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http://www.pdf-archive.com/2012/07/08/jim-grant/jim-grant.pdf
The Golden Rule
James Grant explains why “the classical monetary system called the gold standard … is the wave of the future”
BY JONATHAN BARNES
CFA Magazine July – August 2012
RETURNING TO THE GOLD STANDARD is no longer a fringe idea and even has become part of mainstream political discussion. James Grant, founder of Grant’s Interest Rate Observer, is a longtime advocate of the gold standard and critic of Central Bank monetary policy. In this interview with CFA Magazine, Grant speaks about the failures of the current monetary system, the practical steps toward a new gold standard, and his assessment of Federal Reserve Chairman Ben Bernanke’s four lectures in opposition to the gold standard, given at George Washington University in March 2012.
Why do we need a new gold standard?
Unpredictability is the hallmark of today’s monetary system. Our midget interest rates: will they be with us for three fiscal quarters—or three years? We don’t know. So-called quantitative easing (a.k.a. money-printing): will there be another bout? We will have to wait to find out. This lack of predictability inhibits long-term investment by industry. It stymies savings by ordinary people.
The gold standard is time tested, objective, and synchronous. It delivered more-than-satisfactory results for approximately 100 years between [the battle of] Waterloo and the First World War. It was objective in that currency values were fixed, defined as statutory weight of gold or silver, and it was synchronous in that the gold standard helped to coordinate economic activity among the participating gold-standard countries.
How do you respond to Federal Reserve Chairman Bernard Bernanke’s recent lectures?
Bernanke presents himself to be an historian. But his deconstruction of the gold standard was completely ahistorical. He says that the gold standard failed, but he fails to distinguish between the classical gold standard, which ended in 1914 and the various “road company” versions of the 1920s, the 1940s, up to 1971. These distinctions are important.
A key element of the gold standard is the lack of a privileged or reserve currency. But with the Genoa Conference in 1922 and with the institution of the gold exchange standard in the 1920s and with the further relaxation of the rigor of the gold standard under Bretton Woods in 1944, the very heart and soul of the classical system was eviscerated. For instance, under the Bretton Woods system, only central banks could legally own gold. An essential feature of the classical gold standard was that anyone could own gold. It was the people’s money.
Bernanke trotted out a bunch of shibboleths, such as not having enough gold to go around. Yet gold production has kept pace with population growth for many, many years. Another is that it costs a lot to dig it out of the ground, as if the cost of conjuring up US$2 trillion electronically over the course of a couple of fiscal quarters were cost free. These lectures were not a serious critique of monetary arrangements, old or new.
What steps would take us toward a gold standard?
First, begin a focused discussion about the merits and drawbacks of each of these systems. And take care not to confuse the gold exchange standard and the Bretton Woods regime with the system that we are really talking about—the classical gold standard in place before World War I. Then compare that system with the regime in place.
One of the worst features of today’s system is its inequity. To the bankers goes the upside; to the public goes the downside. What does this have to do with the value of the dollar? It has everything to do with it. Riding to the rescue of our shattered financiers, the Fed emits more and more dollars. It cuts interest rates until there is nothing more to cut.
Comprehensive financial reform means the renewal of the constitutional dollar (i.e., a dollar defined as a weight of a precious metal). It was the dollar in place from Alexander Hamilton’s time until Richard Nixon’s, with time out for the Civil War. The gold system must, it seems to me, be restored in parallel with a capitalist renewal of our banking system. In our regulated financial institutions, those who take risks also bear them.
What would a transition look like?
My friend Lewis Lehrman has written a book called The True Gold Standard. He lays out practical steps on how to get from here to there. I can only echo his blueprint. One would first announce a date for the restoration of the convertible dollar—probably a couple of years into the future. Then, one would let the marketplace discover the price of gold, and one would take great pains to ensure that on conversion there would be no move towards deflation in wage levels.
This was the great mistake the British made when they returned to a pre-World War I exchange value of the pound sterling against gold in 1925. By setting an untenably high gold value, they bought themselves years of trouble—sagging exports and wages, for instance. And they gave “the gold standard” a black eye, though it really wasn’t the true-blue gold standard they restored. Rather, it was that makeshift one called the gold exchange standard. There doesn’t have to be deflation if the proper exchange rate is found.
Is this a proposal for the U.S. or globally?
It’s very much an international proposal. This is an international effort, and there would be a new monetary conference to implement it. The gold standard by its nature is an international undertaking, an international system of organization. It ought to appeal to many countries besides the United States.
What could catalyze a move toward the gold standard?
Maybe a new financial crisis. Maybe—I hope—a political decision reached without crisis. It’s a job of persuasion. Try as I do to impart these ideas, I can’t say I have made enormous headway with the economic and financial establishment. [U.S. presidential candidate] Ron Paul has designated me as his Fed chairman, but I notice that Dr. Paul is not doing so well in the delegate count and I have not yet heard from Mitt Romney. The academic establishment speaks with just about one voice on these matters, and the voice is not entirely sympathetic to the gold idea. In fact, they rather think it is funny.
There is huge resistance from the beneficiaries of our present system. On Wall Street, who doesn’t like funding his or her liabilities at 0%? In the private equity business, who doesn’t like financing a leveraged buyout at today’s tiny interest rates? The answer to these rhetorical questions is: nobody. The present system is corrupt and corrupting. But it is as sweet as candy for the people who benefit by it, and many of those people happen to be in very powerful positions.
What would you do as Fed chairman?
The first thing I would do—with great ceremony—is to undertake the opening of a new office of the Fed. This will be the Office of Unintended Consequences. There’s a crying need for it. We know what the Fed wants to do. It wants a 2% inflation rate, a much lower unemployment rate, a rising stock market, and a solvent banking system. Commendable goals perhaps. But in trying to achieve these objectives, it tamps down interest rates and prints up stupendous volumes of new dollars. I don’t get the impression that the economists who run the central bank are really alive to the possibility that they have inadvertently sown the seeds of a disaster. Certainly, Bernanke gave no hint in his GW lectures that he worries much about it.
Does the current monetary system have an end date, in your opinion?
I said it was going to end about 1980. So perhaps I should make no more guesses. It has been 40 years and counting since Bretton Woods expired—40 years of increasingly irresponsible banking; 40 years of uncollateralized paper currencies; and now, with the advent of digital technology, ever greater waves of new electronic impulses we are pleased to call money (the Fed creates dollars, as you know, with the tap of a computer key). And despite it all, the world has gotten richer.
People don’t mind transacting with dollar bills. In fact, I am rather fond of them myself—I collect as many as I can. So we have the capacity to adapt to any monetary system. But we can all see the fault lines of our present day arrangements. It’s not meant for the ages.
What’s wrong with low interest rates?
You might ask, “What’s wrong with price control?” Talking to the GW students, Chairman Bernanke bemoaned the Nixon administration’s experiment with wage and price controls. They didn’t work, he correctly said. But how could they have worked? In prices is embedded the information that coordinates the actors in a market economy. Yet the same man who mouthed these truths also defends the Fed’s manipulation of the prices we call interest rates. I don’t understand.
What do you think is the Fed’s rationale?
I don’t know. I am not prepared to impugn their motives. I think they mean well. There is a wonderful passage in the 9/11 Commission Report that essentially said that bureaucracies are not known for the quality of imagination. I think what happens in these deliberations of the Fed is that they tend to coalesce around a middling point of view and no one wants to rock the boat.
The world has changed since 1913 and 1971. Is the gold standard modern enough?
Emphatically, yes. I know it seems anachronistic. But in fact, the gold standard—this institution that, in America, last functioned during the first administration of Woodrow Wilson—is as modern as social media. The essential nature of the gold standard was not the exchange from hand to hand of gold coins. The essential nature had to do with the price mechanism, that is to say, with markets. The dollar’s value was fixed, but the price mechanism determined interest rates and the ebb and flow of money across national boundaries.
What is anachronistic are the command-and-control methods of the Federal Open Market Committee (FOMC). Seventeen or so people sitting around a table to set interest rates is like something out of the old Soviet bloc. Today, we are all about wiki this and social media that. It is a collaborative age, correct? And the gold standard is an internationally collaborative monetary arrangement. The classical monetary system called the gold standard—that to me is the wave of the future as well as the wave of the past.
Could the dollar be tied to another commodity or resource? Does it have to be gold?
Gold has unique monetary properties. One might think that “useful” things would be a more desirable source of monetary stability. But gold is instantly and optically recognizable as money. You don’t have to explain it. Special drawing rights (SDRs), like a bad joke, have to be explained. Nobody recognizes an SDR on sight as value, but gold the world over is unrivaled in universal appeal and recognition.
Gold has the unique property that it is never destroyed. A one year’s shortfall in mining production has no meaningful effect on the size of the above-ground stock. If you were to monetize oil or agricultural commodities or the base metals, you would find great fluctuations in value having to do with the supply–demand balance for base metals or with the success or the failure of harvests. Gold output seems to grow between 1.5 and 2% a year, which more or less approximates the long-term rate of growth in population and productivity.
Do you view the European Central Bank in line with the Fed?
Absolutely of a piece. Different techniques, but the same. These so-called Long Term Refinancing Operations (LTROs) allow the banks to borrow at a nominal rate and with the proceeds go out and invest in assets yielding something more. They are manipulating lower the yields on the sovereign debts of the troubled European community members. But here, too, we need—we desperately need—an Office of Unintended Consequences. Artificially low interest rates may give Europe’s sovereign debt markets a lift, but what other mischief will they cause? Sadly, the state of the art in central banking is not much different from one country to the next.
You often reference the depression of 1920–21. Why?
The Fed can seem to talk about no other cyclical episode than the Great Depression. According to Ben Bernanke quoting Milton Friedman, the Fed failed because it wasn’t aggressive enough in creating new dollar bills. The Fed should have done QE all through 1929, 1930, and 1931, so they say.
But there was a previous depression that began in January 1920. It ended, according to the National Bureau of Economic Research, in the summer of 1921, 18 months from peak to trough. During these 18 months, wholesale prices were down 40%, nominal down (I think) close to 20%. In short, a huge crisis. How did the primitives of that day—and they are primitives by the lights of our modern scholars—at the newly fledged Fed and the orthodox politicians in Congress meet this catastrophe? Well, they met it in two ways. They balanced the budget, and they raised interest rates, the first time and the last time in the history of the Fed that rates were higher at the trough of a business-cycle contraction than they were at the previous cyclical peak.
But the depression ended and the Twenties proverbially roared, with terrific growth, a huge dynamic bounce back—nothing like today’s sleepwalking.
Is it just possible that today’s patient is over medicated? Is it not possible that a regime with 0% rates and institutionalized uncertainty has set us back rather than help us move forward? I say yes. Today’s massive monetary interventions, it seems to me, are the cause of our difficulties, not our salvation.
Do you see gold prices continuing to climb?
Gold is the investment that no properly schooled CFA [charterholder] can get his or her head around. It lacks the essential properties of income propagation. Gold has no earnings, no dividend stream, no dividend payments, and no conference calls—we can’t call up management and talk about governance, because it [gold] is in the periodic table.
The gold price is the reciprocal of the world’s faith in the workings and judgment of the likes of Ben Bernanke. For disclosure, I own gold. I have owned gold for a while, and I haven’t sold any recently and I don’t plan to. I believe the techniques of modern central banking ought not to be trusted and that one ought to have some monetary anchor. The best of anchors to me is the golden one, but you also want to recognize that the gold price can be almost any price and still not have a P/E ratio.
What about gold mining stocks?
Dirt cheap, both in absolute terms and relative to the gold price. Newmont Mining Corporation was a US$45 stock when gold was US$391 in 2003, and it is a US$45 stock now that gold is US$1,600.
How would a new gold standard affect investment climate?
Monetary stability—predictability, objectivity—would be a boon and a blessing. Imagine: no more guessing about what the mandarins will do next. Exchange rates would be fixed—no more guessing about them either. How much money today is cowering in cash on account of uncertainties that our present regime has all but institutionalized? I am going to say lots. By no means is the gold standard a perfect system. After all, it’s a human contrivance. But it’s the least imperfect system that we know of—the least imperfect system for which there’s a comprehensive historical record.
http://www.pdf-archive.com/2012/07/08/jim-grant/jim-grant.pdf
The Golden Rule
James Grant explains why “the classical monetary system called the gold standard … is the wave of the future”
BY JONATHAN BARNES
CFA Magazine July – August 2012
RETURNING TO THE GOLD STANDARD is no longer a fringe idea and even has become part of mainstream political discussion. James Grant, founder of Grant’s Interest Rate Observer, is a longtime advocate of the gold standard and critic of Central Bank monetary policy. In this interview with CFA Magazine, Grant speaks about the failures of the current monetary system, the practical steps toward a new gold standard, and his assessment of Federal Reserve Chairman Ben Bernanke’s four lectures in opposition to the gold standard, given at George Washington University in March 2012.
Why do we need a new gold standard?
Unpredictability is the hallmark of today’s monetary system. Our midget interest rates: will they be with us for three fiscal quarters—or three years? We don’t know. So-called quantitative easing (a.k.a. money-printing): will there be another bout? We will have to wait to find out. This lack of predictability inhibits long-term investment by industry. It stymies savings by ordinary people.
The gold standard is time tested, objective, and synchronous. It delivered more-than-satisfactory results for approximately 100 years between [the battle of] Waterloo and the First World War. It was objective in that currency values were fixed, defined as statutory weight of gold or silver, and it was synchronous in that the gold standard helped to coordinate economic activity among the participating gold-standard countries.
How do you respond to Federal Reserve Chairman Bernard Bernanke’s recent lectures?
Bernanke presents himself to be an historian. But his deconstruction of the gold standard was completely ahistorical. He says that the gold standard failed, but he fails to distinguish between the classical gold standard, which ended in 1914 and the various “road company” versions of the 1920s, the 1940s, up to 1971. These distinctions are important.
A key element of the gold standard is the lack of a privileged or reserve currency. But with the Genoa Conference in 1922 and with the institution of the gold exchange standard in the 1920s and with the further relaxation of the rigor of the gold standard under Bretton Woods in 1944, the very heart and soul of the classical system was eviscerated. For instance, under the Bretton Woods system, only central banks could legally own gold. An essential feature of the classical gold standard was that anyone could own gold. It was the people’s money.
Bernanke trotted out a bunch of shibboleths, such as not having enough gold to go around. Yet gold production has kept pace with population growth for many, many years. Another is that it costs a lot to dig it out of the ground, as if the cost of conjuring up US$2 trillion electronically over the course of a couple of fiscal quarters were cost free. These lectures were not a serious critique of monetary arrangements, old or new.
What steps would take us toward a gold standard?
First, begin a focused discussion about the merits and drawbacks of each of these systems. And take care not to confuse the gold exchange standard and the Bretton Woods regime with the system that we are really talking about—the classical gold standard in place before World War I. Then compare that system with the regime in place.
One of the worst features of today’s system is its inequity. To the bankers goes the upside; to the public goes the downside. What does this have to do with the value of the dollar? It has everything to do with it. Riding to the rescue of our shattered financiers, the Fed emits more and more dollars. It cuts interest rates until there is nothing more to cut.
Comprehensive financial reform means the renewal of the constitutional dollar (i.e., a dollar defined as a weight of a precious metal). It was the dollar in place from Alexander Hamilton’s time until Richard Nixon’s, with time out for the Civil War. The gold system must, it seems to me, be restored in parallel with a capitalist renewal of our banking system. In our regulated financial institutions, those who take risks also bear them.
What would a transition look like?
My friend Lewis Lehrman has written a book called The True Gold Standard. He lays out practical steps on how to get from here to there. I can only echo his blueprint. One would first announce a date for the restoration of the convertible dollar—probably a couple of years into the future. Then, one would let the marketplace discover the price of gold, and one would take great pains to ensure that on conversion there would be no move towards deflation in wage levels.
This was the great mistake the British made when they returned to a pre-World War I exchange value of the pound sterling against gold in 1925. By setting an untenably high gold value, they bought themselves years of trouble—sagging exports and wages, for instance. And they gave “the gold standard” a black eye, though it really wasn’t the true-blue gold standard they restored. Rather, it was that makeshift one called the gold exchange standard. There doesn’t have to be deflation if the proper exchange rate is found.
Is this a proposal for the U.S. or globally?
It’s very much an international proposal. This is an international effort, and there would be a new monetary conference to implement it. The gold standard by its nature is an international undertaking, an international system of organization. It ought to appeal to many countries besides the United States.
What could catalyze a move toward the gold standard?
Maybe a new financial crisis. Maybe—I hope—a political decision reached without crisis. It’s a job of persuasion. Try as I do to impart these ideas, I can’t say I have made enormous headway with the economic and financial establishment. [U.S. presidential candidate] Ron Paul has designated me as his Fed chairman, but I notice that Dr. Paul is not doing so well in the delegate count and I have not yet heard from Mitt Romney. The academic establishment speaks with just about one voice on these matters, and the voice is not entirely sympathetic to the gold idea. In fact, they rather think it is funny.
There is huge resistance from the beneficiaries of our present system. On Wall Street, who doesn’t like funding his or her liabilities at 0%? In the private equity business, who doesn’t like financing a leveraged buyout at today’s tiny interest rates? The answer to these rhetorical questions is: nobody. The present system is corrupt and corrupting. But it is as sweet as candy for the people who benefit by it, and many of those people happen to be in very powerful positions.
What would you do as Fed chairman?
The first thing I would do—with great ceremony—is to undertake the opening of a new office of the Fed. This will be the Office of Unintended Consequences. There’s a crying need for it. We know what the Fed wants to do. It wants a 2% inflation rate, a much lower unemployment rate, a rising stock market, and a solvent banking system. Commendable goals perhaps. But in trying to achieve these objectives, it tamps down interest rates and prints up stupendous volumes of new dollars. I don’t get the impression that the economists who run the central bank are really alive to the possibility that they have inadvertently sown the seeds of a disaster. Certainly, Bernanke gave no hint in his GW lectures that he worries much about it.
Does the current monetary system have an end date, in your opinion?
I said it was going to end about 1980. So perhaps I should make no more guesses. It has been 40 years and counting since Bretton Woods expired—40 years of increasingly irresponsible banking; 40 years of uncollateralized paper currencies; and now, with the advent of digital technology, ever greater waves of new electronic impulses we are pleased to call money (the Fed creates dollars, as you know, with the tap of a computer key). And despite it all, the world has gotten richer.
People don’t mind transacting with dollar bills. In fact, I am rather fond of them myself—I collect as many as I can. So we have the capacity to adapt to any monetary system. But we can all see the fault lines of our present day arrangements. It’s not meant for the ages.
What’s wrong with low interest rates?
You might ask, “What’s wrong with price control?” Talking to the GW students, Chairman Bernanke bemoaned the Nixon administration’s experiment with wage and price controls. They didn’t work, he correctly said. But how could they have worked? In prices is embedded the information that coordinates the actors in a market economy. Yet the same man who mouthed these truths also defends the Fed’s manipulation of the prices we call interest rates. I don’t understand.
What do you think is the Fed’s rationale?
I don’t know. I am not prepared to impugn their motives. I think they mean well. There is a wonderful passage in the 9/11 Commission Report that essentially said that bureaucracies are not known for the quality of imagination. I think what happens in these deliberations of the Fed is that they tend to coalesce around a middling point of view and no one wants to rock the boat.
The world has changed since 1913 and 1971. Is the gold standard modern enough?
Emphatically, yes. I know it seems anachronistic. But in fact, the gold standard—this institution that, in America, last functioned during the first administration of Woodrow Wilson—is as modern as social media. The essential nature of the gold standard was not the exchange from hand to hand of gold coins. The essential nature had to do with the price mechanism, that is to say, with markets. The dollar’s value was fixed, but the price mechanism determined interest rates and the ebb and flow of money across national boundaries.
What is anachronistic are the command-and-control methods of the Federal Open Market Committee (FOMC). Seventeen or so people sitting around a table to set interest rates is like something out of the old Soviet bloc. Today, we are all about wiki this and social media that. It is a collaborative age, correct? And the gold standard is an internationally collaborative monetary arrangement. The classical monetary system called the gold standard—that to me is the wave of the future as well as the wave of the past.
Could the dollar be tied to another commodity or resource? Does it have to be gold?
Gold has unique monetary properties. One might think that “useful” things would be a more desirable source of monetary stability. But gold is instantly and optically recognizable as money. You don’t have to explain it. Special drawing rights (SDRs), like a bad joke, have to be explained. Nobody recognizes an SDR on sight as value, but gold the world over is unrivaled in universal appeal and recognition.
Gold has the unique property that it is never destroyed. A one year’s shortfall in mining production has no meaningful effect on the size of the above-ground stock. If you were to monetize oil or agricultural commodities or the base metals, you would find great fluctuations in value having to do with the supply–demand balance for base metals or with the success or the failure of harvests. Gold output seems to grow between 1.5 and 2% a year, which more or less approximates the long-term rate of growth in population and productivity.
Do you view the European Central Bank in line with the Fed?
Absolutely of a piece. Different techniques, but the same. These so-called Long Term Refinancing Operations (LTROs) allow the banks to borrow at a nominal rate and with the proceeds go out and invest in assets yielding something more. They are manipulating lower the yields on the sovereign debts of the troubled European community members. But here, too, we need—we desperately need—an Office of Unintended Consequences. Artificially low interest rates may give Europe’s sovereign debt markets a lift, but what other mischief will they cause? Sadly, the state of the art in central banking is not much different from one country to the next.
You often reference the depression of 1920–21. Why?
The Fed can seem to talk about no other cyclical episode than the Great Depression. According to Ben Bernanke quoting Milton Friedman, the Fed failed because it wasn’t aggressive enough in creating new dollar bills. The Fed should have done QE all through 1929, 1930, and 1931, so they say.
But there was a previous depression that began in January 1920. It ended, according to the National Bureau of Economic Research, in the summer of 1921, 18 months from peak to trough. During these 18 months, wholesale prices were down 40%, nominal down (I think) close to 20%. In short, a huge crisis. How did the primitives of that day—and they are primitives by the lights of our modern scholars—at the newly fledged Fed and the orthodox politicians in Congress meet this catastrophe? Well, they met it in two ways. They balanced the budget, and they raised interest rates, the first time and the last time in the history of the Fed that rates were higher at the trough of a business-cycle contraction than they were at the previous cyclical peak.
But the depression ended and the Twenties proverbially roared, with terrific growth, a huge dynamic bounce back—nothing like today’s sleepwalking.
Is it just possible that today’s patient is over medicated? Is it not possible that a regime with 0% rates and institutionalized uncertainty has set us back rather than help us move forward? I say yes. Today’s massive monetary interventions, it seems to me, are the cause of our difficulties, not our salvation.
Do you see gold prices continuing to climb?
Gold is the investment that no properly schooled CFA [charterholder] can get his or her head around. It lacks the essential properties of income propagation. Gold has no earnings, no dividend stream, no dividend payments, and no conference calls—we can’t call up management and talk about governance, because it [gold] is in the periodic table.
The gold price is the reciprocal of the world’s faith in the workings and judgment of the likes of Ben Bernanke. For disclosure, I own gold. I have owned gold for a while, and I haven’t sold any recently and I don’t plan to. I believe the techniques of modern central banking ought not to be trusted and that one ought to have some monetary anchor. The best of anchors to me is the golden one, but you also want to recognize that the gold price can be almost any price and still not have a P/E ratio.
What about gold mining stocks?
Dirt cheap, both in absolute terms and relative to the gold price. Newmont Mining Corporation was a US$45 stock when gold was US$391 in 2003, and it is a US$45 stock now that gold is US$1,600.
How would a new gold standard affect investment climate?
Monetary stability—predictability, objectivity—would be a boon and a blessing. Imagine: no more guessing about what the mandarins will do next. Exchange rates would be fixed—no more guessing about them either. How much money today is cowering in cash on account of uncertainties that our present regime has all but institutionalized? I am going to say lots. By no means is the gold standard a perfect system. After all, it’s a human contrivance. But it’s the least imperfect system that we know of—the least imperfect system for which there’s a comprehensive historical record.
