The Tyranny of Gold

Gold needs no endorsement. It can be tested with scales and with acids. The recipient of gold does not have to trust the government stamp upon it, if he does not trust the government that stamped it. No act of faith is called for when gold is used in payments, and no compulsion is required. Men everywhere, governments everywhere, and central banks everywhere are glad to get it. When paper is offered instead of gold, it will be accepted on faith if the government or the bank which has issued the paper has proved itself worthy of confidence by a satisfactory record of redeeming the paper in gold on demand. Irredeemable Paper and Gresham's Law. Complaints are always made about gold and the behavior of gold when there is irredeemable paper money. Under Gresham's Law, gold is hoarded, or leaves the country. It ceases to circulate, leaving the dishonored promissory note in possession of the field. Gold will stay only in countries which submit to its discipline. Gold is an unimaginative taskmaster. It demands that ·men and governments and central banks be honest. It demands that they keep their promises on demand or at maturity. It demands that they keep their demand liabilities safely within the limits of their quick assets. It demands that they create no debts without seeing clearly how these debts can be paid. If a country will do these things, gold will stay with it and will come to it from other countries which are not meeting the requirements. But· when a country creates debt light-heartedly, when a central bank makes rates of discount low and buys government securities to feed its money market, and permits an expansion of credit that goes into slow and illiquid assets, then gold grows nervous. Mobile capital funds of all kinds grow nervous. There comes a flight of capital out of the country. Foreigners withdraw their funds from it, and its own citizens send their liquid funds away for safety. Irredeemable Paper as Discounted Promissory Note. When suspension of gold payments comes, speculators in the foreign exchange market treat paper currency most disrespectfully. They sell. it short. They buy it only at a discount. The amount of discount in a free gold market or in a free foreign exchange market will be governed primarily by speculative expectation as to whether and when resumption of gold payments are coming, as to whether and when the government and the central bank will reverse its unsound policy and work back toward orthodoxy. Gold is blamed, speculators are blamed, capital movements are blamed, "hot money" is blamed. In the seventeen years between January I, 1862 and January I, 1879, our greenback period, we had a classical illustration of the behavior of irredeemable paper money with a free gold market and with a free foreign exchange market. The episode has been elaborately worked out by Wesley C. Mitchell in his History of the Greenbacks. The standing of the irredeemable paper in the gold market and in the foreign exchange market was influenced by every circumstance that would affect the probability of its redemption, and the probable time of its redemption. The cessation of printing greenbacks, and the adoption of a strong tax and funded loan policy, made for strong improvement in the standing of the greenbacks. Most influential of all was the success or failure of the Northern armies in the war. The Battle of Chickamauga made the greenbacks drop 4%. Gettysburg, Vicksburg, and Port Hudson pulled down the price of gold from $145.00 in greenbacks for $100.00 in gold to $122.00 in twenty days. Grant's successful campaign against Richmond and Lee's· surrender led to a very dramatic rise in the value of the greenbacks (or, reversely, to a very dramatic fall in the price of gold as measured in greenbacks). In June of 1864 the Congress undertook to punish the speculators by closing the gold market and forbidding futures in gold. The results were disastrous. In isolated markets the greenbacks fell to approxitnately 35¢ in gold, and Congress, two weeks later, without· debate, repealed the measure. The country submitted to the tyranny of gold. It was old-fashioned and it was ho~est. It had promised to redeem its paper money in gold,and it settled down to get its house in order so that it could do so. In 1876 a definite programme promising gold redemption on the first of January, 1879, was adopted by the Congress, and shortly thereafter John Sherman, one of the ablest financiers in the history of the country, as Secretary of the Treasury, began to take definite steps to redeem the greenbacks on that date. Once the country was convinced that Sherman meant to do it,the greenbacks, like a discounted promissory note approaching maturity, moved up month by month to the redemption date, with the discount disappearin.g entirely in late 1878. On January 1,1879, we resumed gold payments. In 1879 the Treasury gained gold instead of losing it. Incidentally, commodity prices rose in 1879 and continued to rise for some time thereafter. Credit was restored. The country was jubilant. Paper Money as Legal Tender. Here you have the main story of irredeemable paper money in a free country with free markets. Paper money is not merely a promissory note, of course. It is also legal tender. The government, moreover, as tax collector will receive it, and finally there are various elements of patriotic support from a loyal people for the paper. Paper Money as a CCThing-in-Itself." There also arises, in a time of monetary disorder, the doctrine that "a dollar's a dollar" or "a pound's a pound" and that the dishonored paper money is somehow or other a "thing-in-itself." Our "Greenbackers," in the period of our currency disorder, anticipated very many of the doctrines which one found current in London in the period between 1 93 1 and 1939 regarding the pound. One has never heard this mystical theory more profoundly or more poetically expressed than by a Polish statesman, who in 1922 protested against the retirement of a single Polish bank note on the ground that every bank note was "imbued with the soul of the Polish people." 1 Prestige of Pound and Loyalty of "City." The prestige of a great government and a long-established government can go far in upholding the value of its paper money even if rational foundations for the value of paper money have waned. In regions where governments do not last long, this factor is rather feeble. A recent writer points out that in Iraq, and in general in the Near East, where few existing governments have lasted more than twenty years, there is a very strong preference for hard money over irredeemable paper. But the pound sterling, in the years 1931 to 1939, tnade a brave show on the basis of this kind of prestige. The people of Britain seem to have accepted it almost without question, though doubtless many of the more sagacious of them put anchor to windward when they could without giving too much offense to associates in "the City." But "the City," the financial district of London, itself was very loyal. to the pound. There was no great flight of British capital from England, though there may have been heavy British investment in gold in the London gold market. But the whole world had long used sterling. As sterling went low the outside world bought it, and we even had the extraordinary spectacle of Scandinavian countries, Baltic countries, and the British Dominions on. a sterling basis putting their central bank reserves into sterling in part, and letting their own currencies fluctuate with the pound against gold. A "Sterling Area" was created, and London thought she had made a new discovery. The Untranquil ccSterling Area." But all was not tranquil in the "Sterling Area." The London Economist of September 2, 1939 (page 452) sums the matter up very well in the following passage. "For some years past the British Exchange Equalization Account had found to its cost' that the adherence of certain foreign countries to the sterling bloc had been a . factor of instability and not of strength. Many sterling bloc countries have panicked into and then out of sterling with the abandon of the most highly-strung speculator. Some of the hottest of London's hot money has consisted of the sterling reserves of the sterling bloc, and their partial disappearance will Aot be altogether a loss." Sterling unanchored to gold was subject to constant fevers and chills, which the Exchange Equalization Account could moderate but could not eliminate. CCnot Money." The "hot money" referred to by the Economist passage above was essentially a product of the unsound monetary policy. In the period from 193 I on there was a great deal of "hot money," nervous money, jumping about from place to place seeking safety. The origin of this money was in the excessive bank expansion of the 1920'S. Bank balances had risen tremendously under the cheap money policy of the 1920'S. Sterlinghad been overexpanded. The British banks had made loans which created new sterling deposits far in excess of what was justified by the gold reserve position of the Bank of England, and foreigners had got hold of these sterling balances because England had spent them abroad or had loaned them abroad. When the foreigner tried to cash in these excessive British liabilitiesfor gold in 193 I, England quit paying gold and went off the gold standard. But the balances remained on the books of the British banks, and the· balances even· grew as gold came to England .from India and other places to buy sterling when sterling went low. The excessive amount is due primarily to the excessive expansion of credit in the 1920'S. The nervousness of the funds is due to the deterioration in quality of this excessive credit, and to the abandonment of gold. How to Avoid "Hot Money." A country which is afraid of "hot money," money which may suddenly jump to another country, has a very simple way of avoiding this danger. It does not need to control capital movements. It protects itself from this danger by having a sound currency, firmly anchored to gold at a fixed rate, by keeping control of its money market so that its demand liabilities do not grow excessive in relation. to its gold, by·keeping a balanced budget-by making a financial environment in which money cools off and wants to stay. England a Sieve for Gold, 1931-1939. Between 1931 and the outbreak of the war in 1939 England became a sieve for gold. Gold came in. Gold went out. The automatic gold standard controls were. gone, and British money market policy did very little to control the movements either way. The fetish of cheap money as the great essential, more important than the safety of the currency, more important than the prestige of the pound, more important than stability in foreign exchange rates, dominated the picture.

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