Letter to Greenspan
Jude Wanniski
December 3, 2003


Dear Alan:

Although you have not mentioned the price of gold recently, I know you well enough to know you are getting very nervous now that gold has made the long climb from $255 an ounce in mid-2001 to $402 today. The monetary deflation some Fed governors still worry about, looking at non-monetary statistics, was left behind when the dollar/gold price got to the $350 range earlier this year. We are not facing "An Inflation Monster," as the Wall Street Journal reported this week, but unless you take steps soon to raise the Fed funds rate from the 1% level appropriate for deflation, Fed policy will continue to add surplus liquidity into the system, push up the gold price, and weaken the dollar against the euro (as the European central bank has been keeping the euro fairly steady against gold).

I`m thinking you may not connect the rising gold price with a fresh bout of inflation because the Bank of Japan had taken its overnight rate below 1% without an outbreak of inflation. The difference, Alan, is that the equilibrium price of yen/gold is on the order of at least 45,000 and while it has crept up to 44,000 from its low of 28,000 at the depths of its deflation, its overnight rate is still not in negative terrain. That is, while the Fed has to add more liquidity than the market needs or wants in order to keep funds at 1%, the BOJ still does not.

David Malpass of Bear Stearns, who I believe you respect, now believes the Fed`s Open Market Committee MUST signal next week that it is no longer concerned with deflation and must give strong hints that it will begin raising the funds rate soon, or the liquidity leakage will continue to push the dollar/gold rate up. And the higher it goes, the more incipient inflation it builds, which means it will be a lot tougher to get it under control if you wait until next summer or fall to get the funds rate where it should be. Malpass thinks that Fed funds should now trade at 2.5% to get them into positive territory and on that I agree with him completely. If we were on a gold standard at $400, the FOMC would have to drop the funds target in order to target gold. Funds would immediately climb to 2.5% and the 2-year note would tack on a few basis points, but the 10-year and 30-year bonds would show lower yields. In other words, we would see a normal, gold-standard yield curve, with inflation and deflation risks eliminated.

This is a good time for you to again be talking about gold, I believe, because the economy is responding favorably to the tax cuts on capital passed last spring. It really does not need any help from a super-low overnight interest rate that is doing nothing for the economy and is causing the supply of liquidity to outrun the demand. It is too much to hope you will argue for a higher funds rate next week when the FOMC meets, given the belief you would be upsetting the Christmas season, but you could begin talking about taking action early in 2004. I`ve advised my Wall Street clients that I do believe six months from now the gold price will be back below $400 and the euro below $1.20, but it needs a little help from the Fed to make that happen.

Please give it some thought, if you are not already.

Sincerely, as always,