Economics and The Public Welfare

Chapter 51

More Money Magic—The Gold Buying Programme

But the planners in Washington were far from having exhausted their repertory. There were many things yet to be tried. If one did not work, perhaps another would. One is reminded of the account of the deathbed of King Charles II, where a group of physicians were trying every possible method of reviving the unhappy King, including the use of a sneezing powder of hellebore root.1

Professor Warren. The Administration turned in late October, 1933, to a new form of money magic. The new doctor who prescribed this magic was George F. Warren, Professor of Agricultural Economics at Cornell University. Professor Warren was recognized by professional economists as having made some important contributions to the study of agriculture. He was not recognized as an authority on the subject of money, though he had written about money, and many economists shuddered at the selection of Professor Warren as monetary adviser.

The new programme called for the control of commodity prices by varying the gold content of the dollar. The general average of commodity prices was to be raised by lowering the gold content of the dollar until it reached a satisfactory point, and then stabilized by further alterations in the gold content of the dollar—the gold content being raised if necessary to hold the price level down, and the gold content being reduced if necessary to hold it up.2

On the Practical Impossibility of a Commodity Dollar. Human beings who have to use money simply will not stand still while the government or the bank of issue is putting through the manipulations. They will, on the contrary, inevitably, in order to protect their own interests, do things which will defeat the purpose of the government or the bank of issue.

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Price Stabilization by Varying the Gold Content of the Dollar. There are three main types of proposal for regulating the price level by currency or credit manipulation. The most definite and exact is that of Professor Irving Fisher, who has proposed to have the government or the Federal Reserve banks redeem paper money in a varying amount of gold, the amount increasing as prices rise, with a view to pulling them down, and the amount decreasing as prices fall, with a view to raising them again.

At the opposite extreme is Professor Cassel’s plan. Professor Cassel, leaving the gold standard in operation, would undertake to stabilize prices by regulating the volume of credit. If prices are falling, he would have the Federal Reserve authorities increase credit, and if prices are rising, he would have them decrease credit, expecting by this procedure to hold the general average of commodity prices stable.

In between is the plan of Mr. J. M. Keynes. He would seek to manipulate the quantity of money and credit, with a view to keeping prices stable, but he would also make use of gold in the process by having the central bank fix temporary buying and selling prices for gold, varying these two prices from time to time. The great difference between Fisher’s plan and Keynes’s plan with respect to the use of gold is as follows: Fisher would have an automatic rule; Keynes, on the other hand, would leave discretion to the managing authorities, both as to the time and as to the amount of the change in the gold behind the currency. Both Fisher and Keynes would, in general, make changes in the same direction.

Professor George F. Warren, the well-known agricultural economist of Cornell University, whose doctrines are supposed to have had large influence in the making of our recent policy, has himself offered no independent plan. His views seem to lean most strongly toward those of Professor Fisher, though there is evidence that he has been influenced by other writers as well.

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Varying the Gold Content Defeats Its Own Purpose. We assume the plan in operation. We must consider how human beings would react to it before we can predict its effect. Let us suppose that the rule is definitely established that the Federal Reserve banks or the Treasury will reduce by 1% a month the amount of gold bullion paid out in redeeming paper dollars in a period of falling prices, and that, conversely, the redeeming authority will increase by 1% a month the amount of gold paid out in redeeming paper dollars in a period of rising prices. How will men react?

We take first the case of falling prices. We shall assume that prices have fallen 2% or 3% and that the tendency is still downward, so that we can confidently expect that for the next two or three months the redeeming authority will progressively lighten the gold content. Will not foreigners withdraw their money from our markets, turning their cash in American banks into gold in order to avoid the loss of 2% or 3% which they can clearly anticipate? Will not speculators rush to turn in their dollars for gold, anticipating that at a later time they can turn back the same gold to the redeeming authority and get more dollars for it? Will not everyone who has foreign payments to make hasten to purchase foreign exchange, thereby increasing the foreign drain upon our gold? And will not all of these transactions operate to reduce the money supply of the country—since it is by turning in paper money that the gold is obtained from the central authority? And will not all these operations withdraw money from bank reserves, tightening the money market, raising rates of interest on short loans, reducing the credit available for the carrying of commodities and securities? But is tightening the money market the correct procedure when one wishes to raise prices?

Take the reverse case. Assume that prices are rising, that they have risen by 2% or 3% in a short time, and that the tendency is still strongly upward. Under these conditions men can look forward with confidence to a progressive increase for the next two or three months of 1% a month in the amount of gold to be paid for paper money by the redeeming authority, as a means of raising the value of money and pulling down commodity prices. Will not, in this case, reverse reactions take place? Will not men hasten to bring gold to the redeeming authority and take out more paper money in the expectation that two or three months later they can get more gold for that paper money? Will not foreign funds come into the country and gold come in from abroad to be exchanged for paper money? Will not speculators bring gold to the Treasury or the Federal Reserve Banks and take our paper money in exchange, and will not all these operations tend to increase the money supply of the country and the volume of bank reserves, reducing interest rates, making money easy, making it easier to borrow to carry securities and to carry commodities? But will these conditions operate to lower prices?

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Varying Gold Content Spoils Credit Control. The plan of regulating prices by varying the gold content cannot be successfully combined with the plan of controlling prices by increasing or decreasing credit, as Mr. Keynes proposes to do. The point is that when you manipulate the gold content, you surrender control of your money market to the play of speculators in gold and foreign exchange and to the transfer of capital funds from one money market to another. This has been shown above in the demonstration that the money supply would be shortened, bank reserves would be depleted, and interest rates would rise when it was anticipated that the gold content of the dollar was to be lowered, while the reverse movements would take place if it was anticipated that the gold content was to be increased. At the times when your policy of controlling prices by increasing or decreasing credit called for expansion, credit would contract, and, at the times when your policy called for contracting credit, credit would relax.

Space does not permit me to discuss here the general question of control of commodity prices by means of expansion and contraction of credit. I content myself by referring to an earlier number of the Chase Economic Bulletin, published in 1929, called “Commodity Price Stabilization a False Goal of Central Bank Policy,” and to a Bulletin on the Goldsborough Bill, published in 1932, in which the statistical evidence is brought down to a later date. My contention, elaborated in these studies, is that commodity price stabilization by means of credit manipulation is both a practical and a theoretical impossibility.

The point I wish to make at present is that these two plans of stabilization by credit manipulation and stabilization by varying gold content are contradictory plans and cannot successfully be combined in the same scheme, because speculation in gold and transfers of funds between one country and another will spoil the power to control credit.

Varying Gold Content Spoils Automatic Corrective through Exports. If a country on the gold standard finds its prices falling in relation to prices in the outside world, an automatic corrective comes—the country becomes a good market in which to buy and a bad market in which to sell. Its exports increase and its imports diminish. The tendency is for gold to flow into it. These forces all tend to check the price decline. A country operating under the Fisher-Keynes plan, however, would find these forces reversed. Foreign activity, as shown above, would be concentrated on taking out gold, rather than sending in gold to take out goods.

Can Governments Outwit Speculators? There are some who would make rejoinder to considerations of this sort that there is a very simple way of meeting all these difficulties. Why should a government pay out gold at all if speculators are going to play against the government, drawing out gold and returning it as their interests dictate? Why should we permit foreigners to take out gold or send in gold at their pleasure rather than at ours? We will cut through it all by paying out no gold, and have irredeemable paper money. Or we will let it be known that if speculators and foreigners do not behave, we shall from time to time suspend gold payment, resuming it after the speculators and foreigners have learned their lesson, or we will keep them uncertain as to what we are going to do, so that they won’t know what to do. It may be observed, however, that it is precisely on uncertainty that speculation thrives.

But the main point here, of course, is that measures of this sort throw away the whole project of commodity price stabilization by varying the gold content of the dollar. If commodity prices are to be regulated by gold manipulation, then gold must be manipulated and the rules must be adhered to, including the redemption of paper money in gold. The subject here under discussion is the possibility of regulating commodity prices and stabilizing commodity prices by varying the gold content of the dollar, and the verdict is that it is a practical as well as a theoretical and technical impossibility.

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Price Raising by Reducing Gold Content. There has been an immense disappointment on the part of those who expected a great rise in commodity prices to follow the sharp reduction in the value of the dollar as measured against gold, or as measured in the foreign exchange market of gold standard countries. The mathematical theory of the thing would have called for a rise of nearly 66% in commodity prices in the United States to accompany the nearly 40% decline in the gold value of the dollar.

But the student of money and banking had few illusions about it in advance. It was clear that the shock to confidence throughout the world that would follow the cutting of the gold content of the American dollar would be so great that it would destroy credit on a great scale, and make men hesitant and timid for a prolonged period, and that a 50% cut in the gold value of the dollar, far from leading to a 100% rise in commodity prices, would lead rather to a great fall in prices as measured against gold and a very disappointingly small increase in prices as measured in the reduced dollar.

After all, the great bulk of the business of the world is done on credit. Moreover, in times when men distrust the future of paper money, gold itself rises in value as measured not only against paper money but also as against goods, because men turn to gold as the one sure thing that will survive the wreck of currencies and the changing policies of governments, and seek to protect themselves by hiding away their wealth instead of using it courageously in production as they would do in a world of reasonable financial certainties.

Prices in this country following our abandonment of the gold standard and our progressive debasement of the dollar have not moved in the manner indicated by the devaluationist theory. On November 25 the dollar showed a decline, in terms of French francs, amounting to 36.6%. From the January-February level, wholesale commodity prices, according to the United States Department of Labor, showed an increase of 17% up to November 25 instead of the increase of 57.7% which, according to the devaluationist theory, should have accompanied a reduction of 36.6% in the gold value of the dollar.

Practically all of the increase in prices which had been experienced since February took place before the end of July, during which time general productive activity in the country was experiencing spectacular improvement. Since July productive activity has declined. Between the dates of July 29 and November 25 the gold value of the dollar showed a decline of 14.3%. Wholesale commodity prices during the same period, according to the Department of Labor, increased 2.6%, whereas an increase proportionate to the decline in the dollar would have been 16.7%.

Again, if the period of most aggressive activity in depressing the dollar, that since October 22, is taken into account it is to be observed that between the dates of October 21 and November 25 the value of the dollar, as measured in gold francs, declined 10.7%. Wholesale commodity prices, according to the Department of Labor, increased only 9/10% whereas the mathematical theory would require an increase of 12%.

Gold prices, that is, the prices of commodities measured in gold dollars rather than in paper dollars, have gone down drastically since February. The decline from the January-February average to November 25 was 25.9%. From July 29 to November 25 it was 12.1%, and from October 21 to November 25 the decline was 10%.

Summary of Wholesale Commodity Price Movements in the United States Since January-February, 1933
	Value of the dollar as measured in gold francs	Wholesale commodity prices in terms of paper (Bureau of Labor Statistics Index—1926 = 100)	Index of wholesale commodity prices as measured in gold rather than in paper
January-February	100	60.7	60.7
November 25	63.4	71.0	45.0
Per cent of change	-36.6	+ 17.0	- 25.9
Per cent of increase called for by devaluationist theory	......	57.7	......
July 29	74.0	69.2	51.2
November 25	63.4	71.0	45.0
Per cent of change	-10.7	+ .9	-10.0
Per cent of increase called for by devaluationist theory	......	12.0	......

Failure of Gold-buying Plan Recognized by January, 1934. The actual procedure in reducing the gold content of the dollar was the purchase of gold, chiefly in London, by the Reconstruction Finance Corporation through the sale of dollars in the London market. Legal warrant for this procedure was dubious enough, so that in Section 13 of the Gold Reserve Act of 1934 it was felt necessary to obtain Congressional sanction for it, nunc pro tunc. Day after day as the Reconstruction Finance Corporation sold dollars and bought gold, the price of gold against dollars rose, and the price of the dollar fell in the foreign exchange markets against gold standard currencies.

There were stories of an eager group of New Dealers standing each morning by the news ticker, to watch the anticipated percentage jump in commodity prices with each percentage rise in the price of gold. Their disappointment and bewilderment was said to have been very great. Commodities barely moved. The markets were bewildered, bowed to the storm, and waited until some clarification should come.

Meanwhile the dollar itself fought hard. It took a tremendous volume of selling of dollars and a tremendous volume of gold buying to beat it down. As the process went on in January of 1934, anxiety grew lest our continued purchases of gold should pull down the gold bloc, France, the Netherlands, Belgium, Switzerland, and some other countries. The only possibility of success of a programme for manipulating the dollar by foreign exchange and gold transactions was regarded as depending on the existence of outside gold standard markets against which we could play. Our programme was threatening to break the gold standard in these outside countries. Our financial power was great and its reckless employment was disturbing to the world.

The policy was a complete failure as regards regulating and controlling commodity prices, as we have seen above. In the Gold Reserve Act introduced in early January, 1934, and in the executive rulings following the passage of that Act, this policy of varying the gold content of the dollar was abandoned.

By January the failure was too complete and too obvious, and the policy changed. We turned to a debased gold dollar, but to one with fixed gold content.

• 1This point will be discussed at length in Chap. 34.
• 2I have not been able to find that this article was ever published. However, the reader will find much of it in two books by Veblen: Imperial Germany and the Industrial Revolution, New York, 1915; and The Nature of Peace and the Terms of Its Perpetuation, New York, 1917.