Rubin, Greenspan and the Dollar Jude Wanniski February 10, 1997

On Friday afternoon, and throughout the weekend, there has been a steady stream of news about the dollar from Treasury Secretary Bob Rubin and the correspondents of The New York Times in Washington and Europe. They report that the principal central bankers of the world are in happy agreement with Rubin that the dollar is as strong as it should get and should not get any stronger. The fact that Rubin has been a cheerleader for a strong dollar since he became Secretary two years ago, and now says enough is enough, leaves the financial markets wondering if this new development is a good or a bad thing for Treasury bonds. We think it’s a good thing, thoroughly in accord with our bullish frame of mind on the bond market.

This is because of the likelihood that Fed Chairman Alan Greenspan -- the Wizard of Oz these days -- is the man behind Rubin’s change of heart. For the last year, Greenspan has steered the Fed through constant market speculation that he was about to raise interest rates to slow down the economy. Rubin’s comments about a strong dollar in this period have been consistent with the market bias toward higher rates; it remains a conventional view that higher rates will attract more buyers. What now has to be of concern to Greenspan is that the price of gold, which had hovered above the $380 level for the past three years, has in the last several weeks fallen to $340. This puts the dollar on the threshold of monetary deflation, as the gold price has rarely been in this vicinity in the decade of Greenspan’s tenure. There are few Fed watchers who take the price of gold seriously, but the most important is Greenspan himself, who over the years has seemed happiest when gold has been at $350 -- which is ten times the $35 price that held from 1934 to 1971. Greenspan came to the Fed in 1987, a year after Wayne Angell became a Fed governor in February 1986, when gold was $350. Angell, now chief economist at Bear Stearns, still believes gold could settle at $330. He may be right, but we believe it will push back to $350.

The fact is, there is no way to prevent the dollar from halting its rise against the yen and D-mark without arresting its rise against gold. The only way that can happen is by having the Fed lower the short-term federal funds interest rate that it now targets at 5.25%. If it is to happen, Greenspan needs to get Wall Street to speculate along those lines. This is because the dominant idea circulating in the financial community is that the current economic expansion will cause a reignition of inflation. Well, if the price of gold at $340 is now telling the world that commodity prices are quiescent, and if the Clinton Treasury department now thinks the dollar may be getting too strong against the yen and D-mark, where is there a case for tighter monetary policy? It is far more likely that Rubin’s commentary about the strong dollar is a sign from Greenspan that he wants Wall Street to begin talking about cutting the funds rate at the March meeting of the FOMC. With only one vote as chairman, Greenspan needs to swing market opinion around to monetary ease in order to win a vote of the FOMC.

There really is no other way to keep the dollar from appreciating against the yen and D-mark. The Bank of Japan and the Bundesbank could theoretically drain liquidity from the banks or raise interest rates, but their economies are already weak and the thought of a monetary squeeze is politically unthinkable. The Bank of Japan should actually be moving in the other direction -- adding yen liquidity to get the yen gold price up to ¥45,000 from ¥42,000. The domestic and worldwide demand for dollar liquidity is not unrelated to the boom on the stock market, which continues to see an almost certain budget deal on the horizon -- including several positive changes in taxation. This virtuous policy circle can feed on itself, as a lowering of the funds rate to 5% next month will begin to set in motion the need for a 4.75% rate later on.

Bob Rubin may think he can help the dollar stabilize by jawboning or even by a Treasury intervention in the foreign-exchange market. The Saturday NYTimes reported Rubin taking credit  for having turned the dollar/yen rate around at 79 through Treasury intervention in April 1995. He had nothing to do with it, except for some support from the sidelines. The evidence is that the dollar gold price remained steady. It was the yen gold price, rising from its floor of ¥32,000, that told us the Bank of Japan was finally taking our advice and pumping liquidity into the banking system. It was our David Gitlitz who publicly debated the Bank of Japan in the pages of The Wall Street Journal and its Asian edition, having spotted the errors the BoJ was making by a daily perusal of its balance sheet. As soon as it began its liquidity adds, we foresaw the dollar/yen rate going back above 100 [“Now, Watch the Nikkei,” April 21, 1995]. On January 2 of this year, we forecast a dollar/yen rate sometime this year of 130 when the average of 57 “blue chip” economists forecast the rate at 112. The 130 rate obtains at $350/¥45,000 gold, which are (we think) the respective equilibrium levels of the two currencies.

Anticipating these events, on January 23 I faxed a memo to Gene Sperling, assistant to President Clinton and chairman of the National Economic Council. Here is the relevant part:

The President has been saying he believes in a strong dollar, which is one of the reasons he was re-elected. I see him repeating his statement in today’s Wall Street Journal. Please be aware that with gold dipping below $350 today, the dollar is beginning to get into deflationary territory, where its strength will begin causing real problems for everyone who owes money in dollars. In other words, if the equilibrium price of gold is $350, at which debtors and creditors are in perfect monetary balance, it helps for the dollar to be stronger when it is above $350, but weaker when it is below $350. Please encourage the President to discuss this with Greenspan. Greenspan has a problem with the Fed and the market’s reading of the Fed because the price of gold has fallen so rapidly in the past two months -- from $380 to $350 -- that Greenspan has not been able to prepare the market for the likelihood that short term interest rates should be lowered if the dollar gold price falls much further. Market chatter is still focused on the strength of the economy, which could easily be unsettled if the gold price decline is not arrested.

Now I can’t say for sure that Sperling dropped everything when he got my fax and rushed in to show it to the President. Still, it had to be on Greenspan’s mind that he had to quickly do something to reverse market sentiment. I can’t imagine Rubin orchestrating the events of the last several days without explicit guidance from Greenspan. If the markets had fallen apart, Rubin would be in a corner with a duncecap, at best. Bonds did take a pounding in Tokyo before making a recovery, as investors there were simply confused by the play. The dollar also waggled a bit in Europe before recovering. Once everyone begins to realize that U.S. bonds aren’t being threatened by a dollar devaluation, and that Greenspan is orchestrating a path to lower interest rates, bonds should continue the rally we have been cheering. This is an event we’d like to read about someday in Greenspan’s memoirs, if he ever gets around to writing them.