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Y, OCTOBER 29, 1981


Remarks by
Henry C. Wallich
Member, Board of Governors of the Federal Reserve System

Cornell University
Ithaca, New York
Thursday, October 29, 1981



Monetary policy Is carrying more of a burden in the struggle

against inflation than would be necessary if other forms of inflation fighting
were employed simultaneously.


A return to the gold standard is being recommended as a means

of bringing down inflation, but examination of how it would work suggests
that it is more likely to destabilize than stabilize money supply.


A gold-backed bond would not serve the purpose of bringing down

interest rates in the absence of other effective measures against inflation.


A move toward better budget balance is essential to redistribute

the burden of inflation fighting, preferably through further expenditure


In the absence of an incomes policy, it is still reasonable to

expect labor and business to take into account the benefits of the tax cut
in setting wages and prices.





Remarks by
Henry C. Wallich
Member, Board of Governors of the Federal Reserve System
Cornell University
Ithaca, New York
Thursday, October 29, 1981

In the fight against inflation, I believe that we now can count
on one important resource.

This is the realization, clearly widespread,

that inflation is a disease that must be conquered.

It is neither a minor

inconvenience nor, let alone, a means of stimulating the economy.
now we have seen the consequences of inflation all around us:

For years


productivity, diminishing growth, inability to provide for one's future,
mounting social and institutional tensions.

The absolute need to deal with

the problem is clear.
At the present time, the burden of the battle is carried by
monetary policy.

Monetary policy can do the job, given a free hand

But doing it alone would be a costly and protracted process.

To speed up the process, reduce the pain, and make success more certain,
monetary policy needs support.

2Is the Gold Standard a Workable Alternative?
It is of great interest, therefore, that at this critical juncture
a new approach is being proposed that, if workable, would relieve monetary
policy of much of the burden of bringing down inflation.
is the return to the gold standard.
to gold."

This new approach

Its proponents say "let us tie the dollar

This will give people new confidence in their money.

It will also

prevent excessive creation of money, which is at the root of inflation.
During periods when the gold standard prevailed, prices were roughly stable
for decades and centuries.

We can regain that stability without the stresses

and pains of a restraining monetary policy by going back to gold.
Given the difficulties of the job ahead, every suggestion deserves
careful examination.

The proponents of the gold standard have in their favor

their undoubted sincerity in the pursuit of stability.

Unlike proposals made

10 and 15 years ago for a doubling or trebling of the price of gold, the present
proposals, I believe, have little to do with speculative profit.

They are

oriented toward stable prices.
The gold standard proposal rests its case partly on the historical
fact that under the gold standard secular price movements were relatively

International exchange rates were stable.

Particularly during the

19th century, the heyday of the gold standard, world trade and income rose

In many ways, the gold standard is a suitable theme for nostalgia.

And, when one looks at the inflation and other financial disorders that have
occurred since the United States formally terminated gold convertibility in
1971, one may well be tempted to try to return to the golden age.


-3I shall have to argue here that this is not workable, because of the difficulty
of fixing a new price for gold, difficulties of extending a gold standard
internationally, the instability likely to be encountered in operating a
gold standard if a price were nevertheless fixed, and the long-run inadequacy
of the supply of gold.
In making this case, and before looking at the problems of a future
gold standard, we need to look at those of the old, which were very serious.
It is true that the gold standard period of the 19th century was, in a sense,
the golden age of capitalism.

It is also true, however, that special conditions

prevailed then that helped to make it work.
extremely limited in scope.

Government economic policy was

Maintenance of the national currency at a parity

with gold was regarded as the paramount objective.
such as full employment, were subordinated to it.

All other considerations,
There were periods of

prolonged depression that in some measure can be traced back to the gold

Moreover, the stability of prices that looks so attractive today

was of a secular rather than a year-to-year order.
of prices were frequent.

Short-run fluctuations

Indeed, this variability of prices, especially

flexibility downward, played an essential role in making the system work.
Problems of a new gold standard.

How would the gold standard —

I shall not dwell on the diverse variants that are available —
reintroduced now?
price of gold.

work if

The first problem, widely recognized, is the "reentry"

The official price of gold was $20.67 per fine ounce in 1929.

It was raised to $35 an ounce in 1934 and to $42.42 in 1973.

After World

War II, however, free (or black) market prices appeared from time to time
whenever gold was not freely supplied by official holders at the

-4official price.

Eventually the market price became the

only effective price.

It went from $35 in 1968 to as high as $850 very

briefly in 1980 and is now around $450.

Over this same period, since 1929,

the United States consumer price index has risen about 380 percent.


1934, when the $35 price was fixed, the CPI has risen over 500 percent.
Since 1971, when we went off gold with gold still officially valued at $35,
the CPI has risen 100 percent.
Fixing the price. The first step in going back to gold today would
require fixing a price for gold.

What would be the right price?

Past levels

of the official price of gold and of the CPI give conflicting indications,
although all point to a price far below the present market price.

Using the

wholesale price index instead would yield another set of conflicting indica­
tions also pointing to a price lower than the prevailing.

The market price

today is heavily influenced by the expectation of private (and probably
official) gold holders that the price will rise.

Many holders, to be sure,

may own gold for diversification of portfolio and protection against risk
rather than for appreciation.

But the forward price for gold contracts,

which reflects a premium of about 15 percent, suggests that the price is
expected to appreciate, even though the premium may also have to do something
with the cost of carrying.

If the market came to believe that the United States

soon would fix the price of gold and would do so in a credible manner so that
no further price increase could be expected for the foreseeable future, many
holders would sell, and the price would come down.

If the price failed to

come down in the face of a U.S. decision to go back to the gold standard, it
would reflect doubt on the part of the market that a fixed price could long
be maintained.

All this makes the fixing of a price very difficult.


whatever market price might prevail could be a mistake, because gold holders'
actions are so dependent on expectations concerning price and the future
success of the plan.
Yet the fixing of the "right" price is of great importance.

If the

price is fixed too high, gold will be sold by holders around the world.
U.S. Treasury would have to buy it at its fixed price.


Dollars would have

to be issued by the Federal Reserve, as required by the normal processes of
the gold standard, against the incoming gold, posing a threat of inflation.
The United States had an experience of this nature during the 1930's after
the price of gold had been raised to $35.

Large amounts of gold then flowed

in from abroad, producing enormous excess reserves in the banks.

Only the

depressed conditions of the times prevented the use of these reserves by the
banks for credit expansion that would have been inflationary.

Some part of

the inflow was "sterilized" by the Treasury which borrowed money in the
market to pay for the gold instead of issuing gold certificates to the
Federal Reserve against it.

This was relatively cheap when the Treasury

bill rate was below one percent, but would hardly be commendable today.
On the other hand, if the price were fixed too low, the Treasury
would become a cheap source of gold to the rest of the world, and perhaps
also to American holders.

Our gold stock would drain away until the money

supply had been reduced by the normal processes of the gold standard, and
economic activity and prices had been deflated sufficiently to put an end
to the drain, provided we were willing to stick by the rules.

We experienced

the effect of a low gold price during the 1960's, when we lost more than

-6half of our high postwar gold stock.

However, this outflow was not allowed

to influence our domestic monetary policy, so that the money supply continued
to expand.
Even if somehow the "right" price could be arrived at, this would
not ensure that it would remain the right price.

Inflation in the United

States, or stability in the United States coupled with inflation abroad,
would after a while make the price too low or too high.
in the price of gold might remedy this situation.

Occasional changes

But that, of course, would

destroy the stabilizing properties of the system and would make a mockery of
the entire concept of the gold standard.
International implementation. Difficulties would arise also if the
United States were to seek an extension of the gold standard to other countries.
This would require, in effect, a return to the system of fixed exchange rates.
In some countries there might exist a willingness to do so, particularly if
they felt protected against the large payments deficits run by the United
States in the final days of the Bretton Woods system.

Such deficits and

the corresponding surpluses in other countries with their inflationary impact
would not easily be possible under a reasonably hard form of the gold standard.
Many other countries, however, might prefer to continue on a
floating system.

Extensive negotiations would probably be required to

establish an internationally coordinated gold-based system.

However, each

country, and especially the United States, could, of course, establish a
gold standard by itself to control its domestic monetary system if it is
not concerned about the fixity or flexibility of exchange rates.

Money-supply determination.

Suppose that by skill or by luck

all such initial problems were overcome and a gold standard had been put
into operation at least in the United States.
then be determined?

How would the money supply

Suppose the money supply is firmly tied to the gold

stock, which seems to be what gold-standard proponents interested in
discipline have in mind.

Given such a firm link, a stable and moderate rise

in the money supply would depend on there occurring a stable and moderate
increase in the gold stock.

Gold would have to flow into the Treasury,

which would issue gold certificates to the Federal Reserve, in just
sufficient volume to keep the money supply growing stably.
Presumably, in the absence of speculative disturbances, interest
rates are the principal means of encouraging or discouraging such private
flows of gold.

One can visualize a system in which interest rates would be

lowered and raised to maintain a stable inflow of gold into the Treasury.
But interest rates set to determine gold flows would not be necessarily
consistent with a stable growth of the money supply.

The chances are that

in such a system interest rates would be volatile and the growth of the
money supply highly erratic.
The alternative would be to make the link between gold and tiie
money supply quite loose, as it has historically been in the United States.
That, however, would probably not serve the purposes of the proponents of
the gold standard.

Very likely it would lead to a repetition of the policies

pursued in the past when restraints imposed by the gold standard upon monetary
policy were frequently set aside when they began to bite.


An important

the restrictive policy actions taken by the Federal Reserve

during the early 1930's to counter international gold outflows and domestic
withdrawals, with adverse effects on economic activity.

-8It may be comforting to conjure up a picture of citizens lining up
at the gold window of their local bank to withdraw gold because they fear
inflation and want to discipline their government.

The history of bank runs

in the early 1930's conveys a somewhat different flavor.

In any event, the

main flows of gold, even under a gold-coin standard, would probably be inter­
national rather than domestic.

Economic expansion and contraction here

and abroad, leading to varying interest-rate differentials and to inter­
national payments surpluses and deficits, would be the main determinants
of gold flows and hence of the U.S. money supply.

In today's environment,

the picture that this conjures up is not that of the Bank of England, as in
1881, regulating gold flows by small changes in its discount rate and keeping
the world monetary system in balance.

More likely we ought to recall the

picture of the early 1930's, with its bank closings, or the late 1930's,
with its threat of inflation and ever-widening payments deficits breaking
down the foundations of the international monetary system.

Such things need

not happen, but under a gold standard rigorously maintained they might.


I abstract here altogether from the additional dangers that might come from
the dominant position in gold mining and new gold supplies held by South
Africa and the Soviet Union.

The wisdom of giving some degree of control

over the U.S. money supply to the main gold-producing countries is questionable.
The same applies to other countries that might decide to change substantially
their existing gold stocks.
Long-run inadequacy of gold supply. Finally, suppose that a goldstandard system somehow had become operative and that the risks I have sketched
had been held in check.


*ng-term prospects?

The chief virtue

-9of gold, as a monetary standard, is that Its supply cannot be changed by
additional production very much in any short period of time.
mined throughout history is still in somebody's hands.

Most of the gold

Annual output

historically has averaged less than two percent of the existing stock.
That is what gives a gold standard its power to protect against excessive
increases in the money supply, provided, of course, that there are no
supplies of gold held outside the monetary system.
The trouble with gold is that this rate of increase is too slow.


system rigidly linking the growth of money to the growth of the gold stock
would not generate a growth of the money supply conmensúrate with the real
growth of the United States and even less of the world economy, which
historically has been in the 3-5 percent range.
at various times during the gold-standard era.

This problem was recognized
In 1930, the League of

Nations published a study which concluded that the growth of the world's
gold stock was too slow to finance world economic growth without deflationary
pressure on prices.

It recommended withdrawal of gold coins from circulation

and the use by central banks of foreign exchange instead of gold reserves as
a means of economizing gold.

During the late 1950's, the International

Monetary Fund conducted a similar study also focusing on insufficiencies of
new gold supplies.

Later this was followed by the creation of the special

drawing right (SDR) as a means of eking out supposedly inadequate inter­
national reserve creation.
It could be argued that at today's incomparably higher prices,
gold output should increase more rapidly.

On the other side of that argument,

however, is the fact that in South Africa, the world's principal producer,

output has declined as price has gone up.

The simple reason is that at

higher gold prices it becomes profitable to employ the not unlimited
capacity of the mining industry in processing lower grade ores which may
never become processable again if the gold price should decline.
Some implications. From both short- and long-run points of view,
therefore, the gold standard presents serious problems.

Under existing

conditions, it probably would not work at all as its proponents hope.


conditions of stability of prices and exchange rates, such as prevailed during
the 1950's, the matter might be different.

But if those conditions prevailed,

would we need a gold standard?
The simple fact seems to be that the gold standard and price and
exchange-rate stability are mutually dependent on each other.
standard encourages stability if it exists to begin with..
facilitates the working of the gold standard.

The gold

Stability in turn

But there can never be any

assurance that this happy symbiosis will continue.
Some of these difficulties might be met by adopting a very loose
form of the gold standard.

If the money supply were linked to the gold stock

only in the sense that some minimum or maximum ratio had to be respected and
could not be exceeded, there could be leeway for the money supply to move
without triggering these constraints, i.e., it would be expanded or
contracted by the same monetary policy techniques now in use.

In that case,

however, the automatic control by the gold standard and its supposed effects
on confidence would be missing.

The gold standard of the 1930's and the

subsequent Bretton Woods period was of that sort.

In the early postwar

period, the critical ratios were never approached and the gold standard

11did not prevent the United States from pursuing any kind of monetary policy.
Later, whenever the restraints threatened to become binding, It was not
monetary policy that gave way, but the restraining ratios.

These were

liberalized from time to time and finally removed altogether.
It is well to recall, at this point, that we already have a
legislative ceiling designed to curb undue expansion.
the Federal debt ceiling.

I am referring to

We know what happens whenever the ceiling is

approached, which is almost every year.
spending, but raises the ceiling.

The Congress does not act to limit

One must ask whether a gold ceiling on

the money supply would fare any better, if as a nation we did not have the
will to constrain the money supply to avoid inflation in the first place.
Ultimate disposition.

Some people who are skeptical of the gold

standard draw from that posture the further conclusion that the United States
should sell its gold stock.

If we are never going to use the gold, why keep

I do not feel sufficiently sure about the future to recommend disposal

of our gold stock.

Conceivably, some day the rest of the world may want to

go back to gold, and the United States then should not find itself handicapped
by lack of gold.
as a warchest.

Conceivably, the gold stock may some day have a usefulness
Conceivably, although I do not believe it, monetary conditions

in our own country could some day be such as to make the case for the gold
standard more persuasive.

We have the means to prevent that from happening,

by conducting sensible policies.
lifesaver, however unlikely.

But one should not let go of a potential

-12Furthermore, the disposal of our gold stock would raise the
question of what to do with the proceeds.

All sorts of undesirable budgetary

and public debt-management schemes immediately come to mind that should be
firmly scotched before they gain currency.

That is another reason for leaving

the stock and the role of gold exactly where it is now.
Gold bonds.

The present high level of interest rates has given rise

to the suggestion that the gold standard would also serve as a means of bringing
down interest rates.

Like much of the gold standard proposal, the assumptions

under which this would happen are not fully spelled out.
in which the gold standard might reduce interest rates.
succeeded in bringing down inflation.

I can see two ways
One would be if it

There can be no quarrel with this view

except, of course, that interest rates would also come down without the gold
standard, if inflation is reduced.

But it is also argued that the interest

rate on bonds could be brought down by a tie to gold, apparently independently
of the rate of inflation and independently of whether the gold standard is
operating in other respects.

It is important to be clear about what is

supposed to be brought down here —

the interest rate on a gold-convertible

bond, or the level of interest rates in general.
It is, of course, perfectly possible to design a bond tied to gold
that could be sold at a very low interest rate.

If the bond is made repayable

in, or better still convertible into, a specified weight of gold equal, at
today's gold price, to the value of the bond, the bond becomes in effect a
warehouse certificate for gold.

Someone willing to own gold should be

willing to own the bond without any interest, considering that he would
save the storage and insurance costs normally involved in gold ownership.

-13He would presumably hold the bond on the assumption of getting a return
on his investment from a rise in the price of gold, or else, for the purpose
of risk diversification.
If the bond, instead of being based on today's gold price, were
made payable in or convertible into gold at a price somewhat above the
prevailing price, the bond would be like the familiar corporate convertible
bond which is issued by a corporation trying to hold down its interest cost
by making the bond exchangeable for its common stock at a price above the

The bond would then have a "gold kicker" analogous to the equity

kicker now often attached to loans made by institutional lenders.

With a

conversion price of gold close to the market price, the Interest rate
presumably could be very low.

With a very high conversion price, unlikely

to be reached during the lifetime of the bond, no improvement in the interest
rate compared to nongold bonds would be attained.

Quite conceivably, a private

issuer could issue such a bond, if he could make a reliable forward contract
for gold to cover his risk and if the combined cost of this contract and the
interest rate turned out to be less than the straight interest cost of a
nongold bond.
It should be noted that the viability of such a bond depends on
an expectation, on the part of the buyer, that the price of gold will rise.
That increase, or else risk diversification, is where the holder must expect
to get part of his return.
expectation could not exist.

If the price of gold were credibly fixed, this
The bond in that case would have to carry the

same interest rate as gold bonds.

If nevertheless it could be sold at a

lower Interest rate, this would be prime facie evidence that the market did
not expect the fixed price to last.

-14All this implies, of course, that gold bond holders expect their
contracts to be fulfilled.

That was not the case with respect to the many

gold bonds outstanding in the United States, issued by corporations whose
gold clause was invalidated in 1935 by the Supreme Court, thus depriving
the owners of the benefit of the appreciation of gold from $20.67 to $35.
A contemporary precedent exists for a gold bond, in the form of
the French government gold bonds now outstanding that were issued before
the great rise in the price of gold.

One of these bonds is gold-indexed

both as to interest and principal, the other as to principal only, which has
made the interest insignificant at the present price of the bond.

Both bonds,

of course, have appreciated enormously, and at present prices represent not
far from one-half of the total debt of the French government.

Far from

reducing the cost to the government, they have increased it by a large
1 have discussed at some length the possibilities of bringing
down inflation and reducing interest rates by returning to the gold standard
or issuing a gold-backed bond.

As you will have noted, I do not believe

that these devices, however well intentioned, would be workable or serve
our purposes.

Hatching Inflation Causes and Remedies
We are still left, therefore, with the question whether monetary
policy alone should continue to carry the burden of bringing down inflation
or whether an array of policies Is needed.

It may be easier to answer this

question if we first ask how we arrived at the high inflation we are suffering


Many contributing factors to Inflation have been alleged:

not only

excessively easy monetary and fiscal policies, but also unanticipated shocks
like the two rounds of oil-price hikes, occasional food shortages, the
superior bargaining power of labor unions, monopoly power of corporations,
and numerous government price-raising actions.
mention only a few —

Among the latter, I need

such as costly regulation, import restrictions, inadequate

anti-trust policies, facm-price supports, and government wage-setting.
It is sometimes argued that with an adequately restraining monetary
policy, none of the other sources of price increases could have brought about
a general inflation.

That is probably true, not in the sense that monetary

policy could have prevented any of these things from occurring but in the
sense that monetary policy could have produced a depression severe enough to
overwhelm all upward pressures on prices.
If one were to take that analysis as a starting point, one could
perhaps arrive at the conclusion that nothing needs to be done about fiscal
policy, oil prices, food supply, union pressure, and government price-raising
actions hereafter in order to bring down inflation.
can do it all.

Monetary policy seemingly

Given the political realities, I do not find that analysis

To the extent that they are subject to policy action, all sources

of inflationary pressure must be regarded at least potentially as foci of

I am aware, of course, that some forms of action are not acceptable

in our present environment.

For instance, an incomes policy, such as the

tax-based incomes policy (TIP) suggested by various economists including
myself, does not rank high on the list of promising techniques.

Even so,

at a time when for several years we are all going to be the beneficiaries

of very generous tax cuts, It does not seem amiss that the resultant
improvement be taken account of by business and labor in their wage- and
price-setting decisions.
If I am right in my belief that inflation must be attacked from
all sides, there obviously is a wide range of possible actions.
these are already being moved ahead.

Many of

Especially in the area of public

spending, a historically unique move has been made to bring down expenditures.
But more needs to be done to bring down the deficit to a level that can be
financed without excessive pressure on financial markets.

The Federal Reserve

is trying to do its job in maintaining a moderate growth of the money supply.
The interest rates to which this leads are in good measure determined, aside
from the level of inflation itself, by demand for funds in the market,
including those of the federal government.

We shall get inflation under

control more quickly, and at less cost, if we use not one of several alterna­
tive techniques, but a combined approach that attacks as many of its sources
as possible.