Default Setting.

I’m not sure that History weighs on us, but Memory certainly does.[1]  For example, inflation and deflation are subjects of learning and memory for those who experience them.  Deflation (falling prices) plagued American borrowers and benefitted American lenders in the last quarter of the 19th Century.  People looked at inflation (rising prices) with longing or loathing.  If you were, say, 64 in 1934, then you were born in 1870.[2]  Growing up, you would probably have heard about reams of paper money printed without any fixed relationship to gold in order to finance your particular country’s search for victory in the Civil War.  As an adult, you would have read with exultation or dread, depending on your social class, William Jennings Bryan’s “Cross of Gold” speech and the Populist calls for the free coinage of silver at a ratio of 16:1.  That is, you would have been familiar with inflation as a good thing (for debtors) or a bad thing (for creditors), rather than as just a normal thing.  In the wake of the election of 1896, a conservative victory, Congress enacted American adhesion to the gold standard.  However, that was just Congress, a bunch of gutless poltroons (why else would you bribe them?) who might change their minds with the wind.  As a result, many lenders inserted “gold clauses” in contracts.  These obligated borrowers to repay in gold coins of “present weight and fineness” or in paper of equivalent value.  Basically, “gold clauses” were inflation-proofing insisted upon by lenders.  They applied to various contracts, but especially to bonds—government and corporate IOUs.

OK, skip ahead to the Great Depression of the 1930s.  Taking the leadership of a country sunk in the slough of despond, Franklin D. Roosevelt opted for inflation over deflation.  He severed the United States from the Gold Standard, which kept currencies fixed at specific rates of exchange, and then revalued the dollar.  This allowed Roosevelt to “raise” the price of gold held by the United States and print more dollars to accommodate its higher price.  The “price” of gold rose from about $21/ounce to $35/ounce.  So, by about two-thirds.  This inflated prices and devalued debts.  Great!  For anyone who had debts not inflation-proofed.

At this point, Roosevelt’s policy slammed into the “gold clauses” on many bonds.  Because of the two-thirds rise in the price of gold, debtors had to pay lenders about two-thirds more than they had borrowed.  One of those debtors was the United States government, which owed about $20 billion in gold-clause bonds.[3]  In 1935, the Supreme Court—in the “gold clause cases:–held that the government could abrogate public and private gold clauses.  That is, the U.S. government is not obligated to pay its debts and it did not pay them in this case.

Still, it is a commonplace that the United States has never defaulted on its debts.  That reassuring belief keeps people buying Treasury bonds when the deficit and national debt keep growing to extraordinary levels.  Except, maybe Bill Gross when he was at PIMCO.[4]

[1] That’s probably why “we” never learn from the past, but individuals often do learn from the past.  There is no way to transmit the acquired knowledge.  They why study History at all?  Because smart people will be among the few who learn lessons and for everyone else, it’s pretty entertaining.

[2] Sebastian Edwards, American Default: The Untold Story of FDR, the Supreme Court, and the Battle over Gold (2018).

[3] Worth about $380 billion in 2018 dollars.

[4] https://www.theatlantic.com/business/archive/2011/03/pimcos-gross-asks-who-will-buy-treasuries-when-the-fed-doesnt/72276/ ; https://www.theatlantic.com/business/archive/2011/05/bill-gross-on-deficits-and-the-fed/238682/

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