s inflation gathered steam during the course of 1968,
the goldbased Bretton Woods system of fixed exchange rates loomed
as .an intolerable restraint on politicians struggling to finance
rising costs of government. The result was renewed interest in gold
among the public as a safe haven destined to fulfill the proverb
that Herbert Hoover had thrown at President-Elect Roosevelt in
1933: "We have gold because we cannot trust Governments."
Yet governments were limited in what they could do if the value of their currencies in the foreign exchange markets were to remain rigidly fixed, as the Bretton Woods regime prescribed. Higher government spending tends to stimulate domestic demand, which often raises prices and sucks in imports, the very conditions that make people want to flee a currency and shift to countries with a more conservative style of managing their economic and financial affairs-or to gold. The more that governments tried to find wriggle room around the constraints of the Bretton Woods system, the more the public and the speculators followed Hoover's dictum and turned to gold as the ultimate hedge against the irresponsibility of governments.
Indeed, nobody was satisfied with the way conditions evolved. The creators of the postwar system had produced an artful design, but economic depression and deflation were the dominant influences on their work. The turbulent economic environment spawned by the overoptimism and aggressive governmental policies of the 1960s was still too novel for anyone to even suggest designing a replacement for Bretton Woods. Once the inflationary genie was out of the bottle, the system had no comfortable way to stuff it back in.
After 1968, inflation became a self-fulfilling prophecy that added momentum to the fundamental inflationary forces at work in the system. Employee compensation in the United States increased at annual rates of more than 7 percent during 1970 in the face of an unemployment rate that rose from 3.5 percent to over 6 percent of the labor force. The unions were convinced they had to keep wages climbing faster than inflation, while business managements were convinced they had to keep prices rising in order to cover the increased labor costs. The whole process developed a dynamic of its own, pushing on regardless of the unemployment rate, the profit rate, the interest rate, the tax rate, or any force that in other circumstances would have tamed it. These stubborn inflationary pressures only added to the tension over the dollar problem and the diminishing gold stock.
The Nixon administration could see just two ways out of these dilemmas. The first alternative, the traditional one, was etched in agony by the British in 1931: raise taxes and interest rates so high that the economy would be pushed into a serious recession, not just a pause as in 1970. That step might kill off the inflation mentality and rescue the dollar, but at an unacceptable human cost, to say nothing of the consequences for an elected politician who selected such a strategy.
The other choice, attempting a direct attack on rising prices, would involve the government in administering a system of controls to keep both wage and price increases in check. By controlling wages, the policy could assure business firms that they could function without constantly raising their prices to protect their profits; by controlling prices, the policy could assure employees that inflation in the cost of living would no longer erode the purchasing power of their earnings. This route, which was known euphemistically as "incomes policy," appeared to many to be the preferable choice. If controls could suppress inflation, there would be no need to crush the business expansion and drive up the unemployment rate. Lower inflation might also take heat off the dollar and the gold stock. Controls would mean interference with the free-market system, but they still appeared to offer the best of all possible worlds. This path had been advocated by many Democrats, but now more conservative support began to develop. In August 1970, Congress enacted legislation that gave the President discretionary authority to impose comprehensive wage and price controls.
Nixon, however, had no enthusiasm for the idea. Wartime experience as an employee of the Office of Price Administration in World War II had given him a good lesson in how challenging both the economics and the politics of wage and price controls could be. At first, he made nothing more than a token move toward controls with a number of meaningless but high-sounding measures such as appointing a National Commission on Productivity or ordering the Council of Economic Advisors to issue "inflation alerts" that were statistical and analytical rather than recommendations for direct action.
Despite his misgivings, the President recognized that conditions were backing him into a corner. In December, he took a major step toward a more active policy when he appointed John Connally as Secretary of the Treasury. Connally was a former governor of Texas who had gained national attention when he was wounded while riding in the car when President Kennedy was assassinated in Dallas. A skilled political operator,' he was a handsome silver-haired man of commanding presence. He also had no preconceptions about policy. One of his favorite expressions was, "I can play it round or I can play it flat, just tell me how to play it."' Connally was just the man to overcome Nixon's reluctance to make spectacular moves in economic policy. Furthermore, as Secretary of the Treasury, the deteriorating international financial position of the United States was Connally's primary responsibility, and here the United States could not postpone action much longer.
Nixon and Connally decided to consider a two-pronged move. Its two elements appeared at first glance to have no clear relationship to each other; as matters worked out, they neatly combined into an integrated program.'
The first move was designed to solve the gold problem for the United States once and for all. The Treasury would simply shut down the gold window, which would mean refusing to sell gold at $35 an ounce to governments or central banks coming to the Treasury to exchange their dollars. This radical step would be the grand finale of the convertibility of the dollar into gold that had been in effect, with only the Civil War hiatus, for nearly two hundred years. The dollar would finally be liberated from the golden fetters, like all the other currencies of the world. Without any fixed anchor, the dollar would be free to "float" in the foreign exchange markets.
It is important to understand the full meaning of this expression. All foreign exchange rates are set in the first instance in a market where supply and demand determine the price of a currency, just as in the markets for common stocks, wheat, or oil. Suppose that a French commercial bank is accumulating more dollars than it needs because American tourists are exchanging large amounts in dollar traveler's checks for francs. There is a market where the bank can sell those excess dollars to foreign exchange dealers or to individuals or institutions willing to buy the dollars and pay for them with French francs. That fresh supply of dollars in the market may cause the price of the dollar to fall in terms of francs. That is, sellers of dollars will now receive fewer francs; however, buyers of dollars will have to pay fewer francs.
If the dollar is convertible into gold at a fixed price, however, the Bank of France may buy the unwanted dollars from the commercial bank, because the Bank can convert those dollars into gold at the U.S. Treasury at a price that will not decline-which means dollars are as good as gold. Under those conditions, the dollar-franc exchange rate will tend to be stable instead of deteriorating in response to the increased supply of dollars for sale.
But what happens when a currency is not convertible into gold, when the gold window in Washington is no longer available? Then no automatic limits exist for how low or how high the currency's exchange rate can go relative to the values of other currencies. The currency is floating. The only way to prevent the dollar from falling under these conditions is for the Bank of France to buy those dollars and just hold them, or for the U.S. Treasury to sell French francs from its reserves (a policy called "dirty floating"). If the Bank of France steps aside, however, or if the U.S. Treasury has too few francs in reserve to meet the demand, the dollar will depreciate and the value of the franc will appreciate.
If the gold window were shut, Nixon and Connally would force the foreign central banks to face a nasty set of alternatives. It was like a game of hearts, in which the Americans had passed the queen of spades to their opponents. The foreign central banks could continue to buy all dollars offered for sale, but that would only swell their already substantial dollar positions-in Wall Street parlance, the dollar was overowned. If they held back from buying, however, the dollar would decline in price in terms of other currencies. That would mean heavy losses to their citizens who had acquired dollars or dollar-denominated assets in the past and were still holding them. Furthermore, if French francs now cost Americans more dollars than before, Americans would tend to buy less French perfume and wine; at the same time, the French would now have to pay fewer francs to buy $1000 worth of American goods and services, which would give a boost to imports into France from the United States.
This was the precise outcome that Nixon and Connally hoped to achieve. All of that would be good for American business and jobs. Furthermore, by making American exports more attractive and foreign imports less attractive, the devaluation of the dollar might tend to be self-correcting as American demands for foreign currencies diminished and foreign demands for dollars picked up.
The second part of the Connally-Nixon strategy was designed to suppress the potentially inflationary consequences of this stimulus to business. In order to persuade the world (including Americans themselves) that the finale to gold convertibility was not also the last step on the sure road to runaway inflation, Nixon and Connally recognized they would have to package the shattering of the link to gold with price and wage controls that would confirm their dedication to fighting inflation.
Nixon was convinced that the time for half measures was past. He intended to stifle all criticism of pussyfooting by moving, as he described it, to "leapfrog them all."3 He anticipated little difficulty. The combination of abandoning the gold standard and adopting mandatory price and wage controls made a perfect fit. The economic attractions were strong, but both Nixon and Connally appreciated even more the political appeal of this new policy: conservatives liked the free market implications of the break with gold while liberals liked the activist policy of wage and price controls.
The last straw came during the week of August 9, in a note of extraordinary irony, when the British economic representative came in person to the Treasury and asked for $3 billion in gold. On the following Friday, the 13th, the President abruptly ordered the sixteen major economic policymakers of the administration to accompany him by helicopter to Camp David. The President made certain that no leaks about the proceedings would occur by cutting the group off from all communication with the outside world. Herbert Stein, Chairman of the Council of Economic Advisors at the time, described the occasion as "one of the most exciting and dramatic events in the history of economic policy."'
The group brought forth what they dubbed a New Economic Policy, which combined the closing of the gold window with a mandatory and comprehensive freeze on prices and wages. The freeze was for ninety days, but the expectation was that this initial step would be followed by voluntary restraints by business and labor. In addition to the decisions on controls and gold, the new policy included recommendations for tax cuts for business, reductions in government spending, and a 10 percent surcharge on about half of all U.S. imports. The import surcharge was the equivalent of a devaluation of the dollar, even without any change in the foreign exchange markets, because it automatically made those imports more expensive for Americans.
All the participants agreed that the announcement of the New Economic Policy should be designed to have major impact around the world. The President was urged to make a public statement on primetime television that Sunday evening. By making his decisions known before the markets opened on Monday morning, no leaks or rumors would be able to dilute the force of his words. Nixon demurred: he hesitated to make his speech on Sunday evening, for fear of irritating the public by preempting Bonanza, one of the most popular programs of the era.'
Under pressure from his advisors, Nixon managed to put the national interest ahead of the well-being of Bonanza fans. The news of his prime-time address broke with banner headlines on Monday morning's newspapers. The President minced no words:
I have directed the Secretary of the Treasury to defend the dollar against the speculators.... Now the other nations are economically strong, and the time has come for them to bear their fair share of the burden of defending freedom around the world. The time has come for exchange rates to be set straight.... There is no longer any need for the United States to compete with one hand behind its back.... We are not about to ease up and lose the economic leadership of the world.6
"They've really shot both barrels," observed the President of Bankers Trust Company on Monday morning. Paul Samuelson, the Nobel Prize-winning economist, asserted in an article for the New York Times that "The President had no real choice. His hand was forced by the massive hemorrhage of dollar reserves of recent weeks.... For more than a decade the American dollar has been an overvalued currency.... [The new policy] also helps Japan ... since it is foolish for Japan to give away goods without being repaid for them in equivalent goods." On Wall Street, one salesman exulted, "All brokers are the happiest people in the world today," as bond prices soared, the stock market boomed by nearly 4 percent, and trading volume was the highest on record up to that date.'
There were a few sour reactions. The only declared candidate for the Democratic presidential nomination, George McGovern, was unhappy: "It is a disgrace for a great nation like ours to end in this way the convertibility of the dollar.... By this act we will become the economic pariahs of the world."" The AFL-CIO (American Federation of Labor and Congress of Industrial Organizations), speaking for the labor unions and bristling at the prospect of controls on wage increases, announced that they had "absolutely no faith in the ability of President Nixon to successfully manage the economy of this nation."'
The negative views missed the whole point. Since the end of World War II, the Americans had locked themselves into a golden prison that only postponed the day of reckoning. They had tried every which way to preserve the tie to gold even as they spent enormous sums of money on imports and investments in foreign countries. They borrowed from and wheedled their friends, they taxed their citizens, they warred on speculators, and they raised bars against their corporations' investing abroad. The one step that might have allowed them to hold onto their gold-the traditional policy of pushing down on the economy and increasing unemployment-was unacceptable in the postwar world.
The only other alternative would have been to abandon gold much sooner than in 1971. A few oddballs dared to suggest that solution, but they were shouted down. Foreigners wanted the gold window kept open so that they could cash in their dollar balances for gold at will. Hubris blocked the American leaders from taking drastic action until the very last moment. At the same time, the Europeans and the Japanese feared a devaluation of the dollar because it would have been bad for their business and would have produced big losses for their citizens who had accumulated dollars and dollar-denominated assets in the past. Dollar devaluation would also have meant fewer exports to America and greater competition from imports from America. Yet only dollar devaluation was likely to convert the reluctant foreigners into buying more American goods and services and bring balance back into the system.
With the golden anchor torn loose, once and for all, the New Economic Policy created instant pandemonium abroad. In contrast to Wall Street, foreign stock markets plummeted. In Tokyo, the market suffered a genuine panic, as the New York Times described it, "with sellat-any-price orders sending prices down sharply.""' One American who wanted to buy a loaf of bread in Paris and offered a dollar bill to the baker was told, "That's not worth anything any more.""
The only alternative to a fall in the value of the dollar against the world's currencies would have been for foreign governments and central banks to stand ready to buy all dol- s offered for sale by private parties who could no longer see any reason to continue taking the risk of holding dollars. While the authorities cogitated over what action to take, foreign exchange markets were shut down; no trading was permitted. Only Japan remained open, but after absorbing $4 billion in the two weeks after August 15, the Tokyo government let go and watched tl yen appreciate against the dollar. Other markets opened on the 23rd, with similar results. The dollar had been devalued.
The flood of dollar selling provoked foreign governments to demand a prompt return to some kind of system of fixed exchange rates. Even the Americans had to admit that such volatile exchange rates created uncertainty for all kinds of business decisions. A long series of negotiations culminated in a meeting in December 1971 at the Smithsonian Institution in Washington to reestablish order in the foreign exchange markets. A new set of parities was agreed upon, recognizing part of the depreciation of the dollar that had occurred in the markets over the past four months, and the United States withdrew the 10 percent import surcharge. A new official dollar price of gold was set at $38-the equivalent of a formal 7.9 percent devaluation of the dollar-although by that time gold in the London market was trading at between $43 and $44, about $5 higher than on August 15. With a preposterous degree of hyperbole, Nixon characterized this agreement as "the most significant monetary agreement in the history of the world."12
The new arrangements were incapable of surviving the intensifying inflationary pressures gathering all around the world. A series of crises led to another set of negotiations that produced an approved increase in the official dollar price of gold to $42.22 (which is the price still in use by the United States, 27 years later), but even this step failed to ward off a final breakdown in the efforts to sustain fixed exchange relationships among the major currencies. To make matters worse, OPEC (Organization of Petroleum Exporting Countries), a consortium of major oil-producing countries, joined together in October 1973 to restrict their production until the price of oil had jumped from $2.11 a barrel to over $10, igniting additional powerful and irrepressible inflationary impulses throughout the world economy.
All of this was too much for the U.S. system of price and wage controls. The administration had no choice but to abandon these arrangements in the face of the tremendous leap in the price of oil combined with the devaluation of the dollar, which automatically raised the price to Americans of most foreign goods and services.
Then, in November 1973, only a month after the OPEC countries had roiled the world economy, the central banks threw in the sponge on their 1968 decision to refrain from trading in gold except among themselves. Now the central banks could buy and sell in the London market at prices far above the official price of $42.22, and several loans from one government to another were collateralized by gold valued at more than $40. The French soon began valuing all their gold reserves at the market price, although others refused to follow their lead and left the French once again as outliers.
Beginning in 1975, tentative steps were taken to liberate the monetary system even further from gold. In January and June 1975, and again in 1978 and 1979, the U.S. Treasury auctioned a total of about 6 percent of its total gold stock, motivated by the belief that "Neither gold nor any other commodity provides a suitable base for monetary arrange- ments."13 Then in August, an International Monetary Fund committee reached two momentous decisions: they agreed to abolish the official price for gold, and they also decided to auction a portion of the Fund's gold holdings. The proceeds of the auction were to be used for the benefit of developing countries and also to return to member countries some of the money they had originally contributed to the Fund. After one hundred years in which hoarding gold was the fashion among the central banks, all of a sudden hoarding was out and dishoarding was in.
The speculating public was unimpressed with both the words and the deeds of the governments and official agencies. If governments wanted to play games with gold at artificial values, or auction off nominal quantities of gold, that was their problem. None of the international agreements to manage exchange-rate volatility seemed to hold up. Inflation in all countries was eating away at the values of stocks, bonds, and cash. Inflation was most intense in Britain, France, and the United States among the developed countries, but even Germany's inflation averaged 5 percent from 1974 to 1981 and included episodes above 7 percent. Consequently, many speculators were only too happy to buy gold from central banks that insisted on behaving as though gold was just a barbarous relic and not worth owning any longer.
The soaring demand for gold as a safe haven for wealth and as a hedge against inflation drove the price in the London market from $46 an ounce at the beginning of 1972 to $64 an ounce at the end of the year. The price broke through $100 during 1973; from 1974 to 1977, gold fluctuated between $130 and $180. A second OPEC oil price increase to $30 a barrel in 1978 created a frenzy that ignited a new and precipitous climb in the gold markets: the price of gold hit $244 an ounce before the year was out and then doubled to $500 in 1979. In the spirit of the times, the famous comedienne Bette Midler, about to depart on a European tour, demanded on July 3, 1978, that her $600,000 fee be paid in South African gold coins instead of in U.S. dollars.14
The headline on the cover of the March 12, 1979, issue of Business Week magazine read "The Decline of U.S. Power" and showed a closeup of the face of the Statue of Liberty with a tear running down her cheek. There was plenty to cry about in the U.S. economy, with most of the trouble homegrown. America had become the victim of her own success. At the end of World War II, American business was so far ahead of the ruined economies in the rest of the world that American managements were convinced they had all the answers. Corporate executives belittled change and played down the competitive pressures that were steadily building beyond the national borders of the United States as Europe and Asia recovered from the war. While a new generation of business management abroad achieved high rates of economic growth and technological innovation, American business continued to suffer from economic hardening of the arteries.
The tragic loss of competitive position by the American economy in the 1970s was the equivalent of a major military defeat. Inflation appeared out of control, unemployment remained stubbornly high, fiscal policy was a mess, the dollar was approaching a major crisis at the end of the decade, and America's share of world markets was shrinking at a distressing rate.
In October 1979, inflation in the United States was running over 12 percent-a significant increase from the distressing figure of 8 percent a year earlier-while the dollar was at bay in the foreign exchange markets. Paul Volcker, the Chairman of the Federal Reserve System, was now confronted by his agitated counterparts in the major European countries and Japan, who feared that the whole world would succumb to a crisis as devastating as the 1930s unless the United States took strong and decisive steps to mend its ways. Volcker pledged the Federal Reserve to bring the surging U.S. money supply under control, even if it meant pushing interest rates up to levels never before seen in history. The Federal Reserve was about to swallow the conventional medicine.
Volcker's strategy was ultimately victorious in the long battle against inflation, but the immediate impact of his policies unleashed another torrent of turbulence in the financial markets. Nobody knew for certain how measures as tough as this would play out over time. The major concern was that the blow to the economy might be so severe, with widespread bankruptcies, plunging production, and soaring unemployment, that the policy would have to be completely reversed, unleashing a whole new wave of inflationary pressures.
The United States was not the only country facing chaotic conditions at that moment. Inflation in most countries at the end of 1979 was running in double digits and even Germany was up to 6 percent. Political conditions were perhaps even more frightening. Iranian radicals in November 1979 took over the U.S. embassy in Tehran and held the entire staff as hostages, initiating a crisis that would endure for more than four hundred days. At the same time, the Russians were building up their strength in southern Yemen near Saudi Arabia, near Afghanistan's border with Iran, and near Bulgaria's border with Yugoslavia-at a moment when Yugoslavia's 87-year-old Marshal Tito was in poor health.
January 1980 in the gold market turned out to be one of the wildest months in the history of any market, anywhere, any time. The price of gold jumped by $110 an ounce to $634 in just the first two business days of the month, while the value of the dollar in terms of German marks fell to a record low. A London branch bank reported that its inventory of one thousand gold sovereigns had sold out in the course of the two days. A precious metals trader for one of the Swiss banks, in a master understatement, told a reporter from the New York Times that "The market shows that people don't trust the governments and they don't trust paper money either."'s
All of a sudden the central banks began to make noises about restoring gold to its traditional role in the monetary system, a complete reversal of recent policies of selling gold out of their reserves. The U.S. Undersecretary of the Treasury declared before Congress that "Gold remains a significant part of the reserves of the central banks available in time of need. This is unlikely to change in the foreseeable future."16 No wonder: the stunning increase in the price of gold since 1978 had swollen the market value of the gold reserves to more than three times their total holdings of foreign currencies.
Then Treasury Secretary G. William Miller held a news conference at which he announced that the Treasury would hold no further gold auctions. "At the moment," he told the press, "it doesn't seem an appropriate time to sell our gold." With 220 million ounces (about seven thousand tons) of gold stored away at Fort Knox, gold hoarding was regaining some traditional respectability. This was a curious observation in light of the auctions of gold that the Treasury had conducted at much lower prices since they had begun the practice five years earlier. Most investors aim to buy low and sell high, but the U.S. Treasury apparently was more attracted to selling low than high: the last auction before these events, just two months earlier, had produced an average price of only $372.30."
Within thirty minutes of Miller's remarks, the gold price shot up $30 an ounce to $715. The next day it was up to $760. The day after, gold hit $820. The manager of the precious metals department of a New York bank specializing in the gold trade was ecstatic: "Certificates, bullion, coins, bars, you name it, our business has been very brisk. Americans are catching the gold fever. As for the international bullion market, which represents the bulk of our business, it's become a zoo."'s
Not everyone was caught up in the panic. Unlike Secretary Miller, many common citizens thought selling high was kind of a good idea. The New York Times for January 12 carried an article that began with these words: "They came clutching all manner of objects precious to them, from heirloom silver to gold coins and jewelry, hoping to turn their old gold and silver into new, fresh [dollar] bills." One prominent dealer's waiting room was described as resembling an airport lounge at peak holiday season rather than a company in the business of purchasing old metal objects. Five days later, when the price in the gold market was at $760 an ounce, a similar article reported, "On 47th Street the dealers were predicting the price would hit $1,000 an ounce by July, but no one seemed to be waiting."
The price touched its record high of $850 on January 21. James Sinclair, a commodities broker, summed it up when he commented that "We're in World War Eight, if you believe the market." 9 Late that afternoon, President Carter announced that the United States would have to "pay whatever price is required to remain the strongest nation in the world." His comment seemed to cool tempers in the gold and foreign exchange markets-the price of gold was down $50 by the close of trading.
Indeed, the temper of the marketplace did a 180-degree turn with extraordinary abruptness. On January 22, the price plunged by $145. The high in 1981 was $599 an ounce. By 1985, gold was down to around $300. The subsequent high, touched only briefly, was $486, in the wake of the stock market crash of 1987. At the end of 1997, gold broke below $300. It had fallen by more than 60 percent in the course of less than eight years.
That fantastic bull market in gold from $35 in 1868 to $850 in the climax of January 1980 is an extraordinary episode in financial history. It represented a gain of 30 percent a year over twelve years, far in excess of the inflation rate of 7.5 percent from 1968 to 1980. Even the greatest bull markets in stock market history pale by comparison. The highest total annual return (including income) in the stock market over a twelveyear period was 19 percent, from the middle of 1949 to the middle of 1961. In 1959, the amount invested in gold was about one-fifth of the market value of all U.S. common stocks; in 1980, the $1.6 trillion invested in gold exceeded the market value of $1.4 trillion in U.S. stocks."' If only Croesus, Charlemagne, and Pizarro had lived to see such a triumphant march in the value of their precious gold!
Nevertheless, the raw data exaggerate the happiness that these zooming prices brought to the gold bugs. Few people who bought at $35, or even under $100, held on to sell at $850. Most of the early buyers undoubtedly took their profits and bailed out long before the peak, for the path to $850 was volatile all the way. The likelihood is that many more people were sucked into the gold market as it approached $850-and shortly afterward-than those who were farsighted enough to go in when the price was fussing around $40.
The rush into the gold markets in the early 1980s produced much the same kinds of results as the gold rush to the Klondike eighty years earlier, where only about four hundred people out of one hundred thousand prospectors hit it rich. Indeed, it is ironic that the State of Alaska Retirement System bought a ton of gold bullion in 1980 at $651 an ounce, and then a second ton at the end of 1980 for which they paid $575. In March 1983, the state sold out at $414.21 Thus, the real winners at the end were the sellers-an opportunity that the U.S. Treasury chose to pass up.
In 1981, the U.S. monetary gold stock amounted to approximately eight thousand tons, a little more than a third of the 1949 peak, only 50 percent more than in 1933, and equal to about a quarter of world monetary gold stocks. At the official price of $42.22, the stock was carried at a mere $11 billion, although the stock was worth $120 billion at the 1981 average market price of $460 an ounce. Liabilities to foreigners, however, were now over $300 billion, an astonishing increase of nearly tenfold over the level that had so agitated General de Gaulle thirteen years earlier.22
Donald Regan, the Secretary of the Treasury, decided that the situation required a thorough examination. As David Ricardo in 1810 had called for the creation of a "SELECT COMMITTEE to enquire into the Cause of the High Price of GOLD BULLION, and to take into consideration the State of the CIRCULATING MEDIUM, and of the EXCHANGES between Great Britain and Foreign Parts," Regan appointed a Gold Commission in June 1981 to "conduct a study to assess and make recommendations ... concerning the role of gold in domestic and international monetary systems." The Conur fission included members of Congress, representatives from the Federal Reserve Board, leading economists, one well-known academic, and two individuals active in the gold markets.
After nine meetings and 23 witnesses, the Commission issued a report that features an extraordinary number of footnotes drafted by individual members, indicating the depth of the disagreements over their understanding of what had happened to gold in the recent past and the appropriate course of action that the Commission should recommend for the immediate future. The report contains an admirable history of gold in monetary systems and a cornucopia of useful historical statistics, but its recommendations hold little interest because they fell so far short of unanimity in support among the members. The Regan Commission of 1981 has passed into anonymity, while the Bullion Committee Report of 1810 continues to be an important element in the study of money and banking. Just about the only vestige of the Regan Commission's recommendations that remains is the small number of gold coins minted after they were authorized by President Reagan in December 1985. Most of these handsome coins now reside in the hands of collectors.21
Quite aside from the failure of the Gold Commission to speak loudly and clearly with one voice, fundamental economic trends in the early 1980s were finally shoving gold away from center stage. Bond yields were in double digits and common stocks were providing a flow of dividend income as high as 6 percent. As gold pays no income and incurs storage costs, owning gold was expensive indeed compared to alternative investment opportunities.
Gold would still have made sense in spite of these hurdles if people had expected inflation to remain out of control. The whole story of the 1980s, however, was the growing recognition, around the world, that the virulent inflation of the 1970s had been beaten back at long last and that the prices of goods and services for the foreseeable future would rise at a more moderate and manageable pace. It is indeed remarkable that U.S. inflation fell from such precipitous heights at the end of the 1970s to as low as 3 percent by 1985, but similar trends were at work in most countries, even in such areas as Italy, Latin America, and the Middle East, where inflation had been a chronic problem. Holding gold can make little sense if inflation is dead or dying, because then there is little hope of recouping the storage costs and offsetting the lost income.
During the two decades after 1980, the ups and downs in the price of gold followed the ups and downs-mostly downs-in the rate of inflation. The price of gold fell absolutely, however, while the prices of goods and services continued to rise, albeit at a slower pace. The cost of living doubled from 1980 to 1999-an annual inflation rate of about 3.5 percent-but the price of gold fell by some 60 percent. In January 1980, one ounce of gold could buy a basket of goods and services worth $850. In 1999, the same basket would cost five ounces of gold.
The stock market offers an even more striking comparison. By some remarkable coincidence, the Dow Jones Industrial Average of stock prices was at just about 850 when gold touched its $850 peak.* Thus, an ounce of gold would have bought one share of the Average at that moment. When gold was down to the $300 area in the autumn of 1999, however, the Dow Jones was around 10,000. Now more than thirty ounces of gold would be needed to buy one share of the Average.
One little-noted recommendation of the Regan Commission of 1981 involved the appropriate size of the government's stock of gold. Although an initial majority vote concluded that "Under circumstances as those that presently exist, the stock should be maintained at its present value," the final report recommends that "While no precise level for the gold stock is necessarily `right,' the Treasury [should] retain the right to conduct sales of gold at its discretion, provided adequate levels are maintained for contingencies."24 Despite the double-talk in the final phrase, this recommendation set the tone for the environment for gold for the rest of the 1980s and throughout the 1990s.
The lower the price of gold fell, the greater became the prospects of official sales, not just from the United States but from other countries and the International Monetary Fund itself. As the gold price rose from $375 in 1982 to nearly $500 after the stock-market crash of 1987, few central bank sales were executed. As the price then drifted downward toward $350 in 1992, about five hundred tons were disposed of. From 1992 to 1999, however, as the price sank below $300, the central bankers sold off three thousand tons, or about four hundred tons a year.25 One does not have to be an amateur investor to sell low.
As the central banks were liquidating their gold, over two thousand tons a year of additional gold came into the markets from new mine production, about double the level of production before the price of gold broke free from the old $35 price. Sales of four hundred tons from the central banks sound small relative to the two thousand tons of supply forthcoming from the mines. Nevertheless, the volume of total central bank and official holdings was still so large-over thirty thousand tonsthat the overhang loomed like a black cloud over the markets. Who could say how much of that hoarded treasure might come to market?
A loud thunderclap along these lines hit the markets in October 1997, when a team of Swiss experts issued a report recommending an amendment to the Swiss constitution that would result in a radical restructuring of the Swiss currency system. "Gold has lost its monetary function," the experts declared. "The gold parity is strictly an accounting tool.... A return to gold standards today is impossible.... The proposed draft of the new constitutional article does not contain any connection of the [Swiss] franc to gold. Paragraph 5 of article E-BV, which mandates the Swiss National Bank to hold adequate currency reserves, should replace the confidence inspiring gold coverage and ensure that the public's trust in the state currency remains. 1116
The experts were not quite ready to go all the way in abandoning gold, however. "Many depositors," they point out, "conceive of gold as the only asset that held its value over the millennia." They therefore recommended that the central bank continue to hold nearly half of its total gold stock and that "the separated portion of gold is to be sold in small steps."27 Despite this bow to potential popular anxieties, the entire spirit of the report rests in its unquestioning confidence that the forecasting and managerial skills of the directors and staff of the central bank would perform a better job than obeisance to the gold stock in "the priority of maintaining price stability."
This view was by no means revolutionary doctrine in 1997-on the contrary, it represented mainstream thinking. Nevertheless, this was the Swiss, not the British or the Americans or some minor-league country. The Swiss were legendary in their attachment to gold and in their aversion to holding currencies of countries whose devotion to the constant struggle to keep inflation in check was less passionate than theirs. The "gnomes of Zurich" had been famous for their speculative attacks on the dollar and sterling during the crises of the 1970s. Now all that was forgotten.
Two years later, the British took a similar step with their gold stock, once upon a time the pride of British power. In May 1999, the British Treasury announced its intention of selling 415 tons out of its 715-ton stockpile. The price of gold promptly lost 4 percent of its value.
The central banks would soon catch on: their enemy was themselves. The overhang of gold held by central banks meant that every time an official sale hit the headlines, the gold price would fall and the proceeds of the sale would be diminished.
The authorities had already made some effort to talk up the price of gold. Six weeks after the report of the Swiss experts had been published, the vice chairman of the Swiss National Bank asserted that "We are convinced that gold will continue to play a role as a currency reserve, especially in times of crisis." In April 1998, the annual report of the Bank of France of 1997 sounded like old times: "Gold remains an element of long-term confidence in the currency.... Above all, holding gold is, from the political point of view, a sign of monetary sovereignty [and] an insurance policy against a major breakdown in the international monetary system." About the same time, a former managing director of the International Monetary Fund affirmed that "Gold remains at the heart of a collective belief in the credibility of an international economy ... a sort of `war chest,' indispensable for a tomorrow whose needs we can only guess :."28 When the new European Central Bank opened in 1998 to manage Europe's new currency, the euro, 15 percent of the bank's reserves were held in gold.
But all of this was mostly talk or just symbolic. Few people were taken in by it.
How times had changed! In the 1960s, the major central banks had organized the gold pool to sell whatever amount of gold was necessary to keep the speculators from driving the price upward. In September 1999, owning nearly half of all gold held by central banks and other official institutions, they were in a position identical to Ruskin's man who strapped his golden wealth to himself as his ship was sinking and promptly sank to the bottom of the ocean. If the central banks all moved at the same time to sell off their hoards of gold, the price would run away from them on the downside and their sales would be a disaster.
They therefore agreed to limit their annual sales to four hundred tons of gold over the next five years-about the same as the annual average liquidated over the previous eight years. The IMF announced that it would "abide" by the spirit of the agreement. Australia and South Africa joined in an informal affiliation, bringing the amount of official gold covered up to 85 percent of the total. The central banks also resolved to limit their lending transactions with the mining companies. The agreement covered the thirteen hundred tons in the pipeline for the Swiss to sell and 365 tons for Britain, leaving only 335 tons for any other country that wants to liquidate gold over the fiveyear period covered by the arrangements.
William Duisberg, the President of the European Central Bank, was honest enough to refrain from describing these decisions as a move back toward restoring gold to its former glory. He was blunt about the matter: the objective was to protect the value of central bank reserves by "[keeping] the value of gold where it is.... The purpose of this action is to give certainty to the gold market."2y
The central banks were not the only important sellers in the market, but they had been eager cooperators with the other major group: the mining companies. We would expect the mining companies to be sellers, because that is what they are in business for. During the 1990s, concerned like so many others about the future outlook for gold, the mining companies began to sell more than their current production. In effect, they mortgaged their future output at the prevailing price in order to avoid having to sell at a lower price later on. Buyers, however, want delivery when they contract to buy. The mining companies enlisted the central banks for this purpose: the miners borrowed gold from the central banks at a nominal rate of interest, secured by the promise to pay off the loan from future production, and then delivered that gold to the buyers. The central banks were delighted to earn anything at all on what was once the glory of their economic power but that they now considered a barren asset. This arrangement worked well-as long as the price of gold was falling. On the occasions when the price of gold went up, however, the central banks became more reluctant lenders and the mining companies got squeezed. As their current production was smaller than the amounts they had borrowed, they had to go into the market and join the other buyers there in order to make their promised deliveries to people who had bought gold from them. The result was an added impetus to the upward movement in the gold price.
The Asians, as in the past, continued to absorb large quantities of gold. The Economist reported in January 1999 that "The Indian lust for gold remains unabated.... Gold jewelery [sic] is the only form of wealth that many women can claim as their own."32 At that moment, the total amount of gold in India, estimated at around nine thousand tons, exceeded even the great hoard stowed away in Fort Knox, Kentucky.33
Meanwhile, in response to the deteriorating economics of the business, mine production and scrap supplies from old gold increased at a much slower rate than demand. With new supply lagging and the basic demand for gold growing, the price of gold should have been expected to rise. Instead, the price fell. Was this surprising outcome due to the shrinking demand for gold as a hedge against inflation, combined with the persistent selling by banks and mining companies? Perhaps, but nothing in economics is that simple. We have no way of knowing whether the demand for jewelry in particular would have increased so much if the price of gold had not fallen so low and made gold jewelry look like a bargain.
How can we derive meaning from this long story, when its last chapter is such a dramatic break with all that had gone before? How could such a thing happen? Is gold now nothing more than a commodity, a beautiful and symbolic bauble, in a class with diamonds and platinum? Or will gold one day regain its grandeur? The time has come to look at the grand illusion of gold in light of these questions.