Currency Wars: The Making of the Next Global Crisis

by James Rickards

  When the banks did reopen on March 13, 1933, depositors lined up in many instances not to withdraw money but to redeposit it from their coffee cans and mattresses, where it had been hoarded during the panic of the preceding months. Although very little had changed on bank balance sheets, the mere appearance of a housecleaning during the holiday combined with the Fed’s new emergency lending powers had restored confidence in the banks. With that behind him, FDR now confronted an even more pernicious problem than a bank run. This was the problem of deflation now being imported into the United States from around the world through exchange rate channels. CWI had now arrived at the White House doorstep.

  When England and others went off the gold standard in 1931, the costs of their exports went down compared to costs in other competing nations. This meant that competing nations had to find ways to lower their costs to also remain competitive in world markets. Sometimes this cost cutting took the form of wage reductions or layoffs, which made the unemployment problem worse. In effect, the nations that had devalued by abandoning gold were now exporting deflation around the world, exacerbating global deflationary trends.

  Inflation was the obvious antidote to deflation, but the question was how to achieve inflation when a vicious cycle of declining spending, higher debt burdens, higher unemployment, money hoarding and further spending declines had taken hold. Inflation and currency devaluation are substantially the same thing in terms of their economic effects: both decrease the domestic cost structure and make imports more expensive and exports less expensive to other countries, thus helping to create domestic jobs. England, the Commonwealth and Japan had gone this route in 1931 with some success. The United States could, if it so chose, simply devalue against sterling and other currencies, but this might have prompted further devaluations against the dollar with no net gain. Continuation of paper currency wars on a tit-for-tat basis did not seem to offer a permanent solution. Rather than devalue against other paper currencies, FDR chose to devalue against the ultimate currency—gold.

  But gold posed a unique problem in the United States. In addition to official holdings in the Federal Reserve Banks, gold was in private circulation in the form of gold coins used as legal tender and coins or bars held in safe-deposit boxes and other secure locations. This gold could properly be viewed as money, but it was money being hoarded and not spent or put into circulation. The easiest way to devalue the dollar against gold was to increase the dollar price of gold, which Roosevelt could do with his emergency economic powers. FDR could declare that gold would now be convertible at $25 per ounce or $30 per ounce instead of the gold standard price of $20.67 per ounce. The problem was that the benefit of this increase in the gold price would go in large measure to the private gold hoarders and would do nothing to free up the hoards or put them back in circulation. In fact, more people might convert paper dollars to gold bullion in anticipation of further gold price increases, and those hoarding gold might sit tight for the same reason, with their original convictions having already been confirmed. Roosevelt needed to ensure that any gains from the revaluation of gold would go to the government and not the hoarders, while citizens would be left with no forms of money except paper. If gold could be removed from private hands and if citizens could be made to expect further devaluations in their paper money, they might be inclined to start spending it rather than hold on to a depreciating asset.

  A prohibition on the hoarding or possession of gold was integral to the plan to devalue the dollar against gold and get people spending again. Against this background, FDR issued Executive Order 6102 on April 5, 1933, one of the most extraordinary executive orders in U.S. history. The blunt language over the signature of Franklin Delano Roosevelt speaks for itself:I, Franklin D. Roosevelt . . . declare that [a] national emergency still continues to exist and . . . do hereby prohibit the hoarding of gold coin, gold bullion, and gold certificates within the . . . United States by individuals, partnerships, associations and corporations.... All persons are hereby required to deliver, on or before May 1, 1933, to a Federal reserve bank . . . or to any member of the Federal Reserve System all gold coin, gold bullion and gold certificates now owned by them.... Whoever willfully violates any provision of this Executive Order . . . may be fined not more than $10,000 or . . . may be imprisoned for not more than ten years.

  The people of the United States were being ordered to surrender their gold to the government and were offered paper money at the exchange rate of $20.67 per ounce. Some relatively minor exceptions were made for dentists, jewelers and others who made “legitimate and customary” use of gold in their industry or art. Citizens were allowed to keep $100 worth of gold, about five ounces at 1933 prices, and gold in the form of rare coins. The $10,000 fine proposed in 1933 for those who continued to hoard gold in violation of the president’s order is equivalent to over $165,000 in today’s money, an extraordinarily large statutory fine.

  Roosevelt followed up with a series of additional orders, including Executive Order 6111 on April 20, 1933, which banned the export of gold from the United States except with the approval of the secretary of the Treasury. Executive Order 6261 on August 29, 1933, ordered U.S. gold mines to sell their production to the U.S. Treasury at a price to be set by the Treasury, in effect nationalizing the gold mines.

  In a rapid sequence of moves, FDR had deftly confiscated private gold, banned its export abroad and captured the gold mining industry. As a result, Roosevelt greatly increased the U.S. hoard of official gold. Contemporary estimates were that citizens surrendered over five hundred metric tons of gold to the Treasury in 1933. The gold depository at Fort Knox was constructed in 1937 for the specific purpose of holding the gold that had been confiscated from U.S. citizens. There was no longer enough room in the basement of the Treasury.

  It is difficult to imagine such a scenario playing out today, although the legal authority of the president to seize gold still exists. The difficulty in imagining this happening lies not in the impossibility of a similar crisis but rather in the political backlash that would ensue in an age of pervasive talk radio, social media, outspoken cable channel anchors and greatly diminished trust by U.S. citizens in their government. Of these factors, the loss of trust is the most powerful. FDR had his talk radio opponents after all, most famously Father Charles Coughlin, with an audience in the 1930s estimated to be larger than Rush Limbaugh’s audience today. While it was not quite Twitter or Facebook, there was no shortage of social media, including newspapers and especially word of mouth readily constructed from a dense web of families, churches, social clubs and ethnic bonds. A powerful rebuke to FDR’s gold confiscations could easily have emerged, yet it did not. People were desperate and trusted FDR to do the right things to fix the economy, and if an end to gold hoarding seemed necessary, then people were willing to turn in their coins and bars and gold certificates when ordered to do so.

  Today’s electronic social media have a powerful amplifying effect on popular sentiment, but it is still the sentiment that counts. The residue of trust in leadership and economic policy in the early twenty-first century has worn thin. It is not difficult to imagine some future dollar collapse necessitating gold seizures by the government. It is difficult to imagine that U.S. citizens would willingly go along as they did in 1933.

  Roosevelt’s gold confiscation left unanswered the question of what new value the dollar would have relative to gold for purposes of international trade and settlements. Having confiscated Americans’ gold at the official price of $20.67 per ounce, FDR proceeded to buy more gold in the open market beginning in October 1933, driving up its price slowly and thereby devaluing the dollar against it. Economist and historian Alan Meltzer describes how FDR would occasionally choose the price of gold while lying in bed in his pajamas, in one instance instructing the Treasury to bid up the price by twenty-one cents because it was three times his lucky number, seven. The story would be humorous if it did not describe an act of theft from the American people; profits from the increas
ed value of gold now accrued to the Treasury and not the citizens who had formerly owned it. Over the next three months, FDR gradually moved the price of gold up to $35 per ounce, at which point he decided to stabilize the price. From start to finish, the dollar was devalued about 70 percent when measured against gold.

  As the coup de grace, Congress passed the Gold Reserve Act of 1934, which ratified the new $35 per ounce price of gold and voided so-called gold clauses in contracts. A gold clause was a covenant designed to protect both parties from the uncertainties of inflation or deflation. A typical provision said that in the event of a change in the dollar price of gold, any dollar payments under the contract would be adjusted so that the new dollar obligation equaled the former dollar obligation when measured against a constant weight of gold. FDR’s attack on gold clauses was highly controversial and was litigated to the Supreme Court in the 1935 case of Norman v. Baltimore & Ohio Railroad Co., which finally upheld the elimination of gold clauses in a narrow 5–4 decision, with the majority opinion written by Chief Justice Charles Evans Hughes. It was only in 1977 that Congress once again permitted the use of gold clauses in contracts.

  Finally the Gold Reserve Act of 1934 also established the Treasury’s exchange stabilization fund, to be financed with the profits from gold confiscation, which the Treasury could use on a discretionary basis for currency market exchange intervention and other open market operations. The exchange stabilization fund is sometimes referred to as the Treasury’s slush fund, because the money does not have to be appropriated by Congress as part of the budget process. The fund was famously used by Treasury Secretary Robert Rubin in 1994 to stabilize Mexican money markets after the collapse of the peso in December of that year. The exchange stabilization fund had been little used and was mostly unknown even inside Washington policy circles from 1934 to 1994. Members of Congress voting for the Gold Reserve Act in 1934 could hardly have conceived that they might be facilitating a Mexican bailout sixty years later.

  The English break with gold in 1931 and the U.S. devaluation against gold in 1933 had the intended effects. Both the English and U.S. economies showed immediate benefits from their devaluations as prices stopped falling, money supplies grew, credit expansion began, industrial production increased and unemployment declined. The Great Depression was far from over, and these signs of progress were from such depressed levels that the burden on businesses and individuals remained enormous. A corner had been turned, however, at least for those countries that had devalued against gold and against other countries.

  Now the gold bloc countries, which had benefitted from the first wave of devaluations in the 1920s, began to absorb the deflation that had been deflected by the United States and England. This led finally to the Tripartite Agreement of 1936, another in that seemingly endless string of international monetary conferences and understandings that had begun with Versailles in 1919. The Tripartite Agreement was an informal agreement reached among England, the United States and France, which acted for itself and on behalf of the gold bloc. The official U.S. version released by Treasury Secretary Henry Morgenthau on September 25, 1936, said that the goal was “to foster those conditions which safeguard peace and will best contribute to the restoration of order in international economic relations.” The heart of the agreement was that France was allowed to devalue slightly. The United States said, with reference to the French devaluation, “The United States Government . . . declares its intention to continue to use appropriate available resources so as to avoid . . . any disturbance of the basis of international exchange resulting from the proposed readjustment.” This was a “no retaliation” pledge from the United States—another sign that the currency wars were ending for now.

  All three parties pledged to maintain currency values at the newly agreed levels against gold, and therefore one another, except as needed to promote domestic growth. The exception made for internal growth was highly significant politically and further evidence that, while currency wars may play out on an international stage, they are driven by domestic political considerations. In this regard, Morgenthau’s statement read, “The Government of the United States must, of course, in its policy toward international monetary relations take into full account the requirements of internal prosperity.” The UK and French versions of the agreement, issued as a series of three separate communiqués rather than a single treaty document, contained substantially similar language. This “internal prosperity” language was not gratuitous, since all three countries were still struggling with the effects of the Great Depression. They could be expected to abandon the agreement readily if deflation or high unemployment were to return in such a way as to require further inflationary medicine through the exchange rate mechanism or devaluation against gold. Ultimately the Tripartite Agreement was toothless, because growth at home would always trump international considerations, yet it did mark an armistice in the currency wars.

  Switzerland, the Netherlands and Belgium also subscribed to the agreement after France had led the way. This completed the cycle of competitive devaluations that had begun with Germany, France and the rest of the gold bloc in the 1920s, continued with the UK in 1931, culminated with the United States in 1933 and now came full circle back to the gold bloc again in 1936. The temporary elixir of currency devaluation had been passed from country to country like a single canteen among thirsty soldiers. The more durable fix of cheapening currencies against gold in order to encourage commodity price inflation and to escape deflation had also now been shared by all.

  One positive consequence of the currency devaluations by France and the new pledge of exchange rate stability in the Tripartite Agreement was the resumption of international gold shipments among trading nations. The era of suspension of gold exports and central bank hoarding of gold was beginning to thaw. The U.S. Treasury, in a separate announcement less than three weeks after the Tripartite Agreement, said, “The Secretary of the Treasury states that . . . the United States will also sell gold for immediate export to, or earmark for the account of, the exchange equalization or stabilization funds of those countries whose funds likewise are offering to sell gold to the United States.” The United States was willing to lift its ban on gold exports to those countries that would reciprocate. The new price of gold in international transactions was set at $35 per ounce, where it would remain until 1971.

  The combination of a final round of devaluations, pledges to maintain new parities and resumption of gold sales might have worked to launch a new era of monetary stability based on gold. But it was a case of too little, too late. The economic destruction wrought by Versailles reparations and Weimar hyperinflation had given rise in Germany to the corporatist, racist Nazi party, which came to power in early 1933. In Japan, a military clique adhering to a twentieth-century version of the feudal code of Bushido had taken control of the Japanese government and launched a series of military invasions and conquests throughout East Asia. By 1942, large parts of the world were at war in an existential struggle between the Allied and Axis powers. Devaluations and struggles over war debts and reparations left over from World War I were forgotten. The next time international monetary issues were revisited, in 1944, the world would be a far different place.

  In the end, the flaws of both the 1925 gold exchange standard and U.S. monetary policy from 1928 to 1931 were too much for the global monetary system to bear. Devaluing countries such as France and Germany gained a trade advantage over those who did not devalue. Countries such as England, which had tried to return to the prewar gold standard, suffered massive unemployment and deflation, and countries such as the United States, which had massive gold inflows, failed to live up to their international responsibilities by actually tightening credit conditions during a time when they should have been loosening.

  The extent to which these imbalances and misguided policies contributed to the Great Depression have been debated ever since. It is certainly the case that the failure of the gold exchange standard has led many economists t
oday to generally discredit the use of gold in international finance. Yet it seems at least fair to ask whether the problem was gold itself or the price of gold, which stemmed from a nostalgic desire for a prewar peg, combined with undervalued currencies and misguided interest rate policies, that really doomed the system. Perhaps a more pure form of gold standard, rather than the hybrid gold exchange standard, and a more realistic gold price, equivalent to $50 per ounce in 1925, would have proved less deflationary and more enduring. We will never know. What followed after 1936 was not a continuation of a currency war but the bloodiest real war in history.

  CHAPTER 5

  Currency War II (1967–1987)

  “The dollar is our currency, but it’s your problem.”

  U.S. Treasury Secretary John Connally

  to foreign finance ministers, 1971

  “I don’t give a shit about the lira.”

  President Richard M. Nixon, 1972

  As World War II wound down, the major Allied economic powers, led by the United States and England, planned for a new world monetary order intended to avoid the mistakes of Versailles and the interwar period. These plans were given final shape at the Bretton Woods Conference held in New Hampshire in July 1944. The result was a set of rules, norms and institutions that shaped the international monetary system for the next three decades.

  The Bretton Woods era, 1944 to 1973, while punctuated by several recessions, was on the whole a period of currency stability, low inflation, low unemployment, high growth and rising real incomes. This period was, in almost every respect, the opposite of the CWI period, 1921–1936. Under Bretton Woods, the international monetary system was anchored to gold through a U.S. dollar freely convertible into gold by trading partners at $35 per ounce and with other currencies indirectly anchored to gold through fixed exchange rates against the U.S. dollar. Short-term lending to particular countries in the event of trade deficits would be provided by the International Monetary Fund. Countries could only devalue their currencies with IMF permission and that would generally be granted only in cases of persistent trade deficits accompanied by high inflation. Although conceived in the form of a grand international agreement, the Bretton Woods structure was dictated almost single-handedly by the United States at a time when U.S. military and economic power, relative to the rest of the world, was at a height not seen again until the fall of the Soviet Union in 1991.