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Greenspan Believes in the Gold Standard

Many probably do not know that the Maestro, Alan Greenspan, was a big supporter of the gold standard back during the days when he was enjoying intellectual banter with Ayn Rand.  In fact, he wrote a rather lucid essay titled “Gold and Economic Freedom” which was first published in a newsletter: The Objectivist in 1966 when Greenspan was 40 years old.  The essay was later reprinted in Ayn Rand’s book, Capitalism: The Unknown Ideal in 1967.

I will attach a copy of the entire essay below, but I just want to highlight the key facts.  Regardless of my current feelings towards Alan Greenspan, he is arguably one of the greatest economists of the century who rather ironically dealt the United States a heavy dosage of easy money for well over a decade.  His argument for gold as a storage of value is simple, “where store-of-value considerations are important, as they are in richer, more civilized societies, the medium of exchange must be a durable commodity, usually a metal….homogeneous and divisible.  Having a high unit value, such a good is easily portable; for instance, an ounce of gold is worth a half-ton of pig iron”. In this first section he has basically made the argument for why gold has beaten most other commodities as a store of value in developed and civilized countries.

In the second section he makes the case for a banking system where gold of individuals and institutions is stored centrally so that people do not have to literally carry gold around to pay for goods and services.  Instead the individual can write a check against the gold that they have deposited at the bank.  He introduces the idea of a fractional reserve system because, “it is rarely the case that all depositors want to withdraw their gold at the same time”.  Therefore the bank can loan out more than the amount of the gold deposits held within its vaults.  That way the bank can make more money, can offer higher interest rates, and everyone is happier.  The amount held for reserves is not arbitrary though, because if too many depositors want to take their gold from the vaults then there is a traditional run on the bank.

The key principle that Greenspan introduces with fractional banking is the idea of self-regulated lending:

“When banks loan money to finance productive and profitable endeavors, the loans are paid off rapidly and bank credit continues to be generally available.  But when the business ventures financed by bank credit are less profitable and slow to pay off, bankers soon find that their loans outstanding are excessive relative to their gold reserves, and they begin to curtail new lending, usually by charging higher interest rates.  This tends to restrict the financing of new ventures and requires the existing borrowers to improve their profitability before they can obtain credit for further expansion.  Thus, under the gold standard, a free banking system stands as the protector of an economy’s stability and balanced growth.”

He elaborates on this idea within an international framework:

“Even though the units of exchange (the dollar, the pound, the franc, etc.) differ from country to country, when all are defined in terms of gold the economies of the different countries act as one — so long as there are no restraints on trade or on the movement of capital. Credit, interest rates, and prices tend to follow similar patterns in all countries. For example, if banks in one country extend credit too liberally, interest rates in that country will tend to fall, inducing depositors to shift their gold to higher-interest paying banks in other countries. This will immediately cause a shortage of bank reserves in the “easy money” country, inducing tighter credit standards and a return to competitively higher interest rates again.

After laying out a very solid argument for the gold standard on its own, Greenspan proceeds to march directly against what the Federal Reserve has been spouting off for decades.  He suggests that contractions prior to the federal reserve were sharp, but mild because of their self correcting nature.  He said that instead of acknowledging the contractions as a cure, they were “misdiagnosed as the disease: if shortage of bank reserves was causing a business decline…why not find a way of supplying increased reserves to the banks so they never need be short! … And so the Federal Reserve System was organized in 1913.”  He goes on to describe how the attempted bailout of Britain’s excessive spending in 1927 via pumping excessive paper reserves into banks, “nearly destroyed the economies of the world in the process”.

In the most eloquent portion of the essay he puts the nail directly into the coffin of the anti-gold standard “statists”:

But the opposition to the gold standard in any form — from a growing number of welfare-state advocates — was prompted by a much subtler insight: the realization that the gold standard is incompatible with chronic deficit spending (the hallmark of the welfare state). Stripped of its academic jargon, the welfare state is nothing more than a mechanism by which governments confiscate the wealth of the productive members of a society to support a wide variety of welfare schemes. A substantial part of the confiscation is effected by taxation. But the welfare statists were quick to recognize that if they wished to retain political power, the amount of taxation had to be limited and they had to resort to programs of massive deficit spending, i.e., they had to borrow money, by issuing government bonds, to finance welfare expenditures on a large scale.”

He ends his piece with something that I have been stating for years, but probably holds more clout coming from the younger mind of our 13th Chairman of the Federal Reserve:

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold…. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

– Alan Greenspan

Chairman of the Council of Economic Advisors 1974-1977

Chairman of the Federal Reserve 1987-2006

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