ALAN GREENSPAN HAS often been described as the second-most important man in America, but this is a gross understatement. Historians who study the late 20th century will devote far more attention to the changes wrought in the world economy by the retiring Chairman of the US Federal Reserve Board than to any of the actions of the four US presidents under whom he has served since 1987.

The war in Iraq, the terrorist attacks on New York, even the defeat of communism, will pale into insignificance beside the extraordinary and unprecedented transformation that has occurred in the world’s monetary system in the past three decades: the replacement of gold, silver, salt, precious stones and all other standards of monetary value that had underpinned economic activity since the dawn of civilisation, with a system of pure paper money that represents nothing more or less than an edict by the issuing government or its central bank.

Mr Greenspan, together with his predecessor Paul Volcker, and if all goes well, his newly announced successor Ben Bernanke, will take pride of place when historians try to understand the transformation from the solid golden world of Midas and Mammon to the modern global economy, where completely worthless bits of paper and coded electronic signals are sufficient to represent all material dreams and aspirations and keep billions of people permanently in their thrall.

To understand the scale of Mr Greenspan’s achievement — and the importance of the institution he has led for 18 years — we need to think back to the state of the world economy until the early 1970s. Although governments had been issuing paper currencies for centuries, they were all theoretically linked (except in periods of war or extreme crisis) to gold, silver or some other “natural” store of value, or to another currency — such as the dollar or pound sterling — that was itself linked to gold. After 1945 the need to re-establish a link to gold for the world economy was met by creating a monetary system in which the pound and other international currencies were all linked to the US dollar — but, crucially, the value of the dollar was itself legally fixed at 1/34th of an ounce of gold.

In 1971, however, President Nixon suddenly suspended the legal convertibility of the dollar into gold. The value of money was no longer linked to any objective standard of value, be it gold or cowrie shells. For the first time the whole world was operating what economists call “pure fiat money”.

Pure paper money was one of those previously unimaginable and irreversible 20th-century inventions, such as the atom bomb, penicillin or the contraceptive pill, that changed the world forever. It finally broke the dependence of economic activity on arbitrary natural phenomena, such as the discovery of new gold mines. Fiat money thus severed one of the most durable links between man and nature and gave governments — and the central bankers whom they appointed — the freedom to manage their economies without regard to external forces and to create standards of value that philosophers and economists had previously ascribed to God.

Not surprisingly, the invention took some time for the world to understand and learn to use. The decades of economic upheaval that followed the breakdown of the gold-based monetary system in 1971 — the great inflations of the 1970s and early 1980s, the oil and commodity crises, the depression of the 1980s and the monetarist counter-revolutions of Margaret Thatcher and Ronald Reagan — can all be seen as part of this learning process. With hindsight, what is amazing about the invention of pure paper money is not how much damage it caused during those booms and busts, but how quickly the disruption ended and how soon some nations and governments took advantage of the new freedom to manage their economies.

This is where we come back to Mr Greenspan and the all-important role of the Federal Reserve. America took only ten years to learn to take advantage of its new freedom of action.

The turning point came in 1981-82, when Mr Volcker crushed inflation with 19 per cent interest rates but then quickly switched his attention to growth and employment, slashing interest rates in late 1982 and unleashing an economic boom.But if Mr Volcker was the man who showed that pure paper money was compatible with stable prices, it was Mr Greenspan who took the next and even more important step: he showed that a central bank that had successfully tamed inflation could then move on to maximise economic growth and minimise unemployment, while always ensuring that price stability was maintained.

In Britain, the possibility of managing an economy with pure paper money to achieve simultaneous price stability and full employment was a lesson that took 20 years to sink in. The moment of truth arrived on Black Wednesday in September 1992, when the Government was finally forced to take full responsibility for maintaining the value of money in Britain, instead of trying to peg the pound to the dollar, the deutschmark or the euro, in the same way as the pre-war Treasury had been obsessed with preserving the link to gold.

Japan took 30 years to start applying the new techniques of monetary management successfully, resulting in the economic recovery that began there in 2003. But in Europe central bankers and politicians still refuse to learn these lessons. They are still trying to apply the simplistic monetarist theory once believed to be the only alternative to the old gold standard, but thoroughly discredited by the Greenspan Fed.

Sooner or later, however, even the flat-earth monetarists of Europe will wake up to the revolution in economic cosmology wrought by Alan Greenspan — and he will be remembered as Copernicus, Columbus and Galileo, rolled into one.

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