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Book Review: American Default – The Untold Story of FDR, the Supreme Court, and the Battle over Gold

by Andrew White  |  July 2, 2018  |  Comments Off on Book Review: American Default – The Untold Story of FDR, the Supreme Court, and the Battle over Gold

July 2018 Book Review: American Default – The Untold Story of FDR, the Supreme Court, and the Battle over Gold, Sebastian Edwards, Princeton University Press, 2018.

This is quite a remarkable book. To realize why, one has to ask a couple of questions. Has the US ever reneged on its fiduciary promises to respect the value of the dollar? In other words, has the US ever defaulted on its financial debts? Has the US government ever unilaterally defied broad-based private (and public) contract terms, specifically related to remuneration? The answer to both is a big fat, “Yes!”

The author tells a compelling, exciting and fascinating story about a period in time that we learn about in school but we tend to know so little about financially. The Great Depression is required history for sure FDR’s New Deal is required knowledge. But did you know that bound up between the two is a huge political and almost legal disaster? The roots lay in monetary policy, the value of the dollar, and the gold standard.

In 1929 the Great Depression really got going with the now infamous stock market crash. We were all told in school that market and financial hype and mass hysteria in investment practices led to massive over valuations of companies and commodities such that bubbles galore were awaiting pricking. The stock market crash was the busting of that euphoria.

At the time the dollar was tied to gold the standard. This meant that every dollar was redeemable at a fixed, public amount of gold. This was a sovereign “promise to pay”.  Though few governments “on gold” ever did pay in gold on demand, the promise was always there.  Up until 1914 the UK and many other sovereign currencies were fixed to gold.

Up until the First World War the gold standards had been effectively managed out of London by the Bank of England. In fact the period up to 1914 is described as a mostly stable monetary period. Today some folks believe the gold standard is a model we should use now, and they often refer to the success of that standard up until 1914. The stability up until then was not really through mutually agreed currency balances and fixed exchange rates; London was the effective global central bank and whatever they did mattered. Most other nations followed suit.

With few globally traded currency competitors, the Bank of England was able to manage the value of sterling against gold to provide a world-wide stable price platform for global trade and debt settlement to take place; this global stability suited the Bank of England as it was nurturing sterling, the then reserve currency.  Also Britain’s economy was based on global trade, unlike the bulk of America’s which is consumer led. With WWI the whole system was thrown into the trash heap.

Britain ended up broke by the end of the war and owed America a fortune, much as France owed the UK a fortune and Germany owed France and others too. Yet sterling was still the global currency for trade and debt settlement. Worse, Britain’s became a global debtor; and the US became the global creditor. Explore books that describe the complexities and issues surrounding war debts and their settlement. Congress has its dirty hands all over agreements to cancel or not respect dependent debts; not support the League of Nations; not ratify the Treaty of Versailles and more. But I digress.

After WWI most advanced nations wondered when ‘normal service would be resumed’. That is, Britain would take its place as the global controller and stabilizing force for price stability. It was never going to happen; the country was broke. Worse, empire trappings, political expediency and even survival required the appearance of an ability to ‘assume control’ and this led to the fiasco where Britain ‘returned to gold’ with a massively over-valued exchange rate. Churchill was poorly advised and even Keynes predicted problems: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1449829

To make matters worse, the US and French politicians after WWI, decided to rejoin gold but at notably under-valued exchange rates. This ‘double whammy’ created a huge sucking sound as gold was drawn to those to nations. The US and France took independent action to increase their own competitiveness at the expense of the UK and all other nations ‘returning to gold’ at pre-War rates. This period – between the two world wars- is referred to as the managed gold exchange rate. It was a choppy period, and collaboration for mutual gain was lacking. Everyone was out for themselves. This was an America First period.  Sound familiar?  With the US and France bucking the system, the standard was never going to last.

The book explores how FDR basically took the US off gold in an attempt to massively devalue the dollar. This would allow a large increase in the monetary base and thus loose money, as with the more recent Quantitative Easing, would help drive prices up and growth.  Only recently it took a long time to work.

But since US debts far exceeded its gold reserves, there was never any chance the US could ever redeem all debts in gold, which was the explicit assumption in ‘gold clauses’ written into public and private debt agreements. FDR used this fact to explain why the clause was a problem.  More importantly, and the main reason used, was that only through devaluing the dollar could the US economy be saved.  Through a series of presidential decrees FDR expunged the legal requirement embedded in those contracts.

The combined action resulted in FDR famously ‘torpedoing’ the pending London Economic Conference that, at that time, was trying to reset the gold standard for global, mutual support. FDR, despite public overtures to the contrary, threw global cooperation to the wind and plumped instead for domestic, dare we say, selfish, reasons. Saving the US economy was a good (selfish) reason. But the unfulfilled part of the book looks at what might have happened if FDR had not depreciated the dollar so and had not re-written legal contracts after the fact.

Domestically the huge monetary stimulus helped support the return to normalcy, and the Great Depression was alleviated. Most commodity prices did rise; businesses returned to growth and employment increased all over the next two years. But were there alternative approaches that may have deliver similar benefits, but that were more reciprocal globally?

Don’t forget what happened after the US default. Though the US recovered economically the rest of the developed world remained paralyzed and bank failures followed; war debts were not forgiven; hyperinflation engulfed Germany and you know what happened then. What would have happened if the London Economic Conference had not been torpedoed? What if reciprocal war debts had been forgiven and only net debts paid?

This is little difference to the US experience after FDR’s actions to when Britain left the European Exchange Rate (ERM) mechanism in 1992. The advantage to the UK then were the same for the US in 1930s. https://en.m.wikipedia.org/wiki/Black_Wednesday.  By depreciating sterling against its erstwhile fixed or pegged European currency, the country was able to – at a stroke- depreciate its way out of being uncompetitive price-wise.

However the facts about the US situation are quite fascinating, up to and including the legal challenges and Supreme Court rulings on the gold clause abrogation, as it became known. The author tells a gripping story exploring justices, politicians and economist.  He compares the US action and its impact to Argentina and other counties that have likewise defaulted in debts and depreciated their currency against a pegged or fixed exchange rate. In Argentina’s case it was to the US dollar; in the US case it was to gold.

Most interesting of all is the last few chapters. The author asks of the depreciation can happen again. Knowing what we know about public debt on the US, as a % of GNP, and unfunded commitments of welfare programs, it seems that it is only a matter of when, not if. At what point in our future will our debts be too great that the market as a whole will lose faith in the ability of the dollar to provide some price stability compared to other alternative global currencies?

If there were alternatives for reserve status, the US situation would be dire. But US public debt as a percent of GNP, though large, is not as big as Japan. So should we first look to shorting Japanese bonds in order to survive a predicted loss of confidence and subsequent devaluation in yen? If I had any money to waste, I’d bet against the yen 7 years out. As the author explains, we might even bet against the euro. If Greece does not bring it down, maybe Italy will.

Either way and whatever your political leaning, this is a fascination book about a gripping period we tend to know little about. Who would have thought that banana-republic like practices have been employed at home by the USA, and accepted!

Hugely recommended 9 out of 10.

 

Category: book-review  

Andrew White
Research VP
8 years at Gartner
22 years IT industry

Andrew White is a Distinguished Analyst and VP. His roles include Chief of Research and Content Lead for Data and Analytics. His main research focus is data and analytics strategy, platforms, and governance. Read Full Bio




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