Memo to Saskatoon
Jude Wanniski
January 30, 1997


Memo To: Michael E. Zilkowsky
From: Jude Wanniski
Re: Gold & Inflation

Following is an e-mail I received from a Saskatchewan cabdriver who has been tuning in our website to learn about economics and whatever else strikes our fancy. My response follows his letter:

Dear Mr Wanniski: Greetings from Saskatoon Sask, where it is presently -35 degrees, good news for us cab drivers. Anyhow, while watching CNBC this afternoon, the talk seems to be about if, or by how much, the Fed is going to raise interest rates at its next meeting. I believe the gold price is down around $350, so how can there be inflation fears? Are they all operating from the assumption that inflation is caused by too much prosperity?

Also, our papers here recently have been writing about the improved Canadian trade surplus, and reporting it as if this is the best thing since sliced bread. I remember reading in Mr. Bartley's book about his meeting with the Mexican Finance minister who reported that since the ejido reforms Mexico had seen capital inflows of $16 billion, to which Mr. Bartley replied "then you must have a $16 billion trade deficit." If I understand this correctly, therefore, the amount of the Canadian trade surplus is matched by that amount of capital leaving the country? How is this good? And if you could add a quick note about the benefits/detriments of inflation-indexed bonds. Thank you for your time, and keep up the good work on your web page, I enjoy it a great deal. Michael E. Zilkowsky

Dear Michael: There is a conventional view that the Fed worries about economic expansion causing a rise in the general price level. Some of the Fed governors believe in this idea, which is called an "inflation/employment" trade-off. It was developed when a British economist in the 1950s observed economic expansion following a currency devaluation, but the devaluation also being followed by inflation. Federal Reserve Chairman Greenspan himself knows that if the price of gold is declining, any increase in prosperity and wages will be real, not induced by monetary excess. He should make his position clearer, but for one reason or another he prefers to say elliptical things on this matter, keeping his options open.

The Canadian trade surplus could either mean that Canada is so prosperous that it has an excess of capital, and is investing it in other countries which have not kept up with Canada's growth. Or, it could mean Canada is going through a period where people are fearfbl of further investments at home, for one reason or another, and is having bargain-basement sales abroad of its most important products. Alas, I am afraid it is the latter condition that afflicts your country. Ottawa has to sharply reduce its capital gains tax, which is about the highest in the world, if it is to turn its economy to genuine expansion. If it does, one of the side effects will be a sharp reduction in its trade surplus, which will be a good thing, not a bad thing. When Bartley was observing Mexico's trade deficit, he was commenting on the healthiness of the capital inflow that it represented. Since then, the Mexican government has screwed up acting upon bad U.S. advice, and it is running a trade surplus, as is Canada, for the wrong reason.

Inflation-indexed bonds are gimmicks, which announce to the world that our Treasury department does not understand that the dollar is first and foremost a unit of account, and that it represents the non-interest bearing debt of the government. A long-term bond in a floating exchange-rate system can run up and down against gold many times until it reaches maturity, which means the bondholder might have to sell during a deflationary swing, which increases the risk of holding such a bond. It is the dollar that should be anchored to gold, which would then permit the government and private debtors to enjoy the lowest interest rates. Alexander Hamilton would laugh at what U.S. Treasury Secretary Bob Rubin is doing. Or maybe he would cry.