The climb in the gold price to $390 can be viewed as the first line of a defensive hedge against the possibility that Federal Reserve Chairman Alan Greenspan will soon abandon his commitment to price level stability. The bond market remains quiet because it continues to believe in Greenspan's commitment, as I do, a belief that is based on a six-year history of Greenspan's public and private statements about monetary policy and central banking. The Federal Open Market Committee meeting next Tuesday and Wednesday will provide Greenspan an opportunity to demonstrate that his commitment is intact. That is, if Greenspan remains passive in the face of the important gold signal, we can expect to see the bond market push its way back toward 7% from the current encouraging level. If he becomes active, as I believe he will, the Fed will signal its resolve by a snugging up of short-term interest rates in a way that should trim the gold price. Greenspan has had the authority to snug up on the federal funds rate since the last FOMC meeting, the markets were advised through anonymous comments to the financial press. Why hasn't he, in the face of a steady upward drift in the gold price? We can only speculate.
First, Greenspan has a history of keeping his powder dry, using the weapons available to him sparingly, when he determines they will not be wasted. In August 1990, when Saddam Hussein invaded Kuwait, the price of gold jumped by leaps and bounds to $420 from $350, on market expectations that had been conditioned over the previous 20 years. That is, always before when there was a major disturbance in the Middle East that might cause a run-up in the price of oil, the Federal Reserve would respond with monetary ease. In the days and weeks after the Kuwait invasion, to be sure, the usual Ivy League Keynesian economists publicly counseled monetary ease to offset the deflationary effects on "aggregate demand" of a higher oil price. Greenspan and Fed Governor Wayne Angell, we have learned since, privately agreed that it would be a dumb thing to do, as it was clear from previous Fed easings in response to Mideast turmoil that the bond market was slapped silly. As gold climbed to $420 in 1990, the bond market was also knocked around badly, but we advised our clients that Greenspan was not going to fall for the old Mideast trap. We were, of course, right. Gold drifted down and bonds were bid up as the Fed watched impassively. In the current situation, the fact that the 30-year bond has been steady lately would tend to keep Greenspan from acting, although not forever.
Second, Greenspan is surely being advised by conventional analysts to ignore this particular rise in the price of gold. Pick up any newspaper and you will find bizarre reasons for the gold price rise, most of them somehow suggesting political uncertainties elsewhere in the world, with gold a "safe haven." We, of course, reject these arguments as we always have, noting that half the time when there are political disturbances the price of gold falls in dollar terms, and the newspapers report expert opinion that the dollar has been bid up as a "safe haven." Greenspan will listen to such arguments, as he listens to many other economic and political arguments that mix into his final policy decision. His patience with such arguments wears thin, especially as he is also listening to the views of Angell, Vice Chairman David Mullins, and Governor Larry Lindsay, who each tend to pick apart the conventional arguments they hear all around them.
Even if the Fed does snug up next week, after the FOMC meeting mixes all the ingredients that go into the policy soup, there will likely remain anxieties in the gold market until the world sees what happens to President Clinton's tax bill later this month. Until the market sees for sure that Greenspan is not going to offset the deflationary effect of the tax bill with monetary ease, there will be the same kind of nervousness in the gold market as there was after the Kuwait invasion. The Keynesian policy mix that underpins the Clinton Plan requires easy money by the Fed, even though Greenspan has repeatedly advised in public as well as in private that THE BOND MARKET WOULD CRASH if he were to do so. The Ivy League economists who know they are out of business if Greenspan is right will not take no for an answer. In the recent Business Week, MIT's Rudi Dornbusch writes glowingly about the Clinton Plan and how beautifully it will work as long as Greenspan keeps his side of the deal. Nor do the Democratic politicians give up easily, as they are the folks who are going to walk the plank if the Clinton Plan is adopted and they discover that Greenspan is right! Senate Budget Committee Chairman James Sasser of Tennessee is quoted in The New York Times today to the effect that Greenspan will pull the economy through the Clinton Plan with easy money. The White House last week had to publicly retract the assurances of spokesperson Dee Dee Myers that Greenspan was a supporter of the Clinton Plan.
The definitive Greenspan statement was made before the Senate Banking Committee last February, which we reported to you in "Clintonomics Watch: Keep Calm," February 22. I wrote, in part:
We would be advising you to head for the hills if, as The New York Times reported Saturday, Fed Chairman Alan Greenspan had told the Senate Banking Committee Friday: 1) He endorsed the Clinton economic plan, and 2) He more or less said he would accommodate the plan's contractionary fiscal policy with easy money. I watched every minute of Greenspan's three hours of testimony and can assure you he did not endorse the plan and, most important of all, he did not give the committee Democrats the slightest indication that he would offset an economic contraction by flooding the banking system with reserves, which is what they wanted to hear. Indeed, the hearing went on as long as it did because Chairman Donald Riegel (D-Mich.) and Senator Paul Sarbanes (D-Md.) spent the last hour trying to get Greenspan to say just that, while he drove them crazy with subtleties, refusing to be pinned down. Greenspan's performance was a masterful job in which he preserved his independence and prestige. He did no more than commend the President for putting a credible plan on the table, initiating a debate that was necessary. He refused several times to say whether the plan would work or not work, pointedly saying he had not analyzed it beyond its outline. He said it was up to Congress to do that work and if they did it well, their work would be rewarded in the bond market with lower long-term interest rates, not by easy money by the Fed....
The most important part of his testimony was a professorial lecture he delivered in his opening statement, in which he noted that there was a time, in the '50s and '60s, when the Fed could aggressively print money with no adverse reaction by the markets. This, he said, is because the markets had been conditioned to a history of low or negligible inflation in the United States. Buyers of government debt overlooked monetary "accommodations." But these excesses in the '70s finally caused "the dam to break," as Greenspan put it, and creditors are now sensitized to the slightest hint that the Fed will play fast and loose with them. They will "dump bonds," he said, if they see such signs. Greenspan was telling them in this little talk that what they wanted out of him was impossible for him to give. It was clear from the questioning that followed that none of the Senators, with perhaps the exception of Senator Gramm of Texas, understood or even listened to what he was saying.
The fact that the White House and Democratic leadership continue to waltz blithely toward the cliffs, even talking as if it will be possible to pass the tax bill without Republican support, is based on this incredible intellectual stubbornness. I harangued Senate Majority Leader George Mitchell yesterday for 15 minutes on the telephone, urging him to get behind the alternative of Rep. Charles Rangel and Sen. Malcolm Wallop rather than waltz over the cliff. And I repeated my warning to Greenspan this morning that the Democrats are still operating on the premise that he could save them. Now, if only I can get Senator Mitchell -- the most intelligent Democrat in the Senate, although not an intellectual -- to call Alan Greenspan, and persuade Greenspan to say slowly and distinctly: "SENATOR, THE BOND MARKET WOULD CRASH."
For these varied reasons, I remain undauntedly optimistic. Yes, the Democrats could, if they really tried hard, pass a bill without a single Republican vote. But it would be like a political KOOL AID party. When everyone troops back to Washington July 12, it should be clear there will have to be an alternative. Of course, I could be wrong. Millions of Americans may actually accost their Senators and Congressmen at this week's political picnics and demand that their taxes be raised in order to save President Clinton from embarrassment! What do you think?
Relax. Keep calm. Enjoy the long weekend. Stay away from the Kool Aid. Try some Snapple.