The Power of Gold: The History of an Obsession

by Peter L. Bernstein

  On March 17, 1968, after seven fruitless years of pouring their treasure into the maws of the speculators, the members of the gold pool decided the game was up. They announced that henceforth they would no longer supply gold to the London market, or any gold market, nor did they intend to buy any gold from those sources in the future. Official transactions in gold between central banks would continue at $35 an ounce; central banks would still be free to buy gold from the United States for dollars at that price. From that point forward, the price of gold in the free market would be left to private parties to determine.

  This decision to dismantle the gold pool was not only long overdue; the pool never should have been organized. Until the American balance of international transactions could exhibit some fundamental improvement, the members of the pool were simply pouring their gold stocks into the London market in a pointless exercise in which the pool could only lose while the speculators were taking a risk that was hard to resist. With the United States setting a floor to the price of gold by standing ready to buy all gold offered at $35, and with the pool members continuing to offer sufficient gold to hold the free market price at around $35.20, the speculators stood to lose only the small difference between what they paid and $35. The potential profit, however, might be enormous.* The incessant demands of the speculators could in time deplete the official gold stocks of the pool members to a level at which the major currencies would no longer appear to have adequate gold back ing. At that point, the authorities would have no choice but to increase the official price of gold by a substantial amount. Who could pass up a deal like that?

  General de Gaulle now proceeded to call the whole gold-pool strategy a sham, merely a stopgap on the way to the ultimate devaluation of the dollar. His blunt statements might have been considered just another of his long series of efforts to damn the dollar if William McChesney Martin, the Chairman of the Federal Reserve, had not been so indiscreet as to echo de Gaulle's prediction. In a speech in Detroit on March 20, 1968, three days after the gold pool had been closed down, Martin expressed his opinion that "We are perhaps on the road to devaluation."" The excitement drove the London gold price as high as $41 during April and May. By the spring of 1969, the price was over $43.

  At this point, another disturbing possibility came into view. The gold pool had been organized so that each member's contribution was specified, in order to control any selling of gold that one or another member might want to undertake. Now the pool had been dismantled and the gold price was above $40. What would prevent one or another of the central banks that were former members of the pool from cashing in their dollars for gold at $35 in New York and quietly feeding gold into the London market at a handsome profit? With the pool no longer in operation, the temptation to cheat might be irresistible.

  The danger was clear, and something had to be done. There was never any confirmation of an official pact, but rumors suggested that an informal handshake had taken place to deal with the problem. The European members of the pool agreed among themselves that they would refrain from converting any dollar balances into gold at least for the duration of the Vietnam War. That was the cutoff point, after which the Americans were expected at long last to come to grips with the gaping imbalance between the receipts from other countries and their payments abroad. The precedent for these arrangements had been set by the Germans a year earlier, when they had publicly forsworn any further redemption of dollar holdings into gold.

  The willingness of the Europeans to play ball did not come for free. In return, the Americans were obliged to swallow the old-fashioned medicine of budget discipline and higher interest rates that had been routine in the 1920s and early 1930s. President Nixon was prevailed upon to support the 10 percent surcharge on all income taxes, which went into effect in 1969, his first year in office, and created a small but transitory budget surplus. The Federal Reserve raised the Discount Rate in a series of steps from 4 percent at the end of 1967 to 6 percent by the middle of 1969. The result was the mild recession of 1970, but even that accomplished little in the way of cooling the inflationary fevers as the rate of price increases showed no signs of subsiding.

  While all this was going on, General de Gaulle was busy. He was determined to restore France to the days of la gloire and assail the AngloSaxons wherever possible. He twice vetoed Britain's entry into the European Common Market, the second time vetoing even negotiation on entry. He called for "a complete change in the structure of Canada," with Quebec elevated "to the rank of a sovereign state," for Quebec must "stand up to the invasion of the United States."12 He rallied the descendants of the French in Louisiana to place their heritage above their American nationality. He limited his cooperation with the North Atlantic Treaty Organization (NATO) and expressed his determination to build an independent French nuclear capability. He decried the increasing ownership of French industry by Americans who were disbursing their dollars in such quantity into his great country.

  Backed by the intellectual firepower provided by Jacques Rueff, de Gaulle and his associates called for an increase in the price of gold to $70, which would have doubled the dollar value of all the monetary gold in the world. This step would have been a juicy benefit for the French, who held the largest share of monetary gold outside the United States. Rueff went on to argue that the United States would have to give up its profit from this windfall by using its gold to pay down what he considered to be its bloated liabilities to foreigners. From that point forward, countries spending more abroad than they received in payments from foreigners would have to settle the difference by transfers of gold.

  De Gaulle's ultimate objective was to bring an end to the special position of the United States, in which Americans could offset the deficit in their international transactions simply by paying over dollars-their own currency-to foreigners, while everyone else had to settle up with some other country's currency or in gold. De Gaulle was far from alone in resenting a process in which only the United States could finance its spending abroad by what amounted essentially to printing dollars, while the rest of the world had to "earn" their foreign currency or gold by running a surplus in their transactions with foreign nations.

  It was de Gaulle's recommended solution that drew no support. The authorities in the other leading financial nations rejected his trial balloon. Quite aside from the inflationary potential in a doubling of the world's monetary base, this gain created by a stroke of the pen would have been a bonanza for the world's two largest gold producers, South Africa and the Soviet Union, neither of which would have won any popularity contests among the Western nations at that time.

  This effort would turn out to be the General's last gasp. In April 1968, the authoritative French newspaper Le Monde reported that "The weakness of the [French] position stemmed from the absence of complex counterproposals to the lax but coherent system of the Americans and their European allies."" Le Monde up to that time had been ardent in its harassment of the dollar. Its defection from that position was a loud signal that de Gaulle's campaign was beginning to crumble.

  The final blow came in May 1968, when a wild swirl of rioting and strikes broke loose in France. The tumultuous uproar was similar in intensity to the passionate uprisings that occurred in the United States at the same time, but the French were motivated by demands for higher wages rather than by protests over the Vietnam War. The strikes delivered a major blow to the French economy, cost over 750 million working hours, and resulted in a sharp increase in labor costs, which led in turn to rising expectations of a devaluation of the franc. The shocking violence of the uprising provoked a flight of capital reminiscent of the panics of the 1920s, accompanied by strong upward pressure on the deutsche mark and the Swiss franc as the most appropriate safe havens of the moment. By the time the dust had settled, de Gaulle had risked his tenure on a popular referendum that forced him to resign from power-and that decision ignited an even greater panic in the markets for the franc.14

  So much for the General's campaign
to force the dollar back to the old gold standard.

  The events of 1968 were a turning point in history. The impact on gold was just part of a profound shift in the entire political, economic, and social scene.

  The year 1968 was marked by radical demonstrations and social turmoil at a level not seen since the 1930s, and not only in the United States and France. In the United States, 1968 also produced the first Republican election victory since 1956. In the fruitless pursuit of victory in Vietnam, the postwar succession of innovative social programs climaxed by Lyndon Johnson's Great Society came to a quiet end. Instead, political leaders around the world became engaged in a great battle against the threats and disruptions of accelerating inflation-a struggle that would last for more than a decade and that would lead to revolutionary changes in the role of government, in the structure and institutions of financial systems, and in the fundamental character of the capitalist system itself.

  The turning point for gold was in the decision on March 17, 1968, to close down the gold pool. From that point forward, the associated governments warned the speculators and the hedgers that gold was theirs to play with on their own. Now there would be neither floor nor ceiling to the price of gold in the free markets. Although aimed only at the public markets, this threat would turn out to be the beginning of the end for gold as the monetary standard. The concept was already tattered, as we have seen, but the dollar as the fulcrum of the financial system was still officially tied to gold at the old price of $35 an ounce. The problem was that the dollar itself was so tattered, and U.S. gold reserves so depleted, that the system was heading toward a climax from which something quite different would emerge. Once the authorities gave up any control over the price of gold in the free markets, the politicians had no choice but to join forces to break free of the golden fetters. For a long time, the politicians were ahead of the financial markets in this endeavor.

  There was a lesson in all this, foretold by General de Gaulle's poignant but significant defeat. De Gaulle reminds us of poor King Midas, who turned his beloved daughter into a golden statue when he embraced her-or of Montagu Norman, whose blind faith in gold made him, as Churchill reminded us, "perfectly happy in the spectacle of Britain possessing the finest credit in the world simultaneously with a million and a quarter unemployed."

  De Gaulle's driving ambition had been to take revenge on the Anglo-Saxons and bring them to their knees before France. His weapon of choice was "gold that never changes ... that is eternally and universally accepted." As his mentor, Jacques Rueff, had insisted, any system other than a pure gold standard would be "a serious obstacle to social progress." Yet in the end, it was France's hoard of gold that was the obstacle to social progress and that drove the General into retirement from the public arena. While General de Gaulle was looking down his oversized nose at the U.S. dollar and gloating over all the gold that France was proudly shipping across the Atlantic, Americans consumed much delicious French food, drank many bottles of fabulous French wine, titillated themselves with haunting French perfumes, and, not incidentally, became owners of prime French companies such as the computer manufacturer Machines Bull. Had the citizens of France and the rest of Europe been the same kind of free-spenders as the Americans, the sequence of events would have been entirely different.

  Disappointment, disillusion, and defeat have overcome everyone in this history who was so blinded in the pursuit of a hoard of gold that they could not comprehend the difference between useless metal and real wealth. That lesson seems to have been learned by the political leaders of the three decades that have followed the 1960s. Let us now see how the disturbances of 1968 started gold down the road to the place it occupies in the world today.

  s inflation gathered steam during the course of 1968, the goldbased Bretton Woods system of fixed exchange rates loomed as .an intolerable restraint on politicians struggling to finance rising costs of government. The result was renewed interest in gold among the public as a safe haven destined to fulfill the proverb that Herbert Hoover had thrown at President-Elect Roosevelt in 1933: "We have gold because we cannot trust Governments."

  Yet governments were limited in what they could do if the value of their currencies in the foreign exchange markets were to remain rigidly fixed, as the Bretton Woods regime prescribed. Higher government spending tends to stimulate domestic demand, which often raises prices and sucks in imports, the very conditions that make people want to flee a currency and shift to countries with a more conservative style of managing their economic and financial affairs-or to gold. The more that governments tried to find wriggle room around the constraints of the Bretton Woods system, the more the public and the speculators followed Hoover's dictum and turned to gold as the ultimate hedge against the irresponsibility of governments.

  Indeed, nobody was satisfied with the way conditions evolved. The creators of the postwar system had produced an artful design, but economic depression and deflation were the dominant influences on their work. The turbulent economic environment spawned by the overoptimism and aggressive governmental policies of the 1960s was still too novel for anyone to even suggest designing a replacement for Bretton Woods. Once the inflationary genie was out of the bottle, the system had no comfortable way to stuff it back in.

  After 1968, inflation became a self-fulfilling prophecy that added momentum to the fundamental inflationary forces at work in the system. Employee compensation in the United States increased at annual rates of more than 7 percent during 1970 in the face of an unemployment rate that rose from 3.5 percent to over 6 percent of the labor force. The unions were convinced they had to keep wages climbing faster than inflation, while business managements were convinced they had to keep prices rising in order to cover the increased labor costs. The whole process developed a dynamic of its own, pushing on regardless of the unemployment rate, the profit rate, the interest rate, the tax rate, or any force that in other circumstances would have tamed it. These stubborn inflationary pressures only added to the tension over the dollar problem and the diminishing gold stock.

  The Nixon administration could see just two ways out of these dilemmas. The first alternative, the traditional one, was etched in agony by the British in 1931: raise taxes and interest rates so high that the economy would be pushed into a serious recession, not just a pause as in 1970. That step might kill off the inflation mentality and rescue the dollar, but at an unacceptable human cost, to say nothing of the consequences for an elected politician who selected such a strategy.

  The other choice, attempting a direct attack on rising prices, would involve the government in administering a system of controls to keep both wage and price increases in check. By controlling wages, the policy could assure business firms that they could function without constantly raising their prices to protect their profits; by controlling prices, the policy could assure employees that inflation in the cost of living would no longer erode the purchasing power of their earnings. This route, which was known euphemistically as "incomes policy," appeared to many to be the preferable choice. If controls could suppress inflation, there would be no need to crush the business expansion and drive up the unemployment rate. Lower inflation might also take heat off the dollar and the gold stock. Controls would mean interference with the free-market system, but they still appeared to offer the best of all possible worlds. This path had been advocated by many Democrats, but now more conservative support began to develop. In August 1970, Congress enacted legislation that gave the President discretionary authority to impose comprehensive wage and price controls.

  Nixon, however, had no enthusiasm for the idea. Wartime experience as an employee of the Office of Price Administration in World War II had given him a good lesson in how challenging both the economics and the politics of wage and price controls could be. At first, he made nothing more than a token move toward controls with a number of meaningless but high-sounding measures such as appointing a National Commission on Productivity or ordering the Council of Economic Advisors to iss
ue "inflation alerts" that were statistical and analytical rather than recommendations for direct action.

  Despite his misgivings, the President recognized that conditions were backing him into a corner. In December, he took a major step toward a more active policy when he appointed John Connally as Secretary of the Treasury. Connally was a former governor of Texas who had gained national attention when he was wounded while riding in the car when President Kennedy was assassinated in Dallas. A skilled political operator,' he was a handsome silver-haired man of commanding presence. He also had no preconceptions about policy. One of his favorite expressions was, "I can play it round or I can play it flat, just tell me how to play it."' Connally was just the man to overcome Nixon's reluctance to make spectacular moves in economic policy. Furthermore, as Secretary of the Treasury, the deteriorating international financial position of the United States was Connally's primary responsibility, and here the United States could not postpone action much longer.

  Nixon and Connally decided to consider a two-pronged move. Its two elements appeared at first glance to have no clear relationship to each other; as matters worked out, they neatly combined into an integrated program.'

  The first move was designed to solve the gold problem for the United States once and for all. The Treasury would simply shut down the gold window, which would mean refusing to sell gold at $35 an ounce to governments or central banks coming to the Treasury to exchange their dollars. This radical step would be the grand finale of the convertibility of the dollar into gold that had been in effect, with only the Civil War hiatus, for nearly two hundred years. The dollar would finally be liberated from the golden fetters, like all the other currencies of the world. Without any fixed anchor, the dollar would be free to "float" in the foreign exchange markets.