Alan Greenspan 1.5A, parts I & II

Alan Greenspan 1.5A, parts I & II

In his famous essay “Gold and Economic Freedom”, Alan Greenspan presents a gold based banking system.ⁱ The way currency is created conflicts with Ayn Rand’s philosophy.

Part I: The banks’ creation of currency. Part II: The conflict with Ayn Rand’s philosophy.

Part I:

Greenspan wrote: “… a logical extension… is the development of a banking system and credit instruments (bank notes and deposits) which act as a substitute for, but are convertible into gold… A free banking system based on gold is able to extend credit and thus create bank notes (currency) and deposits, according to the production requirements of the economy”ⁱⁱ.

Many people would not realize what Greenspan was talking about. And he doesn’t explain it. Greenspan is using a meaning of “deposit” most people don’t know, referring to a bank’s debt. Obviously, a customer’s deposit of gold wouldn’t convert to or substitute for gold.

This is one example of the procedure he described, according to his words:

Step 1: Extend Credit: The banker agrees to loan 900 gold oz to a Borrower, who will spend it on production requirements.

Step 2: Create a Deposit: The banker writes “900 gold oz” in the debt column of the bank ledger. The banker has “created” the bank’s deposit, without a customer deposit or any gold. He wrote down a debt the bank doesn’t owe.

Step 3: Create Bank Notes: The bank notes say the bank owes 900 gold oz, when the bank notes are redeemed. The bank notes document the the banks’ liability in the debt column, not gold. There isn’t any gold yet.

Step 4: Substitute Bank Notes for Gold: Instead of loaning gold to the Business, the bank substitutes the bank notes. The bank retains the loan agreement, a claim for future payments of 900 gold oz plus interest.

Step 5: Convert Deposit into Gold: The value of the loan, 900 gold oz plus interest, is recorded in the asset column next to the banks’ deposit in the debit column.

The result of the process is that the banker, “… holds claims to gold rather than gold as security…ⁱⁱⁱ”.

The process is essentially the same with or without considering reserves.

Greenspan’s “banking system based on gold” prints money that is not backed by gold. They artificially “create” deposits and loan the result, paper money secured by paper claims; which he says “… enables the banker to loan out more than the amount of his gold deposits…^iv”.

What Greenspan describes is current banking practice. Greenspan was reassuring bankers that the gold standard wouldn’t change their procedures.

Part II: Greenspan contradicts Rand’s philosophy.

1. Bank reserves, Greenspan vs Brandon
2. Inflation, Greenspan vs Rand

II.1:Bank reserves, Greenspan vs Brandon

Many people incorrectly think banks loan part of the customer’s deposit and keep part as a reserve. For example, Nathaniel Brandon, a psychologist writing in the same book as Greenspan’s essay, published by Ayn Rand,

“… Banks do not have unlimited funds to loan; they are limited in the credit they can extend by the amount of their gold reserves.”^v

Mr. Greenspan, a trained economist, is clear that is not the case,

“This enables the banker to loan out more than the amount of his gold deposits…^vi”. “… holds claims to gold rather than gold as security…^vii”. Greenspan contradicts Brandon.

Many people think a gold standard will regulate the supply of money. For Mr. Brandon, the requirements of production must be within how much gold already exists,

“On a gold standard… the supply of money and credit needed to finance business ventures is determined by objective economic factors… the principles governing money supply…^viii”

In Ayn Rand’s philosophy, the “objective” economic factor in this case would be the presence or absence of the physical gold.

Mr. Greenspan says gold based banks do the opposite, as they

“create bank notes (currency) and deposits, according to the production requirements of the economy.”^ix Greenspan contradicts Brandon.

For Mr. Brandon, the limited supply of gold money tells banks to slow down business activity:

“… in response to the shrinking availability of money… funds are more difficult to obtain… curtailment and contraction of business investment.^x ”

For Mr. Greenspan, slow business activity tells banks to limit the supply of money,

“But when business ventures financed by bank loans are less profitable and slow to pay off, bankers soon… curtail new lending… restrict financing…^xi ” Greenspan contradicts Brandon.

Once Greenspan is deciphered, the meaning is highly controversial for people who think a laissez faire gold economy automatically does the right thing; that is – the amount of gold available is what determines “the production requirements of the economy”; that people shouldn’t decide production requirements and create currency to match. The idea that money has to be deliberately manipulated to make the economy work is offensive to them. Many people who want a gold standard, want it because they think it prevents human interference with the natural order of things.

Those people are strongly represented in the fan base for Ayn Rand. Greenspan didn’t want to offend them. But he also had to reassure bankers that Objectivism was on their side. So he used technical terminology that regular folks wouldn’t recognize and simply left out any explanation of actual practices.

II.2: Inflation, Greenspan vs Rand

Greenspan advocates “created bank notes” generated by extending credit, based on debt.

This contradicts Rand, who wrote,

“The most disastrous loss… is the loss of the concept that money stands for existing, but unconsumed goods.”^xii

Rand disapproves of

“…paper money which is used as a claim check on actually existing goods- but that money is not backed by any goods, it is not backed by gold, it is backed by nothing. It is a promissory note issued to you in exchange for your goods to be paid by you… out of your future production.^xiii” “… this dear readers is the cause, the pattern, and the outcome of inflation.^xiv”

Rand denigrates what Greenspan advocates. Bank notes are also called promissory notes. The ones the Borrower spends are created out of nothing, cost the banker nothing and are backed by nothing except the future production of the market, which must generate enough income for the Borrower to pay the loan. Yet these promissory notes are in the marketplace competing with actual gold. It is the definition of inflation in a gold economy.

Rand’s philosophy requires money to represent savings from past production. Money based on future production is a major violation. Rand and Greenspan contradict each other.

Rand was wrong when she said,

“Only one institution can arrogate to itself the power legally to trade in rubber checks: the government. And it is the only institution that can mortgage your future without your knowledge or consent: government securities (and paper money) are promissory notes on future tax receipts, i.e., on your future production.”^xv

Greenspan asserts the bank based on gold can do the same thing. Merchants and communities don’t have knowledge of, or consent to, the risk these bank notes represent. Greenspan contradicts Rand.

Ayn Rand authorized the publication of Greenspan’s contradictory essay in her magazine and book as appropriate for her economic philosophy; therefore, Ayn Rand contradicts herself.