In the Y2K Orbit
Jude Wanniski
October 5, 1999

 

Some months back, a client asked me if I thought it would be a good bet to go long gold and short oil, given my position that they were out of whack and would have to converge. My response was that it would have to happen. It was practically a law of physics, not economics, but I reminded him he might have to wait for Y2K when we expected a global shift to commodity money away from paper money. He told me he was going ahead, but when I e-mailed him yesterday to find out if he were happy, he told me he had gotten impatient and closed his position, as yellow gold continued to inch down while black gold inched up. Please note today that as gold continues to advance, up almost $80 in less than a month, oil is now in a slight decline, to $23.40 from $24.87 at its peak a few days ago. As I noted last week, the gold run-up to $300 was the result of the failure of the GOP to give us a tax cut. Part of gold's decline to its low of $252 reflected the Fed's failure to supply liquidity to a market betting on chances there would be a compromise on taxes after the Clinton veto of the bill passed in August. When I added the reminder that this was not a Y2K event, which signifies that Y2K would mean another advance in the dollar/gold price as we approached the end of the year, another client told me he planned to wait another month and then go long gold. Well, I suppose other folks had the same idea and decided to beat him to the punch, with gold at one point jumping 10% today, touching $340.

If we use 15 barrels of oil to an ounce of gold, the laws of physics pretty much have brought about a balance. At $350 gold, which is the average daily price since Jan.1, 1990, West Texas sweet crude, our benchmark, would be at $23.10. But prices can continue to swing in different directions for reasons other than short-term monetary error. One of the reasons oil more than doubled in price since its nadir this year has been the accumulation of oil stocks prior to Y2K. An economic weakness early next year, lasting who knows how long, will decrease the global demand for oil even if gold continues to advance. These are not predictions, but one scenario could see the Fed trying to offset economic weakness with easy money and gold rising to $400 or more while the economic weakness, helped not a bit by monetary ease, sinks oil to $15 or lower. If I were Fed Chairman Alan Greenspan, I would call Treasury Secretary Larry Summers and suggest he take up the suggestion Jack Kemp made in his June 11 letter to the President -- about fixing the gold price by executive order to defend against Y2K financial turmoil. Kemp wrote:

I believe what all of this means is that the burden is on the Presidency and the Treasury Department to take action now to ensure that the dollar remains rock solid throughout the upcoming period of uncertainty and possible turmoil. Throughout the coming year, on a monthly basis I believe we will see extraordinary swings in the demand for liquidity. It is implausible that the standard interest-rate targeting mechanism currently employed by the Fed will work during this window of vulnerability. Moreover, when the clocks click us into the new century, many computers around the world may go down for some period of time, in which case there will be no way to conduct the $1 trillion of transactions required every day by the current floating exchange-rate regime.

The news media have been treating Y2K as a minor inconvenience, which simply reflects the determination of political leaders to downplay their deeper concerns, to avoid alarming the public and creating even worse problems. As the subscribers to our Y2K service learned today, in a four-page countdown review, these more serious anxieties now are beginning to surface in written official reports which can be found if you take the trouble to look for them. Here is how our Paul Bond opens his report: "Following a year of growing public confidence in the U.S. economy's ability to weather Y2K unscathed, a new pessimism is starting to emerge. The blunt and well-researched 100 Day Report' by the Senate Special Committee on Y2K, supported by similar third-party findings, suggests that any mid-range Y2K damage estimate formed during the progress of early 1999 ought to be revised sharply upward."

The least of the problems will involve breakdowns of essential services here and around the world -- although this area has been downplayed as well. The greater problem is in the global financial universe. The executive order that Kemp mentioned in his June 11 letter to the President would "stabilize the value of the dollar by instructing the Fed to conduct open market operations to add and subtract liquidity to keep the price of gold temporarily within a narrow band around the average gold price of the past 12 months. There would be no need of an international conference to discuss this. You need only fix the dollar/gold price as we did under Bretton Woods, and every country in the world could fix to the dollar... We cannot know with any degree of certainty what the Y2K effects will be. However, with the value of the dollar temporarily anchored to gold, we can be sure of a rock-solid currency to see us through whatever Y2K might bring."One amendment that could be made is to forget about fixing the dollar/gold price at the level implied last June, which would have meant a price somewhat above $280. We still think the optimum would be at $350, which now is practically at hand. President Clinton did reject the idea in an August 5 response to Kemp, more or less on the grounds that Greenspan had to have his hands free to deal with any eventuality. My guess is that Summers wrote the letter after a private word with the Fed Chairman. With gold climbing as fast as it has, Greenspan has to suspect he has been kidding himself about being the Master of the Universe. If he could have followed our advice in early 1997 when gold was in decline and stabilized it at $350, there would have been no Asian crisis, no collapse of the Russian economy, no convulsions in Latin America. He has gotten nothing in exchange, but a lesson we should hope he is learning or will learn soon enough to formally stabilize gold in this range -- so it can do some good before we hit the unknown. Greenspan only has to say the word and it would be done, as I'd guess President Clinton would opt for his opinion. Larry Summers has to be baffled and a bit concerned about these gyrations in gold and other commodities.

It was not long ago that Greenspan understood that the dollar price of gold is a ratio of two ratios: The supply of dollar liquidity relative to the demand for dollars in the numerator; the supply of gold relative to the demand for it in the denominator. The denominator is relatively constant, because the stock of gold is so enormous relative to its annual output. It is the demand for liquidity that the Fed has to get right, because if it supplies too much, there is inflation, too little and there is deflation. The announced bias toward tightening today -- based on the size of the unemployment pool -- is exactly the wrong message for the market as Y2K approaches. If Y2K increases the size of the unemployment pool, the Fed will have little choice but to inflate. The gold market is beating Greenspan to the punch.