo-Keynesian economic theory could not explain.

Suppose we were to go back to 1971, before the world's monetary standard of measure was cast adrift by the Nixon administration. Suppose Nixon's economists had advised him to cut tax rates instead of raising them and had urged him to keep the dollar as good as gold by mopping up surplus liquidity when the dollar weakened against gold. With hindsight, we should be able to see it would have worked like a charm, but of all the world's economists, only Mundell could see it. His protégé, Art Laffer, was actually in the Nixon administration at the time, as chief economist of the Office of Management and Budget. He warned of what would happen if the dollar/gold link was cut, but his boss, George Shultz, a friend of Milton Friedman's, ignored him. We can't blame Shultz, really. The demand-side paradigm dominated the academic world, as it still dominates the International Monetary Fund and the World Bank. But if we could replay the history of the Nixon administration in a supply model, the graph of the Indian rupee would show no currency weakness in the period since. Instead of doubling, the population of India would have stabilized and living standards would be as high as parts of Western Europe's are today.

With all our vaunted prosperity here at home, we also have an impoverishment in our underclass that would not exist if we had stayed fixed to gold in 1971, with that Mundellian policy mix. Real wages remain lower today than they were prior to the floating of the dollar. If Lenin or Keynes were alive, they would not laugh if I told them Nixon's floating of the dollar -- on the advice of neo-Keynesians and monetarists -- had the net effect of putting 2 million American men, most of them black, behind bars. In a modern economy like ours, when we more or less get policy right, we can produce enough surplus resources to warehouse 2 million men to prevent them from stealing what they need to sustain themselves and their families.

In 1997, I wrote Alan Greenspan a letter to this effect, warning that the swings in the dollar gold price were the cause of the financial turbulence in Asia. I also asked for a meeting with President Clinton to warn him of what damage our deflationary monetary policy would do to commodity producers. The White House sent me to the Treasury department to meet with Larry Summers, who is now the U.S. Treasury Secretary. At least Summers knows my arguments of how and why things went so wrong, although he is protected in his errors by the Political Establishment's preference for a monetary policy that serves its interests, at the expense of the poor. Greenspan, who had been communicating with me for several years on a regular basis, simply shut his ears to the idea he was in any way responsible for the strife in the poorest countries of the world. In reality, he is, but does not want to think about the fact that because the dollar is the world's monetary standard, he is the central banker for the world. Yet he takes his orders from the Political Establishment and answers only to the Banking Committees of the House and the Senate.

In previous lessons this semester, we have gone over the reasons why small economies are forced to follow the lead of the dollar in setting their own monetary policies. They could learn to defend themselves better than they have done in recent years by paying attention to the dollar/gold price. But only a fixed dollar/gold price would remove the risks that the poorest people on earth must now shoulder when they try to climb out of poverty.