December 7, 2022

Why A Gold Backed Currency Is No Longer Possible

It is ironic that one of the most eloquent proponents of a gold standard did the most to ensure that we will never have one.  Alan Greenspan’s 1966 paper entitled “Gold and Economic Freedom” expounded on the role of a gold backed currency in protecting wealth against inflation by restricting the amount of money that could be produced.

Greenspan notes that the creation of the Federal Reserve was based on the premise that a central bank could supply increased reserves to banks when necessary and thereby offset natural turn downs in the business cycle.

“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 was not long before the Fed’s ability to allow unchecked credit expansion by banks laid the groundwork for the economic collapse know as the Great Depression.  Greenspan states that in an attempt to offset a mild business contraction in 1927, massive amounts of new bank reserves fostered a speculative boom ending with the Wall Street Crash of 1929.

“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… 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.”

Fast forward 75 years and we are looking at an eerily similar situation.  Unlimited credit creation by the Fed creates multiple asset bubbles that precipitate an economic crash and the dawn of Great Depression II.

Greenspan goes on to explain why there was ardent opposition to the gold standard despite the catastrophic results of unchecked  credit creation by the Fed in the 1920’s and why deficit spending is equivalent to the confiscation of wealth.

“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).

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…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.”

Ironically, the man who best understood the merits of a gold backed currency became the driving force behind the unlimited credit expansion that lead to the largest financial crisis in U.S. history.

Greenspan’s compromise of principles is beyond reproach for a man who understood the consequences of  ultra easy monetary policies, yet allowed himself to be corrupted by lobbyists, bankers and politicians.  Does anyone expect a better performance from current Fed Chairman Ben Bernanke, a man who blatantly prints money in an overt attempt to further debase the U.S. dollar?

Incredibly, Alan Greenspan disingenuously initiated another discussion on the need for a gold standard earlier this year.  In an interview with Fox News in January 2011,  Mr. Greenspan had the temerity to say:

“We have at this particular stage a fiat money which is essentially money printed by a government and it’s usually a central bank which is authorized to do so. Some mechanism has got to be in place that restricts the amount of money which is produced, either a gold standard or a currency board or something to that nature, because unless you do that, all of history suggest that inflation will take hold with very deleterious effects on economic activity.”

http://youtu.be/yRJs5yL62BA

Three conclusions can be reached regarding a U.S. gold standard:

1.  Mr. Greenspan should cease talk about a U.S. gold standard and the dangers of unlimited credit expansion – his previous record  speaks for itself.

2.  The ability of the U.S. to adopt a gold backed currency has been overwhelmed by the debt and leverage which now threaten to bring on a deflationary collapse.  Ben Bernanke knows this which is why he has been printing money on an unprecedented scale.

Ironically, the creation of new credit may be the only factor preventing us from sliding into a deflationary depression  triggered by massive debt defaults.  Ben Bernanke’s prescription of inciting inflation and curing excessive debt with more debt may be the only poor policy option remaining to forestall an unimaginable economic nightmare.  With the global economy tottering on the edge of another financial crisis,  the adoption of a gold standard by the U.S. remains a very remote possibility.

3.  Since the government is not interesting in preserving the value of our currency, individual initiative becomes necessary.  Ten years of rising gold prices tells us the smart money is not waiting for a gold backed currency but instead is turning directly to gold.