Jack Kemp's op-ed in The Wall Street Journal Thursday calling for a return to a gold standard was an extremely important and necessary step toward ending the monetary deflation. But unless it is followed by positive steps by senior political figures in Congress, or the Bush administration or Fed Chairman Alan Greenspan, it simply will die on the vine. Kemp has enough standing in the GOP to initiate a discussion about the causes of the economy's weakness, but it will take a commitment by a senior political figure -- even a Democrat -- to force discussion in this direction. My expectation is that Senate Minority Leader Trent Lott, who understands the issue, will find a way to keep the gold idea in motion, but there are no assurances that he will, or that he will not pull his punch as he does so often. The way these things work, it will be the political fear of those most responsible for the economy that will drive the discussion for policy change, which is what Kemp is emphatically calling for. On FoxNews’ "The O'Reilly Factor" Wednesday night, when asked by host Bill O'Reilly if he would fire Greenspan, Kemp said no, he would merely have Greenspan change the focus of monetary policy by targeting the gold price, not overnight interest rates. To access the Kemp piece, click here.
The nervousness at the White House about President Bush's poll ratings, down to 50% or 51% according to the pollster cited, should lead to a serious review of Fed policy. Should -- but then the President's advisors might be telling him that he should be more compassionate or more environmentally sensitive or tougher with the Russians, etc. The failure of the six cuts in the fed funds rate this year to generate confidence in the capital markets still is being viewed as temporary by the Bush administration, which can only suggest that it will take another quarter or two for the cuts -- along with the tax rebates -- to increase "the flow of funds," as Treasury Secretary Paul O'Neill puts it. I've indicated to Treasury officials close to O'Neill that I am not "predicting" continuing economic weakness, but WARNING that it will come unless the Fed changes its operating mechanisms to target gold in order to push it at least to $300 and preferably $325. Water flows downhill and so does monetary deflation. The fact that I made these predictions to the Bush team before the Fed rate-cutting began in January has, I believe, increased the credibility of that warning. When O'Neill or Larry Lindsey next appear on television talk shows to discuss the economy and market, the Kemp initiative surely will be raised with them. This will enable us to determine the extent of disagreement -- if it exists -- between Treasury and the White House.
My guess is that O'Neill is closer to Kemp's view than Lindsey, despite the fact that O’Neill publicly says he continues to support a strong dollar policy. That formulation, which involves the forex market, not gold, can be harmonized with a change in the Fed's domestic goals. In April, when I met with O'Neill, I told him that the 1985 deflation was successfully countered by the Baker Treasury via the Plaza Accord, which involved a joint easing of monetary policy by the Fed, the Bundesbank and the Bank of Japan. Gold rose to $400 from $300, a bigger move than necessary, but there was not much variation in the forex values. Each government must worry about its export industries, which complain they lose competitiveness if their currencies become too strong. This is part of the pressure on the administration that is encouraging, with the National Association of Manufacturing wanting a weaker dollar for its exporters. The NAM does not understand the deflation process, but it is at least pushing in the right direction. The White House (which means Lindsey) is now calling upon the Bank of Japan and the European Central Bank to “ease,” which shows how little Lindsey regards gold’s value as a signal of tightness or ease. Japan is in a monetary deflation, which means it should be adding liquidity to boost the yen price of gold. Europe is in a monetary inflation, which means it should be subtracting liquidity to lower the euro price of gold. O’Neill is not making this mistake. The Lindsey call for “ease” in Japan and Europe reflects not only his conservative Keynesianism, but also his nervousness that the policy mix he created for his boss in the Oval Office is not working. Thus he blames our trading partners for not growing fast enough so they can buy more from the U.S. Lindsey is hopeless, I believe, getting further away, not closer, to figuring out the systemic problem.
The short-handed Federal Open Market Committee also is headed in the wrong direction, as the minutes of its last meeting suggest. There are still inflation hawks on the committee who prefer tightness under any operating mechanism. Greenspan, at least, has positioned himself in a way so that he could, if he wished, lend support to the Kemp initiative on gold. In his op-ed, Kemp bought our formulation that the deflation problem represents an accumulation of “small errors” by the Fed, as it has lacked the anchor which gold provides to quench central bank errors before they become serious problems in either direction.
The bond market and dollar/gold continue to fluctuate in narrow trading ranges, with the long bond bouncing between 5.6% and 5.75% and gold hovering around $270. The tendency, though, is for gold to inch up and the bond yield to inch down as the political winds shift. We still are hunting for defensive sectors for equity investment, assuming a scenario where the Bush administration continues drifting in the wrong direction, and should have some within the next week. Frankly, they are hard to find. As the economy weakens, federal, state and local tax revenues are heading south. This means, at least on the margin, that tax rates will be going up instead of down, thereby changing the risk structure for the overall economy. In our analytical framework, this automatically decreases the demand for dollar liquidity and pushes up the gold price. On the other hand, if the administration acts wisely, it will take direct action to push up the gold price. The Microsoft decision in the U.S. Appeals Court, by the way, was positive in a small way for the risk structure of the overall economy. You may not remember, but we definitely agreed with the government’s decision to act against Microsoft, but emphatically disagreed with the break-up order. The punishment did not fit the crime, and if allowed to stand would cloud the dynamics of the new economy.
The best news of the week, though, was the victory of Jersey City Mayor Bret Schundler in the New Jersey GOP primary for the gubernatorial nomination. The Democrats already have been counting their chickens in expecting to win the governorship with Jim McGreevey, the Woodbridge mayor who lost narrowly to Christie Whitman four years ago. If Schundler, 43, wins in November, he would be instant presidential timber in the Reagan/Kemp growth wing of the Republican party. He is being cast by Democrats as a right-winger, but if he aligns with Kemp on capital gains taxation and gold, he will win New Jersey as easily as Reagan did in 1980 and 1984. Republicans only lose in New Jersey when they run as fiscal or social conservatives. Like Americans in general, New Jerseyans prefer economic growth.