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Zola: As
an investment over the past decade, gold has sucked. This,
combined with the (as often as not) semi-literate
blatherings of gold standard proponents, has managed to give
gold a bad name. The low point was reached on October
24, 1997, when at the New York Commodity Exchange (COMEX)
gold futures plunged to a level last seen 12 years ago.
At issue was a report to the Swiss National Bank
recommending changes in the monetary constitution, including
a revaluation of Swiss gold reserves. The Swiss franc is
virtually the last remaining currency with gold backing. The
Swiss central bank has traditionally valued its 2,600 tons
of gold at 4,595 francs per kilogram, compared with a market
price of close to 17,000 francs. The revaluation would bring
Swiss gold reserves closer to their market value of 44
billion francs from the 11.9 billion francs currently
audited.The recommended changes
would allow the Swiss National Bank to allocate 1,400 metric
tons of its 2,600 tons of gold reserves for purposes other
than stabilizing the Swiss franc. Does that mean some of the
gold would be sold on the open market?
Now, combined
among them, central banks have about a 17-year supply of
gold in their vaults. So if the hold-out Swiss begin selling
their gold, the rest of the world is sure to follow. No
telling how low the price of gold could go. That was the
fear expressed by gold traders as they pushed gold for
December delivery down $16.10 per oz., a price drop of 4.9%,
to $308.30. The last time gold traded this cheaply was in
February 1985.
However, all the knee-jerk reaction is a
little premature. The Swiss finance ministry's proposals for
the revision of the country's monetary constitution must be
submitted to Parliament. After the vote there, there will
also have to be a popular referendum. And this won't
take place until Spring 1999.
The drop in the price of
gold along with a drop in stock prices is strongly
suggestive of deflationary forces at work. But does it also
mean gold is finished as an asset in the international
monetary system? Don't count on it.
Greenspan on Gold
Despite the bad performance and the bad press,
gold still makes up about 26 percent of all central bank
reserves, according to the latest Annual Survey of the
International Monetary Fund. Because, when you come right
down to it, central banks don't trust one another to do the
right thing. Gold is insurance.
This point has been made
by no other than the current Chairman of the Federal
Reserve, Alan Greenspan, who, as we know, is God (his
reputation having risen in concert with world stock prices).
Back in 1966 when he was still a member of his mentor's
(Ayn Rand's) Court, Greenspan penned an essay entitled,
"Gold and Economic Freedom," which explained the staying
power of gold.
"An almost hysterical antagonism toward
the gold standard is one issue which unites statists of all
persuasions," the essay began. "They seem to sense--
perhaps more clearly and subtly than many consistent
defenders of laissez-faire--that gold and economic freedom
are inseparable, that the gold standard is an instrument of
laissez-faire and that each implies and
requires the other."
Greenspan went on to explain the role of gold in a free
society. "In the early stages of a developing money economy,
several media of exchange might be used, since a wide
variety of commodities would fulfill the [necessary]
conditions. However, one of the commodities will gradually
displace all others, by being more widely acceptable. . .
Whether the single medium is gold, silver, sea shells,
cattle, or tobacco is optional, depending on the context and
development of a given economy. In fact, all have been
employed, at various times, as media of exchange. Even in
the present century, two major commodities, gold and silver,
have been used as international media of exchange, with gold
becoming the predominant one. Gold, having both artistic and
functional use and being relatively scarce, has always
been considered a luxury good. It is durable, portable,
homogeneous, divisible, and, therefore, has significant
advantages over all other media of exchange. Since the
beginning of Would War I, it has been virtually the sole
international standard of exchange."
Ironically,
Greenspan himself now presides over the chief competitor for
gold in the international financial system, namely the U.S.
dollar. But, continuing with the essay, Greenspan explained
the rise of banking systems, and then noted the conditions
leading to stock market collapse and depression:
"A
fully free banking system and fully consistent gold standard
have not as yet been achieved. But prior to World War I, the
banking system in the United States (and in most of the
world) was based on gold, and even though governments
intervened occasionally, banking was more free than
controlled.
"Periodically, as a result of overly rapid
credit expansion, banks became loaned up to the limit of
their gold reserves, interest rates rose sharply, new credit
was cut off, and the economy went into a sharp, but
short-lived recession. (Compared with the depressions of
1920 and 1932, the pre-World War I business declines were
mild indeed.) It was limited gold reserves that stopped the
unbalanced expansions of business activity, before they
could develop into the post- World War I type of disaster.
The readjustment periods were short and the economies
quickly reestablished a sound basis to resume
expansion."
Enter the Federal Reserve
Greenspan goes on to explain why the Federal
Reserve was created, and how the Federal Reserve brought
about the Great Depression:
"But the process of cure was
misdiagnosed as the disease: if shortage of bank reserves
was causing a business decline--argued economic
interventionists--why not find a way of supplying increased
reserves to the banks so they never need be short! If banks
can continue to loan money indefinitely--it was
claimed--there need never be any slumps in business. And so
the Federal Reserve System was organized in 1913. It
consisted of twelve regional Federal Reserve banks nominally
owned by private bankers, but in fact government sponsored,
controlled, and supported. Credit extended by these banks
is in practice (though not legally) backed by the taxing
power of the federal government. Technically, we remained on
the gold standard; individuals were still free to own gold,
and gold continued to be used as bank reserves. But now, in
addition to gold, credit extended by the Federal Reserve
banks (paper reserves) could serve as legal tender to pay
depositors.
"When business in the United States
underwent a mild contraction in 1927, the Federal Reserve
created more paper reserves in the hope of forestalling any
possible bank reserve shortage. More disastrous, however,
was the Federal Reserve's attempt to assist Great Britain
who had been losing gold to us because the Bank of
England refused to allow interest rates to rise when market
forces dictated (it was politically unpalatable). The
reasoning of the authorities involved was as follows: if the
Federal Reserve pumped excessive paper reserves into
American banks, interest rates in the United States would
fall to a level comparable with those in Great Britain; this
would act to stop Britain's gold loss and avoid the
political embarrassment of having to raise interest rates.
"The `Fed' succeeded: it stopped the gold loss, but
it nearly destroyed the economies of the world, in the
process. The excess credit which the Fed pumped into the
economy spilled over into the stock market--triggering a
fantastic speculative boom.
"Belatedly, Federal Reserve
officials attempted to sop up the excess reserves and
finally succeeded in braking the boom. But it was too late:
by 1929 the speculative imbalances had become so
overwhelming that the attempt precipitated a sharp
retrenching and a consequent demoralizing of business
confidence. As a result, the American economy collapsed.
Great Britain fared even worse, and rather than absorb the
full consequences of her previous folly, she abandoned the
gold standard completely in 1931, tearing asunder what
remained of the fabric of confidence and inducing a
world-wide series of bank failures. The world economies
plunged into the Great Depression of the 1930's.
Why the Gold Standard is Opposed
The opposition to an international standard
based on gold (or some comparable commodity) is not,
Greenspan says, due to any fact of history. Rather, it is
purely political:
"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.
"Under a gold standard, the amount of credit that
an economy can support is determined by the economy's
tangible assets, since every credit instrument is ultimately
a claim on some tangible asset. But government bonds are not
backed by tangible wealth, only by the government's promise
to pay out of future tax revenues, and cannot easily be
absorbed by the financial markets. A large volume of new
government bonds can be sold to the public only at
progressively higher interest rates. Thus, government
deficit spending under a gold standard is severely limited.
"The abandonment of the gold standard made it
possible for the welfare statists to use the banking system
as a means to an unlimited expansion of credit. They have
created paper reserves in the form of government bonds
which--through a complex series of steps--the banks accept
in place of tangible assets and treat as if they were an
actual deposit, i.e., as the equivalent of what was formerly
a deposit of gold. The holder of a government bond or of a
bank deposit created by paper reserves believes that he has
a valid claim on a real asset. But the fact is that there
are now more claims outstanding than real assets."
The purpose of unlimited expansion of credit is, Greenspan
explains, all a plot to confiscate wealth. "This is the
shabby secret of the welfare statists' tirades against gold.
Deficit spending is simply a scheme for the `hidden'
confiscation of wealth. Gold stands in the way of this
insidious process. It stands as a protector of property
rights."
In other words, gold is insurance against
government confiscation of wealth through the banking system
and government bond markets. Or that's what Greenspan
thought thirty years ago.
Were the thoughts in his essay
simply youthful folly? Or did they reflect wisdom that has
since been forgotten?
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