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STATEMENTS ON GOLD Given by Thomas B. M c C a b e Chairman, Board of Governors of the Federal Reserve System In Reply to Questionnaire of the Joint Congressional on the Economic November Report 1949 Committee Under what conditions and for what purposes should the price of gold he altered? What consideration should he given to the volume of gold production and the profits of Hold mining? What effect, would an increase in the price of gold have on the effectiveness of Federal Reserve policy' and on the division of power over monetary and credit conditions between the Federal Reserve and the Treasury? A n incr'casc in the price Unit the United States p a y s f o r g o l d would have two m a j o r monetary results aside f r o m dangerous psychological r e p e r c u s s i o n s : (1) T h e amount of the increase with respect to any gold purchased would p r o v i d e m o n e t a r y aid f r o m the American e c o n o m y as a whole to p r o d u c e r s of g o l d ( l a r g e l y f o r e i g n ) and to f o r e i g n countries s e l l i n g ' g o l d f r o m accumulated stocks. ( 2 ) A c o r r e s p o n d i n g addition (again with respect to gold purchases) would he m a d e to bank reserves, which would p r o v i d e tlie basis f o r a m a n i f o l d expansion of credit that might be highly inflationary. A s to the first result, an increase in the price of g o l d would p r o v i d e additional dollars to foreign countries without r e f e r ence to the needs of the recipients. T h e extending of g r a n t s or credits, in such amounts as a r c in c o n f o r m i t y with the real needs of the countries receiving them and are in the interest of the United States, is f a r better than increasing the price of gold as a means of p r o v i d i n g a n y additional dollars needed. T h e United States is thus able to select the countries and the p e r i o d s of time f o r which such aid w o u l d be given. Concerning the second result, this c o u n t r y has no shortage of money. In fact, there is an abundance of g o l d reserves, on the basis of which additional m o n e y could be readily created by m o n e t a r y and fiscal action. Increasing the p r i c e of gold is a deceptively easy, as well as potentially d a n g e r o u s , w a y f o r the T r e a s u r y to p r o v i d e more dollars f o r f o r e i g n aid ( b y buying foreign g o l d ) or f o r domestic p u r p o s e s ( b y buying domestic g o l d or by revaluing its existing stock) without having to raise taxes or to b o r r o w . Such an a r b i t r a r y creation of m o r e dollars is as inflationary as would be the a r b i t r a r y creation of an equal amount <>f " g r e e n b a c k s " and more inflationary than T r e a s u r y b o r r o w i n g of a c o r r e s p o n d i n g amount from the banking system. 1 T h i s c o u n t r y should not resort means of raising funds. to such potentially harmful A n y change in the dollar price of gold, either up or d o w n , would have the f o l l o w i n g important e f f c c t s : ( 1 ) Unless accompanied b y a p r o p o r t i o n a t e change in the price of gold in terms of all other currencies, it would dislocate the entire pattern o f f o r e i g n exchange rates; ( 2 ) it would change (he dollar value of existing gold reserves, both at home and a b r o a d ; ( 3 ) it would alter the profitability, and thus the level of production, of the gold-mining i n d u s t r y ; ( 4 ) it would change the dollar value of this c o u n t r y ' s gold stock and all future additions to it, and thus be a basis f o r m o n e t a r y expansion or c o n t r a c t i o n ; and ( 5 ) it would constitute a m a j o r change in United States m o n e t a r y policy, with unforeseeable psychological effects. In what f o l l o w s each of these e f f c c t s is discussed. 1. Unilateral changes in a c o u n t r y ' s price of gold have in the past been a means of altering exchange rates, and thus have served to adjust disparities between c o m m o d i t y price levels in that c o u n t r y and in the outside world. F o r example, if c o m modity prices and costs in a given c o u n t r y are too high in relation to those in the outside world, it: might help to restore equilibrium b y raising the price of gold in that c o u n t r y ' s c u r r e n c y , i.e., b y depreciating its c u r r e n c y in terms of gold and also of such f o r e i g n currencies as remain unchanged in terms of gold. Conversely, if prices in the outside w o r l d were higher than in the given c o u n t r y , the c o u n t r y might reduce its price of gold in o r d e r to help b r i n g about a better relationship. D u r i n g the s p r i n g and summer o f 1.049, price levels in many f o r e i g n countries w e r e too high in relation to prices in the United States. T o attempt to correct the d i s p a r i t y b y a change in o u r price of g o l d (assuming that other countries m a d e no c h a n g e ) , w o u l d have called f o r a reduction in the g o l d price f r o m $35 to some l o w e r figure, that is, b y an u p w a r d valuation of the dollar in terms of gold and of other currencies. This, however, would have caused serious dislocations in m a n y foreign countries and would have had severe psychological consequences domestically. T h e needed adjustments w e r e brought about in S e p t e m b e r by devaluations (in terms both of dollars and of g o l d ) of a number of f o r e i g n currencies. 2. A change in the dollar price of g o l d would alter the dollar value of all existing gold reserves in direct p r o p o r t i o n to the 2 change in price. T h u s a 50 per cent increase in the price of gold would result in a 50 per cent increase in Hie dollar value of gold reserves, both in the United States and throughout the world. In the case of the United States, it is clear that a rise in the price of g o l d is not needed to augment the value of domestic g o l d reserves, since these are m o r e than adequate f o r present and foreseeable monetary needs. Under present legislation, the F e d e r a l R e s e r v e System is required to maintain a reserve of 25 per cent against F e d e r a l R e s e r v e notes and deposits, but the present ratio is actually about 55 per cent. Even if the latter ratio were to fall to the legal minimum, an increase in the gold price would not be an a p p r o p r i a t e means of correction. I n the case of f o r e i g n countries, the situation varies. M a n y countries, because of p o s t w a r dislocations, are seriously handic a p p e d at the present time by a domestic shortage of g o l d and dollar reserves. B u t a rise in the p r i c e of gold would help most those countries which already have large reserves. Fvery country which holds gold would automatically receive an increase in the number of dollars available to it, so that the largest increases would go to the largest holders, which are the Soviet Union and Switzerland as well as the United K i n g d o m . Under present and p r o s p e c t i v e circumstances, if the United States wished to make m o r e dollars available f o r f o r e i g n reserves, it would be p r e f e r a b l e to do so by extending stabilization credits to those countries whose reserves we wish to increase. Making dollars available to selected countries by means of credits would cost the United States less, in real terms, than trying tt. help these countries by making dollars available indiscriminately in exchange f o r gold. 3. A change in the dollar price of gold would alter the profitability of g o l d mining, and thus the level of gold production. Foll o w i n g the increase in the dollar price of gold in 1933-IU ( f r o m $20.G7 to $35 per o u n c e ) , g o l d production, both in physical volume and even m o r e in dollar value, was greatly stimulated all o v e r the world. Because of the world-wide rise in costs of labor and materials which occurred as a result of W o r l d W a r 11, the profitability of g o l d mining has sharply fallen, and production has contracted considerably f r o m the peak level of 1940. A c c o r d ingly, p r o p o s a l s have been f r e e l y f o r t h c o m i n g f r o m w o r l d g o l d p r o d u c i n g interests to raise the dollar price of gold. T h e dollar price of gold, however, is still higher relative to the general 3 level oi' c o m m o d i t y prices than it was in the IDL'O's, and g o l d p r o d u c t i o n remains a b o v e the level of that period. A n increase in the price o f g o l d would no doubt stimulate gold production. A s f o r the United States, however, there is d e a r l y no need f o r an increase in domestic gold p r o d u c t i o n , since g o l d reserves in this country are f a r in excess of minimum requirements. A n increase in the dollar price of gold obviously cannot be justified on the sole g r o u n d that it would increase the profits of g o l d mining. in the case of f o r e i g n countries, those p r o d u c i n g g o l d which would be the immediate beneficiaries of a rise in the gold p r i c e are not the ones whose need f o r assistance is greatest. While they might use the augmented value of their g o l d to pay f o r i m p o r t s f r o m Western E u r o p e and thus enable Western E u r o p e to do m o r e t o w a r d s balancing her trade with the United States, it would be much more to the advantage of the United States to accomplish this end by extending g r a n t s o r loans. 4. A s to the effects that an increase in the price o f gold might have on our domestic monetary system, it is important to emphasize that this c o u n t r y ' s existing gold holdings, valued at the present p r i c e of gold, would s u p p o r t a f a r g r e a t e r volume of m o n e y than needed f o r any likely future contingency. The immediate m o n e t a r y effect of an increase in the price of gold would be a " p r o f i t " f r o m the revaluation of our existing g o l d stock. E x p e n d i t u r e of this " p r o f i t , " which presumably would be within the discretion o f the T r e a s u r y , would increase commercial bank reserves, and thereby foster a multiple expansion of bank credit, subject to the reserve requirements of banks in effect at the time. Increased bank reserves and resulting multiple expansion of bank credit would also be fostered by accelerated inflow of g o l d f r o m foreign sources and d o m e s t i c output. These d e v e l o p m e n t s would expose! the e c o n o m y to great inflationary dangers. T h e Federal R e s e r v e has no means adequate to c o p e with such a danger. In the absence of greatly expanded authority to a b s o r b or immobilize the inflationary reserves thus created, the Federal R e s e r v e would be incapable of p e r f o r m i n g its function of adjusting the credit s u p p l y to the needs of a stable economy. I n c r e a s i n g the price of gold would be an awkward and dangerous instrument f o r this country to use, particularly in view of the f a c t that other more effective and f a r less risky means are available or could readily be found to accomplish anything constructive that would be accomplished b y changing the price of gold. 5. Lastly, it should be emphasized that any change in the price of gold would constitute a m a j o r change in the f o r e i g n economic p o l i c y of the United States. Since J a n u a r y 1934, the price of gold in terms of the dollar has remained unchanged at $35 per ounce. Thus, f o r over fifteen years, there has been a iixed relationship between gold and the d o l l a r — o n e of the few elements of stability in an international e c o n o m i c situation that is only slowly r e c o v e r i n g f r o m the ravages and disruptions of extended world war. Changing the dollar price of g o l d would inevitably weaken the high confidence that this c o u n t r y ' s c u r r e n c y universally enjoys. What would be the principal advantages- and disadvantages of restoring circulation of gold coin in this country? Do you believe this should be done? T h e advantages which might be gained by restoring the circulation of gold coin in this c o u n t r y are negligible and serious disadvantages would be incurred. N o n e of the important d o m e s tic or international m o n e t a r y p r o b l e m s n o w f a c i n g us would be a p p r e c i a b l y helped toward solution. Confidence in money, in our day, is based upon its internal purchasing p o w e r and the ability of a c o u n t r y to meet its external obligations, not upon internal convertibility of the money into gold. T h e c u r r e n c y of the United States is the most generally acceptable c u r r e n c y in the w o r l d today. Confidence in it is assured by the p r o d u c t i v e p o w e r of the United States e c o n o m y . Gold is readily available and existing reserves are m o r e than adequate to meet any conceivable international drain of funds. Since the chief argument f o r instituting a gold coin circulation would be the strengthening of confidence in the currency, it is clear that on these g r o u n d s no need f o r taking such a step exists today. The argument that a return of gold coin circulation would bring about a desirable and automatic regulation of the d o m e s t i c money s u p p l y and would assure the c o u n t r y a " s o u n d " m o n e t a r y system—in the sense that such a system would be " s o u n d e r ' ' than the present o n e — i s not valid. On (he contrary, the adoption of a gold coin standard might actually hinder (he maintenance o f a stable and prosperous e c o n o m y , since there is no automatic 5 relation between the demand f o r g o l d coin and the e c o n o m y ' s need i'or money. The demand f o r gold f o r individual use, as contrasted with its use to balance international payments, reflects v a r i o u s speculative and capricious influences which should not ailect m o n e t a r y policy, and fails to indicate other conditions Which ought to guide monetary policy. T h u s a strong public demand f o r gold coin might arise in time of depression as occurred m 1931-33, imposing a restrictive m o n e t a r y policy at the v e r y time when the o p p o s i t e policy is necessary. In time of rising prices, when shifts f r o m money to c o m m o d i t i e s arc likely, mand f o r gold might be small, so that the necessary restrictive action would not automatically occur. If d u r i n g a wartime, moreover, h e a v y . d e m a n d s f o r gold should a p p e a r , f r e e sales df » o l d would reduce our gold stock, stimulate speculation n g a i n s U h e currency, and hinder the financing of the war. F u r t h e r m o r e depletion of g o l d reserves resulting f r o m private h o a r d i n g <. ou ld conceivably impair our ability to meet e x t r a o r d i n a r y w a r t i m e expenditures a b r o a d . A n o v e r - r i d i n g reason against making gold coin f r e e l y available is that 110 g o v e r n m e n t should make p r o m i s e s to its citizens and to the w o r l d which it would not be able to keep if the denuuid should arise. M o n e t a r y systems f o r o v e r a century, in response to the g r o w t h in real income, have expanded m o r e rapidly than Would be permitted by accretions of gold. In the United Slates today, our g o l d stock, although large, is only 15 per cent of our currency in circulation and bank deposits, and less than 7 per' cent of the e c o n o m y ' s total holdings of liquid assets. The retention of a g o l d base is desirable in o r d e r to maintain international convertibility, and a gold standard system has therefore e v o l v e d in which the v a r i o u s f o r m s of m o n e y and near money in the c o u n t r y are ultimately convertible to gold, where thai is necessary to meet the c o u n t r y ' s international obligations. Upturn to a g o l d coin standard, however, would clearly e x p o s e the e c o n o m y to the risk of drastic and undesirable deflation at times of high speculative demand f o r gold f o r h o a r d i n g , o r else (he Government would have to w i t h d r a w , i t s p r o m i s e of gold convertibility. Conjecture as to the possibility of such i\ withd r a w a l would stimulate a speculative demand f o r gold "mid might precipitate the event feared. T h e long run effect would be to weaken rather than to strengthen confidence in the dollar. . 1 , 1 r e g a r d to the international effects, it is often contended that if g o l d w e r e made freely available by the United States, whether in the f o r m of coin or otherwise, one e f f e c t would be to eliminate the p r e m i u m at which gold is quoted, in relation to the United States dollar, in black or free markets abroad. H o w e v e r , the present p r e m i u m of gold o v e r the dollar in foreign markets is a matter of v e r y limited importance. I t reflects chiefly the special suitability of gold f o r h o a r d i n g , its great familiarity, and its a n o n y m o u s nature. It cannot even remotely a f f e c t the stability of the United States dollar.
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