Memo To: Website Fans, Browsers, Clients
From: Jude Wanniski
Re: The Supply-Side Revolution Part II
This is second part of a two-part brief history of the Supply-Side Revolution, written by a distinguished Los Angeles attorney, Wayne Jett, who seems to have spent countless hours assembling his material. Part I was extremely well received, clocking more referrals by readers recommending it to friends, than any memo this year. This part is more contemporaneous and analytical, Mr. Jettís assessment of where things have been going in the recent period and ďthe road ahead.Ē The gold issue, by the way, is being discussed in lively fashion in our TalkShop. You are welcome to enter, either as a participant or an observer. The link is directly above.
A Supply-Side History
And The Road Ahead
By Wayne Jett
What have we learned, so far, in our discussion? At least this: That the economic insights of one man, Robert Mundell, were the roots and foundation of both the Kennedy tax cuts of 1964 and the tax cuts of the Reagan Revolution in the 80s. President Kennedyís tax cuts were inspired by supply-side economics, just as were President Reagan's, but Wanniski simply hadn't named it 'supply-side' yet.
So, if you're looking for someone to thank for substantially all of the growth achieved by the U. S. economy during the past 40 years, Robert Mundell should be at the head of the line (with Arthur Laffer and Jude Wanniski close behind). And much more economic growth might have been achieved, if only their guidance had been followed more consistently.
What we should also have learned, but many apparently have not, is that Keynesian economics does not work, and neither does monetarist economics. Yet, Democratic Party politicians refuse to listen to anyone but Keynesians, and both Keynesian and monetarist economic views retain significant influence in many Republican circles. The broadcast and print media, for their parts, continue to deride supply-side policies as 'trickle-down economics,' perhaps not realizing the extent of their misconceptions.
Those who suggest that the economic theories developed by Robert Mundell and his supply-side colleagues are surreptitiously intended to benefit the establishment or to preserve the status quo should consider this: Reflecting upon the two historic events of 1913, the outbreak of World War I and the creation of the Federal Reserve Board, Mundell has written that the second of these two events was the more culpable and the more harmful. Mundell has also observed that the Fed has introduced more inflation into the international monetary system than any other institution in the history of the world. These are not the views of one seeking to serve the establishment or partisan politics.
The servants of the establishment were those who, in 1971, convinced President Nixon to abandon any semblance of the gold-based monetary policy that had benefited the United States since its origin. Those who did so acted, not as reformers, but as enablers seeking to preserve establishment prerogatives by extraordinary means. Those extraordinary means are still in use after having produced decidedly mixed, oftentimes highly damaging, results during the past 32 years, and urgently deserve reconsideration.
Now we turn to a brief description of the central premises of supply-side economics.
1. Supply-side economic models focus attention upon the conditions affecting producers, not consumers, of goods and services. By contrast, Keynesian and monetarist models focus upon conditions affecting consumers; thus, demand-side economics.
2. Supply-side fiscal policy follows lessons illustrated by the Laffer Curve. The Curve traces the fact that government revenues are zero at two points: when tax rates are 0% and 100%. Between those two extremes in tax rates, there are two tax rates (one high and one low) that will produce exactly the same amount of tax revenues at every level. The lower of these two tax rates will achieve higher levels of production, employment and economic growth while producing the same total tax revenues.
3. Supply-side monetary policy is centered upon the principle that the monetary unit (i.e., the dollar) must remain stable (fixed, if possible) to avoid creating a harmful drag on the economy. Supply-siders would strongly prefer a dollar with value fixed in terms of an ounce of gold. In present circumstances (with the dollar's value 'floating'), supply-siders advise that the Fed should be targeting the price of gold, keeping the dollar price of gold steady at an announced price by selling or buying government bonds through its open market operations.
A rising gold price signals monetary liquidity in excess of the needs of those willing to invest in the productive economy (excess dollars are flowing into gold purchases); so government securities should be sold by the Fed in the open market to soak up the excess dollars.
A falling gold price signals a shortage of monetary liquidity (gold is being sold to obtain the needed dollars), so the Fed should buy government securities on the open market with newly printed dollars.
One more thing you should know about supply-side economics as espoused by Robert Mundell, Arthur Laffer and Jude Wanniski. Supply-side economics is not taught as a comprehensive academic course of study in any institution of higher learning in this country or, indeed, anywhere in the world. Keynesian and monetarist domination of academic faculties remains a stranglehold.
The Deflation of 1996-2001
Now we must return to the urgent matter mentioned already in this discussion: the unsettled state of U. S. monetary policy and the unsatisfactory international monetary system. From 1996 through 2001, the U. S. experienced an increasingly significant deflation. The price of gold fell (and the dollars value rose) from about $415 per ounce in February, 1966, to a low of $253 in July, 1999.
Beginning in April, 1997, Jude Wanniski communicated to the Fed Chairman that deflation had ensued. The 1997 cut in the tax rate on capital gains from 28% back to 20% required greater monetary liquidity to accommodate expanding private investment.
Rather than heeding this advice, Chairman Greenspan chose to abide by Keynesian concepts of the Phillips Curve; he watched the low unemployment numbers and worried about inflation.
The deflation of which Wanniski had warned drove commodity prices down, including oil to $10/barrel. Oil exploration and marginal production shut down.
Then as the capital gains tax cut took hold, the strengthening economy demanded even more oil and the oil price shot back up. This false signal from the rising oil price caused more inflation fighting by the Fed.
The resulting deflation chased investors from commodities-based industries, and from smaller national economies with currencies tied to the dollar, such as the tigers of southeast Asia. Capital flowed into intellectual property and financial instruments, particularly technology stocks, as a refuge from commodities and other businesses with no pricing power.
By April, 1997, Wanniski had grown exasperated with Greenspanís lack of responsiveness to their exchanges, and he requested a meeting with President Clinton. Clintons chief of staff Erskine Bowles shunted Wanniski to the Deputy Secretary of the Treasury, Lawrence Summers. Wanniski met with Summers at his Treasury Department office in late April, warning Summers of a coming collapse of commodity prices following the decline in the gold price. Wanniski had also told Summers in their meeting that, because the U. S. economy is 90% services, the general price level would take longer to follow the price of gold down, but it would happen in due time.
Wanniski reported that Summers summarily dismissed his forecast of a commodity price collapse as outside the realm of possibility. Yet, in the following two years, commodity prices did, in fact, drop steeply.
Not only commodity producers were suffering the effects of deflation. Debtors of all kinds were collapsing into bankruptcy as they could not repay debts with dollars 40% more valuable than those they had borrowed only a few years earlier. After his failed meeting with Summers, Wanniski urged Greenspan (with another message from Mundell) to move the dollar back to a value of $350 per ounce of gold, as a middle ground between $400 and $275, so that other prices would not continue to fall. But Greenspan, perhaps in retaliation for Wanniski's attempt to seek support from the White House, notified Wanniski that the Chairman did not wish to hear from him in the future.
The non-event of Y2K finally persuaded Greenspan to provide greater liquidity to the monetary system in late 1999. Stocks rocketed upward as the price of gold rose in early 2000, but then the Feds deflationary monetary policy resumed. The NASDAQ technology stocks began dropping sharply in March, and the broader markets followed throughout 2000, 2001 and through October, 2002, as the dollar continued to increase in value.
On November 2, 2001, the New York Times at last announced a whiff of deflation in the air, disclosing in the bowels of the article that the commodities price index had fallen more than 40% since 1996. Perhaps coincidentally, Wanniski had used the same whiff of deflation phrase in the headline of his bulletin to clients in February, 1997, nearly four years earlier.
The Fed's Reprieve: The Dollar's Correction
Chairman Greenspan may have begun targeting the price of gold in 2002, after three consecutive years of crashing stock prices. During those years, investment capital fled the equity markets, some of it moving into bonds. Some individual investors moved their investment capital into residential housing, a hard asset in a rising market, favored by low interest rates and the mortgage interest tax incentive. As corporate stocks retested their lows, the over-strong dollar began correcting as the Fed added dollar liquidity by buying government securities in the open market. Gold moved from $275 to about $400 in the Spring of 2003, then back to $325 and now to about $350 per ounce.
Let's hope the Fed Chairman has learned his lesson and has turned towards the advice offered since 1997 by Mundell and Wanniski. If initially followed, their supply-side economic remedies might have allowed the U. S. and related economies to avoid the deflationary damage and the equity markets crashes of 2000-2002.
If the Fed has begun to target the price of gold, this in itself would be a significant step towards a sound U. S. monetary policy -- one that chooses as its centerpiece the duty to maintain a stable value for the dollar as the primary monetary unit for the U. S. economy and the world. As the Fed becomes comfortable in its capability to keep the price of gold steady through its open market activities in buying and selling government securities, this would make restoring a tie between the dollars value and the price of gold relatively easy. A more satisfactory international monetary system would follow a stable dollar as night follows day.
But the Fed does not have unlimited time to get its monetary policy act together. A sharply fluctuating dollar does great and lasting damage to the U. S. and other world economies. In that circumstance, every other central bank has reason to seek its own means to achieve currency stability. Likewise, producers worldwide continue searching for a stable currency with which to transact commerce.
Professor Friedman's Concession
Remarkably, on June 6, 2003, the Financial Times reported that the monetarists leading theoretician Milton Friedman had conceded the use of quantity of money as a target has not been successful. Although the FT reporter ruefully notes that such a concession might have saved a lot of grief if made 20 years ago, Professor Friedman's conclusion is significant and is useful progress towards a return to responsible, sound monetary policy by consensus.
If Professor Friedman had known in 1971 that his monetary theory involving targeting of money quantities would fail, he would not have argued as he did so influentially for cutting the dollars ties to gold so his theory could be tested. Absent his own theory of targeting money quantities to achieve a predetermined rate of growth, Friedman would not likely have endorsed managing the value of the worlds reserve currency through the power of intellect rather than the historically proven gold-based standard. Surely he would not have simply endorsed such a radical departure from responsible monetary policy in order to achieve the Keynesians objectives, when their prescriptions for policy actions varied so often and so drastically from his own.
Friedmanís abstention from the 1971 debate (or his outright support of Mundellís views) would almost certainly have resulted in President Nixon leaving the gold window open, and instead tightening monetary policy to alleviate the objectionable inflation. Nixon could easily have coupled that action with marginal tax cuts to spur the economy and been even more successful in his re-election bid. Such a well-based approach would have avoided so much of the economic turmoil and harm that have befallen the U. S. and the world economies during the past 32 years. Professor Friedmanís active entry into the policy debate without his money quantities targeting theory, in 1971 or presently, ought to put U. S. monetary policy solidly in the camp of a gold-based currency.
Experience has given the Keynesians every bit as much reason as the monetarists to concede the flaws and failures of their own economic model, particularly with respect to the failed experiment in currency management. A move by Friedmanís monetarists towards the classical economics of Mundell, Laffer and Wanniski could lead very promptly to a stable even a gold-valued dollar. The Keynesians should join in such a move so their theoretical work can benefit from the sound foundation of a currency unit that does not itself inflict friction and distress within the economy through changes in the units own value.
The Europeans were importantly influenced by Professor Mundellís advice in creating the Euro, which surely must have impelled the Royal Swedish Academy to award his Nobel Prize. So they certainly should be inclined to respect his views now on the management of the Euro. What happens if the European Central Bank begins following the advice of Mundell and Wanniski before the Fed does?
The European Central Bank may already be targeting gold, as Mundell advises with respect to the dollar, to maintain the Euros stability. If the Euro is tied to the price of gold before the dollar is, the damage to U. S. interests would likely be significant and long lasting. A gold-based Euro would almost certainly be adopted immediately as the reserve currency favored by oil exporting countries. The Fed should not tarry and await such an outcome.