Gold Standard Doubles as the Greenspan Fed Makes Real Interest Rates Negative


So Alan Greenspan – former chairman of the Federal Reserve – thinks this equals the Great Crash, if not out-bads it.

“It’s getting increasingly evident that this is a once-in-a-century type of phenomenon,” he told the ever-fragrant Maria Bartiromo in an interview with CNBC this week, “not the standard type of liquidity crisis that we have seen in the past.

“It’s verging on the issue of solvency.”

To gauge the true scale of this crisis, Greenspan went on, just consider the fact that it took sovereign credit to stabilize first the UK and then US financial systems. When Northern Rock went belly-up last Sept. and then Bear Stearns blew up this spring, Treasury bonds had to be lent out like adjustable-rate home loans circa 2006, covering short- term black holes with government debt.

Without these loans of government bonds, the banks simply wouldn’t lend to each other. They needed securitized tax payments to gain the credibility needed for raising new funds in the market. Short of offering government debt to put up as collateral, they found the cost of borrowing money – when they found any money to borrow – simply too high to bear.

“It’s still very evident from [inter-bank lending] spreads that we have not gotten closure yet,” Dr.Greenspan continued, pointing to the ongoing premium charged for loans backed by anything other than sovereign credit. So to fix the problem – or at least tease it out for months if not years – clearly the world needs more government bonds for the big banks to borrow and put up against cash loans in the market.

“It’s essentially, fundamentally the price of homes in the United States which are determining…the ultimate collateral of mortgage- backed bonds, pretty much around the world.”

Looking ahead, he concluded that “we’re still nowhere near the bottom of the home-price thing” – the word “thing” standing in for “crash…collapse…crisis…deflation” and all the other phenomena Greenspan must still believe can never apply to real-estate prices.

As key contractor, if not the architect, of today’s pan-global banking crisis, he chose to keep US interest rates way below the rate of inflation – making debt pay and savings a suck of real value – for three years straight starting in August 2002.


That period marked the first run of sub-zero returns paid-to-cash since the inflationary ’70s, back when loose money worldwide led to a bubble in prices that needed 20% interest rates to revive the world’s faith in the Dollar.

The start of this decade also saw the gold price- dormant-to-dead ever since the US took that strong medicine at the start of the ’80s – double inside five years.

“First warning,” as Marc Faber wrote in his Gloom, Boom & Doom Report of Sept. ’07, of trouble ahead.

“Ultra-expansionary US monetary policies with artificially low interest rates led to bubbles all over the world and in every imaginable asset class. The price of Gold more than doubled in nominal terms and against the Dow Jones Industrial Average.”

So why didn’t gold take a dive when Greenspan’s successor – Ben Bernanke – tip-toed his way back to 4% real rates of interest in late 2006…? Because early gold buyers never believed the Fed would succeed in keeping rates there. With housing now a political issue – and home ownership a god-given right for even the flakiest debtors – the first sign of trouble would cause a collapse in real rates, destroying the value of money in the hope of achieving “Reflation Part II”.

Hey, it worked after the Tech Stock bubble blew up. Why not again? And faced with a much greater crisis, or so Ben Bernanke believes, he’s managed to out-Greenspan the Maestro…pushing real US interest rates way down to minus 3% and worse.

Take gold as a marker of stress, and the true extent of today’s crisis becomes clearer still. Bear Stearns’ fire-sale to J.P.Morgan in mid- March – which required an open-ended loan of $29 billion from the Federal Reserve – saw gold jump to $1,032 per ounce. We think it’s signal that Alan Greenspan ignores it.

“Central banks, of necessity, determine what the money supply is,” as he told Congress in a 1999 hearing. “If you are on a gold standard or other mechanism in which the central banks do not have discretion, then the system works automatically.

“The reason there is [now] very little support for the gold standard is the consequences of those types of market adjustments are not considered to be appropriate in the 20th and 21st century. I am one of the rare people who have still some nostalgic view about the old gold standard, as you know, but I must tell you, I am in a very small minority among my colleagues on that issue.”

Today, almost a decade later, the Federal Reserve and its peers across the world are trying to prevent the money supply from shrinking again. That was the fear amid the “Deflation Scare” of 2002, which caused the Fed to ordain sub-zero rates, creating not only the bubble in housing but also the collapse of true money values against oil, food and pretty much all raw materials.

The world’s nostalgia for gold, in response, has seen it treble in price vs. the Dollar and more than double against the Euro, Yen and British Pound. But the cheerleader for cheap money when running the Fed, Alan Greenspan points instead to government bonds when gauging the size of today’s crisis. A true policy wonk, Greenspan thinks only of political bail-outs to protect the system, rather than considering how private investors might choose to protect themselves and their wealth.

Heaven knows they won’t get any help from Bernanke’s repeat of the Maestro’s “reflationary” error.

Adrian Ash
for The Daily Reckoning Australia

Adrian Ash
City correspondent for The Daily Reckoning in London and formerly head of editorial at Fleet Street Publications Ltd, Adrian Ash has been studying and writing about the investment markets for the last 9 years. He is now head of research at BullionVault - giving you direct access to investment gold, vaulted in Zurich, on US$3 spreads and 0.8% dealing fees.
Adrian Ash

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  1. A semi-tale of two Bens

    The historian Niall Ferguson writing in his latest article in the Financial Times opined that:

    “The difference is that the monetary and fiscal authorities have done everything in their power to prevent a repeat of what Milton Friedman and Anna Schwartz dubbed “the great contraction” between 1929 and 1933. What happened then was that falling asset prices caused thousands of banks to fail, while the Federal Reserve did almost nothing to mitigate (and a good deal to accentuate) the consequent monetary implosion. Under Ben Bernanke’s historically informed leadership, the Fed has done the exact opposite, slashing interest rates and, more importantly, targeting liquidity at banks through the discount window and new term auction facilities…

    “No, this is not the Great Depression 2.0; the Fed and the Treasury are seeing to that” (“How a local squall might become a global tempest”).

    It is so disappointing that such a distinguished financial historian displays his ignorance.

    We cannot compare today’s ‘upwave’ response to ‘crisis’ with the the ‘downwave’ response of the 1930s. Anyway we need a depression to “reset” the global economy for sustained growth. Preventing a depression only postpones the adjustment and makes it even more severe when it arrives.

    (Even in the aftermath of October 29, 1929, at the start of the ‘downwave’, Hoover cut taxes and Harrison cut the discount rate.

    “… on Thursday, 31 October [effective November 1]…the Federal Reserve Banks lowered the rediscount rate from six to five per cent. The Reserve Banks also launched vigorous open-market purchases of bonds to ease money rates and liberalize the supply of credit… On all these happy portents the market closed down [i.e., “suspended”] for Friday, Saturday, and Sunday…” (John Kenneth Galbraith, The Great Crash 1929, (London: Penguin Books, 1992), p.141).

    This was followed by a 0.5 percentage point cuts on November 15, 1929, February 7 and March 14 of 1930. Over a period of seven and a half months interest rates went from 6 to 2.5 percent.

    “In the belief that tax reduction would counter the depression Hoover asked Congress in December, 1929 for lower income-tax rates. Congress responded at once” (Harold Underwood Faulkner, American Economic History, 8th edition, New York: Harper & Brothers, 1960, p.649).

    From the post-crash low in November 1929 to the peak in April 1930 the Dow Jones increased by 48 per cent).

    [Compare the tax rebate and interest rate cuts of 2007-08].

    But we are not yet at the stockmarket turning point, so Ferguson is comparing apples with oranges.

    We are leaving the ‘crisis’ that leads to the final rally of the stockmarket before the turn in social mood contributes to debt liquidation and provides the big ‘push’ to the hegemonic and techological transitions that are taking place.

    See “Boom and Bust Republicans” for the historical and the present crisis-boom-bust.

    (In the 19th century the ‘crisis’ was war-related, in the 20th, and now the 21st century, it was and is ‘finance-related’).

    Ben Strong, the Governor of the Reserve Bank of New York, is accredited with ‘saving’ the day in the 1927-crisis and Ben Barnanke, the Chairman of the Board of Governors of the Federal Reserve will be accredited with ‘saving’ the day in 2007-08.

    Both Strong and the treasury-secretary were ‘involved’ in the crisis of 1927, just as Bernanke and Paulson are ‘involved’ with the crisis of 2007-08.

    “Had the situation continued, most European nations would have had to leave the gold standard. Given the complexities of the reparations situation, the United States would be dragged down with them in a major financial crisis. Accordingly, Secretary of the Treasury Andrew Mellon and Benjamin Strong eagerly accepted invitations from European central bankers to a conference on the question. In 1927 Montague Norman of the Bank of England, Hjalmar Schacht of the Reichsbank, and Charles Rist of the Bank of France met with their American counterparts. The situation might yet be saved, they argued, if the Federal Reserve cut its rediscount rate. Such an action would lower American interest rates in relation to those in Europe, and therefore attract funds to European banks. At the same time, low interest rates would encourage borrowing in America and stoke the speculative furnaces. Strong was unhappy about the latter probability, but in the end proved willing to further stimulate an already active American economy in order to save international stability. In 1927, the Federal Reserve lowered its discount rate from 4 to 3.5 percent.

    “Wall Street greeted the lowered rate. It meant businesses could borrow funds more easily, and so expand operations and profits. More important, it assured a continual flow of cheap credit for the call-money market. Member banks were able to borrow money from the Federal Reserve at 3.5 percent and then lend it as call money at 5 percent, making an easy profit of 1.5 percent. Thus, the international situation was resolved in such a way as to encourage speculation on Wall Street” (Robert Sobel, Panic on Wall Street, (New York: Macmillan, 1968), pp.360-361).

    But Ferguson makes a very good point with this statement:

    “But, as in the 1930s, the critical phase is not the US phase. It is when the crisis goes global that the term “credit crunch” will no longer suffice.”

    Events outside America, and response in America, in 1931 provides the template to view the future:

    “The deterioration of the situation in Europe added to the problems of the American authorities. In May 1931 the Credit Anstalt of Vienna was obliged to close and the German banks to which it was heavily indebted were soon in difficulties. They could not meet their short obligations to London, and this frightened other Europeans, especially the French, into withdrawing their balances from Britain. By September England had lost so much of its gold reserve that it was forced to devaluate the pound, an action that set off a series of devaluations around the world. This did not solve the balance of payments problems since it left most countries in about the same position relative to others as before.

    “During the latter months of 1931 the United States also faced a heavy loss of gold. In an effort to stop the drain, the Federal Reserve Bank of New York raised its discount rate from 1.5 to 3.5 percent, with only temporary effect. By February 1932 the gold of the Federal Reserve Banks was close to the legal minimum that the Glass-Steagall Act was passed; it permitted government securities to be substituted for gold as collateral for Federal Reserve notes, above the minimum of 40 percent. This made it possible for the Reserve Banks to increase open-market purchases and pump new funds into the market, but the flood of bank failures continued” (Margaret Myers, A Financial History of the United States, (New York: Columbia University Press, 1970), p.306).

    The response to the “heavy loss of gold” was an attempt to save the gold standard. In the future the response to a “heavy loss of ‘money'” will be an attempt to save the dollar standard.

    “David Tice … believes the canary in the coal mine will probably be the dollar. He expects the greenback to tank as international investors start to lose faith in the U.S. credit bubble. He also predicts the Federal Reserve will respond by jacking up interest rates to protect the dollar from complete collapse. That, of course, would bring the credit market to a grinding halt” (Brett Arends, Prudent Bear’s Tice Says the Plunge Is Coming,, May 4, 2007).

    While a bit simplistic, Peter Temin observed:

    “By the summer of 1931 … the United States was in the grip of a severe depression. But if recovery had come then, the downturn would have been within the historical range of business fluctuation. It would have been a hard time, but not the disaster of the 1930s. The growing depression was turned into the great depression by the Federal Reserve in the fall of 1931” (Peter Temin, “The Great Depression”, The Cambridge History of the United States, (CUP, 2000), p.311).

    The ‘gold’ standard was ‘saved’ in 1927 but not in 1931-32; the present dollar standard was ‘saved’ in 2007-08 but not in a future crisis.

    At least Andrew Mellon, Hoover’s treasury-secretary had the right policy response, unfortunately not implemented, as opposed to Bush’s present treasury-secretary, and I presume, John McCain’s treasury secretary.

    “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate

    “It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.”

  2. Edwards and Clinton

    In using history to understand the future, Future Watch constructs rhymes between the past and the present. Life is complex so one past rhyme cannot be sufficient. The rhymes may be graded as primary, secondary etc.

    The crisis of 2007-08 is rhymed with the crises of 1927, 1971, 1987 and 1997-98. After each crisis past the Dow Jones went higher followed by recession.

    So Future Watch monitors the news and then finds rhymes with the past.

    A headline on the BBC’s website for August 6, 1998 reads “Ex-senator Edwards admits affair”. The rhyme then is captured by the BBC’s headline of August 17, 1998 which reads “Clinton admits Lewinsky affair”.

    So we have a former Democratic presidential hopeful and a then Democratic president having affairs during a crisis before the boom before the bust.

    By collecting news rhymes for each rhyme period and comparing the rhyme period ‘speculations” may be made about the future.

    The rhymes of the past for today are the late 1920s, early 1970s the late 1980s and late 1990s.

    Some examples for each period for today:

    * Jenny Anderson, Wall Street Winners Get Billion-Dollar Paydays,, April 16, 2008:

    “Since 1913, the United States witnessed only one other year of such unequal wealth distribution – 1928, the year before the stock market crashed, according to Jared Bernstein, a senior fellow at the Economic Policy Institute in Washington.”

    * Stanley White and Kosuke Goto, Dollar Slumps Most in Eight Years Against Yen on Credit Losses,, March 17, 2008:

    “The dollar is the weakest since at least 1971 based on a Fed trade-weighted index…”

    * William Kristol, The Shape of the Race to Come,, April 7, 2008:

    And an experienced Democratic operative e-mailed: “Finally, I think [McCain’s] going to win. Obama isn’t growing in stature. Once I thought he could be Jimmy Carter, but now he reminds me more of Michael Dukakis with the flag lapel thing and defending Wright. Plus he doesn’t have a clue how to talk to the middle class. He’s in the Stevenson reform mold out of Illinois, with a dash of Harvard disease thrown in.”

    In a close race, that “dash of Harvard disease” could be the difference.

    * Elizabeth Stanton, U.S. Stocks Fall; Financials Drop to Lowest in Decade,, July 14, 2008:

    “The S&P 500 Financials Index retreated to its lowest level since October 1998, two months after Russia’s debt default sent the index down 23 percent in a month.”

    History, therefore is suggesting that the Dow Jones is going to a new nominal high to be followed by the Second Great Depression.

  3. Oh the classic boom and bust cycle to liquidate the over extended masses at the end of a credit fueled boom. Classic Machiavellian old school economics. The most efficient wealth transfer mechanism outside of warfare. We keep falling for the same old techniques as the media occupies our minds with Britney’s domestic problems. No such thing as investigative journalism or any challenge to the current paradigm that creates these messes ad infinitum. Couldn’t be a conspiracy because such things don’t exist, its just coincidence. Or maybe highly sophisticated market participants just don’t learn or fully understand financial history, mmh! a likely story. Still get the bonuses though and make a tidy profit in the process. Ill pay for it, don’t worry about it, I’m a tax payer and I know my place in the pecking order.


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