GOLD and economic freedom by Alan Greenspan

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GOLD AND ECONOMIC FREEDOM / BY ALAN GREENSPAN / August 19, 1996

From: http://www.321gold.com/fed/greenspan/1966.html

The words below in black are Mr. Greenspan's. The words in blue are from the owner of this website.

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.

We take this to mean that Mr. Greenspan is about to argue that a gold standard is a good thing. Let's see how well he makes his point.

** I wonder what he means by "statists'. At this point, it sounds like these hysterical antagonists are up to no good. Do you think he will make a case that they are scoundrels?

My computer's dictionary defines statism (sounds like satanism or sadism) as "a concentration of economic control and planning in the hands of a highly centralized government -- often extending to government ownership of industry" -- OHMIGOD -- they're Commies. So -- he starts right out by establishing a strawman as an adversary.

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

*** Well written but not convincing. Gold has never been shown to be necessary for a stable modern economy. or 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.

** Where is it shown that a certain commodity or commodities is a precondition of anything, let alone a “a division of labor economy.” ? -- whatever that means -- I think he is missing some punctuation. Certainly a system can be devised which does not need a commodity other than money, which Greenspan acknowledges as a commodity 6 printed lines back from this one

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.

*** Note that Mr. Greenspan cleverly uses the words “medium of exchange” instead of “commodity” but then doubles back and suggests we look for a “durable commodity” -- on a few lines forward. In my humble opinion, this shifting use of terms meant to confuse the reader, thus making it easy to sell his forthcoming point.

*** Also note that he does not mention “money” as being a potential choice for the honor of being the commodity although he has stated earlier that money is a commodity. I suspect, that if Mr. Greenspan is pressed on this point, he will claim that money he was talking about previously is not what the general public thinks is money.

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.

Whether 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. **

** This implies that all international debts are paid in silver or gold. That is not simply not true. It might not even be partially true. International bankers say they are using gold as a medium of exchange -- but in reality, gold is virtually never shipped back and forth to settle accounts. They all now mostly deal by recording all transactions in electronic and paper media. Whether they keep track by gold units or dollar units is not the least bit important. They all know there is not nearly enough gold in existence to replace all the wealth represented by the paper and electronic money records. The numbers that show on balance sheets will never be replaced by gold, silver or any other hard metal. When any debt contract between countries are made, It is commonly known and agreed that the debt may be settled by any commodity that has historically been used between the countries as a standard of value. Thus if country (A) which is rich in mined metals, trades with country (B) , which is rich in wheat, the contract might say they are trading in X dollars or X pounds of gold -- but the contract will always be settled by mined metals and wheat. The fact that the dollars or gold is used as a medium of exchange -- does not mean that the transaction is literally in gold or dollars. Beware of the phrase “medium of exchange”. That phrase does not mean that either trading party has gold or dollars on hand -- it simply means the debt will be settled by some material that has a “book” value of so much gold or so many dollars.

Gold, having both artistic and functional uses and being relatively scarce, has significant advantages over all other media of exchange. **

** We can’t accept this flat, bald statement. He should have, at least, added “except paper money issued by a well established government”. He must know that addition is needed to make the statement true.

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.

**He should have used the words “money system” instead of “banking system”. Using “banking” in place of money, cleverly puts “banks” equal to or superior to “money”.

***The use of “credit instruments (bank notes and deposits” also tilts the argument away from the possibility of simply using the money we carry around in our purses and wallets.

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. (D) Individual owners of gold are induced, by payments of interest, to deposit their gold in a bank (against which they can draw checks).

** Note the new term ”free banking system “

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.***

***This would be true even if the “banking system” (or money system) were not based on gold. Nowhere in the preceding argument has Mr. Greenspan proven that gold is necessary.

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.**

** The gold standard has not been shown to be necessary to make this true. Any accepted standard of value would do

(B) Note that we are now discussing international trade (line 9 to line 16). This issue is separate and distinctly different from national trade within a single country.

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. **

** Note that we are now discussing international trade. This issue is separate and distinctly different from national trade within a single country.

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. **

** This would be true whether or not each country was on a gold standard. There is much wealth in most countries and their wealth is really the backing for that county’s money. The gold is only used as a standard of value.

A fully free banking system ** and fully consistent gold standard have not as yet been achieved.

** What is a “fully free banking system”?

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.

** This is simply not likely if the money system is based on Fractional Reserve Banking. Mr Greenspan is jumping to an unwarranted conclusion.

(Compared with the depressions of 1920 and 1932, the pre-World War I business declines were mild indeed. **

** Mr. Greenspan is shifting semantic gears for no apparent reason. He is now suddenly writing about the severity of various depressions. I think he is trying to argue that a gold standard can limit depressions -- but I do not think he has come close to making his case.

It was limited gold reserves that stopped the unbalanced expansions of business activity, before they could develop into the post-World Was 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 **.

** How dare Mr. Greenspan blithely make this bald claim about why the Federal Reserve System was organized. Many distinguished writers disagree with his analysis. He knows there is a lot more to it than he says.

It ** consisted of twelve regional Federal Reserve banks nominally owned by private bankers, but in fact government sponsored, controlled, and supported ***

** He is talking about the Federal Reserve System. To use the word “it” makes the sentence ambiguous. Mr. Greenspan is an acknowledged expert communicator. He must know that it would have been better to spell out what he claims the government “sponsored, controlled, and supported”.

*** The government has never controlled the Federal Reserve System. Mr. Greenspan must know that. for him to claim otherwise is just awful.The government obviously sponsored and supported the Federal Reserve System -- but that sponsoring and supporting is seen as a terrible travesty by many people in and out of the government.

Credit extended by these banks is in practice (though not legally)** backed by the taxing power of the federal government.

** What is the implication of the words “not legally”?

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. **

** Is there anything wrong with “paper reserves”? They sound so inferior to “gold reserves” -- but in fact, one is as good as the other as a reserve.

** Even if this is true it is beside the question we raise. The question is -- who, according to the Constitution, shall control the money system?

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.***

*** it seems that mr. Greenspan is now arguing (weakly) that the Fed made many mistakes from 1927 to 1931. Whether that is true or not is beside the point of this discussion. Others explain the causes of depression in the early thirties differently. In any case, it looks like the Fed was at fault.

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.

NOTE: We put four asterisks **** after the words “productive members” and “welfare” to show how many times Greenspan used these words in this short article. It seems to us he is unjustifiably fomenting an unhealthy class divide by this unfortunate focus. Shame on him.

(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.)

** “Mixed gold standard” is a new phrase -- probably inserted here to confuse the issue. I hope we are not getting too cynical

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).

*** “Welfare****-state advocates” is a new phrase here. It sounds like a not so subtle attack on Greespan’s natural academic, leftish opponents.

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.

** Notice the phrases “productive members **** of a society” and “welfare**** schemes””. This is typical of Greenspan who is here fomenting fear and class stress -- if not class warfare. In addition to being typical -- it is despicable for a man in his position to say such things. Notice how many times “welfare****” and “productive members ****” are used on these pages.

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.

** Here, instead of putting words in his opponents mouths -- he is putting thoughts “quick to recognize” in their heads. Shame on you Mr. Greenspan for apparently trying to confuse this issue by bringing in right/left arguments.

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.***

*** Greenspan must also know that the American Dollar and the Money of every other country is essentially backed by the inherent value of the wealth in all those countries. All the gold in the world comes nowhere close to the value of all the human wealth in the world. Which would you rather have -- (a) all the gold -- or (b) all the wealth?

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 ***.

*** From here to the end of his writing, Mr. Greenspan is obviously primarily interested in railing against the enemies of a “gold standard”, an “unlimited expansion of credit”, “paper reserves” and those that attempt to “con” the public.

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 (B) money proceeds of the government bonds financed by bank credit expansion. **

** Greenspan must know that it is intellectually dishonest to blame the “this loss” solely on “bank credit expansion”. He is ignoring all sorts of reasons for the inflation he is blaming. Shame on him.

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. ***

*** This theoretical argument is, in my opinion, ridiculous. He sets forth two impossible actions for “everyone” (1) “conversion of all bank deposits to silver or copper or any other good” and (2) “ thereafter declined to accept checks as payment for goods.”. Greenspan must know that theoretical arguments are invalid as an argument as to what would happen in the real world if the actions required by the arguments are impossible. Shame on him.

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. **

** This sentence is a conclusion -- but Greenspan never put forward a logical argument that leads to this conclusion (try to find that logical argument). This is a clever rhetorical trick with no validity. Sharpsters make confusing, disjointed, rambling arguments -- and then state a conclusion knowing full well that his arguments do not logically lead to that conclusion. The trickster is counting on the fact that the reader will be confused and simply assume that he, the reader, just does not understand the argument. This works well if the writer is a generally respected person.

If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard. ***

*** Greenspan certainly hasn’t made an effective argument that leads to this conclusion. He has made an argument -- but it is not the least convincing. (it is more conniving than convincing)

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