The Power of Gold: The History of an Obsession
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No wonder foreigners were so skeptical of America's intentions with regard to gold.
In 1861, early in the Civil War, a shrinking gold stock led Congress to suspend convertibility of dollars into gold, a customary move under the circumstances. In another customary wartime move, the Treasury financed part of the wartime expenditures by issuing a new paper currency. This paper money, convertible into nothing at all, carried the official imprint of "U.S. Notes." They were more commonly known as greenbacks, however, a nickname that is still in use as a generic identifier of today's American dollar-which is also convertible into nothing at all. Like today's paper money, the greenbacks were legal tender, which means that a creditor could not legally refuse to receive them in payment of debts due; as a result, the greenbacks were also referred to on occasion as "legal tenders." Roughly $300 million in greenbacks were in circulation from 1863 until 1971, at which time it was decreed that they were no longer serving any function that was not already adequately provided by Federal Reserve notes.' From that point forward, the Treasury stopped issuing greenbacks and, in 1991, the entire remaining stock held by the Treasury was destroyed. It is worth noting that Federal Reserve notes are also green on one side-and are no more convertible into gold today than were the greenbacks of earlier days.
Gold did not disappear from the scene during the greenback era, although gold coins in circulation fell from over $200 million at the outbreak of war in 1860 to only $150 million in 1865 and continued to decline to a low point of $65 million in 1875.3 The government lived up to its contractual promises to pay interest and principal on the national debt in gold but simultaneously required importers to obey the law to pay their customs duties in gold. Gold continued to circulate in daily payments in the West.
A dollar in greenbacks never commanded a dollar's worth of gold, because there was no certainty that the day would ever return when people could take their greenbacks to the bank and exchange them for gold coins. This condition was the same as in England during the Napoleonic Wars when sterling convertibility was suspended: if paper currency and bank deposits are not convertible into gold, gold ceases to serve as money and becomes a commodity whose price in terms of money is destined to fluctuate.
During most of the Civil War, a dollar's worth of gold cost about $1.30 in greenbacks. In an audacious experiment in 1864, when Jay Gould and Jim Fiske tried to corner the gold market, one buyer paid as much as $310,000 for approximately $100,000 in gold, but that was only a transitory event. Matters improved after the Union victory in 1865, and by 1869 the greenback notes were being valued at better than 900 on the dollar. In January 1875, Congress passed legislation that pledged full resumption of convertibility by January 1, 1879, and authorized the Treasury to borrow the money to acquire a gold reserve, if such a step should prove necessary.
The road to 1879, however, was marked by two notable events that are striking examples of the law of unintended consequences. One took place right after the end of the war; the other came along eight years later.
The first of these events was launched by the Secretary of the Treasury's annual report for 1865. Using the nomenclature of "legaltenders" to refer to the greenbacks, the Secretary asserted that "The present legal-tender acts ... ought not to remain in force one day longer than shall be necessary to enable the people to prepare for a return to the constitutional currency."4 This expression of rectitude enjoyed wide public support. In early April 1866, the House of Representatives joined in by passing a resolution of support by a margin of 144 to 6. Appropriate legislation to start retirement of the greenbacks followed ten days later.
This overwhelming consensus was about to fall apart almost as soon as it had come together. Seldom have the public and its representatives failed so completely to foresee the consequences of their decisions. The myopia is difficult to comprehend. Throughout history, the arrival of peace had always led to an economic downturn, including persistent deflationary pressures on the price level. The end of the Civil War proved to be no exception. Prices had more than doubled in the course of the war, but by 1868 the price level had already fallen by some 15 percent. Financial rectitude was likely to make matters worse.
Second thoughts on the decisions of 1866 appeared in short order and more than a decade of public outcry lay ahead. With prices falling, reducing the supply of greenbacks to an amount equal to the available stock of gold would be certain to intensify the pain already inflicted by deflation on farmers, many business firms, and all debtors. Early resumption of convertibility, virtuous as it had appeared only three years earlier, now began to generate strong opposition.
The problem was that, to paraphrase a familiar aphorism, the $20.67 represented by an ounce of gold didn't buy what it used to buy. Resumption of convertibility would have put the country into a position where the existing gold stock would have purchased less than half what it could have bought before 1860, making the monetary noose even tighter. Even worse, the purchasing power of foreigners' gold would also have withered, and the prices of American exports of cotton and grains would have remained out of line with world markets. Not even the experts seem to have given any consideration to officially cutting the amount of gold in the dollar in half, thereby doubling the effective size of the gold stock. Legal currency debasement of that nature was just not part of the nineteenth-century view of what the gold standard was all about. Just as in Britain after the Napoleonic Wars, resumption was going to have to wait until the price level had receded to a manageable level before the currency could be locked back into gold.
The second example of the law of unintended consequences took place in 1873, seven long years after the pious expressions about the desirability of an early resumption of convertibility into gold. This one turned out to be a real blockbuster.*
By 1873, pressure was building to stop pussyfooting around about the promises for resumption. The time had come to tidy up the currency and finish the job.' Congress held an extended series of hearings on the subject and then passed the Coinage Act of 1873, which listed the various denominations of gold and silver coins to be minted by the Treasury from that time forward. The legislation passed through Congress by the overwhelming margins of 110 to 13 in the House and 36 to 14 in the Senate.
The Act of 1873 contained a startling omission. There is not a single word that refers to the historical standard silver dollar of 371.25 grains that dated all the way back to Alexander Hamilton's establishment of the coinage of the United States. The only mention of silver is for subsidiary small-denomination silver coins. The consequences were momentous: the Coinage Act of 1873 finished off the legal status of bimetallism in the United States.
If the Coinage Act of 1873 had included the standard silver dollar, the demand for silver in the United States to coin silver dollars would have brought huge sums of silver for coinage to American shores. Gold, in contrast, would have moved out from the United States into world markets, to be converted into silver at an irresistible rate of exchange, just as had happened from 1791 to 1834 when gold was in short supply and silver was the underpriced metal. Under those circumstances, resumption of convertibility in 1879 would in all likelihood have been to a silver standard rather than a gold standard.
This event occurred at the precise moment when the price of silver was in any case under powerful downward pressure in world markets, in response to the French decision to reduce the volume of silver coinage and German efforts to replace their silver stock with gold. Even worse, the Act of 1873 occurred at a moment when the pressures of deflation in the United States began to intensify, as output was growing rapidly while the money supply failed to follow along. Wholesale prices would fall by 30 percent by 1878, and stock prices followed suit.'
When the silver advocates woke up to what had happened, they were in a state of shock over what had taken place under their very noses. Later on, after much of the dust had settled, Senator William Stewart referred to the demonetization of silver as the "crime of the nineteenth century."
One of his fellow opponents, Senator John Reagan, carried this theme even further by declaring that these events comprised "the greatest legislative crime and the most stupendous conspiracy against the welfare of the people of the United States and of Europe which this or any other age has witnessed."'
Some scholars are convinced that what has come to be known as the Crime of 1873 inspired Frank Baum's immortal story, The Wizard of Oz, published in 1900. One could argue that the book is a parable in favor of silver coinage and against gold. Oz is the abbreviation of ounce, and the Land of Oz is the East where gold is the favorite. The cyclone that comes out of the West with such power is the movement for unlimited coinage of silver. Dorothy is the plucky, kindhearted American who represents the little people against the moguls of finance. The Emerald City is Washington, and the Wizard, who lives there, the personification of humbug. A detailed and entertaining analysis of this case appears in a delightful article by a Rutgers professor named Hugh Rockoff.s
Crime the Coinage Act of 1873 was not; conspiracy it might well have been. Contemporary evidence demonstrates that the consequences were clear to the major decision makers. H. R. Linderman, the director of the mint, advised the Secretary of the Treasury in 1872 that ". . . Several causes are now at work, all tending to an excess of supply over demand for silver, and its consequent depreciation." In his memoirs, published in 1877, he observed that the Act "placed the United States upon the single gold standard.... The weight of opinion in Europe and America was against the practicability of maintaining a double standard on any basis which might be selected, in favor of a single gold standard." John Sherman, chairman of the Senate Finance Committee, had since 1867 made little secret of his determination to demonetize silver. Sherman even went so far as to have a bill for that purpose drafted at the end of 1869. He was joined in his efforts by both Linderman and the Secretary of the Treasury.9
It is difficult to find a satisfactory explanation for why so few people beyond this tiny circle were aware of what lay ahead. There had been no effort to keep the contents of the Coinage Act a secret. The Act was before Congress for three years before its passage by overwhelming majorities. The chairman of the House subcommittee that considered the bill declared that it had come to him from a Senate committee that had given it "as careful attention as I have ever known a committee to bestow on any measure." Congress ordered the Act to be printed thirteen times. Its text occupied 144 columns in the Congressional Globe. Representative Hooper, who steered the Act through the House, was explicit in his references to the demonetization of silver. Linderman's Report of 1872 had been published by the time Congress voted the passage of the Act. If, as Lincoln had asserted, you can fool all of the people some of the time, this was clearly a case in point."'
The main drama of the 1870s was to occur in 1879, following the official resumption of convertibility of paper currency into gold that took place as scheduled on January 1. Some of the gold on hand to meet demands for redemptions had been accumulated from a surplus of tax revenue (largely tariff receipts) over expenditure, with the remainder purchased abroad with funds that the Treasury borrowed in the capital markets.
Yet conditions were ominous and the viability of the resumption process remained uncertain. Despite passage of the Resumption Law, the credibility of the nation's devotion to gold appeared to be every bit as questionable as it had been in the past. America's export trade was slipping and the prospect of a significant loss of gold to Europe became a general expectation. How certain could anyone be that the Treasury would be either able or willing to live up to the obligation that the Resumption Act had imposed on it?
The day was saved for the U.S. gold stock by a remarkable act of nature. In May, snow fell in France, and England suffered a destructive frost, followed by rains that persisted until late summer. The disaster to British and French crops was almost unprecedented. Bad weather also hit Austria, Germany, and Russia, where the wheat crops were the poorest and smallest in ten years. Just to help matters along, the Indian cotton crop failed. As we shall see, this lucky turn of events was only the first of several occasions on which nature would be kind enough to come to the rescue of the U.S. gold stock at the last minute.
While the catastrophic European weather set wheat prices soaring, the weather in America was perfect. U.S. crops were turning out to be enormous. In addition, an event with great future significance occurred to provide further help to the American trade balance: the tidewater pipeline from the newly discovered Pennsylvania oil wells was completed, swelling American exports of oil to the whole world.
Gold soon began to travel back from Europe toward America. By mid-autumn of 1879, $60 million had come in to the United States. The government's reserve of gold, already rising, climbed from $120 million at the close of June to $157 million in early November. The Treasury was now in a position to pay out gold not just for notes presented for redemption but for the government's ordinary disbursements for goods and services. This was just the beginning. It was almost as though Joseph were on hand making his weather forecasts to Pharaoh: for at least another three years, the extraordinary balance in America's favor in agriculture persisted and attracted even more gold from across the oceans."
We now fast-forward to 189U, the year the Barings crisis hit in London. Just as the currency crisis of 1998 in Asia ricocheted onto markets for Russian and Latin American securities, the Barings crisis of 1890 had a devastating impact on the appetite of foreigners for dollardenominated securities. The backlash from Barings would turn out to be only the first of a number of forces that shaped the first half of the 1890s into a roller-coaster of economic and financial horrors.
Even before the impact of the Barings crisis had begun to be felt in the United States, another major victory by the silver camp served to aggravate the continuing doubts about America's commitment to the gold standard. In July 1890, Congress passed the Sherman Silver Purchase Act (named after the same Sherman who had wanted to demonetize silver twenty years earlier), in essence to obtain support for higher tariffs from the eighteen senators from the nine states west of the Mississippi, where most of the silver resources of the United States were located. The Act stipulated that the Treasury would be required to make monthly purchases of silver to the tune of $50 million annually, double the amounts authorized in the legislation of 1878. Furthermore, payments for the silver were to be made in a new paper currency, the Treasury notes of 1890, which were full legal tender and were redeemable on demand in either gold or silver at the discretion of the Secretary of the Treasury.
That was not all. The Sherman Act was passed when Congress was also at the point of appropriating substantial additional sums for regular government expenditures that would significantly increase the outflow of money from the Treasury. As the Treasury was already having a difficult time making ends meet, the new legislation soon pushed the government into a deficit position. Today, the government would go into the markets and borrow to finance the deficit. In the 1890s, the first response was to cover the deficit by drawing down cash balances-legal tender paper currency or gold itself. Cruel irony was added to the situation when the silver bloc saw an early upward burst in the price of silver rapidly dissipate under the pressure of such heavy selling abroad that the new source of demand was soon overwhelmed.
The timing could not have been worse. Once the Barings crisis broke loose in London, Europeans not only liquidated their holdings of American securities; they chose to convert the proceeds into their home currencies, which ultimately meant shipping their money back in the form of gold. In the first six months of 1891, exports of gold from the United States exceeded the total of gold exports in any twelve-month period in the previous 25 years.'2 The outflow made an alarming dent in the reserve the Treasury held against redemption of the legal tender paper currency into gold. Now everything pointed to a run on the U.S. gold stock, in which the only objective of each holder was to cash out his dollars into gold before every other holder could beat him to the wi
ndows of the Treasury.
Nature came to the rescue in 1891 on short notice, just as it had saved the day in 1879. The South Russian wheat crop, the second most important European source of supply, was a total failure. The French harvest was the worst since the disasters of 1879. The farms of the United States, meanwhile, produced the largest grain crop in history, 65 percent above the previous record. Once again, the outflow of gold was stemmed.
This time the respite was brief. No sooner had 1892 rolled around than the golden hemorrhage resumed. By the end of May, the Treasury's gold reserve had fallen to $114 million, just barely above the $100 million minimum that Congress had intended the Treasury to maintain. The Treasury decided that there was no choice except to halt all government payments in gold; everything was now to be paid for in the form of legal tender paper currency. This unfortunate if unavoidable decision served only to increase the demand for gold among the public and foreigners and to raise even further doubts about the nation's commitment to the gold standard. Meanwhile, imports of merchandise had risen so rapidly in the first nine months of 1893 that they exceeded exports by the staggering sum of $447 million. In his annual report of 1892, a despondent Secretary of the Treasury confessed that a heavy deficit in revenue was impending, and warned that the whole redemption machinery of the government was in peril.13