Sunday, June 22, 2008
The Gold Clause
"People these days fear inflation. We also fear changing rates of inflation. And most of the tools we might use to protect ourselves such as the Treasury Inflation-Protected Securities bond or gold stocks, are imperfect. TIPS are, after all, based on an inflation-measure whose accuracy is itself controversial--the Consumer Price Index. ... Consider an investor in the gold standard era. The dollar was worth $20.67 in gold, and you could, at least in theory, trade your greenbacks for gold at the bank. The gold standard checked a government's willingness to inflate, since it started losing gold when it did so. ... Since investors protected by these clauses [gold] knew that they would get their money back, interest rates were lower. To finance World War I, Washington even inserted gold clauses into Liberty Loans. ... Randall Kroszner, a governor at the [Fed], has studied this period  and has noted that the price went up on most stocks and bonds, even gold-clause bonds, when the Supreme Court eventually validated FDR's action [repudiating gold clauses]. ... The market rally in the spring of 1933 slowed as investors watched FDR fiddle with the dollar and commodities over the course of the fall. In 1934, FDR thought better of it all and fixed the dollar to gold again, albeit now at $35 dollars an ounce. But the abrogation of the gold clause suggested that Washington has no regard for property rights. ... And from then on, the federal government enjoyed wider license to inflate. ... People don't talk more about the damage of monetary uncertainty because that damage is so spread out--harder to discern than, say, a single giant event like the implosion of Bear Stearns. But the old gold clause footnote explains why we may see yet more angst over the [CPI] the TIPS bond, or even LIBOR, the London Interbank rate. We have lost our bearings and our confidence in money generally", my emphasis, Amity Shlaes, (AS) at the WSJ, 5 June 2008.
While generally agreeing with AS, I disagree that "we have lost ... our confidence in paper money". Had we US dollar interest rates would be higher, possibly 20-25% for 30-year Treasuries, not 4.72%. Gold would not be $886, but in the thousands. AS, be patient. Americans misplaced confidence in the dollar will collapse. As to the gold clause, there is no law Uncle Sam will not abrogate if it suits his purpose. Treasury bond buyers, beware. See my 18 November 2007 post.