Call It Deflation Jude Wanniski October 28, 1997

Memo To: Robert L. Bartley, editor, WSJournal
From: Jude Wanniski
Re: Deflation on Wall Street

Your lead editorial this morning, "Market Interconnectedness." makes several good points about the sell-off in stocks around the world. I must point out that there is an error in the editorial that throws it in the wrong direction. It notes: "...the crash began as a regional crisis and series of competitive devaluations in Southeast Asia." This misplaces blame on the countries of Southeast Asia, whereas the blame properly belongs at the U.S. Federal Reserve. The devaluations in SEAsia were not "competitive," in the sense that first Thailand, then Malaysia and Indonesia, devalued their currencies in order to gain a competitive export edge. The devaluations were defensive in nature, as the region was wrecked by the deflation of the U.S. dollar relative to gold. You know we have been warning about this all year, with gold falling from the plateau of $385 where it had been for three years, to a low last Friday of $308. Your editorial never mentions the word deflation, although your analytical framework for almost 20 years has recognized that deflation is defined as a decline in the monetary standard, characterized by a fall in the price of gold. That is Bob Mundell's definition. We first warned of deflationary impulses when gold fell below $340 early in the year. On August 15, in "Deflationary Disturbances," we noted: "It may seem odd to relate what happened in Thailand last month to what's happening in Europe today, unless one understands that all currencies on earth are ultimately linked through commercial and capital flows to the U.S. dollar, the world's key currency and chief accounting unit. The earliest disturbances of a deflationary move of the dollar against gold rippled through southeast Asia, after Bangkok caved under the pressure. Its effects are now rippling through the D-mark currency bloc. The currency volatility adds risks to all financial markets, with no one in the world quite sure of how policymakers will respond to these still relatively minor convulsions."

The "interconnectedness" of the world's markets is primarily because of the dominance of this dollar as the closest thing the world has to a numeraire, the kind of hard accounting unit which gold once provided. The disturbance in Hong Kong and SEAsia is the result of errors made by the Fed, not by the poor bastards who are trying to stabilize their economies by linking their currencies to the dollar — only to inherit the blunders our central bank is making. Alan Greenspan told Senate Banking in 1994 that if we were on a gold standard, the Mexico peso debacle would not have occurred. If we had a gold peg now, at $350, there would be a worldwide boom in stocks and bonds, not the kind of meltdown we've seen of late. You mention in your editorial that Greenspan should promise not to allow gold to fall below $300. That's something. But gold has to find its way back to $350, or the world will have to adjust to a long period of unnecessary price declines, economic weakness, and poverty that flows from this kind of dollar deflation.