Man, Economy, and Liberty

4

Gold and the Constitution: Retrospect and Prospect

Gregory B. Christainsen

Anarchists such as Murray Rothbard have long maintained that no constitution can ultimately be effective in limiting the powers of government. The political pressures to engage in this or that prohibited activity are always present, and when a prohibited activity can be rationalized in terms of plausible views which are opposed to those of the constitution’s founders, the founders’ intentions may have little force.

A striking example in support of the above contention concerns the desire of the authors of the American constitution to limit the power of government with respect to money. This paper documents the role the Founding Fathers intended for gold in a monetary system which was supposed to be devoid of fiat money. It then discusses the actions of the U.S. Supreme Court in two key episodes during which gold was effectively removed as an important factor in the U.S. monetary system. The two episodes concern the so-called “legal tender cases” of the post-Civil War period and the “gold clause cases” of the 1930s. If one interprets the Constitution in accordance with the intentions of the Founding Fathers, it is argued that there was no legal basis for the Court’s behavior during these episodes. The Court’s behavior in the gold clause cases appears to have been especially sinister. The paper concludes by discussing the future of gold.

The Flow and Ebb of Gold: 1787-1834

The Founding Fathers intended for gold to have a central, if not preeminent, role in the U.S. monetary system. Article 1, Section 8 of the Constitution gives Congress the power to “coin” money, by which it was meant simply that Congress was authorized to operate mints. Article 1, Section 8 also gives Congress the power to borrow money “on the credit of the United States.” What is noteworthy about that particular provision is that the corresponding phrase in the Articles of Confederation, the document which the Constitutional Convention of 1787 had the purpose of revising, also gave Congress the power to “emit bills of credit.” The initial draft of the Constitution also gave Congress the power to “emit bills.” In the parlance of the time, “bills” referred (with few exceptions) to non-interest-bearing assets, payable on demand, i.e., paper currency. On August 16, 1787, however, eleven state representatives debated and voted on whether Congress should retain the power to issue paper currency in the new constitution, and by a 9-2 margin1 they moved to strike out the words “emit bills.” In the account of James Madison, “[s]triking out the words … cut off the pretext for a paper currency, and particularly for making the bills a tender either for public or private debts.”2

The Tenth Amendment to the Constitution reserved to the states those powers not expressly given to the federal government, so it was important for Article 1 to be supplemented by Section 10: “No state shall coin money, emit bills of credit; make anything but gold or silver coin a tender in payment of debts.” In the context of the then-dominant Anglo-Saxon common law, which gave legal tender status only to gold and silver, it is thus clear that the Founding Fathers were laying down a policy of “hard” money. Article 1, Section 10, it appears, was written in order to deny the states powers which had already been denied to the federal government.

After the Constitution was ratified the Congress acted on its minting authority and passed the Coinage Act of 1792. A “dollar,” which was understood to refer to the silver Spanish milled dollar, was fixed at 371.25 grains of fine silver. Given the then-prevailing free-market exchange rate between gold and silver of (roughly) 15 to 1, a dollar was also set equal to 24.75 grains of fine gold (24.75 = 371.25/15). So it appeared that a sound monetary system was in place, with gold—”the universal prize in all countries, in all cultures, in all ages”3—playing a central role.

But it was not to be. The Coinage Act of 1792 established a fixed rate of exchange between gold and silver—15 to 1—but not long after the passage of the act, the market value of gold relative to silver rose above the 15-to-1 level. Given the legal tender status of silver, Gresham’s Law was set in motion: “Bad” money drove out “good” money. In payment of debts, creditors were forced to accept silver which had less value than the official exchange rate indicated, and since gold had more value than the official exchange rate indicated, people turned their gold holdings to nonmonetary uses. Many gold coins were thereby led to disappear from circulation until the Coinage Act of 1834, which made an upward adjustment in the exchange rate.

Moreover, bills of credit were emitted under government auspices early in the life of the new republic. The First and Second Banks of the United States, incorporated in 1791 and 1816, respectively, helped to manage the finances of the federal government, which, in turn, owned about one-fifth of the banks’ stock. The banks issued bills of credit, but these bills did not claim to be legal tender.

It was left to the War Between the States for bills of credit to lose their virginity as an untendered medium. To help finance this period of fratricide, creditors were forced to accept in undiscounted form the so-called greenbacks which were issued, but it was not long before the constitutionality of this move was challenged. A key player in the drama was Salmon Chase, the secretary of the Treasury when the bills were first emitted, and later the chief justice of the Supreme Court. In Veazie Bank v. Fenno (1869), which upheld the legality of the federal government’s enactment of a tax on state banknotes, Chase offered the view that the constitutionality of the issuance of paper currency had been “settled by the uniform practice of government and by repeated decisions,”4 but he cited no such decisions. In Hepburn v. Griswold (1870), on the other hand, Chase, writing for the court, argued that Congress could not make the greenbacks legal tender for debts incurred before the legislation that provided for their issuance.5

Knox v. Lee (1871) marked a turning point in the ultimate transition from precious metals to paper money. During the fifteen months between the Hepburn and Knox decisions, the Court’s composition changed, with critics charging that President Grant had appointed at least one of two new justices on the understanding that he (Justice Bradley) would sustain the legal tender legislation. This claim has never really been proved, but the two new justices were responsible for a 5-4 vote to uphold the constitutionality of the greenbacks’ legal tender status for debts incurred either before or after the legislation was enacted. In concurring with the majority, Justice Bradley alluded to the (false) view that Congress’s borrowing power extended to bills of credit, saying that the greenback legislation “is a promise by the government to pay dollars; it is not an attempt to make dollars.”6 The majority opinion authored by Justice Strong, the other new justice appointed by Grant, made a vague and unfounded argument for the constitutionality of the greenback legislation by claiming that it was necessary for “government self-preservation.”7

Juilliard v. Greenman, decided in 1884, however, bolstered the rationale for the groundless “national necessity” argument by citing the Constitution’s clause which states that, within the powers granted by the Constitution, the U.S. government can do what is “necessary and proper” for the achievement of its ends, and while no less an authority than Justice Marshall had argued forcefully that this clause in no way enlarged the powers of the U.S. government beyond those provided for by the other parts of the Constitution,8 the Juilliard court argued that Congress itself, not the Supreme Court, was the appropriate judge of what was necessary and proper, whether in wartime or peacetime. Other parts of the decision wrongly asserted that the emission of bills of credit was part of Congress’s borrowing power, and it was also claimed that their emission was inherently constitutional—”one of the powers of sovereignty in other civilized nations.”9

Even the Juilliard decision, however, did not alleviate Congress of its obligation to maintain the ultimate redeemability of the greenbacks into specie. It was not until the 1930s, with the gold clause decisions, that redeemability into gold was officially ended, and incredibly, from 1934 to 1974, the federal government was able to largely outlaw gold from the private possession of the citizens of the United States.

The debate over the great gold confiscation10 of the 1930s is a classic example of an ideological struggle. As with other such struggles, the parties to the controversy were caught up in momentous times that few really comprehended, but about which people nevertheless held strong opinions. In pursuing their objectives, there was one sense in which many of the people involved could be said to have been idealists; they believed in the ultimate objectives they were pursuing. In trying to surmount the barriers to either their ideological goals or their narrower self-interest, however, people were led to undertake actions which they would never have otherwise condoned.

The Rationale

The Great Confiscation occurred, of course, against the backdrop of the Great Depression. The role of the Federal Reserve in causing the Great Depression remains in dispute, but it is now widely agreed that the Fed at the very least exacerbated the Depression by failing to prevent or offset bank runs of the very sort it had been created to avert. Since each dollar of deposits backs several dollars-worth of money supply, the fact that large numbers of people wanted to convert deposits into currency resulted, absent any Fed counter-measures, in a multiple contraction of the nation’s stock of money (currency plus bank deposits). From 1929-1933, the money supply declined by about a third. Whether the inaction of the Fed in the face of bank runs was the primary cause or just a notable accompaniment of the economic events of those years, the demand for goods and services generally collapsed, and by 1933 a quarter of the labor force was unemployed.

Banks’ efforts to protect themselves from depositor runs only made matters worse. Each dollar of deposits normally backs several dollars-worth of money supply because banks need keep only a fraction of each dollar of deposits on reserve. This enables banks to lend out the remainder, and as loaned funds are spent and, in turn, deposited at other banks, the money supply swells. If banks hold added reserves instead of making loans, however, the multiple by which the money supply can expand is reduced. Faced with low demand for credit and the risk of bank runs, banks greatly increased the ratio of reserves to deposits, causing the money supply to shrink drastically. This factor became very important beginning in 1931.

Many states were led by these events to declare “bank holidays” and ordered banks to close their doors. These moves culminated in the New York holiday which began on March 4, 1933, and finally, the national banking holiday ordered by President Roosevelt on March 6, 1933. Banks were permitted to open one week later provided that they obtained a license from the secretary of the Treasury certifying that they were sound.11 This certification was intended to restore some confidence to the banking system, and by March 15 more than two-thirds of the banks with about seven-eighths of the nation’s deposits were licensed and open. By the end of 1933 about half of the unlicensed banks with about a quarter of the unlicensed deposits had reopened.

Under the terms of the banking holiday, banks were prohibited from paying out gold or dealing in foreign exchange. On March 10, before the expiration of the banking holiday, Roosevelt issued an executive order extending the restrictions on gold and foreign exchange dealings beyond the duration of the holiday, unless a bank obtained a special license. March 10 also saw the proposed Thomas amendment to the Agricultural Adjustment Act, which was enacted into law on May 12. This contained a provision authorizing the President to reduce the gold value of a dollar by as much as 50 percent.

It was now clear what government policymakers were up to. Aside from trying in their own way to restore confidence in the banking system, they were deliberately seeking to debase the nation’s currency in the hopes of stimulating economic activity. But much more was done besides setting new terms for the relationship between gold and the supply of dollars. On April 5 the President issued another executive order forbidding the “hoarding” of gold and commanded that all gold coins, bullion, and certificates be turned into Federal Reserve banks by May 1 at the legal price of $20.67 per fine ounce of gold. Each individual was allowed, however, to keep a maximum of $100 in gold coin or certificates, plus any coins considered rare. Industry and the arts were allowed to keep minimal amounts of gold as well.

At a news conference on April 19, the President indicated that he wanted the dollar to depreciate relative to other currencies in order to bring about an increase in domestic prices. And so it happened. The restrictions on gold ownership greatly limited U.S. exports of gold, and purchases of foreign gold by the U.S. government increased total imports. American exporters ultimately want dollars; exports generate a demand for converting foreign currencies into dollars. Imports on the other hand generate a supply of dollars to be converted into foreign currencies. Thus, government policy caused the supply of dollars in foreign exchange trading to increase and the demand to decrease, leading to a fall in the value of the dollar.12 With prices of key commodities being set, not unilaterally by U.S. sellers, but in a competitive world market, the fall in the value of the dollar meant that the dollar prices of those commodities had to rise in order for dollar prices to equal the real world levels prevailing at that time. That is, if a foreign seller were being paid in dollars that had depreciated relative to his own currency by 10 percent, his dollar prices would have to increase by 10 percent if each unit sold were to generate the same amount of real revenue as before.

The effect of U.S. policies on other countries, however, was in precisely the opposite direction. The value of foreign currencies rose relative to the dollar and there were net outflows of gold from those countries to the United States. So while the dollar prices of traded commodities rose in the United States, other countries experienced additional deflationary pressures.

Of course, for these policies to be effective in stimulating economic activity in the United States, supplementary policies were required. First, it was important that the Federal Reserve not “sterilize” the inflows of gold from abroad by engineering an offsetting decrease in the money supply. And second, there had to be some assurance that any increases in the money supply would lead to increases in real output and employment, and not be purely inflationary.

The first concern was addressed with the help of the Gold Reserve Act, passed on January 30, 1934. Under this Act, title to all gold coin and bullion was vested in the United States, and the President was authorized to fix the gold value of a dollar at between 50 and 60 percent of its prior legal level. The next day Roosevelt changed the legal price of an ounce of gold from $20.67 to $35.00. At this higher dollar price, many people were indeed led to turn in their gold holdings, and the Federal Reserve purchased sizable amounts of the metal with newly-created fiat money. So despite an increasing problem with banks holding excess reserves—a problem which did not even begin to subside until June 1935—the quantity of money accelerated tremendously, with the M2 measure of the money supply (which includes savings deposits as well as checking deposits) growing almost 25 percent from the spring of 1934 to the spring of 1936.

If they had been permitted to do so, people might have been able to protect themselves from the resulting inflation13 through the use of “gold clauses” in contracts, as they had done to some extent during the greenback era. But a joint resolution of Congress had been introduced as early as May 6, 1933, and passed on June 5, 1933, which abrogated all gold clauses in contracts, both public and private.

Under “gold clauses,” an individual who was owed payment could stipulate that any debasement of the dollar relative to gold had to be matched by the payment of additional dollars so that the real payment, in terms of gold, would be the same as if the debasement had not occurred. Contracts could thus effectively provide for a gold standard, and dollar inflation would not, in principle, have any real effects. In other words, if such contracts could be negotiated frictionlessly and universally, inflation would have no effect on real output, employment, and economic activity generally! But generating inflation which would provide a short-run stimulus to economic activity was precisely one of the Roosevelt Administration’s objectives.

There was yet another motive for abrogating the gold clauses. In light of the fact that the clauses were annulled before people could effectively make alternative arrangements, the annulment produced an immediate transfer of wealth from creditors to debtors, one of whom was the U.S. government. If individuals could have enforced gold clauses for their loans to the U.S. government, the fact that the value of the dollar declined relative to gold would have entitled them to additional dollar payments as compensation when their loans were settled. Instead, the U.S. government was enriched by an estimated $3 billion in terms of payments it no longer had to make.14

So at least in a short-run, pragmatic, utilitarian sense, government policymakers achieved their objectives. As a result of government policies, the average level of real income expanded at a 9 percent annual rate from 1933 to 1937 and reattained its 1929 level. In addition, the unemployment rate, properly measured,15 fell back below 10 percent. For better or for worse, the nation’s monetary system and its implied respect for individual sovereignty, were, however, never quite the same.

The Supporting Court Decisions

The key Supreme Court decisions pertaining to the constitutionality of the U.S. Government’s confiscation of the gold stock, and its abrogation of gold clauses in contracts, comprise one of the most curious episodes in the curious history of that distinguished body. There were three crucial cases which the Court elected to hear in 1935: Norman v. Baltimore & Ohio Railroad Co., Nortz v. United States, and Perry v. United States.

In the Norman case, the plaintiff noted that he had bought a railroad bond valued at $22.50 “in gold coin of the United States … of or equal to the standard of weight and fineness existing on February 1, 1930.” He then argued that since the President and the Congress had deliberately devalued the dollar in terms of gold, he should receive considerably more than the nominal value of $22.50 as payment. The Court argued, however, that the contract in question did not specifically call for payment in gold coin; it called for payment of 22.5 “dollars,” deliverable in gold coin of a certain weight and fineness. In addition, the plaintiff conceded that the gold clause implied payment in the “equivalent” of gold if payment in gold became impossible. The plaintiff in fact received silver worth 22.5 dollars and was thus ruled to have suffered no damages. Case dismissed.

What is all the more remarkable about this case is that the plaintiff did not protest the fact that the silver he was paid was worth much less in terms of gold than the amount of silver that $22.50-worth of gold could fetch on February 1, 1930. It should also be noted that the majority decision, authored by Chief Justice Charles Evans Hughes, opined that Congress itself, not the Supreme Court, was the proper judge as to whether gold clauses represented an unwarranted interference with Congress’s monetary powers!16

In the Nortz case, the plaintiff argued that the true value of gold certificates in his possession exceeded their face value in dollars. He thus claimed that a requirement that he redeem his certificates for dollars was an expropriation of property in violation of the Fifth Amendment, which allows takings only if “just” compensation is paid. In a truly remarkable opinion, Chief Justice Hughes replied that, because gold had been seized nationwide, “a free market for gold in the United States, or any market available to [Nortz] for the gold coin to which he claims to have been entitled” no longer existed, and Nortz “had no right to resort to such markets.”17 In other words, in upholding the abrogation of Nortz’s gold clause, Justice Hughes presupposed the constitutionality of the nationwide gold seizure! Ergo, gold didn’t have the value Nortz claimed it had! Justice Hughes also noted, correctly, that Nortz never questioned the constitutionality of the nationwide gold seizure per se.

Finally, in Perry v. United States, the Court considered a gold clause in one of the U.S. Government’s own bonds, and despite the fact that the clause was similar to many gold clauses in private contracts, the Court reached what by now must be regarded as the surprising conclusion that the abrogation of the clause was unconstitutional. Here, Hughes, citing Article I, Section 8 of the Constitution, argued that Congress, of course, had the power to borrow, but only “on the credit” of the United States. Thus, according to Hughes, “the Congress has not been vested with authority to alter or destroy those obligations.”18

But the Court was not done. Whether Perry could recover damages, Hughes continued, “is a distinct question.”19 Hughes argued that the change in the amount of gold considered equivalent to a dollar could not be said to have caused losses to the extent that Perry claimed because, before the change in the gold content of the dollar, gold coin had been withdrawn from circulation! Hence, gold was not as valuable as Perry claimed! In other words, even in declaring some of Congress’s actions unconstitutional, the Court effectively sustained those actions by assuming that the seizure of gold was constitutional. Furthermore, the court held that, irrespective of the changed nature of the gold-dollar relationship, Perry had not shown that he had suffered a loss of “buying power.” But, of course, the bond which Perry possessed did not promise payment of a number of dollars which was tied somehow to, say, the Consumer Price Index. Instead, he was promised payment in a number of dollars equivalent to a certain amount of gold. Legally speaking, the dollar was still redeemable in silver, so if Perry could have shown that he was losing the equivalent of X amount of silver because of the abrogation of the gold clause, he might have been able to recover damages.20 He did not try to do this.

In summary, nowhere in the gold clause cases was the constitutionality of the gold seizure itself a formal issue before the Court. Yet, in arriving at its decisions the Court assumed the seizure’s constitutionality. Also curious is the fact that the Court never heard a case in which the plaintiff’s contract specifically insisted on payment in gold. Finally, the plaintiffs in all of the gold clause cases were noticeably incompetent in pleading their cases. In the Norman case, Norman did not protest the fact that the change in the relationship between gold and silver during the term of his contract meant that he ultimately received less silver than his contract legally called for. In the Nortz case, Nortz never questioned the constitutionality of the gold seizure; the seizure was the reason why the Court argued that gold was no longer worth what Nortz claimed. And in the Perry case, Perry made no use of the fact that dollars were still legally redeemable in silver in his attempt to show that he had suffered harm from the abrogation of his contract’s gold clause.

Note, too, that the Supreme Court elected to hear these cases. It did not have to hear these cases. It could have heard cases presented by other plaintiffs. In his 1982 report to the U.S. Gold Commission Edwin Vieira argued:

To conclude that all of these circumstances were purely accidental strains credibility to the breaking-point. That the only cases the Court selected for review simply happened to involve litigants so devoid of any coherent conception of their own interests that they willingly conceded the key constitutional issue is not merely implausible, but unbelievable.… [t]hat someone may have planned the aberrant decisions in the Gold Clause Cases … strong circumstantial evidence tends to prove.21

Officially speaking, precious metals were not completely removed from the nation’s monetary system until 1971. In 1968, Congress declared it would no longer redeem silver certificates in silver. In 1971, the U.S. Government ended its pledge to deal in gold with foreign governments. Since 1971, gold has staged a mild comeback. In 1974, gold ownership by private citizens was relegalized, and in 1977, gold clauses in contracts became legally enforceable again. The 1980s saw the creation of the U.S. Gold Commission, which ultimately recommended against a return to any form of gold standard, but which did provide the impetus for the government’s minting of new gold coins.

The Future of Gold

Suggestions that gold could, if given the chance, play a useful role in today’s complex world have become more frequent in the last few years, but, at least in most intellectual circles, the metal is still taboo. The taboo persists despite the fact that gold more than any other agent was responsible for the remarkable secular price stability prevailing from the founding of the Constitution until the early twentieth century. Revisionist historical work has also indicated that any short-term instabilities during that time can be traced to government injections of bills and notes and to ill-advised bank regulations. Instabilities are not properly attributed to so-called “free banking.”22

If the money market were today to be restored to one consistent with the intentions of the Constitution’s founders, the creation of fiat money would have to cease. In order for gold or other candidates to then be able to freely compete for money-holders’ affections, sales and capital gains taxes on commodities would have to be ended, and legal tender laws would have to be repealed. In a truly free money market, gold has, historically, emerged again and again as a dominant money (“the universal prize in all countries, in all cultures, in all ages”), but no individual can predict with absolute confidence whether it would prevail today because a free market utilizes more information than any single individual can ever possess. It may also be the case that a truly free money market would not be perfectly efficient, as judged from the standpoint of neoclassical economic theory.23 But except for a few relatively isolated instances,24 recent theoretical and historical work makes clear that the incentives faced by fiat money suppliers are likely to be positively perverse by comparison. The person to whom this volume is dedicated reached that conclusion a long time ago.

Notes

1. Voting with the majority were George Mason, James Madison, Gouverneur Morris, Pierce Butler, Nathaniel Gorham, Oliver Ellsworth, James Wilson, George Reed, and John Langdon. Dissenters: John Mercer and Edmund Randolph.

2. Max Farrand, ed., Records of the Federal Convention, vol. 2 (New Haven: Yale University Press, 1937), p. 310.

3. This quotation is attributable to Jacob Bronowski.

4. Veazie Bank v. Fenno, 75 U.S. 548 (1869).

5. Hepburn v. Griswold, 75 U.S. 603 (1870).

6. Knox v. Lee, 79 U.S. 560.

7. Ibid., 529.

8. McCulloch v. Maryland, 17 U.S. 316, 421 (1819).

9. Julliard v. Greenman, 110 U.S. 450 (1884).

10. For a more detailed discussion of the material in this section, see Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867-1960 (Princeton: Princeton University Press, 1963), pp. 462-74.

11. Licenses were issued by state banking officials for banks which were not members of the Federal Reserve System.

12. As noted by Friedman and Schwartz, A Monetary History, p. 466, the same effects would have followed from government purchases of foreign wheat, perfume, or art masterpieces. It was not necessary to purchase gold.

13. Wholesale prices rose an average of 31% from 1933 to 1937. (Data obtained from U.S. Department of Labor, Bureau of Labor Statistics.)

14. See Friedman and Schwartz, A Monetary History, p. 470.

15. See Michael R. Darby, “Three-and-a-Half Million U.S. Employees Have Been Mislaid: Or, An Explanation of Unemployment, 1934-1941,” Journal of Political Economy 84 (February 1976): 1-16.

16. Norman v Baltimore & Ohio Railroad Co., 294 U.S. 311. Hughes also argued that “contracts … cannot fetter the constitutional authority of Congress,” ibid., p. 307.

17. Nortz v. United States, 294 U.S. 329-30 (1935).

18. Perry v. United States, 294 U.S. 354 (1935).

19. Ibid.

20. This point was made by Edwin Vieira, Pieces of Eight: The Monetary Powers and Disabilities of the United States Constitution (Atlanta, Ga.: Darby Printing Co., 1983), pp. 276-77.

21. Ibid., p. 282.

22. See the contributions by Lawrence White in Thomas D. Willett, ed., Political Business Cycles (San Francisco: Pacific Research Institute for Public Policy, forthcoming).

23. See Leland B. Yeager, “Stable Money and Free-Market Currencies,” Cato Journal 3 (Spring 1983): 305-26.

24. One might note the case of West Germany from 1948-1966 or Switzerland and Japan in most recent years.