2a EST Thursday, March 16, 2000
Dear Friend of GATA and Gold:
Here's another great essay by Reginald H. Howe,
Harvard-trained lawyer and former mining company
executive. Please post it as seems useful.
CHRIS POWELL, Secretary/Treasurer
Gold Anti-Trust Action Committee Inc.
* * *
Collision Course: Gold and Greenspan
By Reginald H. Howe
www.GoldenSextant.com
March 14, 2000
Alan Greenspan has not always had as much difficulty
defining money and differentiating it from credit as he
did in his Humphrey-Hawkins testimony quoted in my
prior commentary. In his 1966 essay "Gold and Economic
Freedom" (reprinted in A. Rand, "Capitalism: The
Unknown Ideal"), the future Fed chairman discussed the
consequences of the Federal Reserve's decision in 1927
to reduce interest rates in response to a mild U.S.
contraction and continuing losses of British gold due
to politically inspired lower rates in Britain:
The Fed succeeded: It stopped the gold loss, but it
nearly destroyed the economies of the world in the
process. The excess credit the Fed pumped into the
economy spilled over into the stock market, triggering
a fantastic speculative boom. Belatedly, the Fed
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 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 worldwide series of bank failures. The world plunged
into the Great Depression of the 1930s.
Today the Fed's critics see wild speculation,
particularly in the technology sector, where stock
market valuations exceed all historic norms of
rationality. But the Fed chairman is among the most
influential propagandists for the so-called "new"
economy. Cogent commentaries on the new economy by
Veneroso Associates (www.venerosoassociates.com)
suggest not only that the new economy's claimed
productivity increases are greatly exaggerated, but
also that no one should be more aware of the shaky
statistical foundations that underlie them than Alan
Greenspan himself. (See "The Myth of the Productivity
Miracle: Part III," Sept. 20, 1999, pp. 2-3.) Indeed,
the Fed chairman must know, the United States is the
only major country that uses the hedonic price deflator
to adjust its gross domestic product statistics for the
increased power of computers. (See "The Myth of the
Productivity Miracle: Part II," Sept. 20, 1999, p. 7.)
While the distortions of GDP resulting from this
practice are difficult to quantify precisely, there can
be no question but that the result is a significant
overstatement of GDP relative to both historic
experience and other nations.
Wide availability of high speed computer power has
given birth to a huge business in financial
derivatives. Indeed, the Black-Scholes option pricing
formula in combination with dynamic or so-called
"delta" hedging has revolutionized financial markets.
Highly complex trading strategies based on these
concepts produced the 1998 Long-Term Capital Management
debacle (www.pbs.org/wgbh/nova/stockmarket), which
threatened the world payments system enough to scare
the Fed into three interest rate reductions when it
should have been moving in the other direction.
Nevertheless, both Greenspan and the secretary of the
U.S. Treasury Department have portrayed financial
derivatives as useful financial stabilizers not
requiring further regulation by Congress. (See, among
others, Statement of Board of Governors of the Federal
Reserve System, House Banking Committee, March 25,
1999, www.house.gov/banking/32599fed.htm.)
Black-Scholes and delta hedging require estimates of
volatility based on historic experience and operate
properly only in fully liquid markets. Whatever the
benefits of financial derivatives in normal markets,
unexpected volatility or loss of market liquidity can
raise havoc with them, leading not just to large losses
but to market destabilizing events. Like LTCM, the
problems of Ashanti, Cambior, and certain gold banks
brought on by the Washington Agreement illustrate what
can happen when financial derivatives crash on wrong
assumptions or abnormal conditions. With his usual
insight, John Hathaway gives an update on the gold
banking situation in his most recent article,
"Apocalypse No" (February 2000,
www.tocqueville.com/brainstorms/brainstorm0057.shthm).
Similar incidents are possible in interest rate or
stock market derivatives, particularly under the
unusual conditions that could follow from the
Treasury's bond repurchases or an unwinding of current
egregious overvaluations in leading NASDAQ tech and net
stocks. But far more frightening would be the
consequences of a panic flight from the dollar on
almost all financial derivatives.
A statistical analysis of recent gold price movements
provides further evidence of Anglo-American
manipulation of the gold market. (See H. Clawar, "A New
Gold War?" (March 13, 2000, www.gold-
eagle.com/editorials_00/clawar031300.html). While
Greenspan denies that the Fed is trying to control
gold, he must know whether the United States and
British treasury departments are actively involved in a
coordinated scheme to cap the gold price. Indeed, the
vehemence of the denial that Greenpsan made in a letter
to U.S. Sen. Joseph I. Lieberman regarding possible Fed
interference in the gold market suggests an effort to
distance both the Fed and its chairman from an expected
scandal over manipulation of the gold price.
Yet as long as this manipulation takes place sub rosa,
gold's usefulness as a monetary indicator is
compromised. One result is unwarranted criticism of the
Fed's efforts to restrain credit growth. See, among
others, J. Wanniski, "The Numeraire" -- Supply-Side
University: Spring Semester, Lesson 6, March 10, 2000
(www.polyconomics.com/searchbase/03-10-00.html) ("There
can be no 'inflation' or 'deflation' with gold
constant," and only a "noodlehead" would think
otherwise.)
The Fed chairman acts as if the new economy is the
productive miracle that its fans assert, that financial
derivatives are the generally benign stabilizers that
their promoters claim, and that the gold price is as
sensitive as ever to monetary debasement. In the
process he has put himself in the same position as his
predecessors in 1927-29. Speculative imbalances, fed by
grossly excessive credit creation and abetted by
dubious financial hedging strategies, are allowed to
grow. At the same time, the gold market -- with British
connivance -- is rigged. But what is different this
time is that the gold standard cannot be made the
scapegoat for the Fed's errors.
Domestically, of course, the currency is no longer tied
to gold. Going off gold was supposed to give the
central bank greater flexibility in managing the
nation's money supply. Instead, the result has been to
undercut not just its ability to regulate money and
credit but also the very foundation of the banking
system itself. Banking depends on a workable
distinction between money and credit. Without it, the
Fed cannot control the growth of the broad monetary and
credit aggregates, and banks no longer possess a unique
franchise separate and distinct from other financial
intermediaries.
Money market funds buying commercial paper, government
agencies like Fannie Mae and Freddie Mac securitizing
loans, and brokerage firms making margin loans all act
effectively to expand credit, but they do so outside
the constraints of bank reserve and capital
requirements. For an interesting discussion of this
process and its effects on the monetary aggregates, see
D. Noland, "The Credit Bubble Bulletin -- Commercial
Paper," March 10, 2000
(www.prudentbear.com/markcomm/markcomm.htm). Banking
based on gold is a demanding business that done
properly is a public good; banking without gold is a
crippled business that, however done, has heretofore
always ended in an orgy of paper and national ruin.
Internationally, the euro is poised to assume many if
not all of the settlement functions that since 1971
could be performed only by the dollar notwithstanding
the breakdown of the Bretton Woods system. What is
more, unless the European Central Bank and European
Union nations lose their nerve, the days of the United
States and Britain dictating international monetary
arrangements are over. There is no practical bar today
to the euro bloc's declaring full independence from the
dollar by linking the euro to gold in some meaningful
fashion. Indeed, a simple declaration that henceforth
most of the EU's international monetary reserves will
be held in gold rather than foreign currencies would
likely have major adverse consequences for the dollar
and the pound.
Nor is monetary confrontation with the euro the only
possible nightmare scenario for the dollar. A problem
for any world reserve currency is that major external
holders of the currency have a potential weapon they
can use against the reserve currency country. The
importance of this weapon is magnified when the
domestic financial structure of the reserve currency
country is overextended or its external accounts are
out of balance. Thus today, for example, any major
confrontation between the United States and China over
Taiwan would inevitably be complicated not only by
questions about what China might do with its very
substantial dollar reserves, but also by what other
large holders of dollar reserves might do to counter
any threat to the value of their holdings.
What was once known as the Great War became the First
World War largely due to the unwillingness of Western
democracies to face hard facts at domestic political
cost. What Greenspan was able to call the Great
Depression could well become the First World Depression
for fundamentally similar reasons. Although another
global depression would almost certainly knock the
dollar from its reserve currency perch, it would mark
not so much the end of a dollar-based financial world
as the end of an illusion: that paper can replace gold
as permanent, international money.
Just as the Second World War forced a return to greater
realism in the conduct of international relations, a
Second World Depression should bring about restoration
of a more normal gold-based international monetary
system. But in this event, Greenspan, having set out to
play Winston Churchill, is likely to end in the role of
Neville Chamberlain -- the man run over by realities
that he could not see or would not admit.
-END-
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