Gold Standards and the Real Bills Doctrine in U.S. Monetary Policy

Article excerpt

[The English gold standard after Waterloo] was a perfectly "free" or "automatic" gold standard that allowed for no kind of management other than is implied in the regulatory power of any central bank that is a "lender of last resort." ... [Despite much opposition] the gold-standard policy was never in real danger politically, and if it was not, until much later, adopted by all other countries, [their delay] was not a matter of their choice: in spite of all counterarguments, the "automatic" gold standard remained almost everywhere the ideal to strive for and pray for, in season and out of season.

--Joseph A. Schumpeter, History of Economic Analysis

In recent decades, several journal articles and some mainline books have blamed what the authors label as "the gold standard" for the failure of the Federal Reserve System (the Fed) to pursue a countercyclical monetary policy that would have prevented the Great Contraction of 1929-33 and the subsequent Great Depression of 1933-41. Although the authors of these publications note differences between the classical pre-World War I gold standard and the post-World War I gold-exchange standard, they nonetheless claim that the latter "gold standard" was operational during the 1920s and early 1930s. They insist that significant changes in the quantity of money or the lack of such changes were dictated by fixed values of gold for the units of account and that this restriction was responsible for the misconduct of monetary policy during the period. They seem unaware that if central bankers are managing a "gold standard" in order to control monetary policy, whatever it is they are managing is not really a gold standard.

These authors also seem to understate the extent to which the Fed and other central banks' deliberate management of the gold-exchange standard prevented monetary adjustment in the period 1929-33 from resembling the pattern of equilibrium typical of the classical gold standard. Indeed, none of the "gold standard" critics specifies the attributes of a true--classical--gold standard. Nor does any of them make any reference to the legal provisions in the Federal Reserve Act that the Federal Reserve Board (Fed Board) could have used to abrogate the gold-reserve requirements for Federal Reserve Banks (Fed Banks) or to the fact that all Fedheld gold was on the table in a crisis. Most important, none of these publications includes any reference to the real culprit in the monetary machinery of that era--the real bills doctrine, which was then the working blueprint of the primary policymakers in the Fed.

In this article, I seek to rectify these errors of commission and omission for the sake of historical accuracy. I do not lobby for any particular monetary policy or system. However, until the policy history of such an important episode as this one is properly analyzed and understood, the general public and its representatives in Congress are being misled and therefore are understandably confused. Policymakers are forever in danger of repeating past mistakes or inventing new ones.

The Constitutional Gold Standard

Joseph Schumpeter's observation about the gold standard that the English Crown restored between 1819 and 1822 reflects the high esteem in which "the world" held the operational, automatic gold standard. Somewhat relaxed lending policies by the Bank of England, after Parliament ordered the restriction of gold payments in 1797, had allowed the market price of gold to rise above its mint price, but after the travail brought about by the Napoleonic Wars, Parliament prescribed policies that eventually restored the prewar gold parity of the pound sterling.

A few years earlier the U.S. Constitution declared that Congress should have the power "[t]o coin money, regulate the Value thereof.., and fix the Standards of Weights and Measures." (1) It further stipulated, in Section 10 that "[n]o state shall ... coin Money; emit Bills of Credit; [or] make any Thing but gold and silver Coin a Tender in Payment of Debts. …