If We Had 'Real' Money We Could Still Salvage the Reagan Revolution

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 at 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 has shattered the great American prosperity.

I know that a 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. The gold standard will win out, too, because its efficacy is based upon its ineffable simplicity and practicality. It is an honest standard, a form of discipline that will guarantee that our money has real value. When we have real money people will again make long-term investments - because they will be confident that their investments will pay off in real money.

Ironically, this very simplicity is a prime reason why sophisticates ridicule the idea. To them, a currency convertible to gold is too straightforward a solution to economic stagnation and inflation. Mathematicians and economists are taught in graduate school that economics and economic statistics are very complex subjects. To them, therefore, economic policies must be equally complex.

But given the dismal failure of the experts' manipulative economic policies, isn't it time we chose a monetary standard they cannot manipulate?

All the 1980 campaign speeches and the rhetoric of President Reagan had repudiated 30 years of failed attempts to manipulate money and credit. But in two years, we have again fallen victim to the manipulators, to the conservatives of the austerity school at the Federal Reserve Board who thought they had a new magic potion to control "the money supply" that would save the economy.

Instead these wizards gave us double-digit real interest rates that 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.

This record was so bad that even Chairman Paul Volcker and his colleagues at the Fed got the message. In July they abandoned their three-year experiment with "targeting" the supply of money by trying to control the size of bank reserves. Last July 1, by an 8-to-4 vote, the Fed's Open Market Committee abandoned the experiment. Eleven percent unemployment and a world banking crisis produced pressures from Congress and the international financial community that forced Volcker to give up on 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 Fed effort to do these things has wrecked America's long-term capital markets.

The Fed could help us out of the mess we are in. By finally announcing a market-related discount interest rate and lending money to banks at that rate, by forswearing any Fed purchase of Treasury bills and notes (an inflationary transaction that expands the money supply with printing-press dollars), and by reestablishing a real gold standard, we can have reasonable price stability and sustained economic growth.

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, gold money can be understood and trusted by working people. They alone can control its quantity. A gold-based currency is 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 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 neo-Keynesians in the White House not to reform our diseased money, but once again to expand central bank credit as quickly as possible. The new Fed credit policy is to accommodate not only U.S. government borrowing requirements, but also the reckless big city banks and the insolvent Third World countries — not to mention the legitimate needs of private industry.

What we will get in the future, under present economic policies, may be something quite different from what we expect. The Fed's policy now is to "reflate" the economy. In the short run, this will boost output, reduce unemployment and reinvigorate commodity markets. Economic growth will exceed the administration's forecasts for 1983. But another speculative bubble lurks on the horizon. It will burst, bringing foreign exchange crises, commodity booms, precious metal hysteria, more budget crises and world monetary disorder.

True, the Fed will have bailed out the big 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 austerity of '81-82. But all we really have at the moment is one more postwar cyclical recovery, engineered by a Fed reflation, and guaranteed to end as all other recent "recoveries' have ended.

And this time engineering the recovery will be more difficult than ever. The Fed is trying to launch a worldwide credit reflation under budgetary conditions unique in our history. This policy on top of historically unprecedented deficits could, if sustained for several years, cause a complete collapse of U.S. financial institutions.

It does not have to be this way. The Reagan Revolution is not necessarily at an end. It is at a 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 misery? Or will it be true monetary reform and an enduring legacy of rapid non-inflationary growth?

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 ever inaugurate a period of sustained noninflationary growth — will be determined by the Reagan administration's 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 boom.

To do so, the administration must establish a convertible currency, end 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 we now have a unified, integrated world economy. There can be no such thing as an independent, national monetary policy, the effects of which are contained within the national economy. We live in one monetary world now.

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 banking system that was at least as integrated 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.

This arrangement was not perfect. But no world monetary system has worked as well as 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 16th and 19th centuries never caused the price level to rise more than an average of 3 percent a year over a long period. Compared to the past 10 years of central bank-managed paper money and floating exchange rates, 3 percent inflation is the essence of stability.


Kathleen M. Packard, Publisher
Ralph J. Benko, Editor

In Memoriam
Professor Jacques Rueff

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