A History of US Economic Law Part 2: G, S, or Bi?

Beyond Saving's picture

 

A serious economic issue back in the late 1800's was which metal should be used to back up the currency. In 1873, the US adopted gold as the official legal tender. Silver was still used in small coins, but was no longer legal tender for large debts. 

 

 

Back in those days, the value of US currency was tied directly to gold. You could bring gold  in to a mint and trade it for its equivalent in gold coins minus a small fee for seignorage. When the country adopted the gold standard, naturally certain sectors of the economy were upset. It created a large divide across party lines with a large group arguing for "free silver".

 

 

The "silverites" as they were called, argued that having the value of the dollar pegged to silver was better than gold because silver was more inflationary, while gold was monopolized by the industry tycoons. They supported silver over gold, but many were willing to accept bimetallism; the use of both metals.

 

 

The 1870's and 1880's saw a lot of expansion into the western US as railroads expanded their lines and increased the number of trains running. This created a boom for both the farmers and railroads. Farmers in the western midwest were now able to export grains (mostly wheat) overseas and railroads made good profits transporting the grains to ports. Another result of the railroads western expansion was the discovery of silver. Lots of silver.

 

 

These events conspired in 1890 to create conditions favorable for the silverites. The prices of silver and food were falling because both were being overproduced. Obviously, silver miners supported using silver as a currency because it added the US government as a consumer. Farmers, many of whom had accumalated debt to purchase land and equipment were having difficulty meeting their obligations. Inflation would help them get more money for their crops and make it easier to pay off the banks using inflated money.

 

Obviously the banks, industrialists and wealthy in general were opposed to the idea. Their holdings were mostly in gold. They argued that inflation wouldn't help anyone because prices would rise on everything with large amounts of new currency entering the monetary supply.

 

 

However, the pressure was significant enough that congress passed the Sherman Silver Purchase Act on July, 14th 1890. Yes, the same Sherman that wrote the Sherman Antitrust Act (who also happened to be the brother of the infamous General William Tecumseh Sherman).

 

 

I can't find the full text of the Sherman Silver Purchase Act anywhere, but basically the law required the US treasury to purchase 4.5 million ounces of silver each month and issue treasury notes that could be redeemed for either silver or gold. 

 

 

For the next few years, smart people made good money by getting silver notes and exchanging them for gold which was more valuable. The result was a dwindling supply of gold in the treasury. When it became apparent that the government was not going to be able to continue to honor gold notes the already struggling economy went into a panic. 

 

 

It is known as the Panic of 1893 caused by runs on banks and a contraction of the credit market. Eurpoean banks started selling their American holdings. Many businesses that were surviving on loans closed down resulting in more defaults and more banks running out of funds. An old newspaper article provides an account of the beginning of the panic.  

 

 

In August 1893, President Cleveland called an emergency session of congress and encouraged them to repeal the Sherman Silver Purchase Act.

 

President Cleveland wrote:
 

The existence of an alarming and extraordinary business situation, involving the welfare and prosperity of all our people, has constrained me to call together in extra session the people's representatives in Congress, to the end that through a wise and patriotic exercise of the legislative duty, with which they solely are charged, present evils may be mitigated and dangers threatening the future may be averted. 

 

Our unfortunate financial plight is not the result of untoward events nor of conditions related to our natural resources, nor is it traceable to any of the afflictions which frequently check national growth and prosperity. With plenteous crops, with abundant promise of remunerative production and manufacture, with unusual invitation to safe investment, and with satisfactory assurance to business enterprise, suddenly financial distrust and fear have sprung up on every side. . . . Values supposed to be fixed are fast becoming conjectural, and loss and failure have invaded every branch of business. 

 

I believe these things are principally chargeable to Congressional legislation touching the purchase and coinage of silver by the General Government. 

 

This legislation is embodied in a statute passed on the 14th day of July, 1890, which was the culmination of much agitation on the subject involved, and which may be considered a truce, after a long struggle, between the advocates of free silver coinage and those intending to be more conservative. . 

 

This law provides that in payment for the 4,500,000 ounces of silver bullion which the Secretary of the Treasury is commanded to purchase monthly there shall be issued Treasury notes redeemable on demand in gold or silver coin, at the discretion of the Secretary of the Treasury, and that said notes may be reissued. It is, however, declared in the act to be 

 

"the established policy of the United States to maintain the two metals on a parity with each other upon the present legal ratio or such ratio as may be provided by law."

 

This declaration so controls the action of the Secretary of the Treasury as to prevent his exercising the discretion nominally vested in him if by such action the parity between gold and silver may be disturbed. Manifestly a refusal by the Secretary to pay these Treasury notes in gold if demanded would necessarily result in their discredit and depreciation as obligations payable only in silver, and would destroy the parity between the two metals by establishing a discrimination in favor of gold. 

 

The policy necessarily adopted of paying these notes in gold has not spared the gold reserve of $100,000,000 long ago set aside by the Government for the redemption of other notes, for this fund has already been subjected to the payment of new obligations amounting to about $150,000,000 on account of silver purchases, and has as a consequence for the first time since its creation been encroached upon. 

 

We have thus made the depletion of our gold easy and have tempted other and more appreciative nations to add it to their stock. . 

 

Unless Government bonds are to be constantly issued and sold to replenish our exhausted gold, only to be again exhausted, it is apparent that the operation of the silver-purchase law now in force leads in the direction of the entire substitution of silver for the gold in the Government Treasury, and that this must be followed by the payment of all Government obligations in depreciated silver. 

 

He continues on, the full text of the speech is here

 

Congress did repeal the act, but much of the damage was already done. Gold reserves were depleted, companies were failing and unemployment was high going from an estimated 3% to the mid teens. Unemployment numbers from back then are not as accurate today, but we know that there was a massive and very fast increase in unemployment.

 

 

With the repeal of the act, demand for silver dropped, causing silver mines to close down as well as the railroads that serviced them, contributing to the recession. It wasn't until 1898 when the country began to really recover, making it the longest recession at that point in our history. 

 

 

Even after repealing the Sherman Silver Purchase Act, the government still had trouble maintaining its gold reserves. In 1895, JP Morgan, financier and banker, formed a syndicate that provided the government with $62 million worth of gold by selling gold bonds, which he reportedly did in an astonishing 22 minutes.

 

 

The debate wasn't over. Prominent silverites insisted that silver was not the cause of economic problems. They blamed the wealthy and (naturally) the Jews. The face of the silverites was William Bryan, a politician who ran for president several times. He gave a prominent speech at the Democratic National Convention in 1896.

 

 

William Bryan wrote:

Mr. Carlisle said in 1878 that this was a struggle between the idle holders of idle capital and the struggling masses who produce the wealth and pay the taxes of the country; and my friends, it is simply a question that we shall decide upon which side shall the Democratic Party fight. Upon the side of the idle holders of idle capital, or upon the side of the struggling masses? That is the question that the party must answer first; and then it must be answered by each individual hereafter. The sympathies of the Democratic Party, as described by the platform, are on the side of the struggling masses, who have ever been the foundation of the Democratic Party.

 

There are two ideas of government. There are those who believe that if you just legislate to make the well-to-do prosperous, that their prosperity will leak through on those below. The Democratic idea has been that if you legislate to make the masses prosperous their prosperity will find its way up and through every class that rests upon it.

 

You come to us and tell us that the great cities are in favor of the gold standard. I tell you that the great cities rest upon these broad and fertile prairies. Burn down your cities and leave our farms, and your cities will spring up again as if by magic. But destroy our farms and the grass will grow in the streets of every city in the country.

 

Full speech is available here

 

 

Also, there was a prominent pamphlet going around called "Coin's Financial School" which was used to create class warfare rhetoric in favor of bimetallism. It is worth checking out for the pictures alone. They say political campaigning is negative today- modern politicians don't know what good mud-slinging is. If there aren't pictures of women have their heads cut off and people dying in the streets, your campaign is positive. If you have stuck with me through all this dryness you should check it out. It has comics. 

 

 

After losing both the 1896 and 1900 elections the silverites pretty much disappeared. But as I will get to later, the gold standard supporters didn't exactly win either.

 

 

It was morality that burned the books of the ancient sages, and morality that halted the free inquiry of the Golden Age and substituted for it the credulous imbecility of the Age of Faith. It was a fixed moral code and a fixed theology which robbed the human race of a thousand years by wasting them upon alchemy, heretic-burning, witchcraft and sacerdotalism.-H.L. Mencken

The lovely internet

Thanks for that.

I still get a kick out of reading old books on the internet and Coin's Financial School was well scanned.

I'd heard before about how all the gold in the world would fit into a few swimming pools and now I know about silver too.

Kapkao's picture

Why stop at a 'Gold' medium?

Why stop at a 'Gold' medium? Why not base one's wealth on the most precious of all metals (until recently) -platinum?

Or how about a unique gold/plat alloy made only by US mints? Why just rely on one metal currency that might be due for a bursting of it's investment bubble?

I mean, as cortez proved, a new 'vein' or 'native supply' (heh) of gold can cause a market collapse, to some extent.

“A meritocratic society is one in which inequalities of wealth and social position solely reflect the unequal distribution of merit or skills amongst human beings, or are based upon factors beyond human control, for example luck or chance. Such a society is socially just because individuals are judged not by their gender, the colour of their skin or their religion, but according to their talents and willingness to work, or on what Martin Luther King called 'the content of their character'. By extension, social equality is unjust because it treats unequal individuals equally.” "Political Ideologies" by Andrew Heywood (2003)

Beyond Saving's picture

Kapkao wrote:Why stop at a

Kapkao wrote:

Why stop at a 'Gold' medium? Why not base one's wealth on the most precious of all metals (until recently) -platinum?

Or how about a unique gold/plat alloy made only by US mints? Why just rely on one metal currency that might be due for a bursting of it's investment bubble?

I mean, as cortez proved, a new 'vein' or 'native supply' (heh) of gold can cause a market collapse, to some extent.

 

The reason for the use of gold was based mostly on tradition. Gold developed into the standard currency for international trade thanks to European imperialism. At that time, the only producers of platinum were Columbia and Russia, so it is pretty pointless to consider basing your currency on a metal you don't have access to. http://www.platinum.matthey.com/publications/a-history-of-platinum/

 

Hence the silverites pushing silver because the US had a large share of the world supply (I believe the US was the worlds largest supplier at that time but don't quote me on that, not 100% sure). The problem was that other countries wouldn't accept silver as payment, thus the necessity of having a currency based on both metals if silver was used. 

 

For today's purposes I think it is utterly foolish to consider going back to a metalism, especially for the US. This is one area where I disagree with several prominent economists in the austrian school. Switching back to a gold standard (or any other metal) would necessarily cause a massive inflation in the value of the metal, making it too expensive to be used for any practical applications like electronics. This would be combined with a lot of deflationary pressure on the dollar due to the extremely large debt the US has combined with the necessity of purchasing enough of the metal to back the currency. 

 

I don't have a problem with fiat money. It has worked especially well for us since our currency has become the standard for international trade. It allows us to hide how broke we truly are, and prevents runs on the treasury. During the 19th and early 20th centuries, the US government experienced many situations where it ran low on gold and had to be bailed out by bankers- fiat money does effectively prevent that problem. And considering our modern economy where even fiat money for most transactions consists of little more than digital information anyway, using metals is simply impractical.

 

Another aspect of the early 1900's is that the use of bank checks was becoming an increasingly common method of payment, which allowed banks to reduce the amount of actual cash they had on location by loaning out more. This was profitable during economic booms, but became a problem when people got scared and ran to take all their cash out of the bank. With fiat money, there isn't much reason to run to your bank to take out cash. Instead of banks failing due to not having enough physical cash, banks today only fail when their assets are less than their liabilities. 

 

That being said, I believe that fiat money needs to be controlled with restraint. Using it as a device to manipulate the economy through interest rates and inflation is inherently dangerous, especially when those manipulations are in direct opposition to market forces. Those that support metalism today see it as a panacea to prevent the abuses of the federal reserve. I don't see it as an effective or desirable solution.

 

We are down the fiat money road now and the only way to get off of it is to collapse all fiat money- something that might happen but would lead to an incredible regression of the world economy. The much preferable course imo is to maintain the fiat money system but manage it with restraint as if there actually was something physical it was based on. Fiat money is only worth what people collectively believe it is worth, when our government treats it as if it is worthless it is only a matter of time before people agree.

It was morality that burned the books of the ancient sages, and morality that halted the free inquiry of the Golden Age and substituted for it the credulous imbecility of the Age of Faith. It was a fixed moral code and a fixed theology which robbed the human race of a thousand years by wasting them upon alchemy, heretic-burning, witchcraft and sacerdotalism.-H.L. Mencken

Kapkao's picture

Ok, assume I skipped the

Ok, assume I skipped the finance/econ lesson on Fort Knox for a second, and explain something to me: why bother having fort knox to begin with, if a metal standard is impractical?

Again, my ignorance is probably already showing on Fort Knox, but it seems we store the gold as a means of strengthening our financial base. Is this not the case?

“A meritocratic society is one in which inequalities of wealth and social position solely reflect the unequal distribution of merit or skills amongst human beings, or are based upon factors beyond human control, for example luck or chance. Such a society is socially just because individuals are judged not by their gender, the colour of their skin or their religion, but according to their talents and willingness to work, or on what Martin Luther King called 'the content of their character'. By extension, social equality is unjust because it treats unequal individuals equally.” "Political Ideologies" by Andrew Heywood (2003)

Beyond Saving's picture

Kapkao wrote:Ok, assume I

Kapkao wrote:

Ok, assume I skipped the finance/econ lesson on Fort Knox for a second, and explain something to me: why bother having fort knox to begin with, if a metal standard is impractical?

Again, my ignorance is probably already showing on Fort Knox, but it seems we store the gold as a means of strengthening our financial base. Is this not the case?

 

When Fort Knox was created we were on the gold standard. It was built in 1936 when the US was running low on gold and FDR the fucking tyrant (it is a reply, fuck non-biased) issued executive order 6102 which criminalized personal ownership of gold (because obviously, the evil rich were responsible for the great depression so stealing from them was the obvious answer.) The government seized gold, with no fucking congressional approval. With a pile of stolen gold, the government needed a place to store it, so they built Fort Knox.  http://en.wikipedia.org/wiki/Executive_Order_6102 

 

After a conference at the Mount Washington Hotel in Bretton Woods NH in 1944 where delegates from all 44 countries in the Allied Nations agreed upon an international standard. This agreement created the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development- which since then has been incorporated into the World Bank Group. Today we call the system the "Bretton Woods System"

 

Basically, the agreement made the US $ the international currency. All currencies based their value upon the US dollar and the US dollar was pegged to gold at a rate of $35 per ounce. Initially, this agreement led to a massive amount of gold being transferred to the US in exchange for dollars. By the end of WW2 the US gold reserves grew up to 60-70% of all the gold in the world because $35 was more valuable than gold. The IMF supervised the exchange and made loans when necessary to allow international trade to occur without interruption.

 

The problem occurred in the 50's when the US was unable to maintain the value of the dollar. To maintain the Bretton Woods system the US had to maintain a large trade deficit, buying excess from 3rd world countries and selling less back to Europe in order to provide excess US $ for liquidity. The Marshall Plan was intentionally converted from loans to grants for the purpose of attempting to maintain the Bretton Woods system. However, over time the open market value of gold exceeded $35 per ounce. Naturally, foreign governments (citizens of the US were banned from trading dollars for gold) traded in their dollars for gold which they could sell on the open market for more than $35.

 

In the 50's the Eisenhower administration attempted to put quotas on the imports of oil and restrictions on trade outflows in order to control a growing trade deficit. However, such actions ran against the Bretton Woods System. By 1959 the amount of US dollars being exported exceeded the amount that could be backed up by physical gold. This created what is known as the "Triffin Dilemma" (a theory made by Robert Triffin) where the US had to continue to maintain a large trade deficit in order to provide enough liquidity in the international market. The result was an overvalued currency- gold sold for $40 US in London but was still redeemable for $35 US in the US. With a $5 per ounce profit sitting there, international investors would trade in dollars for gold and resell overseas in the open gold market.

 

In an attempt to control the price of gold the genius dictocrats created the "London Gold Pool" where the UK put their sterling with the US dollar in an attempt to control the price of gold. The US provided 50% of the gold and the Brits controlled the release in order to fix the price at $35. It worked for 6 years, but you can't ignore reality forever and economic pressures mounted to the point that the scheme couldn't hold the price down.  

 

By 1971 nations no longer had confidence in the US $. They demanded gold in exchange and the US simply didn't have enough. In 1971 President Nixon was faced with significant local inflation and quickly dwindling gold supplies. He unilaterally decided to remove the dollar from the gold standard refusing to exchange gold for the US dollar. Since then we have been a pure fiat currency.

 

Today, the US treasury holds 261.499 million troy ounces of gold http://www.treasury.gov/resource-center/data-chart-center/IR-Position/Pages/04202012.aspx at current market value that is about $428.8 billion worth on the open market. Enough to fund our government for about 1.5 months and significantly less than the estimated $829 billion in cash that is already in circulation and that is only counting actual paper money and coins, not digital money. That is why I say it is absurd to imagine going back to the gold standard despite my agreement with the Austrian School on most other things. Between the dollars in circulation, our spending habits and our debt, there is not enough gold on the planet or probably the universe to leave us anything other than broke. In the 1950's we had over 60% of the worlds supply of gold, today we have about 2.5%. 

 

We still have Fort Knox because our government doesn't know what to do with the gold. There has been proposals to sell it, but they have never had popular support. So Fort Knox sits there until someone decides, I wouldn't count on it happening soon. 

It was morality that burned the books of the ancient sages, and morality that halted the free inquiry of the Golden Age and substituted for it the credulous imbecility of the Age of Faith. It was a fixed moral code and a fixed theology which robbed the human race of a thousand years by wasting them upon alchemy, heretic-burning, witchcraft and sacerdotalism.-H.L. Mencken

EXC's picture

The way I see it, our money

The way I see it, our money is still backed by metal. The metal in guns, bullets, handcuffs, jail cells, missiles, bombs, etc...

I think governments have learned that their real power comes from using deadly force to impose their will on the populace or foreign nations. Governments that are good at waging wars can take whatever they want and give to whomever they want. They can 'print money' at will. All wealth is just whatever the government doesn't take from you, not yet anyways.

 

“Religion is regarded by the common people as true, by the wise as false, and by the rulers as useful.” Seneca