- The Washington Times - Monday, December 13, 1999

Thirty years ago last September, Robert Mundell observed that “The world is moving toward a floating regime. The experience will be so painful that by 1980 it will begin moving back toward fixity.” Professor Mundell, then at Queens College in Ontario, now our newest Nobel Laureate in economics, of course was discussing the international monetary system.
It was 1969, and at a conference he was hosting at the time, he was noting that the foremost champion of a gold dollar in the United States, Robert Roosa, was in the papers saying he did not think the United States could hold on to its gold stocks. Mr. Roosa, who had founded the London gold pool when he was Undersecretary of Treasury for monetary affairs in the Kennedy administration, was then back on Wall Street, anticipating the closing of the gold pool, where Treasury bullion could be bought with dollars. At the time, it was illegal for U.S. citizens to own bullion.
Mr. Mundell, a boy wonder who had been chief international economist of the International Monetary Fund while still in his 20s, looked ahead a few steps further and saw the inevitability of the closing of the Treasury’s gold window where foreign central banks could still theoretically present dollars in exchange for bullion at $35 an ounce. It was a slippery slope, with President Nixon closing the gold window “temporarily” on Aug. 15, 1971, “permanently” in early 1973 as the dollar entered the “floating regime” that exists to the present day.
I met Mr. Mundell in May 1974 and he explained his reasoning. The gold stocks were running down because the United States was trying to use monetary policy to expand the economy instead of maintaining the dollar’s gold value. It could not do both at the same time. With two targets, you need two instruments. As Mr. Mundell put it: “The forces of history are determined to have one of their periodic experiments with a managed currency.”
These were notable observations, but why was Mr. Mundell wrong about the second half of his 1969 forecast? He had predicted that by 1980, the experience of trying to manage the currency would be so painful that the world’s leaders would have no alternative but refixing the dollar/gold rate. Indeed, Ronald Reagan, a fan of the gold standard, was elected in 1980, and a Gold Commission was formed at the congressional behest of Sen. Jesse Helms, North Carolina Republican. The commission, dominated by the monetarists in the Treasury, quickly decided a return to gold was impractical and that the dollar should be permitted to float.
What happened to the pain? First the phased-in Reagan tax cuts of 1981 took hold in 1983. Federal Reserve Chairman Paul Volcker a protege of Robert Roosa kept his eye on gold, which ended the inflation as its peak of $850 per ounce in February 1980 stabilized at roughly $350. The second important development was in the power of the computer chip, which Mr. Mundell had not anticipated.
In a world of 180 or so currencies, with at least a trillion contracts large and tiny “on the books,” it became possible for the interconnected computers to keep track of all those debits and credits even though their values changed moment by moment in terms of dollars, yen, euros, pesos or the Thailand baht. It all happened so fast, it is hard to believe nine dollars of every 10 now is digital. At the beginning of the century every dollar was posted in a ledger by hand, and only 30 years ago the first records of money were being recorded by the earliest computers.
It is this background that led Professor Mundell, now at Columbia University, to recommend that the United States and the Europeans, at least, fix the dollar/euro exchange rate for a few months going into the new century. The concern is the Y2K “computer bug.” As 1999 rolls into 2000, the world’s interconnected computers may have difficulty keeping up with a trillion debits and credits in 180 different currencies. Errors and computer breakdowns are of course constant occurrences in the global financial network, but they are cordoned off and repaired. There is no experience, though, with myriad errors and breakdowns occurring unexpectedly, here and abroad.
Fixing the two major currencies, Mr. Mundell told Marshall Loeb on Marketwatch some weeks ago, would reduce the risk of currency volatility throughout the world, with the yen perhaps coming along for good measure to provide a further stabilization point for Asia. Anchoring these now-floating currencies to gold, he said, would further reduce Y2K risks to global finance. The protocol need only involve a month or two into the new year, while the unknowns become known.
The Mundell idea was not exactly new. Empower America’s Jack Kemp last June 11 sent a letter to President Clinton, urging him to consider a dollar/gold to provide an extra measure of stability through the Y2K unknowns. On Aug. 11, the president rejected the idea, citing the report of the 1981 Gold Commission that a return to gold was impractical and would tie the hands of the Federal Reserve: “I do not believe that fixing the price of gold and the dollar would achieve the objective of stability in the event of Y2K problems.” The implication is that the Fed may wish to flood the banking system with liquidity if small problems evolved into critical ones. Fixing the dollar/ gold parity, though, does not prevent the most liberal use of the Fed’s discount window to disgorge liquidity, which Chairman Alan Greenspan has promised will be wide open at rollover.
Mr. Greenspan is certainly aware of the Kemp/Clinton exchange of Y2K letters and possibly the more recent Mundell recommendation. Although in recent years he has shown less respect for the gold signal than he had in his earlier career, when he was known for his advocacy of a gold standard, Mr. Greenspan may be prepared at a moment’s notice to recommend some such accord with Treasury. Mr. Mundell says Treasury would have to open its gold window, offering to buy or sell in order to stabilize the price, but the Fed would have to cooperate in not sterilizing these operations by not targeting the overnight lending rate that is, creating more or less liquidity than the market is demanding at the fixed gold price. It was such an accord in 1942 that enabled gold to be fixed at $35 and the enormous debt of WWII financed at 2 percent, the process removing the risk of inflation to the government’s creditors.
It would better if the markets were told in advance, says Mr. Mundell. As December opened, with but a month left before rollover, the euro/dollar/yen rates are already exhibiting an agitation that is almost certainly related to Y2K. The weakness of the euro, which now threatens to sink below parity with the dollar after beginning the year worth $1.18, reflects other forces at work as well. But the forward market, showing a slightly stronger euro a month after Y2K, points to this important consideration.
The Nobel Prize was given to Mr. Mundell in September by the Swedish Academy exactly 30 years after his spectacular forecast. Academic economists of every persuasion agree that his theoretical work in optimal currency areas in the early 1960s provided the foundation for the euro. While it is a bit puzzling that his Y2K recommendation is being dismissed so casually, it may pick up support as the countdown continues. Without a helping hand, the fledgling euro may not be able to survive the Y2K unknowns. And while it may take human hands only days or weeks to fix the mechanical problems at airports, seaports and power grids, it may take a lot longer to repair the problems facing digital money in a floating regime.



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