Copyright ©2005 by A.
The Dismal Monetary Science
The Myth of the New American Gold Standard
Antal E. Fekete
Memorial University of Newfoundland
Nov 16, 2005
In 1999 The New York Times
ran an obituary of the "barbarous relic" from the pen
of Floyd Norris under the title "Greenspan Has Become the
New American Gold Standard" (op-ed page, International Herald
Tribune, May 5, 1999). It alleged that the process of removing
the glitter from gold has been a gradual but inexorable one and
the world was more than happy to accept the greenback backed
by Greenspan (no pun intended), just as earlier it had accepted
the yellowback backed by the precious yellow. The earmark of
the new millennium is people's unshakeable faith in the dollar.
My rejoinder suggesting that "rumors about the demise of
gold were grossly exaggerated", written over six years ago,
is reproduced below. It goes without saying that The New York
Times refused to publish it. The occasion for publishing it now
is the impending historic changeover from the Greenspan standard
to the Bernanke standard.
Green cheese factory on the Potomac
There is nothing new about
premature obituaries for the gold standard. In 1936 John Maynard
Keynes noted in the book that has made his name world-famous
(The General Theory of Employment, Interest, and Money; Macmillan,
1967, p 235) that people habitually scramble for gold, which
is to say that they crave for the moon. But the government cannot
let them have the moon. A good central banker, by definition,
is one who can persuade people that green cheese (sic!) is practically
the same thing, and will go on to parcel it up and dish it out
for their delight and satisfaction. Nomen est omen: Greenspan
was destined to be the first (and probably the last) green cheese
monger on the Potomac. Mr.Greenspan certainly understands gold
and the reasons why people habitually scramble for it. He also
understands why the government wants people to take green cheese
for gold. It is not my intention to ridicule the deep-rooted
yearning in the human psyche for Santa Claus. But to me, instead
of cutting a happy figure of Santa Claus, Mr.Greenspan cuts the
sorry figure of the Sorcerer's Apprentice. He learned the magic
word how to start green cheese production; his tragedy is that
he has forgotten to learn the other magic word how to stop it
when enough is enough. Apart from that, the problem is that too
much green cheese is not good for you. It may cause diarrhea
(inflation) and constipation (deflation), although it is impossible
to say in which order.
Competition of gold to irredeemable
promises is too telling for comfort
According to Norris, gold's
reputation as a store of value has been eroded while its price
fell by more than two-thirds from $873 in 1980 to $251 in 1999,
in contrast with the Dow which at the same time increased more
than 12-fold. This is not a new story either. Gold's reputation
as a store of value had been eroded many times before, to wit,
during such historical episodes as the Tulipomania, the South
Seas Bubble, the Mississippi Bubble and, more recently, during
the Roaring Twenties of the Twentieth Century.
Norris informs his readers
that the IMF is to sell "surplus" gold, a move applauded
(ordered?) by the U.S. Treasury, to help finance the laudable
program to forgive debts owed by the very poor countries. He
explains that money from gold sales is to be invested in U.S.
Treasury securities and the income from the investment will pay
off the loans. He concludes that "gold, which does not pay
interest, is a lousy investment".
Here Norris betrays how badly
misinformed he is. As every central banker and gold miner knows,
gold can earn interest even in the Twenty-First Century, provided
that you can find trustworthy borrowers. It is true that the
interest rate on gold loans (euphemistically called the "lease
rate") is but a small fraction of what the U.S. Treasury
is forced to pay on its debt. Yet this does not make gold a lousy
investment. Quite the contrary, it is this very fact that makes
gold such a superb investment. Financial writers ought to know
that yield varies inversely with quality. By Norris's logic a
government bond is a lousy investment in comparison with a junk
bond because the yield on it is lower. The reason why the U.S.
government is so anxious to push gold out of the international
monetary system is that the competition gold offers to irredeemable
promises is too telling for comfort. The fact remains that when
a central bank or the IMF sells gold, it is replacing the best
kind of monetary asset, one that is nobody's liability, with
the worst kind: the irredeemable promises of devaluation-happy
governments. In selling gold central banks and the IMF make their
balance sheet weaker, not stronger.
Why strong central banks fall over
themselves to sell gold
Norris gleefully reports that
the Swiss National Bank has also joined the "let's junk
gold" contest. He mockingly adds that the Swiss defection
is not unlike Rome embracing Protestantism. Of course, he fails
to mention that the Swiss were put under duress: Paul A. Volcker
was dispatched to Zürich to twist their arm. Even so, I
concede that an explanation is in order. When a weak central
bank is selling gold to meet its maturing liabilities, it is
acting logically. It is using gold to maintain its credit standing.
That is what gold is for. But when strong central banks, such
as the Swiss National Bank and the Bank of England are falling
over themselves to sell monetary gold from reserves under the
full glare of publicity, knowing that the inevitable result of
the fanfare will be the worst sales price for the asset on the
block, then logic is turned upside down. The lame explanation
that gold sales are designed to raise funds to perform good deeds
is for simpletons only. If the motif were really charity, then
there would be all the more reason to cut out glare and fanfare,
lest the trustees open themselves to charges of unfaithful stewardship.
We are fully justified in looking for a hidden agenda. I do not
pretend to know the real reason for this "negative gold
rush". I can only speculate: central banks are desperately
trying to prevent a melt-down threatening the financial system.
This crisis is largely unknown to the public, even though it
is potentially more damaging than any previous one in the 20th
century. It has to do with "naked" selling of call
options on gold bullion and other forms of forward sales by banks.
This activity has been officially encouraged by government as
a way to finance the stock market and real estate bubble, the
bursting of which would cause great damage to the world economy.
Central bank gold sales are designed to bail out short interest
in a futile effort to stave off a corner in gold.
What maintains the value of irredeemable
Norris does say that gold has
once served as protection against government plunder through
deliberate currency debasement. Moreover, he admits that there
is still plenty of it going on in the world. But he contends
that, with Mr.Greenspan in charge of green cheese production
and distribution, the answer to the problem is no longer gold.
It is, in the lingo of the day, "dollarization", a
sort of gold standard without gold. This is not a new story either.
In the 1960's governments were experimenting with what they used
to call "paper gold".
In order to appraise the idea
of putting the whole world on a dollar standard, we may recall
some basic facts. The American dollar is an irredeemable promise,
no better and no worse than the Russian ruble. The value of either
stands or falls on one thing, and one thing only: the support
of currency speculators. It is a fable that the difference between
the dollar and the ruble is the difference between the professionalism
of the Fed and the dilettantism of its Russian counterpart. Exactly
the same knowledge is available to central bankers in Moscow
that is available to Mr.Greenspan in Washington. Before currency
speculators decide which currencies to support and which ones
to dump they look at three factors as follows, in the same order
of priority: (1) the balance sheet of the central bank issuing
the currency; (2) the trade accounts of the country; (3) the
history of the government honoring its promises to pay. On the
last two counts the dollar is an unmitigated disaster. The U.S.
has been running a horrendous trade deficit for decades which
still keeps growing. Twice in the 20th century the U.S. government
broke faith with its creditors: in 1933 it defaulted on its domestic
and, forty years later, in 1973, on its international obligations.
In the latter instance the U.S. government was the perpetrator
of the debasement of all the currencies of the world, in wiping
out more than 90 percent of the purchasing power of the dollar
in less than a decade, including the non-gold reserves of central
banks - the greatest monetary destruction on record.
The only count on which the
dollar still shines in comparison with the irredeemable promises
of other central banks is the balance sheet of the Federal Reserve
banks, showing a higher ratio of gold assets to liabilities.
In fact, one reason why American officials are pushing other
governments to get rid of their gold while they themselves hang
on to the "barbarous relic" is that, thanks to Mr.
Greenspan's tutorials, they understand the role of gold in the
balance sheet. They understand that the moment American gold
reserves cease to be second to none speculators will unceremoniously
dump the dollar. In the meantime the more other central banks
can be pushed around to get rid of their gold the better it will
be for the political, economic, and military hegemony of the
Investment or insurance?
The discriminating observer
would look at gold not just as an investment the glitter of which
can be tarnished by central bank gold sales. He would also look
at it as an insurance against disaster caused by recklessness
at the helm, whether the boat of the world economy is run onto
a reef or whether it is run into an iceberg. For the prudent,
gold is an insurance policy the importance of which increases
with the dangers and uncertainties growing in the world with
the passing of every day. The price of gold is of secondary importance.
A low gold price simply means that insurance is momentarily cheap.
Why is it cheap? To put it bluntly, it is cheap because foolish
people are selling their life-savers while staring at the iceberg
which is about to hit the "unsinkable" Titanic. However,
as long as some people are willing to hold on to their life savers,
gold cannot be demonetized through wishful thinking.
This exposes the myth of the
"new American gold standard". It is solely based on
the hoard of fraudulently and unconstitutionally confiscated
gold which the American government still retains while exhorting
other governments to get rid of theirs.
* * *
to be added to update this piece written over six years ago.
At the close of the Greenspan Fed the boat of the world economy
is still buffeted between Scylla (inflation) and Charybdis (deflation).
If it is not smashed to pieces on the rock of Scylla, then it
will be sunk on the reef of Charybdis. Part of the myth is that
we are having low inflation thanks to the adroitness of helmsman
Greenspan. However, as the new helmsman Bernanke has warned,
deflation may well be the greater danger of the two. He is getting
ready to load the helicopters for the dollar-drop while gearing
up the printing presses for a fresh run.
In spite of all the anti-deflationary
maneuvers the Bernanke standard is still vulnerable to deflation.
This is because Mr. Bernanke, who is a devout believer in the
quantity theory of money, sees the essence of deflation in falling
prices rather than in collapsing demand and its corollary, vanishing
pricing power. Obviously, the printing-press remedy of Mr. Bernanke
does not address these. Because of collapsing demand and loss
of pricing power, businessmen will remain lethargic regardless
how much manna is dropped from Bernanke's helicopters. The dollar
bills will be picked up by speculators who thereupon join the
Fed's mad spending spree in the bond market offering risk-free
bets. The result will be falling interest rates further deepening
the deflationary crisis.
This is not to say that Bernanke's
helicopters cannot frighten the speculators. They certainly can.
If and when they do, speculators will dump bonds, currency, and
all. Mr. Bernanke is confident that he can cure deflation through
hyper-inflation. He cannot. Under hyper-inflation the currency
is losing value faster than can be replaced by printing more
of it. That is precisely the difference between inflation and
hyper-inflation. It spells further decline of demand and vanishing
pricing power, that is, more deflation, not less.
The success of the Greenspan
standard was due to Mr. Greenspan's steadfast refusal to authorize
plans to sell U.S. gold. The downfall of the Bernanke standard
will follow Mr. Bernanke's decision to authorize it when he finds,
much to his chagrin, that hyper-inflation is no cure for deflation.
November 15, 2005
Antal E. Fekete
Memorial University of Newfoundland
Professor Antal E. Fekete was born and educated
in Hungary. He immigrated to Canada in 1956. In addition to teaching
in Canada, he worked in the Washington DC office of Congressman
W. E. Dannemeyer for five years on monetary and fiscal reform
till 1990. He taught as visiting professor of economics at the
Francisco Marroquin University in Guatemala City in 1996. Since
2001 he has been consulting professor at Sapientia University,
Cluj-Napoca, Romania. In 1996 Professor Fekete won the first prize
in the International Currency Essay contest sponsored by Bank
Lips Ltd. of Switzerland. He also runs the Gold Standard
Copyright ©2005-2010 by A. E. Fekete<