On April 5, 1933, FDR ordered Americans to sell all their gold holdings to the government. This was followed by the abandonment of the gold standard and the devaluation of the dollar. American Default is the story of this forgotten chapter in America’s history.
00:07 Trevor Burrus: Welcome to Free Thoughts. I’m Trevor Burrus. Joining me today is Sebastian Edwards, the Henry Ford II chair in international management at the UCLA Anderson School of Management. From 1993 until April 1996, he was the Chief Economist for Latin America and the Caribbean region of the World Bank. He is the author of many books. The latest is “American Default: The Untold Story of FDR, the Supreme Court, and the Battle over Gold.” Welcome to Free Thoughts, Sebastian.
00:33 Sebastian Edwards: Alright, thanks for having me. It’s a real pleasure.
00:36 Trevor Burrus: Your book is the story of a time that is oddly forgotten, when between 1933 and 1935, in your words, FDR, Congress and the Supreme Court agreed to wipe out more than 40% of all public and private debts. But your interest in this somewhat forgotten period begin with some of your experiences working with economies of Latin America. How did that happen?
01:01 Sebastian Edwards: Yeah, that is correct. So, my background as an economist is as a development macro‐economist. And throughout my career, I spent a lot of time researching issues related to sovereign defaults in the developing world, and mostly in Latin America. And in 2002, I got a phone call from one of the main law firms in New York, and I was asked by a law partner if I could help them write an expert report on the Argentine Default of 2002, which was a major default. They ended up paying 23 cents on a dollar. And as I was reviewing the brief written by Argentina, I found one paragraph that said something along the following lines, “By the way, there is an international precedent to what we have done.” And that has to do with FDR and the US in 1933. And what the US did is that it changed retroactively all debt contracts. And then the Supreme Court said that that was okay. And I said, “Oh God, how come I don’t know about this?” And I started asking around and almost no one knew about this episode. There were, of course, some economic historians that do but almost no one knew about it. And I said, “Well, someone has to research this case, tell the story and analyze how similar it was to the Argentine Default of 2002.” After all those years, here is the book.
02:51 Trevor Burrus: Yeah, there’s a lot of research that went into it. And you started by talking about The Great Depression ’cause of course, I think it is important to contextualize how bad it was in 1932, 1933 when FDR took office. Have any of us, at least in America, seen anything like the Great Depression and what was happening at that time?
03:13 Sebastian Edwards: Certainly we have not. Some people during what has been called now, The Great Recession, a big crises that started in 2008 with the sub‐prime debt. They have said that it was in some sense similar. But if you look at the data it was very, very, very different. During The Great Depression, there were industries where output went down by 80%. The automobile industry which was taking off and was very important in the Mid‐West, agricultural sector was wiped out and prices collapsed. The price of commodities went down by around 80%. And deflation can be very destructive. So we haven’t seen anything, anything like that. And what really happened during The Great Depression is that it was a world‐wide. As I say in the book, there was nowhere to go. You could not emigrate and go to Argentina or Australia or anywhere. It was every country in the world was affected by the same problem.
04:27 Trevor Burrus: Now, during the campaign with Hoover, with FDR in 1932, did FDR campaign on this issue of gold because we… In American history class, you learn about like William Jennings Bryan and the Cross of Gold speech and something that was a big campaign point. Was this something that FDR thought a lot about? Did he makes some sort of Cross of Gold speech himself when he was campaigning?
04:50 Sebastian Edwards: No, he did not do that. And I make a point in the book of arguing and showing, by going into the archives, not only FDR’s archives but also the archives of… And the papers of his main advisors. They did not know what to do or did not consider the gold issue as something important. And in fact, as the campaign took off in August, and President Hoover realized that he was running behind, he accused FDR of wanting to take the US off gold. And FDR response was, “No. I commit myself to sound monetary policy.” He did say something vaguely about silver. He said,” I will do something about silver.” He didn’t say what something was, nor did he give‐in any details. So the point I make in the book is that this was not a preconceived idea of taking the US off gold. The notion was floating because the British had done that in September of ’31. But pretty much the the idea was that FDR and the Democratic party were going to pursue sound monetary policy and, by and large, maintain the gold standard. And then, he takes over and things sort of evolved in a way where he sort of forced to get off the standard.
06:32 Trevor Burrus: Forced by the just…
06:34 Sebastian Edwards: By circumstances. I’m neither a lawyer nor was I born in this country, so for me to study this period, which I didn’t study in high school, I didn’t take American history because I grew up in South America, but to study this period and then going the archives was fascinating. The first thing that happened is that, for instance in mid‐February, there was an attempt on FDR’s life. When he came back from vacation and he was traveling through the streets of Miami in an open car, someone fired at him and killed the person who was sitting by him, the mayor of Chicago. And the day after that, on February 14th, there was a big banking crisis. And the day FDR took over, at that time, it was the first Saturday in March when he was inaugurated, his first act was to close every bank in the US because there was such a deep crisis. So one event led to another. The crisis, closing the bank, the run on the banks, the fact that people were taking gold out of the banks and taking it home, led to a situation where at the end, he was forced to take the US off of the gold standard. There’s another wrinkle to this, which has to do with the populist block in Congress and in the Senate, and there they are, a couple of senators, who play a very important role in this whole drama.
08:24 Trevor Burrus: See, I find it interesting the forced because the gold standard is a big contentious thing. And here at Cato, and monetary economists and a lot of libertarians think it’s a great thing. And as you mentioned, England had gone off of it in 1931 and we had these runs on the banks and things, but even if you’re forced to go off the gold standard, which I’m not a monetary economist so I’ll grant that, does that require confiscating people’s gold?
08:50 Sebastian Edwards: No, it does not. In fact, the British went off the gold standard and did not confiscate people’s gold, which we did in April. So the sequence of events is very interesting. So FDR is inaugurated on March 4th. The night of the 5th, he declares a National Bank Holiday. And the big debate there is, under what legal authority he can do that. And he decides to do it under the Trading with the Enemy Act of 1917.
09:32 Trevor Burrus: That’s the kind of law that always seems like a really dangerous law, the Trading with the Enemy Act, isn’t it?
09:38 Sebastian Edwards: Yeah. And especially when we were not at war with anyone and there was no enemy that we had declared. So the Trading with the Enemy Act of 1917 was passed in order to make sure that the Federal Government could put in place a gold embargo, so that the enemy would not get the gold.
09:58 Trevor Burrus: Who’s the enemy here?
10:00 Sebastian Edwards: The enemy in 1917 was the Germans. Of course the…
10:00 Trevor Burrus: Oh, okay. Now, who’s the enemy in the New Deal?
10:04 Sebastian Edwards: Right. But in the New Deal, there is no enemy. So he uses that authority, which is very doubtful, and there was big legal controversy. And finally, his newly appointed Attorney General, Homer Cummings, writes an opinion saying that it’s okay to base the holiday on that act. So anyway, so he’s inaugurated. There is this banking holiday which last for one week. At the end of that week, FDR gives his first fireside chat and tells people, “We’re going to reopen most banks and the ones that we reopen are going to be sound, so bring back your money and your gold.” And people do bring back their money but don’t bring back all the gold, so there’s still gold in people’s hands. And then on April 5th, he decides to confiscate the gold and to force people through an Executive Order to surrender all their gold to the Federal Reserve and they will be paid the ongoing price, which is $20.67 per ounce.
11:16 Trevor Burrus: Which had been set like 30 years previously, correct?
11:19 Sebastian Edwards: No, 100 years previously, in 1834.
11:22 Trevor Burrus: Wow.
11:24 Sebastian Edwards: So it’s 100 years and people surrender that. And I have in the book, a photograph of the posters that they placed in the post offices and in different places and people surrendered their gold. And a few months later then, when people had already surrendered their gold, the price of gold went up to $35 an ounce.
11:48 Trevor Burrus: Well that was just set by FDR, though?
11:50 Sebastian Edwards: That was set by FDR on January 31st, 1934. And that act is what triggers the cases that go to the Supreme Court. There are people that say, “We have contracts that say that we have to be paid in gold coin equivalent. And since an ounce of gold now is $35, we have to be paid in paper dollars 69% more than the original contract because the contract is in gold coin equivalent.”
12:26 Trevor Burrus: I wanna step…
12:27 Sebastian Edwards: And most of the cases had gone to the Supreme Court, and at the time were very famous, but what I say in the book is that, “We seem to have entered a period of collective amnesia where we don’t want to remember the fact that there was a time, not too long ago, my dad was alive, he had been born a few years earlier, when the US acted like a Banana Republic.”
12:53 Sebastian Edwards: We annul contracts, debt contracts retroactively, unilaterally imposing severe losses on investors. And when Argentina or Greece or any of those countries do this, we point fingers at them and we tell them, “Contracts are sacred. You don’t do this. This is a Banana Republic paper.” We did it too, not long ago.
13:21 Trevor Burrus: I wanna step back a little bit to the theories about this because… So taking America off of gold, the question here… The words that get thrown around when you read histories at the time, and I’m kind of a student of the New Deal, so your book was particularly interesting to me. But you get the sort of inflationist and deflationist kind of people and a lot of political rhetoric around this. Senators saying, “I’m an inflationist or I’m a deflationist.” And FDR’s position seemed to be that he had to raise prices, that this was the absolute goal. So much that he did the Agricultural Adjustment Act was trying to raise commodity prices to 1926 levels and the National Recovery Administration, National Industrial Recovery Act was also trying to fix prices in different industries. And was the gold part of that idea of raising prices?
14:13 Sebastian Edwards: Yes, that was… It was part of the idea. So all the points you make are great points and you’re right. So FDR campaigned on the basis of, of course, ending the Depression but part of that was raising agricultural prices. And at that time, people were beginning to understand that deflation was really bad for the economy, and it was bad for two reasons. The first one is that, if prices are going down and you expect that they will continue to go down, you postpone purchases, in particular, big item purchases. So if prices of cars are going down and they’re gonna be 50% lower by year end, then you wait until the end of the year to buy your car. And if you continue to postpone, then demands collapses and that’s bad. And the second point is that, if prices go down, people that have debts relative to what they produce, their debt goes up. And I show in the book that, for instance, in terms of bushels of corn, the debt of that farmer’s had sort of tripled. So when they took the debt of the mortgage in 1926, it was so many bushels of corn. And by 1932, it was three times more bushels of corn. So FDR wanted to bring this to an end, and there were theories there that said that, if you increase the price, the dollar price of gold, the dollar price of every commodity will follow almost immediately and will increase by the same amount.
16:04 Trevor Burrus: Even if you’re not on the gold standard?
16:06 Sebastian Edwards: Even if you are not in the gold standard, that was the theory at the time. Now, one should take it to account that, as I said earlier, we didn’t have a lot of information or historical evidence on which to base our analysis. The price of gold had been $20.67 per ounce since 1834, and before that it had been $19.60 since Alexander Hamilton founded the Mint. So we had had only two prices of gold since Independence. 19.6 and then a very small adjustment to bring the price of gold in line with the price of silver in the rest of the world, in 1834. So it was not crisis‐related. Then we had a brief interruption of the gold standard or aspects of it during the Civil War and then again during the First World War. So pretty much, we had three observations to go by. So economists had no idea what was going to happen, but at the same time, there was no evidence for them to actually study the history.
17:31 Trevor Burrus: When we talk about these prices going down, and is it that being FDR and a lot of his brain trust obsession, that seems a little counter‐intuitive because generally when things become cheaper, this is not a bad thing. If a Model‐T becomes cheaper, if corn becomes cheaper, people will adjust. We’ll have fewer people producing corn but they can produce more corn and we can adjust around this. Doesn’t it kind of go against the free market ideology. You’re a Chicago grad so… That playing with these prices is a little bit crazy.
18:02 Sebastian Edwards: It does. Yeah, I know, it does. It does. And when my mother asked me what was my new book about and I told her, she was sort of surprised and said, “I love it when prices go down.” So the problem is that if is generalized and it’s very acute, and then you have the two problems that I just mentioned. What we like is that relative prices change and some prices go up reflecting greater scarcity or greater quality in some goods and some prices go down. So whether the price is moving around, that we like as economists. We think that that is a reflection of the market and it provides the right incentives for people to allocate their resources and their effort to the right sector. But when prices go, in general, down, you have the two problems that I mentioned. People postpone consumption because they’re waiting for lower prices. And what is more serious is that the real value of debt goes up very significantly. And monetarist economists, in particular Milton Friedman and Anna Schwartz in their famous Monetary History of the United States, recognize this and in very great detail analyzed all of this.
19:33 Trevor Burrus: Now, when they confiscate, or they didn’t confiscate the gold, they didn’t pay people the $20.67, correct?
19:40 Sebastian Edwards: They did pay people 20.67, and then… If one, I think that, if one looks at this from today’s perspective, the most impressive thing has to do with the gold certificates. This is the story, these were called yellow‐backs. So if you had gold, you had bars or coins, you could take them to the treasury and give them to the treasury for safekeeping, because you didn’t want to have those coins in your house. And the treasury would give you a certificate. And then when they passed this executive order, you could not get your gold back, they would give you money. And say, you just kept your certificate and so this means the treasury is still holding your gold, then when the price went up to 35 and your certificate said, “One ounce of gold”, instead of giving you back the new price, $35 an ounce, they still gave you 20.67. And this is what people found particularly surprising and irritating. You had given physical gold for safekeeping, and then they didn’t want to give it back to you, which was okay, “So give me the money equivalent.” But they didn’t give you the new price, they gave you the old price, lower, much lower.
21:04 Trevor Burrus: Yeah, it was kind of mind‐blowing that a lot of people may not know that it was illegal to own gold privately in America from basically 1933 until 1975. But how about, I don’t know, jewelers or artists or dentists or people who make electronics with gold, were they all like drug dealers buying on the black market? [chuckle]
21:27 Sebastian Edwards: Yeah. There were three exceptions… Yeah, three exceptions through the executive order. Industrial use, which meant jewelry making and dentists, I suppose. I know that dentists but I don’t know if they fall under industrial use. And coins of numismatic value, so coin collectors could keep their collection. Big problem was that the Secretary of the Treasury, Will Woodin, had one of the most important coin collections in the world. So, it was exempted but the greatest or one of the greatest beneficiaries of that exemption was the Secretary of the Treasury, who was a very nice guy, very loyal, he was a Republican, but served under FDR anyway. So there were those exemptions. And then newly minted gold was a question. What did you do with newly minted or newly mined gold? What price did you pay for it? And until August of ’33, they were paid the old price. And then in August of ’33, FDR tried for a few months an experiment, which is known as the Gold Purchasing Program which did not work out and it was the brainchild of a pretty obscure economist who taught at Cornell at the time.
22:58 Trevor Burrus: George F. Warren? [chuckle] Yeah.
23:01 Sebastian Edwards: George F. Warren, yeah.
23:02 Trevor Burrus: He seems like the most important economist.
23:02 Sebastian Edwards: I haven’t done the exhaustive research of this or had tried, but I’m gonna hedge my bets here. I think that there are three economists who were or have been on the cover of Time Magazine without ever holding public office. One is Milton Friedman, the other one is John Maynard Keynes. So we know those two guys ’cause they’re giants.
23:31 Trevor Burrus: Yeah. [chuckle]
23:33 Sebastian Edwards: And the third one is George Warren.
23:34 Sebastian Edwards: And I can go around a department of economics, to Department of Economics, in the US, and 99% of the faculty would not know who George Warren was. And he was the most powerful economist in the US during the second half of 1933.
23:51 Trevor Burrus: Yeah, I’d like to read this quote here on page 103 of your book, “During the second half of 1933, George F. Warren was the most influential economist in the world. Almost every morning during November and December, he met with FDR while the President was still in bed and helped him decide the price at which the government would buy gold during the next 24 hours. Henry Morgenthau Jr, who often attended these meetings, confided to his diary that the process had a cabalistic dimension to it. In selecting the daily price, FDR would jokingly consider the meaning of numbers or flip coins. On one occasion, he decided that the price would go up by 21 cents with respect to the previous day. He, then, asked the group assembled around his bed, if they knew why he had chosen that figure. When they said that they didn’t, the President smiled broadly and remarked that it was a lucky number. It’s three times seven.” That seems insane. Is that crazy? Is that a good…
24:43 Sebastian Edwards: Insane. Yeah, it was insane.
24:45 Trevor Burrus: Okay.
24:45 Sebastian Edwards: It was totally insane. So much so that it prompted John Maynard Keynes to write an open letter to the president, which was published in The New York Times on December 31, 1933, where he told the president that the gold‐buying program made the dollar look like a drunk. The dollar looks like it’s on the booze, he said and it is not the kind of dignified policy that a country like the US should follow. And shortly after that, then FDR ended the gold‐buying program and George Warren star was eclipsed and he sort of disappeared from the scene and a couple years later, he died.
25:34 Trevor Burrus: That has had some severe international ramifications because we were kind of beginning to build this international monetary system to some degree, at least, the birthing pains of it, and there was a London Monetary and Economic Conference that featured, and especially France and Britain and America, fighting over how these currencies would be denoted. What was that conference like? There was some drama there.
26:01 Sebastian Edwards: There was a lot of drama there. So, FDR and his advisors wanted to solve the US domestic problems first. They didn’t want to deal with international issues but, they inherited a lot of international problems from Hoover, or international unsolved issues, including the fact that the debt moratorium that had been declared in ’31 by Hoover had come to an end and then, France and the UK had to start paying their debts to the US again. So there were a number of… And there was the Smoot‐Hawley Act, and the Brits had put in place the Imperial Preferences Acts so protectionism was coming… Inching or moving up very quickly.
26:58 Sebastian Edwards: So, the conference, in principle had, which was agreed upon during the Hoover Administration, would deal with the debt, with currencies and protectionism, and the end of the Depression. And reluctantly, FDR sent a team which was headed by the Secretary of State, Cordell Hull. One of the issues was how to stabilize currency values and when they were about to come to an agreement, FDR sent a very famous cable, which is known as “FDR’s Bombshell” accusing France and the UK of trying to sabotage the US. And he said, “I’m not interested in stabilizing the exchange rate.” And this was very humiliating for Cordell Hull who almost resigned over it. But FDR was a charmer so he invited him over to spend some time with him in Hyde Park and Hull stayed and became the very well‐known, very highly respected Secretary of the State in American history.
28:22 Trevor Burrus: Now, and we’re wanna get back to the Gold Clause cases here ’cause I am a lawyer, and as I said, I have new interest in the New Deal and I read the Gold Clause Cases in law school. I think most people do or at least, an excerpt from it. And a lot of times, in law school, you read these cases and you’re reading so many pages that you don’t pay attention to the backdrop. And I remember reading this case and it said, “FDR made private ownership of gold illegal.” And I was like, “What?” And then, the case stands for these contract clause and other issues, but can you talk a little bit how the case went up to the Supreme Court. They had taken these Gold Clause contracts which… Explain again exactly what that was and was it in, basically, every contract and also it was in private contracts but it was in public contracts, too?
29:10 Sebastian Edwards: So, the Gold Clauses said, as I pointed out earlier, said that the debt was written in gold equivalent, gold coin of the current degree, level of purity. So, that meant that you got a loan and you committed yourself to paying back the gold equivalent of what you took in. And those clauses were put into contracts during the Civil War, when there were two currencies circulating side by side, the greenbacks which did not have gold backing and the backed dollar. So, they were putting the Supreme… And in 1863, they became a common part of loans and people maintained them. So by 1933, almost every single bond and mortgage in the US, so these are private loans, had a gold clause. Since the price of gold had been constant, and the scare during the Civil War had been dissipated, so at the end we went back and everything was convertible, and gold was available, people didn’t pay much attention to that. So let me give you an example, the Dow Bond Index had 30 bonds at the time, 29 of them had a gold clause. So almost every private debt was written with a gold clause and after 1917, public debt was required by law to have the gold clause. The government could not issue debt without the gold clause, government debt.
31:08 Sebastian Edwards: Now in terms of debt equivalent, the total debt that had the gold clause was calculated to be a $120 billion, and GDP was estimated… We didn’t have very good statistics then, but it was estimated to be, at most, $80 billion. So more than about 140% of the GDP was written with a gold clause. To put things in perspective, today the public debts of the US government, the federal debt, is less… Almost about a 100% of the GDP. So everything was under the gold clause. And when FDR thought, or was prompted by the inflationist senators, Elmer Thomas and Burton Wheeler in particular, he is prompted to devalue the dollar. He said, “Okay, we’re gonna do this. We’re gonna get off the gold standard and do what the Brits did.” His advisors told him “Hold on, if you do that, the value of every debt is going to go up by the amount of adjustment of the price of gold.”
32:20 Trevor Burrus: Yeah. So I wanna just be clear as I said, as a non‐economist lawyer, that…
32:23 Sebastian Edwards: Yeah.
32:24 Trevor Burrus: So let’s say I buy a house in 1914.
32:28 Sebastian Edwards: Yeah.
32:28 Trevor Burrus: And I get, I don’t know, maybe the $3,000 loan, that’s probably about maybe what a house was.
32:33 Sebastian Edwards: Yeah.
32:33 Trevor Burrus: And the gold clause in there says that I can pay… Is it, I can pay it back in the equivalent gold value of the time? Because is this really a thing to protect the creditor against inflationary monetary policy? So they can ask for the gold if the money becomes relatively worthless?
32:53 Sebastian Edwards: That is exactly what it’s trying to do.
32:56 Trevor Burrus: Okay.
32:57 Sebastian Edwards: And as I said, it’s put on during the Civil War because you could try to pay your debt back with greenbacks, which were unbacked by gold, but a greenback was not worth the same as a dollar that was backed by gold. So to protect creditors, every loan, or almost every loan, had the gold clause in it.
33:25 Trevor Burrus: But because the price was so stable, it didn’t really matter.
33:26 Sebastian Edwards: You’re right, that’s the point I was going to make. But since the price had not changed, it didn’t matter.
33:33 Trevor Burrus: Yeah, so the the real problem here seems to be FDR’s decision to raise the price from $20.67 an ounce to $35, so then the problem was that the creditors could call on their debt and ask for it now in the new price of gold, and that means that it seems like a windfall.
33:49 Sebastian Edwards: Every railway, every utility, every electrical power company, every mortgage debtor would have gone bankrupt, or most of them, because they would have had to pay 69% more.
34:05 Trevor Burrus: So I can see how they can say it was necessary for the congress passes this act that says, “All these clauses and contracts that go back decades are now no longer valid.” I could see how that’d be necessary if you raise the price of gold, but you don’t have to raise the price of gold. He could have confiscated gold and kept gold at $20.67.
34:25 Sebastian Edwards: Yeah, but we can get to that later.
34:27 Trevor Burrus: Okay.
34:27 Sebastian Edwards: There’s a raincoat to that. You could have done that. And then I discussed that in the book to some extent. But going back to the gold clause, you’re absolutely right. And so FDR says “Well, we have a huge majority in both houses of Congress, let Congress pass legislation annulling these clauses.” And that’s what Congress does on June 5th of 1933. And it’s a joint resolution… I’m not a lawyer, but a joint resolutions are not that common, of the house and the Senate, and the gold clauses are abrogated. So now the Congress says, “Yes, all these debt were written in gold equivalent but they can be discharged from now on, independently of when they were written, they can be discharged in paper dollars at the old value of the dollar.”
35:28 Trevor Burrus: So now as lawyer, that’s where you come in with this. There’s a few clauses in the Constitution, but one of them for example, says that the Federal Government shall not impair obligations to contracts, and that seems like a really good example of impairing obligations to contract. So a few cases get filed, they get put together into where we call the Gold Clause cases. What are some of those cases that get filed?
35:55 Sebastian Edwards: Yeah, there are… So as people get paid with paper dollars at the old lower price, they bring their cases to court, and there’s a huge confusion. And so the government asked the Supreme Court to consolidate the cases and four cases go in front of the Supreme Court. Two of them are private debt and two of them are public debt. The private debt cases, one is a Railway Bond where the holder has a bond, I don’t know, $10,000 bond and he wants back 16,900, which would be maintaining the gold equivalent at the new price of gold. The government is not part of that case, it’s private. It’s a private debtor and a private creditor.
36:53 Sebastian Edwards: The second private case is a mortgage, where the senior… It’s a bankruptcy case, excuse me. It’s a bankruptcy case where senior creditors have gold clause debt, and they want to be paid in gold equivalent. The junior, unsecured, non‐gold clause creditor say, “No, because if you pay them at the new price, the amount of money leftover for us is going to be diminished significantly by 69%.” And the Reconstruction Financial Corporation, which is a government agency, is one of the junior creditors. So the government, because of that, can be part of that… I’m not a lawyer, but because of that, it’s part of that private case. So the government is part of that private case because it is a creditor in that bankruptcy.
37:52 Sebastian Edwards: The two public sector cases come through the Court of Claims. The Court of Claims asked the Supreme Court what to do. They don’t know whether they should accept these cases. And one is a Liberty bond, which is issued in 1970, and the holder of that bond wants to be paid at the new rate. And the other one is a Gold Certificate, which as I explained, many people considered to be a Warehouse voucher or Warehouse coupon. And they say, “I gave you, guys, a bar of gold. I want my bar back, but I understand that it’s illegal for me to hold it. So give me the money equivalent at the new price or gold.” And the government says, “No. We’ll give you the money equivalent but at the old price.” So those four cases go in front of the Supreme Court. And they are heard on January 8 through 11 of 1935.
38:50 Trevor Burrus: And it didn’t seem… During the oral argument, there were some laughter and some mocking, and some questions from the Supreme Court, it didn’t seem to go too well for the government.
39:02 Sebastian Edwards: Right. So, what is interesting is that… So the timeline, and I have in the book, the timeline, which is interesting. The confiscation of gold is on April ’33, the joint resolution annulling the clauses is in June. The dollar value of gold is increased by 69% in January of ’34, and the cases are heard in January of ’35. So there’s a whole year where the country is functioning at the new price of gold, and things are going well, the country is recovering. So when the cases are heard, people that are not claimants really don’t want the gold clause to be, the annulment, to be ruled unconstitutional because they think, “Well, the country is recovering.” And the government does not do very well in arguing these cases. It’s argued first by the Attorney General himself. I did a little research on how common it is for Attorney Generals to argue in front of the Supreme Court.
40:26 Trevor Burrus: Very rare.
40:26 Sebastian Edwards: I found out that it’s rare.
40:28 Trevor Burrus: Yeah.
40:28 Sebastian Edwards: It was not the only time, nor the first time, nor the last time, but very rare. And the protocol, at least at the time, seemed to be that when the Attorney General argue the case, the justices, because of deference, did not ask questions or interrupt. So the first day goes smoothly, Homer Cummings gives a speech and nothing happens. And the second day, the Solicitor General and some Deputy Solicitor Generals start arguing, and they get interrupted and mocked and there is laughter and all sorts of problems. And you read the press of the time, and there is generalized concern that the government, or agreement that the government has done very poorly and people think the court is going to annul the joint resolution.
41:26 Sebastian Edwards: The Court had just, a few days earlier, had ruled on with the Panama Oil Case, also known as the Hot Oil Case, and it had ruled against the government. So there was a lot of concern by this point that the court maybe was becoming very skeptical about the New Deal, which it did later. So, here we are in mid‐January of 1935, and people think, “Oh my God, this is going to be bad for the government.” And people start preparing for this. And that’s another thing that I found out, which is that FDR, decides that if the court rules against the government, he is not going to abide by the court ruling.
42:10 Trevor Burrus: Yeah. He writes a speech that I find it great that you found in the archives. It says, it’s written in his hand, “This is a speech I would have given if the Supreme Court would have struck down the annulment of the gold clauses.”
42:21 Sebastian Edwards: Yeah, the night after the day.
42:24 Trevor Burrus: Yeah, and it’s basically precipitating a constitutional crisis, which he would a couple years later anyway.
42:28 Sebastian Edwards: Oh, yeah. Yeah.
42:31 Trevor Burrus: So it would just been earlier than the court‐packing plan.
42:34 Sebastian Edwards: Exactly.
42:34 Trevor Burrus: And there’s a lot of gnashing, there was lot of hand wringing and everything from the government coming up and FDR continually made this argument which you point out multiple times that was just wrong, where he kept… He would always say that there’s not enough gold in the world to cover all the debts from the gold clauses. That just seemed to be that, either he didn’t understand or he was just demagogue. I’m not sure. Why is that a bad argument?
42:56 Sebastian Edwards: Yeah, I know, I think that he didn’t understand that. And there is a beautiful article written in ’32 by a Jacob Viner, who at the time was a professor at the University of Chicago and ended up his career at Princeton, very distinguished international economist and who actually was one of the first professional economist who advised the Roosevelt treasury starting in ’34. And Viner says, “We have a pyramid of credit in this country, and gold is the base of that pyramid. It’s not the whole pyramid. So you don’t need it to have all of credits backed by gold. All you need is to have a solid base in this pyramid.” And FDR did… He was very smart. So I don’t think that he didn’t understand that. He was just using that argument because it resonated with people.
44:00 Trevor Burrus: Which he was good at.
44:02 Sebastian Edwards: He was very good at that.
44:03 Trevor Burrus: Yeah.
44:03 Sebastian Edwards: And one of the things that I did while doing this research was to listen to many of his speeches, and he was very reassuring. A slightly nasal voice, tenor timbre, patrician accent. He was a master.
44:27 Trevor Burrus: Yeah. So the decision comes down, and Charles Evans… Chief Justice Charles Evans Hughes… It’s a little bit split because there’s four cases here and there’s two private, two public, but overall it’s a victory for the government. But it’s kind of an interesting victory in a way.
44:44 Sebastian Edwards: It is very interesting. The private cases… So let me slice it in the following way. There is no disagreement that Congress can change contracts going forward. So the Congress can say, “From now on, we don’t allow gold‐based contracts.” That’s not an issue, but that’s of course contestable. On the private cases, the government position is that the Constitution very clearly gives Congress in Article 1, Section 8, power to coin money and determine the value thereon. Or mint money, I think it says. I forgot…
45:27 Trevor Burrus: It says coin money and regulate the value thereof, yeah.
45:30 Sebastian Edwards: Right. Okay. So that’s, yeah, is one of the powers of Congress. And when the court decide by 5 to 4, and it’s not that controversial, is that if in order to run monetary policy as it were, Congress decides that you cannot have or should not have a gold written private contracts, it can do that. So that was the argument for the private cases. Congress has the power to determine the value thereon. It can define what is legal money. And if they say paper dollars are legal money, they’re legal money and if they’re legal money you can pay private debts using that legal money.
46:16 Sebastian Edwards: The problem came with the public debt cases. And there, the Chief Justice who wrote the opinion did something quite remarkable which is he said, “Yes, Congress does have the power to regulate the value of money, but it also has the power to issue debt on the credit of the United States.” And issuing debts means that you are at the same time committing yourself to paying it back. Thus he said, “You cannot use one power to contradict or eliminate another power. So it is unconstitutional for the government to annul the gold clause in public debt.” And then he added, “However, there are no damages because the price of things, prices… ” Because of what we said earlier at the of deflation. “Prices have gone down and the purchasing power that the holder of the debt would obtain by getting his or her money under the old price is enough to buy the same amount of goods, the same basket, that he or she could have bought at the time he or she bought the bond.” So it’s unconstitutional but there are no damages, thus the government wins.
47:50 Trevor Burrus: Yeah, you compared… It’s an incredibly, I don’t know, weaselly opinion… That’s not the word, it’s very, very deft and it gets around some of the issues, but you compare it to Marbury in the sense of being able to rule that something is unconstitutional and at the same time say, “Well nothing happens because of that.”
48:10 Sebastian Edwards: Right.
48:10 Trevor Burrus: Right.
48:11 Sebastian Edwards: Right, right.
48:11 Trevor Burrus: Get out from under.
48:12 Sebastian Edwards: So at the time, there are lots… And what is surprising is that if you go back to the law review articles of the time, they are repeat with articles about these cases. And at the same time, 80 years later, we have collective amnesia. But one of the points that the scholars make at the time is that it is like Marbury. But this also generates a rift between the Chief Justice Charles Evans Hughes and Justice Stone who would become Chief Justice three years later. Because Stone thinks that it’s enough to say that… For the court to say that there are no damages, and there is no need to rule on the constitutionality of the issue. And so, he writes a long letter to his son, which you can find in his archives, of making that point. And some scholars agreed with that. So from… I’m not a lawyer, but after doing this research, sometimes I wonder whether I should have [chuckle] become a lawyer and work on constitutional law, but anyway, it’s too late for that.
49:27 Trevor Burrus: It’s a fun job, I suggest it. But you already had your PhD and everything. Let’s talk about consequences, though, and just how this is perceived. We’ve talked a lot about whether it was necessary raising the price of gold, all these things. And Milton Friedman and Anna Schwartz, had sort of said in their history that a, “Discouraged business investment that this was a bad policy for FDR to do.” We talked about some of the weirdness of it, setting the price of gold from your bed. What can we say? It’s hard to do the counterfactual, but what can we say about how this was done, whether it should have been done and whether there was some other way of doing it, that would have been better.
50:04 Sebastian Edwards: Let me take that from the following perspective. One of the things that we teach our students, when we teach economics at any level, grad level or undergrad level, is that, if a country repudiates its sovereign debt or restructures it in a unilateral fashion imposing great costs to creditors, that the market will punish that country. And it will have no access to capital markets for sometime and when it does, it will have to pay a very high premium, risk premium, because of the precedent that its repudiation has created. We don’t see any of this in this case in the US. The US had no problem of the government recalling its debts. It didn’t have to pay a higher price or higher yield, it was not punished by the markets in spite of what Milton and Anna said.
51:15 Sebastian Edwards: By the way they only have a very short paragraph for the gold clause, which was surprising to me. And likewise Allan Meltzer also devotes very little space to it in his magnificent History of the Federal Reserve. I talked to both Milton and Allan extensively about the issue. So I was fortunate to be a colleague of Milton Friedman in Governor Arnold Schwarzenegger’s Council of Economic Advisers here in California. And during coffee breaks, I would ask Milton about the episode. And so, we talked quite a bit about it, but the surprising things, as I said, the US was not punished by the market. And then we have to sort of speculate, why was that? And you can see Argentina, Greece, all of these countries severely punished. The Dominican Republic. You go through the list, all them have punished by the market in more modern debt restructure.
52:22 Sebastian Edwards: And the point that I make in the book is that, this was seen by the market as un‐excusable default. And in part because of what you said earlier, which is that if you get out of the gold standard, that’s a big IF, we can get that, then you have to get rid of the gold clauses. And it was done by following due process. In independent judiciary looked at the case, claimants had all the time in the world and all the resources to present their case, the Supreme Court deliberated very long and seriously about it. And at the end, I think that the market understood that there was necessity, there was a need to do this in order to get out of the Great Depression. The fact that… Let me just say one more thing, the fact that a year had gone by, 1934, the whole of 1934 had gone by between raising the price of gold by 69% and the cases, and that that year was a year of great economic recovery, I think also played a very important role. Because the market said, “Well, it was needed and the way things are working shows that it was a good thing to do. We are recovering. The US is improving.”
53:52 Trevor Burrus: Well, it was moving up from a very low point, and of course it would crash again in 1937 and never really…
54:00 Sebastian Edwards: Right, and… That is true, yeah. [laughter]
54:01 Trevor Burrus: So that could have been… It’s too hard into the counter‐factual. As a lawyer, the reasoning in the Gold Clause Case is quite suspect and using this necessity. But you, as an economist, it’s interesting that, as you said this, that we didn’t see this consequence of public debt being difficult, the market punishing the repudiation of the debt, but in that… Since we’ve seen so many South American countries and Euro crisis countries doing some other thing, this shouldn’t be something that we would advise anyone to do now. But I wanna ask you the question that you ask at the end of your book, which is, “Could this happen again?”
54:43 Sebastian Edwards: Yes, so we would not advise countries to do this. Now, what we have now is a situation where the government used the necessity argument and the Supreme Court thus agreed with the government. Could that happen again? It happens every day. Argentina used that argument, except that their tribunals did not side with Argentina. That the Argentina lawyers know their constitutional law, know their precedent, and they use the case, the same argument. Now, why the tribunal did not side with them, that’s a different story. But look at Italy now. It has a new government, a very nationalistic, a Euro skeptic government, and they may decide that in order to solve the Italian problems, there is the necessity for Italy to get out of the Euro and re‐issue the Lira. At which point the whole question of contracts will come up because every contract in Italy now is in Euros. And what if they were to reintroduce the Lira, as the Greek seriously considered re‐introducing the Drachma a few years back, then what do you do with the contracts? And then the necessity argument, in this case would be invoked. So internationally it could happen, it does happen.
56:15 Sebastian Edwards: Could it happen in the US? That’s more difficult and more interesting question. And the point here is that we have a huge contingent liabilities debt, contingent debts or undocumented debt that stems from Social Security, and from Medicare and Medicaid. And people, including people at Cato, who have calculated the present value of the unfunded liabilities think that they are 400% of GDP, 500% of GDP, there are all sorts of numbers. And at some point, we could have the government say, “Well, we are going to change these contracts or replace the contracts and we are not going to pay according to promise.” And it will go to court, and people then think that there is a social security crisis looming. And I know that at Cato you have a very vibrant group dealing with this issue. I think that, that could happen, and then the court could say, or the lawyers will say, “Well look, this resonate ’35. And you guys once accepted the necessity argument, you should do it again.”
57:41 Trevor Burrus: Thanks for listening. Free Thoughts is produced by Tess Terrible. If you enjoy Free Thoughts, please rate and review us on iTunes. To learn more, visit us on the web at www.libertarianism.org.