When Alan Greenspan warned of “irrational exuberance” in 1996, investors largely ignored him. The stock market continued to rise for years.
Three decades later, as investors flock to anything related to artificial intelligence and multitrillion-dollar valuations become commonplace, Greenspan’s most famous warning suddenly feels relevant again.
The death of the former Federal Reserve chairman this week at age 100 has investors reconsidering another question. “Was he right about money too?”
Why Greenspan believed in money
Long before he became chairman of the Federal Reserve, Mr. Greenspan argued that gold was more than a precious metal: it was a safeguard against excessive government spending, inflation, and easy money.
In her 1966 essay “Money and Economic Freedom,” first published in Ayn Rand’s Economic Newsletter, she wrote: objectivistHe warned that abandoning a gold-backed monetary system would make it easier for governments and central banks to expand the money supply, eroding the purchasing power of paper money over time.
Nearly 60 years later, these concerns have taken on new relevance. Since the global financial crisis, central banks have relied on multiple rounds of quantitative easing, government debt has increased to record levels, and inflation rates are well above the Federal Reserve’s long-term goals. For many investors, these are precisely the conditions that Greenspan believed would strengthen gold’s appeal as a store of value.
“Greenspan’s philosophy on gold is true to some extent in some respects,” said Ryan Lee, principal analyst at Universal Exchange Bigget. “Gold may not achieve the same growth profile as equities or emerging technologies in the short term, but in the longer term it may act as insurance against currency depreciation, inflation uncertainty and policy volatility.”
Origins of Greenspan’s Gold Philosophy
Mr. Greenspan’s views on gold did not emerge during his time at the Federal Reserve. They were founded several decades ago.
Greenspan’s 1966 article clearly illustrates the conservative ideals behind Greenspan’s core beliefs. Gold is an ideal material for storing wealth and protecting against inflation, and a truly free market will be more self-correcting than a market that governments struggle to suppress.
Greenspan’s logic behind the idea of gold as a proxy for value was simple. That is, gold is rare, durable, homogeneous, and easily divisible.
Moreover, the alternatives to a system like the gold standard could be potentially disastrous. Without the ability to convert the value of goods and services into gold, governments could print money, make loans backed by intangible “assets” (i.e. government bonds), and potentially collapse the entire global economy.
These ideas remained central to Greenspan’s worldview even after he rose to become one of the world’s most influential policymakers. But his years of experience leading the Federal Reserve may reveal the limits of some of those beliefs and ultimately force him to publicly reconsider one of his core beliefs.
Would Greenspan recognize today’s market?
In 1996, Greenspan famously warned the United States that “irrational exuberance” regarding the valuation of publicly traded companies could create a bubble, the collapse of which could lead to an economic recession similar to the one Japan faced over the past decade.
The entire country ignored his warnings, and the recession that followed the bursting of the dot-com bubble ended what was then the longest period of economic growth and expansion the United States had ever experienced.
Nearly 30 years after Greenspan coined the term “irrational exuberance,” investors are once again pouring money into innovative technology. Artificial intelligence is fueling soaring valuations, trillion-dollar companies and a wave of optimism that some economists believe mirrors the dot-com boom of the late 1990s.
History tends to repeat itself, so while the problem may seem obvious, the solution is more vague. If a young Mr. Greenspan were Fed chairman today, the market might choose to correct itself and warn cautious investors to turn to gold as a safe haven.
“He probably would have argued that gold still has a place as a stable asset and would have embraced digital assets and other innovations,” Lee said.
But Mr. Greenspan’s legacy is complicated. He admitted that the theory of laissez-faire economics was wrong when it was tested and failed.
“I found a defect”
Mr. Greenspan remained true to his belief that free markets are best and that manipulating interest rates would only make the recession worse. He maintained a hands-off economic policy and kept interest rates low in the aftermath of the bubble burst, but ultimately allowed the next bubble, the U.S. housing bubble, to inflate.
At a 2008 Congressional hearing, Greenspan famously admitted that he had been wrong about one of his core ideals, finding that banks had been left to their own interests and had not acted to protect the market, themselves, or their customers.
“We found a flaw. We don’t know how serious or persistent it is, but I’m very troubled by the fact…I’ve been studying it for over 40 years with considerable evidence that it works very well,” Greenspan said at the hearing.
Controversy surrounding Greenspan’s gold paper
Mr. Greenspan had long believed that gold’s rarity and inherent value made it a good investment in chaotic markets. In a free market with overextended credit, interest rates rise and investors turn to safer long-term investments such as gold, providing a useful and tangible way to combat inflation.
In some ways, the last 15 years have strengthened that argument. Since the global financial crisis, central banks have undertaken multiple rounds of quantitative easing, government debt has soared and inflation has soared to multi-decade highs in the wake of the coronavirus pandemic. Gold prices also rose significantly during this period, helping to maintain purchasing power during times of economic stress.
But not everyone sees that as vindication of Greenspan’s theory.
Jeremy Siegel, an experienced economist and professor emeritus of finance at the Wharton School at the University of Pennsylvania, expressed concerns about gold’s effectiveness as an inflation cushion. Although their value is maintained at a certain level, they hardly increase in value over the long term compared to index funds or REITs, and they do not provide continuous income like stocks.
Siegel also cautions against using concerns about market excesses to abandon stocks altogether.
What happened to investors who followed Greenspan’s advice?
In one sense, Greenspan and his critics were right.
Gold benefited from many of the factors Greenspan warned about, including rising government debt, aggressive monetary policy, and inflation. But even after the dot-com crash and the financial crisis, stocks continued to outperform over the long term.
If investors had exited the stock market after Mr. Greenspan famously warned of “irrational exuberance” in 1996, they might have missed out on significant gains in the years leading up to the dot-com bubble’s eventual burst.
In retrospect, Greenspan may have been better at spotting economic risks than at predicting how investors should react to them.
Is Alan Greenspan’s claim to gold still gold?
The answer depends largely on what parts of Greenspan’s economic worldview investors believe still apply today.
For decades, Mr. Greenspan argued that gold acts as a safeguard against inflation, government overspending, and excessive financial intervention. As the United States grapples with persistent inflation, high government debt, and years of quantitative easing, the case for gold probably looks stronger today than when Greenspan first advocated for gold.
But his critics can point to an equally important fact. That means stocks are still winning.
Whether Greenspan’s theory ultimately holds true remains a subject of debate. But understanding why he thought of gold as a hedge against financial excess helps explain why his ideas are receiving renewed attention today.
