Sunday, August 2, 2015

GREECE | The Euro 2015 v. Gold 1933 (Updated Aug. 4, 2015)

At one time, some greenbacks were "gold certificates" that could be
exchanged for gold coins.
(The following adds to a chapter of a biography of Will Woodin, FDR's first Treasury Secretary.)

Greece is still in the Eurozone. However, this outcome may be a case of just kicking the can down the road. Another crisis may await.

That thought is prompted by comparisons with 1933.

Similarities with 1933

Greece today has a similarly high unemployment rate to the one that FDR inherited in 1933 - one out of four people in the labor force being unemployed.

As in 1933, in the absence of action, those able to do so take their money out of the country. That happened in the waning days of the Hoover Administration. Until FDR was inaugurated on March 5, 1933, gold flowed out of Hoover's USA in the same way that euros have been flowing out of Greece.

According to Acting Comptroller of the Currency Francis Gloyd Awalt, p. 359, on the Friday before FDR's inauguration, March 3, 1933, the Federal Reserve Bank of New York saw $200 million of gold and $150 million in dollar currency transferred out of its vaults.  It was $250 million short in reserves and meanwhile the Chicago Fed alone needed $100 million in gold.

Another similarity is that in March 1933 when FDR came in, he declared a bank "holiday" for all banks, national and state. The Greek bank holiday used the same euphemism for a forced suspension of business, in response to depositor panic and the government's need for time to consider its options.

Differences from 1933

The differences between FDR's actions and those of Greece are multiple. In 1933 several essential and coordinated actions were taken to direct the United States toward stability and recovery, starting with devaluation. The Eurozone prevents Greece from taking such actions. FDR's devaluation had a triple benefit - a huge write-down of debt, a subsidy of exports and a tax on imports. The worst day of the Depression was just before FDR took office.

FDR quickly severed the formal connection with gold for American holders of currency. The Emergency Banking Act was brought before the Congress and passed before the banks were reopened. A smart lawyer at the Federal Reserve Board, Milton Elliott, had in 1918 inserted an amendment to the Trading with the Enemy Act giving power to the President to prohibit gold exporting or hoarding (Awalt, p. 365). This provision was invoked to require all private owners of gold (with exclusions for industrial use, dentistry, or numismatic uses) to sell their gold back to the U.S. Government. That meant that the United States could face foreign creditors with a gold standard that was nominally in place for international transactions.

In Greece's case, the banks reopened with another loan from the Eurozone authorities. Few fundamental changes were made within Greece that would strengthen the economy and reduce unemployment. From what I have read, the most significant change was the replacement of the defiant Greek finance minister by a less confrontational Oxford-trained economist.

What FDR Did after Closing the Banks

FDR's team, led by Treasury Secretary Will Woodin, used the bank holiday period to:
  • Ensure liquidity by printing $2 billion worth of greenbacks.  Woodin had first toyed with the idea of printing scrip to pay government bills while the banks were closed, an idea passed on by outgoing Secretary Mills, as noted by Awalt, p. 363. Then Woodin realized that scrip would just be another form of greenbacks. The currency was packed off in trucks to the cities with Federal Reserve Banks, then other cities with clearing houses, and finally other cities.
  • Review the solvency of each bank - what we call nowadays a "stress test" - to determine which banks should be allowed to reopen. This is what the Treasury did in 2008 and 2009 after the financial meltdown that put Lehman Brothers out of business. The Treasury's chief economist recollects that the principal reason Lehman was allowed to fail is that the Treasury didn't then have legal authority to lend it money against its assets.
  • Raise public confidence by announcing and publicizing government actions to ensure bank solvency and liquidity.
  • Map out a plan for addressing the consequences of the financial crisis, notably 25 percent unemployment. FDR said it would be "criminal" to adopt a plan that did nothing for the unemployed.
  • Map out a plan for financial reform to avoid a repetition of the crisis, i.e., supporting a plan for deposit insurance (which the banks wanted) and increased regulation (which the banks did not want, but which they were willing to trade for deposit insurance). Rep. Henry B. Steagall of Alabama, Chairman of the House Banking Committee, championed deposit insurance. Sen. Carter Glass of Virginia championed stiffer financial regulation (he had Steagall's position in the House when the Fed was created in 1913).
The tension in the 1929-1933 period and in 2008-2009 in the United States and now for many years in the Eurozone is about the need for national leaders to encourage consumer demand by reducing the burden of debt and creating liquidity, while ensuring confidence in the money supply - confidence that investments today will be repaid in uninflected money. In essence, the government must balance the rights of creditors with the need to encourage investment. With such high unemployment in 1933, FDR was prepared to give borrowers a break as against lenders.

Lessons from the Panic of 1893

The remarkable fact is that the U.S. dollar was pegged to gold for so long, a century between 1834 and 1934, during which an ounce of gold was kept at $20.67, with the exception of the 1860-1879 war years when greenback notes were issued without gold backing. When the price of gold rose, the U.S. Treasury would increase the supply by selling gold. When the price of gold fell, the U.S. Treasury would decrease the supply by buying gold.

The closest that the United States came to going off the gold standard may have been after the Panic of 1893, the worst crisis the United States had hitherto suffered and one that affected Will Woodin's family personally.  As in the previous panic of 1873 it resulted from excessively easy credit, resulting in speculation and overbuilding of homes and railroads. On February 20, 1893 - 13 days before the inauguration of U.S. president Grover Cleveland - the Philadelphia and Reading Railroad went broke.
  A series of bank failures followed, and then the failure of three more railroads. Since Will Woodin's family business was selling to the railroads, his father Clement was deeply troubled by the Panic and his health never fully recovered.

In the Panic of 1893, stock prices plummeted, 500 banks closed, 15,000 businesses failed. Falling prices for export crops such as wheat and cotton pushed numerous farms into foreclosure. The unemployment rate in the country rose as high as 19 percent - Pennsylvania to 25 percent, New York to 35 percent, and Michigan to 43 percent.

Jacob S. Coxey, Sr. led a highly publicized march of unemployed laborers from Ohio, Pennsylvania, and several Western states to Washington, D.C. , demanding a jobs relief program. A wave of strikes in 1894, notably the bituminous coal miners' strike of the spring and the Pullman Strike in July, led to violence in Pennsylvania, Ohio, and Illinoi and a shutdown of railroads in much of the country.

Populists and Democrats responded to poorer cotton and wheat farmers in the South and West who needed easy credit to keep their farms going. The Free Silver movement gained support from farmers who sought to liberate the economy from the straitjacket of the gold standard. President Cleveland borrowed $65 million in gold from Wall Street banker J.P. Morgan and the Rothschild banking family of England to support the gold standard.

In the ensuing 1894 elections, the Democrats were blamed for the Depression and Populists lost heavily. The election marked the largest Republican gains in history, locking the GOP thereafter into defense of the gold standard (in the previous election the party was divided).

The presidential election of 1896 was fought on economic issues and the pro-gold, high-tariff. The pro-silver candidate William Jennings Bryan said:
You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon  cross of gold.
Republicans led by William McKinley won a decisive victory. It was the last major protest of agrarian America against the cities and the industries that were growing in them. Will Woodin decided to join the hard-money Republican movement and ran for Congress in 1898. However, a Civil War veteran advocating easier money defeated him.

FDR Devalues the Dollar

FDR was determined to jettison the gold standard at home because it would get in the way of his plan for recovery. His Treasury Secretary, Woodin, when the subject of going off the gold standard at home came up, would say: "Oh no, not that again." (Woodin was decidedly in the camp of the creditors rather than debtors, but he was also loyal to both his own workers and to FDR.) FDR greatly reduced the straitjacket of the gold standard in two ways:
  • On May 1, 1933 by Executive Order, FDR required that all gold be sold to the Treasury at the existing price. The penalty was a fine of up to $10,000 or up to ten years in prison. This gave ample gold backing to the dollar for international purposes at the same time as it made clear to the U.S. public that backing of currency by gold was no longer on offer. 
  • On January 30, 1934, FDR devalued the dollar against gold, pushing the peg up to $35/ounce, where it remained into the decade of the 1960s, when I worked for the Federal Reserve Board. The panic of 2008-2009 created uncertainty that pushed up the price of gold, which peaked at $1,900 an ounce in August 2011 but fell back in July to about $1,100 an ounce despite the problems in Greece. Both numbers are well above FDR's peg - $35/ounce in 1934 would be equivalent to $623 in 2015 based on changes in the cost of living, using the BLS inflation calculator.