Victory in Gold Battle Saved the New Deal

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

In mid-November 1933, enthusiasm for Franklin Roosevelt's gold-buying program began to wane.

The columnist Walter Lippmann pointed out that relative prices -- or “price disparities,” as he called them -- had moved in the wrong direction. Agricultural prices were now lower, in relation to industrial goods, than in July. Lippmann asserted that this was a severe problem, and that the “country felt it instantly.” He added that the “doubt and discontent of the past three months have reflected" the relative decline in agricultural prices.

In his view, the problem had two components: On the one hand, the gold-buying program was not affecting agricultural prices as anticipated by its promoters, in particular by Roosevelt adviser George F. Warren. On the other, the National Recovery Act, which had been enacted in June, was pushing up prices of manufactured goods in an artificial fashion, through price agreements.

Lippmann added that neither the president nor Warren realized that the mechanics at work were complex and that any change in the value of the dollar would have to be supported by other policies, including fairly massive open-market operations undertaken by the Federal Reserve.

Even those members of Congress who favored inflation became disappointed with the gold-buying program. On November 23, Senator George W. Norris, a Progressive Republican from Nebraska, pointed out that after three months of intervening in the gold market, the administration had little to show for it.

Gold had been purchased at increasingly higher prices, and commodity prices were still significantly below their 1926 level. Norris argued that it was time to try something different; it was time for the president to use the authority given to him by the Thomas Amendment, the May 1933 legislation that gave FDR the power to raise the official price of gold, and devalue the dollar.

Commenting on the resignation of Professor Oliver Sprague, a declared opponent of devaluation, from his post as adviser to the Treasury, Democratic Senator Morris Sheppard of Texas said that this was good news, since the door was now open for deliberations on an official increase in the price of gold. Democratic Senator Key Pittman from Nevada, who had been at the London Conference with Sprague, added that now the president could move forward with a program of generating “controlled inflation.”

On December 31, 1933, the New York Times published an open letter from British economist John Maynard Keynes’s to President Roosevelt. The final part of the note contained the sentence that many people remember today: “The recent gyrations of the dollar have looked to me more like a gold standard on the booze than the ideal managed currency of my dreams.”

Most analysts interpreted Keynes's words as asserting that during the gold-buying program, the dollar exchange rate was excessively volatile, and that this volatility was harmful for the recovery. Keynes told the president that it was time to make policy changes. He wrote:

In the field of gold-devaluation and exchange policy the time has come when uncertainty should be ended. This game of blind man’s bluff with exchange speculators serves no useful purpose and is extremely undignified. It upsets confidence, hinders business decisions, occupies the public attention in a measure far exceeding its real importance, and is responsible both for the irritation and for a certain lack of respect which exists abroad. 

At the end of 1933, almost coincidentally with the publication of Keynes's open letter to FDR, the gold-buying program was effectively ended.

On the first day of the year 1934, the press reported that the president would finally move forward on the currency issue. The New York Times pointed out that, as a result of the gold-buying program, there had been a “slight speculative increase in the commodity price level temporarily.”

On January 16, the Gold Bill was introduced in Congress. The New York Times reported that its “enactment will permit the President to take all powers of currency issue from the Federal Reserve Board, and lodge them exclusively in the government.”

The article explained that the proposed regime would be a modified “bullion standard,” where international trade would be settled in gold. However, private parties would not be allowed to own, buy or sell the metal: “There is nothing in the plan to set up a free or open gold market, and, while the President in his message spoke sympathetically of the increased use of silver … he did not promise any, further pro-silver legislation soon.”

The bill gave the president authority to fix a new official value for the dollar between 50 percent and 60 percent of the original par of $20.67 per ounce of gold. Further, in the future the president could change the value of the currency at his will within that 10 percent window or band.

Toward the end of the long article, the reporter pointed out that a key purpose of this legislation was to remove one of the main criticisms of the administration’s gold policy: “that it was uncertain and no one knew what the new value of the dollar was to be.”

On January 30, 1934, and after a heated debate in both chambers of Congress, the Gold Reserve Act of 1934 was signed into law. The next day the president set the new official price of gold at $35 an ounce. The Treasury announced that it was willing to buy and sell any amount of metal at that price, internationally. U.S. residents, however, were still not allowed to hold gold.

This official price of $35 an ounce was in effect until August  1971, when President Richard Nixon closed the Treasury’s “gold window.”

Almost 10 months after Franklin D. Roosevelt had been inaugurated, the second shoe had dropped. The majority of the population seemed to think that the devaluation was a good thing. Through his many speeches and fireside chats the president had convinced the American public that this was a required step to raise prices, end the Depression and create jobs.

But not everyone agreed. To many investors, bankers, lawyers and politicians, the devaluation of the dollar and the abrogation of the gold clauses constituted a violation of contracts, an outright transfer from the creditor to the debtor class, and an outrageous expropriation of wealth.

All there was left to do now was wait for the highest court in the land to rule on the constitutionality of these Rooseveltian policies.

The first full year of recovery was 1934. Output was up in almost every sector, unemployment declined, and prices began to recuperate. As Milton Friedman, Ben Bernanke and Allan Meltzer, among others, have emphasized, the most important factor behind these developments was a profound change in monetary policy.

For the first time since 1927, the broadly defined quantity of money increased throughout the year. At the heart of this change was the Fed's decision to allow large inflows of gold to be translated into higher liquidity and credit. With an expansion in money and credit came a jump in confidence, higher investment, enhanced sales and a reduction in unemployment.

Between January and December 1934, the stock of monetary gold more than doubled in the U.S.; it went from $3.9 billion to $8.1 billion.

The official devaluation of the dollar on the last day of January 1934 was followed by a period of legal and judicial upheaval. In November, the administration asked the Supreme Court to consolidate a number of cases related to the abrogation of the gold clause and to hear them together.

The court's hearing on the cases began on Jan. 8. The government lawyers, including Attorney General Homer Cummings, did a poor job of presenting their case, and many analysts thought it was possible that the Joint Resolution abrogating the gold clause would be declared unconstitutional.

The plaintiffs’ position was that neither Congress nor the government had the power to annul contracts retroactively. Property rights were protected by the Constitution, and the abrogation of the gold clause was a form of taking property without compensation. Moreover, by abrogating the gold clauses Congress was infringing the rights of states and municipalities. They all recognized that there was a difference between being paid in actual bullion — something their clients did not expect — and receiving the amount in paper dollars corresponding to the face value of the security calculated at the new price of gold. It was this type of gold-equivalent payment that their clients were seeking.

The decision came down on February 18. The government prevailed, 5 to 4.  

As soon as the wire services announced the decisions, investors placed orders for stocks, commodities and industrial goods. The New York Times reported that share prices of active stocks had reacted immediately, soaring "from 1 to 10 points between Noon and 1 o’clock." According to the Times reporter, "The decision yesterday was hailed on all sides with deep satisfaction as a definite aid to the restoration of confidence.”

Every newspaper carried the story in the front page. The Washington Post's headline was concise and effective: “New Deal Abrogation of Gold Clause Upheld as Supreme Court Splits 5–4.”

But the Atlanta Constitution’s headline said it all: “‘New Deal’ Upheld in High Court.”

This is the last of four excerpts from "American Default: The Untold Story of FDR, the Supreme Court and the Battle Over Gold" (Princeton University Press). Read the first, second and third excerpts here.

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