The Power of Gold: The History of an Obsession

by Peter L. Bernstein

  The game came to an end on January 30, 1934, when an executive order fixed the price of gold at $35.00 an ounce, an increase of 69 percent from the old value. That price would prevail without interruption for 37 years, which was three years longer than the dejure value of $20.67 set in the Gold Standard Act of 1900. Although many other factors were at work, it is worth noting that from 1933 to 1937 industrial production jumped by 60 percent and wholesale prices climbed 31 percent while unemployment fell from 25 percent to 14 percent. By early 1937, the Dow Jones Industrial Average stood at 200, a mighty surge from its nadir at 40 touched during the darkest days of 1932. Happy Days were here again!

  Except for the French, the Swiss, the Dutch, and the Belgians, who remained nailed to the cross well into the 1930s. The Dutch and the Belgians clung to their 1913 parities right up into World War II. The French franc, which had once made French goods look so cheap relative to British goods after it was stabilized in 1925, appeared increasingly expensive after the pound broke loose from gold in 1931. The French then caught a bad case of the deflationary disease from which the rupture from gold had liberated Britain and the United States. Prices in France fell by nearly 25 percent between 1931 and 1935, while French national income dropped by a third.""

  By 1936, the horrors had reached the stage where France was besieged by angry sit-down strikes. The political chaos led to the formation of a Popular Front government that included Communists and Socialists-not the most appropriate combination to restore international confidence in the franc. The break from gold and the devaluation of the franc occurred in September under cover of a Tripartite Agreement with Britain and the United States. This agreement added up to little in the way of action but did at least restore international cooperation to something better than the endless friction and backbiting that had characterized international financial relations since the end of World War I.51

  Meanwhile, something strange was happening to gold. As each currency broke away from gold and was devalued, a unit of each currency bought less gold than before-that is, the price of gold went up, as it had risen from $20.67 to $35.00 in the United States. In contrast, the prices of goods and services in all countries had fallen by substantial amounts. The result was that an ounce of gold in the mid-1930s could buy twice as many goods and services as that same ounce could have bought in 1929.11

  In a world in which production was deeply depressed for just about everything that people desperately wanted but could not afford-food, clothing, housing-this leap in the price of gold was a bonanza for gold miners and the equivalent of a whole new gold rush for the world economy. Gold production soared. This new gold came primarily from South Africa, although, as in the past, Russia remained an important producer. In addition, Asia-beset by the Great Depression like everyone elsefor the first time in history dishoarded gold and shipped about $100 million westward. In 1932, the two million tons of gold coming out of the world's gold mines amounted to nearly half of all monetary gold accumulated from the beginning of time to the middle of the nineteenth century. In 1938, output was up another 50 percent from 1932. 13

  The gold reserves of the central banks and related government funds jumped from about forty million tons in 1929 ($10 billion at $20.67 per ounce) to sixty million tons ($25 billion at $35.00 per ounce) ten years later.54 The growth in monetary gold around the world was so vast that by 1939 there was enough gold in the monetary reserves of the world to replace all ordinary currency 100 percent with gold coin.ss

  This was one rare moment when there seemed to be so much gold in existence that nobody knew what to do about it. Only one solution seemed acceptable: send the gold across the oceans to New York, where the United States stood ready to buy everything at $35 an ounce. Consequently, most of this new gold crossed the oceans to New York, along with a lot of old gold. Two contemporary economists, Frank Graham and Charles Whittlesey, described what happened as a "Golden Avalanche." From 1900 to 1913, the rise in monetary gold in the United States had averaged around $70 million at $20.67 ($122 million at $35). From 1934 to 1939, the smallest increase in American gold reserves was $1.1 billion.16 Total U.S. imports of gold from 1934 to 1939 added up to the stupendous sum of $9.6 billion, $3.3 billion more than the greatly expanded production of gold during those years; about 20 percent of this inflow came from France, but, in the pain of the Depression, even India was now exporting gold to the United States.17 When World War II broke out, some $20 billion, or 60 percent of the world's monetary gold, was lodged in the United States compared with a share of only 38 percent in 1929 and 23 percent in 1913.58 This massive hoard weighed more than fifteen thousand tons and was equal to twelve years' worldwide gold production at the time. What a pile it must have been! Atahualpa's chamber, when filled with gold, contained only six tons-and even that was greater than the total annual output of gold in Europe in the early 1500s.

  What could explain such a phenomenal migration of gold from the whole world to the United States? The mountain of new production did raise questions about whether the price of gold might actually fall, along with the rest of the world's commodities, in which case the best strategy was to sell as much as possible to the United States at $35 as long as the opportunity persisted. But the more significant motivation was political: these were frightening days in Europe. Hitler was on the march, with Mussolini and the emperor ofJapan rattling their swords by his side. Hitler rejected the provisions of the Treaty of Versailles, sent German troops back into the demilitarized Rhineland in 1935-touching the French border-and mounted a vigorous and undisguised program of rearmament almost immediately after he assumed the leadership of Germany. While most other countries were still floundering in the mess of the Depression, Hitler's heavy spending on arms succeeded in pulling Germany out of the Depression as rapidly as Roosevelt's new policies had promoted recovery in the United States. Italy invaded Abyssinia (now Ethiopia) in 1935. The Nazis invaded Austria in 1938 and Czechoslovakia in early 1939; Hitler made off with their gold reserves as soon as his troops entered Vienna and Prague. Meanwhile, the Communist system was thriving in Russia, where output and employment kept rising all during the 1930s.

  In this alarming environment, shipping capital across the Atlantic to America seemed to make good sense, especially in the forn-i of gold. The United States, alone in the world, stood ready to buy gold in unlimited amounts at the fixed price of $35.00. Other countries had either stopped buying gold or paid a varying price depending upon the exchange rate of their currencies against the dollar. The dollar/gold relationship was like a fixed star in the heavens to which all other stars and constellations were irresistibly attracted.

  But the strangest thing of all was that the United States absorbed those billions of dollars' worth of gold without any sign of some natural force to throw the process in reverse. What had happened to David Hume's authoritative observation back in 1752 that "It is impossible to heap up money, more than any other fluid, beyond its proper level"? (See p. 160.) None of the necessary steps to fulfill Hume's prediction occurred. The bank deposits received by those who exported gold to the United States sat idle or were invested at interest rates of less than 1 percent per annum. It was no time for taking risks. The banks whose reserves were swelled by the golden imports felt the same way: nothing in those days was as beautiful to behold as a nice, fat pile of cash. In short, money continued to heap up in America far beyond its proper level just to sit quietly until the storms had blown over. The process came to be known as a "liquidity trap." The accumulations of cash would be put to use only later when the pressures of wartime spending demanded it.

  And so the great Victorian gold standard died an ugly, painful, and protracted death, a process that reached all the way back to the prohibitions on convertibility that were put in place after the outbreak of World War I. The old structure was never completely revived after 1918. The remarkable aspect of the story is that so many people believed they could revive that system in a world that the war had altered beyond recognitio
n.

  It is easy to understand the nostalgia for the prewar world that encouraged the struggle to return to gold. It is easy to understand the desire for a system whose simplicity and elegance was unmatched in the history of money. It is easy to understand the fascination with gold-a fascination that had never wavered from the times of Moses and Jason and Croesus and Pizarro right up to the times of Montagu Norman.

  But it is not so easy to understand that men could make such mighty decisions on the basis of obsolete visions rather than objective analysis, with their minds shut tight against consideration of any other solution to the problem at hand.59 It is most difficult to understand how so few seemed to learn-until it was too late-the lessons provided by Britain's example of how the simple decision could lead to unparalleled economic agony. The notion that gold would make everything come out all right was a notion that was upside down: gold would make everything come out all right only when everything was all right in the first place. That was the real meaning behind Disraeli's assertion in 1895 that Britain's gold standard was the consequence, rather than the cause, of her commercial prosperity.

  As so often happens, the errors became increasingly clear after the fact. P. J. Grigg, who was Churchill's principal private secretary, has related that "Winston has almost come to believe [in his later years] that the decision to go back on gold was the greatest blunder of his life. 1101 This was a striking judgment on Churchill's part in view of the nightmare of his key role as First Lord of the Admiralty in the disaster at Gallipoli in 1915.61

  What about Norman himself? In correspondence with Norman in 1944, Russell Leffingwell had observed, "How we labored together, you and Ben [Strong], my partners and I, to rebuild the world after the last war-and look at the damned thing now! "*62 Norman agreed: "As I look back, it now seems that, with all the thought and work and good intentions which we provided, we achieved absolutely nothing.... By and large nothing that I did, and very little that old Ben did ... produced any good effect."63

  'hen the bombings, the bloodshed, and the persecutions of World War II came to an end in the summer of 1945, Europe and Asia were a shambles. Industries, cities, and transportation systems were little more than piles of rubble; millions of people were homeless or jobless, including many who had been forcibly transported far from their own countries; currencies in most countries were worthless-in Germany, cigarettes or nylon stockings were the preferred form of payment. In addition to the United States, only Britain, the Soviet Union, and China had emerged from the war with surviving forms of government, and only Josef Stalin and Chiang Kai-shek were still in office among the wartime leaders. Winston Churchill was voted out of office by a Labour landslide within months after the fighting had stopped.

  Yet within less than twenty years, every vestige of the ravages of war had vanished. By the early 1960s, even western Germany, the Soviet Union, and Japan, which had suffered the worst damage, were vibrant economies enjoying high rates of economic growth and broadly competitive with the one major nation that had emerged unscathed from the hostilities-the United States of America.

  We are about to see how, despite this imposing progress, all the best-laid plans of both leaders and followers ended up far away from their announced destinations. The villain of the piece turned out to be gold. In the disruptions, conflicts, and unpleasant surprises that developed in the course of the 1960s, gold became the focal point and at many points the source of the trouble. The story includes many moments when gold was causing such a rumpus that most authorities wished it would go away and stop bothering them. But then we have noted many occasions in this history where people ended up a long way from where they had intended to end up. Where gold is involved, dreams seldom come true. As Ruskin reminds us, he who has gold is often had.

  The leader most concentrated on gold was General Charles de Gaulle, who commanded the Free French forces against Germany in World War II and was President of France for most of the 1960s. Even twenty years after the fact, he was still smarting from what he considered the inexcusable insults to him and to France when Roosevelt and Churchill had excluded him from their most important consultations and their wartime meetings with Stalin. Nothing would have pleased de Gaulle more than to see the Anglo-Saxons on their knees before him. He was convinced he could accomplish that objective if the world were to follow his advice to restore gold as the primary international standard and means of paymentthereby uprooting the dollar from its current preeminence.

  On February 4, 1965, he assembled one thousand journalists at the Elysees Palace, the official home of the President of France, and seated them in the gilded Salles des Fetes. The ubiquitous gilding of this opulent setting, from the chairs to the walls, was appropriate, for the General had called the press conference to demand nothing less than a return to the nineteenth-century gold standard. "Indeed," he insisted, "there can be no other criterion, no other standard, than gold-gold that never changes, that can be shaped into ingots, bars, coins, that has no nationality, and that is eternally and universally accepted as the unalterable fiduciary value par excellence."'

  He reminded his audience that "The kind of transcending value attributed to the dollar has lost its initial foundation, which was possession by America of the greatest part of the world's gold." His facts were indisputable. By early 1965, the U.S. stock of monetary gold had fallen to its lowest level since March 1937. The stock was down to $15 billion compared with its all-time peak of $25 billion in 1949; America's share of the world's total monetary gold stock had shrunk from 75 percent to less than 50 percent. By the end of the 1960s, the U.S. share would be under 30 percent.

  Later that day, Jacques Rueff, a famous French economist and chief advisor on such matters to the President, declared that de Gaulle was the man of the moment, "the statesman who will restore true money." The present system was "absurd ... a serious obstacle to social progress." Six days later, the French Minister of Finance, with the courtly name of Valery Giscard d'Estaing, delivered a lecture at the University of Paris to a standing-room audience of three thousand students, in which he called for "a solemn and unequivocal declaration" by the major financial powers to settle all international payments deficits with gold. This action, he contended, would "stop the decay of the world money system." He went on to announce that France was taking the lead by starting to convert all new accumulations of dollars into gold.'

  The French would proceed to make their point in no uncertain terms. Most of the time, other nations cashing in dollars for gold left the new gold for safekeeping in the vaults of the Federal Reserve Bank of New York. The French authorities made front-page news by announcing that all increases in their gold stock would travel across the Atlantic on French ocean liners to the secure shores of la patrie.

  What had gone wrong? The designers of the postwar era had had every reason to believe that they had neatly caged the golden monster that had wreaked so much havoc in the 1920s and 1930s. As General de Gaulle went to some pains to point out, however, gold was too mighty to remain a prisoner. The press conference in the Salles des Fetes was just one of a sequence of events in the 1960s that seemed destined to put the dollar in the shade and to restore gold to its former grandeur. Worse was yet to come. Nevertheless, when the moment arrived for gold to break free from its shackles and soar to its zenith in a blaze of glory, the blaze would turn out to be too bright, too hot, too magnificent to be sustainable. In a strange and most unexpected fashion, the world has come full circle since the early 1960s, with the dollar once again the transcending value and with gold in the shade.

  The story begins in the immediate aftermath of World War II, one of those rare moments in history when people make all the right decisions. Most of the world outside the United States was in such a chaotic mess that the framers of the postwar era had a unique opportunity to shape the new structure on a clean slate and make the dreams of the Enlightenment and the Victorian age finally come true. The broad outlines of what was necessary were easy to define: the cascad
e of tragic errors in the 1920s and 1930s provided the leaders of the second postwar era with a perfect blueprint of what not to do. As John Maynard Keynes put it, "In 1918, most people's only idea was to get back to pre1914. No one today feels like that about 1939."3

  Instead of exacting reparations, the Allies carried on vigorous financial and political efforts to bring Germany, Italy, and Japan into the mainstream of democratic society. Instead of insisting on repayments for the huge amounts of military aid that the United States had provided during the war, Americans gave only lip service to demanding payment. Instead, they converted most of their contribution to the Allied war effort into gifts-and then added the prodigious assistance of the Marshall Plan and other substantial aid programs on top of that. Instead of a world where each nation stubbornly pursued its own self-interest, the United Nations was created to manage a world of international cooperation and harmony; unlike the League of Nations, the plans for the United Nations featured the enthusiastic participation of the United States.

  The plans for a new international economic system were worked out by 730 delegates from 44 countries who gathered in the White Mountain resort of Bretton Woods, New Hampshire, in 1944. Most of the final design came from John Maynard Keynes, representing the British Treasury, and his counterpart, Harry White of the U.S. Treasury Department.* The scheme that Keynes and White concocted seemed like an obvious one for the times.

  Instead of an international economy where each nation was at the mercy of its stock of gold, the new system made the U.S. dollar the centerpiece of the structure. The almighty dollar was then supported by 75 percent of the world's stock of monetary gold. The huge U.S. economy had sustained no war damage and was more productive than ever before in its history. The Economic Report of the President of January 1947 declared that the country had made "the swiftest and most gigantic changeover that any nation has ever made from war to peace." Total production in 1947 was 30 percent above 1941, the last full year of peacetime output.