Angell's Errors Jude Wanniski July 22, 1994

In today's Wall Street Journal, former Fed Gov. Wayne Angell, now chief economist at Bear Stearns, presents an essay on monetary policy, "As Good as Gold." It reaffirms Angell's commitment to a dollar linked to gold, and is useful in keeping the debate alive, but it is filled with errors, many serious. These reflect the fact that Angell studied economics toward his PhD at a time when academic economists had already decided against gold as a "scientific instrument," which did not fit in with their plans to convert economics from a behavioral to a mathematical science. The textbooks then and now reflect the contortions to which both Keynesians and monetarists resorted to disparage gold. Many of these distortions were absorbed by Angell as well as by Alan Greenspan, when he took his PhD in the late 1970s. I gained my knowledge as a journalist, and I relied upon the thinking of Robert Mundell and Arthur Laffer, who in the 1960s began to think through the classical theories of production (supply) that had been disparaged by the Keynesian revolution spawned by the Great Depression. Because we are so close to Angell in our appreciation of gold, but are further apart on policy prescriptions, it is useful, I think, to share this divergence with you.

2nd Graph: "Under Bretton Woods, currencies were 'fixed' at $35 an ounce. But gold was not truly convertible." In fact, only the dollar price of gold was fixed at $35. The other nations agreed to fix their currencies to the dollar, which indirectly fixed their currencies to gold at the comparable value. Gold was "truly convertible," in that the United States promised to exchange gold out of its vast hoard, at the $35 price, for dollars presented by foreign central banks who were participants to the agreement. And for more than 20 years the U.S. lived up to that pledge.

3rd Graph: "there was a second flaw in the system, and it lay with the U.S. central bank. There was no free market in gold. There was no market mechanism that forced the Fed to automatically adjust bank reserves as the supply of gold fluctuated. The Fed's $35-an-ounce promise was very difficult to monitor. In effect, the dollar was not anchored to gold." There was, of course, a free market in gold. Foreigners could sell gold in their own currency at the market price, exchange their currency for dollars through their central bank, and the central bank could then acquire gold at the promised $35 price from the U.S. This is the automatic adjustment mechanism that made Bretton Woods the success that it was for as long as it was. The greater flaw in the system was that U.S. citizens could not own gold in serious amounts. It firmly anchored the dollar to gold and would have continued to work if U.S. politicians, bankers and industrialists did not decide, for their own vested interests, that they wanted a cheaper dollar. When the Federal Reserve produced more dollars than the U.S. banking system wanted, the banks could not claim gold for dollars at the Treasury, because of the prohibition against U.S. ownership of bullion. They had to resort to the foreign mechanism, which began to break down when the Johnson Administration in 1967 decided against giving up any more gold from the U.S. hoard in exchange for surplus dollars, mopping them up instead with Treasury bonds that went into the portfolios of the foreign central banks as reserve assets, supposedly "as good as gold."

5th Graph: "The [Bank of England's] gold standard [of the 18th and 19th centuries] meant it made monetary policy adjustments automatically. If a country ran a trade deficit with Britain, the result would be a flow of gold to Britain." The process that Angell goes on to describe in this paragraph is among the most serious of his errors, a hoax straight out of modern textbooks, as it misrepresents the gold standard mechanism. When a country ran a trade deficit with Britain, the result was not a flow of gold to Britain, but a flow of paper financial assets, stocks and bonds. This "specie flow" argument is pure myth, "cash flow" nonsense dreamed up by academics who did not know why the gold standard worked, and assumed that it did through the mechanism described by Angell. The United States ran a trade deficit with Britain every year for a century, and except for the export of a trickle of gold that went into jewelry and dinner plates in England, there was no such outflow. The Bank of England issued banknotes to satisfy the market's demand for them, not because of a gold flow into its vaults from abroad.

6th Graph: "The amazing thing about this arrangement is that the Bank of England did it without owning much gold." Yes, it is truly amazing that in the fifth graph Angell could describe a cash flow mechanism built on gold inflows, and in the sixth graph the gold mysteriously disappears. Angell follows up with a nice twist, though, "In other words, the Bank of England and Britain were on a gold-targeting system -- the very kind Mr. Greenspan appeared to allude to this week!" Indeed, if someone straggled into the bank with gold, requesting banknotes, it would signal to the Bank there was not enough banknotes in circulation, otherwise the straggler would have sold his gold in the gold market. If someone came with banknotes requesting gold, the Bank would know it had too many in circulation and would withdraw them, by selling interest-bearing assets, including government debt, from its portfolio.

7th Graph: "This monetary expansion boosted imports into Britain and lessened the adjustment difficulties of deficit countries." Angell is now back to the cash-flow theory he was taught in college. The rest of this paragraph is mostly garble, as with "the world's reserve system had a true gold anchor." There was no world reserve system. Any government that wished to sell its debt to its own private banks had to emulate the Bank of England -- defining its currency as a specified weight of gold, and adding or subtracting currency in circulation to maintain the currency/gold exchange rate at the promised level. Gold was almost everywhere the national money, with paper currency defined in terms of gold. Governments would shift to "greenback money," as in the U.S. Civil War, on the theory that it was easier to claim private resources by fiat than to sell bonds or raise taxes.

7th Graph: "America's interwar [WWI-WWII] gold standard lacked some of the essential ingredients of the old British system. Gold flowed to the U.S. But since the Fed was a government central bank, not a private one, it made its own policy decisions, decisions which had nothing to do with profit." The dollar was defined as a specified weight of gold throughout the period, although the dollar was devalued to $35 per ounce from $20.67 per ounce in 1934, in an unsuccessful attempt to spur the economy. The Fed's mechanisms in maintaining the gold price at the level determined by the government were identical to those of the private Bank of England, and had the same effect. Angell misleads in stating the Fed "was a government central bank." The Fed was established as a quasi-public bank, independent of the government, as a lender of last resort to the private banks, its members. Insofar as "gold flowed to the U.S." it did not flow to the Fed, but to the Treasury, in exchange for Treasury bills and bonds going into private hands. As the gold prohibition went into effect, most of the increase in U.S. government gold stocks were from domestic holdings.

8th Graph: "Many economists blame the deflation, and even the Great Depression, on the gold standard. But it wasn't a gold standard. The truth is that if the U.S. had expanded the money supply to correspond to its new gold reserves, it would have avoided the deflation and depression." This is an archaic assertion based on monetarist quantity theory. Angell's economic hero, until very recent years, was Milton Friedman, and the specious argument here is pure Friedman. The private banks were getting all the banknotes they wanted from the Fed. If the Fed were to have expanded the money supply to correspond to its new gold reserves, the banks would have had to export the dollars to foreigners who could then legally claim gold from the Treasury, and gold would be exported, reducing their "new gold reserves." If President Roosevelt did not wish to lose the gold, he would have had to close the gold window as President Nixon did in 1971, and the Great Depression would have turned into the Great Stagflation. The hypothesis cited by Angell has been obsolete since I demonstrated in 1977 that the Great Depression and price declines of 1930-34 were caused by the fiscal shock of the Smoot-Hawley Tariff Act and the Hoover tax increases, which caused a catastrophic decline in the private demand for banknotes at the private banks.

10th Graph: "True currency convertibility would compel each government to pursue domestic policies consistent with price stability." Angell cites Henry Simon of the University of Chicago who "was correct in worrying that Bretton Woods failed to commit the U.S. to a domestic price-stability standard." Bretton Woods absolutely committed the U.S. to a price-stability standard, a dollar defined as one-thirty-fifth of an ounce of gold. True currency convertibility in the Bretton Woods regime merely required each government to manage its own currency on a "dollar-targeting" regime, adding or subtracting its own banknotes to prevent the accumulation of dollars in its monetary reserves. The nationalized Bank of England became afflicted with the "British disease" by trying to spur economic growth by printing more banknotes than the private market demanded. "[Simon] recognized the inherent contradiction between Bretton Woods and the IMF." Indeed, in the 1950s, when the British found itself losing reserves as it printed extra banknotes, it appealed to the IMF to permit a devaluation. The IMF bureaucrats, as incompetent then as now, agreed to permit this "adjustment" instead of telling the Brits that they should take banknotes out of circulation. To really spur the British economy, the government should have lowered the WWII tax rates on income, 96% encountered at the equivalent of $30,000. Not until Maggie Thatcher arrived in 1979 was this achieved.

11th, 12th, 13th Graphs: Comments on Keynes are on the mark.

14th Graph: "When the Great Society program demand for resources met Vietnam War production demands the pegged Fed funds rate fell further and further behind the natural rate." This entire paragraph is ad hoc and specious. The Great 
Society/Vietnam deficits were trivial compared to the WWII debts financed with 2% bonds. The problem was that by 1966, the Keynesian drums were beating in both political parties for an income surtax to help pay for "guns and butter." The stock market began sliding from its peak, and so did the demand for dollars. Instead of slowing the flow of new cash into the system, the Fed kept it up, and the unwanted dollars landed in Europe. President de Gaulle demanded gold for the dollars accumulated by the Bank of France and he finally got it. The Bundesbank settled for Treasury bonds for the dollars it was scooping up. "The underlying price of gold soared, eventually forcing the U.S. to recant on its promise or surrender all gold reserves and then recant." Well, all right, although I cannot understand how "the underlying price of gold soared" even as it continued to sell in private markets at prices not that far from the official $35. Clearly, the De Gaulle episode helped persuade the global financial markets that the United States either did not know what it was doing, or was preparing to cheat its creditors with devaluation, and interest rates inched up steadily. Even at the 11th hour, the Fed could have sold bonds to soak up surplus banknotes, reversed the process, and watched the gold price fall and interest rates recede.

15th Graph: Angell cites lessons learned from the floating exchange rate era, and says they "do not enable a country to avoid a high interest rate penalty for overspending on wars or domestic projects." Nobody ever said they would. The intimation is that high interest rates are caused by wars and domestic projects. "Second, floating exchange-rates provide no automatic corrective mechanism to ease monetary policy and thereby reduce excess savings for chronic balance-of-trade surplus countries such as Japan." No exchange-rate regime does this. The idea results from the specie-flow, cash-flow hoax. The concept of "excess savings" only occurs in a demand-side, cash flow model. What Angell might say in a supply model is that if the Bank of Japan were targeting gold, its price would not be permitted to fall due to a shortage of yen liquidity, which is a deflationary scenario that discourages people from taking on yen debt.

16th Graph: "The best way to guarantee stable exchange rates is to join in a commitment to zero inflation." This is correct, as long as it is accompanied by each country committing to maintain a specific currency/gold ratio. To simply "pledge a stable domestic price level" will not do, as creditors will accept nothing so mushy when asked to buy a government's debt. As a result, the currencies of such country's will continue to fluctuate. Angell makes a silly mistake when he says "No one likes to borrow in yen, because it is difficult to sell goods or services in Japan, and so earn the cash to pay back the debt." For every yen saved there is a yen borrowed. Angell says Japan has "excess savings," but nobody likes to borrow from Japan. In fact, Japan has been the world's favorite lender for the last 25 years, which is why Japan has such an enormous trade surplus with the rest of the world.

17th Graph: "A decisive action of, say, a 100-basis-point hike in short-term interest rates is needed." In this, the last graph of the essay, Angell pulls out of his sleeve a policy remedy for which he has provided no foundation. He tells us the price of gold at $380 is too high, and on that we can agree, but we are not told why a 100-basis-point rise in short-term-interest rates will reduce the price of gold. Nor does he explain why the 125-basis-point rise in interest rates since February 4 has had no effect whatsoever on the price of gold. It is as if we had read 16 paragraphs on why we should buy Pepsi, and in the last graph are told we must buy Coke.