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Is Greenspan hinting at a new gold standard?

Section: Daily Dispatches

3:12p ET Tuesday, January 21, 2003

Dear Friend of GATA and Gold:

GATA doesn't necessarily think much of the essay
from Canada's National Post that is appended here,
but at least it shows that gold is becoming a
mainstream issue.

The essay's author wonders whether Fed Chairman
Alan Greenspan is hinting at a new gold standard.
GATA might argue that the United States went back
to the gold standard surreptitiously when it
started rigging the gold price about 1995, and
that Greenspan's linking monetary policy to the
gold price now would be nothing new, except
insofar as it might be hinted about IN PUBLIC,
as in quot;publicquot; policy, which one might think
a democracy's monetary policy would be.

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

* * *

Is Greenspan hinting at
a new gold standard?

Seemingly out of the blue, the U.S. Federal Reserve
chairman is hinting at a return to the gold standard. If
so, currency markets are in for a shock

Reuven Brenner
National Post, Canada
Tuesday, January 21, 2003

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Last month in a speech before the Economic Club of
New York, Alan Greenspan praised the gold standard,
the first time he has unambiguously done so since
joining the U.S. Federal Reserve.

quot;Although the gold standard could hardly be portrayed
as having produced a period of price tranquility, it was
the case that the price level in 1929 was not much
different, on net, from what it had been in 1800,quot; he
stated. quot;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.quot;

Is Greenspan returning implicitly to his long-held
strong beliefs, which he voiced explicitly before
he became Fed chairman, of having the gold
price guide U.S. monetary policy? If so, that would
mean keeping the gold price (in terms of the dollar)
stable. Under this standard, as Greenspan
accurately points out, the price level in the United
States stayed stable through wars and much
technological and political upheaval. The implication
is clear: There is no problem achieving such stability
in future, even if the United States goes to war, and
even if much technological and political upheavals

During the six decades since the Americans left the
gold standard, prices rose tenfold. This happened
not because these decades were more turbulent than
the preceding 13, but because of the faddish belief,
rationalized by much of the economic profession,
that central bankers could do a better job managing
monetary policy by setting interest rates and exchange
rates than by market-guided, gold-price-anchored

The fad's long life is not surprising. Central planing,
based on the belief that bureaucrats know how to
price wheat, physicians, nurses, and teachers better
than people involved in the respective businesses,
has been enduring for centuries, in spite of evidence
to the contrary. The view that central banks could best
manage monetary affairs by pricing interest rates and
exchange rates thus fit perfectly into this bureaucratic
frame of mind. Though, as Greenspan points out, the
evidence contradicts this viewpoint.

Before 1996, Greenspan often indicated that gold
prices were guiding his monetary policy. Then he
abandoned all reference to them -- until last month's
speech. His strong statement comes like lightning
out of the blue sky. With another Federal Reserve
governor, Ben Bernanke, repeating part of Greenspan's
comments, we get a strong signal of where the U.S.
dollar is heading -- if Greenspan goes from words to
actions. Before we get to the numbers, here is what
Greenspan said concerning monetary policy and
deflationary pressures:

quot;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 over-issuance of money, even at the
cost of considerable 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, with the support
of both the Carter and 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

Greenspan also said that, in the short and medium
run, the link between money and prices is unclear,
which means that targeting quot;inflationquot; rates cannot
have the desired effects. If Greenspan will act upon
all these views -- and that's yet to be seen -- U.S.
monetary policy will be radically transformed.

What can we expect, then, to happen to the U.S.
dollar? To gold prices? To the euro? To the
Canadian dollar?

First, let's understand that using gold prices for
monetary guidance means, as Greenspan emphasizes,
that companies and governments can safely get into
U.S. dollar contractual agreements without worrying
about its value, be it over short, medium, or very long
hauls. The difference between a gold-guided policy
and one guided by inflationary targets is important.
Price levels are backward-looking and mismeasured.
It's not surprising, then, that although central bankers
have targeted low inflation in the United States, Europe,
Canada, and elsewhere, the policy did not have the
desired results that most economists expected.
Exchange rates have fluctuated up and down in 50
percent ranges, violating the value of contractual
agreements and making capital more expensive.
While one could mitigate the consequences by
hedging with complex and expensive derivatives,
derivatives do not come cheap.

What happened to lead Greenspan to abandon his
opaqueness of the last few years and clearly tout the
benefits of the gold standard? Here I enter the realm
of speculation.

In the last decade, the world lost two of its three reserve
currencies -- the yen and the Deutschmark -- leaving
only the U.S. dollar. The Japanese have been
mismanaging their economy and monetary policy for
a dozen years and, contrary to expectations, the euro
has not been anchored in the DM, but in a vague,
unreliable quot;inflationaryquot; target that Greenspan dismisses
with good reason: As noted above, such targets did not
prevent exchange rates from sharply fluctuating.
Something was obviously not working. The euro's recent
rise is no indication that it is about to become a reserve
currency. The dollar continues to stand alone, its
mismanagement over the last five years notwithstanding .

Between late 1993 and mid 1996, gold was roughly at
US$400, give or take US$10. At the end of 1996, the
severe decline in gold prices and the rise in the U.S.
dollar starts, with gold hitting its lowest level on July 20,
1999, at $252.80. Why did the U.S. dollar go up relative
to almost every currency and commodity prices? The
increased demand for the dollar had a number of
causes, only one of which was its expanding status
as reserve currency. Another cause was the growing
demand for the U.S. dollar around the world with the
faster-growing economies of the 1990s. Greenspan
did not respond to the increased global demand;
instead he brought about the disastrous currency
fluctuations of the last six years.

Based on Greenspan's earlier speeches, we may then
speculate on what might have caused him to pursue
the erroneous policy, and what may have led to his
drastic change of mind. It was in 1996 that Greenspan
made his famous speech on quot;irrational exuberancequot;
at a time the Dow was in the 6,000 range. Since now,
six years later, the Dow is hovering between 8,000 and
9,000 even after expectations of lowered growth rates,
terror, war, and Latin American upheavals, Greenspan
may have realized his mistake, thinking that the 6,000
level was too high, and that he must apply restrictive
monetary policy to lower it. Also, last year, finally,
Greenspan started to talk about deflation. Since
Greenspan had been an ardent believer in the gold
standard before becoming chairman of the Fed, he
may have put together the sequence of events and
recognized the errors of his ways. After all, if one
looked at all these facts and sequence of events
over the last six years through a quot;gold pricequot;
perspective, they should not have been a surprise.
They were predictable.

This realization does not imply that the Fed will now
buy either treasury or other government bonds (the
two options that he and Bernanke raised in their
speeches) with newly minted dollars until gold goes
back to the US$400 level. With war and diminished
growth rates on the horizon (even with the fiscal
stimulus), the global demand for the dollar is not what
it was in the late 1990s. Choosing a rough, rounded
average of US$350 as a target may be a reasonable
guess for a Greenspan quot;targetquot; point. He might have
chosen it already: He knows that the global demand
for the dollar has been declining since 2001, yet the
monetary base is up by roughly 8 percent over the
last year. Unsurprisingly, the dollar has been in
decline relative to most major currencies, sliding to a
level where it should have been.

If my analysis is in the right ballpark and Greenspan
from now on uses the gold price to guide his monetary
policy, no further significant increase in the price of gold
should be expected. If demand for the U.S. dollar
continues to drop, the Fed will issue treasury bonds,
and if it rises, it would buy them or other government
bonds. Once the U.S. dollar becomes quot;as good as
gold,quot; even if informally, and with the present fiscal
stimulus, capital will flow to the U.S., the euro will
weaken, and so will the Canadian dollar.


Reuven Brenner, a professor at McGill University's
Faculty of Management, is the author of quot;Force of
Finance.quot; He is a member of the Financial Post's
Board of Economists.