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15 August 2001

Memo To: Jude Wanniski
From: Ed Bugos
Re: Monetary Deflation

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With all due respect, a concept of yours with which I have grave difficulty is the idea of monetary deflation. Your use of the term is simply incorrect.

A monetary deflation relates to a contraction in the money supply. Whether caused by or resulting from a decline in prices is a matter of debate, but when you ascribe the word monetary then you surely must be referring to that effect on prices from a contracton in the money supply, or the effect on the money supply of a decline in prices, and not simply the volatile external (ephemeral) value of money; that very value which is determined by the manipulative policies which you yourself criticize each week.

A decline in nominal prices resulting from a manipulative currency policy whose objective is to steal foreign purchasing power and export domestic inflation is by no means a real, or even sustainable, deflation. It is certainly not a monetary deflation. It is a mock deflation, and it provides the disguise for rampant monetary confiscation.

Neither is a broad decline in prices as the result of productivity gain a monetary deflation for that matter, it is profit, but true profit, not confiscated wealth.

A decline in some prices and a rise in others is what? It is the objective of dollar policy. In which historical episode of monetary deflation had wages ever risen as fast as they have this past 3, 5, or 10 years? Or which episode of monetary deflation has ever witnessed a rise in oil prices, or asset prices, such as we have seen this past decade? How can there be a deflation when the money supply has been growing at between 7% and 11% annually since 1997?

Yet, while we are diametrically opposed on this issue, you still manage to come to the same conclusion, that the value of the almighty dollar is a Machiavellian manifestation of political power, rather than a product of the free market, and furthermore, that this is bad for capitalism. We are also in agreement with your views of the floating exchange rate mechanism.

It is understandable why our conclusions converge: because whether the policies of the Fed are inflationary or deflationary, matters little to the fact that they interfere with the free market price mechanism.

Still, we differ sharply with your conclusion of deflation, which in our opinion is virtually impossible under a floating exchange rate mechanism anchored by an ignorant (and arrogant) democracy. Please see "There is No SafeHaven," where we list the seven reasons that the Fed is in an inflation trap. Your unwarranted and widely shared fear of deflation is one of them.

In your memo to Greenspan on "Our Floating Unit of Account," you said:

"The average price of gold over the last 10 years has been roughly $350, but it is now around $270, a clear indication the Fed has again been engaged in deflationary policies that have accumulated over time."

Your assumption is that gold is as effective an indicator of inflation as ever. We have noticed this in your writing frequently, and wonder how it is that you can acknowledge the Treasury's manipulative dollar politics, yet discount the notion that gold has been manipulated. Just because no one can prove it, does not mean that the investor, or policy maker, ought not take it into account, especially when the circumstantial evidence is so overwhelming.

The declining value in the price of gold over the past 5 years is out of sync with the inflationary realities in the US economy. In fact, there is no broad deflation in prices anywhere, yet gold declines. There is no contraction in money supply or credit growth, yet gold declines. There has yet to be a contraction in output, yet gold declines. Nominal prices rise, but then only get excluded from the data when they rise to fast.

Where is the monetary deflation? Is it only by observing the strong foreign exchange value of the dollar and the decline in gold prices that you come to this conclusion? Would your conclusion be different if all else were equal, but the price of gold was above $400 and the dollar index below 100? Is there anywhere else, besides the price of gold, where you derive your deflationary conclusion?

Furthermore, in terms of gold, most prices are up since 1990, and even 1980. The CRB, for instance, valued in the quantity of gold required to purchase a unit of the index, has inflated by 31% since 1990. Under a proper gold standard, this is how inflation is measured, in terms of gold, at least if it is to be the standard. As an example of the way in which currency politics, not just taxes, influence inflation, consider that when the US abandoned its bimetallic ratio in favor of the monometallic gold standard, in the late 19th century, the result was a silver inflation as the excess unwanted metal couldn't fetch a decent basket of bread.

But we know that gold is not perceived as a monetary standard, or an inflation indicator for that matter, today. And while prices measured in dollar terms, such as those measured by various price indexes, have risen in the past ten years, even after the public's focus has been dragged right to the corest of the corest data, the CRB is down 15%, in dollar terms.

The world is on a dollar standard. The Fed's policies have been inflationary, but the inflation has been managed by an aggressive dollar policy. Such a currency policy cannot be sustainable without one day creating massive shortages in the physical economy. Thus, even in this regard, in the way that it interferes with the free market, and misallocates global resources, the manipulative dollar policy is setting the stage for a massive dollar inflation to spread beyond just the price of oil.

Consider, where those dollar denominated numbers would be if the Machiavellian dollar did not exist and the gold market was not manipulated? They would be higher of course, reflecting the truth, that the Fed's policies have been highly inflationary, rather than deflationary.

This is opposite to the view that the Fed has been fighting the forces of deflation, or disinflation, for the past 20 years, we know that. But you know that too. In fact, you agree with us, but won't admit it. If the dollar is a political animal, opposing the forces of the free market, then it is not deflation that is making it appear more valuable relative to the price of gold.

I do not see any monetary deflation either now, in the recent past, or in the near future. Where do you see it besides in the one commodity that is an obvious target of Machiavellian politics?

Ed Bugos

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