Memo To: Treasury Secretary Lawrence Summers
From: Jude Wanniski
Re: Anchoring the dollar at Y2K
When Jack Kemp of Empower America wrote President Bill Clinton on June 11, urging specific action as a precaution against serious damage to the financial and commercial world because of the Y2K computer bug, you were not yet confirmed as Treasury Secretary. My assumption is that Kemp's letter may have gotten misplaced because of the changing guard at the Treasury Department, but with several weeks having elapsed, we are that much closer to Y2K and Kemp tells me there has been no response -- from the President or from Treasury. Because Y2K will occur on your watch, Larry, I advise you to give the Kemp proposal serious consideration. There really is no cost to it. There are no partisan politics involved. It was conceived out of a genuine effort to help the nation and the world pass through the Y2K barrier into the unknown. My belief is that without the incredibly powerful mainframe computers that have evolved during the past 30 years, we never could be able to manage a world monetary system of floating currencies. Our computers may be 100% compliant, which I still doubt, but those in the rest of the world will be capable of causing major problems to world commerce...coming into our system the way a virus can from anywhere. Here is the Kemp letter to the President, preceded by a memo I wrote to our mutual friend Sen. Bob Bennett [R-UT], chairman of the Senate Select Y2K Committee.
* * * * *
As chairman of the Senate Select Committee on Y2K, you have spent the last two years exploring the ways our federal government can help the country and the world get through the "computer bug" problem as we enter the new century. You know several times I have discussed the real need to anchor the dollar to gold through a presidential executive order as a precautionary move, if only for the brief period between the end of November and the beginning of spring. I had told you that Jack Kemp had been thinking about this too, out of concern that even a minor problem with global computers that track the floating exchange-rate regime would cause financial turbulence and global economic recession. As a member of the Senate Banking Committee and Joint Economic Committee of Congress, you are practically made for the job of seeing that this precaution be taken. I think you know there would normally be a great outcry from opponents of a gold standard or fixed-exchange-rate monetary regime of any kind, but given this leap into the unknown which the world soon will be forced to take, the advantages of a gold anchor should mute those voices of opposition. In the last week, Jack decided that with only six months left before that leap, there must be an increased sense of urgency in dealing with it. Last Friday, he wrote to the President on this topic. The letter follows. I hope you will circulate the letter and the idea on your Y2K Committee, especially bringing it to the attention of the ranking Democrat, Senator Chris Dodd of Connecticut. A hearing may be necessary, but as it would take only the stroke of the President's pen, you might be able to arrange this with a telephone call to Fed Chairman Alan Greenspan and the incoming Treasury Secretary, Larry Summers, who surely should be asked about the idea in his confirmation hearings.
June 11, 1999
The White House
Dear Mr. President:
In six months and 19 days, computer clocks around the globe will click over to "00" and no one knows for sure what will happen. The predictions range from nothing more than a few minor disruptions to worldwide chaos. As a board member of Oracle and several Internet companies, I am convinced that we in the United States are technically well prepared but even so, significant disruptions in the economy may result if preventative steps are not taken.
One thing we do know for sure is that the behavior of individuals, business firms and governments is being affected by Y2K considerations. People are behaving differently than they otherwise would, and that change in behavior will have an effect on the global financial system that neither the Federal Reserve Board nor any other central bank is equipped to handle.
All of these changes in behavior have a common effect: They alter the demand for liquidity. The problem is, under the Fed's current operating procedures, it does not receive adequate signals on how the demand for liquidity is changing so the central bank does not know when to increase or decrease liquidity or by how much.
In my opinion, there has been a considerable increase in the demand for dollar liquidity around the world, in part caused by Y2K considerations, that the Fed does not recognize it should be supplying. There is widespread evidence of a dollar liquidity dearth. The price of gold is down to $260, and commodity prices are weak (the CRB index is more than 20 percent below its levels a year ago). The price of oil has now receded to $18 a barrel from its spike up to $19 after the OPEC production cutback earlier this Spring.
What happens after the turn of the year? Even if Y2K effects are minimal, there may still be an economic slowdown as inventories are depleted. If the pessimists are correct, we may confront a genuine recession. In either case, the demand for liquidity likely will fall, perhaps precipitously, and excess liquidity may have to be soaked up to prevent an eruption of inflation. Under the Fed's current operating procedures it will not know what to do because it will not receive clear signals on the liquidity being demanded by the market. In fact, in the face of a weaker economy or recession, the Fed's current model will tell it to increase liquidity in order to stimulate economic growth, precisely the wrong thing to do.
Economists of every stripe understand that the modern world is held together electronically by trillions of bookkeeping entries that not too long ago were managed by pen and ink, on paper ledgers, with help from adding machines or desktop calculators. Most transactions involved the exchange of currency for goods and services. Now, high-powered computers keep track of most of the "promises" that make up local, regional and national economies. It was even simpler in the days of the Bretton Woods international monetary system, with the dollar linked to gold and all other currencies linked in one way or another to the dollar. High-powered computers were not needed to manage the daily adjustments in electronic debits and credits. In today's world of floating currencies, computers enable the world's banks to manage chaos.
I believe that what all of this means is that the burden is on the Presidency and the Treasury Department to take action now to ensure that the dollar remains rock solid throughout the upcoming period of uncertainty and possible turmoil. Throughout the coming year, on a monthly basis I believe, we will see extraordinary swings in the demand for liquidity. It is implausible that the standard interest-rate targeting mechanism currently employed by the Fed will work during this window of vulnerability. Moreover, when the clocks click us into the new century, many computers around the world may go down for some period of time, in which case there will be no way to conduct the $1 trillion of transactions required everyday by the current floating exchange rate regime.
With the stroke of your pen you can, temporarily at least, restore the simplicity of the Bretton Woods monetary system as an insurance policy against disruptions and guarantee a stable dollar throughout the Y2K window of vulnerability. Therefore, I want to urge you to issue an executive order immediately to stabilize the value of the dollar by instructing the Fed to conduct open market operations to add and subtract liquidity to keep the price of gold temporarily within a narrow band around the average gold price of the past 12 months. There would be no need of an international conference to discuss this. You need only fix the dollar/gold price as we did under Bretton Woods, and every country in the world could fix to the dollar.
This action would guarantee that, whatever the economic effects of Y2K, the Fed will continue to receive clear and unambiguous signals on the demand for liquidity and on what open market operations it must undertake to keep the dollar stable. We cannot know with any degree of certainty what the Y2K effects will be. However, with the value of the dollar temporarily anchored to gold, we can be sure of a rock-solid currency to see us through whatever Y2K might bring.
Is there a downside to this anchoring of the world's currencies to a single accounting unit? Perhaps it would prevent the Fed from raising or lowering the Fed funds rate to affect small changes in output and employment. But the risks of not anchoring the dollar are enormous and could invite the kind of recession or global depression that at least a few economists predict. I will be speaking about this issue in the weeks and months ahead, and I hope you will take the idea as seriously as I have in thinking it through. There are other areas of the federal government where simplicity would also help get the country through this unprecedented leap into the unknown. I'd be happy to discuss those with you as well, but because this one affects everyone on earth, I put it forward by itself.
Very sincerely yours,