If you've read Diary the last few days, you know I've had Wanniski-one of, along with Arthur Laffer, the two main father's of modern Supply Side economics-which is essentially the GOP's official ideology over the last 30 years-on my mind as I'm currently reading his magnum opus The Way the World Works.
http://diaryofarepublicanhater.blogspot.com/2013/07/jude-wanniski-laffer-curve-and-battle.html
While he was a big Reagan supporter-he advised Reagan during the 1980 campaign and was a long term adviser of GOP Congressman Jack Kemp-he saw things in terms of a battle for the very mind of the Gipper. The Old Guard-he saw these as Milton Friedman, Alan Greenspan, David Stockman, Dick Darmn, etc.- he saw as opposed to him and his fellow Wild Men-the Supply-Siders.
In the early 80s during the disinflation there was some more battling between the Old Guard and the Wild Men. Wanniski and Mundell were very concerned about the disinlfaiton. This is not surprising-at the time it was a very read source of concern. However, when discussing 'deflation' it's interesting to realize what were the prices dropping that were his real source of concern.
"In 1979-80, we experienced a serious burst of monetary inflation, as the Fed tried to offset a decline in the demand for liquidity by adding more of it. The rationale was provided by the monetarists, who observed a statistical decline in the M-1 monetary aggregates from their preferred targets but did not see the rapid jump in the velocity of money until well after the damage was done. The new Fed Chairman, Paul Volcker, had shifted to the monetarist targets from the previous interest-rate targets. This in itself loosed a new round of inflation. The gold price responded to the combination of increased supply and decreased demand for liquidity by jumping from $240 in the spring of 1979 to $850 in February 1980."
http://diaryofarepublicanhater.blogspot.com/2013/07/jude-wanniski-laffer-curve-and-battle.html
While he was a big Reagan supporter-he advised Reagan during the 1980 campaign and was a long term adviser of GOP Congressman Jack Kemp-he saw things in terms of a battle for the very mind of the Gipper. The Old Guard-he saw these as Milton Friedman, Alan Greenspan, David Stockman, Dick Darmn, etc.- he saw as opposed to him and his fellow Wild Men-the Supply-Siders.
In the early 80s during the disinflation there was some more battling between the Old Guard and the Wild Men. Wanniski and Mundell were very concerned about the disinlfaiton. This is not surprising-at the time it was a very read source of concern. However, when discussing 'deflation' it's interesting to realize what were the prices dropping that were his real source of concern.
"In 1979-80, we experienced a serious burst of monetary inflation, as the Fed tried to offset a decline in the demand for liquidity by adding more of it. The rationale was provided by the monetarists, who observed a statistical decline in the M-1 monetary aggregates from their preferred targets but did not see the rapid jump in the velocity of money until well after the damage was done. The new Fed Chairman, Paul Volcker, had shifted to the monetarist targets from the previous interest-rate targets. This in itself loosed a new round of inflation. The gold price responded to the combination of increased supply and decreased demand for liquidity by jumping from $240 in the spring of 1979 to $850 in February 1980."
"These inflationary impulses ended as the Fed slowed down its liquidity additions in September 1980 and as the Reagan victory in November spurred an increase in the demand for liquidity, foreshadowing the bigger economy produced by the promised 1981 tax cuts. Still fighting the inflation, though, the Fed starved the system of liquidity and the gold price tumbled by leaps and bounds. In September 1981, Bob Mundell recommended a stabilization of the gold price at $425, but the Monetarists were in control of the monetary policy levers in the Reagan Treasury and insisted on squeezing the monetary aggregates. As the tax cuts phased in, the gold price dropped faster as liquidity demands were not supplied. With Mundell, a Canadian citizen, reluctant to inject himself into the debate in Washington, we took the initiative at Polyconomics in trying to get the White House and Treasury to understand the process that was crippling the economy. I wrote to President Reagan in the fall of 1981 and wrote a column in BusinessWeek urging monetary ease. Reagan wrote me that he was getting divided counsel. Milton Friedman, he said, was warning against ease and had assured him interest rates soon would fall."
This explains what he meant by his comment that understanding the deflation of the early 80s will help explains the deflation of the late 90s. My first reaction upon reading this was: what deflation in the late 90s. Then it occurred to me. He meant the price of gold...
"On St. Patrick’s Day of 1982, I was lecturing on supply-side economics at Campbell College in North Carolina. In my guest room on campus, I heard on the radio that gold had dropped to $310 from $320. I called the Fed and asked to speak to Chairman Paul Volcker, whom I had first met at the Nixon Treasury when we left gold in 1971. After exchanging pleasantries, I told him he had to stop the decline in the gold price. He said the Fed did not have anything to do with the gold price. I said he could stop the decline by buying bonds from the banks. “You want me to inflate?” he said. “No, but you must stop deflating,” I said, explaining that if the gold price were not arrested, the recession we were already into would deepen and dollar debtors would be forced into bankruptcies all over the world. I remember mentioning that Poland, which had borrowed heavily in dollars, would be among those countries unable to meet their dollar debt obligations."
For Wanniski, gold was much more than just a commodity- it's drop somehow threatened debtors and the world economy.
We get more the sense of how Wanniski saw everything in terms of a war for the President's mind:
"At the time I wrote this, it was not yet obvious to me or to Mundell on how Volcker could extricate himself from the official monetary targets. In 1982, there were no supply-siders in the Reagan administration who were at all interested in monetary policy. Treasury had two “supply-side fiscalists,” the late Norman Ture and Paul Craig Roberts, but they believed the Reagan tax cuts would cause the economy to expand, just as the Kennedy tax cuts had invited an economic boom. At the time of the Kennedy tax cuts, though, monetary policy was still driven by the dollar’s link to gold, under the terms of the 1944 Bretton Woods Agreement. As the demand for liquidity increased, the Fed supplied all that was demanded, automatically. In 1982, there was no such automaticity in the floating regime. Still another burden for the supply-side position was at the Office of Management and Budget, where two erstwhile supply-siders, David Stockman as director and Larry Kudlow as chief economist, took the position that budget cuts and the closing of tax loopholes such as the oil-depletion allowance would narrow the emerging budget deficit and inspire a decline in long-term interest rates. This was the Old Time Religion, applauded by Alan Greenspan, who at the time was back on Wall Street. The Monetarists inside the Reagan administration controlled the key posts at Treasury and the Council of Economic Advisors. They were disinterested in either tax cuts or spending cuts, believing everything would be fine if only Volcker would hit their monetary targets."
Finally, however, the Mexico crisis forced Volcker off the M
"With no intellectual support inside the Reagan administration for an end to the monetary deflation, it took a crisis to end it. Mexico supplied the crisis. In August 1982, Mexico advised its creditors at the U.S. banks that it could not pay interest or principal on the $60 billion of public debt it assumed in the inflationary phase of the floating regime. It needed $20 billion immediately to pay the banks, but after two IMF-advised peso devaluations that spring and summer, Mexico had run out of hard-currency reserves. As the price of gold had fallen, the price of Mexico’s oil -- which the U.S. banks had collateralized at $36 a barrel -- in the conventional expectation that it would soon top $40 -- dropped to $31. The U.S. recession, the direct result of the monetary deflation, also had dried up the market for Mexico’s farm goods."
"In mid-August, Paul Volcker had no choice. If Mexico could not pay the banks, the banks would become illiquid. Their capital soon would disappear and bankruptcies would occur. Volcker of course could not permit this to happen, so he advised the Treasury Secretary that he could no longer worry about the monetarist targets. He had cut the discount rate several times trying to ease as the stock market plumbed new lows, but gold only dipped further. He would have to monetize $3 billion in Mexican peso bonds so its government would have the dollars to pay the banks. The injection of that much liquidity into the bloodstream of the U.S. banking system ended the crisis. The price of gold leaped up. The prices of stocks and bonds on Wall Street instantly followed -- although the monetarists had warned of a bond market collapse if all that “M” was put into the system. The DJIA went from 790 to almost 1100 by year’s end; the NASDAQ rocketed to 250 from 150 in that same brief period."
He believed that gold needed to stay under 400-if it got higher this would mean the painful tightening of disinflation had been for naught. Euphoria ultimately pushed it over $500 However, things calmed down after that.
The main outcome he notes was the end of the Monetarist experiment by the Fed.
"In the sudden euphoria, gold actually shot above $500 in the several weeks that followed, as the markets were given no guidance on how monetary policy would adjust in the future. When it became clear the fresh liquidity was not going to be followed by another burst from the Fed, gold subsided, settling closer to $400 for the next year to 18 months. If anything was clear, though, it was that the monetarists were through as a guiding force for monetary policy. Senate and House Democrats immediately announced plans to require the Fed to return to interest-rate targeting, which in any case was the de facto result of the disastrous experiment with monetarism."
Back to Sumner's interest rate targeting... Wanniski was an interesting figure in policy circles as while he had no official power himself and it wasn't clear what impact he had on policymakers, they would nevertheless answer the phone when he called as Bill Geider tells us.
See pg. 418
Wanniski then drew the parallels with the-at the time he wrote-the President-actually it was 2001 during the Nasdaq bear market.
"The most significant difference between the deflation of 1980-82 and the deflation of 1997-2001 is in the sharpness and severity of the earlier deflation, which took place alongside high marginal tax rates that were being phased out slowly to a still prohibitive level. When the deflation of 1997-01 began, it emerged in an already expanding economy as growth expectations rose on the hope of a 1997 budget compromise on capital gains relief. Beginning as early as November 1996, the market began to discount the passage of the new, lower statutory capital gains tax (to 20% from 28%) and new Roth IRA accounts that increased the demand for liquidity as economic actors geared up for a larger, more productive dollar economy. When the Greenspan Fed did not supply the new liquidity, gold began its retreat from its longstanding $350-$400 trading level. Greenspan, who never believed in monetarist targets, was being guided by the Keynesian concept of the Phillips Curve, which posits a trade-off between unemployment and inflation. He is, in effect, “targeting the unemployment rate.”
There are certainly some differences! For one thing the deflation of 1981-82 was caused deliberately by Volcker. Another 'difference' is not many remember this 5 year period as deflation. The inflation rate never became negative-though it's true that in 2003 there was concern by Bernanke and Greenspan making sure that 'it doesn't happen here.' Yet what they were thinking about was the Japanese deflation-making sure it didn't literally come 'here'-to the U.S.
The 2000-2002 fall in the market was a source of this concern. Not many outside of Wanniski and some like minded Supply-Siders, a la Mundell-saw gold dropping as 'deflation.' Would Wanniski interpret the drop in gold today the same way?
In any case, his dream for the Fed to stand ready to make purchases of gold to keep it within a certain range-one target has been 40% of the dollar as his buddy Laffer calls for-is still around.
While I'd say he's wrong about the importance of the price of gold and he was wrong that the dollar weakening is deflation he also may have been right that Greenspan remained-thanks to the Phillips Curve preoccupation-too concerned about a totally imaginary inflation threat in the late 90s.
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