Keep the Gold Reserve

May 22, 1961

If Congress, as the Administration now proposes, repeals the requirement for the Federal Reserve System to hold even a 25 percent gold reserve against its note and deposit liabilities, the United States will, in effect, drop the last vestige of a domestic gold standard.

The international gold standard, when it prevailed, was the chief safeguard against tampering with the currency on the part of politicians and bureaucrats. It was the chief safeguard against domestic inflation. It did not “break down”; it was mismanaged and abandoned; and precisely because the politicians in most countries wanted to inflate. The result has been monetary chaos. In its May letter the First National City Bank of New York prints a table covering 43 countries. It shows that the dollar has been losing more than 2 percent of its purchasing power every year since 1950; the British pound, 4 percent; the currencies of Brazil, Argentina, Paraguay, Chile, and Bolivia, from 14 to 37 percent a year. Even the American depreciation rate would mean the loss of half the value of the currency in 33 years.

Every major step we have taken since 1932 has been away from the discipline of the gold standard. For 30 years the Federal Reserve Banks had been required to keep gold reserves of 40 percent against their notes and of 35 percent against their deposits. In June 1945 the Reserve authorities, fearing the continuation of World War II, asked that the legal reserve ratio be reduced as an “emergency” measure to only 25 percent for both notes and deposits. Though the war went on only a couple of months more, the higher reserve requirement was never restored.

BLOW TO CONFIDENCE

Meanwhile, we have continued to expand our credit and paper-money supply. Our total of demand and time deposits and currency outside of banks has increased from $150 billion at the end of 1945 to $250 billion. As its expiring act, the Eisenhower Administration prohibited Americans from buying or owning gold even abroad. And now the Kennedy Administration asks that even the legal requirement for a 25 percent gold reserve be abandoned.

Whether the first effect of such a measure would be to increase or undermine confidence in the dollar abroad, to reduce or intensify the foreign drain on our gold, we would learn very shortly. But its long-run effect could only be to undermine confidence in the dollar still further, both at home and abroad. Some Americans may fear that foreigners would drain us of gold, leaving us with no gold backing for our dollars at all. Even if such fears prove to be exaggerated, the last legal obstacle to an indefinite expansion of the Federal Reserve’s note and deposit liabilities would be removed. Congress would be assumed to have given a green light to further inflation.

HALT THE INFLATION

Only under one condition would even a temporary suspension of the 25 percent gold-reserve requirement (already legally possible by simple vote of the Federal Reserve Board) be justified. This would be to accompany the suspension by the requirement that neither Federal Reserve Banks nor member banks would be permitted to expand their total net loans or investments by a single dollar until the reserve ratio was restored.

Even this would not be too much assurance against further inflation. The present reserve ratio is 38 percent. This would still permit a substantial credit expansion under the present 25 percent legal minimum.

The abandonment of the 25 percent gold-reserve requirement, in brief, is the very opposite of what should now be done. What is required is a statement by the Kennedy Administration, accompanied by appropriate action, that our inflation can and will be halted. But every major economic measure that the Administration has so far supported moves toward more inflation.

We seem to have come to a point where the least-harmful immediate steps would be to put a temporary embargo on gold export, and permit a free market in gold. Later we could try to fix a sustainable value for the dollar and return to the discipline of a full gold standard.