Greenspan the Great!!
Jude Wanniski
July 17, 2002


Memo To: Sen. Phil Gramm [R TX]
From: Jude Wanniski
Re: The Greenspan Standard

When I tuned in Tuesday morning to catch Fed Chairman Alan Greenspan's testimony before Senate Banking, right off the bat I watched you gurgling about how he was the greatest central banker in the history of civilization!! The reason you chose this moment to smother him with wet kisses on his nether body parts, you said, was because you were leaving the Senate this year and probably would not have the privilege of genuflecting before him again. I turned green and looked around for a bucket.

What really bothered me, Phil, is when you reminded the committee you were in a perfect position to make this evaluation because you specialized in monetary theory when you were getting your PhD in economics. As I recall, you even wrote a paper on the monetary deflation of the 1870's, when the United States came back to the gold standard in a way that caused great hardship to the American people. With all that background and expertise, surely you should see that Greenspan has made a mess of the U.S. economy and a mess of the world by failing to learn those lessons.

Except for a rocky start, when he helped cause the stock market crash of October 1987 by saying he was in favor of a weaker dollar, Greenspan did a good job at the Fed in 1988, 1989, 1990, 1991, 1992, and 1993, a poor job in 1994, 1995 and 1996, and a miserable job from 1997 to the present. Like you, Phil, Alan at one time was an advocate of a gold standard as the best possible means of conducting monetary policy. In the good years, while he was continuing the practice of former Fed Chairman Paul Volcker of keeping a weather eye on the dollar price of gold for signals of incipient inflations or deflations, Greenspan never let the gold price get far from $350 per ounce. He and Fed Governor Wayne Angell would tilt policy toward that point, making it easier for American businesses to make financial decisions without worrying about inflations or deflations. The dollar stability also became the envy of the world, and governments everywhere found their own economies flourishing by linking their currencies to the dollar. It was in late 1993 when Greenspan began running into trouble, and in 1994 began raising interest rates to pinch off inflation when he saw gold rising above $350, and the higher rates did nothing to halt the increase. I'd explained to him that only reducing dollar liquidity would halt the process, but he did not have a mechanism to do so, and said nothing about it, as the economy seemed healthy with a mild inflation that took gold to $385, where it stayed until late 1996.

That's when you folks in the Senate pushed through tax cuts, which increased the demand for liquidity. When Greenspan did not supply it, the gold price began its long slide. In the process it caused the Asian Crisis and Russia's insolvency and a mess of problems throughout Latin America and Africa. In September 1997 I begged Greenspan to halt the decline, but he asked that I not bother him any more. We are still in a mess, Phil, as the problems the deflation created have contributed mightily to the accounting difficulties which the business community is now wrestling with. So you see, Greenspan has his good points and his bad points, and lately there has been nothing much to cheer about. Here is a letter I wrote last week to the Financial Times that will give you a clear picture of the problem. We really do need to get back to a gold standard, which is much better than a Greenspan standard:

To the Editor of the FT:

Martin Wolf's "Rescue Plan for Capitalism," (July 3) begins with the observation that "the trickiest question in capitalism is how precisely companies can be controlled." Perhaps, but the question becomes trickiest in a capitalist system with a floating unit of account. The floating dollar is at the core of the problem in America today.

The simple reason for the accounting miseries now surfacing with Enron and Worldcom et al is that we are not on a gold standard -- and for the last 30 years have been struggling through inflations and deflations. The U.S. Savings&Loan crisis of the 1980's was the result of the inflation, which made it impossible for creditors to recover their assets. An S&L needs a gold footing so it can borrow short and lend long. When those who made the worst loans faced bankruptcy, they made riskier and riskier loans, trying to make up for the losses. Those who were caught went to jail. Those who survived then benefited from the deflation that followed, where customers were required to give the S&Ls more in real terms than they had borrowed.

This is what has happened in the current monetary deflation, which has transpired over the last five years, with gold falling from $383 to as low as $253, now at $310. For the economy to recover, gold would have to be at $350, and it cannot get there as long as the Federal Reserve is not (and has no means) to target gold. At the margin, those debtors who could not pay their debts juggled the books, hoping for economic recovery that was promised by the Bush tax cuts and the Greenspan interest rate cuts, neither of which can solve the monetary deflation. When the recovery did not come, the jugglers at Enron and Worldcom, etc., had to come clean. It is something like the otherwise honest bank teller promising to return the cash as soon as his luck improves at the race track.

Note the gold price has been in decline these last few weeks. This, I believe, is the result of the lower risks of political terrorism, as there has been progress toward diplomatic solutions in the Middle East and on the subcontinent. When there is increased risk of doing business, there is less demand for dollar liquidity, and if the Fed does not drain it off, the gold price rises. When the risk declines, there is more demand for liquidity and if the Fed does not supply it, the gold price falls.

This is a nonsensical way to manage a domestic monetary regime, let alone a global capitalist system. No amount of new rules and accounting procedures can keep pace with such monetary turbulence in the unit of account. Unless the United States takes the lead in re-establishing a dollar/gold foundation to the world economy, it will have to be done elsewhere. Either Europe or Greater China have the economic mass required to anchor the world monetary system to their currencies, as the United Kingdom once did.


Jude Wanniski