Dr. PAUL. Thank you, Mr. Chairman.
Mr. Greenspan, a lot of economists look to the price of gold as an indicator and as a monetary tool. It has been reported that you might even look at the price of gold on occasion.
Last summer on a couple of occasions here when you were talking before the committees on securities and on derivatives you mentioned something that was interesting. You said that central banks stand ready to sell gold in increasing quantities should the price rise, which I thought was rather interesting.
Then I followed up with a letter to you to ask you whether or not our central bank might not be involved in something like that, in the gold market. And you did answer me and stated that since the 1930's the Federal Reserve has had no authority to be involved with the gold markets.
I am quite confident that the Treasury has authority to be in gold markets, but you stated that the Federal Reserve did not. But this contradicts some reports that have been made by some Federal Reserve officials that said that the New York Fed was very much involved in the London gold pool from 1961 to 1971. But your answer implied that the Fed has never been involved since the 1930's, which I think is interesting.
The reason why this could be of importance is that we do know that our Treasury was supporting a fixed price of gold at $35 an ounce in the 1960's, so therefore the price of gold of $35 an ounce was totally useless in predicting what might happen and what did happen in the 1970's. So if central banks stand ready to lease and sell gold in increasing amounts should the price rise, we are more or less, you know, in a time when the gold price is probably so-called fixed; and we do know that the evidence is there that central banks do loan gold, they sell gold. So could it be that the price of gold today is less valuable to the economists, who think that gold could help us, in thinking that maybe we are in a period of time comparable to what we had in the 1960's?
Mr. GREENSPAN. I think the price of gold has, over the decades, been a generally usable indicator of what the level of inflation has been. Obviously, during the period of an active gold standard, which was really prior to World War I, the price level pretty much locked itself in to the gold price. In fact, by definition it did.
The issue of buying and selling gold as the price changes is indeed exactly what we used to do. We used to, at a certain thing called the gold points, which was the price of gold plus the transportation cost differentials, we, that is, the United States Treasury, stood ready to buy and sell gold at a spread, as indeed all other participants in the gold standard did. So in that regard that was exactly what was happening.
But, needless to say, since we have gone off the gold standard, and especially since 1973, there has been basically a general float of the dollar vis-a-vis gold, which means that the gold price is like another commodity's price.
Nonetheless, like a lot of commodity prices, and perhaps better than most, it has been useful, in my judgment, in trying to get some sense of what inflationary pressures have evolved in this country.
Dr. PAUL. Even if the central banks, who are the major holders of gold, are willing to sell gold in order to manipulate the price or hold the price at a certain level? We are not on a gold standard, so what would the motivation be?
Mr. GREENSPAN. They are not doing it for purposes of fixing the gold price. They are looking for it to reduce their stock of gold when they have sold on the grounds that: one, it costs to store the gold; and, two, it didn't obtain any interest. So they perceived it to be a poor asset to hold. But the purpose was not to manipulate the price of gold.
Dr. PAUL. Another quick question on another subject, on Argentina. You stated earlier that you have been studying this and will answer the question about whether Argentina can use the dollar as their currency. It has been reported that there was a consideration, and I surely hope this is not true, that the Federal Reserve could become the lender of last resort, and they would have access to the discount window.
Along that line, how does it work when a foreign country dollarizes and they expand their credit through fractional reserve banking? Does that put an obligation on us and can that interfere with the dollar's value?
Mr. GREENSPAN. That is a good question, Congressman. The answer is no. We view monetary policy in the United States as for the United States. We have no interest in, nor does the Treasury, of being a lender of last resort outside the United States.
Dr. PAUL. Outside the IMF?
Mr. GREENSPAN. The issue of whether or not another country wishes to use the American dollar as its medium of exchange is theirs to make. They can do it unilaterally. Panama did. Liberia did. If they choose to do that, that is their sovereign right to do that. But we have no obligation in that regard.
Clearly, we do sense some obligation with respect to our Latin American colleagues for the same reason that we have had relationships with all of our trading partners. Their interests do concern us, and we would like them to be prosperous. To the extent that we are helpful in trade negotiations or other negotiations, that is fine. But lender of last resort, no.
Dr. PAUL. Thank you, Mr. Chairman. I appreciate this opportunity.
First, I would like to say that I hope the Humphrey-Hawkins requirement continues; I think that is important. I do also note that frequently at these hearings we don't talk much about monetary policy, which is the purpose of the meeting. We frequently talk about taxes and welfare spending.
I would like to concentrate more on the monetary policy and the value of the dollar. There are some economists who in the past, such as Mises, von Hayek, as well as Friedman have emphasized that inflation is a monetary phenomenon and not a CPI phenomenon, it is not a labor cost phenomenon. When we incessantly talk about this, whether it is the Federal Reserve, the Treasury, Congress, or the financial markets, we really distract from the source of the problem and the nature of our business cycle.
I certainly agree that technology has given us a free ride and has allowed us this leverage, but we have also been permitted a lot of inflation, that is, the increase in the supply of money and credit. Since 1987, we have had a tremendous increase in money. The monetary base has doubled; M3 has gone up $2.5 trillion. This money has gone into the economy, but we have reassured ourselves that the CPI has been stable so therefore everything is OK. Yet the CPI has gone up 44 percent since 1987.
Real growth in the GDP has not been tremendous. It is about 2.3 per year. But we have had a tremendous increase in capitalization of our stock market going from $3.5 trillion up to $14 trillion. That is where the money is going. This generates revenues to the Government. This has helped us with our budgetary problems.
At the same time, we ignore the fact that hard money people emphasize that not everybody benefits, and there has been a lot of concern expressed that people are left behind, farmers are left behind, the marginal workers are left behind. Some people suffer more from a higher CPI than others. These are all monetary phenomena that we tend to ignore.
But you have admitted here today and in the past that the business cycle is alive and well and that we shouldn't ignore it-in your opening statement, you said that we should be especially alert to inflation risks. I think that we certainly should be. And you have expressed concern today and at other times about the current account deficit, and this is getting worse, not better. Our trade balances are off. But I would suggest maybe we have seen some early signs of serious problems because foreign central bank holdings now of our dollars have dwindled to a slight degree. In 1997, they were holding over $650 billion and they are slightly below $600 billion. At the same time, we have seen the income from our investments dwindle to a negative since 1997. So I think the problems are certainly there.
But I would like to talk a little bit more about, or ask you a question about, this balance of trade and the value of the dollar, because history shows that these dollars eventually will come back. And you have assumed that, that they will, but that essentially the problem that we got into in 1979 and 1980, there is no guarantee that that won't happen again. That means that the markets will drive interest rates up, we will have domestic inflation, the value of the dollar will go down.
My question is, what will your monetary policy be under the circumstances? In 1979 and 1980, you were-not you, but the Fed-was forced to take interest rates as high as 21 percent to save the dollar. My suggestion is, it is not so much that we should anticipate a problem, but the problem is already created by all of the inflation in the past twelve years and that we have generated this financial bubble worldwide and we have to anticipate that. When this comes back, we are going to have a big problem. We will have to deal with it.
My big question is, why would you want to stay around for this? It seems like I would get out while the getting is good.
Mr. GREENSPAN. Dr. Paul, you are raising an issue which a significant number of people have been raising over the years and for which, frankly, we are not quite sure what the answers are. It is by no means clear, for example, that one can trace the increase in money supply, which presumably has not reflected itself in CPI, into stock values. A lot of people say it is happening and a lot of people assume that is what it is, but the evidence is not clear by any means.
Dr. PAUL. May I interrupt, please? Did you not write that that was the case with the 1920's and that was the problem that led to our Depression?
Mr. GREENSPAN. No, I didn't raise the issue that it was in effect the money supply, per se. What I was arguing many, many years ago, and I still think, is that in 1927 involving ourselves with an endeavor to balance the flow of gold in favor of Britain at that time, we did create a degree of monetary ease which was one of the possible creators of speculation in the market in 1928 and 1929. What is not evident in today's environment is anything like that is going on.
We cannot trace money supply to a speculative bubble. If a bubble, in fact, turns out to be the case, after the fact, we will have a considerable amount of evaluation of where it came from. But as I have said before this committee and, indeed, before the Congress on numerous occasions, we are uncertain as to the extent to which there is a bubble because, as I said in my prepared remarks, to presume there is a bubble of significant proportions at this particular stage and that the bubble isn't significant doesn't have any meaning; we have to be saying that we know far more than the millions of very sophisticated investors in the markets. And I have always been very reluctant to conclude that.
We do know that a significant part of the rise in prices reflects rising expected earnings, and a goodly part of that is a very major change in the view of where productivity is going. What we do not know is whether it is being overdone or to what extent it is being overdone.
I have always said I suspect it is, but firm, hard evidence in this area is very difficult to come by. It is easy to get concerned about it on the basis of all sorts of historical analogies, but when you get to the hard evidence, we do know that inflation is a monetary phenomenon, but what we have a very great difficulty in knowing is how to measure what that money is.
Remember, M2, M1, all of that are proxies for the money that people are talking about when they are referring to money being the creator of inflation. We have had great difficulty in filtering out of our database a set of relationships which we can call true money. It is not MZM, that is, money with zero maturity, it is not M2, it is not M1, it is not M3, because none of those work in a way which would essentially describe what basically Hayek and Friedman and others have been arguing, and I think quite correctly, on this issue.
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