What Happened to the Gold Standard?
by David John Marotta & Megan Russell | 04-20-2014
The U.S. dolla r was first regulated by the Coinage Act of 1792 and
prescribed as 371.25 grains of pure silver. The eagle , worth $10, was
247.5 grains of gold. One cent , worth a hundredth of a dollar, was 24
grains of copper.
The value of the metal contained in the currency kept prices relatively
constant before the founding of the Federal Reserve. During those 120
years, prices rose only 3%. In contrast, during the 100 years since the
Federal Reserve, prices have risen 2,280%.
The Constitution gives Congress the power to "to coin money" and
"regulate the value thereof." This dictum was understood to be setting
the currency's weight and metallic content and was necessary to allow
the currency to keep up with a growing economy.
Before the Constitutional Convention, many states issued their own
paper money called "bills of credit" or declared foreign coins "legal
Only pennies of its original value remain in our dollar
today.
tender" that could be used to settle debts. Some states had issued
paper money to excess during the Revolutionary War and caused
severe price inflation.
The Constitution prohibited states from emitting "bills of credit" in Article I, Section 10 . It also forbade them from making legal tender anything but
gold and silver coins. An early draft of the Constitution by Charles Pinckney gave that power to the federal government. However, it was specifically
deleted by a motion of Gouverneur Morris, who declared, " If the United States had credit such bills would be unnecessary; if they had not, unjust
and useless ."
Because the U.S. government is based on enumerated powers, powers not specifically enumerated to the government are powers the government
does not have. At least some of the Founders believed that striking this clause from the Constitution by a 9-2 vote would close the door on the
federal government printing money.
Almost a century later, the effect of removing this power was put to the test. In Hepburn v. Griswold (1869), the Supreme Court held that paper
money violated the Constitution.
Mrs. Hepburn owed Henry Griswold a debt payable on a promissory note. Five days before the debt was due, the Union issued paper currency,
known as "greenbacks," to fund the Civil War. These were inferior to coined currency. The exchange rate was favorable for Mrs. Hepburn to try and
pay her debt in the cheapest legal tender required by the terms of the note.
Griswold sued and lost in the lower court. On appeal it was overturned, and the Supreme Court also sided with Griswold by a 4-3 vote. Chief Justice
Salmon P. Chase had overseen the issuance of greenbacks as secretary of the treasury, implementing the legal tender acts. Now as chief justice he
overruled his own actions.
President Ulysses S. Grant added two Supreme Court justices in 1870. The following year, the opinion was overturned in two 5-4 votes , with Chase
now writing for the minority.
The expansion of the federal government into wielding powers that were never enumerated in the Constitution is all too common. And once such a "
necessary and proper " power is taken for the " regulation of commerce ," the federal government never gives it up.
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The Coinage Act of 1873 demonetized silver, and the Gold Standard Act of 1900 guaranteed gold as the only standard for redeeming paper money,
stopping bimetallism and no longer permitting the dollar to be redeemed in either gold or silver. It confirmed the government's commitment to the
dollar by assigning gold a specific dollar amount: $20.67 per troy ounce.
The creation of the Federal Reserve in 1913 marked the beginning of the end of the gold standard.
Five years later, the Fed accepted gold from foreign countries as a payment for World War I debt. This allowed excess gold reserves to accumulate,
called "free gold" because it wasn't currently required to back printed currency. This so-called free gold gave the Fed discretion over how much gold
to use in backing the currency and the ability to inflate our currency with the stroke of a pen.
A little over a decade later, the Fed forced all Americans to surrender their gold currency to the Treasury in exchange for U.S. dollars. And the
following year, it revalued their gold, increasing the dollars required to buy an ounce. This action also created more free gold.
During World War II, the Fed used some free gold to purchase bonds and drive interest rates down to help the Treasury finance the war. Price
controls were put in place to hide the resulting inflation until almost 1950. When they were removed, Congress instructed the Fed and the Treasury
to operate "independently" of one another. This instruction officially came into focus when the two agencies signed an accord in 1951. But little
independence has occurred in recent years.
With the gold standard suspended in many other countries, foreigners converted their leftover gold into U.S. dollars. This devalued the currency but
cornered the gold market. By 1945, the United States had 75% of the world's monetary gold and the only gold-backed currency.
At this point, the Fed could already function as though it didn't have a gold standard. With excess gold in its reserves, currency could be changed at
will. This occurred even during the 1969 recession, buying securities and inflating the currency to try and "get the economy going."
In 1971, the United States finally dropped the gold standard, now kept in name only. In the Fed's first decade of existence, the dollar was devalued
55% (compared to 10% in the decade prior). From the creation of the Fed in 1913 until the gold standard was dropped in 1971, the dollar lost 75% of
its value. From 1913 to date, the dollar has lost over 96% of its value. Only pennies of its original value remain in our dollar today.
Arthur Burns, chair of the Fed at the time we went off the gold standard, wrote, "Persistent inflation . . . will not be vanquished . . . until new currents
of thought create a political environment in which the difficult adjustments required to end inflation can be undertaken."
A gold standard helps protect a currency from rampant inflation. The Fed could perform this function only if it could somehow display perfect
self-control. Such an ideal may never occur and will never last when the temptation and incentives for the Fed to manipulate other parts of the
economy are so great. Reform is necessary to protect our currency.
Photo by Tax Credits used here under Flickr Creative Commons.
Marotta Wealth Mangagement, Inc. of Charlottesville provides fee-only financial planning and asset management. Visit www.emarotta.com for more
information. Questions to be answered in the column should be sent to [email protected] or Marotta Wealth Management, Inc., 1000 Ednam
Center, Charlottesville, VA 22903-4615.
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