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A review by the Federal Reserve Bank of Chicago Business Conditions November 1971 Contents The coming upsurge in employment Gold-Part I: An historical perspective 2 12 Federal Reserve Bank of Chicago The coming upsurge in employment 2 Seventy-one million Americans were em ployed by nonagricultural establishments in October—600,000 more than at the start of 1971 but a quarter of a million less than at the employment peak reached in March 1970. Manufacturing employment, at 18.6 million in October, was no higher than at the start of the year, and 1.6 million less than at the peak set in 1969. In most of the industrial areas of the Midwest, the employ ment picture in recent months has been less favorable than for the nation. Following two years of declining activity or subnormal growth, a substantial rise in spending, output, and employment is gener ally expected for next year. Currently, how ever, most job markets remain soft with few companies recruiting actively on a large scale. Some companies continue to retrench, and layoffs are still occurring, particularly among manufacturers of machinery and equipment. In some industries that have increased pro duction, increases in output per man-hour (productivity) and longer workweeks have reduced the need for additional workers. No sustained uptrend in payroll employ ment has occurred in the two years since a cyclical peak in general business activity was reached late in 1969. In the five-year period, 1965-69, employment rose at the very rapid pace of 3.8 percent annually. Even in 1967, a year of retarded growth in general activity, employment averaged 3 percent more than in 1966. In most industrial areas of the Mid west, employment has remained below the 1969 level, reflecting cutbacks in locally im portant producer equipment industries. While wage and salary employment has been sluggish in 1971, the labor force has continued to grow, although at a somewhat slower pace than in past years. Despite slight declines in September and October in na tional totals, unemployment is substantially higher than it was two years ago in almost all Business Conditions, November 1971 major labor markets. In addition, average workweeks are below the levels of the late 1960s. Finally, many workers released by employers, and many new entrants to the labor force, now hold jobs that do not fully utilize their experience and education. This article describes recent developments in employment and unemployment, with spe cial reference to the Midwest. It explores the major causes of the current condition, and looks ahead to the substantial growth in em ployment that appears probable. The recent decline in nonfarm payroll employment followed several years of large gains change in millions The g ro w in g la b o r force Total employment was estimated at more than 82 million in October 1971. This total includes, in addition to the 71 million non farm wage and salary workers, more than 5 million self-employed and unpaid family workers, about 3.4 million agricultural work ers, and 2.7 million members of the armed services. The unemployed — those without jobs, but available for work and seeking jobs—numbered about 5 million in October. The total labor force, including the armed services and the unemployed, was 87.5 mil lion in October. This number increased by 2.5 million in two years. Growth in the labor force was faster in the late Sixties. From 1966 through 1969, the increase averaged 1.8 million annually. Individuals are counted as part of the labor force either if they have jobs or are actively seeking work. Each year this number is aug mented, at least potentially, by growth in the number of people of working age—de fined as those 16 through 65. Of course, many of the people in the 16-25 age bracket, choosing to devote full time to their educa tion, are not in the labor force. Others, in all age groups, are too ill to work, or are con fined in institutions. Many women devote full time to their families. People approaching 65 Ananu)(a a uring _ rn [1 M M 1 ______ ■ *Ten m o n th s. may take early retirement, an option increas ingly more available. On the other hand, mil lions of people continue to work past 65. Many millions of potential workers—es pecially students, housewives, and retired people— are not continuously in the labor market, but take jobs or seek work periodi cally, depending on individual circumstances and the availability of suitable job oppor tunities. In times of vigorous expansion, in creases in employment may reflect new en- 3 Federal Reserve Bank of Chicago 4 trants, or reentrants, to the labor force more than reductions in unemployment. In times of declining activity, workers who lose jobs through layoffs do not necessarily remain in the labor force as unemployed people seek ing work. In some cases, they “drop out” of the labor force, assuming—rightly or wrongly —that a job search is not worthwhile. About 61 percent of the noninstitutionalized population 16 years and over are now in the labor force. This proportion rose slightly each year from 1964—when it was 59.6 per cent—through 1970. The string of increases may have been broken in 1971. In the third quarter, the labor force participation rate was slightly less than a year earlier—prob ably because of slack demand. The trend of labor force participation has differed markedly for men and women since World War II. For men, the rate has declined from 87 percent in 1950 to less than 81 per cent now. For women, the participation rate increased fairly steadily in this period—from 34 percent in 1950 to 43 percent now. Various factors have produced diverse trends in labor force participation rates for men and women. Longer years of schooling and earlier retirements have tended to reduce labor force participation rates for both men and women, but these trends have been more important in the case of men. Offsetting de velopments have brought additional numbers of women into the labor force. Labor saving appliances, and fuller processing of foods, have reduced the time women must spend at household tasks, allowing them more free dom to take full- or part-time jobs. The stig ma once attached by some people to women, especially married women, working for pay has gradually eroded. Changes in the age mix of the population, and the long business ex pansion of the 1960s, also have influenced participation rates for men and women. About 97 percent of American men, aged 25 to 45, currently are in the labor force. This proportion has not changed significantly since World War II. For men 45 to 55, the rate is 94 percent, down slightly in the past 15 years. Clearly, virtually all of the ablebodied men 25 to 55 are either working or seeking work. Men in these age groups are in their prime working years, usually have completed their formal education, and, typi cally, support dependents. The maximum labor force participation for women is in the 20 to 25 year old bracket, at 58 percent. The rate drops to 45 percent in the 25 to 35 bracket, and then rises again in following years, reflecting the easing of family responsibilities as children grow older. In each of the age brackets, how ever, the proportion of women in the labor force has increased steadily in the past 20 years. This is true even for those women An increase in the proportion of women in the labor force has off set a gradual decline for men percent in labor fo rce Business Conditions, November 1971 with children of preschool age. This trend is likely to continue. Commentaries on trends in unemployment often emphasize the situation for married men (now somewhat less than half of the total labor force) who normally support de pendents. As a group, married men obviously are more strongly attached to the labor force than other groups. But needless to say, a large share of the women and single men in the labor force also must work to provide necessities and comforts for themselves and others. Even in cases where workers merely supplement the income of the “bread win ner,” they contribute to the nation’s supply of goods and services, and comprise a vital por tion of the nation’s labor resources. Employment has continued to rise in state and local government and in the service industries percent change (1969 averoge to October 1971) 8 4 - 0 + 4 8 Em p lo ym en t b y sector During the past two years of widespread economic adjustment, changes in employment have varied substantially among industries, and among regional labor markets. For the most part, differences in regional trends in employment reflect developments in the in dustries that are most important in the area. The last year of relatively “full employ ment” was 1969. The following comparisons relate employment in major industries in October 1971, seasonally adjusted, to the annual average for 1969. In October, state and local government employment showed the largest gain of any sector, up almost 9 percent from the 1969 average. These governments now employ more than 10 million people. States and municipalities have been under strong pres sure to improve and expand their services— including education, public health, welfare, sanitation, and police protection. Recently, the limited availability of funds caused by the economic slowdown, and by voter reluctance to approve bond issues and tax hikes, has forced curtailment of desired programs. But state and local government employment has continued to rise, although at a slower rate than in past years. Federal government civilian employment was 2.7 million in September, only about one-fourth as large as state and local govern ment employment. Instead of expanding, fed eral employment in October was 3 percent less than the 1969 average. Part of the decline since 1969 reflects reductions in the Depart ment of Defense and in aerospace activities. A further decline in total federal employment is under way. In August, the President di rected federal departments to reduce employ ment by 5 percent by mid-1972, as part of his economic stabilization program. While federal civilian employment has de clined moderately in the past two years, the armed forces have been cut sharply. In Sep tember 1969, the armed forces numbered 5 Federal Reserve Bank of Chicago 6 more than 3.5 million—near the Vietnam War high. By October 1971, the number was 2.7 million, after declining for 25 consecu tive months. The decline apparently contin ues, but the great bulk of the planned reduc tion probably has been accomplished. Among the stronger private employment sectors are finance (including banking, in surance, and real estate) and services (a wide variety of miscellaneous activities), each up about 7 percent in October from the 1969 average. About 3.8 million people are em ployed in the financial sectors, and almost 12 million in service activities. Employment in these sectors probably will continue to rise because of increasing demands for the serv ices they render. Opportunities to increase output per man-hour through automation in these industries are limited. Employment in wholesale and retail trade totaled more than 15 million in October, up 4 percent from the 1969 average. Further in creases in employment in the trade sectors are likely because of population growth, de spite increased emphasis on self-service in many stores. Total employment in the transportation and public utility industries combined, now about 4.4 million, has changed little in recent years. Within the category some diverse trends have developed. Transportation com panies, especially the airlines, have reduced employment, while the utilities have con tinued to hire additional workers. A recent step-up in air traffic has caused some airlines to increase hirings again. Contract construction employment, at 3.3 million in October, was 5 percent lower than the 1969 average. Residential construction has been very strong in 1971, but nonresidential construction has declined. Activity in residential construction is expected to remain near this year’s level in 1972, while non residential construction is expected to in crease somewhat. Employment in agriculture (including the self-employed) was less than 3.4 million in September, compared to a 3.6 million aver age in 1969. Agriculture is the only major sector in which employment has trended downward for many years. Currently, agri cultural employment is only half as large as 20 years ago, and only one-third as large as in the 1930s. Innovations in agricultural equipment and techniques over the years have resulted in increases in output per man hour at a much faster pace than in most non farm sectors. Because modern technology is not yet applied universally, a substantial further decline in agricultural employment is probable in years to come. Trends in m an u factu rin g For all U. S. manufacturing industries, payroll employment totaled 18.6 million in October, seasonally adjusted, down 8 per cent from the 1969 average—the largest de cline for any major sector. Manufacturing employment apparently is rising again, but no early return to record levels is anticipated. Even assuming a steady rise in manufactur ing output, probable increases in output per man-hour and extensions of average work weeks will reduce the need for additional employees. In recent months, manufacturing employ ment in most Midwest centers has been fur ther below the 1969 level than has been the case for the United States as a whole. The difference largely reflects lower levels of out put in the machinery and equipment indus tries, and in the primary metal industries— both steel and nonferrous. With less than 16 percent of the nation’s population, the states of Illinois, Indiana, Iowa, Michigan, and Wisconsin produce almost one-third of its Business Conditions, November 1971 Employment in durable goods manufacturing has declined more than employment in nondurable goods percent change (1969 overage to October 1971) -38 -12 -8 -4 0 machinery and equipment, and account for about 28 percent of its primary metal indus tries. According to the Federal Reserve in dex of industrial production, output of busi ness equipment in October was more than 10 percent below its 1969 average, compared with a decline of less than 5 percent for all industrial production. (In recent months, total output of business equipment has in creased slightly.) Primary metal industries were also operating at relatively low levels in October. Steel industry activity was down almost one-third from 1969 as steel buyers reduced strike-hedge inventories accumulated prior to August 1, 1971. Employment in almost all major categor ies of manufacturing, both in the nation and in the Midwest, was down from the 1969 average in October, to a greater or lesser degree. In two relatively stable industries, printing and publishing and food processing, the national decline was less than 2 percent. For paper, apparel, and chemicals, the de cline was less than 5 percent. In the more volatile machinery and equipment and pri mary metal industries, however, employ ment was down 12 percent in October. By far the sharpest decline in manufac turing employment since 1969 has occurred in aerospace — both aircraft and missiles. From an 850,000 average in 1969, aero space employment declined almost 40 per cent to less than 500,000 recently. Cutbacks in these industries have played a major role in causing widespread unemployment in some labor markets, especially in the state of Washington, in southern California, and in the Boston area. Aerospace is relatively much less important in the Midwest. The decline in employment in the ma chinery and equipment and aerospace indus tries probably may be giving way to modest increases. But no substantial rise is prob able in the near future. A recent survey of plant and equipment spending intentions for 1972 indicates a rise of only 2 percent in physical volume for all industries. Steel out put, on the other hand, will rise significantly as inventory reduction programs are com pleted. Some recalls of laid-off steel workers were announced in October. A lo o k a t u n em p lo ym en t Unemployment was estimated at just un der 5 million for the nation in October, 5.8 percent of the civilian labor force. State esti mates for September indicate that the un employment rates for Illinois, Iowa, and Wisconsin were less than 5 percent. The Indiana rate matched the national average. In Michigan, despite stepped-up auto output (the state’s dominant industry) the unem- Federal Reserve Bank of Chicago The total unemployment rate has remained near the cyclical peak for the past year percent of labor force 8 ployment rate was almost 8 percent in Sep tember. The rates are seasonally adjusted. The U. S. Department of Labor estimates unemployment each month for many sub groups in the labor force—by age, sex, mari tal status, race, and previous employment. Recently, special quarterly estimates have been made for Vietnam War veterans and for poverty-stricken sections of major cities. Such detailed data are not estimated for states or metropolitan areas. In a free economy some “frictional” un employment always exists, as people “be tween jobs,” and new entrants to the labor force, seek suitable positions. Unemploy ment compensation, welfare programs, home ownership, the ability to draw on past sav ings, and help from friends or relatives reduce pressure on individuals to take jobs that do not suit their inclinations and capabilities. These factors, probably more important than in past decades, tend to raise the level of frictional unemployment. The overall unemployment rate for the nation has hovered near the 6 percent level since November 1970. In 1969, this rate averaged only 3.5 percent, the lowest level since the Korean War years 1951-53. Over all unemployment rates below 4 percent— some would say 4 V2 percent—have been as sociated with large numbers of job vacancies, high labor turnover, inefficiency, and rapid price inflation. These conditions prevailed in 1968 and 1969 in the eyes of many. Although much higher than in the late 1960s, the current 6 percent unemployment rate is not a record for the postwar period. The rate averaged 6.8 percent in the last half of 1949, 7.5 percent in the worst months of the 1958 recession, and 7.0 percent for a four-month period in 1961. But the duration of the high plateau in unemployment—a full year—is without precedent since the 1930s. Among the subgroups of the labor force, The unemployment rate for married men is well below the rates for other groups percent unemployed men women population Business Conditions, November 1971 the unemployment rate for married men (liv ing with their wives) receives close analysis. The unemployment rate for married men was 3.0 percent in October. This rate aver aged only 1.5 percent in 1969. As in the case of the rate for the entire labor force, the un employment rate for married men in 1969 was the lowest since the Korean War. At no time in the recent business adjustment has the unemployment rate for married men ap proached the 5.1 percent average rate for 1958, or the 4.6 percent average for 1961. There are no data on the number of mar ried men, or others, who have lost relatively well-paid jobs, and who have accepted work at lower compensation. Such cases have been especially numerous in the aerospace field, but parallels exist to some degree in many other industries in which managements have been under strong pressure to reduce costs and improve profit margins, even when this has required the release of employees with many years of service. The frequency of such situations in the past year or two probably has not been equaled since the 1930s. Unemployment rates almost always aver age lower for men than women, for teenagers than adults, for whites than blacks, and for white-collar workers than blue-collar work ers. The relative difference within these groups has not been constant over the years. For men 20 and over, the October unem ployment rate was 4.3 percent, compared to 5.5 percent for women 20 and over. For both sexes aged 16-19, the September unemploy ment rate was 17 percent. Since late 1970, the teenage unemployment rate has averaged much higher than for any period of similar length since World War II. Teenage unem ployment has been boosted in the past dec ade compared to the 1950s, mainly because of the larger number of young people in the work force, both absolutely and relatively. How e m p lo y m e n t estim ate s a r e m ad e The U. S. Departm ent of Labor pub lishes two separate sets of employment data. The household series is based on replies to monthly interviews with individual house holds. The establishment series is based on monthly reports made by employers to state labor departments. Together with informa tion on unemployment compensation, the household series and the establishment series provide the m ajor sources of statistical in formation on labor m arket developments. Data on the total labor force, total em ployment and unemployment with break downs by age, sex, race, and general cate gories of employment are derived from the household series. The sample used was de signed by the Bureau of the Census (De partm ent of Com m erce), which collects and tabulates data for the Bureau of Labor Statistics (D epartm ent of Labor). It con sists of 52,500 households located in 449 areas, some in each state. Trained inter viewers contact these households each m onth to obtain responses to standardized questions. The sample is considered ade quate to provide accurate estimates of the characteristics of the U. S. labor force. The sample is not suitable for providing informa tion for regions or states. Data on wage and salary employment, payrolls, average workweeks, and labor turnover by industry (including types of manufacturing) are obtained from the es tablishment series. Reports are furnished by employers to state labor departments, which tabulate the data and forward re sults to the Bureau of Labor Statistics, which develops national statistics. Compar able data are available for states, metropoli tan areas, and for many smaller cities. Many state labor departments also make estimates of total employment and unem ploym ent, using a variety of sources. Federal Reserve Bank of Chicago Classifications of labor markets by U.S. Department of Labor O cto b e r 1969 O cto b e r 1970 O cto b e r 1971 B C C C C B C C C D C D C B B B C C C C C C D C C C D C C C Illin o is C h ic a g o D aven p o rtRock Is la n d -M o lin e P e o ria R ockford In d ia n a E v a n s v ille Fort W a y n e G a ry -H a m m o n d In d ia n a p o lis South Bend T e rre H au te Io w a C e d a r R a p id s Des M oines B B C C C C C C B C C B D C D D D D C E D D D D D D C E D C B B C C C C D C C C D M ich ig an B attle C re e k D etro it Flin t G ra n d R a p id s K a la m a z o o La nsin g M uskegon S a g in a w c W isco n sin K en o sh a M ad iso n M ilw a u k e e R acin e E x p la n a tio n o f la b o r m a rk e t c la s s ific a tio n s C la ss A B C D E F D e scrip tio n O v e ra ll la b o r sh o rta g e Low u n e m p lo ym e n t M o d e ra te u n e m p lo ym e n t S u b s ta n tia l u n e m p lo ym e n t S u b s ta n tia l u n e m p lo ym e n t S u b s ta n tia l u n e m p lo ym e n t 10 U n e m p lo ym e n t ra te U n d e r 1 .5 p ercen t 1 .5 -3 .0 3 .0 -6 .0 6 .0 -9 .0 9 .0 -1 2 .0 O v e r 1 2 .0 The unemployment rate for all whites in October was 5.3 percent, compared to 10.7 percent for non whites (90 percent of whom are blacks). The unemployment rate for blacks has been about twice the rate for whites for many years. In designated poverty neighborhoods, un employment rates are substantially higher than the national average, both for the total and for all subgroups—as might be expected. For Vietnam veterans, 20-29, the unemploy ment rate was estimated at 8.3 percent in the third quarter, compared to 6.9 percent for nonveteran men in the same age bracket. The differential between veterans and non veterans was much narrower a year earlier. D ifferences in local la b o r m a rk e ts In cooperation with state agencies, the Department of Labor classifies 150 major labor markets each month, assigning letter grades indicating the relative strength of sup ply and demand for workers. Consideration is given not only to current estimates of un employment, but also to qualitative judg ments of local experts as to the probable persistence of current conditions. The letter grade A (unemployment less than 1.5 percent) has not been used to clas sify a labor market since 1957. Grades B and C indicate low to moderate unemployment (under 6 percent), while grades D, E, and F indicate increasing severity of unemploy ment. These last three groups are designated as areas of “substantial labor surplus.” In October 1969, only five of 150 major labor markets were in the substantial labor surplus groups. Currently, 65 labor markets are in these groups. Of 24 major labor mar kets in Illinois, Indiana, Iowa, Michigan, and Wisconsin, only one was in the substantial labor surplus category in September 1969. Currently, 11 are so classified. Two years Business Conditions, November 1971 ago, 62 of the nation’s major labor markets were in the B group (low unemployment, under 3 percent), compared to only six to day. None of these are in the Midwest. Substantial unemployment in major labor markets of the Northeast, Midwest, and Far West is related to conditions in the machin ery and equipment, steel, auto, and aero space industries. The low unemployment centers, of which Washington, D. C., is by far the largest, are all in the South. W h y u n em p lo ym en t persists In 1968 and 1969, the final years of the nation’s longest economic uptrend, many companies were unable to recruit all the qualified workers they needed. A widely-held view in late 1969 was that such conditions would change as the ebullient economy was dampened by restrictive monetary and fiscal policy. Few analysts predicted, however, either the rapidity of the shift from excess demand for workers to underutilization of the labor force, or the extended duration of the changed conditions. Continued high rates of unemployment, in large part, reflect the fact that total output (real GNP) is only slightly higher than it was two years ago. The long-term growth trend is about 4 percent annually. The fact that man ufacturing output is 5 percent below the peak rates of two years ago is reflected in high un employment rates for industrial centers, par ticularly those specializing in durable goods. Other factors have been at work. The growth of imports relative to exports, deci sions to close marginal plants (which usually have relatively high labor inputs), gains in output per man-hour, and management deci sions to keep new hirings, and training pro grams, to a minimum until the economic sit uation is clarified—have all played a role. At present, few private industries or public agencies are expanding their staffs rapidly. Moreover, new layoffs have been announced recently by companies in the industrial equip ment, construction machinery, computer, and aluminum industries — all characterized as “growth” industries through much of the decade of the 1960s. Im p ro vem en t in 1972 The widely accepted “standard forecast” for the economy for 1972 projects a rise of about 6 percent in total output of goods and services. Following two years of sluggish activity, growth of such magnitude can be expected to be associated with a strong rise in employment and reduced rates of un employment nationally. Consumer expenditures have accelerated in recent months, especially for autos and other durable goods. Business firms, how ever, continue cautious in making capital in vestments and additions to inventory. Con tinuance of the improvement in consumer spending can be expected, in time, to encour age increases in business investments. Never theless, even economic growth of the magni tude foreseen in the most optimistic projec tions is not expected to reduce unemployment to the levels prevailing in the late Sixties. 11 Federal Reserve Bank of Chicago Part 1: An historical perspective 12 On August 15, the President of the United States announced suspension of the convert ibility of the dollar into gold. With that one action an international arrangement that had been one of the mainstays of the inter national monetary system for the past quarter century came to an end. The gold exchange international monetary standard—as the ar rangement was known—ceased to exist. Negotiations among the trading nations of the world for new monetary arrangements started almost immediately after the Presi dent’s announcement. As yet no concrete re sults have emerged from these negotiations. The foreign exchange markets quickly recov ered from the initial shock of August 15, and trading in foreign currencies soon re sumed. But arrangements underpinning these operations are viewed by responsible officials as temporary and of a contingency nature at best. Negotiations for more permanent ar rangements are continuing. Clearly, more time is needed for negotiators to arrive at an agreement. Many complex issues, glossed over for several years in the cooperative ef fort of the participating nations to make the system work, surfaced in the wake of the U. S. action. Resolution of these issues will re quire extended negotiations and compromises on questions of vital interest to individual sovereign nations. One of these issues centers on gold, its price and its future role in international monetary arrangements. The controversial nature of this issue stems largely from the peculiar mixture of myths, emotions, and sound economic principles that surround gold. Over the centuries, when gold played an important role both in international monetary arrangements and in the monetary systems of individual countries, this mixture became an integral part of public folklore— and political realities. While sound principles of modern monetary management had long argued for a diminution of the role of gold in monetary arrangements, the widespread Business Conditions, November 1971 popular mystique of gold has tended to make such a step politically unpalatable. The re cent suspension of dollar convertibility set the stage for a fundamental reappraisal of the entire international monetary system, including the role of gold. This article pro vides an historical perspective on the role of gold in monetary arrangements in the way of background for such a reappraisal. An article to appear in the next issue of Business Con ditions, will focus on recent developments. G o ld a s n a tio n a l m o ney The world hardly would have progressed beyond primitive stages of economic devel opment if it were not for the emergence of a medium of exchange—money. Money fa cilitated the specialization of production that transformed countless simple barter societies into an international market economy. The wide acceptance of gold as a medium of exchange contributed to this process. Be cause of its durability and scarcity, gold served this function well. Use of gold as money goes back to early recorded history. Some scholars trace the initial use of gold as a medium of exchange to the Egypt of 4300 B.C. As a result of Greek and Roman conquests, the use of gold coins spread throughout Europe by the fourth century B.C. Contrary to popular belief, however, the role of gold in the development of money as a medium of exchange is not rooted in the dawn of civilization. Clay, porpoise teeth, and slave girls—to name only a few commodities—served as money long before gold. And even after gold was adopted as a metal for coinage in ancient times, gold coins remained rather scarce. Silver, be cause of its relatively greater abundance, was far more widely used. It was only as fresh supplies of gold reached Europe from the newly discovered American continents in the sixteenth century that gold joined silver as a widely used metal for coinage. The emergence of gold as a focal point of the monetary system is even more recent. It was only in 1816 that England established the gold sovereign as its primary monetary unit, with silver given only a limited role as legal tender. More than fifty years passed before Germany-(in 1871) and the United States (in 1873) followed.1 Only at the turn of the century did a monetary standard based on gold become prevalent in major countries of the world. Another popular misconception exists con cerning the ability of gold—or of any metal lic monetary standard—to assure “proper” monetary management of a country. Evi dence shows that as early as the fifteenth and sixteenth centuries, European economies were buffeted alternately by shortages, fol lowed by oversupplies, of the precious metals. In the early fifteenth century, Europe ex perienced a deep economic depression as a result of an increasingly severe shortage of gold and silver. The situation was somewhat relieved by the discovery of new silver mines lOn the North American continent, the silver and gold money that circulated in the early period of colonization was brought in by immigrants from England, Spain, France, and the Netherlands. An independent monetary system in the United States was established by the Coinage Act of 1792. The act established the dollar as the basic mone tary unit, and defined it as equal to 24% grains of pure gold, or to 371% grains of pure silver. The bimetallic standard continued in the United States until Congress passed the Coinage Act of 1873. This act demonetized silver and placed the dollar on the gold standard. Effective converti bility of dollars into gold was not achieved until 1879, however. Initially, the gold value of the dollar was based on the world price of gold— $19.39 per troy ounce. The price was changed in 1834 to $20.69 and again in 1837 to $20.67, where it remained until 1933. Federal Reserve Bank of Chicago in Germany and Bohemia in 1450. It was not until the New World exploits of the Spanish and Portuguese augmented the “money supply” that the stage was set for the economic and commercial expansion of Europe. But the influx of precious metals soon proved to be economically damaging. The money supply rose too rapidly, and by 1550 Europe found itself in the throes of severe inflation. Gradual development of bank notes, is sued by individual banks and fully convert ible into gold, eventually relieved the prob lem of shortages of supply, but introduced a new element of instability. Economic cycles in many countries tended to be exacerbated by virtually unregulated expansions of money during upswings, and massive contractions (often accompanied by wholesale conversion of paper currencies into gold) during down swings. It was only after individual countries established strong central banking systems charged with the responsibility to regulate the money supply that monetary disturbances of this nature were brought under control. G o ld a s in te rn a tio n a l m o n ey 14 Historically, the international payments system evolved from the domestic payments systems of individual trading countries. As the currencies of all major countries con sisted of, or were freely convertible into, gold, international transactions were settled by shipping gold. Besides simplifying inter national transactions, such shipments were supposed to provide an automatic mechanism for the elimination of deficits and surpluses in a country’s balance of payments. In a country where individual international transactions undertaken by its nationals in volved payments to foreigners in excess of receipts from foreigners—i.e., in a country experiencing a deficit in its balance of pay ments—the money supply was reduced auto matically as gold flowed out. Scarcity of money in the deficit country was supposed to lead to a reduction in economic activity and to a fall in prices, making the country’s goods cheaper to foreigners. This, in turn, was expected to stimulate foreign demand for the country’s goods and help eliminate the coun try’s balance-of-payments deficit. A set of forces tending in the opposite direction would be at work in a surplus country: inflows of gold would increase the money supply, push up prices, and thus inhibit exports. This was supposed to reduce the country’s balance-ofpayments surpluses. Unfortunately, however, the international gold standard never really functioned as was intended. The price structure in many coun tries—particularly in those with advancing industrialization and unionization—was too rigid to respond smoothly to changes in the money supply. Reductions in the money sup ply due to the outflow of gold did not always lead to export-stimulating reductions in price Free world’s production of gold... billion dollars Business Conditions, November 1971 . . . is largely absorbed by industrial uses and private hoarding billion dollars private hoarding industrial uses changes in monetary gold stocks n n n 1. 61- .8 - 1.6 - 2.4 i 1958 i i '60 i i '62 i i '64 i___ I___ I___ I___ I__ I '66 '68 '70 protect themselves from worsening economic depression.2 A few countries clung stubbornly to gold. At the London Monetary Conference in July 1933, France, Switzerland, Belgium, the Netherlands, Italy, and Poland signed a pledge to retain the gold standard, forming the so-called “gold bloc.” By 1936, long after the rest of the world embarked upon the road to recovery, even the gold-bloc countries abandoned gold amidst deepening depression, rising unemployment, and the resulting social and political turmoil. With that, the gold standard came to an end. Having experienced the stifling influence of the gold standard, no country (except the United States in the post-World War II in ternational monetary arrangements) permit ted its currency to be convertible into gold again. G o ld — p o stw a r levels. Rather than cutting prices, producers cut back production and employment. Pro longed balance-of-payments deficits led to rising unemployment. The impact of gold movements on the eco nomic conditions in individual countries be came a great concern to governments, in creasingly committed to maintaining the social and economic welfare of their people. It ultimately led to the demise of the gold standard during the worldwide depression in the early Thirties, but only after the govern ments’ prolonged adherence to the “rules” of the gold standard had extracted its toll in terms of spreading unemployment and human misery. Large speculative flows of gold— combined with large-scale conversion of pa per currencies into gold—contributed signifi cantly to the spread of the Depression in the early 1930s. By 1933, some 40 countries had abandoned gold in a desperate effort to In the postwar international monetary sys tem, the role of gold was reduced substan2The United States suspended its commitment to the gold standard in 1933. In January 1934, President Roosevelt, acting under the authority of the Thomas Amendment enacted in Congress in 1933, set the gold content of the dollar at 13.71 grains, increasing the dollar price of a troy ounce of gold to $35.00. The Gold Reserve Act of 1934 terminated circulation of gold coins and free convertibility of paper currency into gold for U. S. residents. It also prohibited U. S. citizens in the United States from holding gold—a prohi bition that in the 1950s was extended to holding gold abroad. The only domestic tie between the dollar and gold that remained—largely as a carry-over from the earlier days—was a require ment that the Federal Reserve maintain gold re serves against its notes and other liabilities. Ini tially, the requirement set these reserves at 40 percent against notes and 35 percent against other liabilities. In 1945, the reserve requirement was reduced to 25 percent on both notes and liabilities. In 1965, the reserve requirement against liabilities was abolished. In 1968, the 25 percent gold reserve requirement against Federal Reserve notes in cir culation was dropped by an act of Congress. 1 Federal Reserve Bank of Chicago 16 tially. Although the values of the currencies of individual countries were defined in terms of gold, the fixed exchange rates among cur rencies—the main feature of the postwar system—were no longer maintained by ship ments of gold. Instead, monetary authorities in individual countries agreed to maintain a fixed rate of exchange of their currency in terms of the dollar by buying and selling dollars in their respective exchange markets in response to supply and demand conditions. The United States, in turn, undertook to buy and sell gold to and from foreign official institutions at a fixed price of $35 per ounce. Individual currencies were thus tied to gold only indirectly, through the gold-convertibil ity of the dollar. Commitment to intervene in the exchange markets to maintain fixed exchange rates implied that countries must hold reserves. Drawing on these reserves permitted any particular country to offset the temporary imbalance in foreign accounts that occurred when the demand of nationals for foreign currencies to purchase goods abroad created a demand that was greater than current earn ings on the country’s sales of goods abroad. Without sufficient reserves, the governments had to impose restrictions on foreign pur chases to equate the supply and demand of foreign currencies. Given the shortage of supply of gold, and given the role of the dollar as the “inter vention” currency, countries began to hold dollars as part of their official reserves. But even the dollar was in short supply abroad in the years immediately following World War II. To aid reconstruction of war-de stroyed economies, the United States em barked upon a massive program of foreign aid. As a result, more dollars flowed abroad than were being received from abroad. Large portions of these were retained by official in- Importance of gold in w orld’s m onetary reserves continues to decline billion dollars stitutions abroad as reserves. The resulting growth of reserves made it possible for foreign countries to liberalize trade and foreign ex change policies. This, in turn, fostered growth of international trade and, with it, of the world’s prosperity. But in the process of sup plying dollars, the United States ran massive balance-of-payments deficits. Eventually, the consequences of the de ficits had to be faced. The U. S. gold stock dwindled as foreign governments ex ercised their right to convert into gold dol lars accruing to them through the deficits. At the same time, claims on the diminishing supply of gold that were held by those gov ernments that chose to retain dollars in liquid form mounted rapidly. Those devel opments gradually began to undermine the confidence of the world in the U. S. ability to maintain its commitment to convert foreign-held dollars into gold at a fixed price. Business Conditions, November 1971 Many began to suspect that the United States might substantially increase the price of gold in terms of the dollar in order to increase the dollar value of its gold stock and thus place itself in the position to maintain its commit ment. These suspicions began to generate de mand for gold by private speculators who hoped to profit by such a move. The first such speculative attack came in 1960. The price of gold on the London gold market rose well above the official price of $35 as speculators bought large quantities of gold in anticipation of an imminent re valuation. To allay the speculative atmos- After ye a rs of officially maintained stability, price of gold fluctuates in response to private supply and demand U .S. dollar equivalent per fine ounce 1968 1969 1970 1971 ‘ M arket supported by G o ld Pool up to M arch 15, 1968 an d closed M arch 15-April 1, 1968. phere, monetary authorities entered into arrangements designed to stabilize the price of gold on the free market, thereby demon strating their determination to maintain a fixed price. The United States, in coopera tion with seven major European countries formed a so-called “Gold Pool,” which un dertook the sale of gold from official re serves to the private market whenever the demand for gold tended to increase the price above the official $35 per ounce. The success of this arrangement to stem future disruptive speculation in the gold market was clearly predicated upon the elimi nation of the fundamental, underlying causes of the speculation—the U. S. balance-ofpayments deficit. As long as the deficit would continue to pour increasingly unwanted dollars abroad, the suspicion that the re valuation of gold may take place would persist. The international monetary system was at an impasse. To accommodate a growing volume of world trade and capital move ments, the system needed a growing volume of reserves in the hands of the official insti tutions charged with maintaining fixed ex change rates to smooth out ever-larger tem porary shortfalls of flows of funds. Gold and the dollar had been the primary sources of reserves. But world gold production was in sufficient to fill the growing need. The flow of U. S. dollars abroad through U. S. balanceof-payments deficits supplied the needed re serves but at the same time led to confidencedestroying imbalance between the amounts of dollars held abroad and the amount of gold in U. S. reserves that were “backing” these dollars. This, in turn, generated speculation on the revaluation of gold, increasing the pri vate demand for gold, thereby further reduc ing the supply available to monetary authori ties. At the same time, had the United States 17 Federal Reserve Bank of Chicago succeeded in eliminating the source of the instability—the flow of dollars abroad—the world would have had to face the possibility of an inadequate supply of reserves. Recognizing the impasse, in the early Sixties, monetary authorities of major coun tries initiated studies and negotiations aimed at developing an international reserve asset that could be relied on to supplement, and eventually to supplant, the existing assets. This process culminated in 1967 when “Spe cial Drawing Rights” (SDRs) were accepted at the meeting of the International Monetary Fund (IMF) in Rio de Janerio as an inter national asset to be issued to individual countries. It was not until 1970, however, that the first issue of the SDRs took their World reserves continue to decline relative to the volume of world trade billion dollars 18 C .I.F.: Includes cost, insurance, an d freight. percent place in the official reserves of nations. In the meantime, the gold exchange stan dard was rapidly approaching its final agonies. In 1966, the private, largely specu lative, demand for gold exceeded the world’s gold production of $1,440 million, and officially-held, international monetary reserves of gold actually declined by $45 million. In 1967, the decline in the world’s gold reserves amounted to $1.6 billion. The drain peaked in early 1968, as speculation on revaluation reached a fever pitch. In March of 1968, monetary authorities aban doned efforts to stabilize the private gold market and determined henceforth neither to buy newly-mined gold, nor sell gold to private sources.3 The two-tier gold market emerged as a result. One tier was open to the public, and here the price of gold was permitted to fluctuate daily in response to supply and demand conditions. On the other tier, sales and purchases of the existing stock of monetary gold were limited to monetary authorities of individual countries. On this tier, the authorities agreed to maintain the price of gold at $35 per ounce. The establishment of the two-tier gold market and the decision by monetary author ities to stop buying newly-mined gold were important steps in the modem evolution of the role of gold. These arrangements, in ef fect, drew a sharp line separating two distinct characteristics of gold—one as a useful commodity for industrial use, the other as a monetary metal. A freely fluctuating price in the private market provided an efficient mechanism by which supply and demand could become self-regulating. It provided a framework within which human and capi3The agreement not to buy gold was later modified to permit purchases of newly-mined gold by the IMF under certain circumstances. Business Conditions, November 1971 tal resources could be devoted to the labo rious process of extracting gold from the depths of the earth in response to the needs of industry—or to the decisions of private holders who wished to hold gold as an asset —as reflected in their willingness to pay the necessary price. On the other hand, the fixed price of gold within the international payments system preserved the role of gold as a point of reference for determining the relative values of individual currencies. At the same time, the decision not to purchase additional newly-mined gold for official monetary purposes formally acknowledged the diminished importance of gold as a source of reserves in the face of the develop ment of the new reserve asset—the SDR— shortly to be put to use. The March 1968 agreement laid the foun dation for a new era in international mone tary relations. But before these foundations could be built upon, the problem of the chronic surpluses and deficits in individual countries’ international accounts still had to be met. The difficulties involved here were not diminished by the “solution-in-principle” of the monetary reserve-creating problem. Even though, technically, the U. S. deficit no longer needed to be relied upon to pro vide growth in reserves in the form of dollars flowing abroad (the SDRs were to assume that role), “turning off” the flow of dollars continued to be as difficult as before—if not more so. The inflationary pressures that developed in the U. S. economy in the latter half of the Sixties led to sharp diminution of the U. S. trade surplus—traditionally the strongest point in the U. S. international accounts. In 1969, the U. S. balance-ofpayments situation improved briefly as a result of a tight monetary policy instituted for purposes of combating domestic infla tion. As U. S. interest rates rose and at tracted foreign-held dollars into the United States, the United States recorded a surplus in its balance of payments on the official transaction basis. But the improvement was short-lived. As monetary conditions in the United States began to ease in late 1970, the flow of funds abroad resumed. In early 1971, the flows were superimposed on the deteriorated U. S. trade position. The combined result was an unprecedented deficit in the U. S. balance of payments and large surpluses in several major European countries and Japan. With the gold issue largely out of the picture, specu lators turned their attention to the exchange markets as a possible source of quick profit. Speculation developed that changes in the par values of world currencies would be the means of eliminating the imbalances. By taking a position in currencies to be revalued, speculators stood to make good profit when selling these currencies after their revalua tion. The inflow of dollars into official in stitutions in countries whose currencies were rumored to be likely candidates for revalua tion reached staggering dimensions. In re cent years, foreign official institutions had refrained from demanding U. S. gold for the “excess” dollars they held in their reserves. But by mid-1971, there was increasing dan ger that the deluge of dollars into their re serves might force these institutions to cash in large quantities of dollars for U. S. gold. At the end of July, foreign official institu tions held almost $33 billion of liquid claims —against which the United States held $10.4 billion in gold. A “run on the bank” under these circumstances could have brought the entire monetary system tumbling down in an atmosphere of panic. It was to preclude this eventuality that the President of the United States suspended the gold convert ibility of the dollar on August 15. 19 Federal Reserve Bank of Chicago International Letter presents a weekly re cap of significant events relating to banking, business, and governmental economic policies on the world scene, together with brief ana lytical backgrounds. The letter also contains charts showing interest rates in the world’s money and capital markets and exchange rates of major world currencies. Prepared by a team of research economists on the staff of the Chicago Fed, International Letter is the latest addition to a series of newsletters pub lished by the Chicago bank. Subscriptions free on request. Write: Re search Department, Federal Reserve Bank of Chicago, Box 834, Chicago, Illinois 60690. BUSINESS CONDITIONS is p u b lish e d m o n th ly b y the F e d e ra l R eserve B a n k o f C h ic a g o . G e o rg e W . Cloos w a s p r im a rily re sp o n sib le fo r the a rtic le "T h e com ing u p su rg e in e m p lo y m e n t" an d Jo sep h G . K v a s n ic k a fo r " G o ld —P art I: A n h isto rica l p e rsp e c tiv e ." Su b scrip tio n s to Business Conditions a re a v a ila b le to the p u b lic w ith o u t c h a rg e . For in fo r m atio n co n cern in g b u lk m a ilin g s , a d d re ss in q u irie s to the R esearch D e p a rtm e n t, F e d e ra l R eserve B a n k o f C h ic a g o , B o x 8 3 4 , C h ic a g o , Illin o is 6 0 6 9 0 . A rtic le s m a y be re p rin te d p ro v id e d so urce is cred ite d . P le ase p ro v id e the b a n k 's R esearch 20 D e p artm e n t w ith a co p y o f a n y m a te ria l in w h ic h a n a rtic le is re p rin te d .
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