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Gold: The ultimate insurance policy

Posted by Jerrald J President on February 25, 2017 at 8:05 PM

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Gold: The ultimate insurance policy


 

Dr Alan Greenspan was Chairman

of the Federal Reserve from 1987 to

2006 and has advised government

agencies, investment banks, and

hedge funds ever since. Here, he

reveals his deep concerns about

economic prospects in the developed

world, his view on gold’s important

role in the monetary system and

his belief in gold as the ultimate

insurance policy.

Alan Greenspan

Chairman of the Federal

Reserve from 1987 to 2006

1

In recent months, concerns about

stagflation have been rising.

Do you believe that these concerns

are legitimate?

We have been through a protracted period of stagnant

productivity growth, particularly in the developed world,

driven largely by the aging of the ‘baby boom’ generation.

Social benefits (entitlements in the US) are crowding out

gross domestic savings, the primary source for funding

investment, dollar for dollar. The decline in gross domestic

savings as a share of GDP has suppressed gross nonresidential

capital investment. It is the lessened investment

that has suppressed the growth in output per hour globally.

Output per hour has been growing at approximately ½%

annually in the US and other developed countries over

the past five years, compared with an earlier growth rate

closer to 2%. That is a huge difference, which is reflected

proportionately in the gross domestic product and in

people’s standard of living.

As productivity growth slows down, the whole economic

system slows down. That has provoked despair and a

consequent rise in economic populism from Brexit to

Trump. Populism is not a philosophy or a concept, like

socialism or capitalism, for example. Rather it is a cry of

pain, where people are saying: Do something. Help!

At the same time, the risk of inflation is beginning to rise.

In the United States, the unemployment rate is below 5%,

which has put upward pressure on wages and unit costs

generally. Demand is picking up, as manifested by the

recent marked, broad increase in the money supply, which

is stoking inflationary pressures. To date, wage increases

have largely been absorbed by employers, but, if costs

are moving up, prices ultimately have to follow suit. If you

impose inflation on stagnation, you get stagflation.

The Federal Reserve’s gold vault.

Gold Investor | February 2017

Gold: The ultimate insurance policy

2

As inflation pressures grow, do

you anticipate a renewed interest

in gold?

Significant increases in inflation will ultimately increase the

price of gold. Investment in gold now is insurance. It’s not

for short-term gain, but for long-term protection.

I view gold as the primary global currency. It is the only

currency, along with silver, that does not require a counterparty

signature. Gold, however, has always been far more

valuable per ounce than silver. No one refuses gold as

payment to discharge an obligation. Credit instruments and

fiat currency depend on the credit worthiness of a counterparty.

Gold, along with silver, is one of the only currencies

that has an intrinsic value. It has always been that way. No

one questions its value, and it has always been a valuable

commodity, first coined in Asia Minor in 600 BC.

3

Over the past year, we have

witnessed Brexit, Trump’s election

victory, and a decisive increase in

anti-establishment politics. How

do you think that central banks

and monetary policy will adjust to

this new environment?

The only example we have is what happened in the 1970s,

when we last experienced stagflation and there were

real concerns about inflation spiraling out of control. Paul

Volcker was brought in as chairman of the Federal Reserve,

and he raised the Federal Fund rate to 20% to stem the

erosion. It was a very destabilising period and by far the

most effective monetary policy in the history of the Federal

Reserve. I hope that we don’t have to repeat that exercise

to stabilise the system. But it remains an open question.

The European Central Bank (ECB) has greater problems

than the Federal Reserve. The asset side of the ECB’s

balance sheet is larger than ever before, having grown

steadily since Mario Draghi said he would do whatever it

took to preserve the euro. And I have grave concerns about

the future of the Euro itself. Northern Europe has, in effect,

been funding the deficits of the South; that cannot continue

indefinitely. The eurozone is not working.

In the UK, meanwhile, it remains unclear how Brexit will

be resolved. Japan and China remain mired in problems as

well. So, it is very difficult to find any large economy that

is reasonably solid, and it is extremely hard to predict how

central banks will respond.

I view gold as

the primary

global currency.

12

Gold Investor | February 2017 13

Gold: The ultimate insurance policy

4

Although gold is not an official

currency, it plays an important role

in the monetary system. What role

do you think gold should play in

the new geopolitical environment?

The gold standard was operating at its peak in the late

19th and early 20th centuries, a period of extraordinary

global prosperity, characterised by firming productivity

growth and very little inflation.

But today, there is a widespread view that the 19th century

gold standard didn’t work. I think that’s like wearing the

wrong size shoes and saying the shoes are uncomfortable!

It wasn’t the gold standard that failed; it was politics.

World War I disabled the fixed exchange rate parities and

no country wanted to be exposed to the humiliation of

having a lesser exchange rate against the US dollar than it

enjoyed in 1913.

Britain, for example, chose to return to the gold standard

in 1925 at the same exchange rate it had in 1913 relative

to the US dollar (US$4.86 per pound sterling). That was a

monumental error by Winston Churchill, then Chancellor of

the Exchequer. It induced a severe deflation for Britain in

the late 1920s, and the Bank of England had to default in

1931. It wasn’t the gold standard that wasn’t functioning;

it was these pre-war parities that didn’t work. All wanted

to return to pre-war exchange rate parities, which, given

the different degree of war and economic destruction

from country to country, rendered this desire, in general,

wholly unrealistic.

Today, going back on to the gold standard would be

perceived as an act of desperation. But if the gold standard

were in place today we would not have reached the

situation in which we now find ourselves. We cannot afford

to spend on infrastructure in the way that we should. The

US sorely needs it, and it would pay for itself eventually in

the form of a better economic environment (infrastructure).

But few of such benefits would be reflected in private cash

flow to repay debt. Much such infrastructure would have to

be funded with government debt. We are already in danger

of seeing the ratio of federal debt to GDP edging toward

triple digits. We would never have reached this position

of extreme indebtedness were we on the gold standard,

because the gold standard is a way of ensuring that fiscal

policy never gets out of line.

Today there is a

widespread view that

the 19th century gold

standard didn’t work.

I think that’s like

wearing the wrong size

shoes and saying the

shoes are uncomfortable!

Significant increases in

inflation will ultimately

increase the price of gold.

Investment in gold now

is insurance. It’s not for

short-term gain, but for

long-term protection.

Gold Investor | February 2017 14

5

Do you think that fiscal policy

should be adjusted to aid monetary

policy decisions?

I think the reverse is true. Fiscal policy is much more

fundamental policy. Monetary policy does not have the

same potency. And if fiscal policy is sound, then monetary

policy becomes reasonably easy to implement. The very

worst situation for a central banker is an unstable fiscal

system, such as we are experiencing today.

The central issue is that the degree of government

expenditure growth, largely entitlements, is destabilising

the financial system. The retirement age of 65 has changed

only slightly since President Roosevelt introduced it in

1935, even though longevity has increased substantially

since then. So, the first thing we have to do is raise the

retirement age. That could cut expenditure appreciably.

I also believe that regulatory capital requirements for banks

and financial intermediaries need to be much higher than

they are currently. Looking back, every crisis of recent

generations has been a monetary crisis. The non-financial

part of the US economy was in good shape before 2008,

for example. It was the collapse of the financial system that

brought down the non-financial part of the economy. If you

build up enough capital in the financial system, the chances

of serial, contagious default are much decreased.

If we raised capital requirements for commercial banks,

for example, from the current average rate of around

11% to 20% or 30% of assets, bankers would argue

that they could not make profitable loans under such

circumstances. Office of the Controller of the Currency

data dating back to 1869 suggests otherwise. These data

demonstrate that the rate of bank net income to equity

capital has ranged between 5% and 10% for almost all

the years of the data’s history, irrespective of the level of

equity capital to assets. This suggests we could phase in

higher capital requirements overtime without decreasing

the effectiveness of the financial system. To be sure there

would likely be some contraction in lending, but, arguably,

those loans should, in all likelihood, never have been made

in the first place.

6

Against a background of ultra-low

and negative interest rates, many

reserve managers have been

large buyers of gold. In your view,

what role does gold play as a

reserve asset?

When I was Chair of the Federal Reserve I used to testify

before US Congressman Ron Paul, who was a very strong

advocate of gold. We had some interesting discussions.

I told him that US monetary policy tried to follow signals

that a gold standard would have created. That is sound

monetary policy even with a fiat currency. In that regard,

I told him that even if we had gone back to the gold

standard, policy would not have changed all that much.

The very worst situation

for a central banker

is an unstable fiscal

system, such as we are

experiencing today.

Gold: The ultimate insurance policy

Gold Investor | February 2017 15

The Central Bank of the Republic of Turkey.

Maximising g


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