Saturday, November 3, 2012
The British Equalization Account, The American Stabilization Fund, and The American Sterilization Fund
Under the gold standard, imports of gold ease the money market of the importing country. Gold goes from the importing commercial banks to the central bank or (in our case) the Federal Reserve banks, and the commercial banks get additional reserves in exchange for the gold. Gold leaving a country reduces the reserves of the commercial banks. They are obliged to pull down their reserve balances with the central bank in getting the gold for export. This tightens the money market. British Equalization Account-Created Out of Government Debt. With the abandonment of the gold standard in England this automatic working of gold imports and exports ceased. When sterling dropped low after the abandonment of the gold standard considerable amounts of gold and foreign exchange came to England to purchase sterling. India, in particular, sent a good deal of gold to England. By July of 1932 the Bank of England was said to have had substantial holdings of gold and foreign exchange gained in this way. Apparently they were put into a special account, as examination of the figures of the Bank for gold in the Issue Department, cash reserves and other assets of the Banking Department, and bankers' balances and other elements in the Bank's liabilities, shows no clear evidence of it, though there was an increase in bankers' balances between October 28, 1931, and June 29, 1932, from £63,5°0,000 to £86,- 600,000, or £23,100,000. Beginning with July I, 1932, the British Equalization Account came into existence. It was created primarily out of government securities, government debt. It took over the foreign exchange holdings of the Bank of England, giving to the Bank government securities (presumably Treasury bills) in exchange. Its secrets were well kept and statements regarding it are based primarily upon the opinions of informed men in London and in New York. One purpose of the creation of the Equalization Account was to let the government rather than the Bank assume the risks of fluctuating gold prices and fluctuating foreign exchange prices. Another purpose was to moderate fluctuations in the foreign exchange markets-not to stabilize the pound. Created primarily out of government securities, it could function effectively only in so far as gold movements toward England gave it enough gold to offset gold movements out of England at a later time. Perverse Effect of Gold Movements on British Money Market. Under the functioning of the British Equalization Account, British gold imports and exports had a perverse effect upon the money market. When gold came in, the Equalization Account, in order to purchase the gold, had to borrow sterling, which it would normally do by selling British government securities to the commercial banks. 2 This would increase the investments and the deposits, of the British banks, operating to tighten the money market. When the Equalization Account was losing gold, exchanging gold for sterling, it would use the sterling thus obtained to repurchase government securities from the commercial banks. This reduced the investments and deposits of the commercial banks and eased off the British money market. So far as the working of the Equalization Account was concerned, the more gold England lost, the lower her money rates went. Of course the Bank of England could take separate action to offset this, and doubtless sometimes did, but there was nothing automatic about it. American Stabilization Fund-Created Out of Gold-Early I934. Now the American Stabilization Fund, on the contrary, was created solely out of gold. It consisted initially, as we have seen, of 2 billions of dollars of gold taken out of the so-called "gold profit" which arose from reducing the gold content of the American dollar to 59.06% of the old parity. The British Equalization Account functioned most effectively in acculnulating incoming gold and keeping it from having the ordinary effect on the money market. It was, in effect, when England was receiving gold, a "sterilization fund." But our Stabilization Fund, consisting of gold, had nothing with which to buy gold except gold itself. Gold Movements Had Normal Effects on Our Money Market. Incoming gold in the United States, in general, did not go into our Exchange Stabilization Fund,3 but rather, via the Federal Reserve banks, into that part of the gold in the Treasury which stands behind the gold certificates. The Federal Reserve banks bought incoming gold for the Treasury, paying for it with Federal Reserve checks, which almost immediately created new reserves for the member banks, beating down money rates. We restored the automatism of the gold standard, so far as the relation of the money· market to gold was concerned. When our Stabilization Fund of 2 billion dollars was created by the Gold Reserve Act of· 1934, it was supposed to be something like the British Equalization Account, though in fact it differed radically from it. The Senate Committee dealing with. the bill obviously knew nothing about the actual workings of the British Account. The Chairnlan of the Committee said, "We were told· that there were only three men in all England who knew what they did." 4 There is no reason to suppose that our Treasury at that time knew more about the workings of the British Equalization Account than the Senate Committee did. It was said privately at the time that one reason for creating our Exchange Stabilization Fund was to put the gold in a special account so that Congress could not appropriate it for anything else, but the probability is that the Treasury was simply trying to follow a British model. Our Sterilization Fund More N early Based on British Model-December, 1936. Our Treasury, having failed in 1934 to create a Stabilization Fund on the model of the British Equalization Account, and having become aware of that fact, tried again. In December, 1936, alarmed at the continued inflow of foreign gold, our Treasury adopted the policy of "sterilizing" this gold by borrowing money from the commercial banks with which to buy it, .much as the British Equalization Account did, instead of allowing the incoming gold to increase the money supply and to "pay for itself." The gold thus purchased did not add to the credit base. If our bank reserves had not been excessive, the operations would have tended, as was the case in England, to tighten the money market· as the gold came in. But with our great volume of excess reserves it had no effect on the money market other than t~ increase the already excessive volume of commercial bank deposits. In January, 1937, it seemed probable 5 that the sterilization policy was only a temporary palliative. This proved to be the case. In April of 1938, when the fund had grown to $1,392,000,000, it was suddenly abandoned. Gold certificates in a corresponding amount were placed in the Federal Reserve banks, and the Government got a corresponding deposit with the Federal Reserve banks, which promptly began to go into member bank reserves as the Government spent the money. We discuss this episode in connection with the crisis and depression of 1937-I 938. British Opinion Regarding Great Increase in Gold Production in 1937. In May of 1937 the proposal was made, in· consultation with bankers in London, that we and Britain should simultaneously raise the gold content of the pound and the dollar) and anchor the currencies at this higher valuation. The danger to money market stability and to the long-run future of an ,annual production of gold of 1200 million dollars was stressed. The total "bankers' balances" of the British banks with the Bank of England amounted to about. 90 million pounds at that tim~-say 450 million dollars. If Britain were to receive, in the regular way, one-third of the world's gold production and let it have its ordinary effect on the money market, it would very nearly double bankers' balances in a single year, nearly treble them in two years, and so on. The proposal met with a sympathetic response in influential quarters. An Empire Conference was· being held in London at the time of the Coronation, May, 1937. The South Africans, who were very influential, had come prepared to demand a continued, high price of gold in terms of sterling. 6 But as the price of gold was increasingly· discussed, the South Africans were said to have come to the view that a lower price of gold (i.e., a higher gold content of the pound) would suit them very well, if only they could be sure that the pound would be definitely stabilized in terms of gold. England was strong in gold at this time, and the pound, partly under the influence of tourists' expenditures in London in' the Coronation month, was rising against both dollars and gold (March, $4.88; May, $4.94; August, $4.98). Our own gold position was so strong thatit would have made very little difference to us if we had lowered the price of gold to a point which would have used up the "gold profit." But the war clouds gathered in 1938. Gold suddenly began to leave Europe on a greatly intensified scale, and there was speedily no disposition anywhere in Europe to do anything about lowering the price of gold. Everybody began to expect a further rise in the price of gold (i.e., a further depreciation of European paper moneys).