Friday, August 31, 2018

Book Review: “American Default: The Untold Story of FDR, the Supreme Court, and the Battle over Gold” by Sebastian Edwards

For many years, I worked on public debt management issues at the U.S. Treasury Department. One of the things we touted was the safety of U.S. Treasury securities. Of course, Standard & Poor’s downgraded the credit rating of Treasury securities in 2011 from AAA to AA+ in reaction to the debt limit crisis of 2011—I was no longer working at the Treasury thenbut Treasury has always held to the line articulated by Secretary of the Treasury Robert Rubin that default was “unthinkable,” which, if you think about it, is a clever bit of ambiguity. 
Lurking usually quite quietly in the background, though, has been the abrogation of the gold clauses on government bonds (and private-sector ones) by the Joint Resolution of June 5, 1933. This resolution stated in part:
Resolved by the Senate and House of Representatives of the Clauses in Congress assembled, That (a) every provision contained in or made with respect to any obligation which purports to give the obligee a right to require payment in gold or a particular kind of coin or currency, or in an amount in money of the United States measured thereby, is declared to be against public policy; and no such provision shall be contained in or made with respect to any obligation hereafter incurred. Every obligation, heretofore or hereafter incurred, whether or not any such provision is contained therein or made with respect thereto, shall be discharged upon payment, dollar for dollar, in any coin or currency which at the time of payment is legal tender for public and private debts. Any such provision contained in any law authorizing obligations to be issued by or under authority of the United States, is hereby repealed, but the repeal of any such provision shall not invalidate any other provision or authority contained in such law. 
Sebastian Edwards new book, American Default: The Untold Story of FDR, the Supreme Court, and the Battle over Gold tells the story of the Roosevelt Administration’s improvisational approach to handling the Depression and its concomitant financial sector problems with respect to gold. The aim was to combat deflation and, especially, increase the price of agricultural commodities, and this eventually led to the Joint Resolution. The action then moves to the Supreme Court, which effectively, though in the case of government bonds not literally, upheld the abrogation of the gold clauses for both government and private sector bonds in opinions (decided 5-4) written by Chief Justice Charles Evan Hughes. The opinions give different reasons for the two type of bonds. Technically, in the case involving government bonds, the opinion stated that Congress had exceeded its power in abrogating the gold clause but that the plaintiff had not suffered any damages. It relies on the fact that gold was no longer permissible to be used as money in the United States. The reasoning is a bit hard to follow, but here is the key paragraph of the opinion:
Plaintiff demands the “equivalent” in currency of the gold coin promised. But “equivalent” cannot mean more than the amount of money which the promised gold coin would be worth to the bondholder for the purposes for which it could legally be used. That equivalence or worth could not properly be ascertained save in the light of the domestic and restricted market which the Congress had lawfully established. In the domestic transactions to which the plaintiff was limited, in the absence of special license, determination of the value of the gold coin would necessarily have regard to its use as legal tender and as a medium of exchange under a single monetary system with an established parity of all currency and coins. And, in view of the control of export and foreign exchange, and the restricted domestic use, the question of value, in relation to transactions legally available to the plaintiff, would require a consideration of the purchasing power of the dollars which the plaintiff could have received. Plaintiff has not shown, or attempted to show, that, in relation to buying power, he has sustained any loss whatever. On the contrary, in view of the adjustment of the internal economy to the single measure of value as established by the legislation of the Congress, and the universal availability and use throughout the country of the legal tender currency in meeting all engagements, the payment to the plaintiff of the amount which he demands would appear to constitute not a recoupment of loss in any proper sense, but an unjustified enrichment.
For those really interested, the government bond opinion can be found here, 294 U.S. 330 (1935), and the private sector bond opinion can be found here, 294 U.S. 240 (1935).) It is worth noting that this is the same Supreme Court which infuriated FDR in its decisions on some other cases involving laws implementing the New Deal, leading to his failed court packing scheme. In the event, personnel changes at the Supreme Court during FDR’s long presidency ultimately resolved the Administration’s problems with the Court.
I became aware of these cases early in my tenure of working in the Domestic Finance section of Treasury. At the beginning of the Reagan Administration, there was pressure from supply siders and conservative economists, most prominently Milton Friedman, for the Treasury to sell bonds linked to gold. The aim was to return the U.S. to an ill-defined gold standard, the last vestiges of which had been ended by President Nixon in August 1971. A gold commission was set up by the Administration, but, for those in the know, it was clear that the idea of returning to some sort of gold standard was going to be rejected, given the makeup of the commission. Secretary of the Treasury Donald Regan was not keen on the idea. (As an aside, I hated Secretary Regan’s management style of creating discord among Treasury staff, but he usually made reasonable decisions after all the fighting. He did understand finance and was no dummy.) 
In our commenting on gold backed bonds, Domestic Finance did mention the abrogation of the gold clauses, thought not as the main argument against issuing gold backed bonds. (I wrote these memos but am now relying on memory since I do not have access to them.) The abrogation of the gold clauses also came up in public presentations of Treasury’s plans to issue inflation-indexed bonds in the 1996 and 1997. Some people publicly complained about Treasury having “defaulted.” Treasury’s position of course is that the Supreme Court in 1935 had upheld Treasury’s payment on these bonds as payment in full.
For those interested in this subject, Edward’s book provides a wealth of information. It is an interesting episode in the financial history of the United States, and, while, at least to the lay reader, the Supreme Court opinion on government bonds appears somewhat tortured, one can understand why Chief Justice Hughes wrote it given the times. 
Unfortunately, though, I cannot recommend this book for the general reader. The book was obviously written and produced in a hurry. I have never read a book with as many typographical errors as this one. Also, graphs are not clearly labelled, which puts an unnecessary burden on the reader to figure out what is being shown. More importantly, the author demonstrates in his introduction that he can write well, but the rest of the book in not as engaging as the introduction. As a commenter on the Goodreads said, the book is not a “page turner.”
The author, who is an economics professor at UCLA, writes that he became interested in this subject when working on Argentinian debt issues in 2002. While he concludes at the end of the book that some emerging nations are likely to default on foreign currency obligations on their debt, he does not provide much in the way of analysis of the similarities and differences between what the U.S. did in the 1930s and what some countries have done and may do in the future. 
In short, the book is useful as a starting point for a discussion of these issues given the research the author undertook, but it does not present a fully formed argument. If Edwards returns to this subject, I hope he has more to say than that it is a myth that the U.S. has never defaulted on its debt (a proposition that can quickly turn into a legal and semantic argument.)