The Gamble: If Gold Won’t Go Up, Push the Dollar Down

(Bloomberg Opinion) -- This is the third of four excerpts from “American Default: The Untold Story of FDR, the Supreme Court and the Battle Over Gold.”  

On the day President Franklin Roosevelt announced that the U.S. government would buy gold at above world-market prices — Oct. 22, 1933 — the official price of the metal was still $20.67 per ounce, the same as it was almost 100 years earlier. This posed a serious legal problem for FDR’s newly announced program, the aim of which was to increase gold prices to help inflate the prices of commodities like wheat, cotton and corn.  

It was unlawful for the government to use public funds to purchase gold at a higher price than the one established by law. This was the case independently of the merits and desirability of the policy.

Herman Oliphant, the head lawyer at the Treasury Department, found a way around this impediment: Instead of paying in cash, the Reconstruction Finance Corporation would pay with its own debentures, which it would issue at a discount. The Treasury would immediately buy these securities at face value from the gold producer or from the foreign dealer selling the metal.

This back-to-back operation would amount to paying a discretionary and higher price to the gold seller, and at the same time the law would not be broken. If on a particular day the president wanted to pay $31.32 per ounce of gold, the debentures would be issued at 66 percent of their face value: 20.67 divided by 0.66 is exactly 31.32.

FDR and his close adviser Henry Morgenthau Jr. believed that this clever system effectively allowed the government to circumvent the Gold Act of 1900. However, there was a problem.

Dean Acheson, the acting Treasury secretary and the official in charge of implementing the program, did not agree with them. He believed that the government did not have the authority to pay any price different from the one set by statute, and that price was $20.67 per ounce. In his view, “The sale was a sham and a violation of the law which, since the Treasury must redeem them [the debentures] at face value, contemplated a sale at full market value.”

Acheson was a lawyer by training, and until he became undersecretary of the Treasury in April 1933, he did not have much experience in financial or economic issues. He was tall and famous for his wit. He often dressed in tweeds and cut a dashing figure with his well-kept mustache.

In many ways he was a typical representative of the Eastern establishment. Like FDR, he had attended the Groton School in Massachusetts. He then went to Yale College and Harvard Law School, where he became one of Felix Frankfurter’s proteges. After graduating with top honors, he clerked for Justice Louis B. Brandeis for two years. It was from Brandeis that he got a keen interest in constitutional law, and a desire — never fulfilled — to serve one day as the nation’s solicitor general.

According to Sir Frederick Leith-Ross, Acheson could be mistaken for a British gentleman, a fact that could “prejudice his prospects in American political life.” The son of an Episcopalian bishop, Acheson was highly principled.

It was because of these principles that in October 1933 Acheson decided not to go along with the gold-buying program, which he considered illegal. In a tense meeting with Attorney General Homer Cummings — the atmosphere was close to “open warfare” — Acheson said he would only authorize the program if he got written instructions either from the Treasury secretary or from the president.

On Oct. 24, two days after Roosevelt used his fourth fireside chat to announce the plan, Acheson received a telegram from Treasury Secretary William H. Woodin, who was ailing and recovering in New York. The communication left no room for interpretation:

I hereby direct and instruct you in my behalf and in my name to approve the issuance of ninety day debentures by the Reconstruction Finance Corporation to be sold at a discount basis in accordance with its resolution of October 20th and further to approve such prices of said debentures to be payable as stated in the said resolution in gold as the Corporation may determine after consultation with the President. 

From that point on the relations between Acheson and FDR became strained, cold and distant. On Nov. 15, Secretary Woodin asked Acheson for his resignation. In a short letter to the president, the undersecretary expressed his thanks for having been allowed to serve during “stirring times.”

Morgenthau replaced him. Less than two months later, after Woodin's health took a turn for the worse, Morgenthau was promoted to Treasury secretary, a post he held until July 1945.

On Oct.  25, the first day of the new gold-buying program, the Reconstruction Finance Corporation paid $31.36 per ounce of gold, 27 cents above the world price. During the next 45 days or so, FDR, with economist George F. Warren’s assistance, determined every morning the price at which the RFC would buy gold during that day, almost always at a premium over the world price.

In a column published two days after FDR’s announcement, Walter Lippmann argued that the Roosevelt administration was trying to manage the dollar in a way similar to the way the British had taken control of the pound. While the British used their Equalization Fund, the United States had put in place a gold-buying program.

In a subsequent piece, Lippmann declared that this was not a first step toward a system of fiat money, that is, paper currency that can’t be converted to gold but declared legal tender by government decree. On the contrary, he said, the goal of the experiment was to find the appropriate level of the dollar at which the gold standard would be re-established. Lippmann warned against impatience, arguing that it would take a few months to find out if the experiment worked.

The RFC made its first international transaction on Nov. 1, when it bought a small batch of gold in France at $32.36 an ounce. The size of the deal was not known exactly, the New York Times said, but “the amount was understood to have been small.” The reporter added that in the view of international experts, as long as the purchases continued to be insignificant it was “virtually certain that the French authorities will offer no objection.”

As days went by, bankers and reporters began to wonder about the scale of the program. The administration, however, was secretive, fearing that too many details could trigger retaliation by foreign governments. Anonymous sources confirmed that “purchases would be kept within bounds which would not provoke counter-actions by other nations.”

At the end of November, University of Chicago professor Jacob Viner, who would soon join the Treasury as an adviser, wrote a long memorandum to Morgenthau explaining that the gold-buying program was not working as promised. The purchases abroad were too small, Viner asserted, and did not really change the international price of gold. In addition, the discretionary changes in the price of gold and the absence of a clear program geared at stabilization were generating uncertainty, encouraging speculation, and negatively affecting investment decisions.

The rest of the world continued to react to the decision to abrogate the gold clause and to the policy of deliberately pushing the dollar value down.

On Nov. 28, the Tokyo Electric Bond Company canceled the provision that allowed debt holders to collect payments on gold bases. The measure was justified “by the cancellation by the United States of the gold clause on contracts.” That same day, the Italian government announced that it was paying $3 million corresponding to the 1925 7 percent loan granted by JP Morgan in paper dollars.

On the same day the Brazilian government canceled contracts with gold clauses, allowing utility companies to make payments on their debts in milreis, its currency.

In other words, as 1933 came to a close, politicians and analysts around the world anxiously waited for FDR’s next move. Things had changed dramatically since his inauguration on March 4. The U.S. had abandoned the gold standard, the president had repudiated efforts to stabilize currency values, the gold clause had been abrogated, and an experimental gold-buying program had been implemented.

And yet, the official value of the gold was still $20.87 an ounce. The next step was, surely, a devaluation. But to what level? And under what conditions? This is the subject of the fourth and final part of this excerpt.  

Read parts one and two in this series of excerpts from “American Default,” which is being published this week by Princeton University Press. 

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