Memo To: Alan Greenspan
From: Jude Wanniski
Re: Kemp's Open Letter
There are a number of people who are calling to congratulate me on having written the letter Jack Kemp wrote to you and ran Monday on The Wall Street Journal editorial page. I want you to know, Alan, that I had almost nothing to do with the writing of the letter, although the ideas are certainly those that Jack and I have been discussing since we first met in early 1976. I've been urging Jack since last summer to join in criticizing your monetary deflation, but as I am only one of several people who have his ear on matters economic, it has taken a while for him to come to a boil. I'd written a statement several weeks ago that I sent him to consider releasing, but it was so ferociously critical of you that he discarded it. What he wrote in the Journal is still pretty tough, but it is distinctly Jack's touch. At least you know that he now believes that the Greenspan Fed is the source of the collapse of the Asian economy — and Mexico and Russia and maybe China and Hong Kong next. You really do have to do more than add up the votes at the Fed and divide by 12 to determine policy. You have to look at yourself in the mirror while shaving and realize your proclivity to deflation, which you have had for most of your adult life, is having terrible consequences around the world and in the United States. As Jack writes, you have to lead. With the President as weakened as he is, you have to step up and take responsibility. Nobody else in Washington in the executive or legislative branch has a clue to what is happening or is in a position to fix things. Give it a shot.
* * * * *
The Wall Street Journal, August 17, 1998, page A14
We Need Liquidity, Mr. Greenspan
To: The Hon. Alan Greenspan
Dear Mr. Chairman:
I have just returned from Empower America's annual retreat at which he economy was the major topic of discussion. Everyone agreed that you deserve high praise for bringing us price stability, which in conjunction with the Reagan-era tax and regulatory reforms has provided the fertile environment for this extraordinary 15 years of noninflationary economic expansion. But there wasgrowing anxiety that the Fed, having led the nation out of inflation, may be slow in recognizing emerging signs of global deflation.
It is clear that the Fed's tight-money policy is causing some serious financial problems in the domestic and world economy by fighting nonexistent inflation to the point of causing a liquidity shortage. The Fed seems unmindful of the steep decline in commodity prices that is the direct result of the world economy demanding more dollar liquidity than the Fed is willing to supply.
The signs of a liquidity shortage are widespread. What's disturbing is that for every clear signal among financial indicators that the economy is being starved of liquidity, members of the Federal Open Market Committee — which meets again tomorrow — appear to concoct offsetting theories as to why the signals are false.
In preparation for our retreat, I read your most recent Humphrey-Hawkins testimony. I was deeply disappointed by your description of the sentiment among FOMC members that "the potential for accelerating inflation is probably greater than the risk of protracted, excessive weakness in the economy." You, of course, have a trustee's responsibility as chairman of the Fed to represent the views of committee members when appearing before Congress. I respectfully suggest, however, that your overriding responsibility is to lead the FOMC.
In your testimony, again presumably reflecting the views of some members of the FOMC, you state that "it is the balance of supply and demand in labor and product markets in the United States that will have the greatest effect on inflation rates here." I don't believe that — do you? Labor and product markets do not need the central bank to keep supply and demand in balance. They need the Fed to keep the value of the dollar stable and ultimately, in the words of President Kennedy, "as good as gold."
It pains me to hear you put your own judgment above the price signals of markets, and that is just what you do by implying that you know the stock market has "soared" to unwarranted an unsustainable levels and that continuation of last year's stellar economic performance would be 'threatening [to] the balance and longevity of the expansion."
As recently as 18 months ago, you stated publicly that the price of gold vas the indicator in which you had most confidence as a signal of incipient inflation. The price of gold then was $385. Today it is below $285. Some argue that the people of the world never went off the gold standard even though their governments did. From this perspective, one is led to interpret the dramatic drop in the price of gold among all the major currencies, and especially the fall in the dollar-price of gold, as a direct measure of a serious world-wide deflation. Based upon this view, the Fed should buy bonds through open-market operations until the price of gold rises back toward $325.
Other members of the gold-price rule fraternity are not persuaded that gold sends such precise signals when governments do not use it explicitly in maintaining the value of their currencies. Those in this camp would perceive most of the recent collapse in the price of gold not as indicative of a serious world-wide deflation but rather as a signal of markets1 sudden and final acceptance that we have indeed achieved price stability. In this view, the gold price has fallen, and may yet continue to fall, to a level that markets consider the "correct" price at price stability. However, with all other financial indicators now uniformly signaling tight money, even this view suggests that the Fed should ease.
I am inclined more toward the former view than the latter. But let me put the question to you from the latter perspective, which I take it is more in line with your own view today. How can it possibly be that a 25% depreciation in the price of gold signals inflation just ahead?
In other words, Mr. Chairman, unless you repudiate our past views about gold, it is totally inconsistent to believe inflation poses a threat or that the economy is growing too fast or that the stock market is too high and must be brought to ground by a central bank that can prick the bubble and let the air out slowly.
These are not just esoteric arguments. Getting the answer right has a huge impact on the entire world. For example, writing in The Wall Street Journal in June, David Malpass of Bear Stearns concurred with Mark Mobius's suggestion of a gold standard for Southeast Asia, which Mr. Malpass argued "would have immediately stabilized the situation if proposed by the U.S. or IMF."
Instead, the International Monetary Fund continues to prescribe fiscal austerity, tax increases and managed economic growth, which only drives countries toward eventual devaluation and increases the demand for dollars.
I know it may seem easy for me to say this, not having to deal as you do with the cross pressures of the myriad factions within the FOMC. But the very fact that monetary policy must emerge as a political compromise among competing theoretical factions within a bureaucratic committee inside an unelected, unaccountable central bank illustrates the dangerous and untenable situation in which we find ourselves.
You find yourself presiding over a central committee of appointed bureaucrats who are expected to direct an $8 trillion economy—an impossible task. It never worked when the central committees of socialist systems attempted to set prices and production schedules, and it won't work when a committee of the central bank attempts to fine-tune the flow of liquidity to maintain economic expansion within a range it determines sustainable.
The ultimate sign of this sorry state of affairs is the article in last week's New Yorker magazine in which Milton Friedman is quoted as saying that there is "more of a bubble in today's [stock] market than there was in 1929." Money has become the loose joint in the world economy, detached from any automatic directing mechanism, and as a result has enticed our best economic minds into the ill-fated occupation of second-guessing markets. This is what happens when the world's monetary system remains disconnected from its moorings for so long.
In the near term, I believe the Fed immediately should employ the only mechanism at its disposal to inject needed liquidity into the economy: Lower the 5.5% federal-funds rate at least to a point consistent with declining long-term interest rates, which are set by the market. If such a rate cut were justified specifically within the context of falling gold and other commodity prices, you also would establish the ground rules for raising rates again if prices began to rise, and in the process you would assure markets that the Fed will have zero tolerance for inflation in the future.
Moreover, you would avoid setting the dangerous precedent, which we may come to rue in the new century, of allowing the price of gold and other commodities to plummet while the Fed does nothing.
Beyond this immediate policy change, I believe it is imperative that you use your influence to initiate steps to move the world back toward a stable monetary regime anchored to the price of gold. No one else has the knowledge, respect and experience to do the job. We may slide by without a disaster as long as you remain chairman of the Fed, but your successor is not likely to possess your wisdom and luck.
Your legacy and the fate of the world economy depend upon restoring a global monetary anchor as soon as possible.
Sincerely yours, Jack Kemp
Mr. Kemp was the 1996 Republican vice presidential nominee.
* * * * *