EVER SINCE ALAN GREENSPAN handed the reins of the Federal Reserve over to Ben Bernanke, he's been on the lecture circuit making market-moving pronouncements about the markets, the economy and Fed policy. Frankly, as I’ve already written here, it probably would have been better if he just kept his mouth shut and let Bernanke get on with his terribly difficult job in peace.
But this week Greenspan said something that's just so right on I have to be grateful that he's still regarded as The Maestro.
Bloomberg reported that Greenspan said in a speech that gold's rally to $1,000 an ounce is "an indication of a very early stage of an endeavor to move away from paper currencies."
Another way of saying the same thing is: inflation. When investors "move away" from currencies, it's because they fear those currencies will lose their purchasing power. They fear inflation.
How else to explain that, of all the major asset classes gold, as I pointed out last week, is one of only two to be virtually at all-time highs. Pretty good for what many economists have long ago written off as a barbaric relic.
But gold is no relic. Even though no nation is on anything like a gold standard anymore -- and most public statements about gold seem like the rantings of lunatic fringe "gold bugs" -- gold has retained its power as an inflation indicator. With almost no industrial uses to determine its price, it exists solely as an inflation hedge -- a physical substitute for paper money.
As Greenspan put it this week, "What is fascinating is the extent to which gold still holds reign over the financial system as the ultimate source of payment."
Zhou Xiaochuan, the equivalent of Ben Bernanke at China's central bank, the Peoples' Bank of China, has spoken favorably about gold for years, saying it "still has a strong financial nature and remains an indispensable investment tool." In fact, there were stories this week about the PBOC buying gold as an alternative to owning even more U.S. Treasury bonds than they already hold.
What's more, last week there was a story that China is exhorting its citizens to own gold -- and silver, too -- having recently lifted long-standing restrictions on private ownership.
But don't misunderstand this potential demand for gold from China as the explanation for gold challenging the $1,000 level. Consider the reason for China's buying gold -- it's because China prefers hard money to paper money. In other words, China fears inflation.
Greenspan understands. He got it exactly right in his speech this week when he said gold's move is "strictly a monetary phenomenon."
Greenspan has long been an admirer of gold. In 1967, he wrote a chapter in Ayn Rand's book, "Capitalism: The Unknown Ideal" called Gold and Economic Freedom in which he called for a "fully free banking system and fully consistent gold standard." Why? Because the gold standard -- the link between the banking system's paper money and a measure of objective value -- was the free citizen's guarantee against inflation.
Greenspan put it this way:
As the supply of money…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. …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.
Were those just the ravings of a young man under the influence of Ayn Rand? Hardly. Greenspan was 41 years old when those words were published.
And two years ago, at age 81, when he published his autobiography, "The Age of Turbulance," he wrote:
I have always harbored a nostalgia for the gold standard’s inherent price stability – a stable currency was its primary goal. But I’ve long since acquiesced in the fact that the gold standard does not readily accommodate the widely accepted current view of the appropriate functions of government – in particular the need for government to provide a social safety net. …There is no support for the gold standard today, and I see no likelihood of its return."
Let's translate that, and bring it up to the present. Greenspan is simply saying that today's big governments need to be able to print as much paper money as they like -- for welfare, nationalized health care, and especially nowadays, so-called stimulus packages to bring the world out of recession -- without the objective constraints of gold.
But that doesn't mean the gold price won't react, just because it no longer has an official role. Greenspan's whole point about gold at $1,000 is precisely that it is reacting, in its unofficial capacity as the world's inflation watchdog.
Gold is saying that we are going to pay a price for the way the world's governments are spending their way out recession. Sure, it's nice to come out of recession. But there's no such thing as a free bailout.The price is inflation. That's always the price when government prints money in excess of the tangible objective value of real things, like gold.
Knowing what he knows, it's sadly ironic to think of Greenspan in charge of the U.S. government's money printing operation -- the Federal Reserve. Surely he knew all along he had an impossible task, printing as much money as the politicians demanded, without any hard link to the discipline of gold that he knew was necessary.
I'm still billish on gold because I'm convinced that no one has the power to do anything about the inflation threat until it's very much too late. Right now there is a solid political consensus that inflation is simply a price that will have to be paid. And we're going to pay it. Make no mistake about that, because the world is going to take a lot more money to keep this nascent recovery going.
