The Greenspan Gold Standard
September 23, 2007
Sorry, I was out of the country for a couple weeks there. I thought I would be able to update the website on my notebook computer, but it turned out that I didn’t have the right software.
The dollar broke down below the 80 level on the Fed’s dollar index — the measure most people use for technical purposes — and peeked over its May 2006 lows vs. gold as well. Even crude oil made a new high, along with wheat, just in case someone wasn’t getting the message. While it would make sense to see the dollar/gold return to the $690/oz. range for a while to consolidate, it looks like it will evenutally break out to new highs and probably keep going until we see $1,000 /oz. sometime next year. According to our 1970s analog, the next leg up in gold would take us to about $1,200/oz. That would probably be accompanied by crude oil somewhere around $125/barrel, which would be pretty exciting as it translates to about $5/gallon gasoline. Boone Pickens — smartest guy around regarding the crude oil situation — points to expected demand of 88mb/d this winter (winter is the high season for oil demand) and production that seems to be maxed out around 85mb/d. That’s a big hole to fill.
The big news last week was the Fed’s cave-in to Wall Street rah-rah for a rate cut — delivering not only the expected 25bps cut, but 50bps. While comparisons might be made to the behavior of Bernanke’s predecessor “Easy” Alan Greenspan, I think that is not the case. Greenspan was only unusually “easy” when the dollar was on the high side of its Plaza Accord-Louvre Accord band between $320 and $400/oz. of gold — as it was in 1998 and 2001. When the dollar was on the weak side, in 1988 or 1994, Greeenspan was irritatingly hawkish. In this way, Greenspan attempted to maintain the dollar’s value crudely within the Plaza-Louvre band, a sort of caveman-type gold standard. In fact, Greenspan’s tool (the Fed’s interest rate target) is not an appropriate method to accomplish this goal, which is best done through direct base-money adjustment. But, by hook or crook and a bit of luck, Greenspan did manage to stay in the general neighborhood of the Plaza/Louvre band throughout his tenure. The result was generally pretty good, as interest rates fell and economies prospered — at least compared to the monetary turmoil of the 1970s and 1980s, though it was rather pathetic compared to what could be accomplished with a real gold standard.
Indeed, I hear that Greenspan has been out expressing this idea more forcefully during his recent talks — that he was actually targeting gold during his tenure. Central bankers, are you paying attention? Certainly Ben Bernanke and crew seem to care little for gold’s message, happily flying around in their helicopters while the inflation warning bell goes BONG-BONG-BONG.
On the other hand, maybe Bernanke and crew are very well aware of what they are doing, which is an attempt to mitigate a tendency towards a housing bust/credit collapse and recession with a stiff dose of monetary distortion. Very “what we should have done in the 1930s.”
Also very “what we actually did in the 1970s.”
Here are a few quotes from Sir Alan, when he was still in office, chatting with Congressman Ron Paul. (More quotes are available here.)
Mr. PAUL. Thank you, Mr. Chairman.
Good morning, Chairman Greenspan. Yesterday’s testimony was received in the press as you painting a pretty rosy picture of the economy. You have already remarked a second time on one statement you made that I would like to comment on again, because I think my colleagues should pay close attention to it: And that is your statement that corporate investment in fixed capital and inventory has apparently continued to fall short. The protracted nature of this shortfall is unprecedented over the past 3 decades. The proportion of temporary hires relative to total employment continues to rise.
I think that is very, very significant and probably should be taken in the context of the rosy picture of the economy.
Also, at the end of your statement, you make a comment about inflation in the long run, which I entirely agree with. And that is, it is important to remind ourselves, you say, that inflation in the long run is a monetary phenomenon. However, you sort of duck the issue on the short run, that various factors affect inflation in the short run, and yet I think monetary policy is pretty important in the short run. And our temptation here and too often with central banks is to measure inflation only by Government measurement of CPI, where the free-market economists, from Ricardo to Mises to the current free-market economists, argue the case that, once a central bank interferes with interest rates and lowers them below the real rate, that investors and others do make mistakes, such as overinvestment and now investment over-capacity, excessive debt, and speculation. And, therefore, I think that we should concentrate more on the short run effects of monetary policy
Over the last several months, you had been hit by two groups. One half is saying that you are raising rates too fast, and the other half says you are way too slow. And of course it begs the question of whether or not you are really right on target. But from a free-market perspective, one would have to argue that you can’t know and you don’t know, and only the market can decide the proper money supply and only the market can decide the right interest rates. Otherwise, we invite these many problems that we face.
As the economy slowed in 2000, 2001, of course, there was an aggressive approach by inflating and lowering the interest rates to an unprecedented level of 1 percent. But lo and behold, when we look back at this, we find out that manufacturing really hasn’t recovered, savings hasn’t recovered, the housing bubble continues, the current account deficit is way out of whack, continuing to grow as our foreign debt grew, and consumer debt is rising as well as Government debt.
So it looks like this 1 percent really hasn’t done much good other than prevent the deflating of the bubble, which means that, yes, we have had a temporary victory, but we have delayed the inevitable, the pain and suffering that must always come after the distortion occurs from a period of time of inflating.
So my question to you is, how unique do you think this period of time is that we live in and the job that you have? To me, it is not surprising that half the people think you are too early and the other half think you are too late on raising rates. But since fiat money has never survived for long periods of time in all of history, is it possible that the funnel of tasks that you face today is a historic event, possibly the beginning of the end of the fiat system that replaced Brenton Woods 33 years ago? And since there is no evidence that fiat money works on the long run, is there any possibility that you would entertain that, quote, ”We may have to address the subject of overall monetary policy not only domestically but internationally in order to restore real growth”?
Mr. GREENSPAN. Well, Congressman, you are raising the more fundamental question as to being on a commodity standard or another standard. And this issue has been debated, as you know as well as I, extensively for a significant period of time.
Once you decide that a commodity standard such as the gold standard is, for whatever reasons, not acceptable in a society and you go to a fiat currency, then the question is automatically, unless you have Government endeavoring to determine the supply of the currency, it is very difficult to create what effectively the gold standard did.
I think you will find, as I have indicated to you before, that most effective central banks in this fiat money period tend to be successful largely because we tend to replicate which would probably have occurred under a commodity standard in general.
I have stated in the past that I have always thought that fiat currencies by their nature are inflationary. I was taken back by observing the fact that, from the early 1990s forward, Japan demonstrated that fact not to be a broad universal principle. And what I have begun to realize is that, because we tend to replicate a good deal of what a commodity standard would do, we are not getting the long-term inflationary consequences of fiat money. I will tell you, I am surprised by that fact. But it is, as best I can judge, a fact.
Mr. PAUL. If, indeed, this is your last appearance before our committee, Mr. Greenspan, I would have to say that, in the future, I’m sure I’ll find these hearings a lot less interesting.
But I do have a couple of parting questions for you. Keynes, when he wrote his general theory, made the point that he has tremendous faith in central bank credit creation because it would stimulate productivity.
But along with this, he also recognized that it would push prices and labor costs up. But he saw this as a convenience, not a disadvantage, because he realized that, in the corrective phase of the economic business cycle, that wages had to go down which people wouldn’t accept, a nominal decrease in wages, but if they were decreased in real terms, it would serve the economic benefit.
Likewise, I think this same principle can be applied to our debt. To me, this system that we have today is a convenient way to default on our debt to liquidate our debt after the inflationary scheme.
Even you, in the 1960s, described the paper system as a scheme for the confiscation of wealth.
And, in many ways, I think this is exactly what has happened. We have learned to adapt to deficit financing. But in many ways, the total debt is not that bad because it goes down in real terms.
As bad as it is, in real terms, it’s not nearly as high.
But, since we went on a total paper standard in 1971, we have increased our money supply essentially 12-fold. Debt in this country, federal debt, has gone up 19-fold but that is in nominal dollars, not in real dollars.
So my question is this: Is it not true that the paper system that we work with today is actually a scheme to default on our debt? And is it not true that, for this reason, that’s a good argument for people not eventually, at some day wanting to buy Treasury bills because they will be paid back with cheaper dollars?
And, indeed, in our lifetime, we certainly experienced this in the late 1970s that interest rates had to go up pretty high and that this paper system serves the interests of big government and deficit financing because it’s a sneaky way of paying for it.
At the same time, it hurts the people who are retired and put their money in savings.
And aligned with this question, I would like to ask something to dealing exactly with gold, is that: If paper money today it seems to be working rather well but if the paper system doesn’t work, when will the time come? What will the signs be that we should reconsider gold?
Even in 1981, when you came before the Gold Commission, people were frightened about what was happening and that’s not too many years ago. And you testified that it might not be a bad idea to back our government bonds with gold in order to bring down interest rates.
So what are the conditions that might exist for the central bankers of the world to reconsider gold?
We do know that they haven’t given up on gold. They haven’t gotten rid of their gold. They’re holding it there for some reason.
So what’s the purpose of the gold if it isn’t with the idea that some day they might need it? They don’t hold lead or pork bellies. They hold gold.
So what are the conditions that you might anticipate when the world may reconsider gold?
Mr. GREENSPAN. Well, you say central banks own gold or monetary authorities own gold. The United States is a large gold holder. And you have to ask yourself: Why do we hold gold?
And the answer is essentially, implicitly, the one that you’ve raised namely that, over the generations, when fiat monies arose and, indeed, created the type of problems which I think you correctly identify of the 1970s, although the implication that it was some scheme or conspiracy gives it a much more conscious focus than actually, as I recall, it was occurring. It was more inadvertence that created the basic problems.
But as I’ve testified here before to a similar question, central bankers began to realize in the late 1970s how deleterious a factor the inflation was.
And, indeed, since the late ’70s, central bankers generally have behaved as though we were on the gold standard.
And, indeed, the extent of liquidity contraction that has occurred as a consequence of the various different efforts on the part of monetary authorities is a clear indication that we recognize that excessive creation of liquidity creates inflation which, in turn, undermines economic growth.
So that the question is: Would there be any advantage, at this particular stage, in going back to the gold standard?
And the answer is: I don’t think so, because we’re acting as though we were there.
Would it have been a question at least open in 1981, as you put it? And the answer is yes.
Remember, the gold price was $800 an ounce. We were dealing with extraordinary imbalances, interest rates were up sharply, the system looked to be highly unstable and we needed to do something.
Now, we did something. The United States Paul Volcker, as you may recall, in 1979 came into office and put a very severe clamp on the expansion of credit, and that led to a long sequence of events here, which we are benefiting from up to this date.
So I think central banking, I believe, has learned the dangers of fiat money, and I think, as a consequence of that, we’ve behaved as though there are, indeed, real reserves underneath the system.
This “maybe it’ll be sort of OK if we’re in the general vicinity of stability against gold” sort of thinking has been around at least since Greenspan was a member of the Congressional Gold Committee in 1981. Here’s his September 1, 1981 WSJ op-ed in its entirety.
CAN THE U.S. RETURN TO A GOLD STANDARD?
By Alan Greenspan
The growing disillusionment with politically controlled monetary policies has produced an increasing number of advocates for a return to the gold standard – including at times president Reagan.
In years past a desire to return to a monetary system based on gold was perceived as nostalgia for an era when times were simpler, problems less complex and the world not threatened with nuclear annihilation. But after a decade of destabilizing inflation and economic stagnation, the restoration of a gold standard has become an issue that is clearly rising on the economic policy agenda. A commission to study the issue, with strong support from President Reagan, is in place.
The increasingly numerous proponents of a gold standard persuasively argue that budget deficits and large federal borrowings would be difficult to finance under such a standard. Heavy claims against paper dollars cause few technical problems, for the Treasury can legally borrow as many dollars as Congress authorizes.
But with unlimited dollar conversion into gold, the ability to issue dollar claims would be severely limited. Obviously if you cannot finance federal deficits, you cannot create them. Either taxes would then have to be raised and expenditures lowered. The restrictions of gold convertibility would therefore profoundly alter the politics of fiscal policy that have prevailed for half a century.
Disturbed by Alternatives
Even some of those who conclude a return to gold is infeasible remain deeply disturbed by the current alternatives. For example, William Fellner of the American Enterprise Institute in a forthcoming publication remarks “…I find it difficult not to be greatly impressed by the very large damage done to the economies of the industrialized world… by the monetary management that has followed the era of (gold) convertibility… It has placed the Western economies in acute danger.”
Yet even those of us who are attracted to the prospect of gold convertibility are confronted with a seemingly impossible obstacle: the latest claims to gold represented by the huge world overhang of fiat currency, many dollars.
The immediate problem of restoring a gold standard is fixing a gold price that is consistent with market forces. Obviously if the offering price by the Treasury is too low, or subsequently proves to be too low, heavy demand at the offering price could quickly deplete the total U.S. government stock of gold, as well as any gold borrowed to thwart the assault. At that point, with no additional gold available, the U.S. would be off the gold standard and likely to remain off for decades.
Alternatively, if the gold price is initially set too high, or subsequently becomes too high, the Treasury would be inundated with gold offerings. The payments the gold drawn on the Treasury’s account at the Federal Reserve would add substantially to commercial bank reserves and probably act, at least temporarily, to expand the money supply with all the inflationary implications thereof.
Monetary offsets to neutralize or “earmark” gold are, of course, possible in the short run. But as the West Germany authorities soon learned from their past endeavors to support the dollar, there are limits to monetary countermeasures.
The only seeming solution is for the U.S. to create a fiscal and monetary environment which in effect makes the dollar as good as gold, i.e., stabilizes the general price level and by inference the dollar price of gold bullion itself. Then a modest reserve of bullion could reduce the narrow gold price fluctuations effectively to zero, allowing any changes in gold supply and demand to be absorbed in fluctuations in the Treasury’s inventory.
What the above suggests is that a necessary condition of returning to a gold standard is the financial environment which the gold standard itself is presumed to create. But, if we restored financial stability, what purpose is then served by return to a gold standard?
Certainly a gold-based monetary system will necessarily prevent fiscal imprudence, as 20th Century history clearly demonstrates. Nonetheless, once achieved, the discipline of the gold standard would surely reinforce anti-inflation policies, and make it far more difficult to resume financial profligacy. The redemption of dollars for gold in response to excess federal government-induced credit creation would be a strong political signal. Even after inflation is brought under control the extraordinary political sensitivity to inflation will remain.
Concrete actions to install a gold standard are premature. Nonetheless, there are certain preparatory policy actions that could test the eventual feasibility of returning to a gold standard, that would have positive short-term anti-inflation benefits and little cost if they fail.
The major roadblock to restoring the gold standard is the problem of re-entry. With the vast quantity of dollars worldwide laying claims to the U.S. Treasury’s 264 million ounces of gold, an overnight transition to gold convertibility would create a major discontinuity for the U.S. financial system. But there is no need for the whole block of current dollar obligations to become an immediate claim.
Convertibility can be instituted gradually by, in effect, creating a dual currency with a limited issue of dollars convertible into gold. Initially they could be deferred claims to gold, for example, five-year Treasury Notes with interest and principal payable in grams or ounces of gold.
With the passage of time and several issues of these notes we would have a series of “new monies” in terms of gold and eventually, demand claims on gold. The degree of success of restoring long-term fiscal confidence will show up clearly in the yield spreads between gold and fiat dollar obligations of the same maturities. Full convertibility would require that the yield spread for all maturities virtually disappear. If they do not, convertibility will be very difficult, probably impossible, to implement.
A second advantage of gold notes is that they are likely to reduce current budget deficits. Treasury gold notes in today’s markets could be sold at interest rates at approximately 2% or less. In fact from today’s markets one can construct the equivalent of a 22-month gold note yielding 1%, by arbitraging regular Treasury note yields for June 1983 maturities (17%) and the forward delivery premiums of gold (16% annual rate) inferred from June 1983 futures contracts. Presumably five-year note issues would reflect a similar relationship.
A Risk of Exchange Loss
The exchange risk of the Treasury gold notes, of course, is the same as that associated with our foreign currency Treasury note series. The U.S. Treasury has, over the years, sold significant quantities of both German mark – and Swiss franc denominated issues, and both made and lost money in terms of dollars as exchange rates have fluctuated. And indeed there is a risk of exchange rate loss with gold notes.
However, unless the price of gold doubles over a five-year period (16% compounded annually), interest payments on the gold notes in terms of dollars will be less than conventional financing requires. The run-up to $875 per ounce in early 1980 was surely an aberration, reflecting certain circumstances in the Middle East which are unlikely to be repeated in the near future. Hence, anything close to doubling of gold prices in the next five years appears improbable. On the other hand, if gold prices remain stable or rise moderately, the savings could be large: Each $10 billion in equivalent gold notes outstanding would, under stable gold prices, save $1.5 billion per year in interest outlays.
A possible further side benefit of the existence of gold notes is that they could set a standard in terms of prices and interest rates that could put additional political pressure on the administration and Congress to move expeditiously toward non-inflationary policies. Gold notes could be a case of reversing Gresham’s Law. Good money would drive out bad.
Those who advocate a return to a gold standard should be aware that returning our monetary system to gold convertibility is no mere technical, financial restructuring. It is a basic change in our economic processes. However, considering where the policies of the last 50 years have eventually led us, perhaps there are lessons to be learned from our more distant gold standard past.