by LEWIS E. LEHRMAN at the PARLIAMENT OF FRANCE (Assemble Nationale) November 7, 1996
Distinguished Leaders of France:
In what I now say to you, I draw
from the speeches, the writings, and the letters of the greatest economist of
the twentieth century. Your courtesy may
require you to hear politely the words I now speak. But I beg you to believe me, that all the
arguments I shall make in your presence are
distilled from the wisdom of the master himself. The ideas I set before you originate in the proven
genius of an extraordinary teacher, a selfless servant of the French people,
and a peerless citizen of the world -- in the words of General de Gaulle --
“une poète de finance.”
I speak of Jacques Rueff.
As a soldier of France, no one knew
better than Jacques Rueff that World War I had brought to an end the
preeminence of the classical European states system; that it had decimated the
flower of European youth; that it had destroyed the European continent’s
industrial productivity. No less
ominously, on the eve of the Great war, the gold standard – the gyroscope of
the Industrial Revolution, the proven guarantor of one hundred years of price
stability, the common currency of the world trading system – this precious
institution of commercial civilization was suspended by the belligerents.
The Age of Inflation was upon us.
The overthrow of the historic money
of commercial civilization, the gold standard, led, during the next decade, to
the great inflations in France, Germany, and Russia. The ensuing convulsions of the social order,
the rise of the speculator class, the obliteration of the savings of the
laboring and middle classes on fixed incomes, led directly to the rise of
Bolshevism, Fascism, and Nazism – linked, as they were, to floating European
currencies, perennial budgetary and balance of payments deficits, central bank
money printing, currency wars and the neo-mercantilism they engendered.
Today, three quarters of a century
later (1996), one observes -- at home and abroad -- the fluctuations of the
floating dollar, the unpredictable effects of its variations, the abject
failure to rehabilitate the dollar’s declining reputation. Strange it is that an unhinged token, the
paper dollar, is now the monetary standard of the most scientifically advanced
global economy the world has ever known.
In America, the insidious
destruction of its historic currency, the gold dollar, got underway in 1922
during the inter-war experiment with the gold-exchange standard and the
dollar’s new official reserve currency role.
It must be remembered that World War I had caused the price level almost
to double. Britain and America tried to
maintain the pre-war dollar-gold, sterling-gold parities. The official reserve currency roles of the
convertible pound and dollar, born of the gold-exchange standard, collapsed in
the Great Depression and so did the official foreign exchange reserves of the
developed world – which helped to cause and to intensify the depression. Franklin Roosevelt in 1934 reduced the value
of the dollar by raising the price of gold from $20 to $35 per ounce, believing
the change to be a necessary adjustment to the post World War I price level
rise.
But it must be emphasized that it
was twelve years earlier, in 1922, at the little known but pivotal Monetary
Conference of Genoa, that the unstable gold-exchange standard had been
officially embraced by the European financial authorities. It was here that the dollar and the pound
were first confirmed as official reserve currencies to supplement what was said
to be a scarcity of gold. For those of
you who remember his writings, Jacques Rueff warned in the 1920s of the dangers
of the Genoa gold-exchange system and, again, predicted in 1960-61 that the
Bretton Woods system, a post World War II gold-exchange standard, flawed as it
was by the same official reserve currency contagion of the 1920s, would soon
groan, under the flood weight of excess American dollars going abroad. Rueff in the 1950s and 1960s forecast
permanent U.S. balance of payments deficits and the tendency to constant budget
deficits, and ultimate suspension of dollar convertibility to gold. After World War II, he saw that because the
United States was the undisputed hegemonic military and economic power of the
free world, foreign governments and central banks, in exchange for these
military services and other subsidies rendered, would for a while continue to
purchase, (sometimes to protect their export industries,) excess dollars on the
foreign exchanges against the creation of their own monies. This was the inevitable result of the
dollar’s official reserve currency status.
But these dollars, originating in the U.S. balance of payments and
budget deficits, were then redeposited by foreign governments in the New York
dollar market which led to inflation in the U.S., and inflation in its European
and Asian protectorates which were absorbing the excess dollars. Incredibly, during this same period, the International
Monetary Fund authorities had the audacity to advocate the creation of Special
Drawing Rights, SDRs, so-called “paper gold,” invented, as International
Monetary Fund officials said, to avoid a “potential liquidity shortage.” At that very moment, the world was awash in
dollars, in the midst of perennial dollar and exchange rate crises. Jacques Rueff casually remarked to Le Monde
that the fabrication of these SDRs by the International Monetary Fund would be
as gratuitous as “irrigation plans implemented during the flood.”
The dénouement of post-war financial
history came at the Ides of March, in 1968, when President Johnson suspended
the London Gold Pool and, mercifully, abdicated his candidacy for
reelection. And so after a few more
disabling years, Bretton Woods expired on August 15, 1971. The truth is that Monetarists and Keynesians
sought not to reform Bretton Woods, as the gold standard reform of President
DeGaulle and Jacques Rueff did, but rather to demolish it. The true gold standard, indeed any metallic
currency basis, was passé among the cognoscenti. I shall give you just one example of the
obtuseness of the political class, which happened at the height of a major
dollar crisis. A friend of Jacques
Rueff, the renowned American banker and policy intellectual, Henry Reuss, Chairman
of the Banking and Currency Committee of the United States House of
Representatives, went so far as to predict in The New York Times, with great
confidence and even greater fanfare, that when gold was demonetized, it would
fall from $35 to $6 per ounce. (I am not
sure whether Congressman Reuss ever covered his short at $800 per ounce in
1980.)
President Nixon, a self-described
conservative, succeeded President Johnson and was gradually converted to
Keynesian economics by so-called conservative academic advisers, led by Prof.
Herbert Stein. Mr. Nixon had also
absorbed some of the teachings of the Monetarist School from his friend Milton
Friedman -- who embraced the expediency of floating exchange rates and central
bank manipulation and the targeting of the money stock. Thus it was no accident that the exchange
rate crises continued, and on August 15, 1971, after one more major dollar
crisis, Nixon defaulted at the gold window of the western world, declaring that
“we are all Keynesians now.” In 1972,
Nixon, a republican, so-called free market President, imposed the first
peacetime wage and price controls in American history – encouraged by some of
the famous “conservative” advisers of the era.
In President Nixon’s decision of
August 1971, the last vestige of monetary convertibility to gold, the final
trace of an international common currency, binding together the civilized
nations of the West, had been unilaterally abrogated by the military leader of
the free world.
Ten years later at the peak of another inflation crisis, the gold price touched $850. At the time, Paul Volcker, chairman of the Federal Reserve declared that the gold market was going its own way and had little to do with the Fed’s monetary policies. The gold market is but “a side show,” added Professor Wallich, a prominent Federal Reserve Governor. Secretary of the Treasury William Miller, who had been selling United States gold at about $200 in 1978, announced solemnly that the Treasury would now no longer sell American gold. Presumably Secretary Miller, an aerospace executive, meant that whereas, more than one-half the vast American gold stock had been a clever sale, liquidated at prices ranging between $35 and $250 per ounce -- now, in the manner of the trend follower, the Secretary of the Treasury Miller earnestly suggested that gold was a “strong hold” at $800 per ounce.
On January 18, 1980, Henry Wallich,
a former Yale Economics professor, explained Federal Reserve monetarist
policies in an article appearing in the Journal of Commerce:
“The core of Federal
Reserve….measures,” basing “control upon the supply of bank reserves,” he said,
“gives the Federal Reserve a firmer grip on the growth of monetary aggregates
...”
Subsequent events showed, the
Federal Reserve promptly lost control of the monetary aggregates. The bank prime rate rose to 21%. As all of Jacques Rueff’s experience as a
central banker had taught him, what his monetary theory and his econometrics
demonstrated was, in fact, that no central bank, not even the mighty Federal
Reserve, can determine the quantity of bank reserves or the quantity of money
in circulation -- all conceits to the contrary notwithstanding. The central bank may influence indirectly the
money stock; but the central bank cannot determine its amount. In a free society, only the money users --
consumers and producers in the market -- can determine the money they desire to
hold. It is consumers and producers in
the market who desire and decide to hold and to vary the currency and bank
deposits they wish to keep; it is central banks and commercial banks which
supply them.
During the past twenty-five years,
the important links between central bank policies, the rate of inflation, and
the variations in the money stock have caused much debate among the
experts. It is still generally agreed by
neo-Keynesian and some monetarist economists and central bankers that the
quantity of money in circulation, and economic growth, and the rate of
inflation can be directly coordinated by central bank credit policy. May I now firmly say that, to the best of my
knowledge, no one who believes this hypothesis, and, as an investor, has
systemically acted on it in the market, is any longer solvent. But I do confess, that the neo-Keynesian and
monetarist quantity theory of money still hangs on -- even if its practitioners
in the market cannot. But the economists
at the Federal Reserve have been required to accommodate to a reality in which,
for example, during 1978, the quantity of money in Switzerland grew
approximately 30% while the price level rose only 1%. Indeed in 1979, the
quantity of money, M-1, grew about 5% in the United States while the inflation
rate rose 13%.
If then, a central bank cannot
determine the quantity of money in circulation, what, in Rueffian monetary
policy, can a central bank realistically do?
To conduct operations of the central bank, there must be a target. If the target is both price stability and the
quantity of money in circulation, one must know, among other things, not only
the magnitude of the desired supply of money, but also the precise volume of
the future demand for money in the market -- such that the twain shall
meet. It is true that commercial banks
supply cash balances, but individuals and businesses -- the users of money --
generate the decisions to hold and spend these cash balances. Thus, the Federal
Reserve must have providential omniscience to calculate correctly, on a daily
or weekly basis, the total demand for money -- assuming the Fed could gather
totally reliable statistical information -- which it cannot; and even if the
Fed’s definitions of the monetary aggregates were constant -- which they are
not.
Jacques Rueff, himself the Deputy
Governor of the Bank of France, clarified this fundamental problem in the form
of an axiom: -- Because the money stock cannot be determined by the Federal
Reserve Bank, nor can it determine a constant rate of inflation, the monetary
policy of the central bank must not be to target the money supply or the rate
of inflation. The Federal Reserve Bank
simply cannot determine accurately the manifold decisions to hold money for
individual and corporate purposes in order to make necessary payments and to
hold precautionary balances. Neither, may I say, with respect, can the leaders
of the great Bundesbank; nor even the geniuses at the Banque de France.
But, if the true goal of the central
bank were long run stability of the general price level, the operating target
of monetary policy at the central bank must be simply to influence the supply
of cash balances in the market, such that they tend to equal the level of
desired cash balances in the market. To
attain this goal, the central bank must abandon open market operations and
simply hold the discount rate, or the rediscount rate, above the market rate –
when, for example, the price level is rising -- providing money and credit only
at an interest rate which is not an incentive to create new credit and
money. Indeed, if the target of monetary
policy is long run price stability, the Central Bank must supply bank reserves
and currency only in the amount which is equal to the desire to hold them in
the market. For if the supply of cash
balances is approximately equal to the demand for them, the price level must
tend toward stability. If there are no
excess cash balances, there can be no excess demand, and, thus, there can be no
inflation.
Professor Rueff shows in “l’Ordre
Social” why an effective central bank policy must reject open market
operations. He shows further that, in
order to rule out inflation, and unlimited government spending, the government
Treasury must be required by law to finance its cash needs, including a
sometimes limited Treasury deficit, in the market for savings, away from the
banks. That is, a government Treasury,
in deficit, must be denied the privilege of access to new money and credit at
the central bank and commercial banks, in order also to deny the government the
pernicious privilege of making a demand in the market without making a supply –
the ultimate cause of inflation. This
exorbitant privilege is a necessary cause of persistent inflation. It is also a necessary cause of unlimited
budget deficits and bloated big government.
You can see that the monetary theory
and policy of Jacques Rueff finally does come to grips with, indeed it
modifies, the famous Law of Markets of Jean Baptiste Say, building of course on
Say’s insights, but perfecting the flawed Quantity Theory of Money. Jacques Rueff reformulated the quantity
theory of money, definitively, in the following proposition: aggregate demand
is equal to the value of aggregate supply, augmented (+/-) by the difference
between the variations, during the same market period, in the quantity of money
in circulation and the aggregate cash balances desired. This is a central theorem of Rueffian
monetary economics. Rueff demonstrated
that Say’s law does work, namely, that supply tends to equal demand, provided,
however, that the market for cash balances must tend toward equilibrium. Any monetary system, any central bank, which
does not reinforce this tendency toward equilibrium in the market for cash balances
destroys the first law of markets, namely, overall balance between supply and
demand, the necessary condition for limiting inflation and deflation.
Now it is conventional wisdom that
Milton Freedman and the Monetarists try to regulate the growth of the total
quantity of money through a so-called money stock rule designed to constrain
the central bank monopoly over the currency issue. In practice, the central bank has failed and
will fail to succeed with such a flawed, academic, and impractical rule. But the much simpler, more reliable,
market-biased technique, proven in the laboratory of history, as Professor
Rueff demonstrated, would be to make the value of a unit of money equal to a
weight unit of gold, in order to regulate, according to market rules, the same
central bank monopoly. But academics
have argued for a century that a monetary “regulator”, such as gold money,
absorbs too much real resources -- by virtue of the laborious process of gold
production-- and is therefore, in social and economic terms, too costly.
Whatever the minor incremental
economic cost of a convertible currency, it is a superior stabilizer, as all
occidental history shows. The empirical
data also show that it is a more efficient regulator of price stability in the
long run. This is no accident. The gold standard was no mere symbol. It was an elegantly designed monetary
mechanism -- carefully orchestrated over centuries by wise men of great purpose
-- who developed convertibility into a supple and subtle set of integrated
financial institutions organized to facilitate rapid growth and a stable price
level of free economic institutions.
Thus did the international gold standard become a gyroscope of rapid
economic growth during the industrial revolution. Who can deny that a generation of floating
exchange rates, and discretionary central banking, have burdened the world with
immense inflation costs, orders of magnitude greater than the comparatively
modest cost of mining gold.
Therefore, in order to bring about
international price stability and long run stability in the global market for
cash balances, the dollar and other key currencies should be defined in law as
equal to a weight unit of gold -- at a statutory convertibility rate which
insures that nominal wage rates do not fall.
Indeed, nothing but gold convertibility will yield a real fiduciary
currency, un vrai droit, as Professor Rueff called it.
As we approach the millennium, the
world requires, indeed, it is begging world leaders to create a real monetary
standard to deal with the monetary disorder of undervalued, pegged, currencies
and manipulated floating exchange rates -- the diabolical agents of an
invisible, predatory mercantilism.
Despite all denials, the currency depreciations of today, are, without a
doubt, designed to transfer unemployment to one’s neighbor and, by means of
undervalued currency, to gain share of market in manufactured, labor intensive,
value-added, world traded goods. If
these depreciations and undervaluations are sustained, floating exchange rates
will, at regular intervals, blow up the world trading system. Great booms and
busts, inflation and deflation must ensue.
To head off the mercantilism of
present floating exchange rates, and the exchange rate disorders caused by
official dollar reserves, an international monetary conference is
indispensable. The present high rates of
unemployment and perverse trade effects, associated with floating exchange
rates, require an efficient and lasting international monetary reform. A
European Monetary Union may be necessary; but it is not sufficient.
Now we see clearly, what before we
saw in a glass darkly -- the dollar’s official reserve-currency status still
gives an exorbitant privilege to the United States. Jacques Rueff spoke of American “deficits
without tears,” because the American budget deficit and balance-of-payments
deficits were -- they still are -- almost automatically financed by the Federal
Reserve and the reserve-currency system -- through the voluntary (or coerced)
buildup of dollar balances in the official reserves of foreign
governments. These official dollar
reserves were, and still are, immediately invested by foreign authorities,
directly or indirectly, in the dollar market for United States securities, thus
giving back to the United States, at subsidized rates, the dollars previously
sent abroad as a result of the persistent United States balance-of-payments
deficit and budget deficits. To describe
this awesome absurdity, Jacques Rueff invoked the metaphor of an overworked
tailor to the King, yoked permanently to fictitious credit payments by His
Majesty’s unrequited promissory notes.
There is not sufficient time to
dwell on all the intricacies of the superior efficacy of the
balance-of-payments adjustment mechanism grounded in domestic and international
convertibility to gold. But it can, I
think, be shown that, in all cases, currency convertibility to gold is the
least imperfect monetary mechanism, both in theory and in practice, by which to
maintain global trade and financial balance, a reasonably stable price level,
and to insure budgetary equilibrium.
This proposition has been proven in the only laboratory by which to test
monetary theory -- namely, the general history of monetary policy under paper
and metallic regimes, and, in particular, the history of the international gold
standard, 1813-1914.
Whereas, by contrast, when one
country’s currency -- the dollar reserve currency of today -- is used to settle
international payments, the international adjustment and settlement mechanism
is jammed -- for that country -- and for the world. This is no abstract notion. During the past 12 months alone, (1996) 100
billion dollars of foreign exchange reserves have been accumulated by foreign
governments which have been directly invested in U.S. Treasury securities held
in custody at the New York Federal Reserve Bank -- thus financing the U.S.
current account and U.S. budget deficits.
It is essential to understand the
nature of this ongoing process of currency degradation -- because the dollar’s
reserve-currency role in financing the U.S budget and balance of payments
deficits did not end with the breakdown of Bretton Woods in 1971.
The anomaly of perennial U.S. budget
and balance of payments deficits still persist because there is, today, no efficient
international monetary mechanism to forestall the United States deficits. Indeed, Professor Rueff argued over and over
that if the official reserve role of the dollar, i.e. the dollar standard, were
abolished, and convertibility restored, the immense U.S. budget and current
account deficits must end -- a blessing not only for the U.S., but for the
whole world.
The reality behind the “twin
deficits” is simply this: the greater and more permanent the official reserve
currency facilities for financing the United States budget and trade deficits,
the greater will be the deficits and the growth of the U.S. Federal
government. All administrative and
statutory attempts to end the United States deficits have proved futile, and
will prove futile, until the crucial underlying flaw -- namely the absence of
an efficient international monetary mechanism -- is remedied by international
monetary reform and a new international gold standard.
That is why Professor Rueff and
President De Gaulle, in the 1960s, called for a new international monetary
system which we now need, above all, to solve the additional problems of
manipulated floating exchange rates inaugurated in 1971-1973.
Broadly speaking, three essential
steps toward convertibility could be taken by French, American and other great
power authorities.
(1) President Chirac should request the
Bank of France to cooperate with, say, the Group of Five to stabilize the value
of key currencies at levels consistent with balanced international trade among
national currency areas. That is to say,
exchange rates should be stabilized at approximately their longer term
purchasing power parities, based largely upon comparative unit labor costs of
standardized world traded goods. To do
this, indexes of purchasing power can be agreed upon within the Group of Five
and, thus, an optimum and fair value determined for convertibility of national
currencies. But how should the value of
the gold monetary standard be determined?
The optimum value of the gold parity should reflect a gold price
correctly positioned within the hierarchy of all prices; that is, a price
proportional to its underlying cost of production. This dollar price of gold, or more properly,
the defined gold weight of the monetary standard, must be set above the average
of the marginal costs of production of gold mines operating throughout the
world. This price would provide for
steady output of the gold monetary base (about an average of 1.5% to 2%
increase per year over a long run, as centuries of available monetary
statistics show). Such a gold price
would also prevent any decline in the average level of nominal wages --
avoiding, for example, the British problem of gratuitous underemployment in the
1920's caused by an overvalued pound.
Under existing conditions, during the present market period, I have
estimated, based on empirical data, that the optimum convertibility price of
gold is not less than $600 per ounce.
(1996)
(2) President Chirac should recommend to
the Group of Ten, that convertibility regimes take effect at a fixed date in
the future, perhaps three years from now, just after the European monetary
union is created. The gold dollar and
the European gold currencies should become the monetary standards of Europe, of
the United States, of the world, just as the gold standard should again become
the common money of world trade and finance.
Then, to simplify, if the United
States government creates too many or too few dollars, under conditions of gold
convertibility, it will be forced in a relatively short period to change,
because market participants will exchange paper dollars for gold, or gold for
paper, to bring the quantity of money in circulation into balance with the
desire to hold these dollar cash balances.
Moreover, domestic monetary reform
in the United States, France, and elsewhere, would also mean that only gold and
domestic, non-government, short-term self-liquidating securities, convertible
at maturity to gold, could serve as collateral, or backing for new currency
issues such as, for example, Federal Reserve Notes or French bank notes. Gold coins, minted according to the statutory
standard, should be generally circulated in the market to be held by all
working people, so as to guarantee that neither the monetary standard, nor the
wages and savings of working people, will be arbitrarily abridged by
inflationary governments. Such a regime,
among other purposes, eliminates the advantage of clever speculators over
middle income people and those on fixed incomes.
(3) The new international monetary
system would rule out, by treaty, the official reserve currencies which so
plagued the entire financial history of the Twentieth Century. Existing official dollar-reserves could be
consolidated and refunded and then gradually amortized over the long term, even
to a certain extent refunded through the rise of the official value of gold
above the last official revaluation ($42.22 per ounce).
This was and is the Rueff plan,
brought up to date to deal with the exigencies of 1996. May I say, it is an intellectual scandal that
such a solution is today regarded as impractical. For if we and our former adversary, Russia,
can share capsules in space, why can the United States and its trading partners
not agree to restore monetary convertibility, the indispensable condition for
stable currencies, world economic growth, and free trade?
By pinning down the future price
level by gold convertibility, the immediate effect of international monetary
reform will be to end currency speculation in floating currencies, and
terminate the immense costs of inflation hedging, thus channeling immense new
savings out of financial arbitrage and speculation, into long-term financial
markets (and, incidentally, ending the predatory reign of speculators, and
Federal Reserve dealers, with inside knowledge of Treasury and central bank
operations.)
Increased long-term investment,
improvements in world productivity will surely follow, as investment capital
moves out of unproductive hedges and speculation, seeking new and productive
outlets. Naturally, the investment
capital available at long term will mushroom, inspired by restored confidence
in convertibility because the long run stability of the price level will be
pinned down by gold convertibility -- as history shows to be the case in
certain, previous, well-executed monetary reforms of the past two hundred
years. Along with increased capital
investment will come sustained demand for unemployed labor to work the new
plant and equipment.
Indeed, domestic and international
monetary reform, i.e. the gold standard -- a common, neutral, non-national
currency, is the only true and lasting road to full employment. This is the reform plan set out for us by
Jacques Rueff two generations ago. It is
the outcome he looked forward to in his “combat pour l’ordre financier.”
Fondly do we hope, fervently do we
pray that some great statesman -- will
arise to lead the free world toward the age of financial order, clearly set out
for us long ago by a great statesman of France, Jacques Rueff.
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