A Gold Polaris
Jude Wanniski
September 19, 1997


Supply-Side University Economics Lesson #2

Memo To: Students of Supply-Side University
From: Jude Wanniski
Re: A Gold Polaris

Supply-side economics is generally associated in the press with tax-cutting, but as I discussed last week in our initiation session, it is a system of thinking about all of the economic universe. And there are several branches of supply-side thinking that have grown up since Robert Mundell and Arthur Laffer revived the basics of classical theory in the 1960s. Mundell, who was chief international economist of the International Monetary Fund in 1960, in that year published his theorems on optimal-currency areas, which are still cited in almost every textbook on international economics. In that year also, Mundell proposed the idea that for each economic target there should be an economic instrument: That the correct instrument for an employment target was fiscal policy, and the correct instrument for an inflation target was monetary policy. This entirely cut against the grain of conventional thinking in the economic establishment.

The opposite side of the debate was taken up by James Tobin of Yale, who in 1961 joined the Kennedy Council of Economic Advisors as a junior member. Tobin argued that monetary policy should be the instrument aimed at employment and that fiscal policy be the instrument aimed at inflation. This became known in the small circles where such issues are discussed as the debate over the Policy Mix. Mundell lost the debate in the sense that after the assassination of President Kennedy, the political center of gravity moved decisively into the neo-Keynesian framework and its demand model. When Richard Nixon was elected in 1968, he carried forward the Tobin policy mix. His economic advisors, including Herbert Stein, recommended higher taxes to balance the budget, which would then supposedly dampen inflation. In 1969, Nixon proposed and got from the Democratic Congress an increase in the capital gains tax. When recession appeared and unemployment rose, the instrument he reached for was monetary policy. The idea was to print money faster to expand the economy, and when that failed because the dollar was linked to gold, his advisors persuaded Nixon to sever the dollar-gold link in 1971, on the idea that a devalued currency would help expand U.S. exports and thereby create jobs.

You can see, then, how these origins of a supply-side revival first centered on monetary policy and the dollar, both as a domestic instrument and as an international currency. This week, I'd like you to read the essay I wrote in early 1995, "A Gold Polaris," which was originally meant as a primer for Senate Majority Leader Bob Dole, who I had been advising at the time. Because members of Congress, with a very few exceptions, have no understanding of international economics, I wrote the material in a way I believed would be accessible to the uninitiated. It is still not as easy as pie, which is why I recommend you plan to read it once, put it down, and come back for a second reading. It is important as we go forward that you have a firm foundation in money and monetary policy or the other elements of the economy will not make as much sense to you. For this purpose, I'll ask you to suspend what you think you know about gold and money and read the essay without prejudice.