The Federal Reserve did not oppose the bill. Black testified against the transfer of gold.85 Burgess and Young (Boston) urged Congress to limit the secretary’s use of the Exchange Stabilization Fund to an emergency. Both pointed to the potential conflict between Treasury and System policy actions. Burgess also warned about the potential increase in excess reserves if the administration used the profits on devaluation to expand credit.
Several economists testified against passage. H. Parker Willis is representative. He opposed abandoning the gold standard and devaluation, but he recognized that the administration intended to devalue. He opposed transferring the gold to the Treasury, but he argued that if it was done, the dollar should be stabilized at some depreciated level by returning to the gold standard. Always an opponent of the quantity theory, Willis showed how little he knew about economics when he rejected the argument that devaluation would raise the domestic price level: “I refuse to accept the idea at all that a change in the theoretical weight of the dollar would have any effect whatever on prices” (Senate Committee on Banking and Currency 1934, 230).86
Congress passed the Gold Reserve Act on January 30, by votes of 370 to 40 in the House and 66 to 23 in the Senate.87 The following day the president fixed the price of gold at $35 an ounce, a 59.06 percent devaluation against gold. Secretary Morgenthau announced that the New York Federal Reserve bank would buy gold for the Treasury at $34.75 and sell at $35.25, but purchases and sales were restricted to transactions with central banks and governments.88 The nominal gold price remained fixed for more than thirty-seven years, until President Richard Nixon stopped gold sales and purchases on August 15, 1971.89
85. Black testified in executive session, so his criticisms are not part of the hearings on the bill. He read his testimony to the Board before presenting it. His statement outlines the dispute with the administration before the bill (Board Minutes, January 20, 1934, 280–81).
86. Other opponents believed there would be serious inflation if the dollar was devalued. Edwin W. Kemmerer of Princeton feared that insurance and endowments would be wiped out (Senate Committee on Banking and Currency 1934, 213). Walter Stewart said the bill would “scrap the Federal Reserve System” (358).
87. As the vote suggests, many Republicans voted for the bill on final passage. Robert A. Taft, son of a former president and a leading Republican member of Congress, was more active in defending the gold clause than opposing the devaluation (Patterson 1972, 152).
88. The official price of gold rose from $20.67 to $35, an increase of 69.3 percent. In terms of grains of gold, however, the devaluation is from 23.22 to 13.71 grains, or 59 percent of 23.22. This is the equivalent of a devaluation from 25.8 to 15.238 ounces, nine-tenths fine.
89. By the end of December 1933, gold coin in circulation had fallen to $24 million from $181 million a year earlier.
Devaluation raised the relative gold price and stimulated world gold production. Schwartz (1982, table SC2) reports that world gold production did not exceed 25.4 million fine ounces a year until 1934. World production rose each year of the 1930s, reaching a local peak of 41.8 million fine ounces in 1941. United States production rose from 2.28 to 4.86 million fine ounces in the same period. The United States share of world production rose from 9 percent to 11.6 percent, but the largest part of the production subsidy went to foreign producers (Schwartz 1982, tables SC2 and SC5).
The Treasury used $2 billion of the profit from devaluation to establish the Exchange Stabilization Fund, $650 million to retire national banknotes, and $27 million to finance industrial loans by reserve banks. The Federal Reserve received gold certificates for its gold. The initial effect was a one-time increase in the gold price and ultimately in the prices of goods and services.90
United States devaluation made life difficult for the countries remaining on the gold standard, France among them. Gold flowed toward the United States. Once the act passed, the Treasury started buying gold immediately and in relatively large quantities. It purchased $454 million in February, of which $239 million came from London and $124 million from France (Crabbe 1989, 439). In the three years 1934–36, before the Treasury began to sterilize inflows, the United States purchased more than $4 billion of gold, a 57 percent increase in the stock held on January 1934. By the end of 1936, the Treasury held more than half of all gold at central banks (Schwartz 1982, table SC8). Purchases were made directly, not through the Exchange Stabilization Fund. The latter did not begin operations until April 27, 1934, when the Treasury transferred $250 million from the capital of the fund for use in market transactions.
The Federal Reserve paid for its inactivity by losing control of monetary policy. The fund gave the Treasury a strong hand in setting policy toward interest rates, money, and debt, and it used its power. The Treasury remained the dominant partner for the next fifteen years, until the March 1951 accord released the Federal Reserve from Treasury control.
90. In addition, the Treasury issued $180 million in gold certificates to the Federal Reserve for gold that the Federal Reserve purchased in January. The Board’s counsel ruled that the reserve banks could “safely comply” with the requirement to transfer their gold to the Treasury (Wyatt to Black, Board of Governors File, box 164, January 30, 1934). The transfers were made the same day, so that all domestic gold was held by the Treasury when the dollar price of gold changed. Devaluation did not change the monetary base. The increase of $2.8 billion in the value of gold certificates offset an increase in the liability “general fund in gold” included as part of the liability “Treasury cash.”
Silver Policy
The Gold Reserve Act did not end either the agitation for reflation in Congress and the farm states or Roosevelt’s interest in raising the price level. The focus shifted to silver, where the combined influence of senators from the silver mining states and the reflationists constituted a sizable bloc of votes.
Their first action, part of the Thomas amendment, authorized the president to accept silver in payment of foreign debts, coin silver, and issue silver certificates. Like other parts of the amendment, these actions were permissive, not mandated.
The silver interests wanted more. To accommodate some of their demands, Roosevelt appointed Key Pittman, a Nevada senator and chairman of the Foreign Relations Committee, as a delegate to the London Monetary and Economic Conference. Pittman was able to get an agreement to stop countries from melting silver coins, replace paper money with silver coins, and purchase an agreed minimum of 35 million ounces of silver a year for four years. The United States agreed to purchase about two-thirds of the total. In advance of the new congressional session, on December 21, Roosevelt committed the United States Treasury to buy silver produced in the United States at 64.5 cents an ounce and to coin silver dollars (Krooss 1969, 4:2782–85). The price was about 20 cents above the world market price.
The president’s action did not appease the silver advocates. They failed by two votes to attach an amendment to the Gold Reserve Act requiring the government to buy 50 million ounces of silver a month to add 1 billion ounces to monetary reserves. The narrow defeat encouraged new approaches. By May, Roosevelt conceded and began work on the Pittman Silver Purchase Act of 1934, committing the Treasury to purchase silver until the silver reserve reached one-fourth of the gold reserve. The act became law on June 19. Unlike its predecessor, the act committed the Treasury to purchase silver from foreign as well as domestic sources at prices up to $1.29 an ounce.91
Since the Treasury purchased large volumes of gold, the required volume of silver purchases rose substantially. The Treasury purchased silver and issued silver certificates up to the purchase price of the silver. The demand for currency did not increase as rapidly as the supply, so most of the new currency substituted for Federal Reserve and national banknotes (Blum 1959, 188–89). In July, Morgenthau used the Exchange Stabilization Fund to buy silver in London. Table 6.1 shows the price of silver in selected years. The price rose after the purchase program started but reach
ed a peak in 1935 and subsequently declined. The price was high enough, however, to increase domestic silver production.92
91. The price at which the Treasury coined silver, $1.29, was the equivalent at a sixteen-to-one ratio to $20.67 per ounce of gold. Warren claims that Morgenthau and Roosevelt believed silver purchases would raise commodity prices (Pearson, Myers, and Gans 1957, 5663). Seigniorage on silver (arising from the difference in the prices at which the Treasury purchased silver and issued coins and certificates) rose from $80 million in 1934 to $181 million in 1935. For the years 1934 to 1940, seigniorage on silver was $600 million (Board of Governors of the Federal Reserve System 1943, 515).
There were two prices for silver, just as there had been for gold. Domestic producers received 64.5 cents an ounce. Foreign purchases by the New York Federal Reserve Bank were at the world market price. Treasury purchases were far in excess of domestic production in 1934 and 1935, so the world market price rose toward the domestic price. As the price rose, silver activists offered new legislation to raise the price. Table 6.2 shows production of gold and silver on five-year averages.
A new complication entered. China and Mexico were on a silver standard.93 At 72 cents an ounce, it paid to melt Mexican pesos and sell the silver to the Treasury. Morgenthau fixed the domestic price at 71.11 cents. This did not satisfy the silver activists, and the price went to 77.57 cents. Pressure mounted for a $1.29 domestic price, but Roosevelt refused because he had the votes to prevent legislation that term (Blum 1959, 190–92). Speculators acted on the presumption that the price would continue to rise, but Morgenthau sold silver from the Exchange Stabilization Fund to stop the rise at 81 cents in April 1935. By August the price was back to 65 cents. Prices did not reach this level again until after the World War II inflation.94
92. On August 9, 1934, by proclamation, President Roosevelt ordered all silver not used as coins or in arts and manufacture to be sold to the Treasury (Krooss 1969, 4:2833–35).
93. The problem for China is discussed as early as December 1934 (Minutes, New York Directors, December 6, 1934, 29).
Silver activists argued that raising the silver price would help China and Mexico by raising commodity prices in countries on the silver standard. This was backward. The policy drew silver from these countries, forcing monetary contraction. In November 1935, China abandoned the silver standard and offered to sell the United States most of its remaining silver, 200 million ounces, for approximately $130 million at the Treasury’s buying price, $50 million above the market price (Friedman 1992, 171–78).
That was too much for Morgenthau.95 Silver sold in China for about 40 cents an ounce. He allowed the world price to fall toward 40 cents after an understanding with the silver state senators that he would continue to buy newly mined domestic silver at 64.5 cents.
The silver purchase policy hurt China more than Mexico, because Mexico had large silver mines and was able, for a time, to increase its exports to the United States. China was less fortunate. Forced off the silver standard and soon afterward attacked by Japan, China experienced a major inflation that a more rational silver policy would have avoided.
Domestically, the program was a waste of money. It subsidized a relatively small number of miners and companies at large cost. Like several of the experiments during these years, the program achieved very little. It continued until November 1961.
SUMMARY: INFLATIONARY POLICY IN 1933
Roosevelt was right to be concerned about congressional and public reaction to his policies. At the end of 1933, his experiments with the NRA, the AAA, gold, and silver had not succeeded. Prices were 20 percent or more below the 1929 or 1926 level. After a robust recovery in the second and third quarters, Balke and Gordon’s (1986) quarterly real GNP growth declined at a 24 percent annual rate in the fourth quarter. Despite the low levels of employment and output, the GNP deflator continued to rise in the fourth quarter, although at a much lower rate than in the summer.96
94. On August 14, to hold the price near 65 cents, the Treasury purchased more silver in one day than the entire production in the United States in 1934 (Blum 1959, 195).
95. In his diary he called the policy “stupid.” He was particularly incensed by the encouragement to smuggling of silver from China to Japan for sale to the United States (Blum 1959, 196).
96. Perhaps for reasons such as this, economists who associate inflation with low unemployment typically ignore the 1930s.
Market indicators showed continued anxiety and fear of inflation. The risk spread between Aaa and Baa bonds remained above 3 percent, not much lower than at the end of 1932. The term spread between long- and short-term securities was above 4 percent and had increased over the course of the year.
One reason for the aborted recovery was the change in the thrust of monetary policy. Annual growth of the monetary base remained low in the spring and summer. Growth in the money supply, M1, had a similar pattern.
The Federal Reserve committed to an expansive policy, mainly for political reasons during the congressional session, but it failed to follow through. If it had made substantial open market purchases, the administration’s gold (and silver) purchase policy would have been unnecessary. The 1926 price level could have been restored by domestic monetary expansion, particularly after April when the president suspended the gold standard. Instead, the administration bought gold at a fixed (but adjustable) price. The policy drained gold from countries in the gold bloc, forcing further deflation there without much domestic benefit until purchases became large enough to change the world gold price.
Early in 1934, devaluation brought an increase in money growth. The Gold Reserve Act devalued the dollar against gold and fixed the United States buying price above the world market price. Instead of limited purchases of 1933, the United States announced its willingness to buy all gold offered at the $35 price. Thus, disappointment at what appeared to be a failed policy produced a change that achieved the desired end of higher commodity prices and economic expansion that the administration sought.
ECCLES AND MORGENTHAU
The new year brought in a new economic team. Early in January 1934, Henry Morgenthau became secretary of the treasury. In June, Eugene Black resigned as governor of the Federal Reserve Board to return to the Atlanta bank.97 The vice governor, J. J. Thomas, served as acting governor until November, when the president nominated Marriner S. Eccles to be governor of the Board.
97. He left in August. Hyman (1976, 154) attributes his resignation to the much lower salary at the Board. His lasting contribution to the Federal Reserve was to start planning for the Board’s own building. The Board and its staff were scattered in offices at the Treasury Department and in buildings around Washington. In July 1934 the Board approved an assessment on the reserve banks to build the Board’s building (Minutes, New York Directors, July 5, 1934, 11). Black died in December 1934, a few months after his return to Atlanta.
Eccles was a Utah banker and businessman whose father and grandfather had emigrated from Scotland in 1863. Though impoverished when he arrived, Eccles’s father built a successful timber and sugar business. Like many self-made men, he was a strong believer in hard work, personal effort, and responsibility and an opponent of government involvement in the economy. His son, Marriner, inherited responsibility for the family business. With his brothers, he expanded the business and added banking. His banking corporation, the First Security Corporation, had branches throughout the region. Until the depression, he held many of the same political and social views that he learned from his father and mother.
Eccles first came to national prominence during the banking crises from 1931 to 1933. By pluck, boldness, and careful planning, all his banks remained open until ordered to close in March 1933. None of his depositors suffered a loss.
The experience had a lasting effect on Eccles’s beliefs. The prevailing belief was that the depression was purgative.98 Business leaders argued that “a depression was a scientific operation of economic laws” and could
not be interfered with (Eccles 1951, 73). The 1920s had been a profligate era. The price of profligacy was (eventual) depression—the inevitable consequence of prior events.
Experience caused Eccles to reject these views. He recognized that many of the same people who had declared in the 1920s that depression could not occur again now found the seeds of depression in the excesses of that decade. Eccles recognized this argument as fallacious; in the 1920s the economy had produced in the aggregate more than it had consumed. There was no evidence of national overconsumption or indulgence (ibid., 74). Further, he convinced himself that there was nothing “natural” or preordained about what was happening. He believed the depression was caused by an overexpansion of debt and investment; the maldistribution of wealth—too much wealth concentrated in too few hands; and underconsumption by low-income earners (76–77). His solution was government spending for investment, timed countercyclically to take up the shortfall resulting from the depression. He accepted an unbalanced budget as a means of paying for public works—a result of the depression, not a cause. He favored redistribution to aid the poor and unemployed (78–81).
His views soon attracted national attention. In February 1933 he testified at hearings before the Senate Finance Committee that the economic system’s failure was “due to the failure of our political and financial leadership.” The problem was “purely of distribution.” The cure was more purchasing power, to be achieved by deficit spending until prices and employment rose (Eccles 1933, 705, 708).
98. “As I looked to the business and financial leaders . . . their stock reply was that a deflation in values, and a scaling down of the debt structure to meet existing price levels, would in time create a self-corrective force” (Eccles 1951, 71).
A History of the Federal Reserve, Volume 1 Page 67
