Monetarism Lives!
Jude Wanniski
May 21, 1987


The leadership vacuum at- the White House, Treasury, Fed continues to plague the bond market with no relief in sight. The.most disheartening sign is the reemergence of monetarism in high places. CEA chairman Beryl Sprinkel and OMB Director Jim Miller III have bombarded Treasury Secretary Baker with "M" charts that show a slowing of money-supply growth in recent months, thus arguing against a Fed tightening! Fed Governor Robert Heller, who pooh-poohed soaring Ms last year in arguing for further monetary ease (pointing instead to sluggish commodity prices), now cites the sluggish Ms and pooh-poohs soaring commodity prices as he argues against tightening. The Fed staff couples mindless monetarism with the silly Keynesian argument that inflation can't occur with so much "excess capacity" in the economy. It actually projects declining inflation rates through the balance of 1987. Meanwhile gold bumps $480 and bonds sink.

Why are the Ms slowing? The same reason Ms in Japan have been racing. A decrease in demand for dollars and an increase in demand for yen dollar velocity rising, yen velocity falling as we inflate and they deflate. The process began with President Reagan's trade sanctions against Japan March 27, which reduced the investment demand for dollars, sending the gold price up, the dollar and dollar bonds down. Over the lifetime of the T-bills and bonds issued in the May 5-7 refunding, this $300 million "punishment" of Japan will cost U.S. taxpayers billions (as it has already cost bondholders tens of billions). The monetarists can't grasp that a raising of short-term rates would stabilize the dollar and thus increase demand for it (which shows up as an increase in M). Lifting the sanctions in itself would increase the demand for dollars, put downward pressure on fed funds, forcing the Fed to drain reserves to keep the current 6 3/4 target from slipping. Bonds rallied May 20 when funds slipped to 6 3/8 and the Fed drained reserves.

With the Fed shying from direct, vigorous moves to defend the dollar (a 6 1/2% discount rate, 7 1/4% fed funds), we will have to await the Venice economic summit June 6, when, presumably, a deal to remove the sanctions will be worked out, hopefully coupled with a Bank of Japan/Fed maneuver on discount rates. I say "presumably" because Treasury and White House sources tell me the sanctions will come off "at the right time." White House chief of staff Howard Baker has no idea what's going on, though, and really seems to think the sanctions were imposed because Japan violated the chip agreement and can only come off when there is proof of compliance. There is nobody in the White House who can converse halfway intelligently on financial markets or exchange rates. The President himself reads more of the financial press than all of Howard Baker's team combined. A Paul Volcker reappointment would be helpful, permitting him to be more aggressive in countering the fresh signs of inflation. A source close to Jim Baker thinks a Volcker reappointment likely, that it may come as early as this Memorial Day weekend. If Volcker accepts, this will help bonds greatly, because he knows better than the Fed staff that $480 gold means plenty of wage and price inflation ahead.