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?
Other Works by Zola
Laissez Faire City Times,Volume 1 Issue 1 November 1, 1997