Fed up.

The Fed has too much else on its mind to be bothered controlling inflation. But that can be changed.

Bretton Woods is really a metaphor for gold and price stability," said Jack Kemp as he launched an Empower America conference commemorating the fiftieth anniversary of the postwar global monetary pact. Indeed, John Maynard Keynes, one of the architects of the Bretton Woods agreement, told the House of Lords that it was "the exact opposite" of a return to the classical gold standard.

Kemp - the only prominent national politician who understands the complexities of monetary policy - stopped way short of calling for a full return to the Bretton Woods system, wherein the dollar was convertible to gold at $35 per ounce and all other currencies were pegged to the dollar.

Instead, Kemp, who is poised to announce a 1996 presidential bid immediately following this year's elections, is searching for a new approach that will promote economic growth by ensuring low inflation, and hence low interest rates, as far as the eye can reasonably see. Often accused of being a big-government conservative, Kemp knows full well that the power of government finance ministries and their central banks is dwarfed by the awesome power of global financial markets, driven by high-tech information processing, where daily dollar transaction flows total well over $1 trillion.

The subject of money is a timely one, as the U.S. economy again shows signs of rising inflation. The producer price index has increased at a 4.5 per cent annual rate over the past three months, after remaining flat for all of last year. The consumer price index rose at a 3.7 per cent annual rate for the three months ending in August, following a 2.7 per cent 1993 performance. Anticipating inflation, long-term Treasury-bond yields have moved up to 7.7 per cent, compared to 5.75 per cent nearly a year ago. The Eurodollar market expects short-term rates, which are now just under 5 per cent, to rise to 5.75 per cent in December and 6.5 per cent by next June. The overall stock-market averages have not advanced since early this year, and inside the market over 70 per cent of the S&P 500 listings have fallen at least 20 per cent from their highest level. Gold is again flirting with $400, and gold stocks are one of the hottest performing groups. Broad commodity indexes are very bearish on the inflation outlook: the Journal of Commerce index of raw materials has risen at a 25 per cent annual rate over the past six months, and the Dow-Jones spot index is up 24 per cent from a year ago.

A Wobbly Model

Once Again a bout of inflation threatens to disrupt the economy. However, a return to the old Bretton Woods system is not the answer. Bretton Woods' creators, Keynes and Harry Dexter White, both believed strongly in the benign intervention of government and would not have understood any better than Bill Clinton and his wrecking crew that next-century economics will be driven by market action, not government action. (Not long after the Bretton Woods conference, White committed suicide rather than face charges that he was a Communist spy.)

At the Empower America conference, former Reagan Treasury economist Paul Craig Roberts presented a critique of Bretton Woods, reminding participants that it permitted many fluctuations and crises, especially from France and England. The signatories relied on exchange controls and tariffs to prevent sporadic outflows. Countries whose currencies had been weakened by anti-growth tax and regulatory policies were constantly borrowing to support their currencies, then would periodically throw in the towel and devalue anyway. In effect, any country could withdraw from the system at any time, without penalty or sanction.

Meanwhile, Bretton Woods' other offspring, the IMF and the World Bank, were ruining the economies of Africa and Latin America. The twin banks also - by expanding paper money through the creation of special draw-ing rights (SDRs) and by a flood of new lending - helped to promote global inflation. What is more, the leading central banks, especially the U.S. Federal Reserve, never explicitly recognized the domestic-monetary-policy link to Bretton Woods, which was necessary to preserve the $35-per-ounce gold ratio or the foreign-currency peg to the dollar. Indeed, it was the U.S. that inflated its way off the system, ringing the death knell in 1971, when the gold window was formally closed.

In short, neither the U.S. Government nor any other was able to maintain the necessary discipline. Supporters of Bretton Woods ascribe the beginning of 1970s inflation to 1971, when President Nixon formally terminated the system. In reality, the beginning of the end came in the middle 1960s, when the Fed created new dollars at a very rapid rate. Federal Reserve credit (consisting mainly of the central bank's portfolio of U.S. Treasury securities and loans to member banks) which is the source of monetary-base dollar creation, increased at a 10.7 per cent yearly rate between 1963 and 1968, double the pace of the previous five years. In response to this inflationary money growth, gold that was trading freely in the London market moved up from $35 to $43 per ounce, a 23 per cent rise, which correctly heralded the coming inflation. So did long-term Treasury yields, which moved up from 4 1/4 per cent to 7 1/2 per cent between 1965 and 1970. The U.S. inflation rate, which averaged 1.6 per cent a year for the five years up to 1964, promptly moved to a 5.4 per cent annualized pace for the four years to 1970. All this occurred before the Bretton Woods system expired in 1971.

Why? Mainstream Keynesian economists continue to blame the 1970s inflation on Lyndon Johnson's Great Society program of Vietnam guns and welfare-entitlement butter. As this story goes, the lack of fiscal discipline created huge deficits that subsequently drove up inflation. However, from 1965 to 1970 the budget deficit averaged a tiny $7 billion a year, or 1.1 per cent of gross domestic product. It was an excess of money, not deficits, that started the age of inflation. And this excess, corroborated by the rise in the private-market gold price, occurred despite the Bretton Woods system.

After 1971, as gold completely disappeared from the official monetary scene, inflation raged among all the industrial countries. (When gold was the reference point, from 1950 to 1971, real GDP expanded at a 3.8 per cent annual rate, and the consumer price index at 2.1 per cent. When gold was removed, economic performance from 1971 to 1993 slumped to 2.5 per cent growth with 6 per cent inflation.) This undermined growth, capital formation, entrepreneurship, employment, financial markets, free trade, consumers, elderly pensioners, farmers, and the poor. Orthodox economists blamed greedy businessmen for raising prices, or ungrateful workers for demanding higher wages, or Arab sheiks for increasing oil prices; even God was blamed for bad weather and poor harvests. But none of the orthodox attempts to curb inflation worked. Wage and price controls failed, higher taxes failed, monopolistic regulations failed, managed-exchange-rate schemes failed. They failed because the root cause of inflation was the printing of bad money. By government.

That's right, government. The Federal Reserve is an arm of the U.S. Government, just as central banks everywhere are. And governments are not to be trusted. In the United States, the Fed is to money as the Department of Health and Human Services is to social policy: it represents the narrow interest of elite Washington planners and their mistaken theories, not the grassroots interests of the population at large. The latter wants stable money in order to invest, save, borrow, lend, trade, take risks, and prosper. The former want Keynesian fine-tuning, demand management, and economic control.

There are of course some in the Fed who have their ear closer to the ground, but even these good people get caught up in the prevailing ethos of Washington's corridors of power, the infectious culture of big government. For all its alleged independence, the Fed is very much a part of this culture.

"Everything the government touches turns to c---. It's a reverse Midas touch," Craig Roberts told the somewhat startled conservatives at the Empower America conference. But why were these conservatives startled? And why is it so difficult to recognize that the Bretton Woods system, designed by Keynes, was the perfect vehicle for big-government planning and tinkering with money? Conservatives do not trust government to tax, or spend, or regulate. They abhor government interference with property rights, hiring policies, family values, or school curricula. Why should money be any different?

Good as Gold

To restore sound money and permanent price stability, a new system must be designed which places the private international gold market at the center. That gold is still the best inflation indicator, I have no doubt. If the Fed had heeded the message of the world gold market, then the U.S. and the rest of the world would not have been forced to suffer the consequences of repeated stop-and-go policies. The gold price signal worked in the Sixties and Seventies to warn of impending inflation, and it worked in the Eighties and Nineties to signal disinflation. It even picked up the mild reflation of the late Eighties, just as it is now signaling another reflation.

Private citizens today are permitted to own and contract for gold. Indeed, they are free to exchange dollars for gold, commodities, foreign currencies, and foreign financial instruments as they wish. In that important sense we are already on a new gold standard. And for those who remain uncomfortable with gold as the single instrument of policy, there is no reason why the Fed should not also monitor price movements in the international auction markets for bonds, commodities, and currencies. All send off early warning signals of inflation.

The trouble is, the Federal Reserve - and the Treasury - are not heeding the markets' message. The authorities are still focused on economic variables such as unemployment, capacity utilization, retail sales, and real GDP, as if too much employment, or production, or growth will create inflation. But prosperity does not cause inflation; bad money does. If money is sound, then people will hold it. If they hold it, then bond yields will fall, gold will be soft and commodities uneventful, and the dollar will rise. Call it the World Information Standard, or the New International Gold Standard, or the Bond Market Vigilantes. Whatever the label, markets, not government, should regulate the money supply.

What is to be done? We must take money out of the politicians' hands. To achieve this, I propose a series of new monetary reforms.

First, the Humphrey-Hawkins Act must be amended to eliminate the directive of low unemployment and to make price stability the Fed's sole objective. Printing more money will not reduce unemployment. Real purchasing power comes not from money creation but rather from profits, production, entrepreneurship, and risk taking. These are a function of low taxes, deregulation, free trade, and restrained federal spending, all of which permit proper incentives and returns for the private economy. The Fed's rule should be preservation of steady dollar purchasing power and stable prices. Government cannot and should not try to control the economy.

Second, price stability should be defined in terms of a specific inflation target; I propose a 0 to 3 per cent range for the rate of change of the CPI. Inflation targets have been successfully implemented in Britain, Canada, and New Zealand; Germany and France are on the verge of such targets. It is time for the Fed to surrender. A cost-of-living target is something the public understands.

Third, the Fed's chairman and vice chairman should be given two years to meet this target. If after 24 months there is deflation, or above 3 per cent inflation, then they must resign. No position, no office, no parking spot, no tennis privileges. If the target is met, they may complete the remainder of their four-year terms.

Fourth, the Reserve Board must be subjected to strict term limits to avoid the Washingtonization trap. Right now board members are eligible to serve for 14 years. This is an outrage; no one should be permitted such power for so long. Terms should be limited to six years.

Fifth, all Federal Reserve operations to buy and sell - whether government securities, or foreign currencies, or gold, or desk chairs and computers - must be publicly announced in advance. The public has a right to know, and the Fed should not be in the business of favoring the New York financial community, as is now the case.

One additional point. Internally, the Fed should abandon control of the overnight federal-funds rate as a means of regulating Reserve Bank credit. Instead, the Fed should use global gold, commodity, financial, and currency market price signals. Let the overnight interest rate float according to market conditions. Right now, for example, the Fed fund rate is rising, but so are gold and commodity prices. This means policy is still too loose. Indeed, interest rates are rising because the Fed is inflating. Operationally, the Fed should be extinguishing dollars until the gold price falls back to around $325.

Sound as - a Dollar?

What I have described here is a domestic price rule, subject to a clear target and to public accountability. The ultimate goal is a stable cost-of-living price index and steady domestic dollar purchasing power. The supply of dollars will be calibrated to dollar demand by price signals emanating from world gold and financial markets.

Way back in 1944, the economic journalist Henry Hazlitt wrote: "The first essential is a determination to make currencies sound within each country. . . . This can only be done by the maintenance of the value of the dollar in terms of gold, along with a sound national budget and other sound internal policies." He was right then, but ignored. He is still right today.

There is no reason to "fix" international currencies, for central banks merely waste taxpayer money in a futile effort to buck world markets. Nations that raise taxes and impose regulations, or engage in protectionist trade practices, will suffer a falling exchange rate. If the Clinton Administration has its way on raising taxes and nationalizing health care, then the dollar will decline, as it has already done this year. On the other hand, nations that strengthen their private sector through fiscal incentives will see their currency appreciate. But each nation has a right to do as it wishes. Supranational governmental agencies must not dictate.

In the event, if all nations set a domestic inflation target, and use the international gold and financial markets as a disciplinary guide to meet it, then currencies will take care of themselves. This twenty-first-century monetary plan win create stable money and stronger growth, with low interest rates. Undergirding the system will be the information-efficient private global-market trading system, a populist and democratic expression of the free will of billions of people who are searching for prosperity and social progress. It will replace the perverse and destabilizing structure of government control and intervention. I call it common cents.