|Posted by Jerrald J President on February 25, 2017 at 8:05 PM|
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
Chairman of the Federal
Reserve from 1987 to 2006
In recent months, concerns about
stagflation have been rising.
Do you believe that these concerns
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
As inflation pressures grow, do
you anticipate a renewed interest
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.
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
Gold Investor | February 2017 13
Gold: The ultimate insurance policy
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,
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
Gold Investor | February 2017 14
Do you think that fiscal policy
should be adjusted to aid monetary
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.
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
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
Gold: The ultimate insurance policy
Gold Investor | February 2017 15
The Central Bank of the Republic of Turkey.