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
II. The Classical Monetary Policy
President Reagan need not accept economic stagnation and slow growth which have caused inordinate deficits. Nor must we Americans accept the gradual destruction of our money. The remedies are available. They are historic remedies. We can stabilize the price level. We can grow rapidly again. We can balance the budget. We can have full employment and four percent interest rates. But we will not have them until we have real money.
Only the President can reestablish confidence in the future purchasing power of American money. That is the way to rebuild faith in the future of the American dream itself.
To do so, the Administration must establish a convertible currency, end the era of floating exchange rates, and create a new international monetary order based on a common world currency, the gold standard.
The world needs a unified currency because there is only one economy, and that is a unified, integrated world economy. Through the mechanism of arbitrage, the prices of all national economies are linked indissolubly together. There is no such thing as an independent monetary policy, the effects of which are contained within the national economy. Therefore, there can be no monetary policy in the true national interest, unless it is consistent with the interests of the international monetary system to which it is inextricably bound.
History shows that the optimum monetary institution of international financial order must be an impartial, global coordinating mechanism, outside the control of any sovereign state. Such a coordinating mechanism is a multilateral, fixed exchange rate regime based on unrestricted convertibility of national currencies to gold. The true international gold standard operated effectively between 1879-1914, amidst a sophisticated worldwide fractional reserve banking system, at least as integrated, then, as ours is today. The true gold standard was successful because, as an efficient world currency regime requiring prompt gold settlements to adjust balance-of-payments deficits, it operated in the manner of a global gyroscope to maintain long-run price stability and an efficient allocation of scarce capital the world over.
Though imperfect, no world monetary system has worked as well as (or less imperfectly than) a gold-based exchange rate regime.
Even huge gold discoveries never resulted in sustained, high inflation. The vast expansion of gold money in Europe during the sixteenth century and the nineteenth century never caused the price level to rise in excess of an average of 3 percent over a long period. Compared to the past 10 years of central bank-managed paper money and floating rates, 3 percent inflation is the essence of stability.
Even the part-time absence of large countries like Germany or the United States from the mid-nineteenth century international monetary order did not destabilize the British-led currency regime. Nor, for similar reasons, could the Soviet Union and South Africa disrupt a modernized real international gold standard today. Gold is the optimum monetary standard because it exhibits, better than any commodity, a necessary virtue of money: total new gold production in any single year is only a very minor fraction of the total supply of gold in existence--about 2 percent. Indeed, the average rate of increase of new gold production is equal to the average rate of gain of productivity since the onset of the Industrial Revolution. That is why gold money is stable money.
Moreover, South African production, c. 21 million ounces, and Soviet production, c. 8-10 million ounces, is but a drop in the bucket compared to total world stocks, c. 2.5 billion ounces. Withholding or selling new production of such small quantities cannot disturb the stability of the gold standard, one rule of which causes the authorities to sell or buy at the established rate all gold demands or offers. In addition, only with gold does the rate of growth of world money stocks naturally conform to the conditions of the monetarist rule--a steady rate of growth of the money supply, consistent with the long-term rate of economic growth. And this is because, uniquely among commodities, gold is not susceptible to scale production techniques which can vastly or quickly increase its supply through new discovery or invention. Over the long run, production statistics show that the values of the supply and demand for gold are stable. The alleged volatility of the price of gold is a curious inversion of the truth. It is not gold which is unstable. On the contrary, the steady long-run value of gold is recorded today by the extraordinary and unstable fluctuations in the value of paper and credit money.
A study of the supply conditions of gold production over centuries shows that it takes a relatively constant rate of application of a certain quantity of capital and labor to produce a constant quantity of gold. Gold production is therefore like a metering device, an optimum standard, a yardstick by which to gauge equitably the relative productivity, over time, of all capital and labor in an integrated world market economy. The unique characteristics of the conditions of gold production can be established with respect to no other commodity, product, or man-made banking device. The conditions explain why gold has been world money from time immemorial.
It is also for this reason, among others, that gold emerged as the natural standard of the free monetary order. In an imperfect world, the gold standard was freely selected as the commercial yardstick of free people. It served, less imperfectly than any other contrivance, the economic purposes of exchange, standard calculations of price, and as the enduring repository of saving. When free to choose, in the absence of legal tender laws, free people choose gold as money.
The gold standard, finally, may be seen as the way to end the mindless speculation and fluctuation of inconvertible national currencies. In particular, the real gold standard spells the end of unproductive speculation in gold and eliminates the inflationary premium which now benefits only the South Africans and the Russians.
The gold standard, a convertible dollar, can end the present financial disorder in America and the world. In plain English, it is the missing link in the search for a lasting economic renewal in America. It is a financial policy which I deeply believe can create the conditions of rapid non-inflationary economic growth. And only rapid economic growth can pay for the expanding scale of national defense.
Given the other aspects of President Reagan’s economic policy, the monetary reform leads to full employment and low, long-term interest rates in a free economic order. The monetary reform is the only effective way to make the outstanding budgetary and tax reforms of the Reagan Administration work. The monetary reform will breathe a long life into the present cyclical expansion.
Indeed, the history of the West and of our own country bear witness. After the hyperinflation of the American Revolutionary War and the corresponding economic decline (1775-1789), the new constitutional republic we established upon the bedrock of a new monetary order. It was Alexander Hamilton who brought about the Mint Act of 1792. By this act, the American dollar was fixed to a gold and silver basis by law. Economic historians and scholars of the period all remark the extraordinary 10-year boom which followed. Low long-term interest rates, rapid growth in the work force, and a stable price level were the hallmarks of a return to convertibility at the birth of the American nation.
Napoleon ended financial catastrophe in France, after the paper money debacle of the French Revolution, by establishing the gold franc. Financial stability and prosperity followed, generating the revenues which filled the Imperial Treasury.
The restoration of the gold standard in England of 1819-1821 ended the 24-year financial nightmare (1795-1819) of alternating wartime inflation and peacetime austerity and deflation. English economic historians all report that one of England’s greatest investment booms followed in the wake of the restoration of currency convertibility in 1821.
America in 1879 ended a 17-year period of floating exchange rates and paper money, begun in 1862 by the outbreak of the Civil War. This period of war and reconstruction had also been characterized by a doubling of the price level, then a peactime deflation. The gold standard and currency convertibility were restored in January of 1879. Real growth of national income averaged 8.4 percent annually for the next four years.
These are but a few examples, drawn from the only reliable laboratory for economic experiments, the real history of nations and peoples. These historical cases are the stuff of reality, not airy abstractions drawn from computers and blackboards. They show that the effects of a thoroughgoing monetary reform--the end of irredeemable paper money and the end of floating exchange rates--lead to new faith in the future.
Just as important, the restoration of the monetary standard will encourage, once again, new long-term business lending--for 30-50-100 years at 4 percent. Between 1879 and 1960, under the gold standard, 4 percent mortgage and business loans for 30-50 years were commonplace. And the price level was reasonably stable. Average prices were almost exactly the same in 1914 as in 1879. After a period of inflation and austerity caused by managed paper currencies, a convertible dollar creates confidence and a boom in long-term lending--leading to an investment boom, rapid economic growth, a huge demand for labor, and a stable price level. These are the same effects which can again be brought about by virtue of a sound financial policy. The same causes, under similar conditions, will tend to product the same effects.
When I forecast 4-5 percent mortgage interest rates under a modernized gold standard today, some of my younger friends are incredulous. But it was only 14 years ago, in 1968 at age 30, that I obtained my first home mortgage at 5 ˝ percent. Even then, in the waning days of the Bretton Woods gold-linked exchange rate system, long-term interest rates were low and reasonably stable compared to those of today.
III. Real Money and the American Dream
The first and necessary cause of sustained non-inflationary economic growth will be a dollar once again as good as gold. Under the real gold standard, the world will be reassured that the price level in the future will be permanently pinned down. The gold standard is an actuarial guarantee to working people that the purchasing power of money will be approximately the same in the future as it is on the first day of convertibility. Professor Roy Jastram has shown that the purchasing power of gold was constant for four centuries, 1540-1940. Permanent inflation and high interest rates are ruled out by the gold dollar. Thus, are expectations stabilized and the inflation premium in interest rates eradicated.
Our grandparents lent their long-term savings to American railroads for 50-100 years at 3 percent under the international gold standard. They did so, and we shall do so again, because only the gold monetary standard will restore our faith that the savings we lend to business today will yield us and our grandchildren future rewards paid in honest dollars of similar purchasing power.
It is this faith in the integrity of the monetary standard which will rebuild the foundations of long-term capital markets. With the advent of real money, the sluice gates will open and savings, now held at short term, will pour into new, long-term debt and equity investments. At first, the rush of a great new supply of long-term savings will exceed the demand. As a result, long-term rates of interest will fall. As real interest rates fall, the demand for low-cost financial capital will rise--to build businesses and homes. As the investment boom in technology, plant and equipment gets under way, the demand for labor will rise rapidly. Unemployment will fall.
After the monetary reform, economic growth will approach 7 percent per year and be sustained for at least four years. A decade of economic growth averaging 5 percent will be under way. Tax revenues will pour into the Treasury. For each 1 percent fall in the unemployment rate, the government deficit will fall $30-40 billion. Long-term interest rates on high-quality private debt would fall to 6-7 percent within 12 months of the monetary reform. For each 1 percent fall in the rate of interest, the Treasury could save $10 billion in service costs. The government debt could be refinanced at about one-half current interest rates, thus saving the Treasury $60-70 billion annually. At 5 percent unemployment, the Treasury would save an additional $150-200 billion.
The fiscal effect of rapid economic growth, joined to a refunding of the national debt, would refill the public treasury with increased revenues and balance the budget.
The monetary reform is the sole remaining path to sustained, long-term economic growth and a balanced budget. In truth, an authentic demand for a balanced budget means an end to austerity. The demand for a balanced budget is now a demand for rapid economic growth. Today, the demand for sustained economic growth is a demand for a long-term investment boom. The demand for a long-term investment boom is a demand for restoration of the long-term credit markets. The demand for long-term financial markets can only be a demand for honest insurance of the value of money rewards to those who have the faith to lend their savings many years into the future. The demand for faithful insurance of the future value of money, by every test of equity and history, is a demand for the real gold standard.
Once and for all, if America is to give the world a real money, it is necessary and it is sufficient to reestablish a free monetary order. Under the American Constitution, a free monetary order consists in a currency of intrinsic worth, a gold dollar, fueled by a moral principle-the unimpeachable integrity of a true money. The substance and integrity of the dollar, until 1934, rested upon the right of every American to bring precious metal to the mint to have it freely coined into standard money. Free coinage gave rise to the right to convert all paper and bank deposit claims, such as Federal Reserve notes and checking accounts, into the monetary standard. Thus was the dollar referred to as a convertible currency. But in 1933, the integrity of the dollar was put in question by government intervention.
Franklin D. Roosevelt unilaterally made contractual paper claims to gold dollars irredeemable. The U.S. government repudiated its covenant to convert Federal Reserve notes into standard gold coin held in reserve for those who trusted the guarantees of the Constitution. Moreover, in 1933, lawful gold money held by American citizens was forcibly confiscated by the government without due process.
As the integrity of our domestic currency was destroyed in the 1930s, its international substance was eviscerated in 1971 when Richard Nixon unilaterally repudiated the contractual right of foreigners, enshrined in the Bretton Woods Agreement of 1944, to claim gold dollars for undesired paper and deposit dollars. The present era of financial disorder, marked by alternating cycles of inflation and unemployment, originated in these monetary repudiations of 1933 and 1971.
Now is the moment to end this age of inflation and redeem the promise of economic growth signaled by the election of President Reagan.
To rule out inflation, to restore the essential condition for rapid economic growth, full employment, and four percent interest rates, to undergird the substance and integrity of the dollar, it is necessary to establish a monetary standard upon the principle of free coinage--the sure foundation of a convertible dollar--to be upheld by the organic law of the land. The law of the land, the law of money, must be as it was from 1792--the year of Alexander Hamilton’s Free Coinage Act--until 1933. During those 150 years, 13 impoverished little colonies by the sea rose to world power while their commerce and monetary standard, the gold dollar, engirdled the earth. It is true that protectionism, trade wars, and Federal Reserve deflationary policy after 1929 ended that epoch of growth and created the Great Depression. But these same mindless policies also destroyed the international gold standard.
Now is the time for America to launch a new gold standard era of open-world trade, peace, and prosperity. Only the U.S. has the power to do so, for the U.S. is the natural equilibrium leader of the free-world economy. It is true that the classical monetary policy is no panacea. Neither was Keynesian and monetarist doctrine. But the latter two are man-made gods which have failed, while the former, the gold standard, present from the creation of the Industrial Revolution, has actually worked in the only laboratory on earth which counts--the real world of history.
The international gold standard is the least imperfect of monetary institutions by which the U.S. can establish sound money, a reasonable stable price level, a long-term investment boom, and a general tendency toward full employment. It is true that all human institutions are imperfect, as we are all fallen creatures. But we do have the limited power to rule out the wild inflation inherent in the doctrine of Keynes and the austerity implied in the dogma of the monetarists. We also have the power to rule out sub-optimal international exchange rate regimes, such as the merchantilist float of today, as well as the superior, but defective, Bretton Woods exchange rate regime of yesteryear.
If America truly desires to give the world the real money it needs to grow, then we can choose the international gold standard. But it can only be brought into being by the leadership of President Reagan. Such an exchange-rate regime also will rule out the protectionist anarchy and competitive depreciations caused by floating rates. And once and for all, it will eliminate the privileges and burdens of the reserve currency status of the managed dollar. Only domestic convertibility and the true international gold standard can establish a common currency for a free, open, and integrated world economy.
Even without such a sound financial policy, friends and cynics say we shall still survive as a country. True it is the lot of working people and businessmen to survive, especially in America. But to what end? In order to subsidize a cartel of high-rolling big city bankers and undisciplined third-world elites? In an armed camp? Amidst conditions of permanently high unemployment, inflation, and 10 percent interest rates? Increasing bankruptcies? Wage and price controls? Is this the stuff of the American dream?
Yes, we can attain the goals of financial order and full employment, and thereby restore the American Dream, but only with real leadership and real money. In President Reagan, we have the potential leadership to end inflation, rebuild our economy, and balance the budget.
Now, for real money.