Greenspan 1966: Fiat Money Steals From The Rich To Give To The Poor


In Alan Greenspan’s famous (famous to us Econ nerds, that is) essay of 1966 entitled Gold And Economic Freedom, the then-young economist, writing with the subtext of condescension, resentment, and hint of conspiracy-theorizing prevalent among (Ayn) Randians, decried America’s departure from the Gold Standard. Greenspan painted the nation’s rejection of the Gold Standard as a sneaky, backdoor policy aimed at siphoning money from the rich to give to the poor.

I’ve found that most people who extol the Gold Standard focus on Gold’s ability to cool down an overheated economy. There remains a tell-tale silence about Gold’s ability on the flipside– that is, to revitalize an ailing economy. Surely this apparent drawback to Gold is an important one, and one deserving of a solid answer– an answer which, after a hundred years of modern debate– appears to be non-existent.

Greenspan, following the usual pro-Gold-Standard argument, praised Gold for its ability to shut down an economy. Greenspan implies that Gold is an inelastic Money-Supply-base.  But actually, I contend that Gold does indeed possess some elastic qualities, including, to name the most obvious:

1) the ability to expand the Money Supply when Central Governments release their Gold Reserves into the economy

2) the ability to expand the Money Supply when banks reduce the amount of Gold-reserves held in bank-vaults versus the amount of their loans-outstanding

3) the ability to vary the Money Supply with increasing or decreasing Gold-mining

4) and in a more drastic maneuver, governments can simply re-value how much Gold they want their currency to represent.

All that said, compared to fiat money, the money supply in an economy based on a Gold Standard DOES remain less changeable.  I almost said “more stable”– but that’s not quite true– a Money Supply increasing at 3% per year is “stable”– though changing.  Greenspan explains the generally accepted way in which this is unchangeability is supposed to occur in an economy in which banks are assumed to hold their reserves mostly in Gold…

“When the business ventures financed by bank credit are less profitable and slow to pay off, bankers soon find that their loans outstanding are excessive relative to their gold reserves, and they begin to curtail new lending, usually by charging higher interest rates. This tends to restrict the financing of new ventures and requires the existing borrowers to improve their profitability before they can obtain credit for further expansion.”

In other words, a recession is induced.

As one notices quickly while reading Gold Standard essays, supporters of the Gold Standard do not make the claim that Gold keeps the economy running smoothly, only that a Money Supply based on Gold will tend to constrict sooner than one using Fiat money, with the advantage being that the resultant recession will be less drastic than one which had been delayed by an overly expansive money policy, such as one which can occur easily under Fiat funds. Under a Gold Standard, claimed Greenspan, “readjustment periods” are “short” and the economy “quickly” resumes expansion with a sound base.

On the other hand, Greenspan contended that a Government acting in an economy unfettered by a currency requiring specie-backing, can implement a virtually “unlimited expansion of credit.”  However, although Greenspan certainly mentioned that such an overlong money-expansion policy would eventually lead to an economic collapse harsher and longer than it need have been under a Gold regime, this is not what has gotten the great economist’s dander up about Fiat Money.  Instead, Greenspan was ticked-off by the connection he thought existed between an overly expansive Money Supply and the Redistribution Of Wealth from richer to poorer…

“The Welfare State is nothing more than a mechanism by which governments confiscate the wealth of the productive members of a society to support a wide variety of welfare schemes,” he wrote.  “[…] Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights.”

Hellz yeah.  But back to the facts…

Price Inflation (when most people say “inflation,” they mean Price Inflation) occurs when the Money Supply increases but NOT the amount of assets which that money represents.

Greenspan suggested in his essay that what we may call the True Value Of Money (my term, not his) is determined by the amount of assets in an economy. If the Money Supply remains constant, but the amount of assets in an economy grows, each dollar will be forced to represent (or cover) a larger asset base.  Thus, each dollar will be worth MORE (in terms of assets, by definition). 

Let’s imagine an economy with a Money Supply of $200, and an asset base of 50 widgets. In this economy, there will be $4 for every 1 widget, thus (under our “True Value” principle) each dollar will be worth 1/4 widget.

However, if the Money Supply shrinks to $100, then the ratio of dollars to widgets falls to $2 for every widget, and the True Value of each dollar would then be $1 = 1/2 widget– the value of every dollar just went UP.  Or to say the same thing in reverse, instead of each widget costing $4, they will now each cost only $2– each dollar now buys MORE. Thus, when the Money Supply goes DOWN, there is Price DEFLATION.

Conversely, if the original Money Supply increased from $200 to $400, then there would be eight dollars for every one widget. Therefore, the dollar-to-widget (or, money-to-asset) ratio would be $8-to-1.  Every widget now “costs” $8 instead of $4.  Thus, we can see that when the Money Supply goes UP, there is Price INFLATION.

Now imagine that the wealthiest 1% of a population is holding 50% of that country’s wealth (hard to imagine, I know, but stay with me). In our 50-widget economy, that would mean the wealthiest one-percent holds 25 out of 50 widgets. Now let’s say they have loaned out their 25 widgets (just holding assets is not what makes rich people rich– they must be able to put their assets “to work”). The assets are loaned with the requirement that the widgets be returned at the end of the loan-period along with the payment of a dollar for each widget borrowed. This means, at the end of the loan period, the investors (the lenders) receive their widgets back plus $25. However, if in the meantime, the Money Supply increased from $200 to $400, instead of each dollar now being worth 1/4th a widget, they will each be only worth 1/8th a widget (50 widgets divided by $400). Thus, the Investors were “cheated” out of the return on their investment (loan) they had expected.

As Greenspan complained in his essay, “As the supply of money (of claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise. Thus the earnings saved by the productive members of the society lose value in terms of goods.”

Such a terrible outcome would not have occurred, contended Greenspan, under a Gold Standard, for the Money Supply could not have increased so much. Greenspan considered Price Inflation to be a “confiscation” of wealth…  “In the absence of the Gold Standard,” he wrote, “there is no way to protect savings from confiscation through inflation.”

Greenspan then leaps directly from the idea of a nibbling inflation to the dark picture of an economy in which “there is no safe store of value.” (Greenspan neglected to mention the fact that it is the curse of the rich that, actually, there is NEVER a “safe store of value”… Some pesky peon or immoral community is always finding some way to steal a crumb or three of your amassed wealth!)

Greenspan then leaned toward hyperbole when he implied that Price Inflation leads to a chaotic world in which… “neither long-range planning nor exchange would be possible.” Such a situation would not be unprecedented in human history, but it is highly unlikely in any modern economy experiencing anything less than extreme and exceedingly uncommon conditions.

Greenspan also points out that, in a Fiat-Money economy, banks are allowed to use government bonds as reserves. These bonds are based — not on tangible assets– but merely on the government’s promise to buy back the bonds (with interest), using future tax revenues. By being allowed to hold their reserves as government bonds (issued at will by the government) instead of gold, banks will be able to lend out much more money.

Furthermore, banks under the Fiat system of the United States are allowed to pay-out to their clients “Federal Reserve Bank Notes” — paper money based neither on gold nor on anything else tangible, thus further increasing the ease of increasing the Money Supply relative to the economy’s actual base of assets.

“The abandonment of the Gold Standard,” wrote an unhappy Greenspan, “made it possible for the Welfare Statists to use the banking system as a means to an unlimited expansion of credit. They have created paper reserves in the form of government bonds which — through a complex series of steps — the banks accept in place of tangible assets and treat as if they were an actual deposit, i.e., as the equivalent of what was formerly a deposit of gold. “

Greenspan held that a government can issue more bonds when there is no Gold Standard since… “under a Gold Standard, the amount of credit that an economy can support is determined by the economy’s tangible assets, since every credit instrument is ultimately a claim on some tangible asset. But government bonds are not backed by tangible wealth, only by the government’s promise to pay out of future tax revenues.”  He then went on to state that, under a Gold Standard, “a large volume of new government bonds can be sold to the public only at progressively higher interest rates.”  Due to this demand of the investing public for higher returns each time it buys yet more government bonds, “government deficit spending under a Gold Standard is severely limited. “

However, I find Greenspan’s description of the interplay of bonds and bank-lending confusing. To my mind, government bonds –whether they be issued in an economy based on a Gold Standard or a Fiat System– are ALWAYS based on the government’s promise to repay later (with interest) what it is given today. And any time– whether in a Gold-based or Fiat-money-based economy, if a borrower continues pressing investors for money, the investors are going to demand more return for each increase in their exposure to risk.  

Also, even in a Fiat economy, as the money supply increases, investors demand higher interest returns to compensate for the induced Price Inflation of an expanding Money Supply. What matters when it comes to loans (selling bonds in this case) is simply how confident the investors (loan-givers, a.k.a. bond-buyers) are that the money can be paid back according to the agreed-upon terms. Our economy could be based on jellybeans, and it would not affect the fundamental mechanisms of lending very much as long as investors remained confident that the government could fulfill the terms of the loan-transaction.

Furthermore, Greenspan painted the financial picture as if banks were buying government bonds to serve as reserves to lend out more money– thus inevitably and always increasing the Money Supply.  However, the situation is actually more convoluted than that…

It is a long-established maneuver of the government to sell bonds to the banks when it wishes to DECREASE the Money Supply (by absorbing, like a sponge so to speak, the money in the economy in the form of payment for bonds). I’m not saying that this is a great or efficient policy the government uses– for the government can then spend the money it receives, thus putting the money into circulation anyway– only that such is the strategy employed.

And what’s more, whether in a Fiat-based or Gold-based economy, when a country’s government-borrowing drives up interest rates, money from other nations will flow into that country to take advantage of the higher rates– and with money knocking at the door to get it, the government will not face the same intense necessity to keep raising interest rates as it would without the pulling-in of foreign investors.

So I don’t think Greenspan was correct when he asserted a direct connection between government-deficits and Fiat Money.  And I think he oversimplified matters, and overstated outcomes, when he claimed that “the Gold Standard is incompatible with chronic deficit spending (the hallmark of the welfare state).”

Greenspan was more correct when he maintained that there would be a direct match-up between “the goods purchased by the government for welfare or other purposes with the money proceeds of the government bonds financed by bank credit expansion.” The only correction I would add is that, here, he is is using more the art of the sophist than the economist by making sure to speak of government expenditures as “welfare and other purposes” (he could have just as easily have said “national defense and other purposes” or “delivering the mail and other purposes”). And it is also sophistry when he tags-on to the end of the sentence “financed by bank credit expansion”– the direct truth of the sentence ends with “proceeds of the government bonds.”  Yes, the bonds are financed by the banks, but there is some interfering complexity to contend with before we can assert what the sentence’s crafty structure WANTS us to read: “government bonds [are] financed by… credit expansion”– not precisely nor necessarily true.

So Greenspan’s argument boils down to the attempt to establish an unbreakable chain of events, running something like… 1) a country drops the Gold Standard –> 2) the Government will borrow more –> 3) there will be a bigger welfare state.

Unfortunately, this argument proves unsound at every juncture.  I don’t think people have realized just how incorrect Greenspan’s essay was because his predicted OUTCOME did, indeed, come to pass.  But not for the reasons he asserted.  The Welfare State has been enabled by a confluence of events, both global and domestic.  To name a couple… due to the existence of an unquestionably sound and entrenched Central Government, and to the continued existence of a growth-trending economy– not only are more guns AND butter capable of being purchased, but investors are encouraged to trust the Government when it says it will repay its loans.  Inflation (the multi-decade “Great Inflation,” as one economist called it) has indeed played its part, and I don’t want to discredit that theory, but it’s not been according to the fashion described by the young Mister Greenspan.


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