Monday, June 5, 2017

FDR | June 5, 1933 — FDR & Woodin Nullify Gold Contracts

Instant Relic, Gold-Backed Currency.
June 5, 2017 — On this day in 1933, the United States took the third of several steps in going off the gold standard.

Under the gold standard, contracts guaranteed payment in a certain quality of gold.  Certain greenbacks were designated as "gold certificates" that could be exchanged for gold (others were call "silver certificates," allowing an expansion of the reserves backing currency to include silver).

Going off the gold standard allowed for the expansion of the money supply, which had been previously restricted by the requirement that currency be backed by gold reserves.  Christina Romer at the NBER concluded in 1991 that the main reason that the United States eventually recovered from the Depression is that the money supply was expanded by gold inflows in the 1930s and this stimulated investment.

Origin of the Problems.  In some ways policies of both the Federal Reserve and the Treasury were at the heart of the cause of the Great Depression. For one thing, the Treasury Secretary was also the ex officio Chairman of the Federal Reserve Board in Washington. The person who best understood how the Fed's actions were affecting the financial markets was Benjamin Strong, President of the Federal Reserve Bank of New York. The Fed began raising its the target short-term interest rate, the Federal Funds rate, in the spring of 1928 because it felt the stock market had become frothy and inflation was taking its toll. It kept increasing interest rates, even though the economy turned down in August 1929. The Fed’s action helped generate the stock market crash in October 1929.

After the Crash of 1929, speculators began trading their dollars for gold, creating a serious drain on reserves in late 1931. Dollar-holders lost confidence in the dollar, which had two consequences

  • Banks ran out of gold to exchange for gold certificates and their cash reserves dwindled. Then they ran out of cash completely as depositors lined up to withdraw all their deposits.
  • The Treasury worried about their loss of gold reserves as overseas claims for gold to settle accounts.
To preserve the value of the dollar and stop the outflow of gold, the Fed raised interest rates again. But that further restricted the availability of money for businesses. More bank closures followed and the Fed still did not try to calm the markets by increasing liquidity.

Investors withdrew their deposits from banks and banks failed, creating panic. (The scene is well recreated at the small town level in It's a Wonderful Life (Frank Capra, 1946). The Fed did not respond to the panic by lending money to the banks. More people withdrew their deposits and took their cash home. The money supply fell 30 percent. When FDR was inaugurated many states had declared a bank holiday and their banks were closed until further notice.

1.  No Bank Payouts of Gold. Part of the problem was that the United States had been on a gold standard since 1879, except for an embargo on gold exports during World War I. When FDR was inaugurated on March 4, 1933, he and his Treasury Secretary, Will Woodin declared a national bank holiday. Woodin personally supervised round-the-clock printing of $2 billion in greenbacks by the Bureau of Engraving and Printing, filming of the presses at work late at night and the dispatch of vans filled with currency for banks, and distribution of the film clips to cinemas around the country to be screened along with the latest movie offerings. Advisers had previously suggested issuing "government scrip" and Woodin scratched his head, noting the ban on banks' redeeming gold certificates in gold coin, and advised FDR: "What are greenbacks if not government scrip?"

From the first day of his presidency, FDR embargoed payment in gold.
At the same time as the bank panic spread within the United States, reaching its apex just as FDR was sworn in, foreign creditors were cashing in their claims on the U.S. Treasury and demanding gold, as was their right under the gold standard regime. Gold was flowing out of the United States at an alarming rate. So along with the bank holiday, FDR and Woodin prohibited banks from paying out gold or exporting it. This was a suspension of gold payments similar to what occurred in the Great War (World War I).

2.  Ban on Private Holding of Gold. On April 5, 1933, Roosevelt ordered all gold coins and gold certificates in denominations of more than $100 turned in for other money. Everyone had to turn in all gold coin, gold bullion and gold certificates they owned to the Federal Reserve by May 1 for the set price of $20.67 per ounce. By May 10, the government had taken in $300 million of gold coin and $470 million of gold certificates.

Will Woodin, a world-class coin collector, co-author of the definitive book on American pattern coins (i.e., unique American coins that were samples of a new design), obtained a valuable specific exemption from the new law for coin collectors. They were allowed to keep their collectible coins.

3. Nullification of Contracts Defined in Gold. Different from WWI, on June 5, 1933, Congress made the exit from the gold standard permanent, and in the absence of a war. It enacted a joint Senate-House resolution nullifying the right of creditors to demand payment in gold. This applied to both public and private contracts.

The impact of this was possibly clear to Wall Street experts right away, and would become clear the following year, when the government price of gold was increased to $35 per ounce. This effectively increasing the gold on the Federal Reserve’s balance sheets by 69 percent, and reduced the value of all contracts defined in gold. This increase in assets allowed the Federal Reserve to further expand the money supply, but it reduced the wealth of contract-holders by 69 percent.

The theory behind this action was not yet developed, as it would be three years before John Maynard Keynes would publish his General Theory. But FDR either learned from the Bank of England, which has already gone off the gold standard in 1931 in response to the Crash of 1929, or he understood instinctively that greenbacks had more credibility if the issuer had a lot of gold reserves, and this allowed the Treasury to print more greenbacks and the Federal Reserve to put them into circulation, expanding the most basic definition of the money supply.

Treasury Secretary Will Woodin, being a life-long Presbyterian and Republican, disagreed with FDR on this move. He felt bound to honor contractual commitments to pay back in gold. He had campaigned on the hard-money platform in 1998 when he ran for Congress in his home district around Berwick, Pennsylvania. However, his loyalty to FDR made him swallow his doubts and support FDR in his action.

But it was FDR-Keynes theory, already implemented by the Bank of England, that expanding the money supply and making credit easier would spur investment and economic growth. The Great Depression created an unemployment rate of 25 percent, and Britain's going off the gold standard two years before justified an equivalent action in the United States, an action that Herbert Hoover could not take because of his own commitment to hard money.

Aftermath. The American economy turned around as soon as FDR came into power. The Depression formally ended in the quarter he was inaugurated, although it would be years before the economy recovered to the pace it was running at in the steaming 1920s.

The U.S. Treasury held the $35 per ounce price until August 15, 1971, when President Richard Nixon announced that the United States would no longer convert dollars to gold at a fixed value, thus completely abandoning the gold standard. Since there was no longer any need to back the dollar currency with gold, President Gerald Ford in 1974 signed legislation that permitted Americans again to own gold bullion as an investment independent of jewelry, dental or industrial uses.

Related Posts: Are Fed Models Out of Sync? . Mnuchin Testimony, May 18, 2017 . Glass-Steagall . FDR's First Fireside Chat