Jude Wanniski and David Goldman
November 29, 1989
THE DOLLAR/DEUTSCHEMARK CONTEST
As the dollar price of gold climbed sharply during the past two weeks -- which also saw some of the most portentous events of postwar history -- the Deutschemark price of gold remained steady. It should be considered whether these events are related. A good part of the dollar rise in gold can be related to speculation of further Fed easing to combat recessionary fears. But it's also worth considering that another element was at work, i.e., a reduction in the seignorage value of the dollar relative to DM.
Seignorage is the amount of wealth that accrues to a government when its currency is used as a circulating medium, currency being its non-interest-bearing debt. Of the $220 billion of currency in circulation, more than half may be outside the U.S., some of which is circulating in the underground economies of Third World and East Bloc countries. In their September visit to Moscow, Fed Gov. Wayne Angell and Jude Wanniski advised officials of the Soviet government that unless they soon had a gold ruble, Eastern Europe and the Baltic states would gravitate to the Deutschemark. The commercial dynamic requires a real money.
The post-war political and monetary arrangements are now in question as a result of the upheaval in Eastern Europe. It is now possible to envision -- as the Deutsche Bank does --a return to pre-1914 financial conditions in Europe, in which German-centered finance predominates in the industrialization of Eastern Europe. At the same time, the expansion of Europe's market for goods as well as financial services makes more credible the establishment of a common European currency and a European central bank. As this process unfolds, the DM will contest the dollar for seignorage gains, at the margin adding to surplus dollar liquidity that drives up the dollar gold price, unless the Fed counters by selling bonds, i.e., interest-bearing debt.
The perceived disadvantages of monetary union (e.g. to Britain) may be outweighed by the common advantages (lowered cost of capital in a bigger market). The failure of most European countries to develop broadly-based equity markets means that European measures to improve the efficiency of markets would drastically cheapen the cost of capital by making equity more available.
World War I began over the struggle between Austria and Russia for Eastern Europe, at a time when the German Empire extended into the northwestern Soviet Union, and Hungary, Czechoslovakia, Rumania and Yugoslavia belonged to Vienna. As Deutsche Bank chairman Alfred Herrhausen emphasized in a recent interview, the old contacts are not dead. The issue of German reunification is in important respects a red herring. The Germans did quite well prior to 1914 with two states (Hapsburg and Hohenzollern), and can now do well with three. The economic issue is not so much the juridical future of the Germans, who in any event have never been good at politics, but rather the expansion of the German economic zone to include many non-German, but essentially Western peoples, most importantly the Czechs, Hungarians, Poles, Croats, Lithuanians, Estonians, and Latvians. These all belonged to Western currents of Christianity, and were late and unwilling conquests of Russia. Among them the tradition of entrepreneurial individualism is not dead. All were in an advanced phase of industrial capitalist development by 1914.
The most intelligent of the Germans -- e.g. Herrhausen, who is Chancellor Kohl's personal economic advisor -- will let political and military arrangements work themselves out over time, and concentrate on rebuilding the old trade roads east. They will press for European monetary integration in order to cheapen their cost of capital. To the extent they succeed, the demand for dollars as a reserve instrument will decrease at the margin. It is ridiculous to think that (as matters stand) a hostile European (or Japanese) bloc will dump dollar holdings; on the contrary, all the major institutions are hedging their bets with huge investments in the United States. But the expectations of marginal shifts in long-term demand for dollars may have significant short-term effects as they are discounted into today's markets.
David's provocative observations are especially relevant on the eve of the Malta summit. It helps us see that the dynamic that Angell and I explained to our Soviet hosts in September has its influence in the U.S. as well. That is, as urgent as it is for Moscow to adopt a gold ruble as a counter to the magnetism of the DM, it's clear the United States faces parallel pressures. It's already dawned on Angell, of course. It will soon be evident to Greenspan and others that unless the U.S. counters with monetary reform of its own, it will fall steadily to the advance of the DM, losing seignorage along the way and forcing tighter Fed policies to prevent a rise in the gold price and inflation.
In this light, the nomination of Assistant Treasury Secretary David W. Mullins to the open Fed seat is critically important. The Wall Street Journal says this will give Treasury Secretary Brady an important voice at the Fed, Mullins being a Brady protege. The paper suggests Mullins will soon be arguing for lower interest rates. I don't think so. It's the Mulford-Dallara faction at the Treasury that has been trying to sink the dollar. I identify Mullins with Undersecretary Bob Glauber, Brady's other protege at Treasury, who has been receptive to supply-side thinking. My guess is that the communication flow in the other direction will be far more important, with the Fed governors able to influence Treasury's monetary policies through the Mullins connection. If there is to be renewed discussion of monetary reform, given the new pressures emanating from Europe, this personal linkage will be valuable.
The picture that is emerging lately is of a capital-strapped United States sandwiched between a capital-rich Japan and a Europe dominated by a capital-rich Germany. In addition to the monetary pressures on the United States to get going on monetary reform, it should also occur to the White House team that the United States is going to get pushed deeper into the sandwich unless we have a capital-gains differential.
This is the kind of appeal President Bush has to make to the country at large. He can do it in his State of the Union speech in January. He can also do it on his new Saturday biweekly radio program, arranged primarily so he can have this vehicle at the ready when he needs to go to the public for support. We're moderately optimistic the political tides are running with us.