SO MANY STORIES HAVE

been written this week about Alan Greenspan on the occasion of his retirement as chairman of the Federal Reserve, my saying anything more is like throwing a log on a fire that is already blazing. But I have some views about the Maestro's tenure at the Fed that are quite different than anything else you've probably read so here goes.

Most of the stories about Greenspan this week have been quite flattering, many crediting him for the era of general prosperity that occurred under his leadership of the Fed. I've noticed that several stories have referred to him as "the greatest central banker who ever lived." At the same time, there have been a fair number of stories that have focused on some of the ways in which he failed.

But I haven't seen a single story that was able to pin down exactly why Greenspan succeeded, or why Greenspan failed. Love him or hate him, everybody seems to be mystified by what moved him to do what he did. It seems everyone has concluded that Greenspan was either operating on some secret formula known only to himself, or on the basis of some ineffable instinct.

It wasn't instinct. It was a formula. When Greenspan followed the formula, markets were stable. When he failed to follow it, markets went into crisis.

The formula wasn't a secret. Greenspan talked about it openly. But it was so simple, nobody who heard it realized what he was hearing.

I can tell you the formula in just a single word of only four letters: gold.

When Greenspan was a young man, he was part of the inner circle of Ayn Rand, the novelist, philosopher, and radical advocate of laissez-faire capitalism. In 1967 he wrote a chapter for "Capitalism: The Unknown Ideal" a Rand anthology extolling the virtues of a gold standard:

"...gold and economic freedom are inseparable... the gold standard is an instrument of laissez-faire and... each implies and requires the other.

"...In the absence of the gold standard, there is no way to protect savings from confiscation through inflation."

Twenty years later, Greenspan took control of the world's largest manufacturer of paper money the Fed. The irony couldn't be more complete: There is no institution in the world more completely divorced from the gold standard. And by that point, the profession of economics had completely dismissed gold as an archaic artifact of a quaint bygone era, calling it (in Keynes's term) a "barbaric relic," and consigning it to the scrap heap of economic history.

But that didn't stop Greenspan. He didn't literally revive the gold standard. But he talked frequently about gold and other commodities as sensitive indicators of inflation risk. When the gold price rose, Greenspan argued that the market was forecasting inflation which is the decline in the value of the dollar vs. hard assets.

This view had two other friends on the Fed when Greenspan arrived in 1987. Fed Governors Manuel Johnson and Wayne Angell were both avid followers of gold and other commodity prices as inflation indicators.

Take a look at the chart below, covering the entire period of Greenspan's tenure as Fed chairman. The light blue line is the fed-funds rate, the key overnight interbank interest rate determined by Fed policy. The gold line is, of course, gold the two-year moving average price.

Note that for the first half of Greenspan's tenure, the fed-funds rate closely tracked the moving average gold price. This means, simply, that whenever gold was in an intermediate-term rising trend, Greenspan was raising interest rates to head off the inflation that the gold price was warning about. When gold was in a falling trend, Greenspan lowered interest rates because gold was now warning of deflation.

This "virtual gold standard" helped Greenspan make some great decisions which all the recent stories about his career have been at an utter loss to explain. For example, from late 1989 to early 1991, inflation was on the rise, with the consumer price index moving from 4% to 5.5%. But Greenspan was cutting interest rates during those years because the two-year moving average price of gold was falling. And what do you know? Inflation ended up turning around and heading lower.

Greenspan abandoned his golden formula in early 1996, shortly after he gave his famous "irrational exuberance" speech and started worrying about the "wealth effect" created by elevated stock prices. The gold price started to fall in early 1997, and Greenspan responded by raising interest rates, in direct contradiction to his formula.

The result was an era of unprecedented turbulence in financial markets, starting with the Asian debt crisis, and then rolling into the Russian debt crisis, the collapse of Long Term Capital Management, the Nasdaq bubble-and-bust, and finally the monetary deflation that prompted Ben Bernanke in 2002 when he was a Fed Governor to talk about dropping money out of helicopters, if necessary, to right the economy.

In his last two years in office, Greenspan made the opposite mistake. With gold screaming higher, the Fed has kept interest rates too low for too long. I guarantee you that the result over the next several years will be a great deal more inflation than anyone expects now and a lot more market turbulence.

I have no idea what prompted Greenspan to abandon his "virtual gold standard" when it had been such a winning formula for so many years. If Bernanke is reading these words, I invite him to consider this explanation of the Greenspan era at the Fed, and to put Greenspan's formula into service once again.

Donald Luskin is chief investment officer of Trend Macrolytics, an economics consulting firm serving institutional investors. You may contact him at don@trendmacro.com.