Greenspan on Gold (1966)

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may already have read Alan Greenspan’s essay, “Gold
and Economic Freedom
,” which was published in Ayn Rand’s “Objectivist”
newsletter in 1966, and reprinted in her book, Capitalism:
The Unknown Ideal
, in 1967.

has never publicly retracted a word of this essay.

This essay
is a good introduction to the government’s war on gold. It summarizes
the basic issue: the comparative liberty that a government-guaranteed
gold coin standard offers to a society. A gold coin standard places
a restraint on the government’s ability to defraud the public
through monetary inflation.

The problem
is, a government-guaranteed gold standard is guaranteed by the
government. As I like to say, a government-guaranteed gold standard
isn’t worth the paper it’s written on. But, for as long as the
government redeems its paper money or its credit money on demand
— in gold coins of a fixed weight and fineness, at a fixed exchange
rate with the government’s money — the public does possess a
lever of power against the government: the threat of a “bank run”
against the biggest bank, the government’s central bank. In the
case of the United States, this is the Federal Reserve System.
How ironic that Alan Greenspan is the chairman of the FED’s Board
of Governors.

Please note:
Greenspan can speak in English when he wants to. He is not confined
to what James Grant has called central banker Esperanto.


by Alan Greenspan

An almost
hysterical antagonism toward the gold standard is one issue which
unites statists of all persuasions. 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.

In order
to understand the source of their antagonism, it is necessary
first to understand the specific role of gold in a free society.

Money is
the common denominator of all economic transactions. It is that
commodity which serves as a medium of exchange, is universally
acceptable to all participants in an exchange economy as payment
for their goods or services, and can, therefore, be used as a
standard of market value and as a store of value, i.e., as a means
of saving.

The existence
of such a commodity is a precondition of a division of labor economy.
If men did not have some commodity of objective value which was
generally acceptable as money, they would have to resort to primitive
barter or be forced to live on self-sufficient farms and forgo
the inestimable advantages of specialization. If men had no means
to store value, i.e., to save, neither long-range planning nor
exchange would be possible.

What medium
of exchange will be acceptable to all participants in an economy
is not determined arbitrarily. First, the medium of exchange should
be durable. In a primitive society of meager wealth, wheat might
be sufficiently durable to serve as a medium, since all exchanges
would occur only during and immediately after the harvest, leaving
no value-surplus to store. But 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. A metal is generally chosen because it is homogeneous and
divisible: every unit is the same as every other and it can be
blended or formed in any quantity. Precious jewels, for example,
are neither homogeneous nor divisible. More important, the commodity
chosen as a medium must be a luxury. Human desires for luxuries
are unlimited and, therefore, luxury goods are always in demand
and will always be acceptable. Wheat is a luxury in underfed
civilizations, but not in a prosperous society. Cigarettes ordinarily
would not serve as money, but they did in post-World War II Europe
where they were considered a luxury. The term “luxury good” implies
scarcity and high unit value. 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 the early
stages of a developing money economy, several media of exchange
might be used, since a wide variety of commodities would fulfill
the foregoing conditions. However, one of the commodities will
gradually displace all others, by being more widely acceptable.
Preferences on what to hold as a store of value will shift to
the most widely acceptable commodity, which, in turn, will make
it still more acceptable. The shift is progressive until that
commodity becomes the sole medium of exchange. The use of a single
medium is highly advantageous for the same reasons that a money
economy is superior to a barter economy: it makes exchanges possible
on an incalculably wider scale.

the single medium is gold, silver, seashells, 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 uses and being relatively scarce, has significant
advantages over all other media of exchange. Since the beginning
of World War I, it has been virtually the sole international standard
of exchange. If all goods and services were to be paid for in
gold, large payments would be difficult to execute and this would
tend to limit the extent of a society’s divisions of labor and
specialization. Thus a logical extension of the creation of a
medium of exchange is the development of a banking system and
credit instruments (bank notes and deposits) which act as a substitute
for, but are convertible into, gold.

A free banking
system based on gold is able to extend credit and thus to create
bank notes (currency) and deposits, according to the production
requirements of the economy. Individual owners of gold are induced,
by payments of interest, to deposit their gold in a bank (against
which they can draw checks). But since it is rarely the case that
all depositors want to withdraw all their gold at the same time,
the banker need keep only a fraction of his total deposits in
gold as reserves. This enables the banker to loan out more than
the amount of his gold deposits (which means that he holds claims
to gold rather than gold as security of his deposits). But the
amount of loans which he can afford to make is not arbitrary:
he has to gauge it in relation to his reserves and to the status
of his investments.

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. When gold is accepted
as the medium of exchange by most or all nations, an unhampered
free international gold standard serves to foster a world-wide
division of labor and the broadest international trade. 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.

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.

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.

With a logic
reminiscent of a generation earlier, statists argued that the
gold standard was largely to blame for the credit debacle which
led to the Great Depression. If the gold standard had not existed,
they argued, Britain’s abandonment of gold payments in 1931 would
not have caused the failure of banks all over the world. (The
irony was that since 1913, we had been, not on a gold standard,
but on what may be termed “a mixed gold standard”; yet it is gold
that took the blame.) 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 law of supply and demand is not to be conned. As the supply
of money (of claims) increases relative to the supply of tangible
assets in the economy, prices must eventually rise. Thus the earnings
saved by the productive members of the society lose value in terms
of goods. When the economy’s books are finally balanced, one finds
that this loss in value represents the goods purchased by the
government for welfare or other purposes with the money proceeds
of the government bonds financed by bank credit expansion.

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. If everyone decided, for example,
to convert all his bank deposits to silver or copper or any other
good, and thereafter declined to accept checks as payment for
goods, bank deposits would lose their purchasing power and government-created
bank credit would be worthless as a claim on goods. The financial
policy of the welfare state requires that there be no way for
the owners of wealth to protect themselves.

This is
the shabby secret of the welfare statists’ tirades against gold.
Deficit spending is simply a scheme for the confiscation of wealth.
Gold stands in the way of this insidious process. It stands as
a protector of property rights. If one grasps this, one has no
difficulty in understanding the statists’ antagonism toward the
gold standard.

29, 2003

North is the author of Mises
on Money
. Visit
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