Capital Markets

Remembering Peter Bernstein

When it came to writing the history of finance, he had the Midas touch.
Edward TeachJune 10, 2009

Peter L. Bernstein, the well-known economic historian, journal editor, investment manager, and newsletter publisher, died on June 5 at the age of 90. In the Journal of Portfolio Management,which he founded and edited, Bernstein created an important forum for academics and traders to advance sophisticated ideas about finance and risk management.

In popular books like Capital Ideas: The Improbable Origins of Wall Street and Against the Gods: The Remarkable Story of Risk,Bernstein made those ideas available to a wider audience. In 2001, Bernstein spoke with CFO about his then-latest book, The Power of Gold: The History of an Obsession. Here is what we wrote then, followed by our interview with Bernstein.

Peter L. Bernstein has seen many things in the course of a long and varied career, but few have been as spectacular as what he beheld one day in 1940 at the Federal Reserve Bank of New York. Five stories beneath the earth, the massive stainless-steel door to the bank’s vaults was opened for the young researcher, as a treat from his boss. Within, gleaming under the electric lights, lay more than 100,000 gold bars, the overseas hoards of many countries. It was, remembers Bernstein, “an unforgettable and chilling sight.”

The ability of this precious metal to dazzle and dismay is amply documented in his new book, The Power of Gold. Alchemists tried to change base metals into gold, but as Bernstein shows, gold itself possesses a more sinister power of transmutation: to change from a blessing to a curse. This theme is the master thread of his narrative, a fascinating history of ancient kings and modern statesmen, conquistadores and speculators, a Gilded Age and a Great Depression.

Bernstein is well qualified to tell this complicated, many-stranded story. Dubbed “America’s greatest living economic journalist” by the Boston Globe, he has written seven other books on economics and finance. The best known of these are Capital Ideas (1992), on the development and application of modern theories of finance and investing; and Against the Gods (1996), an award-winning history of risk management.

Dubbed “America’s greatest living economic journalist” by the Boston Globe, he has written seven other books on economics and finance. The best known are Capital Ideas (1992), on the development and application of modern theories of finance and investing, and Against the Gods (1996), an award-winning history of risk management.

But Bernstein is more than a journalist. For more than 20 years he was a Wall Street money manager, handling institutional and individual portfolios. Since 1973, he has been president of an economic consultancy that serves institutional investors. He was the first editor of the Journal of Portfolio Management, for which he remains a consulting editor, and he is much sought after as a lecturer and commentator.

CFO’s Edward Teach talked with Peter Bernstein in 2001, just before the venerable economic and financial historian release his book The Power of Gold. Their chat, with the help of a little alchemy, turned into “A 24-karat Tale,” which is featured below.

Still, when the suggestion was made that he write about the history of gold, Bernstein balked. “I immediately rejected the idea—who cares about gold at this moment?” he explained during a recent interview in Bernstein’s Manhattan office. But then he remembered how he felt in the 1970s about the so-called gold bugs—those investors who flocked to the metal as the ultimate hedge, driving its price to an all-time high of $850 an ounce in 1980—and he changed his mind.

“When the gold pool was abandoned in 1968 and the central banks let the price go up, it stirred up a very antigovernment sentiment—that governments, as Herbert Hoover said, are not to be trusted,” recalls Bernstein. “Having grown up in the 1930s with a strong New Deal orientation, I have always felt that government is basically a force for the good. And the sense that government was something to flee from, to a stateless currency, was repugnant.”

Since Bernstein felt so passionately about that, “I thought maybe gold would be worth looking into after all,” he says. Judging by the acclaim for The Power of Gold, he was right on the money. That shouldn’t surprise anyone. After all, when it comes to writing financial history, Peter Bernstein has the Midas touch.

Why has gold always had such a powerful and universal attraction?
Nobody really knows. Yesterday and the day before, I received letters from two men in the mining business who are about my vintage; they’re not kids. And one describes it as a curse, and the other one uses very similar kinds of words—that once you’re bitten by this bug, you can’t stop. You look at gold—at your wedding ring, or your watch, or your wife’s bracelet—there’s something so beautiful about it. And when you see a mass of it, it’s really startling. It never tarnishes, never loses its luster. It doesn’t decay with time, as all other metals do. You’re in touch with eternity, you’re in touch with sunshine. And because of the sunshine and the eternity, if you have a lot of gold, you have power, and people have not denied that you have power.

You begin your book with a cautionary tale by John Ruskin, the Victorian Age art critic and social commentator. A man on a sinking boat straps his gold around his waist and jumps overboard, whereupon he drowns. And Ruskin asks, “Now, as he was sinking, had he the gold? Or had the gold him?” Why did you consider this so relevant to your history?
It’s much more than gold that Ruskin is really asking about, and it crystallizes the way I feel: That greed is devastating; money isn’t everything; that blind drives for power can lead you into the ditch. As you go through the history of gold, in instance after instance where it was made the primary objective, it led to disaster. Whether it was the Roman Crassus, who thought because he was a rich man he could be a general, and was defeated in battle, and had molten gold poured down his throat; or Philip II of Spain, who spent the great amount of gold that came from the New World on luxury and empire building. Or, in our own era, the belief after World War I that the restoration of the 19th- century gold standard would make everything come out all right. Instead, it made a significant contribution to the Great Depression—it made it much worse.


There seems to be a consensus now among economists that what really deepened the Depression wasn’t protectionist tariffs like Smoot- Hawley, but rather efforts to stick to the gold standard.
Well, it certainly started the British down the tubes. There were a lot of things at work in the Great Depression, but they all fed on one another. What was shocking was the belief that even with large bank failures, and unemployment, and prices dropping, you had to hold on to gold. The British tried to do it at enormous cost to their economy, until 1931. And then our gold began to leave, after the British went off the gold standard.

It seems remarkable when you think of what people are talking about today—that if there’s a recession, Alan Greenspan is going to ease up on the discount rate. In the middle of 1931, the Fed doubled the discount rate.

They tightened money to protect the gold.
Yes. As the chairman of the Fed said, this was the only known strategy, and the Europeans would have thought we were weaklings if we didn’t do this. This was in addition to Smoot-Hawley, and trying to balance the budget, and raising taxes in 1931. The mindsets of the 19th century didn’t work in the 20th century.

Let’s talk about the international gold standard, which took hold around 1870—the beginning of the Gilded Age. What were the advantages of going on the gold standard?
It’s a very important question, because it also explains why fixed exchange rates don’t work. Robert Mundell [the Nobel Prize­winning economist] said that under the gold standard, there were no currencies. There were only things that were different weights of gold. Sterling had about five times as much gold per pound sterling as the dollar had behind it, so a pound was worth about $5. Gold was a collateral that the exchange rate would remain fixed. In order to maintain a fixed rate of exchange, you can’t have inflation. Gold was therefore collateral that there would not be inflation. Since it was the reserves of the banking system as well as this large standard, if you had inflation, gold began to leave. It would force you into deflation.

Now, you could deflate in the 19th century. “Deflate” means not only that prices go down, but wages go down. You let debtors go bankrupt. There is no lender of last resort in this system. There is a lot of risk in it. People got hurt. You had a social structure in which if people got hurt, that was tough, but it was for the greater good. The greater good was the good of the ruling classes, the financial powers, the City of London—it was as though Wall Street ruled America. In the 19th century we could do this. But not in the world that followed World War I, when millions of guys went out and got killed for their country. They weren’t going to take that crap anymore.

Asia and Latin America went through the same ugly process in 1998. Political structures crumbled under the pressure of trying to maintain the exchange rate. That’s what happened in Britain in the 1920s, and it’s why Roosevelt went off the gold standard in the 1930s, and why Richard Nixon finally cut the knot in the 1970s.

People still push for the return of a gold standard—people such as Jack Kemp and Steve Forbes. I believe it was mentioned in the Republican Party’s platform in 1984.
I think there are people who believe that fixed exchange rates are a better system than floating exchange rates, and that gold as a collateral to secure that system is a great idea. It is a great idea— except that it’s not feasible in a dynamic world where countries develop at different rates, and at different rates of inflation; and have different social structures, different abilities to absorb the shocks that happen when the exchange rate is fixed.

This is why I think the euro is an interesting experiment. You need flexibility to have a common currency. People willing to move from one place to another and so on.

To join the European monetary union, a country has to rein in budget deficits, interest rates, inflation, and so on. The euro strikes me as sort of a gold standard.
Yes and no. The euro functions like a gold standard in that there are certain requirements that you have to meet before you can join the club, in addition to the disciplines imposed once you are in. But the purpose of that, as I understand it, was that the playing field should be level as [Europe goes] forward in this adventure—that the rates of inflation should be approximately equal. Unless all these different countries are at approximately equal rates of inflation, the whole thing will never work.

As time evolves—and it’s already beginning to happen—inflation will no longer be uniform across the area. But the Europeans hope that because the euro is a common currency, people and resources will move toward the areas that are doing well and away from the areas that are doing badly. The big problem with the euro is getting the flexibility and movement of resources and labor that we have in America.

That won’t be an easy problem to solve, given the tremendous differences in language and culture.
Language and culture, you bet! Still, in Europe, what we think of as the Euroland, an awful lot has happened in the last 20 years. They still speak German in Germany and Italian in Italy and French in France, but nearly everybody speaks English. Certainly, upper-class people speak English. And the volume of intra-European trade is so enormous. And travel—they’re much more familiar with one another than they used to be. They used to be much more insular.

I’m old enough to remember when the French and the Germans couldn’t even sit down together. Now they’re pals in this process. We have to give the leadership of those countries very high marks.

Do you think gold will ever regain its luster as a hedge?
Gold is in the shadows today. We’re talking about maybe 30 years out of the history of humanity [since Nixon closed the gold window in 1971]. These 30 years have been marked by a sense of diminishing risk worldwide. It’s really extraordinary. I can’t believe that in the mother of all crises, it won’t once again be a hedge.

A hedge is a bet that your primary bet won’t work. Consequently, you take only a small position with a hedge, because it’s a bet on what you think won’t happen. You surely don’t want to have all your money in gold today, because the worst may never happen. It’s a very costly asset to own. But a small amount of gold—given the leverage of the kind of thing that I’m talking about—can be a fantastic hedge. It doesn’t cost much to have 2 percent, 3 percent, 5 percent of your assets in gold. I can’t think of any hedge against disaster that can explode in value like gold.

What kind of disaster would drive people back to gold?
The only event I can think of that would lead people to flee back to gold would be a dollar crisis. I call that the mother of all crises because we have seen that we can get through euro crises, and Thai baht crises, and Mexican peso crises. The dollar is serving the purpose of the gold standard in the 19th century. If the standard gives way, it could be very frightening.

I don’t know what the trigger to a dollar crisis would be. I do know that all the necessary conditions for a dollar crisis are here, because we have exploding liabilities to other countries. [Economist] Henry Kaufman said recently that we’re lucky that the rest of the world is slowing down with us, because if we slowed down and Europe and Japan were getting stronger, a dollar crisis could happen—because then maybe Europe or Japan would be the place to go. Imbalances do develop.

We think that the Internet stock market was a momentum-driven stock market. That’s kid’s stuff compared to the kind of momentum that develops in foreign exchange markets. Foreign exchange traders don’t do purchasing power parity calculations; they don’t look for value. They herd, and they chase one another. Once the sense is out that the dollar is no longer the strong currency, it can change very fast. Gold will not come back into prominence as a hedge until that happens. It takes something really big—like 1978, 1979, 1980, when it went from a few hundred dollars in price to $850.

But until that happens, gold will remain just a metal, albeit a precious one.
Let me tell one poignant story that is worth keeping in mind. Britain made the terrible error of going back on the gold standard after World War I. It wasn’t such a bad idea to go back on gold, but not at the old parity, when $4.86 [the prewar value of the pound sterling] didn’t buy anywhere near what it used to buy, because of World War I inflation. The mastermind of that was a man named Montagu Norman, who was the governor of the Bank of England for 20 years. He was the Alan Greenspan of his day—a world figurehead, an icon of the world economy and financial system. It was he who persuaded the Chancellor of the Exchequer—in 1925, it was none other than Winston Churchill—to go back at the old parity. Norman was absolutely convinced that no matter what happened, that no matter how many people got unemployed, going back on the gold standard was the only thing that would save the British Empire.

And after the disasters of the 1930s, Norman was in the shadows. During World War II, he carried on a correspondence with people at J.P. Morgan & Co., because when Britain was in trouble, Morgan came to its rescue with loans. He was in correspondence with Russell Leffingwell, who was the key Morgan partner. Leffingwell wrote to Norman and commented on how they had struggled so much to reestablish the gold standard. This was in 1944.

And Norman wrote back. He said, “As I look back, it now seems that, with all the thought and work and good intentions which we provided, we achieved absolutely nothing.”

This was the man who thought that gold was the thing that ruled the world, and learned that it was not—that there are many more things that come into play, in economic power and in economic stability, than this crazy yellow stuff.