Volcker (6 page)

He had nothing to worry about. The U.S. Treasury served as the guardian of American gold. And the dwindling reserves in Fort Knox threatened American finance.

Gold has served as a store of value ever since King Tut passed into the afterlife with a treasure chest of the metal, in addition to his famous mask. Gold developed into money, something useful for making payments, in part because it is a good store of value. But many things are
valuable and are not used as money, such as the New York Yankees, Buckingham Palace, and French antiques. Gold serves as money because in addition to holding its value, it is easily divisible and standardized.

More than 2,500 years ago, King Croesus invented gold coins by dividing the precious metal into a fixed number of grains and then certifying its weight with his stamp of approval.
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Gold in the form of standardized coins facilitated all types of payments, to the tailor for a brand-new suit, to the local tavern for a neighborhood celebration, and of course to the king's tax collector for waging war and building castles.

Before 1933, U.S. gold coins, such as the famous twenty-dollar double eagle and the less-well-known ten-dollar eagle and five-dollar half eagle, had circulated as American currency alongside the familiar Federal Reserve notes still used today. The U.S. Mint, a bureau within the Treasury Department, created these coins out of gold bullion brought in for minting. The Treasury would also exchange paper dollars into gold at the rate of $20.67 in currency per ounce of gold.
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People preferred dollar bills rather than gold for most payments because gold is physically dense, making it cumbersome to carry and costly to ship. A gold bar, worth about $8,000 in 1933, is slightly smaller than an ordinary brick and weighs about as much as two bowling balls.
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As long as people knew they could convert dollars into gold, as the U.S. Treasury promised, they chose not to bother. They would rather hold dollar bills for convenience, or better yet, put the money into their neighborhood bank, where it would earn interest. Gold coins served primarily as Christmas presents for children of privilege rather than as pocket change for everyday shoppers.

All this changed in March 1933. President Franklin Roosevelt wanted to allow banks to expand credit without the limitations of gold, to help rescue the economy from the ravages of the Great Depression. He pushed Congress to pass a law authorizing a Presidential Executive Order requiring American citizens to turn in all gold coins and receive paper currency in exchange.
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Now that people had to give up the precious metal, of course, they did not want to. FDR's treasury secretary, William Woodin, ordered the president's directive printed up like Wanted Dead or Alive posters, exhorting the public “To deliver … all gold coin” or face criminal
penalties, including a “$10,000 fine or 10 years imprisonment, or both.”
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He then distributed the placards to post offices throughout the country for display along with other criminal notices from the postal inspection service.

U.S. citizens complained about the dictatorial decree and squirreled away their gold in safe-deposit boxes, while litigating (unsuccessfully) that Congress had abrogated their inalienable rights.
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Mary Meeker, a recently unemployed fifty-one-year-old single woman, sent a latter dated April 30, 1933, to the
New York Times
, summarizing the complaint:

I was frugal in the use of my earnings, and what I managed to save … amounted to about $31,000.00 … A few months ago I became very much disturbed over the financial situation in this country and decided to withdraw my money from savings banks, convert it into gold and place it in safe deposit boxes … Congress [then] adopted the banking emergency bill requiring all persons to convert into currency … all gold coin … under penalty of a heavy fine or long imprisonment … We were assured that the bills we received in exchange for gold … were just as good and just as valuable … Will you kindly explain to me where I will stand in the event President Roosevelt does revalue the dollar by reducing the gold content? I worked for many years to accumulate the $31,000.00 in gold that I turned over … under duress of the law enacted by Congress at the behest of President Roosevelt … The government now holds my gold and all I have to show for it is the Federal Reserve notes given me in exchange for it.
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Money is a social contrivance, worth something only because others will accept it in payment for real things. A dollar retains its value if prices remain stable, which is precisely what the gold standard accomplished by allowing people to convert paper dollars into gold. It prevented inflation by controlling the printing press, holding the creation of paper dollars in check, for better or worse. The restraint on prices made Mary Meeker happy, but it also prevented banks from expanding credit to jump-start the economy.

Loosening the link with gold provided some leeway for the central
bank to expand credit during a crisis, such as the Great Depression. And as long as the Federal Reserve managed its mandate responsibly, so that price increases did not become a way of life, dollars provided a safe store of value. Of course, that is precisely what worried Mary Meeker—she trusted gold more than the Federal Reserve. And she was right to worry.

The Gold Reserve Act of January 1934 established the secretary of the treasury as the czar of American gold.
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It specified that “all gold coin … shall be formed into bars … as the Secretary of the Treasury may direct.” It gave the secretary the power to “prescribe the conditions under which gold may be … transported, imported, and exported … for industrial, professional, and artistic use.” And finally, to stabilize the international value of the dollar, it gave the treasury secretary the right to “deal in gold and foreign exchange.” As far as gold was concerned, the secretary of the treasury was like a grand pooh-bah, an exalted official in charge of all matters, and worthy of the title Lord High Everything Else.
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The 1934 legislation also devalued the dollar, reducing its gold content to 13.714 grains of pure gold, which translated into a price of $35.00 per ounce rather than $20.67, but it did not take the United States off the gold standard.
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It softened the link between money and the precious metal by preventing Americans from exchanging paper dollars into gold, but the Federal Reserve still had to hold a reserve of 40 percent in gold against its liabilities, such as the familiar Federal Reserve notes Americans use as currency. Without further legislation, this “gold cover” provided an upper limit on credit creation by the central bank. Moreover, foreign central banks retained the right to exchange paper dollars for gold. The United States had to manage its monetary affairs so that the U.S. Treasury could meet America's international obligation to redeem dollars in gold.

President Kennedy put Undersecretary of the Treasury for Monetary Affairs Robert Roosa in charge of defending America's gold reserves, which had declined to nearly $17 billion by the time Kennedy took office in 1961.
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Roosa's assignment was more difficult than it appeared, because over $11 billion of that hoard was immobilized as gold cover for Federal Reserve liabilities.
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America's immediate obligations to
foreign central banks amounted to double the remaining $6 billion of free gold.
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Roosa assigned the job of helping him protect the gold stock to Paul Volcker when he arrived at the Treasury in 1962. At times the task bordered on the mundane. The 1934 prohibition against U.S. citizens investing in gold lasted forty years, until 1974, and Volcker had to prevent gold coins from entering the country without a proper visa.
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He responded to numerous requests for exemptions from regular people like Mary Meeker of thirty years earlier, efforts that tested his diplomatic skills.

Volcker felt bad about being unable to make exceptions for sentiment, including the letter he had to write to a Mr. Schubert in Oklahoma City:

I understand and sympathize with your feelings in connection with the fact that the Collector of Customs in Kansas City detained gold coins which you [received as a] bequest from your deceased brother. Unfortunately they cannot be allowed under present regulations governing the importation of gold coins … only genuine and lawfully issued gold coins of exceptional numismatic value may be acquired abroad and imported to the United States. The determination as to exceptional value is made with reference to the coin itself and not the individual wishing to import it.
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Volcker could not single out Schubert (or his brother) for special treatment, because the gold coin restriction did not play favorites. JFK's brother-in-law Sargent Shriver had been honored in Germany for his work as director of the Peace Corps. When he returned to the United States with a solid-gold medallion presented by the German government, it was promptly seized by the Customs Bureau. Shriver appealed to Treasury Secretary Douglas Dillon (Roosa's boss) for help, and Dillon turned the matter over to Volcker. Shriver made his case to Volcker like the good lawyer he was.
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“What if I had won an Olympic gold medal?”

“We make an exception for Olympic medals.”

“What about a 1729 King George Gold Guinea?”

“It gets the okay as a collector's coin.”

“So what's wrong with my medallion?”

“It doesn't fit either category.”

“That's ridiculous.”

“You're probably right. Do you want me to ask Secretary Dillon to instruct the Customs Bureau to make an exception?”

“I'll think about it.”

According to Volcker, “Shriver was sore as a boil at being denied his gold medallion, an award he had been given for exceptional public service. But Shriver knew it would have looked bad to fight the law, so he waited until after resigning as director of the Peace Corps before successfully reclaiming his medal.”

Roosa responded to President Kennedy's challenge to protect America's commitment to redeem dollars in gold with a blizzard of innovations. His first initiative was to organize an international consortium, called the “Gold Pool,” to help defend the fixed price.
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Germany, the United Kingdom, Italy, France, Switzerland, the Netherlands, and Belgium agreed to help the United States fix the thirty-five-dollar price of gold by jointly selling gold in the London market if excess demand pushed up the price and buying gold if excess supply pushed it down. This was good for the entire world, since it maintained international financial stability under the Bretton Woods System, but it was a bonanza for the United States, like living in the Magic Kingdom, since it solidified the dollar as the world's reserve currency.

A reserve currency serves like a checking account, a vehicle for exchanging payments, for central banks and financial institutions. The Bank of Japan, for example, would use dollars to settle obligations with the Bank of France. Business firms with extensive exports and imports would do the same, making dollars the international medium of exchange. Not everyone understood the benefits to America of having a reserve currency, not even JFK, who had pledged allegiance to gold to help sustain the dollar's supremacy as international money.

Kennedy knew that “if everybody wants gold, we're all going to be ruined because there isn't enough gold to go around,” and he believed that “gold really should be used for international payments.”
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But JFK also worried about the political repercussions, and invited
Undersecretary of State George Ball to balance the views of his financial brain trust. Ball thought that the Treasury's monetary objectives might compromise national security. “Should [we] become more heavily involved in Southeast Asia … there is a fair chance that our European friends would walk away from us … [and] it would be a real temptation to exploit our own balance of payments difficulties … for political purposes.” Ball then added, “We're not persuaded that it is at all vital to the United States that we … be the principal reserve currency.”
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Kennedy interrupted and turned to his Treasury team: “What
is
the advantage to the United States of our being a reserve currency?”
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Volcker knew that if JFK had posed that question while working for Roosa at the Federal Reserve Bank of New York he would have been dispatched to the sub-basement, fifty feet below sea level, right next to the gold vault, for indoctrination under the care and guidance of Tomás de Torquemada. Roosa believed with the faith of a zealot that America had an obligation to “provide the principal reserve currency for the monetary system of the world—a duty which involves special responsibilities as well as conveying special opportunities.”
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In answering the president, however, Roosa skipped the responsibilities and focused on the opportunities, something tangible that JFK could take to the bank. “[A reserve currency] makes it possible for us … year in and year out … to finance any [balance-of-payments] deficit we may run very readily, because you have the world accustomed to holding dollars. When you run behind for a year you don't have to negotiate a credit, they just hold dollars … This is a situation similar to that of any commercial bank. If it controls the rate at which it creates credit, it can go on creating credit and perform a general service as well and make a profit.”
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Roosa told the president that the dollar's status as a reserve currency allowed America to import more goods and services than it exported, and to enjoy a higher standard of living than otherwise. The advantage did not go unnoticed, and would eventually destroy the Gold Pool.

Roosa asked Volcker to craft a second initiative to defend America's commitment to redeem dollars in gold. He wanted a plan to remove the “gold cover” that immobilized the bulk of America's gold stock. Recall
that the Federal Reserve had been required to maintain a reserve of 40 percent in gold against its liabilities, such as the dollar bills Americans use as currency. In 1945, Congress lowered the required “gold cover” to 25 percent, but that still isolated $11 billion of America's $17 billion hoard in solitary confinement in Fort Knox.
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