Morning Memo Jude Wanniski March 21, 2001

Here are copies of two e-mails I sent this morning before 8 a.m. -- to David Sanger and Richard Stevenson, both of The New York Times Washington bureau. Both have page one reports today that relate to the problems on Wall Street. The first, by Sanger, is about the blackouts in California. It is extremely important because it quotes Daniel Yergin of Cambridge Associates as saying the energy crisis is due to the Asian crisis of 1997-98. It now only takes one more step before the NYT sees that the Fed caused the Asian crisis. If our establishment cannot make that connection, it of course has to draw the conclusion that we will have energy crises every time there is a recession in some other part of the world, which does not make much sense.

Stevenson now covers the Fed for the NYT. I've been peppering him with e-mails for months about the deflation, but he has remained immune to them. Maybe one more pepper will put him on track. There is now enough fear out there that we may change enough minds to get this thing turned around. I'm going to DC this weekend and will be there to the following Thursday,spreading the gospel. Wish me luck.

To David Sanger:

It is nice to see you quoting Dan Yergin as saying the energy problems we face now are the result of the Asian economic downturn in 1997-98, when the price of oil collapsed and made it unprofitable for the oil and gas industry to develop new sources of energy. You could have pointed out that I advised you way back then that it was Greenspan who invited the Asian crisis by ignoring the fall in the price of gold, which preceded the price declines not only of oil, but of all commodities, including farm prices here in the U.S. Had Greenspan followed his own principles in seeing the price of gold as a signal of incipient deflation, he would not have ignoredthe decline and early in 1997 would have urged the additions to liquidity necessary to stem the price decline. The Asian economies were wrecked because their central banks were targeting the dollar, which meant they were pulled down by the deflation. Our commodity sectors were wrecked too, but because we are primarily producers of intellectual goods and services, the first wave of the deflation benefitted our overall economy. We now are paying the price for these errors, as Dan Yergin points out.

At the time all this was happening in early 1997, I believe you will recall that I was warning not only Greenspan, but also the Clinton administration. You might also check with my clients, who were getting my warnings as well, including the American Farm Bureau Federation and the Independent Petroleum Association of America. George Yates of New Mexico, president of the IPAA at the time, had me address a gathering of oilmen in Washington, D.C., several of whom were facing bankruptcy as the oil price declined to $10 from $25. I only could advise them that it would take a reversal of policy by the Federal Reserve to halt the decline. When the Asian economies began to recover, having broken their links to the deflated dollar, their fresh demands on world energy supplies drove the oil price up.

Energy is the world's most important commodity, the primary input to much of the world's production of goods and services, a secondary input to all the rest. The experience we've had demonstrates that it is impractical for the United States as the world leader to continue floating the dollar. As smart as Greenspan may be, he cannot determine the market's liquidity needson a day-to-day basis without help from the market. And the market needs a fixed price of the paper dollar to something real in order to provide that signal. Unless we adjust the dollar price of gold back to a more appropriate level, dollar debtors here and around the world will be bankrupted and their creditors will face bankruptcy themselves. South Africa, the country that most relies upon gold production for its economy, is approaching widespread economic collapse.

You and the editors of the Times should get busy pursuing this line of reasoning as the editors of The Wall Street Journal have decided to shield Greenspan from criticism and argue instead for tax cuts as a cure for what ails the economy. Like Humpty Dumpty, once the breakage occurs, it becomes impossible to make repairs that restores the status quo ante. We're now experiencing rolling blackouts in California, one of the richest political subdivisions in the world. Imagine what's happening to the poorest places on earth and how much worse it can get.

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To Dick Stevenson:

The Fed cannot arrest the economic decline by lowering the funds rate, even to zero. It has to signal the market that it wishes to inflate in order to offset the accumulation of deflationary errors it has made. The market has been taught that the Fed desires deflation. It now has to be taught that the Fed desires inflation, at least a little inflation, which is the only thing that works. This is the same problem the BoJ is having. A zero interest rate is a deflationary rate, so by setting it as a target, the BoJ continues to instruct the market to hold yen, not invest yen, certainly not borrow yen. I have not spoken to Peter Kilborn in a decade, but I think he may have been on the Treasury beat when the Plaza Accord was reached in 1985. You might talk to him. The Plaza Accord helped end the deflation at the time because the Treasury and Fed agreed to work with the BoJ and Bundesbank to jointly devalue, so exchange rates would not get out of line. The lowering of the funds rate was then seen by the markets as part of a strategy to weaken the currencies against gold, which then rose from the low $300 level to more than $400, when they went a bit too far. You might also talk to Dick Darman at the Carlyle Group, as he was a key architect of the Plaza Accord. Bob Zoellick may also have had a hand in it. Wayne Angell was at the Fed then; Greenspan was not. You should of course talk to Angell. Your financial page credited him with turning around the stock market last month when he had a press conference saying the Fed might lower rates earlier than expected. The story did not report that he also said the January rate cuts were ineffective because they did not raise the gold price. That is what the markets are waiting for. The Fed doesn't even have to add liquidity to get that to happen. It only has to indicate that's what it wants and then not change its mind.