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Why Greenspan Has A Touch Of Gold Fever

Top of the News: Commentary


Ever since Richard Nixon severed the last links between the dollar and gold in 1971, the Federal Reserve has scarcely given a thought to the precious metal. So what was Fed Chairman Alan Greenspan doing on Feb. 22, when he told a House banking subcommittee that gold prices have become an important factor in setting short-term interest rates?

Greenspan took care to stress that gold is just one of several measures that are used to guide the central bank's inflation watchers. Still, his remarks raised eyebrows and brought to center stage a debate that has been carried out mainly in the wings of economic policy for the past two decades: Would the U.S. economy be better off now if the dollar had remained linked to gold? "I happen to be one of those who believe things were a lot better in many respects back when we had stable gold prices," Greenspan said.

Somewhere, Ronald Reagan's heart was racing. But the Gipper and other gold bugs shouldn't get their hopes too high. Greenspan wasn't signaling a return to the gold standard, even though his elevation of the metal as a monetary tool is significant. Money-supply growth, the beacon of Fed policy for most of the '80s, is no longer a good predictor of economic activity, and no other benchmark has emerged. Greenspan's message to the markets: Watch metals for clues of what the Fed will do on interest rates.

SCOUTING OUT. The theory behind the Fed's back-to-the-future move is simple: The central bank is more worried about inflationary expectations than actual inflation, which remains in check. Since gold is a classic hedge against inflation, its price is a sensitive indicator of expectations. So if prices are headed up, the Fed may boost short-term interest rates.

Of course, Greenspan is trying to scout any other hints he can find of accelerating inflation, too. In addition to gold, he is eyeing commodity prices, the spread between long-term and short-term rates, and the movement of the dollar on currency markets. With current inflation, as measured by the consumer price index, slowing to just 2.5% over the past year--and with the CPI dead flat in January--there was no justification in actual price movements for the Fed's Feb. 4 decision to boost short-term rates a quarter-point. But Greenspan wants to be at the ready.

That's where gold comes in. After falling to below $350 an ounce in mid-September, the metal has been trading between $380 and $390 for the past three months. Greenspan sees this as a signal of market fears that the Fed hasn't been moving aggressively enough against the inflationary potential of the current economic expansion. That, he thinks, is why stock and bond prices have fallen recently. "[Gold] is not a perfect indicator, but it is a very good indicator," he told Congress.

That's music to the ears of gold bugs, who contend that the key to price stability is tying the dollar to gold prices. Former Governor Wayne D. Angell, who left the Fed on Feb. 10, has long advocated a gold-price rule, and he smiled in the audience as Greenspan testified. Angell predicts the comments will trigger a drop in gold prices and a bond-market rally in coming weeks.

BONE-SURE. That seems a little too pat, though. If gold is such a great predictor, then why has the Fed eschewed it for years in favor of other indicators? Indeed, gold speculators, along with gold producers such as Russia and South Africa in need of hard currency, can create huge swings in gold's price. If the Fed had focused on gold last summer, for instance, the run-up in the market (chart) could have prompted tightening--just as the economy was gaining a bit of speed. "Gold ought to be put into the mix, but it can be very misleading over long periods of time," says former Fed Vice-Chairman Manuel H. Johnson.

Surely Greenspan knows that. But he is convinced in his bones that the Fed needs to nudge up interest rates again to keep inflation in check. And he knows that folks on Wall Street, on Main Street, and at both ends of Pennsylvania Avenue aren't going to buy a policy based on the Fed Chairman's hunches.

His predecessor, Paul A. Volcker, used rigid money-growth targets to rationalize his squeeze on inflation. And before Volcker, Arthur F. Burns pulled a new money-supply measure out of his pipe to justify Fed policy. Now, Greenspan may likewise use gold as cover for his actions. If he's right, he may look like a genius for whipping out his gold card.Owen Ullmann

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