By the third week of September, the jig was up. The Bank of England asked the government to relieve it at once of the obligation to provide gold bullion on demand, an obligation that had been in place a mere six years. The requisite legislation passed the House on September 21. The Economist announced "The End of an Epoch." Unwilling to admit the consequences of the Norman Conquest of $4.86, the magazine put the blame on "the slump that followed the extravagances of the American boom [which] showed up in all their crudity the various defects which have prevented the gold standard from working properly and led to trade depression." Keynes's observations on September 27 were more to the point; he looked forward rather than backward. "There are few Englishmen," he wrote, "who do not rejoice at the breaking of the golden fetters. We feel that we have at last a free hand to do what is sensible.... I believe that the great events of the last week may open a new chapter in the world's monetary history. I have a hope that they may break down barriers which have seemed impassable."•22 The most poignant comment came from Tom Johnson, a former Labour Minister, who said, "They never told us they could do that."23
A few days before these events, feeling much improved and ready to go back to work, Norman had sailed from Canada on a ship bound for home; he was totally unaware of the grand denouement of all his endeavors that lay just ahead. His colleagues at the Bank felt obliged to let him know about the momentous decision that was about to go into effect in his absence, but they did not want the news to leak out ahead of time. On the Saturday before the Monday on which the official announcement was to be made, and referring to the Old Lady of Threadneedle Street-the favorite nickname of the Bank of Englandthey cabled Norman, "Old Lady goes off on Monday." Poor Norman was so spaced out that he thought they were referring to his mother's plans for a vacation.24 Did he get a shock when the ship landed at Southampton!
The pound, no longer convertible into gold, took a steep tumble in the foreign exchange markets during the next three months. Foreigners who held sterling on September 21, the day that Britain broke loose, could now convert their pounds into only $3.75 instead of $4.86-a major loss; in December it would touch $3.25. Central bankers around the world rapidly lost their appetite for holding their reserves in the currencies of other countries, even the almighty dollar itself. There were to be no substitutes for gold.
Twenty-four out of the 47 nations on the gold standard immediately raced down the path that Britain had just blazed through the thickets of economic chaos: they suspended convertibility into gold within days of the British action. A year later, only the United States, France, Switzerland, Holland, and Belgium remained on the gold standard; six years later, not a single country permitted their citizens to convert their currency or bank deposits into gold.25 The golden hoards were to be defended by rendering them inactive!
The dash toward gold hit America hard. This urgency to get out of dollars was a surprise, for the official U.S. gold stock at that moment amounted to $4.5 billion-over 40 percent of the gold reserves of all central banks and treasuries around the world and 65 percent larger than France's gold holdings .26 Nevertheless, on September 22, 1931, the Belgian national bank pulled $106 million in gold from New York in one fell swoop; France took $50 million on that day and another $70 million a few weeks later. From the end of September to the end of October, a total of $755 million in gold flowed out of the United States, of which nearly half went to France and the rest mainly to Belgium, Switzerland, and the Netherlands. About one in every seven gold bricks in the vaults of the Federal Reserve banks had departed.27 The panic induced by this news led Americans to follow suit by making massive withdrawals from commercial banks in the form of currency and gold coin, leading almost at once to another eight hundred bank failures.
The prescription for dealing with this crisis was once again the conventional one: deflate and create unemployment. The Federal Reserve lost no time in more than doubling the Discount Rate, boosting it in one giant step from 1'h percent to 3% percent. The prescription performed as expected. The gold outflow ceased-for the moment. Deflation and the creation of additional unemployment were also successfully achieved. Manufacturing production, already down by a third from 1929, sank by an additional 25 percent over the next nine months. Unemployment doubled from a worrisome 10 percent of the labor force to well over 20 percent, while wholesale prices dropped by 25 percent and would end up in 1932 almost 40 percent below their 1929 levels.
At this point, hoarding of currency and coin by the public was restricting even further the ability of the banks to provide credit to their customers. In the middle of 1930, Americans had held $11 in bank deposits for every dollar of currency in their pockets and cash registers, but this ratio dropped over the next twelve months to only $6 in deposits per dollar of currency.2s President Hoover then invited Colonel Frank Knox of Chicago to conduct an educational campaign to discourage the hoarding; Knox must have been quite a salesman, for his pitch served at least to slow the rate of decline in the ratio for a while .*
The savage deterioration in economic conditions forced the Federal Reserve authorities to conclude that they had pressed the policy of deflation far enough. Positive action could no longer be postponed. In the spring of 1932, the Reserve banks bought $1 billion of government securities, a move that Ralph Hawtrey, the British Treasury economist, characterized as "heroic."s" Although the May 30, 1932, issue of Time magazine had placed a photograph of Federal Reserve Chairman Eugene Meyer on the cover (and included a surprisingly technical discussion of Federal Reserve operations in the government securities market), the billion-dollar purchase would prove to be little help to the economy. A fresh wave of anxiety and uncertainty broke out, prompted by concerns that the Federal Reserve was acting to promote inflation. The heroic step simply led to a renewed outflow of gold.
Now began a chilling replay of the events that had led to the final crisis of the British government in 1931: frantic efforts to extinguish a swelling budget deficit as tax revenues shriveled while the demand for government assistance to the unemployed increased in urgency. A deficit of $2 billion was estimated for the fiscal year ending in June 1932, over 3 percent of the total national output (an astonishing number for its time); the actual figure would exceed that amount.31 Following dutifully in the footsteps of Bruning and MacDonald, Hoover pressed Congress to act to reduce this forbidding deficit by cutting expenditures and raising taxes. "Rigid economy is a real road to relief to home owners, farmers, workers, and every element of our population," he assured Congress. "Our first duty as a nation is to put our governmental house in order. 1132
Hoover's determination in this matter was inexhaustible, but Congress was less motivated than the President for such noble objectives. Their spending cuts and tax increases were well below what Hoover sought. Nevertheless, the economic impact of these measures added to the prevailing deflationary pressures and led to an even greater budget deficit in 1933.
And so matters wobbled along until the election of November 1932, when the Democratic candidate, Franklin D. Roosevelt, defeated Herbert Hoover in a landslide. The moment for action to revive the economy had not yet arrived, however, because in those days the inauguration took place on March 4 rather than January 20. A lame-duck President and Congress continued in place for four long months.
Despite untiring efforts to induce Roosevelt to work with him, Hoover complained again and again to the public about Roosevelt's flat-out refusal to cooperate in any measure whatsoever until Roosevelt had been inaugurated and was in power.33 One of Hoover's most protracted efforts to engage Roosevelt's participation concerned plans for a major international economic conference on the world depression and the war debts. Hoover pleaded with Roosevelt:
Ever since the storm began in Europe, the United States has held staunchly to the gold standard.... We have ... maintained the one Gibraltar of stability in the world and contributed to checking the movement of chaos.... [A] mass of gold dashing hither and yon from one nation to another, seeking maximum
safety, has acted like a cannon loose on the deck of the world in a storm.... Confidence cannot be reestablished by the abandonment of gold as a standard in the world.34
Even these strong words failed to persuade Roosevelt to cooperate. As a result, it was a rough four months up to the inauguration, with uncertainty growing as to what actually would lie ahead after the new president was installed. Roosevelt's campaign promise that the government would provide jobs for all the unemployed had the perverse effect of creating a new wave of unemployment by businessmen frightened by fears of socialism and reckless government spending.
Rumors were soon circulating that the new administration would begin "tinkering" with the currency. On January 2, 1933, thirty prominent economists expressed their alarm and insisted that "The gold standard of present weight and fineness should be unflinchingly maintained ... agitation and experiments would impair confidence and retard recov- ery."3s In a clear state of alarm, the famous financier Bernard Baruch, who had supported Roosevelt, told a Senate committee on February 13 that inflation was the road to ruin and that "If you start talking about [devaluation] you would not have a nickel's worth of gold in the Reserve System day after tomorrow."36
These exhortations only added to the spreading fear, but the litany on maintaining the gold standard resumed in the press, among leading members of Congress, and from George Harrison of the New York Federal Reserve himself. On January 31, however, Henry Wallace, who had been mentioned as a member of the new Cabinet, flew in the face of orthodoxy by declaring that "The smart thing would be to go off the gold standard a little further than England has." On February 18, the press announced that Senator Glass, one of the foremost experts on gold and currency in the Congress, had refused Roosevelt's invitation to be Secretary of the Treasury because the President-elect would not give him satisfactory assurances on maintaining the gold standard.37
Frightened Americans now joined agitated foreigners in seeking safety by moving their capital abroad or into gold. A renewed run on the U.S. gold stock resulted in $160 million leaving for foreign climes in February 1933 and another $160 million in the first four days of March that led up to Roosevelt's inauguration. The mounting panic included withdrawals of gold coin from the commercial banks, with over $80 million going out in the last ten days of February and over $200 million during the first four days of March.38
A dramatic incident occurred in Cambridge, Massachusetts, when one of the best-known members of the Harvard Business School faculty, Professor Arthur Dewing, marched into the Harvard Trust Company office on Harvard Square, withdrew his substantial bank account in gold coin, and placed the coins in his safe deposit box. When the crowds inside the bank reported Dewing's action to the people on the street, a mob gathered on the Square, fighting to get into the bank to follow the example set by the distinguished professor. Dewing was subsequently called on the carpet by the dean of the Business School for setting such an example of unpatriotic behavior. Dewing left the faculty soon afterward.*
The Harvard Trust Company survived, but thousands of other banks hit by runs on their deposits did not. Over ten thousand banks disappeared from the scene during 1933, by which time the total number of banks in the United States had fallen to fewer than ten thousand from thirty thousand in 1925 and about 25,000 in 1929.39 The frantic liquidation of bank accounts had driven the ratio of bank deposits to currency in circulation into a precipitous drop from $6 of deposits for every dollar of currency in circulation at the end of 1932 to only $4 for every dollar of currency in March 1933 just about one-third of what this ratio had been before 1929.4"
Where was the Federal Reserve while all of this was going on? The eminent economists Milton Friedman and Anna Schwartz provide an answer to this question in their monumental monetary history of the United States: "The System was demoralized [and] participated in the general atmosphere of panic that was spreading in the financial community and the community at large. The leadership which an independent central banking system was supposed to give to the market ... [was] conspicuous by [its] absence."41
On March 5, the day after the inauguration, the new Secretary of the Treasury assured the country that the gold standard was inviolate. Over the next couple of days, the press both at home and abroad joined in repeating these sentiments. On March 8, Roosevelt held his first press conference and declared that the gold standard was safe.
So much for that. On March 9, Roosevelt pushed the Emergency Banking Act of 1933 through both houses of Congress, authorizing him to regulate or prohibit the export or hoarding of gold or silver and empowering the Secretary of the Treasury to require the surrender of all gold coin, bullion, and certificates (paper notes fully secured by gold) held by the public.42 The public perceived the March 9 legislation as temporary! Anxiety eased, and gold and paper currency started to return to the banking system.
Everything seemed just fine for a few weeks, until the market began to suspect that Roosevelt really did plan to cut the gold value of the dol lar. He had made no secret of his intention to stem the deflationary cycle and start prices back upward, because he was confident that bold steps in that direction would encourage business to start rehiring and increase the depressed level of production. As the rumors about gold proliferated, the run on the dollar resumed, and with good reason: on April 18, legislation was passed giving the President wide powers over the economy, including a reduction in the gold content of the dollar.
Hoover's memoirs are unsparing in their slashing attack on Roosevelt's policies. Hoover claimed that abandonment of the convertible gold standard was the first step toward "communism, fascism, socialism, statism, planned economy." Gold, he argued, is essential to prevent governments from "confiscating the savings of the people by manipulation of inflation and deflation." He goes on at length in this vein; in a footnote, he quotes an old proverb: "We have gold because we cannot trust Governments."43
Roosevelt was determined to proceed. On April 5, only a month after his inauguration and acting under the authority of the Trading with the Enemy Act of 1917 and the Emergency Banking Act passed in March, he issued an executive order requiring all persons to deliver all gold coin, gold certificates, and bullion to the banks in exchange for paper currency or bank deposits, and for the banks to deliver the gold to the Federal Reserve. According to Hoover, only about $400 million in gold came into the banks, adding less than 10 percent to the existing gold stock.
Further enabling legislation in April gave the President the authority, among other things, to fix the weight of gold in the dollar at not less than 50 percent or more than 60 percent below the weight that had established an ounce of gold at $20.67 in 1837, nearly one hundred years earlier. This act prompted Lewis Douglas, Director of the Budget, to predict that "This is the end of Western civilization."44 There was more to come. Further congressional action on June 5 provided that any clause in any contract that provided for payment in gold was now abrogated-even including obligations of the U.S. government.
The cancellation of the gold clause in U.S. government obligations resulted in a rash of lawsuits that ended up in the Supreme Court. The Court agreed that Congress had no right to cancel the promise to redeem its debts in gold at the option of the holder. But then the justices went on to declare that, since the private ownership of gold coin was no longer legal, the plaintiff's demand for damages equal to the change in the gold value of the dollar from $20.67 to $35.00 was without merit!45
On July 3, Roosevelt issued a statement-which came to be known as the "bombshell" message-declaring that efforts to stabilize exchange rates by going back to rigid relationships to gold were "old fetishes of so-called international bankers" and that exchange-rate stability was "a specious fallacy."46 The statement scandalized most conservative politicians, financiers, and academic experts, but the President did find one supporter when John Maynard Keynes proclaimed "Roosevelt magnificently right!" Raymond Moley, one of the President's chief advisors, subsequently quipped, "Magnificently left, Keynes means.
1141
The dollar was now varying from day to day in the foreign exchange markets as Secretary of the Treasury Morgenthau followed Roosevelt's order to gradually reduce the amount of gold a dollar could buy-or, stated differently, to increase the number of dollars required to buy an ounce of gold. Secretary Morgenthau's diaries recite a famous anecdote from this period, as he and two other officials would meet each morning in the President's bedroom to set the price for gold for the day:
Franklin Roosevelt would lie comfortably on his old-fashioned threequarter mahogany bed.... The actual price [of gold] on any given day made little difference. Our object was simply to keep the trend gradually upward, hoping that commodity prices would follow. One day, when I must have come in more than usually worried about the state of the world [Hitler had just recently come to power in Germany], we were planning an increase of from 19 to 22 cents. Roosevelt took one look at me and suggested a rise of 21 cents. "It's a lucky number," the president said with a laugh, "because it's three times seven...."
He rather enjoyed the shock his policy gave to the international bankers. Montagu Norman of the Bank of England, whom FDR called "old pink whiskers," wailed across the ocean, "This is the most terrible thing that has happened. The whole world will be put into bankruptcy." The president and I looked at each other, picturing foreign bankers with every one of their hairs standing on end with horror. I began to laugh. FDR roared.41
For once, Keynes sided with his traditional adversary Norman and refused to join in the fun. He described the gyrations of the dollar "like a gold standard on the booze."49
The Power of Gold: The History of an Obsession Page 37