Gold-price history charts denominated in US dollars show a flat line
at $35 that runs through most of the 20th century. Thirty-five dollars was, after
all, the official gold price as set by the United States Treasury from 1934
on. Prior to 1934, the gold price had been fixed at $20.67 for almost a
century, before President Franklin Roosevelt confiscated Americans' gold and
revalued the price to $35 that year.
The $35 price was an integral part of the Bretton Woods Agreement
negotiated after World War II. Bretton Woods specified a system of fixed
parities between the US dollar and other industrialized currencies,
and the convertibility by foreign central banks of US dollars into gold at
$35 an ounce. In other words, each dollar paid out around .03 ounces of gold,
or 0.888671 grams.
This was not like the classical gold standard of the 1800s but a
pseudo gold standard foisted on the world by central planners. Convertibility
could not be exercised by private individuals, only central bankers, and most
currencies were not redeemable in gold; only the dollar was. Again, gold
charts show a flat line through the Bretton Woods era of the 1940s, '50s, and
'60s at $35.
The problem with these flat lines is that they imply that monetary
authorities were able to keep the actual gold price fixed at the precise
level they specified, and conversely, that the purchasing power of the dollar
remained constant. This was not the case, as the market price for gold often
differed from the official $35 price, sometimes quite significantly, and the
dollar actually lost value against most goods, even though it was officially
fixed versus gold.
When doing research for a gold chart project of my own, I spent
several weeks nosing through old papers and magazines for market data from
the era of $35 gold. I hope to bring back into public memory the divergence
of gold's market price from the official price, a data set that has been
forgotten.
Our chart begins in 1954 with the reopening of the London gold market,
which, prior to being closed at the outbreak of World War II, had been the world's
largest venue for trading the metal. Through the 1950s the London price
fluctuated between $34.85 and $35.17. These upper and lower limits were set
by arbitrage and the threat thereof. Foreign central banks, as stipulated in
Bretton Woods, could go to the Federal Reserve in New York and convert their
dollars into gold or gold into dollars at $35 plus 8.75¢ commission. The cost
of shipping and insuring gold from New York to London and vice versa was 8¢
to 10¢ per ounce.[1]
Thus, when the London price traded down to $34.82 or so, it made sense
for central banks to buy gold in London, ship it to New York for 8¢, then
sell it to the US Treasury at the $35 official price less 8.75¢ commission,
earning arbitrage profits of around 1¢ an ounce. Conversely when gold rose to
$35.18 in London, it made sense to buy gold from the US Treasury at $35.0875,
ship it to London for 8¢, sell it at $35.18, and earn arbitrage profits of
1¢.
In the mid to late 1950s the balance of payments between the United
States and the rest of the world grew ever more dramatically in the latter's favor. This was due to growing US military expenditures
overseas, corporate investment outflows, and foreign aid to a rebuilding
Europe. As a result, European and Japanese central banks accumulated
continuously growing US-dollar reserves.
Nineteen fifty-eight marked the first year in which foreign central
banks exercised their convertibility rights in significant amounts and
returned their dollars for gold. US gold reserves fell 10% from 20,312 metric
tons to 18,290 that year, another 5% in 1959, and 9% in 1960. At the same
time, the US Federal Reserve continued to increase notes in circulation,
resulting in dollars being backed by ever smaller amounts of gold. Since this
threatened future potential convertibility, rumors grew that the United
States would be forced to devalue the dollar to staunch the outflow.
The US government tried to prevent gold from leaving by twisting the
arms of foreign central banks to keep their dollars, and, later, setting
travel limits on American tourists overseas and US private investment in
Europe. By 1958, London gold was trading closer to its $35.18 upper limit
rather than the bottom limit at $34.82, which it touched in 1957.
Participants in the London market — increasingly dominated by throngs of
private investors and speculators — were ever more certain that the United
States' plunging gold reserves would force it to dramatically devalue the
dollar.
In September 1960, the United States experienced its largest weekly
decline in reserves since 1931[2] as
foreign central banks went to New York for the metal. At the same time it was
becoming evident that presidential challenger John F. Kennedy would win that
fall's election. Kennedy's promises to lower interest rates and increase government spending convinced many that gold
outflows would only increase. The Dow Jones Industrial Average plunged 12%
from the end of August to October 25, hitting its lowest point since 1958.
In this context, London gold prices rose above $35.20 for the first
time in September 1960, and on October 20 hit $36, far above the ceiling
implied by arbitrage. The next week, a speculative gold rush touched off and
the price soared, briefly hitting $41 before closing at a high of $38. With
London trading at an impressive 17% premium to the official price, the
world's monetary architects had lost control of the market price of gold.
Gold's market premium to the official price was no small matter as it
questioned the very fundamentals of the planned monetary system. After all,
if an ounce of gold was trading at a premium over dollar claims to that same
ounce of gold, then the validity of those dollar gold claims was being
challenged by the market. Furthermore, by giving foreign central banks even
more incentive to exchange dollars for gold at $35 in New York in order to
sell it in London at $36 to $38, the premium would exacerbate the United States'
gold drain.
"Gold's
market premium to the official price was no small matter as it questioned the
very fundamentals of the planned monetary system."
At the eleventh hour, the New York Federal Reserve cut an informal
deal with the Bank of England to resupply said bank with any gold it spent,
at its own discretion, in suppressing the gold price. Prices soon began to
fall as the Bank of England sold. As one of his last acts as president in
1960, Eisenhower tried to suppress gold demand further by making it illegal
for Americans to buy the metal overseas — an extension of Roosevelt's 1933
ban on American domestic holdings of gold. By March 1961, the gold price had
been strong-armed back to $35.10.
Fearing another gold rush in October 1961, Western central banks
formalized a plan by which they pooled together several hundred million dollars worth of gold, this stock to be mobilized to
control the London gold price. Thus was born the famous London gold pool. The
pool became an active buyer of gold when the London price fell below $35.08
an ounce and a seller at $35.20.[3] In
its first test — the week of the Cuban Missile Crisis in October 1962 — the
pool effectively supplied the London market despite demand for the metal
being greater than the 1960 gold rush. Prices could not penetrate $35.20. The
pool's reputation strengthened: gold would stay benign and near $35.08 for
the next few years.
In 1963 and 1964, the United States would lose only small amounts of
gold reserves to foreign central banks, and the London pool bought gold to
support its price rather than suppressing it. Bretton Woods, the dollar, and
the $35 fix seemed safer than ever. But with the Gulf of Tonkin incident in
late 1964 and the acceleration of the Vietnam war in 1965, US foreign
military spending exploded. This was compounded by President Lyndon B.
Johnson's expensive Great Society project, paid for in part by the Federal
Reserve issuing new money to buy government debt.
The balance-of-payments deficit grew ever faster, and the United
States lost more gold reserves to dollar-laden foreign central banks
exercising convertibility and through gold-pool sales in London. US gold reserves
resumed their downward trajectory, declining by 9% in 1965. At the same time,
speculators were buying gold in record numbers in London, forcing price up to
$35.20, the London pool's line in the sand.
Things only got worse with the exit of the French from the gold pool
in early 1967, tensions in the Middle East, and the collapse of the British
pound in November 1967. The Tet offensive of early 1968 indicated the US
commitment to Vietnam would only grow. Speculators bought en masse in London
through the remainder of 1967 and into March 1968. By March 14, the members
of the gold pool, having sold about $2.75 billion worth of gold to protect
the $35.20 ceiling, or about 10% of the member's total reserves since the
pound's devaluation, had had enough.[4]
They asked the Queen of England to close the London market the next day and
dissolved the once-feared gold pool. When London reopened two weeks later,
without suppression, prices immediately vaulted up to $38 and would soon rise
to $42.
Reviewing this period in gold's history makes evident the extreme
difficulties experienced by the monetary authorities in controlling the price
of gold. The typical flat $35 line on charts gives the illusion that the dollar
was a stable store of value. In actuality, market prices diverged from $35 —
and dramatically so in 1960. The attempt to fix the dollar at 0.888671 grams
and gold at $35 — this while the dollar's purchasing power had declined
versus all other goods — was a losing battle carried out at great expense.
The United States and its allies would sell huge quantities of gold at prices
below what a free market would have borne. In 2009, amidst some of the
largest central-bank rescues and bailouts in history, let the 1960 gold rush
and the eventual collapse of the London gold pool in 1968 stand as a reminder
to us that central planning of monetary matters is doomed to fail.
Notes
[1] The
Economist, October 22, 1960.
[2] Globe
and Mail, September 23, 1960.
[3] The
Economist, February 16, 1962.
[4] The
Economist, March 16, 1968
Read
the next part of the article here
John Paul Koning
John Paul Koning is a
financial writer and graphic designer who runs Financial Graph & Art.
His Recent History of Gold,
1954-2009 Wallchart is available here.
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