Why Gold is Not The Answer – Interview with Stephen Zarlenga

Despite AMI’s research conclusions that gold need not and should not play an important role in monetary systems, in May, 2000 The Gold Newsletter published a controversial interview with AMI Director Stephen Zarlenga. The interview was made possible thanks to the rare talent of interviewer Robert Meier to get to the heart of the subject without grating on the sensitivities of their readers, who generally (and sometimes passionately) hold views contrary to those excerpted here:

True to our tradition of presenting both sides of gold – related arguments, we recently conducted the following interview with Mr. Zarlenga, his first interview since making a long-term bearish forecast for gold in 1987. We invite our readers to send us their comments on and/or rebuttals to Mr. Zarlenga’s views.

GNL:  You’re a “problem child” for the hard money economists.  Your gold forecasts have been better than theirs, and you take them to task on what money really is.  Where’s the big divide?

ZAR: The answer may seem obscure but has bottom line value investors dare not ignore.  It’s whether money is a power, embodied in a commodity like gold; or a creation of the law.  That is, does its value come from its “intrinsic” (commodity) value or from sponsorship or legal requirements of government? Or a combination?

GNL:  And your view is?

ZAR: History shows money is an abstract institution of society and government.  As far back as 340 BC Aristotle wrote: “Money exists not by nature but by law.” He’s saying true money is a fiat (decree) of the law. Of course, say fiat to a hard money advocate and it’s like waving garlic in front of a vampire.

GNL:  Are you saying paper money can be real money?

ZAR: Certainly.  In 1994, I issued a paper disproving (challenging actually) Carl Menger’s “Theory Of The Origin Of Money,” the foundation of Austrian Economics hard money philosophy, but try as I might, I can’t get them to seriously debate my stand.

GNL:  Just exactly what did you write that upset them so?

ZAR: Menger uses only 4 historically based arguments to support his trading origin of money – the idea that money began without institutional sponsorship. I noted that three of those arguments – commentaries from Aristotle, Plato and Julius Paulus – were actually 180 degrees against Menger’s idea. The fourth argument is a demand for historical proof from opposing views.
Stripped of this historical ornamentation Menger’s origin is based only on deductive theoretical reasoning – no places or times are cited.  Its not appropriate to divine an historical event only from deductive logic, and I challenged his method, his reasoning and his facts.

GNL:  Do your views lead to different investment recommendations?

ZAR: Yes.  Take the belief gold is a depression/deflation hedge.  That overlooks gold did well in the Great Depression  because it was officially money — and its official value was raised from $20.67 to $35 an ounce by law in 1933; while other commodity prices collapsed.

GNL:  What about Silver?

ZAR: Great example.  Silver prices, unprotected by law, fell 68% from $1.38 an ounce in 1919 to 44 cents in 1932.  Then, Roosevelt legally raised the price to 65 cents in December 1933, and up to a flexible $1.29 maximum, in June 1934.  See the point?  Without official support both metals would have been poor hedges, at best.

GNL:  So what do you think will happen to gold in the next major recession or depression?

ZAR: Unless the official  price is raised, it’ll probably act like a commodity rather than money, and fall.  The U.S.  price is $44.22.  Perhaps more important, the world’s largest depository of gold, the Bank for International Settlements in Switzerland, uses $208 per ounce in its accounting which, I think, may prove to be  important downside support.   It will be the same basic story for silver.

GNL:  But what about stagflation or inflationary collapse?

ZAR: An inflationary depression is  theorized to occur when the government rescues banks, with the liquidity created to bail them out causing runaway inflation, but it doesn’t have to happen that way.
Panics are caused by fractional reserve banking, where banks create money in the form of bank credits. But these credits aren’t  the same as money because they depend on the bank’s staying liquid.
Paper money in hand is more secure. In a crisis this leads to cash runs on banks.  Von Mises and the Austrians insist a crash is inevitable, but this conclusion has been out of date since the 1930’s when Henry Simon created the 100% Reserve Solution.

GNL:  What is the 100% Reserve Solution?

ZAR: It avoids collapse by changing outstanding bank credit into actual cash.  First, banks (including the Federal Reserve Banks) are required to establish 100% reserve backing for all deposits. To do this, the US Treasury loans them (at interest) freshly printed US currency to bring their cash reserves up to 100 %.  Treasury paper held by banks,  gets credited against these borrowings; canceling an equal amount. Banks are then confined to lending existing funds.
This elegant reform transforms the private bank credit money created out of thin air for decades, into US legal tender — real money.  All US debt  held by the banking system is canceled out by the banks borrowings from the Treasury. Banks become panic proof, with cash to pay all claims.
This reform wouldn’t be inflationary or deflationary  – it simply makes tangible what had been thought to be the existing money supply. This reform removes the money issuing power from private banks and places it in the US Treasury. Its not paper money thats immoral; its the private issuing of it.

GNL:  Are lawmakers aware of this solution?

ZAR: If the rumors are true Alan Greenspan religiously reads Gold Newsletter, they are now!  But seriously, the 100% reserve solution is a real, well-known option.

GNL:  How does this view differ from the Austrian School?

ZAR: They can’t imagine this solution because they view  money as a commodity — or an economic good — that can’t be brought into existence out of thin air.  But if you understand money as an abstract legal power, then a nation can successfully create and substitute cash for the already existing and suspect bank credit.

GNL:  So you don’t spend much time worrying about a U.S. banking collapse?

ZAR: Well, I know the nation has the power to avoid it. But considering how myopic American bankers have been, almost anything is possible

GNL:    Don’t you like anything about the Austrian economists?

ZAR: I truly admire Prof. Rothbard’s clear unequivocal condemnation of fractional reserve banking as a Ponzi scheme. Von Mises criticized it less forcefully; but most Austrians support it in the name of free markets. Rothbard understood that free markets stop, where fraud and privilege begins. As I said our main divide is over the nature of money.

GNL:   Where do you stand on the inflation/deflation issue?

ZAR: Measuring inflation or deflation  is more complicated than just tracking prices. The Fed places too much emphasis on inflation rates (price statistics actually) to set monetary policy; even though they admit the measure isn’t accurate, and other factors are involved. In fact, I think they’ve  slipped into deflation, by some important measures.
The M1 money supply (cash, checking accounts and travelers checks) peaked in 1994 and was down almost 8 % since then (its still off 3-4% from the 1994 high). Its never declined annually since first measured in 1959. This is significant because M1 is the closest to true money of the M’s…Importantly, large amounts of M1’s cash are being hoarded in Russia and other monetary disaster areas, and isn’t available here, which is even more deflationary.
Greenspan’s Fed maintains an irresponsible deflationary bias measured by M1, and allows an unstable inflation of stocks which are being used as money.

GNL:  Didn’t Alan Greenspan vindicate some of your controversial views on the proper definition of money in his recent exchange with Congressman Ron Paul in a House Banking Committee hearing?

ZAR: Yes. Greenspan admitted “We have a problem trying to define exactly what money is…the current definition of  money is not sufficient to give us a good means for controlling the money supply.”  Ron Paul replied “Well if you can’t define money, how can you control the monetary system?” and Greenspan answered “that’s the problem.”

GNL:  So where do you think falling M1 is taking us?

ZAR: When, not if,  the high stock market P/E multiples collapse it will drastically reduce the billions in paper stock market profits being used as “money”.   For example, when AOL used it’s stock to buy Time-Warner; and the untold billions of dollars in consumer and real estate debt will suddenly become much harder to repay.   So there’s a  real danger of gradual deflation slipping into uncontrolled deflation. People should avoid all debt!

GNL:  Is there a conspiracy against gold?

ZAR: There may be some games being played, for example by the Bank of England (it its strange announcement regarding gold in mid 1999). But much of what appears as a conspiracy – especially the central bank selling – is really a continuing move away from dependence on gold as the sole international monetary reserve toward an eventual demonetization of gold. In retrospect this trend began at the 1922 Genoa Conference and continued at the IMF in 1946, where legally based money became acceptable as international reserves, along with gold. In 1969 the IMF adopted SDR’s (special drawing rights) as a kind of “paper gold”, though they have only created $21.4 billion, and none since 1981. The IMF gold sales of the 1970’s began an actual demonetization of gold. Central bank sales are continuing it.

GNL:  Will this ongoing demonetization eventually dump all central bank gold onto the market?

ZAR: No, it will probably only be sold down to strategic as opposed to monetary reserve levels as long as the US and Russia are still potentially in a nuclear face – off. Gold investors understandably view events narrowly by how it immediately affects them. But the central banks have time and gold, and do want reasonable prices for any they sell.  So don’t expect them to  break the market. Like OPEC, they hold the largest inventory of a commodity that without official price supports would generally be much lower in price.

GNL:  Good points.  But what about the new Euro currency and gold?  Rumor has it the EU is pressuring gold to support the Euro demand if it gets weaker against the dollar.

ZAR: The Eurosystem  indicated  a 10 to 15% gold reserve target for the EURO. They value their gold at the end of quarter market price (March 31st – 288.81 EUR per ounce) which means the  Euro central banks gold reserves are closer to 25%. That’s a lot of metal  available to dampen a rise in gold.
Remember the amount available for sale increases automatically if gold rises and decreases if gold falls. Investors might be angered by this, but it comes with the territory when investing in a politicized commodity. The European announcement was actually positive for gold -  they didn’t have to use it in their reserves. As the Euro money supply grows, this gold component could grow too.

GNL:   So given your deflationary bias your current outlook for gold and silver is bleak?

ZAR: Not really. Presently, the gold market looks steady to higher for basic technical reasons, and there’s certain to be more big moves in these metals which are, after all strategic for reasons other than monetary (i.e. as a political football).  But my point is investors have seriously over emphasized the monetary factor in their supply/demand and price forecasts and  you can expect more central bank selling — and producer hedging — if  gold starts showing real strength over $350.

GNL:  What about silver?

ZAR: Short term the gold price action looks brighter to me but longer term I’d  favor silver because its already suffered the full effect of demonetization and official dis-hoarding, beginning with partial demonetizations in England  from 1774; and in the US from 1873.   Gold, whatever the other factors, has yet to feel the full impact of demonetization, and official dis-hoarding down to strategic reserve levels.

GNL:  There’s been some talk of another big break in gold, one that would take prices down into the $210 to $185 range  Let’s assume that happens, what would you recommend then?

ZAR: It would be a superb buying opportunity (unless it was occurring as part of a deflationary collapse).  Remember BIS  uses $208 for their gold accounting, and then there’s the technical significance of the $200 level.  It was important resistance back in the 1970s, then became strong support repeatedly stopping corrections since then. Finally, the constant dollar chart, going back to 1890, shows powerful support in the same area.

GNL:   What are your favorite gold and silver trading strategies?

ZAR: What I’ve told you in this interview is based on ten years of focused monetary research, not investment research …

GNL:  Tell us about  the American Monetary Institute?

ZAR: AMI is a publicly supported charitable trust founded in 1996 to study monetary history, theory and reform. We rely on tax deductible donations and the sale of our research reports. I hope your readers will support us.

GNL:   I understand you have research on all the major points in this interview; and that readers can make a tax deductible donation and get an equal Dollar value of reports free?

ZAR: Thats correct. For an introduction to our work, your readers your readers are welcome to a free copy of the AMI paper “An Abbreviated Monetary History Of The US”. Its quick reading and shatters many dangerous monetary myths…


Presented here by kind permission of The Gold Newsletter; published monthly by Jefferson Financial, 2400 Jefferson Highway, Jefferson, LA 70121.


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