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.)
7/21/2004
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.
7/20/2005
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.
Nathan
Lewis
Nathan Lewis was formerly the chief international
economist of a leading economic forecasting firm. He now works in asset
management. Lewis has written for the Financial Times, the Wall Street
Journal Asia, the Japan Times, Pravda, and other publications. He has
appeared on financial television in the United
States, Japan,
and the Middle East. About the Book: Gold:
The Once and Future Money (Wiley, 2007, ISBN: 978-0-470-04766-8, $27.95) is
available at bookstores nationwide, from all major online booksellers, and
direct from the publisher at www.wileyfinance.com or 800-225-5945. In Canada,
call 800-567-4797.
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