The Paralysis at the Fed
Jude Wanniski
April 24, 1987


The markets remain chaotic given the total absence of leadership in Washington. The President is on hold. Howard Baker has taken the protectionists off the leash and they are running wild conducting international trade terrorism. Jim Baker is the only potential leader inside the Administration, but seems immobilized, almost neutered by the Baker White House. Volcker should be taking a lead, but he's also on hold, given renomination politics which is a sad thing to have to say about him. He's given us "enough is enough" rhetoric, but nothing of substance, and one wonders again whether it's worth while having him around for yet another term. He's permitted this monetary chaos instead of asserting himself. The nonsense has taken hold that the bond market collapse is due to (a) rising inflation expectations evidenced by climbing metals prices and the free-falling dollar and (b) the fear that the Fed will do something about (a). In August 1982, with gold on the floor and the dollar sky high, the Fed was terrified that the bond market would not appreciate more liquidity! Now, we have the opposite condition and the Fed is again paralyzed. It should be moving up short rates, even a half point to 6 on the discount rate to boost the dollar and knock down climbing gold. Even better, a Fed intervention in the forward markets that would strengthen the market without disturbing short-term rates at all. Bonds would soar! But I've talked to all five of the Fed governors in recent weeks and find cold fear that such action will sink bonds instead of booming them. My only hope is that intellectual integrity will overcome this cold fear. Vice Chairman Manley Johnson has been a great disappointment during this monetary crisis, for all practical purposes hiding out in hopes that the storm will blow over. He wishes Japan to take the lead in defending the dollar!!! Meanwhile, the Fed continues to add reserves to the system in accord with staff calculations on seasonal reserve requirements! That is, the open-market desk pegs a 6 3/8 fed funds rate in order to accommodate their calculations, and will presumably hit it even if gold tops $1,000! This parallels November 1979-January 1980, when the staff set Ml targets to fuel a projected expansion of the economy and Volcker watched reserves thrown into the market even as gold climbed toward $850. Does he never learn? It's no doubt true that the H.Baker-Baldridge-Yeutter protectionist triad is adding to the Fed's problems. They're still talking down the dollar (Yeutter's target of 100 yen to the dollar implies $650 gold!). And they're also poisoning the commercial climate, which sinks demand for the dollar and dollar assets! Treasury Secretary Baker, the chief economic spokesman for the Reagan Administration, the man the President has relied most upon in these matters, has retreated into immobility, presumably shell-shocked at finding himself a focal point of sharp press criticism for the first time in these last six years. Third-string bureaucrats are making policy pronouncements that should be his exclusive domain. If it is always darkest before the dawn, it's getting awfully dark. We should see something soon from the Fed.