The Fed, the US Treasury and gold in the early 20th century

Hi Koos,

There are two gold prices, the official one and the market one.

By mid 1933 Roosevelt had taken the U.S. off the gold standard, although the official gold price was still at its old level of $20.67. In October 1933 Roosevelt began to buy gold at prices above that level. He had soon bid the market price of gold into the $30s. He used the Reconstruction Finance Corp, not the Fed to do the buying. So he would not have been creating new money to do the buying, since only the Fed creates new money. He bought in limited amounts, according to Scott Sumner, the evidence of this being that the international price did not converge to the U.S. price.

The January 31, 1934 event was a re-establishment of the gold standard at a new official price of $35.

The peg was maintained by having the Treasury buy all gold at a price of $35 from foreigners and mines. However, once this gold was bought the Treasury could write a gold certificate and deposit it at the Fed, getting new deposits in return. So in essence the peg was financed by Fed money creation, just as it had been from the founding of the Fed until mid-1933.

Ah, Frank Graham. Not a fan of the gold standard. He advocated a commodity basket approach to money, if I recall correctly.

Another question I can't get my head around.

Graham first writes on page 4 gold purchasing power increased over '100 years', which he finds remarkable but is likely due to technological development that made commodities cheaper to produce. The resulting deflation (denominated in gold) is clear to me.

But then he writes on page 5, “the purchasing power of an ounce of gold in 1920 was … less than a third of what it is today [in 1939]” . Here I'm thinking if the devaluation of the dollar vs gold (20.67 - 35) had a side effect of increasing gold's purchasing power. My first logic tells me that if one devalues anything but gold, for example the dollar, gold's purchasing power versus commodities would remain equal. Or did the devaluations of the GBP (1931) and USD (1933) and gold's new fixed parity to the dollar in international markets drive up gold's purchasing power 'internationally'?

J

Be careful. Graham finds the rise in gold's purchasing power remarkable because it happened while major technological developments in mining were occurring. Technology meant more gold coming out of the ground, which all-things-staying-the-same should lead to gold's value--or its purchasing power--falling, not rising. In a nation on a gold standard, this would cause inflation, not deflation. But surprisingly enough, gold's purchasing power actually increased over the 100 years he describes, i.e. a steady deflation occurred in gold standard nations.

As for his points about gold volatility on page 5, David Glasner has written some interesting stuff about gold's behaviour during WWI. When nations suspended the gold standard, the demand for gold declined. This happened for two reasons. The requirement for gold as backing for the money supply disappeared(replaced by war-time financing) as did the necessity of buying gold to issue gold coins. Secondly, governments actively suppressed the private demand for gold. So most actors became sellers during the war. Thus gold's purchasing power steadily declined, reaching a bottom in 1920 or so. Which is the date that Graham brings up as being "far less than any of the years mentioned."

Graham then says that the purchasing power of gold rose by 2/3 until 1939. Did the devaluations have something to do with that? A devaluation could not have increased gold's purchasing power for more than a short period because prices would soon adjust, restoring gold to its pre-devaluation purchasing power. One caveat is that consumer goods and services prices are generally sticky and cannot be arbitraged (i.e. think hair cuts) so "short" could mean several years. But prices of tradeables and durables would adjust very quickly.

What may have driven the price of gold up from 1920 was the reverse of WWI. Nations were all trying to restore the gold standard, so they once again became buyers. When nations left the gold standard between 1931-1933, one would expect a return to the WWI experience (i.e. a fall in gold demand and declining purchasing power of gold), but that didn't seem to happen... which may be why Graham says that there is a gold problem.

Ok, one final short question. Why do you think China sold gold in the 1930s? (I like to be more confident on this)

Graham writes:

'For hundreds, perhaps thousands, of years the demand for gold in the Orient was so large and constant that the East was referred to as a “sink for the precious metals.” Since 1930, however, the Orient has been not a sink but a spigot. Hoarding has given way to dishoarding; in the early ’thirties a billion and a half dollars’ worth of gold poured out of India and China and was added to the stocks of gold available in world markets. … In other words, a usual source of demand has, in recent years, turned into a source of supply.'

Did they sell before the US devalued? Or after? Was it because other nations like the UK also devalued against gold?

Did China sell gold for fiat simply because they thought that after devaluations of fiat this fiat had bottomed vs gold?

What about this theory... (Yes, I'm still thinking about why India and China became gold sellers in the 1930s. I'm writing an article about it and like to be sure.)

When in 1929 countries started to abandon the gold standard, to devalue against gold, did that push up the "international gold price"? It would right? This would explain a lot.

China was on a silver standard until 1935. After 1929 the gold price dominated in yuan started rising (just like the gold silver ratio, btw). Maybe Chinese people sold some gold simply because the gold price in yuan went up?

Same with India. In 1931 the rupee gold price went up (because the UK devalued against gold?), and then it fell again, only to raise again in 1934 (because the US devalued against gold?).

drive.google.com/open?id=18osb-LoDN1TJeA2-mvEUzPr6QVUnzuGT

I know all over the world people sold gold in the 1930s. Maybe for the simple reason its price had gone up, and by 1934 the US guaranteed to buy all gold in exchange for $35 dollars an ounce.