Halt Inflation Now

January 11, 1960

Three weeks ago I discussed here the proposal of Roy L. Reierson of the Bankers Trust Co. of New York that we eliminate the present 25 percent gold-reserve requirement against Federal Reserve notes and deposits. Because of limitations of space, I could not do full justice to that proposal. I believe Reierson’s solution is wrong. But he has had the clear-sightedness and courage to call attention to the problem.

The problem, to restate it, is this. Though our gold reserve still stands at about $19.5 billion, more than half of this must be held as a reserve against liabilities. About $12 billion in gold is required to be held as a 25 percent reserve against $48 billion of Federal Reserve notes and deposits. This leaves available only $7.5 billion of “free” gold against some $19 billion short-term dollar balances held by foreigners (including $3 billion held by international institutions).

Foreigners, says Reierson, measure our gold losses not against our total stock of gold but against our very much smaller amount of free gold. This may lead to fears that, if this “free gold” is exhausted, we will be compelled to stop making gold available for international settlement, and thus devalue. His suggested remedy is that we either reduce or eliminate our present 25 percent gold-reserve requirement entirely, to assure foreigners that the whole amount would be available to them.

NO SOLUTION

I do not think this step would provide any real solution. It would drop the last vestige of a domestic gold standard. It would keep the dollar temporarily good for foreigners at the cost of undermining permanently its value for Americans. If foreigners withdrew all their present short-term balances in gold, it would leave Americans with no gold backing for their dollars at all. The proposal turns the perfectly sound principle that gold convertibility ought not to discriminate against foreigners into the untenable proposition that it ought to discriminate against Americans.

And even so it would give only temporary assurance to foreigners unless accompanied by unmistakable evidence of the determination on the part of our government to halt our inflation immediately. With the gold-reserve requirement entirely removed, this assurance would have to take the form of an act of Congress, forbidding any further increase in the supply of money and bank credit. This in turn could only be achieved by not allowing any bank to increase the total of its loans and investments—which means that it could not make any new loan until an equivalent old loan had been repaid.

In the present inflationary mood of Washington, such a proposal would be dismissed as unthinkable.

STRINGENCY NEEDED

But no solution of the problem is possible unless the inflation is halted, by whatever means. Instead of eliminating the gold-reserve requirement entirely, it ought to be restored immediately to the pre-1945 level of 35 to 40 percent—preferably to a flat 40 percent against both notes and deposits. But as the reserve has already been allowed to fall to this level, this too would mean that no further increase could be allowed in money and bank credit until our gold holdings themselves increased.

Even if we hope to remain merely on our present for-foreigners-only gold standard, we must continue to let gold, if demanded, flow out. On this point Reierson is right. But if we hope to keep our foreign creditors from demanding gold, if we mean to protect the integrity of the dollar, if we intend to prevent devaluation, we must stop the further expansion of money and bank credit by one method or another.

If this takes the form of “orthodox” measures, those orthodox measures must be stringent. The budget must be immediately balanced. (Renewed promises of a balance in the sweet by-and-by are no longer enough.) Congress must repeal the legislative ceiling of 4½ percent on long-term government bonds. Interest rates must be raised to the point where they cease to encourage further expansion of credit.

The future of the dollar depends on whether we have the stomach for such decisions.