Fed chairman Alan Greenspan is regarded by many people today as the greatest Fed chairman ever for steering the economy through several major crises. He’s been knighted by the queen and awarded numerous honorary doctorates from some of the world’s most prestigious universities.
In December 2002 he gave a speech to the Economics Club of New York that offered an interesting perspective on our country’s monetary systems. In the 50 or so years following the abandonment of the gold standard in 1933, he said, prices rose by approximately 750 percent, as measured by the Consumer Price Index. The CPI, as it’s called, is a basket of household goods that excludes certain items because of their volatility. He also noted the fact, startling to some, that in 1929 prices were about the same as they had been in 1800, though there were price fluctuations during that period. In other words, the gold standard held the line on prices over a 129-year period. Throughout most of this period, as we know, the country experienced spectacular growth, rising real wages, and miniscule government debt.
But Mr. Greenspan’s speech suggests another observation. If we take his period and cut it off at 1912 instead of 1929 – 1912 of course being the year before the Fed was born – we find the CPI falling by roughly 57 percent. Put another way, 19th century Americans, whose dollars were defined as a weight of gold or silver, experienced falling prices and economic prosperity at the same time, a state of affairs we have a hard time even imagining today.
Let me say that again: Americans once understood falling prices and prosperity as natural bedfellows. And the reason is quite simple. In those days the production of goods and services outpaced the production of money.
So what happened after 1933 that drove prices through the roof? Chairman Greenspan said: “Monetary policy, unleashed from the constraint of domestic gold convertibility, had allowed a persistent overissuance of money.”
The Fed’s eager printing press could have led to our destruction, but fortunately it didn’t. “The adverse consequences of excessive money growth provoked a backlash,” he said. Beginning in 1979, the Federal Reserve, under new leadership and with the support of the government, “dramatically slowed the growth of money.” Consequently, we went through a sobering recession and the pace of inflation eased up.
Following this, the economy rebounded vigorously, and “the progress made in reducing inflation was largely preserved,” Mr. Greenspan told his audience. “Although pressures for excess issuance of fiat money are chronic,” he concluded, “a prudent monetary policy maintained over a protracted period can contain the forces of inflation.”
In other words, when the Fed stops inflating, inflation stops.
But is this what Mr. Greenspan meant? Mr. Greenspan, you will remember, was famous for using words in such a way that no one was ever quite sure what he was talking about. For example, what did he mean by “contain the forces of inflation”? With little imagination it’s possible to assign four or five meanings to that expression. And he used the words “can contain the forces,” not “would contain” those forces. Nor did he say how the Fed would or could contain those forces, because we still operate without the constraint of gold convertibility.
But taking him in good faith, we assume he meant something positive, like “the Fed knows better than to push too hard on the peddle because we don’t want another ‘backlash.’” As long as the Fed has a backbone, with the will to resist the “excess issuance of fiat money,” we’ll stay out of trouble economically. So, while it makes no sense to talk of a political entity such as the Fed being politically independent, it makes a great deal of sense to talk of the determination of Fed officials to “just say no” when conditions warrant.
Chairperson MASON: You have some impressive notes at your disposal, Dr. Mathews. We all remember Mr. Greenspan, of course, but it’s helpful to be refreshed on some of his comments. He had a fondness for gold.
Dr. MATHEWS: Yes, he did.
Chairperson MASON: In connection with your last comment – “just say no” – someone once wrote that gold says “no” a lot. Is that an expression you would agree with?
Dr. MATHEWS: It does say “no” because of its limited supply. Gold says “no” to a lot of bad ideas. It says “no” to deficit spending, which is precisely the reason it was ditched. As history makes clear, people in the twentieth century were sold on the idea of big government, so they needed a debt-based monetary unit to provide the “liquidity” needed to pay for it.
Fiat currencies have been very dangerous because there’s no limit to their supply. They’ve also been very profitable to some people. Fiat currencies are monetary yes men and go along with just about anything. But saying “yes” has painful consequences, as Mr. Greenspan acknowledged. The nickel I tossed you is one of those consequences. If we allow ourselves to be taken in by “liquidity,” as other countries have for over three centuries, it will be our downfall. But the United States is not just another country. As you’re well-aware, we play a pivotal role in the global economy by virtue of the popularity of the American dollar. To a large extent it underpins the world economy. A dollar collapse, therefore, would have global consequences.
Chairperson MASON: Dr. Mathews, this “liquidity,” what has it cost us in the past? Can you give us some examples? . . .
