greenspan and gold

  1. 374 Posts.

    by Bill Bonner

    Last month, Alan Greenspan spoke to the N.Y. Economic Club
    and sounded, for a while, like his old self.

    "Although the gold standard could hardly be portrayed as
    having produced a period of price tranquility," he
    conceded, "it was the case that the price level in 1929 was
    not much different, on net, from what it had been in 1800.
    But, in the two decades following the abandonment of the
    gold standard in 1933, the consumer price index in the
    United States nearly doubled. And, in the four decades
    after that, prices quintupled. Monetary policy, unleashed
    from the constraint of domestic gold convertibility, had
    allowed a persistent over-issuance of money. As recently as
    a decade ago, central bankers, having witnessed more than a
    half-century of chronic inflation, appeared to confirm that
    a fiat currency was inherently subject to excess."

    Mr. Greenspan was setting the stage. He might have added
    that no central banker in all of history had ever succeeded
    in proving the contrary. Every fiat currency the world had
    ever seen had shown itself 'subject to excess' and then
    subject to destruction.

    Against this epic background, the new Mr. Greenspan
    strutted out, front and center.

    Today's essay is not about Mr. Greenspan, per se, but
    rather about his trade. Each métier comes with its own
    hazards. The baker burns fingers...the psychiatrist soon
    needs to have his own head examined. The moral hazard of
    banking is well documented. Given the power to create money
    out of thin air, the central banker almost always goes too
    far. And if one resists, his successor will almost
    certainly succumb.

    There are some things, dear reader, for which success is
    more dangerous than failure. Running a central bank - like
    robbing one - is an example. The more successful the
    central banker, that is, the more people come to believe in
    the stability of his paper money, the more hazardous the
    situation becomes.

    Warren Buffett's father, a congressman from Nebraska,
    warned in a 1948 speech:

    "The paper money disease has been a pleasant habit thus far
    and will not be dropped voluntarily, any more than a dope
    user will without a struggle give up narcotics...I find no
    evidence to support a hope that our fiat paper money
    venture will fare better ultimately than such experiments
    in other lands...."

    In all other lands, in all other times...the story was the
    same. Paper money had not worked; the moral hazard was too
    great. Central bankers could not resist; when it suited
    them, they overdid it, increasing the money supply far
    faster than the growth in goods and services that the money
    could buy.

    Asked to produce a list of the world's defunct paper money,
    Addison was soon overwhelmed.

    "I don't think you want all these," he replied, "looking at
    his screen. They're in alphabetical order. But there are
    318 of them and I'm still in the B's. And every one of them

    Against this sorry record of managed currencies is the
    exemplary one of gold itself. No matter whose face adorns
    the coin...nor what inscription it bears...nor when it was unmanaged gold coin today is still worth at
    least the value of its gold content, and will generally buy
    as much in goods and services today as it did the day it
    was struck.

    Gold is found on earth in only very limited amounts - only
    3.5 parts per billion. Had God been less niggardly with the
    stuff, gold might be more ubiquitous and less expensive.
    But it is precisely the fact that the earth yields up its
    gold so grudgingly that makes it valuable. Paper money, on
    the other hand, can be produced in almost infinite
    quantities. When the limits of modern printing technology
    are reached, the designers have only to add a zero...and
    they've increased the speed at which they inflate by a
    factor of 10. In today's electronic world, a man no longer
    measures his wealth in stacks of paper money. It is now
    just 'information.' A central banker doesn't even have to
    turn the crank on the printing press; electronically
    registered zeros can be added at the speed of light.

    Given the ease with which new 'paper' money is created, is
    it any wonder the old paper money loses its value?

    But for a while, Mr. Greenspan seemed to have a light
    shining on him. Standing there, center stage of the world
    economy like Moses in front of the Red Sea, he believed he
    had found the promised land of managed currencies - for his
    paper dollars rose in value against gold for two decades,
    when they ought to have gone down.

    Mr. Greenspan explains how this Exodus came about:

    "But the adverse consequences of excessive money growth for
    financial stability and economic performance provoked a
    backlash. Central banks were finally pressed to rein in
    overissuance of money even at the cost of considerable
    temporary economic disruption. By 1979, the need for
    drastic measures had become painfully evident in the United
    States. The Federal Reserve, under the leadership of Paul
    Volcker and with the support of both the Carter and the
    Reagan Administrations, dramatically slowed the growth of
    money. Initially, the economy fell into recession and
    inflation receded.

    "However, most important, when activity staged a vigorous
    recovery, the progress made in reducing inflation was
    largely preserved. By the end of the 1980s, the inflation
    climate was being altered dramatically.

    "The record of the past twenty years appears to underscore
    the observation that, although pressures for excess
    issuance of fiat money are chronic, a prudent monetary
    policy maintained over a protracted period can contain the
    forces of inflation."

    Until recently, Mr. Greenspan's genius was universally
    acclaimed. Central banking looked, at long last, like a
    great success. But then the bubble burst. People began to
    wonder what kind of central bank would do such a dumb

    "Evidence of history suggests that allowing an asset bubble
    to develop is the greatest mistake that a central bank can
    make," wrote Andrew Smithers and Stephen Wright in "Valuing
    Wall Street," in 2000. "Over the past five years or so the
    Federal Reserve has knowingly permitted the development of
    the greatest asset bubble of the 20th century."

    When the stock market collapsed, Mr. Greenspan's policies
    began to look less prudent. During his tour of duty at the
    Fed, the monetary base tripled, at a time when the GDP rose
    only 50%. More new money came into being than under all
    previous Fed chairmen - $6,250 for every new ounce of gold.

    All this new money created by the Greenspan Fed had the
    defect of all excess paper money; it had no resources
    behind it. Though taken up by shopkeepers and dog-groomers
    as if it were the real thing, it represented no increase in
    actual wealth. The retailer and the dogwasher thought they
    had more 'money', but there was really nothing of real
    value to back it up.

    The new money was issued, light on value but heavy on
    consequences. It helped lure the lumpeninvestoriat into
    their own moral hazard; they no longer needed to save -
    because the Greenspan Fed always seemed to make money
    available, at more and more attractive rates. And it misled
    suppliers into believing there was more demand than there
    really was. Consumers were buying; there was no doubt about
    that. But how long could they continue to spend more than
    they actually earned?

    Encouraged by what seemed like almost unlimited buying from
    America, foreigners - notably, first in Japan in the '80s,
    then in China in the '90s - constructed new factories on a
    monumental scale. They sold their products to
    Americans...and then invested the proceeds, either in more
    capacity at home, or in more assets in the U.S. As
    mentioned above, by the end of 2002, U.S. manufacturing was
    in still in a 30-year slump...and foreigners owned nearly
    20% of the U.S. stock market...42% of the treasury bonds
    market...and total dollar assets of as much as $9 trillion.

    The effects of this moral hazard are just now being felt.
    The consumer is more heavily in debt than ever before - and
    seems to need increased credit just to stay in the same
    place. State and Federal governments have gone from modest
    surplus to flagrant deficit. Where was the money going to
    come from? Americans have very little in savings; it must
    be imported from abroad. But the current account is already
    in deficit by $450 billion annually. Stephen Roach
    estimates that the new capital demands will push the
    deficit to $600 billion - or $2.5 billion every working

    Foreigners may be willing to finance the new U.S. spending
    binge. Then again, with the dollar already falling, they
    may not. We cannot know what will happen, but we can take a
    guess: they won't be willing to do so at the same dollar
    price. The dollar ought to fall against gold...and against
    foreign currencies. It probably will.

    Bill Bonner

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