Monetary Moment of Truth
Jude Wanniski
May 22, 1989


The surge of the dollar outside the G-7 range, along with the continued sinking of the price of gold toward $350, has concentrated the minds of policymakers in the Bush Administration and Federal Reserve. Unless the Fed responds to these price signals that are battering at its walls, by lowering short-term interest rates, we'd expect the dollar to continue its climb and gold to sink again. This new deflation at some point below $350 gold would have adverse consequences to the economy and stock market, although bonds would continue to hold up well unless the Fed deflated with a tightness reminiscent of early 1982.

Peter T. Kilborn's New York Times report today, "New Strategy on the Dollar," is thoroughly confused and misleading, suggesting that CEA Chairman Michael Boskin and OMB Director Richard Darman are trying to push Treasury away from its "status quo" posture on the dollar to "a partial reversion to the practices of the decade from the mid-1970s to the mid-1980s, when countries left the fate of their currencies largely to the marketplace." This is wholly incorrect. The White House practically from stem to stern is eager to see the Fed trim short-term interest rates as a means of arresting the dollar's climb and gold's decline. The idea that the Fed has to keep the Fed funds rate bumping 10% to fight off incipient inflation has no adherents we can find in the Administration, except perhaps with Treasury Secretary Brady himself, who does not wish to be seen in open conflict with Alan Greenspan. This also reflects the views of his international duo, Mulford and Dallara, who do not want the dollar to rise against the DM and yen, but who have believed exchange-market intervention alone could do this job. ("The dollar's surge has baffled economists," writes Kilborn, who is well aware that Polyconomics has been shouting of its inevitability as long as the Fed refuses to supply the liquidity the economy has been demanding.)

As we have been arguing for at least 15 years, intervention has almost no influence on exchange rates for more than a day or two and zero influence within a week. It is physically impossible for foreign central banks to influence the value of the dollar when the U.S. central bank is determined to offset, dollar-for-dollar, every foreign intervention. In the bathtub of global dollar liquidity, only the Fed controls the faucet and the drain. All the other players operate with teaspoons. Imagine the collective density of central bankers and their Keynesian advisors in trying to counter the Fed's insistence on keeping the water level at 9 7/8 % overnight money! Billions of dollars a year are burned up annually in transaction costs, subtracted from seignorage that should accrue to taxpayers, with zero effect on policy.

There is one sense in which Kilborn's article was correct. A moment of truth is fast approaching when the President will have to decide if he is going to continue the international monetary reforms begun by Baker and Darman in 1985, to bring stability to currencies and commodity prices, or return to the "benign neglect" period when it was every man for himself. Bush can break the gridlock between the Fed and Treasury by publicly asking the Fed to cooperate with the Treasury in halting the dollar's rise (and not sterilize the interventions). Alan Greenspan would then be protected against any inflation he may still be worried about, Bush taking the heat for it should it appear. Central bank intervention can easily steady the dollar, even with teaspoons of liquidity, as long as the Fed doesn't open the drain. Several of the Fed governors would love to see the President do just that.