America’s Money Machine

THE HISTORIAN OF THE ROMAN EMPIRE, TheodoreMommsen, characterizes inflationary progress in the third century as a “chute.” Something like that nowbegan in the U. S.—an accelerating drop in the purchasing power of the irredeemable currency on which the economy had subsisted since 1934.

In October, 1960, a near panic had occurred in the exchanges with the London market price of gold rising to $41 an ounce, a premium of $6 over the official price, before the Treasury was able to throw sufficient metal into the breach. The cost of maintaining the official parity of the dollar at $35 an ounce was the loss of 200 million ounces of gold from the Treasury stock. As usual, the cry arose laying the blame upon unpatriotic citizens, and President Eisenhower, as one of his last acts in office, issued an executive order forbidding U. S. citizens from owning gold anywhere in the world. In 1963, Congress followed up this autocratic act by passing the “interest equalization tax” on foreign securities sold in the U. S., as a measure to discourage American citizens transferring to foreigners dollar claims payable in gold. These official actions, and various so-called voluntary programs of restraint under official suasion, did little to counter the effect of a continually diluted currency. During 1961-65, the balance of payments deficit increased by nearly $13 billion, and another 106 million ounces of gold were paid out. The federal budget remained also in chronic imbalance, with a cumulative deficit for the years 1960-65, inclusive, of $27 billion, of which half was financed by Federal Reserve purchases of Treasury securities.

The gold panic of 1960 had led the U. S. and six major European countries to form a “gold pool” to subdue any speculative tendencies born of distrust in the dollar, by funneling all gold sales to the public through one agency managed by the Bank of England, with the U. S. Treasury providing 59 per cent of the gold.

Extraordinary measures were also taken to shore up European currencies, all of them weak from the double fault of inflationary domestic policies and of reliance upon U. S. dollar claims as good-as-gold equivalents. In 1961, and again in 1965, massive loans were made to Great Britain to support the pound sterling—a currency that was once, but no longer, the standard of the world—while reeds leaned upon reeds in the “swap” arrangements whereby the fragile dollar was propped up by a fund of borrowed European currencies equally fragile, or more so.

An added peril to the monetary system developed from the U. S. military involvement in Southeast Asia—an involvement that began as a “police action” but grew into a full-scale war lasting nearly fifteen years. As the conflict expanded, under the administration of President Lyndon B. Johnson, concern and opposition spread, marked by reversals at the polls at home and by a demand for gold from abroad. Further political settlement occurred in March, 1968, when a “dove,” Senator Eugene J. McCarthy, won 40 per cent of the vote in the New Hampshire primary against the “hawk” Johnson. The London gold pool was now losing $100 million a day, with a hemorrhage of nearly $400 million on March 14.

“That night,” reported the New York Times, “Queen Elizabeth was awakened by her ministers for her to sign a proclamation closing the gold markets.”

“The central bankers and finance ministers,” the Times continued, now “hurried off to another huddle, this time in Washington. On Sunday, March 17, they announced a two-tier system. Speculators would trade among themselves at free market prices and governments would deal with each other at $35 an ounce. In London, thousands of British youths stormed the American Embassy in further protest over Vietnam.”

With access to gold increasingly difficult the American public turned to the feeble barricade of paper money as a defense against the threats of another bank closing. The circulation, that had been rising at the rate of some $300 million annually, now began to increase at the rate of $2 billion. Since by law the note issue required a gold backing of 25 per cent, the closing of the London gold market in March was followed almost at once by an act of Congress (March 18, 1968) ending the gold reserve requirement of Federal Reserve notes (as, earlier, the gold reserve against deposit liabilities had been removed). Removed now, and for the foreseeable future, was any impediment (except public dismay) to the unlimited issue by the Federal Reserve of irredeemable paper notes passing as money, and a corresponding open sesame to unrestricted spending by the government without regard to budgetary balance. By this time the U. S. gold stock was down to 300 million ounces from a peak of 700 million ounces in 1949.

Significant of the generally unrecognized revolution that was taking place in monetary theory and practice, the legend that had appeared on all Federal Reserve notes that they were “redeemable in lawful money” now quietly disappeared—by whose authority diligent enquiry by this author was unsuccessful in discovering.

Paradoxically, although no gold coin was in circulation and although the note issues and the subsidiary coinage no longer bore any legal relation to gold, the dollar was still defined by statute as consisting of so many grains of fine gold (1/35 of an ounce).

Of passing interest in the account of international efforts to maintain a facade of stability to an increasingly unstable structure of managed currencies was the experiment of “special drawing rights” in the International Monetary Fund. A simple explanation of this phenomenon is that each member of the Fund was allocated a quota of SDRs, an SDR being in the nature of a basket of member currencies together having a theoretical gold value according to their several official gold parities. However, since none of the component currencies was actually convertible into gold, the effect was a statistical fiction, a bookkeeping entry; even so, indigent countries preferred the currency of the stronger, however intrinsically weak, and the tendency was to exchange their SDR’s for dollars to the extent possible. The Act of June 19, 1968, that authorized U. S. participation in the special drawing rights, also authorized their use as a reserve asset against Federal Reserve notes, and very soon thereafter some $1.3 billion nominal amount of this “paper gold”—as it came to be called—was monetized into legal tender currency through the mechanism of the Federal Reserve System.

The special drawing rights having proved to be another reed to lean on, the demand for gold from the U. S. Treasury resumed, and on August 15, 1971, President Nixon abruptly closed the “gold window” by ending further conversion of foreign held dollar claims. So ended the Bretton Woods system of gold parities supported by the U. S. dollar, and for the trade of the entire world there now existed only various paper currencies of fluctuating and uncertain value.

Under the Articles of the International Monetary Fund, however, the U. S. was committed to deliver gold to foreign central banks at $35 an ounce, and in December, at a meeting of the ten principal central bank powers, Nixon obtained agreement—an agreement which he described as “the most significant monetary agreement in the history of the world”—to a devaluation of the dollar to 1/38 ounce of gold (the so-called Smithsonian Agreement). This was given legal force by the Par Value Modification Act of 1972 (P.I.. 92-2b8, March 31, 1972).

The principal effect of these changes was to increase the dollar liabilities of the U. S. to the International Monetary Fund by the difference in the new value of gold. So far as the market was concerned, the actions were meaningless, for by the end of 1974 gold was trading in the European markets at $195 an ounce.

There remained the prohibitions of law and edict against U. S. citizens holding or trading in gold. Congress now recognized the inconsistency, and in 1974 removed these restrictions.

In 1976, the U. S.Treasury declared U. S.policy to be the demonetization of gold, not only domestically but internationally—in effect, the abandonment of use of a metal that had throughout history provided a universally accepted medium of payments. Characteristic of administration timidity and uncertainty about the effects was the fact that the announcement was entrusted to a deputy assistant secretary of the Treasury and made before an obscure meeting of miners in Spokane, Washington. The language of the announcement was also timorous. It read:

Confusion and dislocations only increased in a world trade compelled to transact business and settle accounts in currencies that were forever fluctuating in value against each other and against basic forms of wealth, their course dictated by bureaucracies dominated by an equally confusing mixture of personal, political and economic interests. An important commodity of that trade was petroleum, the principal sources of which were in the Middle East and Africa under control of peoples newly released from European colonial rule, and somewhat testy about their prerogatives. Seizing control of the producing properties they now began to dictate world prices for petroleum, functioning through the Organization of Petroleum Exporting Countries—OPEC—which they dominated. The renewal of war between Israel and its neighbors in October, 1973, together with the gradual weakening of the dollar in the exchanges, gave them further opportunity; prices were multiplied four times, and the trade balance in their favor mounted into the billions. How to settle these balances in continually depreciating currencies now became a concern to the world’s monetary authorities. Fortunately, hugely ambitious development programs provided objects in which to spend some of these billions, and other billions were allowed to accumulate in paper currency accounts abroad.

But not for long. As the universal settler of balances, gold now came again into play. The “barbarous relic” acquired new interest. Gold that sold at the end of 1974 at $195 an ounce by 1979 sold at more than $350 an ounce, with the end not yet in sight.

Like Canute bidding the waves recede, however, authorities persisted in the fiction. In 1976 the International Monetary Fund, largely at the instigation of the U. S. announced that some 50 million ounces of its 103 million ounce reserve would be disposed of—one-half to the member countries and one-half offered on the market. A little later, in 1978, the U. S. Treasury announced a program of gold sales on the ground that gold was no longer needed in the monetary system. (The program was discontinued in 1979 after less than 16 million ounces were offered.)

Shrewder money managers, however, were not misled. In 1967 the government of South Africa, suspecting a market for a good gold piece, began coinage of the one-ounce gold Krugerrand, and the issue became so popular that by 1979 some 49 countries were issuing gold coins—though continuing to maintain their shaky paper notes as the legal standard of payments.