Euro's father favors rigging the currency markets -- gold too?

Section:

10:14p ET Monday, May 23, 2011

Dear Friend of GATA and Gold (and Silver):

Writing for The Wall Street Journal today, Sean Rushton of The Supply Side Blog quotes Nobel Prize-winning Robert Mundell, who is regarded as the father of the euro, as advocating an agreement by which the United States and the European Central Bank should fix the dollar-euro exchange rate in a narrow band calculated to avoid inflation and deflation.

That is, presumably, the Federal Reserve and the ECB would buy as much of the other's currency and sell as much of their own as necessary to maintain the targeted exchange rate.

But such a scheme could hardly work as long as the dollar and euro traded freely against other currencies or against gold. For then the dollar and euro would be market-priced against each other through intermediaries -- particularly through gold, the other most liquid international currency.

Does Mundell's idea frankly contemplate the (continued) rigging of the gold market? It would have been nice of Rushton to ask. But Mundell still gets out and about and maybe someone else will put the question to him.

Rushton's commentary is appended.

CHRIS POWELL, Secretary/Treasurer
Gold Anti-Trust Action Committee Inc.

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Mundell: Deflation Risk for the Dollar

By Sean Ruston
The Wall Street Journal
Monday, May 23, 2011

http://online.wsj.com/article/SB1000142405274870481660457633525042615879...

Conservative economists have been raising alarms for months about the Federal Reserve's second quantitative-easing program, QE2. They argue it has lowered the dollar's value, leading to higher oil and commodity prices -- a precursor to broader, more damaging inflation.

Yet the man many of them regard as their monetary guru -- supply-side economics pioneer and Nobel Laureate Robert Mundell -- says dollar weakness is not his main concern. Instead he fears a return to recession later this year when QE2 ends and the dollar begins its inevitable rise. Deflation, not inflation, should be the greater concern. Avoiding the recession is simplicity itself: Just have the U.S. Treasury fix the exchange rate between the dollar and the euro.

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Mr. Mundell's surprising statement came at a March 22 conference in New York sponsored by the Manhattan Institute, The Wall Street Journal, and the Ronald Reagan Presidential Foundation. His economic predictions carry great weight because, unlike most economists of his generation, he is often right. His analysis of international economics has revolutionized the field, making him the euro's intellectual father and a primary adviser to China's economic policy makers.

Nevertheless, with gold around $1,500 and oil above $100 a barrel, supply-siders are scratching their heads: How can he possibly see deflation ahead? How can dollar weakness not be the problem?

The key to Mr. Mundell's view is that exchange rates transmit inflation or deflation into economies by raising or lowering prices for imported items and commodities. For example, when the dollar declines significantly against the world's second-leading currency, the euro, commodity prices rise. This creates U.S. inflationary pressure. Conversely, when the dollar appreciates significantly against the euro, commodity prices fall, which leads to deflationary pressure.

From 2001-07, he argues, the dollar underwent a long, steady decline against the euro, tacitly encouraged by U.S. monetary authorities. In response to the dollar's decline, investors diverted capital into inflation hedges, notably real estate, leading to the subprime bubble. By mid-2007, the real-estate bubble had burst. In response, the Fed reduced short-term interest rates rapidly, which lowered the dollar further. The subprime crisis was severe, but with looser money, the economy appeared to stabilize in the second quarter of 2008.

Then, in summer 2008, the Fed committed what Mr. Mundell calls one of the worst mistakes in its history: In the middle of the subprime crunch -- exacerbated by mark-to-market accounting rules that forced financial companies to cover short-term losses -- the central bank paused in lowering the federal funds rate. In response, the dollar soared 30% against the euro in a matter of weeks. Dollar scarcity broke the economy's back, causing a serious economic contraction and crippling financial crisis.

In March 2009, the Fed woke up and enacted QE1, lowering the dollar against the euro, and signs of recovery soon appeared. But in November 2009, QE1 ended and the dollar soared against the euro once again, pushing the U.S. economy back toward recession. Last summer, the Fed initiated QE2, which lowered the value of the dollar, allowing a second leg of the recovery to take hold.

Nevertheless, Mr. Mundell views QE2 as the wrong solution for the problem. Instead, the United States and Europe simply should coordinate exchange-rate policies to maintain an upper and lower limit on the euro price -- say, between $1.30 and $1.40. Over time, the band would be narrowed to a given rate. Further quantitative easing would be off the table.

With a fixed exchange rate, prices could move free from the scourge of sudden deflation and inflation, allowing investment horizons and planning timelines to expand along with production levels on both sides of the Atlantic. To supercharge the U.S. recovery, he also recommends permanently extending the Bush tax rates and lowering the corporate income tax rate to 15% from 35%.

Above all, he made it clear that the volatile exchange rate is the responsibility of the U.S. Treasury, not the central bank. Without a breakthrough on exchange rates, he predicted another dollar appreciation following QE2, resulting in a return to recession and a worsening of the U.S. debt crisis. This would likely lead to a third round of quantitative easing, continuing the dysfunctional cycle.

Criticize the Fed all you like, Mr. Mundell says, but the key to recovery is to stabilize the dollar at a healthy level relative to the euro. Given his stellar track record, it's worth asking: Is anyone in Washington listening?

-----

Mr. Ruston edits The Supply Side Blog.

* * *

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Wall Street Journal Publishes Lewis Lehrman's Call for the Gold Standard

In its April 26 edition The Wall Street Journal published an important essay by the Lehrman Institute's chairman, Lewis E. Lehrman, explaining why a gold-convertible dollar is critical to eliminating the shocking federal deficit.

"Experience and the operations of the Federal Reserve System compel me to predict that U.S. Rep. Paul Ryan's heroic efforts to balance the budget by 2015 without raising taxes will not end in success -- even with a Republican majority in both Houses and a Republican president in 2012. ...

"What persistent debtor could resist permanent credit financing? For a government, an individual, or an enterprise, 'a deficit without tears' leads to the corrupt euphoria of limitless spending. For example, with new credit the Fed will have bought $600 billion of U.S. Treasuries between November 2010 and June 2011, a rate of purchase that approximates the annualized budget deficit. Commodity, equity, and emerging-market inflation are only a few of the volatile consequences of this Fed credit policy."

To read more, and to sign up for The Gold Standard Now's free, noncommercial, weekly report, "Prosperity through Gold," please visit:

http://www.thegoldstandardnow.org/gata