Is Gold Just a Relic?

December 21, 1959

Roy L. Reierson, vice president and chief economist of the Bankers Trust Co. of New York, has proposed that we reduce or even eliminate the present 25 percent gold reserve requirement against Federal Reserve note and deposit liabilities. His proposal illustrated what happens once a full gold standard has been abandoned for a partial or make-believe gold standard.

Reierson argues that, though our gold reserve is still about $19.5 billion, more than half of this must be held as reserve against domestic liabilities. “Almost $12 billion of gold is required to be held as a 25 percent reserve against approximately $47.5 billion of Federal Reserve note and deposit liabilities, even though these are no longer redeemable in gold. This gold is thereby barred from functioning as a means for settling international accounts—the remaining essential function of gold in our monetary system.” This leaves available only $7.5 billion of “free” gold against some $16 billion of short-term dollar balances held by foreigners, plus $3 billion held by the IMF and other international institutions.

PURPOSE OF A RESERVE

The situation, Reierson thinks, has led to fears abroad that “if further heavy inroads are made upon the free gold, the United States will be compelled to stop making gold available for international settlement and thus devalue, even though most of our gold reserve might still be intact.” On the other hand, “if the United States were to eliminate altogether a formal reserve requirement for the central bank the monetary gold stock would cover these foreign liabilities by about 100 percent.”

The astonishing thing about this proposal is that it is not made by an irresponsible inflationist but by a highly reputable banker and economist who deplores inflation. Its ostensible purpose is to strengthen our present for-foreigners-only gold standard. That it would achieve this declared purpose is improbable. Such an announcement would more likely be interpreted as dropping the last vestige of a domestic gold standard.

What, after all, was the purpose of a legal gold reserve? It was to ensure convertibility at all times of bank notes and deposits into gold. The chief purpose of this, in turn, was to prevent an undue or unsound expansion of credit and currency. The reserve ratio was a sort of thermometer; it was constantly watched, both at home and abroad. When credit expansion or a gold drain brought the reserve ratio dangerously low, the monetary authorities had to raise interest rates and halt further credit expansion to prevent a further gold drain. Reierson’s proposal would destroy the thermometer, smash the pressure gauge, remove the warning signs and traffic signals.

TO RESTORE CONFIDENCE

Consider the history. In 1933 and 1934 we abandoned a real gold standard, devalued the dollar to 1/35 of an ounce, put even this on a “24-hour basis,” and allowed only foreign central banks, not American citizens, to demand gold. In 1945, Congress, at the request of the Federal Reserve, reduced the legal requirement of a 40 percent gold certificate reserve against Federal Reserve notes and 35 percent against deposits to a uniform requirement of only 25 percent. At the end of 1944 total deposits and currency amounted to $151 billion; today they exceed $248 billion. The increase of 64 percent in the total money supply is enough to account for the increase of 64 percent in consumer prices in the same period.

Reierson thinks that: “In the future, as in the past, we shall have to depend upon the integrity and good judgment of the Federal Reserve officials to establish a credit policy appropriate to conditions in the United States economy.” I submit that we need something much more solid to depend on than the arbitrary discretion or caprice of present or future monetary managers.

The immediate need is to halt the inflation, and to restore confidence in the dollar at home as well as abroad. To prevent resumption of inflation, we must ultimately restore the discipline of a full gold standard. Meanwhile our measures should move toward that goal and not remove the last hopes for its attainment.