Ron Paul's Great Question
Jude Wanniski
July 26, 2005


Memo To: Rep. Ron Paul [R TX]
From: Jude Wanniski
Re: Greenspan and Gold

Dear Ron...I didn't watch all of Greenspan's testimony before the House Financial Affairs Committee last Wednesday, but I was lucky enough to catch the one question they gave you time to ask. Indeed, you were the only member of either your committee or Senate Banking the following day to ask him about gold and its place in the monetary realm. But first, by way of background, you reminded him that with this floating dollar, tied to nothing real, we have a system that is "a convenient way to default on our debt -- to liquidate our debt after the inflationary scheme."

Even you, in the 1960s, described the paper system as a scheme for the confiscation of wealth.... Is it not true that the paper system that we work with today is actually a scheme to default on our debt? And is it not true that, for this reason, that's a good argument for people not -- eventually, at some day -- wanting to buy Treasury bills because they will be paid back with cheaper dollars?....

And aligned with this question, I would like to ask something to dealing exactly with gold, is that: If paper money -- today it seems to be working rather well -- but if the paper system doesn't work, when will the time come? What will the signs be that we should reconsider gold? Even in 1981, when you came before the Gold Commission, people were frightened about what was happening -- and that's not too many years ago. And you testified that it might not be a bad idea to back our government bonds with gold in order to bring down interest rates. So what are the conditions that might exist for the central bankers of the world to reconsider gold? We do know that they haven't given up on gold. They haven't gotten rid of their gold. They're holding it there for some reason. So what's the purpose of the gold if it isn't with the idea that some day they might need it? They don't hold lead or pork bellies. They hold gold. So what are the conditions that you might anticipate when the world may reconsider gold?

Given the fact that this was probably the last shot you'd have to put a question to Alan, the Fed Chairman these past 18 years, Ron, this was a great question. And to tell you the truth, I was shocked by Greenspan's answer:

GREENSPAN: Well, you say central banks own gold -- or monetary authorities own gold. The United States is a large gold holder. And you have to ask yourself: Why do we hold gold? And the answer is essentially, implicitly, the one that you've raised -- namely that, over the generations, when fiat monies arose and, indeed, created the type of problems -- which I think you correctly identify -- of the 1970s, although the implication that it was some scheme or conspiracy gives it a much more conscious focus than actually, as I recall, it was occurring. It was more inadvertence that created the basic problems.

But as I've testified here before to a similar question, central bankers began to realize in the late 1970s how deleterious a factor the inflation was. And, indeed, since the late '70s, central bankers generally have behaved as though we were on the gold standard. And, indeed, the extent of liquidity contraction that has occurred as a consequence of the various different efforts on the part of monetary authorities is a clear indication that we recognize that excessive creation of liquidity creates inflation which, in turn, undermines economic growth.

So that the question is: Would there be any advantage, at this particular stage, in going back to the gold standard? And the answer is: I don't think so, because we're acting as though we were there. Would it have been a question at least open in 1981, as you put it? And the answer is yes. Remember, the gold price was $800 an ounce. We were dealing with extraordinary imbalances, interest rates were up sharply, the system looked to be highly unstable -- and we needed to do something.

Now, we did something. The United States -- Paul Volcker, as you may recall, in 1979 came into office and put a very severe clamp on the expansion of credit, and that led to a long sequence of events here, which we are benefiting from up to this date. So I think central banking, I believe, has learned the dangers of fiat money, and I think, as a consequence of that, we've behaved as though there are, indeed, real reserves underneath the system.

Too bad you had no time for a follow-up question, or you might have asked him about the wide swings in the dollar gold price during his tenure, and how they seem to have gotten worse with time, not better. Look at the chart of the dollar/gold price and you'll see after an initial spurt to $500 from $400, gold dipped to $350 oz in 1985 and hovered there for several years, to 1997. Greenspan could then have said he was producing a de facto gold standard. But look at the path gold followed thereafter, bringing in its wake a great deflation and now a new, incipient inflation, with consequences Greenspan now admits he still does not understand. He calls the movement of interest rates just this past year as a "conundrum."

Yes, at first I was shocked to hear Greenspan say he did not see any circumstances that would require the dollar to be fixed to gold again, as it had been for most of our history until President Nixon floated the dollar in 1971. But then, Greenspan would have had to acknowledge the gold signal would have done a vastly superior job in managing the value of the dollar these past 18 years than he has done, and that is not the legacy he wishes to leave.

Notice he credits his predecessor, Paul Volcker, for having "put a very severe clamp on the expansion of credit, and that led to a long sequence of events here, which we are benefiting from up to this date." That's part of the conspiracy among central bankers who essentially don't know what they are doing from day to day, as Greenspan should know Volcker never put a "severe clamp on credit." It was Volcker, the new Fed chairman in 1979, who presided over the stunning rise in the price of gold, from the $240 oz level to as high as $850 oz on February 1, 1980. The price of gold only came down because the Reagan tax cuts of 1981 sharply increased the demand for dollars, and Volcker simply watched as the markets ended the inflation.

One member of your committee after another heaped praise on Greenspan, knowing he will not be back next year to appear before the committee. The same was true in Senate Banking. My gosh, the Maestro!! What would we have done without him? Well, I think you know the answer, that we would have done a lot better if we had been on the gold standard Nixon left instead of the paper standard that Greenspan should have ended… which is what so many of us expected him to do.