Edwards, American Default

No, this is not a dystopian account of the consequences of bad tax policy, wanton spending, and political gridlock. American Default (Princeton University Press, 2018), by Sebastian Edwards, is, in the words of the subtitle, The Untold Story of FDR, the Supreme Court, and the Battle over Gold. And a fascinating story it is. I couldn’t put this book down.

At its heart is “the great debt default of 1933-1935, … when the White House, Congress, and the Supreme Court agreed to wipe out more than 40 percent of public and private debts” by abandoning the gold standard, devaluing the dollar, and abrogating gold-denominated contracts retroactively.

Edwards takes the reader on the long, tortuous path to devaluation. FDR was largely ignorant of economics, not that economists of the day themselves understood the intricacies of the monetary system. He used commodity prices, especially the price of cotton, as the benchmark against which to measure the success of his economic policies. (In 1932 about half of the American population earned their living by farming.) During the first year of his administration he “obsessively” followed these prices, and “their movements often guided public policy. When commodity prices went up, the president felt confident; however, when prices faltered, the president would become very upset, and his tendency to experiment and try new policies would rise to the surface.”

The president was taken with agricultural economist George F. Warren’s “elegant charts drawn on onionskin paper.” The theory was that if the price of gold increased, higher prices for agricultural commodities would immediately follow. The New York Times reported that the administration’s goal was to adopt “a ‘commodity dollar’ which will fluctuate in line with general commodity movements instead of remaining as a constant factor through all periods of changing values.” Despite spurious theory and many stumbles, between March 1933, when Roosevelt was inaugurated, and December 1934, “the price of corn quadrupled, that of cotton almost doubled, the price of rye doubled, and that of wheat increased by 114 percent. During the same period, the Dow stock market index had increased by 67 percent.”

One of the most controversial policies, enacted at the behest of the Treasury Department, was the congressional joint resolution voiding the gold clause for both past and future contracts. If the White House’s policies rested on spurious economic theory, the legal basis for them seemed even dodgier. After all, the sanctity of contracts was part and parcel of accepted legal theory. The Supreme Court took up four cases challenging the joint resolution.

The Court, by a 5-4 vote, ruled that “the abrogation of the gold clauses for private contracts was constitutional, and debtors could discharge their debts using legal currency.” As applied to public debt, however, the Court ruled 8-1 that the abrogation of the gold clause was unconstitutional. But, again by a 5-4 vote, it “accepted the government’s secondary argument that the abrogation of the gold clause had not produced any damages to bond holders; in terms of purchasing power over goods and services, bondholders were at least as well off in 1933, as they had been at the time the Liberty Bonds were issued.” So bondholders could not sue for damages, and “there was no practical economic consequence for having passed an unconstitutional law.”

Contrary to the dire predictions of the Court minority, there was no major fallout from the rulings. The government had no difficulty rolling over its debt or issuing new securities. The U.S. abrogation was an “excusable default.”

Could an American default happen again? Yes, but, Edwards maintains, it would not be related to deflation, exchange rates, or the monetary system. The debt crisis that looms on the horizon “has a completely different genesis: it is rooted in unsustainable promises made in the present for future delivery of services.” And, presumably, this time around a default would not be excusable.