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Weekend: Greenspan's Secret Gold Standard

Written By Brian Hicks

Posted May 14, 2011

Welcome to the Wealth Daily Weekend Edition — our insights from the week in investing and links to our most-read Wealth Daily and sister publication articles. 

It has been a long time since anyone called Alan Greenspan “The Maestro”.

But before he handed the keys to the printing press over to Ben Bernanke, he was hailed by many as the greatest central banker who ever lived.

Then came the housing crash and the collapse of the financial markets, and those same accolades evaporated. What followed sounded more like a symphony of kazoos.

The Maestro??

Perhaps he was — of the collapse that ensued after he jumped off the sinking ship…

Today, the guy is more of side show act than a hero to be revered.

But the truth is it didn’t have to end this way for Alan, because earlier in his tenure, The Maestro was clearly on to something… and that something was gold.

The Secret Gold Bug

You may not know this, but Alan Greenspan was actually a gold bug. He even wrote a paper about the gleaming metal in 1967 called “Gold and Economic Freedom” in which he argued about the wonderful virtues of the gold standard.

Among other things, he wrote: “… gold and economic freedom are inseparable, that the gold standard is an instrument of laissez-faire and that each implies and requires the other.”

He went on to say: “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.”

But more to the point, he explained:

The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means of an unlimited expansion of credit. They created paper reserves in the form of government bonds which — through a complex series of steps — the banks accept in place of tangible assets and treat them as if they were an actual deposit, i.e. as the equivalent of what was formerly a deposit of gold.

The holder of a government bond or bank deposit created by paper reserves believes that he has a claim on a real asset. But the fact is there are now more claims outstanding than there are real assets.

The laws of supply and demand cannot be conned. As the supply of money (claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise.

In short, what Greenspan proclaimed is that our ability to borrow beyond our means through the issuance of bonds (printed money/QE2) creates inflation because it is not based on a tangible asset (gold).

That’s the last thing you would expect to hear from a central banker.

And while he said this some 20 years before he took the helm of the greatest money-creating machine of all time, it was a belief that he carried with him to the Fed. In his 1999 testimony before the U.S. Banking Committee, Greenspan had this to say about the metal: “Gold still represents the ultimate form of payment in the world.”

But there’s more…

In a famous exchange with Sen. Paul Sarbanes, Greenspan responded to a query from the Senator in regards to whether or not he recommended a return to the gold standard with this: “I’ve been recommending that for years, there is nothing new about that.”

So herein lies the ultimate irony — a gold standard bearer spent years at the helm of the Fed.

Greenspan’s “Virtual Gold Standard”

How Greenspan’s belief in the gold standard manifested itself in his tenure at the Fed is interesting, to say the least. It has been pointed out by Donald Luskin of Trend Macrolytics, and it goes like this…

According to Luskin, Greenspan’s views on gold led him to impose a “virtual gold standard”.

In essence, the Greenspan Fed adjusted its rates up or down in relation to the amount of inflation that the price of gold was forecasting in the economy.

When the price of gold went up, Greenspan saw it as a sign of inflation; he raised rates in tandem with the price movement of the commodity, in effect shrinking the monetary base. Conversely, when gold fell, rates dropped and the money supply expanded. A simple premise, to be sure — but it worked.

But in 1996, The Maestro did the unthinkable, abandoning his “virtual gold standard” for good.

When gold fell, he raised rates; when gold rose in price, he cut them. It was the exact opposite of his original plan.

Since then, credit and consumption bubbles have sprung up like mushrooms, first in the internet bubble and then in housing.

But that is the problem with money that’s created out of thin air… Since it’s not tied to a tangible asset, the result is inflation — just as Greenspan himself predicted in 1967.

That is what the price of gold is telling us today, since Greenspan’s replacement is working that same old, tired path to oblivion…

And unless the Fed begins to raise rates in a manner that is consistent with the “virtual gold standard”, the price of the metal will continue to rise.

After all, we cannot print our way to prosperity. Greenspan knew this, and he caved.

It’s a mistake we’ve been paying for ever since.

As for some ways to hedge yourself against these characters and their printing presses, metals guru Luke Burgess has been on the gold case for years now, earning his subscribers big profits as Ben Bernanke works to take down the dollar.

Luke will unveil his latest winner in a free report next week, so stay tuned.

He told me this week if there’s one gold exploration stock to own right this very second, it’s the one featured in his new report. Working with one of the biggest players in the Yukon, Luke believes this $1.25 a share mining outfit could easily double in what is quickly becoming a second North American gold rush.

As always, our editors have put together a few of their best profit strategies for the coming years in this week’s top-read articles from Wealth Daily and Energy & Capital, below.

Have a great weekend.

Your bargain-hunting analyst,

 steve sig

Steve Christ
Editor, Wealth Daily

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