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Any doubts about why I own gold as an investment were
dispelled last Saturday when I met the maestro himself: former Fed Chair Alan
Greenspan. It��s not because Greenspan said he thinks
the price of gold will rise �� I don��t need his investment advice; it��s that
he shed light on how the Fed works in ways no other former Fed Chair has ever
dared to articulate. All investors should pay attention to this. Let me
explain.
 
The setting: Greenspan participated on a panel at the New
Orleans Investment Conference last Saturday. Below I provide a couple of his
quotes and expand on what are the potential implications for investors.
Greenspan: ��The Gold standard is not possible in a welfare state��
The U.S. provides more welfare benefits nowadays
than a decade ago, or back when a gold standard was in place. Greenspan did
not explicitly say that the U.S. is a welfare state. However, it��s my interpretation that the sort of government he described was
building up liabilities �� ��entitlements�� �� that can be very expensive. Similar
challenges can arise when a lot of money is spent on other programs, such as
military expenditures.
It boils down to the problem that a government in debt
has an incentive to debase the value of its debt through currency devaluation
or otherwise.
As such, it should not be shocking to learn that a gold
standard is not compatible with such a world. But during the course of
Greenspan��s comments, it became obvious that there
was a much more profound implication.
Who finances social programs?
Marc Faber, who was also on the panel, expressed his
view, and displeasure, that the Fed has been financing social programs. The
comment earned Faber applause from the audience, but Greenspan shrugged off
the criticism, saying: ��you have it backwards.��
Greenspan argued that it��s the
fiscal side that��s to blame. The Fed merely reacts.
Doubling down on the notion, when asked how a 25-fold increase in the
Consumer Price Index or a 60-fold increase in the price of gold since the
inception of the Fed can be considered a success, he said the Fed does what
Congress requires of it. He lamented that Fed policies are dictated by
culture rather than economics.
So doesn��t this jeopardize the
Fed��s independence? Independence of a central bank
is important, for example, so that there isn��t
reckless financing of government deficits.
Greenspan: ��I never said the
central bank is independent!��
I could not believe my ears. I have had off the record
conversations with Fed officials that have made me realize that they don��t touch upon certain subjects in public debate �� not because they are wrong �� but because
they would push the debate in a direction that would make it more difficult
to conduct future policy. But I have never, ever, heard a Fed Chair be so
blunt.
The maestro says the Fed merely does what it is mandated
to do, merely playing along. If something doesn��t go
right, it��s not the Fed��s
fault. That credit bubble? Well, that was due to Fannie and Freddie (the
government sponsored entities) disobeying some basic principles, not the Fed.
And what about QE? He made the following comments on the
subject:
Greenspan: ��The Fed��s balance
sheet is a pile of tinder, but it hasn��t been lit ��
inflation will eventually have to rise.��
But fear not because he assured us:
Greenspan: ��They (FOMC members) are very smart��
Trouble is, if no one has noticed, central bankers are
always the smart ones. But being smart has not stopped them from making bad
decisions in the past. Central bankers in the Weimar Republic were the
smartest of their time. The Reichsbank members thought printing money to
finance a war was ��exogenous�� to the economy and wouldn��t be
inflationary. Luckily we have learned from our mistakes and are so much
smarter these days. Except, of course, as Greenspan points out it��s the politics that ultimately dictate what��s going to happen, not the intelligence of central bankers. And
even if some concede central bankers may have above average IQs, not everyone
is quite so sanguine about politicians.
Now if they are so smart, the following question were
warranted and asked:
Q: Why do central banks (still) own gold?
Greenspan: ��This is a fascinating question.��
He did not answer the question, but he did point out: ��Gold has always been accepted without reference to any other
guarantee.��
While Greenspan did not want to comment on current
policy, he was willing to give a forecast on the price of gold, at least in a
Greenspanesque way.
Greenspan: Price of Gold will rise
Q: ��Where will the price of gold be in 5 years?��
Greenspan: ��Higher.��
Q: ��How much?��
Greenspan: ��Measurably.��
When Greenspan was done talking, I gasped for air. I��ve talked to many current and former policy makers. But at best
they say monetary policy is more difficult to conduct when fiscal policy is
not prudent. It appears Greenspan has resigned himself to the fact that it
was his role to facilitate government policies.
The reason this is most relevant is because many
politicians think there��s unlimited money to spend.
And, of course, if the Fed��s printing press is at
the disposal of politicians, the temptation to use it is great. Not only is
there the temptation, some politicians truly believe the Fed could and should
help out any time. As Greenspan now acknowledges, these politicians have a
point.
While we have argued for many years that there might not
be such a thing anymore as a safe asset and investors may want to take a
diversified approach to something as mundane as cash, Greenspan��s talk adds urgency to this message. The dollar has lost over 95%
of its purchasing power in the first 100 years of the Fed��s existence.
We now have a ��box of tinder�� and an admission that the Fed is merely there to enable the
government. We are not trying to scare anyone, but summarize what we heard.
My own takeaway from Greenspan��s talk was that
anyone who isn��t paranoid isn��t paying attention. Did I mention he said the promises made by the
government cannot be kept? Mathematically, he said, it��s impossible.
As part of the panel discussion, the topic of
Switzerland��s vote to force its central bank to hold
20% of its reserves in gold came up. We will have an in-depth discussion of
this vote in an upcoming Merk Insight (to ensure you don��t miss it, register
to receive our free newsletters). Marc Faber
spoke from my heart when he argued that the only credible gold standard is
one that an individual puts in place for oneself; one should never trust a
government to adhere to a gold standard. On that note, please register for our upcoming Webinar on November 20, 2014, where we will discuss how investors can build their personal
gold standard.
For more of Greenspan��s
comments, please review my tweets at twitter.com/AxelMerk (please follow me
to instant analysis of events affecting the dollar, gold and currencies).
Axel Merk
Axel Merk is President & CIO , Merk Investments
Manager of the Merk Funds
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