Close X Cookies are necessary for the proper functioning of 24hGold.com. By continuing your navigation on our website, you are accepting the use of cookies.
To learn more about cookies ...
EnglishFrench
In the same category

Why the Fed needs golden handcuffs

IMG Auteur
Published : January 30th, 2013
1203 words - Reading time : 3 - 4 minutes
( 3 votes, 5/5 )
Print article
  Article Comments Comment this article Rating All Articles  
0
Send
0
comment
Our Newsletter...

Jan Skoyles looks at how 100 years of the Federal Reserve system has affected asset prices, from the Dow Jones Industrial Average to the gold price. Read on to find out what happened in the last century to cause prices to rocket and what the Federal Reserve had to do with it. 

This year the US Federal Reserve System will celebrate its 100-year existence thanks to the signing of the Federal Reserve Act in December 1913.

The Federal Reserve System was set up in response to a series of financial crises and ‘panics’, in the hope that it would redress the financial system’s shortcomings.

Following the First World War many countries sought to follow the US and set up an independent central bank. So successful was the US set-up perceived to be that ‘money men’ such Edwin Kemmerer of Princeton University travelled the world ‘preaching the gospel of the gold standard and the independent central bank’.

Since that time, the Federal Reserve’s role has become far more varied to include ‘fostering a sound banking system and healthy economy’ whilst upholding the three key objectives to monetary policy: maximum employment, stable prices and moderate long-term interest rates.

Given that the Federal Reserve’s ever growing role includes maintaining a healthy economy and stable prices, we have looked into the price behaviour of gold, silver, the DJIA, S&P 500 and Case-Shiller housing index, over the Fed’s life time.

The research shows up some interesting results. Namely that the Federal Reserve is unable to manage stable prices if the ‘golden handcuffs’ of a gold-backed dollar are no longer in place.

Clear asset price inflation

First up let’s look at the big picture. The Federal Reserve Act was passed in 1913 and since then we have seen, quite clearly, asset price inflation. It begins to creep in around the start of the Bretton Woods agreement which was signed in 1944.


24hGold - Why the Fed needs go...

However, it then takes off in two stages. The first, upon the closing of the gold window, in 1971 which we can see more closely if we look at it on a quarterly basis (below) followed by the arrival of Alan Greenspan in 1987 and again in the handover from Greenspan to Bernanke in 2006.

24hGold - Why the Fed needs go...

If an extra-terrestrial being came down and looked at a graph of the selected asset groups between 1900 and 2012 they would want some kind of explanation as to what had happened.

Is it just the Fed to blame?

We can’t blame the existence of the Fed on the inflation of asset prices. If you look back to asset prices in the decade before then there is very little change from one decade to another.

24hGold - Why the Fed needs go...

This was, of course the period when the world operated either within or in the peripherals of the Classical Gold Standard. Between 1800 and 1914, the value of the US dollar remained relatively unchanged. However, as we see from the graphs above and below, this can no longer be the case.

When we look back on the last 113 years using a log-scale we see very clearly that the introduction of Bretton Woods and then the closing of the gold-window, led to an on-going increase in asset prices.

24hGold - Why the Fed needs go...

Whilst the Bretton Woods agreement was a half-attempt at a gold-standard, it was nowhere near as strict a control as the central banks needed to prevent them from inflating the economy.

The issue with Bretton Woods was that it failed to limit the discretionary Federal Reserve issuance of the dollar’s convertibility into gold, therefore it was unable to stabilize the long-term price levels. As Hazlitt wrote, ‘The system [seemed] to relieve every other country but the United States from strict monetary discipline,’

The Bretton Woods System was designed to assure stability and reduce the need for gold reserves. Currencies were tied to the Dollar and only the Dollar remained convertible to gold. The Bretton Woods agreement left the US as the only country able to determine its own monetary policy as they were left with the highest gold reserves at the end of WWII.

International cooperation was a significant strength of Bretton Woods, however the strict discipline a classical gold coin standard had offered, was absent. Countries still wished to grow their gold reserves and maintain a balance between their exports and imports; but the US did not have any incentive to balance their trade, as they had done when operating under a full gold-standard. According to Bretton Woods the US could pay their debts in Dollars which, as the sole provider of Dollars, they could print themselves – thanks to the Federal Reserve.

Confidence in the Dollar fell as foreign central banks perceived currency mismanagement, causing gold-reserves to flow out of the country. Nixon closed the gold window in 1971 to stem the run on US gold reserves.

Since then countries have operated a system of floating exchange rates, which Milton Friedman agreed would only be successful ‘if the Federal Reserve does not tamper with the rate of growth’ as would have been the case under the golden-handcuffs. However, as we have seen through repeated easy monetary policies the Federal Reserve does tamper with the rate of growth.

The golden handcuffs and golden rules

In simple terms, since 1971 the number of dollars in circulation not need to equal the amount of gold in the bank. Since then easy money is issued for the ‘benefit’ of an economy where rising prices, whether stocks or housing is deemed to be beneficial.

Yet, look at how volatile this policy approach makes asset prices.  As we know (now) from experience, Keynesian economics and central bank currency and economy management creates bubbles. If you look at the years surrounding the year 2000, there is a sharp decline in the Dow Jones and S&P 500. Following on from the Dot-Com bubble burst, Greenspan had raised interest rates.

Shortly after, in 2001, he began an initiative which would see interest rates reduced down to 1% by 2004. Like clock-work gold and silver, as you can see from the graph, began to climb like warning flags of the dangers of this ultra-loose monetary policy which was just beginning.

Since then the US Federal Reserve, now under the leadership of Ben Bernanke, has seen an unprecedented series of quantitative easing rounds. Whilst asset prices are on their way to breaking new records, the price behaviour of assets since 1971, cannot be referred to as ‘stable prices’, nor can an unemployment rate of 7.8% or a federal funds rate of 0.25% be considered as the Fed fulfilling their mandate.

After 100 years, and most specifically the last 50 years, the burden of proof appears to rest with the Fed to justify their existence, policy responses and economic theory.

What do you think? Has the Fed got some questions to answer? Let us know in the comments below.
Want protection from inflationary central banks? Buy gold online in minutes…

Please Note: Information published here is provided to aid your thinking and investment decisions, not lead them. You should independently decide the best place for your money, and any investment decision you make is done so at your own risk. Data included here within may already be out of date.

Companies Mentionned : Gold |
<< Previous article
Rate : Average :5 (3 votes)
>> Next article
Jan Skoyles is Head of Research at The Real Asset Company, a platform for secure and efficient gold investment. Jan first became interested in precious metals and sound money when she met Ned Naylor-Leyland whilst working alongside him in the summer of 2010. Jan then went on to write her undergraduate dissertation on the use of precious metals in the monetary system. After graduating from Aston University Jan joined The Real Asset Co research desk. Her work and views are now featured on a range of sites including Kitco, GATA and The Telegraph. She has appeared on news channels including Russia Today to discuss the gold price and gold investing. You can keep up with Jan's commentary by subscribing to our RSS feed Gold Investment News.
WebsiteSubscribe to his services
Latest comment posted for this article
Be the first to comment
Add your comment
Top articles
Latest Comments
Elizabeth Warren: The 14 Trillio...
02:15sneezy67
Good ideas...good information....but somewhat behind the curve...the water has already gone under the bridge.
Man Grabbed, Crushed to Death By...
00:00user4779
The "lump of labour" fallacy raises its tired old head yet again, mixed in with B-movie-style sci-fi speculation about a terrible robotic future wo...
Max Keiser Interviews GoldCore’s...
03 Julovertheedge
"The IMF said that Greece requires additional bailout funds of around 50 billion euros until 2018 under the current bailout conditions, and slashed...
Greece’s referendum
03 Julend
"History may judge him instead to have played a poor hand very well indeed." I'm quite sure both Macleod and Varoufakis will be quite disa...
Gold Daily and Silver Weekly Cha...
02 Julglasstiger
Jesse, you use the term "could care less" frequently. Is this American speak for "couldn't care less"? Similar I suppose to the ubiquitou...
One more book, Mr. Stockman
02 Juluser4779-1
While it is true that "[Gold standards] were abused, suspended, and ultimately abandoned in favor of a currency that central banks could inflate at...
Panicked Hedge Funds Now Praying...
30 Junovertheedge1
"... and the silly game theory ..." Obviously you have no knowledge of game theory and its applications. Otherwise you wouldn't have used ...
The Gold Standard: Generator & P...
30 Junuser4779
Is it really so bad for Americans that they do not spend their lives labouring on a production line to make mass-produced goods, and have left this...
Most commented articlesFavoritesMore...
World PM Newsflow
ALL
GOLD
SILVER
PGM & DIAMONDS
OIL & GAS
OTHER METALS
Mining Company News
Gray Rock(Au)GRK.V
Gray Rock Closes Non-Brokered Private Placement
CA$ 0.02+0.00%Trend Power :
Corporate news
BowmoreBOW.V
Bowmore Closes First Tranche of Private Placement and Resignation of Board Member
CA$ 0.07+0.00%Trend Power :
Corporate news
Royal Dutch Shell(Oil)RDSA.AS
This Week In Energy: Top 4 Reasons Oil Prices Are Heading Back Down
€UR 25.54-0.66%Trend Power :
Corporate news
PetrobrasPBR
Petrobras to Sell Stake in Bijupira & Salema Fields for $25M - Analyst Blog
US$ 8.83+2.08%Trend Power :
Corporate news
Royal Dutch Shell(Oil)RDSA.AS
Shell to Go Ahead with GoM Appomattox Deepwater Project - Analyst Blog
€UR 25.54-0.66%Trend Power :
Corporate news
BP plc(Ngas-Oil)BP
BP to Settle Federal, State GoM Oil Spill Claims for $18B - Analyst Blog
US$ 41.29+5.14%Trend Power :
Corporate news
Clean EnergyCLNE
ALLETE Clean Energy Acquires Wind Farm in Pennsylvania - Analyst Blog
US$ 5.37-0.56%Trend Power :
Corporate news
du Pont de NemoursDUPP.PA
DuPont Tumbles to 52-week Low After Chemours Spinoff - Analyst Blog
€UR 54.00-0.79%Trend Power :
Corporate news
Junex(Ngas)JNX.V
Junex Closes a Portion of its Private Placement for Proceeds of $5 Million
CA$ 0.80+0.00%Trend Power :
Corporate news
Yingli GreenYGE
SHAREHOLDER ALERT: Pomerantz Law Firm Reminds Shareholders With Losses on Their Investment in Yingli Green Energy Holding Co. Ltd. of Class Action Lawsuit and Upcoming Deadline - YGE
US$ 1.15-3.36%Trend Power :
Corporate news
Comments closed