Wednesday, September 7, 2016

Why Did the U.S. Go Off the Gold Standard in 1933?


The other day we took a poke . . . or maybe that was a peek . . . at what people mean when they say “gold standard.”  Today we look at why the U.S. abandoned the gold standard in 1933.  It might surprise you.
Founder of Chartalism
Getting off the gold standard had been the goal of John Maynard Keynes ever since he became an economist. As a follower of Georg Friedrich Knapp, the founder of the socialist monetary theory called “chartalism,” the basis of "Modern Monetary Theory" (MMT), he believed that the entire money supply should consist of government debt — “bills of credit” . . . which the individual states are expressly prohibited from issuing, and the Congress does not have the power to emit (the language that would have permitted Congress to do so was removed from the first draft of the Constitution).
Keynes’s alleged reason was that gold is both expensive and insufficient to serve as a currency. In that he was correct . . . but he didn’t realize that gold and silver have never served as the primary currency.  Instead, the bulk of the money supply has from ancient times has consisted of financial paper representing private sector hard assets, i.e., mortgages and bills of exchange. A gold or silver standard for the currency was useful to help people measure the value of other money, e.g., this bill of exchange for 100 sheep has the same value as 100 ounces of silver of the weight of Troyes. Convertibility of non-coin money into coined money (gold and silver) was to establish and maintain public confidence in the currency, whatever it consisted of.
Man of the People: Franklin Delano Roosevelt
In the U.S. in 1933 right before Keynes induced Roosevelt to take the U.S. off the gold standard the only currency backed specifically by gold were the gold certificates. The United States Notes (“Greenbacks”) and the National Bank Notes were backed by government debt (by 1933 the government debt-backed Treasury Notes of 1890 had been withdrawn), albeit convertible into gold, but the intent of the Federal Reserve Act of 1913 was to replace the debt backed Greenbacks and the National Bank Notes with debt backed Federal Reserve Bank Notes, and then the debt backed Federal Reserve Bank Notes with indistinguishable asset-backed Federal Reserve Notes as the debt was paid down and member banks presented qualified paper for rediscounting.
As a result of financing WWI with government debt, the politicians realized they could emit bills of credit by sneaking through the loophole left open to redeem the Greenbacks and National Bank Notes. Keynes used this to start shifting the currency from a backing of private sector assets, to government debt, thereby giving the State total control of the economy . . . presumably. (Keynes didn’t realize that the money supply, technically, consists of all contracts, not just government debt or “money contracts.”)
What really led to the abandonment of the gold standard in the U.S.?  Dr. Harold G. Moulton gave this analysis:
Great Britain’s abandonment of the gold standard resulted in a wholesale breakdown of the international monetary system.  The British act of September 1931 was a signal for similar action on the part of a large number of other countries.  As soon as the gold standard system began to crumble, governmental control of foreign exchange transactions also began to be widely introduced.  Some countries used exchange control in conjunction with the abandonment of gold for the purpose of regulating fluctuations in foreign exchange rates; others employed it to prevent depreciation of their currencies, thus insuring a nominal maintenance of the gold standard.  In either case, these artificial measures represented essentially an abandonment of the gold standard.  (Harold G. Moulton, The Recovery Problem in the United States.  Washington, DC: The Brookings Institution, 1936, 45.)
The bottom line?  The gold standard had to be abandoned if the government was going to exercise effective — and presumably total — control over the economy and be able to implement something like the New Deal.  An objective standard is something that either is, or isn’t.  It acts as a constraint against arbitrary acts by people or institutions.  By replacing a fixed standard with a changeable one, everyone is at the mercy of whoever has the power to manipulate the standard, which is suddenly not a standard at all.
#30#

2 comments:

Jayasri Hart said...

I had always wondered why USA went off the gold standard, so thanks for this bit of history. That said, I didn't get this: "by 1933 the government debt-backed Treasury Notes of 1890 had been withdrawn." Was the reason part of your previous blogpost? And I've always wondered how precious metals represented a "standard" since they too were a commodity whose value would fluctuate with supply and demand.

Michael D. Greaney said...

One of the goals of the original Federal Reserve Act was to replace all the different government debt-backed currencies — the National Bank Notes, the Treasury Notes of 1890, and the United States Notes — with private sector asset-backed Federal Reserve Notes. Since 1878 all the currencies had been convertible into gold on demand, even though they were backed with government debt. The Treasury Notes of 1890 represented the smallest amount, so they were retired first, and replaced with Federal Reserve Notes. The National Bank Notes were next, with the redemption program closing in 1938, at which time all remaining National Bank Notes were legally Federal Reserve Notes . . . by that time government debt backed, thanks to the hijacking of the Federal Reserve to fund the New Deal. In 1963 all United States Notes legally became Federal Reserve Notes.

A commodity standard only causes problems if you have two running concurrently, as with bimetalism, e.g., both gold and silver are considered standards, and must be in a legally fixed ratio. With a single standard, all that happens when the standard commodity changes in value is that all prices go up or down in response, e.g., gold becoming twice as valuable means that, all things being equal, all prices would fall by half. The value of gold drops, and all prices rise. With a double standard, if the two commodities don't change in exactly the same ratio (and they never do), one standard becomes cheaper in terms of the other, and the more valuable one drains out of the economy (Gresham's Law). It becomes almost impossible to have an adequate money supply.