by Matthew Hart
A declining world gold supply and a European war increased demand for gold. In 1797 the report of a French fleet landing an invasion army in Wales caused a run on the Bank of England. The report was false, but before it could be countered Londoners rushed to cash their gold-backed banknotes into gold. Some £100,000 worth of gold was leaving the central bank every day. To keep the national reserve from evaporating, Parliament passed a law that made banknotes “deemed payments in cash.”
The French too were short of gold. In 1803 they sold Louisiana to the United States for $15 million—at 4 cents an acre, a good deal: it doubled the area of the United States. The Americans paid for the land with U.S. government bonds. The bankers running the transaction sold the bonds for cash, and Napoleon got the gold he needed to pursue his war.
Inevitably the appetite for gold pushed up the price, driving it above the exchange rate set by law in the United States. An owner of gold could sell it for more in England than he could in America. In response, gold flowed out of the United States to Europe, toward the higher price. Traders used the higher gold price obtained in Europe to buy silver, took the silver back to the United States, and used it to buy more cheap gold at the established rate. By 1834 the supply of gold in America was so low that a visiting French economist wrote, “Since I have been in the United States, I have not seen there one piece of gold money, except on the scales at the Mint. Once minted, gold is embarked for Europe and remelted.” Congress acted, setting the gold price even higher than it was in Europe. The gold-to-silver price ratio became 16:1. Now a trader could get more by buying gold in Europe and selling it in America. The gold flowed back.
The ebb and flow of gold not only described the fortunes of countries; it intensified them. A nation with a trade deficit, for example, would see its gold stock dwindle as it paid out bullion to foreign creditors cashing in their paper money. The shrinking gold stock of the deficit country would curtail domestic spending by the government. Business activity would suffer from the declining money supply.
It was not a scarcity of gold in the world at large that caused these problems. There was soon to be more gold than anyone could have conceived. It erupted into the world from a series of breathtaking discoveries—a gusher of new gold that poured into the markets and founded the modern gold supply. Far from taming the demons of international finance, the gold invigorated them.
ON JANUARY 24, 1848, JAMES MARSHALL panned some bright flakes from the water at Sutter’s Mill, on the south fork of the American River, 130 miles northeast of San Francisco. “This day,” one of his workmen noted in a diary, “some kind of mettle was found in the tail race that looks like gold.” Within days Marshall had his crew knee-deep in the river dredging soils. They tried to keep the find secret, but word got out. In the next seven years, 500,000 men swarmed into the Sierra from around the world.
It was the first gold rush of the modern age. “The whole country from San Francisco to Los Angeles and from the seashore to the base of the Sierra Nevadas resounds with the sordid cry of gold, GOLD, GOLD!” the San Francisco Californian reported. “The field is left half planted, the house half built, and everything neglected by the manufacture of shovels and pickaxes.” They dammed the streams and sluiced the gravels, they pulled the hills apart. “Three men using nothing but spoons dug $36,000 dollars in gold from cracks in a rock,” said one account. “A rabbit hunter poked a stick in the ground, hit rock quartz, and dug up $9,700 worth of gold in three days.” But these were the lucky few; the California gold rush didn’t run on spoons. A different utensil appeared to exploit the goldfield: the mining company.
Dozens of new companies formed, attracting capital from the cities of the east coast and Europe. When silver was discovered in Nevada, the speculative boom caught fire. The dozens of companies became thousands. The inrush of investment supported the development of new technology, but not until later in the rush, when the most accessible deposits had been emptied out. The first equipment in the hills was rudimentary. The sluices were no different in design from the ones the Romans had used. Water washed away light soils to reveal the heavier flakes of metal left behind. The chain pumps brought to California by Chinese miners had been known in Asia from antiquity: a treadle turned a belt that carried wooden trays: the trays scooped water out of flooded areas and fed the sluices.
Tradition bathes the California gold rush in a honeyed light. “Few events in the history of the United States have been as glamorized,” one expert on the period said. “From the nineteenth century to the present, most historians have portrayed it as both a heroic and dramatic epic and as a giant step toward the fulfillment of the nation’s Manifest Destiny.” In this rousing view, a horde of enterprising men catch fortune’s wind and write the founding story of the Golden State. The truth is bleaker. Some Americans brought slaves to the mines. One researcher reckons that half the black men working in California in 1850 were slaves. Mexican miners lived in peonage, tied by debt to their patrones. Chinese “coolies” worked as indentured labor under a “credit-ticket system” that bound them to the middlemen who’d paid their passage. White Americans weren’t slaves, but they toiled from 6:00 A.M. in freezing water that flowed down from the melting snow at higher elevations. A miner had to wash 160 pails of dirt a day to get an ounce of gold. “You can scarcely form any conception of what a dirty business this gold digging is,” one miner wrote. “We all live more like brutes than humans.” Even the investors suffered, as insiders manipulated the stock market, cheated shareholders, wrested mines from weaker individuals, and drained the cash from companies into their own pockets.
But the gold billowed into the world. The satanic mill of slavery, oppression, and fraud was a bullion spinner. In terms of today’s money, billions of dollars worth of gold flowed from the hills of California. It swelled supply with almost unimaginable speed. Robert Whaples, a professor of economics at Wake Forest University, has calculated that from 1848 to 1857, California produced 848 tons of gold. At the official U.S. government price of $20.67 an ounce, that single decade’s production amounted to a staggering $561 million worth of gold—nearly two percent of the gross domestic product of the whole country. New discoveries elsewhere in the world added even more production, and by 1852, only four years after the discovery at Sutter’s Mill, the world’s gold mines were producing 280 tons a year—forty times the volume at the end of Spain’s century of plunder and 200 times the volume from before it. A cataract of gold went foaming into an eager market.
“As the creditor of the whole earth,” wrote one historian, “London got the first of this gold.” In four years the Bank of England grew its gold reserves from £12.8 million to £20 million. The Bank of France bought even more, increasing its bullion stock from £3.5 million to £23.5 million. At the time, only Britain was formally on the gold standard, with banknotes convertible to gold. But the flow of so much gold into the financial system, and Britain’s place as world banker, opened a crack in the continent’s facade of bimetallism. In 1871 Germany bought £50 million worth of gold and issued a new gold-backed currency. “We chose gold,” said Ludwig Bamberger, a German politician, “not because gold is gold, but because Britain is Britain.”
The silver dominoes began to fall. In the United States, the Coinage Act of 1873 effectively demonetized silver—the “crime of 1873,” as the silver lobby later called it. Scandinavian countries scrapped the monetary role of silver in 1874, and Holland followed one year later. France and Spain went on the gold standard in 1876. Looking back, it can appear as if an irresistible monetary wisdom was sweeping the large trading nations into its inevitable embrace. But some scholars think bimetallism was a better system than the gold standard, partly because the use of both metals provided the stability of a bigger money supply. The gold standard did produce periods of financial harmony, but could also suddenly reverse the fortunes of a country.
In 1861, when the costs of the Civil War were swallowing the federal gold stock, the United States suspended
dollar redemptions. Instead of a convertible dollar, the Union issued a paper note, the infamous “greenback.” But in 1875, as the gold standard was consolidating its rule, the United States reinstituted gold convertibility, and set 1879 as the date for it to begin. As that date approached, however, a trade deficit with Europe meant that America faced the prospect of a rapid outflow of its gold. The Treasury was saved at the last minute by a European disaster: a late-spring frost wiped out French and English crops. Now the shoe was on the other foot.
As the cost of wheat shot up in Europe, America had a bumper crop. Gold moved from Europe to the United States to buy the needed food. So began a three-year boom in American farm exports, and a hefty boost to the gold reserve. But the gold standard operated with perfect impartiality in dealing out misery; the next twitch of international finance would almost ruin America.
In 1890, a banking crisis in Argentina rattled European confidence in overseas ventures. Investors began to sell American debt, exchanging their dollars for gold. Now gold flowed the other way, out of the government’s vaults and onto ships and across the ocean to Paris and London and Berlin. By 1892 the American gold reserve had fallen to $114 million, dangerously close to the $100 million level the Treasury had set as its minimum reserve. Once again the United States took the most drastic measure available: it halted gold payments.
The havoc that followed showed how radical and useless such an action was. The public concluded that the whole banking system was circling the drain, and started a run on the banks. The trade deficit with Europe widened to $447 million—a horrifying abyss. The interest rate for short-term money in New York climbed to 74 percent. The stock market fell apart. Four railroads went under, and 500 banks. Thousands of businesses failed. In this tempest of disaster, the United States was facing ruin.
The government had $40 million left in monetary gold, a store that was dwindling by $2 million a day. In the financial community, they thought it certain that the Treasury would fail. On the last day of January 1895, $9 million in gold bullion—almost half the reserve—sat on ships in New York Harbor bound for Europe. At the last possible moment, at the very brink of the abyss, the country was rescued from insolvency by one of the men that the public was blaming for the state of things, the greatest grandee of them all, the American prince—the financier J. Pierpont Morgan.
In American terms, the Morgans had been rich forever. They had not scrabbled their way out of poverty but had glided along a path to prosperity that began sixteen years after the arrival of the Mayflower at Plymouth, when Miles Morgan bought a farm at Springfield, Massachusetts, and set about, in the words of the family’s chronicler, “spawning generations of land-owning Morgans.”
Morgan’s father, Junius, moved to Boston in 1851 to expand his business into merchant banking. He enrolled his son at the English High School, admonishing him to make friends with those of the “right stamp.” Morgan was a lively, passionate, and moody youngster. He was beset by sudden rashes on his face and suffered bouts of scarlet fever. In 1852 he was sent to the Azores to recover from a rheumatic disease that left one leg shorter than the other.
Banking then was a dynastic occupation. The great English banking families such as Baring and Rothschild fed a cult of personality that Walter Bagehot, a British journalist and commentator of the day, captured when he wrote: “The banker’s calling is hereditary; the credit of the bank descends from father to son; this inherited wealth brings inherited refinement.”
Junius moved his headquarters to London in 1854. Morgan went to a school on Lake Geneva, and then to the University of Göttingen. Later he returned to America to become his father’s eyes and ears on Wall Street.
Troubled throughout his life by his skin, and afflicted at times by nervous ailments and migraine headaches, Morgan nevertheless became the greatest banker in America, a tall, burly, laconic, and intrepid financier, prowling Wall Street behind the smokestack of a huge cigar. His yacht, the Corsair II, with its sleek black hull and yellow funnel, was said to be the largest private craft afloat. He collected bronzes, porcelains, watches, ivories, and paintings, rare books, manuscripts, and ancient artifacts. He bought rare furniture, tapestries, and armor. In two decades he spent almost a billion dollars in today’s money indulging his passion for collecting. In his refinement, cosmopolitan upbringing, and fortune he was probably the only man in America that European bankers would accept as an equal, and for that reason, he was political poison in the United States.
Still a largely agricultural country, the United States was not the creditor it is today. It was a debtor nation. Its rural voters hated the eastern establishment bankers, whom they viewed as having enslaved America to British gold. The operation of the gold standard could punish farmers by depressing prices, an effect they attributed to the wicked machinations of Europeans, abetted by American financiers. Such was the political temperature at the end of January 1895, as $9 million sat in New York waiting to be shipped to Europe.
As the sense of crisis heightened, Morgan held a meeting with August Belmont, Jr., the Rothschild agent, at the New York Subtreasury. Just the fact of the meeting of two such powerful financiers drained some of the tension from the situation. Overnight, the $9 million in bullion was taken from the ships and put back in the government’s vault. But the relief was temporary. In Washington, the cabinet rejected a private bond offer put together by the two banking houses, and gold started leaving the Subtreasury again as skittish dollar owners cashed in their paper. Morgan boarded his private railway car and set out for Washington.
On arrival he went to the White House. He was told that the president, Grover Cleveland, would not see him. Morgan replied: “I have come down to see the president, and I am going to stay here until I see him.” He stayed in the White House all day. He returned to the Arlington Hotel, played solitaire all night, and in the morning walked back across Lafayette Square, and was shown into a meeting in the president’s office. He sat there silently while Cleveland and members of his cabinet discussed the emergency. Finally a clerk came in and informed the secretary of the Treasury, John G. Carlisle, that the government was down to its last $9 million in gold coin. Morgan spoke up, informing Cleveland that he knew about a $10 million draft soon to be presented. “If that $10 million draft is presented, you can’t meet it,” he said bluntly. “It will all be over before three o’clock.” Cleveland made the only sensible reply he could: he asked Morgan what to do.
Morgan’s solution was his masterpiece—a $65 million bond to be sold to a European syndicate organized by Morgan and the Rothschilds. Once the important European banking houses joined the syndicate, New York banks came in too. In exchange for a premium interest rate, subscribers agreed to pay for the bond in gold. Not only that, they promised to “exert all financial influence . . . to protect the Treasury of the United States against the withdrawal of gold” until the bond was paid off. It was a brilliant stroke. Morgan had kept America on the gold standard by suspending it. Without the need to redeem foreign-owned dollars in gold, the American treasury had time to restore itself.
FOR ALL ITS HARSHNESS, THE gold standard reigned over a period of economic expansion. Its gift to the industrializing and trading world was the credibility of one another’s currencies. The system solved two main problems.
First, it removed uncertainty about fluctuations in the value of a currency. With a currency defined in terms of gold, the holders of the currency could make rational decisions about the future, because they knew what the currency would be worth at any time. If they owned dollar bonds maturing in twenty years, say, they knew what the bonds would be worth because that value was expressible in terms of gold.
Second, the gold standard told central bankers what to do with monetary levers such as interest rates. Let’s say the central bank’s interest rate was low. Money poured out into the economy as borrowers took advantage of easy credit. The fresh money stimulated the economy, which was the object of the low interest. But when was the stim
ulus just right, and when too much?
On the gold standard, a central banker could see when prices in the stimulated economy rose too high, because the rise in prices made gold look cheap. Noticing this, dollar owners would start converting their currency into gold, taking advantage of the bargain. Gold left the Treasury, and in came paper money. But according to the gold standard, the amount of gold and the number of dollars had to tally at a certain ratio or there would not be enough gold to back the dollar. To stop the flood of paper money in and gold out, the central banker would have raised interest rates. Suddenly you could earn more by cashing in your gold for dollars, and investing the dollars in the economy. Gold flowed back in. Once things had matched up in the Treasury again, the central banker could ease off on interest, and so it went.
Proponents of a return to the gold standard are seduced by the apparent serenity of this monetary picture, and either forget, or think we should accept, the bloodshed in the background. Those who disagree with them consider gold a blunt instrument for monetary purposes today, when economic planners have an abundance of data, such as the consumer price index, to help them assess how a currency is doing. Against these more sophisticated measurements, then, gold is just not a good indicator.
There are other reasons too that economists think gold’s hour has passed. In a growing economy, for example, a gold-backed currency has to cover a correspondingly growing number of transactions, and it can only do this if prices fall, which is deflation, a killer of jobs.
“Under a true gold standard, moreover,” writes Barry Eichengreen, “the [Federal Reserve] would have little ability to act as a lender of last resort to the banking and financial system. The kind of liquidity injections it made to prevent the financial system from collapsing in the autumn of 2008 would become impossible because it could provide additional credit only if it somehow came into possession of additional gold. Given the fragility of banks and financial markets, this would seem a recipe for disaster. Its proponents paint the gold standard as a guarantee of financial stability; in practice, it would be precisely the opposite.”