Monetarism: the last days
Tom Bethell
Washington President Reagan, vacationing at his California ranch, signed the new Tax and Budget Bill last week. It will reduce government spending by a small amount in the years ahead, while tax-rates will be reduced appreciably; since tax rates and tax revenues are not commensurate (a high tax rate will collect little revenue), it is difficult to estimate the long-range effect of the rate reductions on the economy. But they no doubt will be beneficial.
The changes in the tax code are regularly described in the US press in terms of revenue losses Ca 750 billion dollars tax cut,') but this is misleading. Just as the Phrase 'tax cut' itself hopelessly blurs the distinction between tax rates and revenues. A better way of looking at the matter is to argue that tax rates are the price of government. If a shopkeeper has unsold goods, then he must lower their price if he is to sell them and so increase the revenue coming into his till. Likewise, when there is a lot of unsold government about — in the shape of budget deficits — then it must be sold at a cut rate. Put government on sale and you will sell more of it. The tax rate reductions, looked at this way, will produce revenue increases in the years ahead.
Say what you will, that's the way Calvin Coolidge looked at the matter, and Coolidge is the newly installed hero of President Reagan and his merry band of .supply-siders'. The latter group, in conjunction with Mr Reagan's outstanding salesmanship, have been primarily responsible for forcing through the change in Political direction.
Fiscal policy having been rectified, the supply-siders' are now turning with characteristic zeal to monetary affairs. Their goal Is to discredit monetarists in general and Milton Friedman in particular. A leading SUpply-sider' said recently that Friedman could end up doing more harm than Keynes, while the fiery Jude Wanniski called last week for the public flogging of Beryl Sprinkel, a monetarist official at the US Treasury.
'Supply-siders' believe that the quantity of money in circulation should be allowed to rise and fall in response to the demand for money, not in response to arbitrary 'money supply' formulae. The demand for money can be expressed in the market place in only one way (argue the `supply-siders) — by allowing the people to go to the bank Whenever they so desire and exchange hank notes for some commodity which stands in for all the other goods and services produced in the economy. This commodity is gold. Nothing else will do. When people start bringing a fixed number of dollars to banks in exchange for gold, they thereby signal the onset of inflation to the monetary authorities. If the government is to staunch the outflow of gold from the central bank into private hands, then it must immediately correct monetary policy (by raising the discount, or bank rate, for example). Money will then become scarcer, until one day people begin showing up with gold in hand, demanding bank notes in exchange. When there is no net inflow or outflow of gold from the central bank, then the currency is maintaining its value. The market place for money acts as a giant computer, utilising far more information than is available to monetarist economists. The people control the money supply by revealing the relative desirability of gold and money.
A barbarous relic perhaps, but still a revered one. It has been tried in the past and it has worked a good deal better than the world-wide monetary chaos of the past decade. The Nixon administration 'closed the gold window' ten years ago this week, meaning that they stopped selling off Fort Knox ingots to foreign governments at the bargain price of 35 dollars an ounce. Gold had been flowing out of the Treasury since 1949 — a signal of inflation that was neglected for 22 years. Closing the gold window did not solve the problem of course; it was reminiscent merely of the doctor who snaps his thermometer rather than treats the fever. Since then paper money the world over has proliferated inordinately. Herbert Stein, President Nixon's chief economic adviser, noted in the Wall Street Journal last week that the 'experience of 1971 does suggest that it is unrealistic to think that the gold standard will present governments with an unequivocal choice between inflation and gold.' He reasoned that for a gold standard to work people must have a 'deep-seated loyalty' to gold, yet hardly anyone objected to the closing of the gold window in 1971. It is true that a gold standard rests ultimately on a widespread faith in the efficacy of gold, but people in recent years have displayed just this faith by exchanging their eroding dollars for the metal, the gold price soaring in response. In effect, gold remonetised itself.
`Supply-siders' are as certain as they can be that gold will be officially remonetised in the US within the next decade. That seems far-fetched at present. Nothing is likely to happen unless there is a tremendous new burst of inflation. But the newly formed Gold Commission did meet in Washington last month, and Treasury officials and Federal Reserve governors found themselves in the unaccustomed position of having to discuss gold seriously. (To the annoyance of 'supply-siders', Anna Schwartz, Milton Friedman's monetarist co-author, took charge of the meeting. Making the case for gold were Congressman Ron Paul of Texas and a New York businessman, Lewis Lehrman.) Gold has the following important characteristics, its advocates point out. Governments have not yet mastered the alchemy needed to print it and thus devalue their debts; most of the gold mined over the past several thousand years is still with us (mostly in bank vaults), making it very difficult to increase or diminish sharply the total amount of it that exists (this in response to those who wonder whether the Russians or South Africans could mess things up by withholding gold from the market). Over long market intervals the gold supply grows slowly but steadily — just as monetarists would like the money supply to behave.
In addition, gold is not subject to economies of scale in production. This is the answer to Friedman's jibe that a pork belly standard would be as good as a gold standard. But if pork were convertible at a fixed and unchanging rate, pig farms would multiply and the Great Bacon Inflation would soon follow. This doesn't happen with gold because it is so attenuated throughout the earth's surface that, if you want to double the amount mined, you more or less have to double the number of people out there with picks and shovels looking for it. A certain increase in gold production requires a similar increase in the labour and capital diverted to the task. And thatis why the gold standard works, in fact: gold production fairly accurately 'expresses' economic activity generally. By contrast, GNP statistics and the various aggregates so beloved of monetarists certainly do not.
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