Memo To: Supply-Side Students
From: Jude Wanniski
Re: A 1983 Classic
One of the original supply-siders back in the days we were inventing it was Lewis Lehrman, a Pennsylvanian who made a fortune as a founder of Rite-Aid Corporation. Lew drove around the northeast signing up drug stores for the chain and spent his motel evenings reading books on classical economics. He became a big fan of Jacques Rueff, Charles de Gaulle’s finance minister, and a true believer in the gold standard. In the mid-1970s and 80s, the Lehrman Institute at 71st street off Park Avenue became official headquarters for a return to gold, with regular dinner meetings and round-table debates in the posh town house. When Ronald Reagan won the presidency in 1980, we were sure we could get Lew a high post at Treasury, but Milton Friedman and his monetarist allies used their clout with Reagan aide Ed Meese to block any appointment. Lew said he would gladly settle for janitor at the Council of Economic Advisors, if he could get his two cents in, but even that was too much for the currency floaters. So Lew ran for governor of New York in 1982 and narrowly lost to the Democrat, Mario Cuomo. What you will read here is the first part of a lecture he delivered at Hillsdale College in Michigan, in the Ludwig von Mises “Champions of Freedom” series, soon after the 1979-82 experiment with Friedman’s monetarism failed miserably in a deflation even deeper than the one we are now experiencing. Part II will run next Friday. At 63, still a dozen years younger than Alan Greenspan, Lew would make a wonderful Fed chairman when Alan retires. Asap.
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Full Employment, Four Percent Interest Rates, Stable Prices and a Balanced Budget:
The Monetary Standard and Economic Growth
by Lewis E. Lehrman
I. Neo-Keynesians, Monetarists, and The Classical Monetary Policy
Those of us who believe in the goals of the Reagan revolution had better face up to the consequences of the last two years. We called for boom and got something very close to bust. We called for a balanced budget and got record-shattering deficits. We called for a restoration of capital markets so business could borrow money for long periods of reasonable interest rates, and we got a devastating credit crunch.
Why? There are many possible explanations, but in my view, the missing link is a policy we called for nearly three years ago but quickly forgot. Let me quote the 1980 Republican platform: “One of the most urgent tasks...will be the restoration of a dependable monetary standard.” The restoration of the true American monetary standard--a gold standard, the symbol of the classical monetary policy--was held up as an alternative to the conventional economics that have shattered the great American prosperity.
All the 1980 campaign speeches and the rhetoric of the President repudiated thirty years of Keynesian credit and fiscal manipulators. President Reagan’s campaign for economic renewal also called for an end to the budget deficit in 1983. It was argued at that time, only rapid economic expansion could create sufficient new tax revenues to balance the budget. But double-digit real interest rates made such an expansion impossible. Instead, Fed policy ended the recovery from the 1980 recession, overwhelmed the 1981 tax cut, and sent the economy reeling for the second recession in as many years. This back-to-back double recession in two consecutive calendar years is unique in the recorded history of American business cycles.
In terms of real growth figures, Presidents Carter and Reagan have presided over a three-year recession. It ended only after a three-year Fed monetarist experiment, begun by Paul Volcker on October 6, 1979, collapsed. In October 1979, Chairman Volcker announced that monetary policy by interest rate manipulation had been reformulated. Instead of targeting interest rates, a new-Keynesian prescription, the Fed, he said, would henceforth target a monetary quantity; that is, a specific quantity of bank reserves held to be consistent with a certain rate of growth of the quantity of money in circulation (M1b). This reform was branded as a monetarist revolution. In force for three years, the monetarist policy of the Fed, with the goal of fixing the quantity of money, was abandoned by Chairman Volcker on July 1, 1982. The decision came on an 8-4 vote of the Fed Open Market Committee under rising pressure from Congress and international debt problems. Eleven percent unemployment and a world banking crisis forced an end to Fed austerity.
The underlying truth is the Federal Reserve cannot fix the quantity of money in circulation. Nor, over the long run, can it fix interest rates, the monetary base, or the level of bank reserves. Nor should it try! The effort to do these things by the Fed has wrecked the long-term capital markets of America. In a free country like ours, if we must have a monopoly central bank, then it must be governed by the rule of a monetary constitution. Ours is a nation of laws, not of men.
The most efficient monetary rules would require the Fed to remobilize the discount rate, to prohibit the purchase by the Fed of government debt, and to join this central bank reform to a more general monetary reform--the establishment of a real gold standard. These rules will lead to reasonable price stability and sustained economic growth.
It is true that the classical monetary policy, a real gold standard, is unfashionable among the political, bureaucratic, and academic elites. But so, until 1980, was President Reagan. And he won without them because he was right. An so, too, will the gold standard, because the efficacy of the gold standard is based upon its ineffable simplicity and practicality. Ironically, that is a prime reason why the sophisticated experts reject it. To them, a convertible currency is too straightforward a solution for the problems of economic stagnation and inflation. Mathematicians and economists are taught in graduate school that economics and economic statistics are very complex subjects. Therefore, they conclude, economic policies must be equally complex, and so, too, must the bureaucracies which conceive them.
We must reject the abstruse incantations of a new self-appointed economic priesthood. Every false priesthood is opaque. True priesthoods are accessible, open, and simple. A marvel of the gold standard is that, in the absence of world war and trade war, it worked reasonably well in the past. It is also true that no free economic institution can long survive global war and protectionism. Most important, it is a virtue of gold money that it can be understood and trusted by working people. They alone can control its quantity. A gold-based currency is in fact democratic money. It is a populist institution beyond the reach of a guardian elite. If we adopt the gold standard, there is, of course, a price to pay. The central government and the Federal Reserve System will no longer be able to manipulate the value and supply of the American dollar. Alone, free people will determine its quantity.
Curiously, for a conservative administration, the Fed has been pressed by White House neo-Keynesians not to reform our diseased money, but once again to expand central bank credit as quickly as possible. The new Fed credit is to accommodate not only U.S. government borrowing requirements, but also the reckless big-city banks and the insolvent third-world countries abroad--not to mention the legitimate needs of private industry.
Change had to come. The gratuitous austerity imposed by the monetarism of the Fed during 1981 and 1982 rankled a free people too much. This was especially because the U.S. government had increased its own lavish spending in 1982 by 11-12 percent, while the wages of workers rose only 5 percent.
What the American people will get in the future, under present economic policies, may be something quite different from what they now expect. The reflation under way will, in the short run, increase output, reduce unemployment and re-invigorate commodity markets. Economic growth will exceed OMB and CEA forecasts for 1983. But, on the horizon, lurks another speculative bubble, foreign exchange crisis, commodity booms, precious metal hysteria, more budget crisis and world monetary disorder. True, the Fed will have bailed out the money-center banks and the bankrupt third world; monetarism will be a thing of the past; the immediate unemployment crisis will have passed; nominal interest rates will have fallen under the weight of Fed credit policy. All these things are certainly better than the feckless austerity and recession of 1981-1982. But, all we really have at the moment is one more postwar cyclical recovery, engineered by a Fed reflation.
We have not yet launched a sustained economic recovery upon the necessary basis of a sound currency and a stable price level. Nor will we bring about low, long-term interest rates with the present monetary policy.
This recovery, too, will pass, leaving behind a residue of profoundly disappointed expectations. Left behind also will be an American people more and more looking for radical change and thoroughgoing reformation of our increasingly moribund political and financial institutions.
It does not have to be this way.
The Reagan revolution is not at an end. It is at the way station. Here and now, the President can decide the direction of the world economy for a generation. Will it be more of the same--stop-go credit cycles into the future? Or will it be true monetary reform and an enduring legacy of rapid non-inflationary growth?
The failures of past economic policies also suggest that the choice should not be between monetarism and Keynesianism. Both well-meaning monetarists and Keynesians care little about the integrity of the monetary standard, believing as they do in academic dogmas which assure them that they can wisely manipulate the quantity of paper and credit money needed to bring about prosperity. Often the abstract formulas of these experts work well in a computer or in a classroom. But neither the simultaneous equations of an econometrician, nor the blackboards of a professor, are true substitutes for the real world of the market and its standards.
Only a few economists argue that a thoroughgoing monetary reform on the classical model will fulfill the promise of the Reagan election. And the present indifference toward monetary reform--of academic economists, politicians and bureaucrats--has deferred the promise. The complicity of the guardian elites in the destruction of the historic American monetary standard is an economic heresy which ravages the world. In the economy, the wages of sin are alternating seizures of inflation and unemployment.
Meanwhile, because of the administration’s timid and uncertain policy towards the Fed, and its failure to understand the principal cause of the colossal deficits, namely recession, economic growth has been held back for the past 18 months. As a result, we now face the major challenge of postwar American financial policy, as the Fed launches a worldwide credit reflation under budgetary conditions unique in our history. Rising government credit demands, historically high unemployment and interest rates, combined with the political decision by the Fed to (1) create a worldwide credit expansion in order to raise commodity prices; (2) rescue the world banking system; and (3) revive the U.S. economy, could, if sustained for several years, cause a complete collapse of U.S. financial institutions.
Once the wonder of the Western world, American long-term capital markets have already ceased to exist as our forefathers knew them. Whether they have a future at all--whether we shall inaugurate a period of sustained non-inflationary growth--will be determined by the Reagan Administration monetary policy.
The political stakes are great. That is because a true reform of monetary policy can change the present cyclical upswing into a long-term investment boom.