A Threat to the Bush Boom
This article is from the archive of The New York Sun before the launch of its new website in 2022. The Sun has neither altered nor updated such articles but will seek to correct any errors, mis-categorizations or other problems introduced during transfer.

In 1914 the German chancellor was reported to have dismissed a treaty with Belgium as “a little scrap of paper.” The world was rightfully shocked by this. Treaties are sacred obligations of the participating states. So, by the way, are those other little “scraps of paper” – dollars. That is the way to view the Federal Reserve’s failure to heed the signals in the steadily rising gold price, a failure that is threatening a crisis of confidence in the dollar. The recent series of new bottoms in the foreign exchange markets, particularly in respect of the greenback against the euro, reflects a perception that our central bank sees dollars not as sacred obligations, but as little scraps of paper.
No wonder that the post election bull market was interrupted on Tuesday by a plunge of more than 100 points in the Dow Jones Industrial Average. Who can blame foreign investors’ wariness of placing their economic futures in the hands of the Fed. Imagine that you have spent the evening sitting at a poker table in a large and prosperous casino. You gather your winnings, partly due to your luck, partly to skill, and take them to the cashier to turn the chips into a currency that you can spend outside the casino – only to discover they were be redeemed for less than you paid. You’d probably find a new venue to place your bets.
Which is why one of the things one is hearing is that the greenback’s status as a reserve currency is in danger. Some of this is disingenuous, coming from liberals who for most of their lives failed to credit the idea of gold as an important measure – except when the administration it is cautioning is that of President Bush. But some of it is not disingenuous. The fact is that capital goes where it is welcomed, and stays where it is well treated. This has made the dollar the reserve currency of the world. It has enhanced our prestige in the world, and has made trade easier for us. More important than any of that, however, is that we kept our promise.
Cuts in marginal tax rates and in capital gains last May were a step forward. They ended a recession inherited from the prior administration. However, supply-side economics is not just about tax cuts; it’s also about sound money. While America has officially discarded the gold exchange standard, there is nothing that prevents the Fed from using gold as the basis to set a price rule. Under a price rule, if gold’s price is rising, the money base is expanding too quickly; if it is falling the money base is contracting too quickly.
It was a commitment by Fed chairman Paul Volcker, backed by President Reagan, to wring inflation out of the economy and re-establish sound money in America that sustained the great boom that began under Reagan. This expansion, which continued through the Clinton years, took place against a gradual restoration of sound money. Monetary policy was not always been perfect in the en suing years. As the chart shows, during Reagan’s second term non-supply-side elements were able to temporarily sell the administration on a ‘competitive devaluation’ of the nation’s currency. Then, as now, foreign investors crowded around the exit doors. The result, in October of 1987, was dubbed “Black Monday” by the traders who witnessed it. The administration saw the danger and corrected the policy.
Occasionally the central bank errs in the opposite direction, deflating the currency. Declining gold prices at the end of the Clinton years were a sign that the Fed was overly tight. The Fed (again) lost its focus, shifting its attention away from currency management to slowing the bull market and ending “irrational exuberance.” Supply-side economists predicted recession, and the recession came. A price rule might have prevented that recession along with the heavy job losses and record bankruptcies that immediately followed it. A gold-price rule followed today would end the only major threat that the Bush Boom has left: namely, unsound money.