Alan Goldspan

From: Rakesh Bhandari (bhandari@BERKELEY.EDU)
Date: Wed Nov 17 2004 - 10:59:55 EST

oops in the last message I meant money is half man,half horse--a
modern centaur.

Here is another piece by someone, let's say, well connected. Good title.
Professor Reuven Brenner, "Alan Goldspan," Financial Post.

January 21, 2003

(This article was reprinted as part of a White Paper before the
Australian Senate from the Committee on How to Re-Plan Australia, p.
16, Spring 2004)
Seemingly out of the blue, the U.S. Federal Reserve chairman is
hinting at a return to the gold standard. If so, currency markets are
in for a shock.
Last month in a speech before the Economic Club of New York, Alan
Greenspan praised the gold standard, the first time he has
unambiguously done so since joining the U.S. Federal Reserve.
"Although the gold standard could hardly be portrayed as having
produced a period of price tranquility, it was the case that the
price level in 1929 was not much different, on net, from what it had
been in 1800," he stated. "But in the two decades following the
abandonment of the gold standard in 1933, the consumer price index in
the United States nearly doubled. And in the four decades after that,
prices quintupled. Monetary policy, unleashed from the constraint of
domestic gold convertibility, had allowed a persistent over-issuance
of money."
Is Greenspan returning implicitly to his long-held strong beliefs,
which he voiced explicitly before he became Fed chairman, of having
the gold price guide U.S. monetary policy? If so, that would mean
keeping the gold price (in terms of the dollar) stable. Under this
standard, as Greenspan accurately points out, the price level in the
United States stayed stable through wars and much technological and
political upheaval. The implication is clear: There is no problem
achieving such stability in future, even if the United States goes to
war, and even if much technological and political upheavals continue.
During the six decades since the Americans left the gold standard,
prices rose tenfold. This happened not because these decades were
more turbulent than the preceding 13, but because of the faddish
belief, rationalized by much of the economic profession, that central
bankers could do a better job managing monetary policy by setting
interest rates and exchange rates than by market-guided,
gold-price-anchored discipline.
The fad's long life is not surprising. Central planing, based on the
belief that bureaucrats know how to price wheat, physicians, nurses
and teachers better than people involved in the respective
businesses, has been enduring for centuries, in spite of evidence to
the contrary. The view that central banks could best manage monetary
affairs by pricing interest rates and exchange rates thus fit
perfectly into this bureaucratic frame of mind. Though, as Greenspan
points out, the evidence contradicts this viewpoint.
Before 1996, Greenspan often indicated that gold prices were guiding
his monetary policy. Then he abandoned all reference to them -- until
last month's speech. His strong statement comes like lightening out
of the blue sky. With another Federal Reserve governor, Ben Bernanke,
repeating part of Greenspan's comments, we get a strong signal of
where the U.S. dollar is heading -- if Greenspan goes from words to
actions. Before we get to the numbers, here is what Greenspan said
concerning monetary policy and deflationary pressures:
"But the adverse consequences of excessive money growth for financial
stability and economic performance provoked a backlash. Central banks
were finally pressed to rein in over-issuance of money, even at the
cost of considerable economic disruption. By 1979, the need for
drastic measures had become painfully evident in the United States.
The Federal Reserve under the leadership of Paul Volcker, with the
support of both the Carter and Reagan administrations, dramatically
slowed the growth of money. Initially, the economy fell into
recession and inflation receded. However, most important, when
activity staged a vigorous recovery, the progress made in reducing
inflation was largely preserved. By the end of the 1980s, the
inflation climate was being altered dramatically."
Greenspan also said that, in the short and medium run, the link
between money and prices is unclear, which means that targeting
"inflation" rates cannot have the desired effects. If Greenspan will
act upon all these views -- and that's yet to be seen -- U.S.
monetary policy will be radically transformed.
What can we expect, then, to happen to the U.S. dollar? To gold
prices? To the euro? To the Canadian dollar?
First, let's understand that using gold prices for monetary guidance
means, as Greenspan emphasizes, that companies and governments can
safely get into U.S. dollar contractual agreements without worrying
about its value, be it over short, medium or very long hauls. The
difference between a gold-guided policy and one guided by
inflationary targets is important. Price levels are backward looking
and mismeasured. It's not surprising, then, that although central
bankers have targeted low inflation in the United States, Europe,
Canada and elsewhere, the policy did not have the desired results
that most economists expected. Exchange rates have fluctuated up and
down in 50% ranges, violating the value of contractual agreements and
making capital more expensive. While one could mitigate the
consequences by hedging with complex and expensive derivatives,
derivatives do not come cheap.
What happened to lead Greenspan to abandon his opaqueness of the last
few years and clearly tout the benefits of the gold standard? Here I
enter the realm of speculation.
In the last decade, the world lost two of its three reserve
currencies -- the yen and the DM -- leaving only the U.S. dollar. The
Japanese have been mismanaging their economy and monetary policy for
a dozen years and, contrary to expectations, the euro has not been
anchored in the DM, but in a vague, unreliable "inflationary" target
that Greenspan dismisses with good reason: As noted above, such
targets did not prevent exchange rates from sharply fluctuating.
Something was obviously not working. The euro's recent rise is no
indication that it is about to become a reserve currency. The dollar
continues to stand alone, its mismanagement over the last five years
notwithstanding .
Between late 1993 and mid 1996, gold was roughly at US$400, give or
take US$10. At the end of 1996, the severe decline in gold prices and
the rise in the U.S. dollar starts, with gold hitting its lowest
level on July 20, 1999 at $252.80. Why did the U.S. dollar go up
relative to almost every currency and commodity prices? The increased
demand for the dollar had a number of causes, only one of which was
its expanding status as reserve currency. Another cause was the
growing demand for the U.S. dollar around the world with the faster
growing economies of the 1990s. Greenspan did not respond to the
increased global demand; instead he brought about the disastrous
currency fluctuations of the last six years.
Based on Greenspan's earlier speeches, we may then speculate on what
might have caused him to pursue the erroneous policy, and what may
have led to his drastic change of mind. It was in 1996 that Greenspan
made his famous speech on "irrational exuberance" at a time the Dow
was in the 6,000 range. Since now, six years later, the Dow is
hovering between 8,000 and 9,000 even after expectations of lowered
growth rates, terror, war and Latin American upheavals, Greenspan may
have realized his mistake, thinking that the 6,000 level was too
high, and that he must apply restrictive monetary policy to lower it.
Also, last year, finally, Greenspan started to talk about deflation.
Since Greenspan had been an ardent believer in the gold standard
before becoming chairman of the Fed, he may have put together the
sequence of events and recognized the errors of his ways. After all,
if one looked at all these facts and sequence of events over the last
six years through a "gold price" perspective, they should not have
been a surprise. They were predictable.
This realization does not imply that the Fed will now buy either
treasury or other government bonds (the two options that he and
Bernanke raised in their speeches) with newly minted dollars until
gold goes back to the US$400 level. With war and diminished growth
rates on the horizon (even with the fiscal stimulus), the global
demand for the dollar is not what it was in the late 1990s. Choosing
a rough, rounded average of US$350 as a target may be a reasonable
guess for a Greenspan "target" point. He might have chosen it
already: He knows that the global demand for the dollar has been
declining since 2001, yet the monetary base is up by roughly 8% over
the last year. Unsurprisingly, the dollar has been in decline
relative to most major currencies, sliding to a level where it should
have been.
If my analysis is in the right ballpark and Greenspan from now on
uses the gold price to guide his monetary policy, no further
significant increase in the price of gold should be expected. If
demand for the U.S. dollar continues to drop, the Fed will issue
treasury bonds, and if it rises, it would buy them or other
government bonds. Once the U.S. dollar becomes "as good as gold,"
even if informally, and with the present fiscal stimulus, capital
will flow to the U.S., the euro will weaken, and so will the Canadian
Reuven Brenner, a professor at McGill University's Faculty of
Management, is the author of Force of Finance. He is a member of the
Financial Post's Board of Economists.
 Copyright 2003 National Post

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