Finance, Banking & Monetary Policy

August 3, 2020 4:47PM

If Only Senator Hawley Could Legislate Away Unintended Consequences

Seeking to prove the old adage about roads and good intentions, Missouri Senator Josh Hawley has recently introduced legislation, The Slave‐​Free Business Certification Act of 2020, that would impose steep fines and other penalties on large companies doing business in the United States, unless they regularly audited their global supply chains and certified that they and their suppliers did not utilize “forced labor.” The bill’s presumed intent is to discourage slave labor around the world – a goal that’s both laudable and, given troubling reports out of China and elsewhere, still quite important. Unfortunately, good intentions don’t usuallynecessarily make good policy, and in this case recent history shows how Hawley’s bill would likely make things worse, not better, for the world’s most vulnerable people.

The Mercatus Center’s Tyler Cowen helpfully summarized the bill’s theoretical flaws in a recent Bloomberg column, noting that the onerous supply chain regulations would most likely cause companies – worried about high compliance costs, bad publicity, and scary penalties – simply to move their supply chains “from the poorest and neediest” countries to wealthier places clearly free of “forced labor” (which, as Cowen helpfully adds, the Hawley bill defines more broadly than slavery). Sadly, forced labor remains somewhat common around the world, but an exodus of multinational capital and business practices from these places would likely lead to worse, not better, labor conditions. And, like most forms of regulatory protectionism, the law also would likely boost largest corporations (i.e., the ones with the in‐​house lobbying, legal and accounting resources to shoulder new compliance burdens) and increase prices for U.S. consumers. This is Trade Econ 101.

We needn’t, however, rely on wonky economic theory to see the likely consequences of Hawley’s legislation. In fact, recent experience with a similar policy – the “conflict minerals” reporting requirements in Section 1502 of the 2010 Dodd‐​Frank Act – shows that, contrary to some some claims that onerous supply chain reporting mandates are easy and effective, their end result would most likely be more, not less, of the very thing the mandates are trying to discourage. Section 1502 was similar to Hawley’s proposal in that it required multinational manufacturers like Apple and Intel to audit and disclose whether their supply chains utilized “conflict minerals” (tantalum, tin, gold or tungsten, which are commonly found in smartphones and other consumer electronics) sourced from the Democratic Republic of the Congo (DRC) or an adjoining country. Section 1502 also had similar intentions: the mining of these minerals reportedly funded warlords and fueled violence in the region, so a supply chain disclosure rule would force multinationals to scrutinize their suppliers and weed out the bad actors, and thus cut off the warlords’ funds.

Unfortunately, the Section 1502 rules proved to be a huge mistake. Shortly after the law entered into force, reports emerged that, instead of complying with the new regulations, global corporations simply abandoned the DRC – and its poor miners and small‐​scale purchasers – entirely. This effective embargo on the region not only devastated it further, but it actually benefited “some of the very [DRC warlords] it was meant to single out,” allowed less‐​scrupulous Chinese manufacturers to move in, and undermined civil society groups working to end horrific violence and poverty in the DRC.

Things didn’t improve in the following years, either. In fact, Hawley’s fellow Republicans in 2013 held a hearing before the House Subcommittee on Monetary Policy and Trade on “The Unintended Consequences of Dodd-Frank’s Conflict Minerals Provision,” at which several participants from across the spectrum advocated for Section 1502’s reform or elimination due to its harmful impact on the DRC. In 2014, dozens of human rights activists and academics called for the provision’s repeal because, while a few industry giants had resumed business in the DRC, most mines remained off limits and millions of Congolese miners remained unemployed (or worse). Meanwhile, armed groups and smugglers continued to thrive.

Subsequent academic work has confirmed these anecdotes – and the activists’ worst fears. A 2016 study found that Dodd‐​Frank conservatively “increased infant mortality from a baseline average of 60 deaths per 1,000 births to 146 deaths per 1,000 births over this period—a 143 percent increase,” likely by reducing mother’s consumption of infant health care goods and services. A separate study from 2016 found that the “legislation increased looting of civilians and shifted militia battles toward unregulated gold‐​mining territories” in 2011 and 2012. Another paper from 2018 found that the policy also backfired in the longer run (2013–2015): “the introduction of Dodd‐​Frank increased the incidence of battles with 44%; looting with 51% and violence against civilians with 28%, compared to pre‐​Dodd Frank averages.” Finally, in late 2019 economist Jeffery Bloem found that “the passage of the Dodd‐​Frank Act roughly doubled the prevalence of conflict in the DRC,” and “[v]iolence against civilians, rebel group battles, riots and protests, and deadly conflict all increase within the DRC due to the passage of the Dodd‐​Frank Act.”

In short, a U.S. law seeking to discourage conflict and suffering in the DRC ended up breeding more it.

It’s a depressing tale of Unintended Consequences that puts a real face on Cowen’s theory and crystallizes the flaws in Hawley’s plan to stop forced labor around the world. It also shows why alternative policies, such as the Xinjiang boycotts and targeted sanctions that Cowen suggests, are a better approach to attacking the serious issues of slavery and human trafficking. Of course, as I noted last year, arguably the best way to improve working conditions for the world’s poorest people is freer trade with least developed countries:

The lowering of U.S. trade barriers, along with American leadership in creating agreements and institutions such as the WTO, has produced immeasurable benefits for the world’s poorest people. As the World Bank noted in its Report on the Role of Trade in Ending Poverty, since 1990, “a dramatic increase in developing‐​country participation in trade has coincided with an equally sharp decline in extreme poverty worldwide,” and the number of people living in extreme poverty has collapsed. Trade has also “helped increase the number and quality of jobs in developing countries, stimulated economic growth, and driven productivity increases.”

A new report from the International Labor Organization provides jaw‐​dropping stats in this regard: Between 1993 and 2018, the share of individuals in low‐ and middle‐​income countries working in extreme poverty fell from almost 42 percent to less than 10 percent — a decline of around 600 million people. Most moved from subsistence farming to formal wage or salary work, providing themselves with first‐​time access to health care and other benefits. And, contrary to popular belief, the job creation in developing countries did not happen primarily in “sweatshop” manufacturing: The share of industrial workers in low‐ and middle‐​income countries almost did not change between 1991 and 2018, with job growth instead coming from sectors such as construction and retail trade; between 1999 and 2017, inflation‐​adjusted real wages in these countries tripled. Child labor is also disappearing: The overall number of child workers (ages five to 17) decreased by approximately 94 million between 2000 and 2016 (from 246 million to 152 million) and is projected to decline by tens of millions more by 2025. These improvements have been especially strong among women and girls, who in many countries faced truly horrible social conditions (hunger, arranged marriages, etc.) before these new jobs existed.

I can’t say I’m optimistic that the Senator – who has elsewhere demonstratedquestionable understanding of trade and forced labor (which U.S. law already restricts) – will learn this economic lesson or the unfortunate history of Dodd‐​Frank and the DRC. Hopefully, his colleagues in Congress will learn about it before millions of the world’s poorest suffer a similar fate.

July 30, 2020 10:42AM

Dollarization for Lebanon

"The Lights Go Out in Lebanon as Financial Collapse Accelerates," declared a recent headline in The Washington Post. The headline refers specifically to worsening power outages but more generally to Lebanon's ongoing "economic implosion." This breakdown is due in large part to chaos in Lebanon's monetary and banking systems. Since October 2019 the Lebanese pound (also called the lira) has lost more than 80 percent of its value on the black market, with USD1 most recently trading around LBP8100. There is a black market because, although the Banque du Liban (the Lebanese central bank) continues to declare an official exchange rate of LBP1507.5 per USD, that rate is now available only to importers of a few favored goods.[1]

The peg became unsustainable, as pegged exchange rates invariably do, when the central bank created more money than was consistent with preserving parity between the purchasing power of its currency and that of the US dollar at the pegged rate. Instead of tightening when necessary to stop an outflow of dollar reserves, the Banque du Liban after 2016 began desperately to borrow from Lebanon's commercial banks (at high interest rates) the dollars it needed to maintain the semblance of a peg. The commercial banks attracted dollars by passing those high rates on to depositors who presumably hoped to cash out before a devaluation came. The scheme, called "financial engineering" by Riad Salameh, long-time head of the Banque du Liban, devolved into Ponzi finance, racking up an estimated $40 billion in losses.

There are legal exchange houses in Beirut at which the dollar could recently be purchased for LBP3850, but residents may buy only small amounts there, creating a dollar shortage at that rate. Around 75 percent of bank deposits are in US dollars, but commercial banks since October have refused to redeem their dollar deposits in dollars (with remarkable legal impunity), allowing only conversion to LBP at the 3850 rate.

In June, Lebanon's annualized inflation rate topped 50%. Imported goods' prices have risen at a much faster rate with the depreciation of the pound.

The monetary chaos is not unrelated to Lebanon's sovereign debt fiasco. Its ratio of sovereign debt to GDP is the world's third highest (after Japan and Greece), above 150 percent and climbing with the annual budget deficit running 11.4 percent of GDP in 2019. In March 2020, the government defaulted on its external dollar debt. Behind this fiscal crisis is the tangled history of a state built on clientelism (legislative seats are apportioned among the major religious communities) and fueled by widespread corruption.

Is there a way back to a sane monetary system? Full dollarization offers a reform that has proven practical and effective in Ecuador and elsewhere.

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July 28, 2020 1:45PM

The New Deal and Recovery, Part 6: The National Bank Holiday

"The public plainly showed that it recovered from the fear and hysteria which characterized the last few days before the banking holiday was proclaimed." (The New York Times, March 14th, 1933.)

During the opening days of March, 1933, the U.S. economy resembled a stricken body slowly bleeding out, its organs failing one by one. The Federal Reserve System was hemorrhaging gold, and entire state banking systems were shutting down one after another. If the economy was to survive and recover, FDR had first to staunch the bleeding, and then to arrange for a transfusion. Here I explain how he managed the first of these steps.

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July 20, 2020 11:55AM

The New Deal and Recovery, Part 5: The Banking Crisis

Today, when we speak of ways to fight recessions, two options inevitably take pride of place: expansionary Fed policy (meaning lower interest rates or more asset purchases or both) and expansionary fiscal policy (more government spending or lower taxes or both).

But if you've been keeping up with this series, you'll know that, although the U.S. economy rebounded between March 1933 and early 1937, neither expansionary fiscal policy nor Fed actions of the sort we count on today deserve much credit for that rebound. Instead, the Treasury and the Fed played only bit parts, while the spotlight shone on FDR and his virtuoso gambol with gold.

FDR's handling of gold helped the U.S. economy recover from the Great Depression in part by getting the precious metal to flow into it, countering the persistent effects of a previous gold drain. That drain led to a nationwide banking crisis that brought the U.S. economy to its knees just before FDR took office. Before I can explain how, and to what extent, FDR's gold policies contributed to the recovery, we must step back in time to consider the causes of the banking crisis, including the part gold played in it.

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July 13, 2020 11:52AM

Fed’s Intervention in Corporate Credit: A Risky Venture

Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, Congress appropriated $454 billion to the Treasury's Exchange Stabilization Fund (ESF) to backstop emergency lending facilities known as "special purpose vehicles" (SPVs).[1] With the Treasury backstop, the Fed has the potential to lend a maximum of $4.5 trillion to fund the SPVs, which hold the assets off the Fed's balance sheet—including emergency lending to corporations, small and medium-sized businesses, municipalities, and states (see Torres). In April, the Fed announced plans to lend nine SPVs up to $2.3 trillion to boost the economy (see Timiraos and Fed's Press Release). However, the Fed has only provided about 6 percent of that amount (see Cox). All of the SPVs have now been activated (see Condon).

Although the Fed's new lending powers were intended to counter the U.S. economic collapse following the government-ordered lockdown to combat the pandemic, they risk giving the Fed a permanent footprint in private credit markets. In this article, I focus on the consequences of the Fed's entry into the corporate credit market, with the establishment of the Primary and Secondary Market Corporate Credit Facilities (CCFs).[2]

The Primary Market CCF, which opened on June 29, is designed to buy newly issued bonds, while the Secondary Market CCF began buying ETFs specializing in corporate debt on May 12 and began purchasing individual corporate bonds (including both investment-grade and high-yield bonds) after June 15. The later are "fallen angels"—that is, bonds of firms that were investment grade prior to March 23, but are now rated as junk bonds. The Primary Market CCF is backed by $50 billion from the Treasury's ESF, while the Secondary Market CCF is backed by $25 billion. As of June 24, the Secondary Market CCF's asset purchases only amounted to $8.7 billion (see Condon). The following section examines the objectives and operation of the Secondary Market CCF; the Primary Market CCP has yet to buy any bonds.[3]

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July 10, 2020 12:30PM

Where Have All the Coins Gone?

“If you put the federal government in charge of the Sahara Desert,” the economist Milton Friedman once quipped, “in five years there’d be a shortage of sand.” The U.S. Mint, to its credit, had a much longer run.

The Federal Reserve, which purchases coins from the Mint and distributes them to depository institutions, announced it would begin rationing coins “based on historical order volume by coin denomination” last month as its coin inventory had been “reduced to below normal levels.” The Fed also called on the Mint to increase the supply. Until the shortage is resolved, however, retailers unable to acquire enough coins from banks are left requesting customers pay with a card or use exact change.

No doubt many find the idea of a coin shortage perplexing. Coins are not consumed; they get passed along from one person to another. In the US, the average coin circulates for around 30 years. How, then, can there suddenly be a shortage of coins? Where have they all gone?

Each year, some coins are lost, discarded, or worn beyond use. They get thrown in a well with a wish; or, dropped down a drain by mistake. To offset the outflow, and keep up with secular growth in demand, the Mint must produce new coins. It issued nearly 12 billion circulating coins in 2019.

Figure 1. Cumulative Mintages, Billions

Cumulative Mintages, Billions

Source: This graph is based on data collected by the author from multiple data tables on Coin​News​.net and USMint​.gov.

So far, the Mint has not matched its 2019 pace. The global pandemic slowed production at the Denver and Philadelphia branches in March and April. By the beginning of May, the cumulative mintage—that is, the total number of circulating coins produced for the year—was just 4.02 billion, compared with 5.07 billion over the same period in 2019. Both facilities have been operating at full capacity since June 15, though, so that the gap has since fallen to less than 0.06 billion.

But the temporary shortfall in production is only a small part of the problem. A much bigger issue has been the limited extent to which coins have been circulating.

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July 6, 2020 4:55PM

The New Deal and Recovery, Part 4: FDR’s Fed

“Roosevelt had conducted an active monetary and fiscal program of recovery…working along lines suggested by Keynes.” Eric Rauchway, The Money Makers, p. xvi.

As we saw in the last installment to this series, New Deal fiscal policies did little to help the U.S. economy recover from the Great Depression. Yet the U.S. did see substantial gains in output and employment between 1933 and 1937. If those gains weren’t a result of fiscal stimulus, what caused them? And just what did New Deal policies have to do with these causes?

A Money‐​Fueled Recovery

The answer to the first question, according to most economic historians, is growth in the U.S. money stock, which rose from just over $4 billion in late 1933 to nearly under $23 billion by late 1941. “Nearly all of the observed recovery,” Christina Romer says in the abstract to her influential 1992 article, “was due to monetary expansion.” Just as the monetary collapse of 1929–33 contributed to the “Great Contraction” of 1929–33 (to use Milton Friedman and Anna Schwartz’s famous term for it), money growth fueled a “Great Expansion” between 1933 and 1937, reviving the overall demand for goods and services, raising equilibrium prices, and boosting output.

According to Romer’s calculations, illustrated in the chart below, if instead of growing exceptionally rapidly the U.S. money stock had only grown at its average historical rate, “real GNP would have been approximately 25 percent lower in 1937 and nearly 50 percent lower in 1942 than it actually was.”

Figure 1. United States Real GNP and Predicted GNP, 1933–1942

United States Real GNP and Predicted GNP, 1933-1942

Romer, Christina D. “What Ended the Great Depression?” The Journal of Economic History 52, no. 4 (1992): 757–84. Accessed July 6, 2020. www​.jstor​.org/​s​t​a​b​l​e​/​2​1​23226.

For comparison’s sake, here is Romer’s chart showing how much New Deal fiscal policy contributed to the post‐​1933 recovery:

Figure 2. The Contribution of New Deal Fiscal Policy to the Post‐​1933 Recovery

The Contribution of New Deal Fiscal Policy to the Post-1933 Recovery

Romer, Christina D. “What Ended the Great Depression?” The Journal of Economic History 52, no. 4 (1992): 757–84. Accessed July 6, 2020. www​.jstor​.org/​s​t​a​b​l​e​/​2​1​23226.

But before we assign credit to the New Deal for any part of the Great Expansion, we have to ask what role New Deal policies played in boosting money growth. As we’ll see in a moment, that growth depended both on the extent of the Fed’s net purchases of commercial paper and Treasury securities and on growth in the Fed’s gold reserves. This post will concentrate on the Fed’s direct contribution to money growth and the New Deal’s bearing on it. My next post will look into the effect of New Deal policies on the Fed’s gold reserves.

Sources of Money Growth

To assess the New Deal’s role in the Great Expansion, we must first consider the proximate causes of that period’s money growth. The most important of these causes consisted of growth in the size of the Fed’s balance sheet. As that grew, so did the sum of bank reserves and the public’s holdings of Federal Reserve notes. The size of the Fed’s balance sheet in turn depended on the amount of gold (or “gold certificates”) that came its way, and also on the nominal value of commercial paper (“bills”) and Treasury securities the Fed acquired through its lending and open‐​market operations. The other source of changes to the money stock consisted of changes in the ratio of the total money stock to the quantity of Fed assets, which itself depended mainly on what ratio of reserves to deposits banks wished or were required to maintain.

The progress of these different money stock determinants can be seen or inferred from the following chart, in which the blue line shows the U.S. “M1” money stock (currency in circulation plus bank demand deposits), the red one shows the Fed’s gold holdings, and the purple one shows the Fed’s holdings of bills and securities. I’ll come to the green line later. The values are all index numbers, with March 1933 = 100. Using these makes it easier to assess the relative importance of the different factors driving money growth.

Figure 3. Growth within the Great Expansion

Growth within the Great Depression

National Bureau of Economic Research, retrieved from FRED, Federal Reserve Bank of St. Louis

A remarkable conclusion that emerges from this chart is that the rapid money growth between 1933 and 1937 was entirely due to growth in the Fed’s gold holdings. The banks, for their part, increased their reserve ratios over time, causing both bank deposits and the total money stock to grow less than proportionately with the Fed’s gold holdings. Finally, the Fed’s bill and security holdings remained almost constant. Its commercial paper holdings, very modest to begin with, actually fell by $10 million between December 1933 and December 1934, after which they were virtually constant. And although the Fed bought $600 million in Treasury securities between April and December 1933, it made no more purchases between then and 1937, when it added a measly $50 million to its holdings.[1]

In short, although the Fed let its balance sheet and bank reserves grow passively in response to gold inflows, contributing to money growth to that extent, it did next to nothing to actively encourage money growth.

The New Deal and Fed Policy

Why did the Fed do so little? It certainly wasn’t because there was no “Keynesian” case for additional monetary stimulus: for all the progress the U.S. economy made between 1933 and 1937, at the end of that upturn it was still running well below full capacity, with output barely above its 1929 level, and an unemployment rate still well into double digits.

Yet instead of taking steps to ramp‐​up the money stock, Fed officials became increasingly worried about…inflation! Noticing that banks had been storing‐​up excess reserves, they feared that a revival of bank lending might lead to excessive money growth, and therefore refrained from contributing directly to that growth. Then, finding a merely passive stance inadequate, they joined forces with the Treasury to offset gold inflows. These steps were among several that contributed to the “Roosevelt Recession” of 1937–8, which undid many of the gains of the preceding four years. Far from regarding these anti‐​inflation measures as consistent with his own theories, Keynes is supposed to have complained that Fed and Treasury officials “professed to fear that for which they dared not hope.” Only after the ’37-’38 debacle did “Keynesian” ideas begin to inform Roosevelt’s fiscal and monetary policies.[2]

What role did the New Deal play in all this? The answer is, a much bigger one than you might think. The 1932 Glass‐​Steagall Act (not to be confused with the 1933 New Deal measure of the same name) had somewhat relaxed gold’s grip on U.S. monetary policy by allowing the Fed to issue “Federal Reserve Bank Notes” backed by certain Treasury securities instead of bills or gold.[3] The Emergency Banking Act of 1933 in turn made all direct U.S. obligations, as well as the Fed’s holdings of notes, drafts, bills of exchange and bankers’ acceptances, temporarily eligible as collateral for Federal Reserve Bank Notes. Finally, Roosevelt made the gold constraint almost entirely irrelevant, first by suspending gold payments and then (in January 1934) by officially devaluing the dollar. Following these steps, although the Fed could and generally did allow its balance sheet to grow passively with its gold receipts, it also enjoyed considerable freedom to alter the supply of currency and bank reserves independently of changes to its gold holdings.

Had these changes alone occurred, they would only have enhanced the Fed’s discretionary powers, making it, rather than FDR or the New Deal, responsible for any subsequent lack of monetary stimulus. But other New Deal steps dramatically reduced the Fed’s independence, placing monetary policy almost entirely under the administration’s control. It follows that, if the money stock didn’t grow as much as it should have, the blame ultimately rested with the administration.

The Thomas Amendment

After the Emergency Banking Act, which allowed FDR to put the gold standard on ice, the next significant increase in FDR’s monetary policy powers came with the controversial Thomas Amendment to the Agricultural Adjustment Act of May 12th, 1933. That amendment allowed FDR to ask the Fed to buy up to $3 billion in Treasury securities directly from the Treasury or (if the Fed demurred) to have the Treasury itself issue up to $3 billion in its own “greenbacks.” It also allowed him to revive bimetallism by authorizing the minting of full‐​bodied (as opposed to token or subsidiary) silver coins and the tendering of silver certificates for silver received by the Treasury for that purpose. Finally, the Thomas Amendment gave the president the power to reduce the gold content of the dollar by as much as 50 percent, paving the way to devaluation.

These were sweeping powers—or so it seemed, at least, to the amendment’s conservative critics, including Lewis Douglas, FDR’s very orthodox budget director, who thought they’d put paid to Western Civilization! Testifying in 1941 before the Senate Banking Committee, Edwin Kemmerer, the famous “Money Doctor” and gold‐​standard champion, was only slightly less melodramatic. The Thomas Amendment, he said,

gives to the President and his appointees a legal authority over the nation’s currency that is almost complete. A Stalin or a Hitler could hardly have more. The things that the President has legal authority to do to the currency directly and their necessary implications could give us a gold standard, a silver standard, a bimetallic standard, a paper money standard or a commodity dollar standard. They could give us serious deflation or a runaway inflation.

It’s doubtful, though, that FDR ever intended to take full advantage of the powers the Thomas Amendment gave him. Although he certainly welcomed and would soon make use of the power to devalue the dollar, he was neither a greenbackist nor a silverite. As the late Elmus Wicker (1971, pp. 866–7) explains, much as he may have looked forward to raising gold’s price, FDR

did not view with favor the expedient of simply adding to stock of money to achieve the desired price level. He objected to outright money creation as ‘inflationary’ because [it] had historical connotations of reckless spending by government, extreme difficulty in funding the public debt, and a general wage and price spiral.

According to Wicker and most other historians, FDR went along with the Thomas Amendment’s “inflationary” provisions to kill another amendment, proposed by Montana Senator Burton Wheeler, that would have authorized additions to the money stock whether FDR approved of them or not. Fearing Congress might override his veto of the Farm bill so amended, he accepted Thomas’s alternative, which merely gave him the option of calling for outright money creation.[4]

Whatever FDR’s true intentions, the Thomas Amendment made it possible for him to compel the Fed to create more of its own money by threatening to have the Treasury issue greenbacks or silver money instead. Yet he wielded that threat but once when, in September 1933, he said he’d issue greenbacks if the Fed didn’t roll‐​over $50 million in maturing securities. FDR also went on to authorize Treasury silver purchases. But he did so not to encourage monetary expansion but to placate the powerful silver lobby and those senators and representatives beholden to it. For that reason it made no difference to him that the Treasury retired enough national banknotes to offset most of the new silver currency it issued.[5] In short, despite the Thomas Amendment, FDR did very little to encourage money growth beyond what gold inflows alone would accomplish.

The Gold Reserve Act

Two other New Deal measures further strengthened the administration’s grip upon monetary policy. This time the administration was to take full advantage of the changes. But it would do so, not for the sake of further boosting money growth, but to put an end to that growth, with dire consequences I’ll treat in full in later segments.

Fed economist Gary Richardson and his coauthors have called the first of these measures, the Gold Reserve Act of 1934, “the culmination of Roosevelt’s controversial gold program.” Having ordered Americans to surrender most of their monetary gold holdings to the Fed in April 1933, FDR now secured Congress’ permission (1) to have the Fed transfer its gold to the U.S. Treasury in exchange for Treasury “gold certificates,” and (2) to alter the dollar’s gold value by proclamation, which he did on January 31st, the day after signing the new law, by raising gold’s official price from $20.67 per ounce to $35 per ounce. The dollar was thus deprived of 41 percent of its former gold content.

Although Richardson et al. suggest that the government compensated the Federal Reserve “at a rate of $35 per ounce,” that’s not so. As a different Fed publication points out, because the Treasury took possession of the Fed’s gold before FDR announced gold’s new price, it paid for it at the old statutory price of $20.67 per ounce. The Fed’s nominal “gold” reserves therefore stayed unchanged, except that they now consisted not of actual gold but of Treasury gold certificates.

It’s here that the green line in the FRED chart above becomes relevant. To save you some scrolling here’s that chart again:

Figure 4. Growth within the Great Expansion (Same as Figure 3)

Growth within the Great Depression

National Bureau of Economic Research, retrieved from FRED, Federal Reserve Bank of St. Louis

National Bureau of Economic Research, retrieved from FRED, Federal Reserve Bank of St. Louis

Because the nominal “gold profit” from the devaluation went not to the Fed but to the Treasury, it didn’t result in any immediate increase in the Fed’s assets, bank reserves, or the money stock. The way in which devaluation was handled thus demonstrated, in an especially neat fashion, FDR’s desire and willingness to try and raise prices generally by raising the price of gold, but not by encouraging growth in the money stock.

As for what the Treasury did with its gold profit, $2 billion of it went to establish an “Exchange Stabilization Fund.” According to Roosevelt’s proclamation announcing the dollar’s devaluation, that fund would serve “to stabilize domestic prices and to protect the foreign commerce against the adverse effect of depreciated foreign currencies.” But Fed officials saw it rather differently: according to an internal Fed memo sent to Fed Board governor Eugene Black, it would allow the Treasury Secretary “to assume complete control of general credit conditions and to negate any credit policies that the Federal Reserve might adopt.” Precisely what use the Treasury made of this newly acquired control is something I’ll take up in the next installment in this series. Suffice it to say that there was nothing “Keynesian” about it.

Marriner Eccles and the 1935 Banking Act

While the Farm and Gold Reserve Acts awarded FDR money creating powers he could employ without the Fed’s cooperation, or appeal to compel it to cooperate, by appointing Marriner Eccles as the Fed’s new governor in November 1934 and letting him draft the Banking Act of 1935, FDR got himself a Fed that would sing his tune.

Unlike Eugene Black, who was himself a Roosevelt appointee who stepped down after clashing with him when he made the Fed banks surrender their gold, Eccles was said (by the New York Evening Post ) to have “views on monetary policy…even more liberal than those already embraced by the New Deal.” Henry Morganthau, who was then FDR’s secretary of the Treasury, recommended Eccles to FDR for this reason and so that the Treasury could count on a highly cooperative Fed.

But Eccles agreed to take Black’s place only on one condition: FDR had to let him author a radical Fed overhaul that would substantially increase both his own and other politically‐​appointed officials’ influence upon Fed policy, while reducing that of the governors of the 12 Reserve banks.

Eccles’s proposal became the Banking Act of 1935, which Roosevelt signed that August. The Act replaced the former Federal Reserve Board with the present seven‐​member presidentially‐​appointed “Board of Governors.” It also changed the composition of the FOMC, which had been established by the Banking Act of 1933 to coordinate the Fed’s open‐​market operations. That committee’s voting members had originally consisted solely of the “governors” (as they were then styled) of the 12 regional Fed banks. The new law established the one in place today, with the “presidents” of only five Fed banks (New York’s and four others chosen on a rotating basis) serving on the committee at any one time, and doing so along with the seven members of the Board of Governors.

Besides allowing the Board of Governors to make up a majority of the FOMC, the new law also allowed it to set Fed bank discount rates and reserve requirements. The Act’s ultimate goal, according to Peter Conti‐​Brown (p. 32), was nothing less than that of subsuming monetary policy under administration policy. “It is no surprise, then,” says Brown,

that the Eccles Fed of the 1930s saw less of a need to declare formal independence from government, as the Banking Act of 1935 had done in a declaration of independence from private bankers. Even during a brief and painful interlude of further recession in 1937–38, the Fed’s policy during the 1930s was fully congenial to the administration’s.

In their 2014 paper, “Navigating Constraints: The Evolution of Federal Reserve Monetary Policy, 1935–59,” Fed economists Mark Carlson and David Wheelock reach a more or less identical conclusion. “New Deal legislation,” they write, “limited the Fed’s ability to conduct an independent monetary policy. The Fed was forced to cooperate with the Treasury in the 1930s, and fully ceded monetary policy to Treasury financing requirements during World War II.”


To sum up: if ever an administration had control over Fed policy, and monetary policy more generally, FDR’s was it. It follows that, if monetary policy did less than it should have to end the Great Depression, the Roosevelt administration must bear a good share of the blame.

But everything is relative: until the last months of 1936, the Roosevelt administration’s monetary policy errors were errors of omission only: unlike Hoover, who acquiesced to Fed policies that contributed to the Great Contraction, FDR and his Treasury team merely failed to encourage the Fed to contribute more to money growth than it did, or to contribute more to that growth themselves. Alas, this ceased to be so toward the end of 1936, when actions by both the Fed and the Treasury resulted in a second severe monetary contraction that would reverse many of the gains achieved over the course of the preceding four years.

It’s also true that, if New Deal policies failed to encourage monetary expansion beyond what gold inflows alone provided for, those policies deserve much of the credit for those gold inflows. Just how much credit they deserve will be the main topic of this series’ next installment.

Continue Reading The New Deal and Recovery:


[1] The Fed’s 1937 purchases were part of its “flexible portfolio policy”—an early version of “Operation Twist”—aimed not at promoting money growth but at arresting the decline in Treasury bond prices that began in late 1936. To prop those prices up, the Fed actually bought $200 million in Treasury bonds. But it simultaneously sold $150 million in shorter‐​term Treasury notes and bills. For further details see Chandler (1949).

[2] See Renshaw (1999, especially pp. 349–50). According to this very well‐​informed article, the decisive change occurred while Roosevelt was at Warm Springs in March 1938. Here he “was finally converted to the idea of a package of federal spending to act counter‐​cyclically on the now seriously depressed economy.” It was also subsequent to this meeting that the administration’s monetary policy, which “had been crucial in deepening” the recession, was “abruptly reversed.”

[3] Federal Reserve Bank Notes resembled national bank notes, and could be issued on precisely the same terms, though by individual Federal Reserve banks rather than national banks. They were first used during WWI, but had been withdrawn afterwards.

[4] Eric Rauchway (2015, pp. 65–6) rejects this interpretation, which rests upon the testimony of original brain trust members Raymond Moley and Paul Warburg. “Roosevelt,” he says, “operated so deftly that even people close to him believed his hand had been forced.” In fact, Rauchway says, Roosevelt “told [George] Warren to keep pushing” for the Thomas Amendment’s inflationary provisions so he’d have “the tools…he wanted” to manage the dollar. But according to Warren’s theory, to which FDR fully subscribed by this time, the only tool Roosevelt needed was the authority to alter gold’s price. There is no reason to suppose, therefore, that he welcomed, much less encouraged Warren or anyone else to “push for,” the Thomas Amendment’s other provisions.

[5] Although Treasury silver purchases added $1.22 billion to Fed member bank reserves between late 1933 and the end of 1938, most of these purchases resulted not from the Thomas Amendment but from the Silver Purchase Act of 1934. In any case their effect on the money stock was largely offset by the Treasury’s concurrent retirement of $900 million in national bank notes. The Treasury’s net contribution to bank reserves was just $320 million, a very small share of the total increase of about $6 billion, most of which was due to gold inflows.