AMERICAN DEFAULT

2019-05-07 · Guest: Sebastian Edwards (UCLA Economics Professor) · 50:11

Filed under: Markets and money · The Constitution and the courts
Topics: Monetary Policy · Supreme Court

The 1933 United States Debt Default

Bob Zadek explores the little-known history of the 1933 United States debt default under Franklin D. Roosevelt. Guest Sebastian Edwards explains how FDR abandoned the gold standard, confiscated private gold, and used a Supreme Court ruling on “necessity” to devalue the dollar and transfer wealth from creditors to debtors.

Topics: American Default, Gold Standard, FDR, Supreme Court, 1933, Monetary Policy, Gold Clause Cases, Deflation, Great Depression

Speakers: Bob Zadek, Sebastian Edwards

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The Myth of the Unblemished Record [00:15]

Bob Zadek: Hello everyone, welcome to the Bob Zadek Show, the longest-running live libertarian talk radio show on all of radio. Thanks so much for listening this Sunday morning. We are this morning and always the show of ideas, never ever the show of attitude.

It is part of the American ethos that our country has never and will never default in any of its obligations. We have had an unblemished record throughout our almost 240-year history. We, we proudly say, honor our obligations. But is that made up? Is that really true? Well, most people who hear that question would say, “Of course it is. There is no record of America, even during troubled times, not honoring its contractual and more specifically, its economic obligations, its obligations under its debt. We just don’t do that. After all, this is America.”

Well, my friends, I’m afraid I have to destroy your view of the tooth fairy and of Santa Claus and of America never defaulting. That is simply not the case. In a little-known but quite significant part of American history, FDR, under the advice of one of the most significant economists you have never heard of, FDR was able to default without defaulting in our debt. Not only did FDR actually cause a default—and we’ll see if you agree during the course of this hour—but that default was strategic and by many observations, the default by America engineered by FDR and his advisors, that default in 1933 may very well have been a brilliant economic move and political move and may very well have shortened the Depression, at least postponed it because it revived again in 1937, but it shortened the Depression and gave Americans a significant respite from the evils of the Depression.

So what is this story of American default you have never heard of? To help us understand, I’m happy to welcome my new best friend, Sebastian Edwards. Sebastian teaches economics in the graduate program at UCLA, has worked with—lucky Sebastian—Milton Friedman and other very well-known Chicago School free-market economists, and discovered the story of this default by FDR almost accidentally. It’s a great story with great lessons. Sebastian, welcome to the show this morning.

Sebastian Edwards: Good morning, Bob. It’s great to be with you and with your listeners and to have a conversation about this little-known episode.

Bob Zadek: And just a word for our listeners: Sebastian, who gets the Bob Zadek Award for Valor, had a flight scheduled for later this morning, but American Airlines, as they are wont to do, canceled his flight, put him on an earlier flight. So thus, instead of carrying on sharing his thoughts with us from the comfort of an easy chair at home, he is at the terminal right now waiting for his flight. But he assures me he will not be doing this from his seat in the airlines. He has enough time to do the entire show. So Sebastian, thank you for that yeoman’s duty this morning.

Sebastian Edwards: You’re welcome, Bob.

Discovering the Default [04:51]

Bob Zadek: Now Sebastian, you discovered this story, this event, this economic event, even though you are of course a student and a teacher of economics and you would have prided yourself on knowing all of the significant economic events in recent and not-so-recent American history. You came upon the story of America’s only default quite by accident. Tell us briefly how you discovered who taught you the story of FDR’s engineering of a default.

Sebastian Edwards: Sure. So about 15 years ago, I was asked by a law firm to work as an expert witness in a number of cases related to the Argentine default of 2001. And I was preparing my report for those cases for the arbitration tribunal, and I found one paragraph which was very intriguing. It said, “By the way, there is a precedent to what we did,” and what they had done was defaulted on their debt. “And the precedent is the United States in 1933.” And they added the Supreme Court said it was okay to do exactly what we’re doing now. So if the US Supreme Court says it’s okay for the US, it must be okay for us, Argentina.

So I started asking around and almost no one knew about it. And that’s when I decided to write a book on the subject, and that’s the book that we are talking about this morning.

Bob Zadek: And of course it didn’t occur to you, given the quality of the law firms, that they had just made the whole thing up to justify the default by Argentina. So you took it seriously, and that was the good, the right call because you then discovered that yes, not only was Argentina not the first—of course they were not—country to default, but they were relying upon the bad example, if it is a bad example, set by none other than the United States during the early stages of the Depression in 1933.

The Gold Standard and Gold Clauses [07:52]

Bob Zadek: So let’s flash forward. It’s 1933. FDR wants to un-link the dollar from gold. And that’s the origin—trying to get out of the gold standard—and he realizes that there is a problem there. So let’s back up. Let us help the audience understand a few concepts that will be quite important as you tell the story. First is the concept of the gold standard. That is a phrase as part of American vernacular, but it is a very important economic concept. So tell us, if you will, when you use the phrase “gold standard,” what do you mean in general and particularly, because it’s so important, what does it mean in the concept of indebtedness, especially bond indebtedness?

Sebastian Edwards: Right. So the gold standard is a monetary system whereby the liabilities of the central bank—in our case, the Federal Reserve System—these liabilities are backed by gold, either fully or in a very large percentage, like 50%, 45%. So the Fed issues paper money, the way to think about it is that it issues paper money, but this paper money is backed by gold. So the only way to issue more paper money is if you have more gold as backing. And that is the gold standard, and there is a fixed price between the paper money and gold. And in the US since 1834, that price was $20.67. And it had been constant for a hundred years. And then FDR says, “Well, we have the Depression. Maybe we should end this tight connection between gold and the US dollar.” And that’s the beginning of the story.

Bob Zadek: Now the reason—now let me just help the audience understand—the reason why creditors insist upon having dollar debt linked to gold is that when bonds are issued by the government, a government could obviously simply issue more money. And when there is more of anything, it is worth less. So if the government issues more money, which is called in everyday language inflation, the buying power of a dollar is decreased. Which means if somebody owes you $10,000 and they owe you $10,000 but the $10,000 buys less, in effect, the value of the obligation goes down. So as a hedge, as a protection against the government in effect inflating their way out of obligations, creditors forever have learned: link it to a commodity, and government cannot issue more money unless they acquire more gold, which they can’t do. And therefore, a creditor is protected against having inflation, a government action, diminish the value of their holdings. That’s the key. And by the way, Sebastian, it’s true—sorry, go ahead, please.

Sebastian Edwards: No, what I was going to add to your great explanation is that during the Civil War, we had two currencies that were circulating side by side: gold-backed currency and greenbacks, which were not backed by gold. And the problem was that creditors wanted to make sure or to know in which of the two currencies their funds were going to be invested. So most debt, not only government debt but most private debt as well, incorporated or added gold clauses, meaning that it said, “We’re going to pay you back so many dollars or the gold equivalent to so many dollars.” And that’s how the gold clause got incorporated into our debt. But it was not only the government debt; it was also the private debt. And that’s what made the situation so complicated in ‘33. There were about a hundred billion dollars—which was a lot of money then, about 2.5 trillion dollars of today—of private debt, mostly utilities and railroads, that had the gold clause. So there was a government debt that had the gold clause, and there was private debt that had the gold clause. And if we changed the value of gold in dollar terms, that meant that debtors had to pay much more in terms of paper dollars because the debt was linked to gold.

Bob Zadek: Now, just so the audience can really relate to this gold standard, in many transactions today, Social Security and various aspects of our tax law, we know many relationships are keyed to inflation, like keyed to an index such as the Consumer Price Index. That is simply the same thing. When you have your Social Security benefits keyed to, let’s say, the Consumer Price Index, what that means is as inflation causes the dollar to be worth less, your payments go up accordingly, so inflation cannot diminish the absolute value of your payments. So the concept of having an inflation-proof transaction is quite common to Americans in many aspects of life. It happens in the tax law, Social Security, and many other relationships. Isn’t that a fair parallel, Sebastian?

Sebastian Edwards: That is a very good parallel, Bob. And so COLA, cost-of-living adjustment clauses like the one that Social Security has, it’s the same principle. The main difference is that in COLA or Social Security, what we have is linked to a basket of goods, and in this case, it was linked just to one commodity: gold. We also have some government debt that has the same issue, and those are TIPS, Treasury Inflation-Protected Securities. So you can buy a government bond that is a TIPS, and then the maturity is linked to inflation plus a little bit more in what the economists call real terms.

FDR’s Economic Dilemma [14:40]

Bob Zadek: So now we have creditors who have learned this very effective device to assure themselves that if inflation occurs, which is a governmental activity, a conscious governmental activity, that inflation cannot diminish the absolute value of their obligations. So they have protected themselves. So now we have 1933, the Depression, farmers are suffering, there is huge deflation. Nothing is worth very much at all. Prices in the entire globe have declined in value. And here we have the farmers who have one financial relationship which is locked to gold, and that is their debts. But everything else in their life is deflating. So when your income goes down in absolute terms, but your debts do not go down in absolute terms, you’re in a vice. And that was the circumstance that FDR found himself in in 1933. Okay, Sebastian, pick up the story from there.

Sebastian Edwards: Yeah, so that’s absolutely true. And FDR had received a very massive support from the rural states during the election when he defeated Herbert Hoover in 1932. And in addition to that, he thought of himself as a gentleman farmer. He had a farm in upstate New York, and he had also a farm in Georgia where he had his sort of summer vacation where he actually exercised for his legs. So FDR wanted commodity prices to go up. And someone told him, “One way to do this is to devalue the dollar relative to gold.” So instead of the price of gold being 20.87, basically $21 in round numbers, why don’t you make the price of gold more expensive? And that same person or others told him, “Look, the United Kingdom just devalued in September of ‘31, devalued the pound, and they seem to be recovering.” And FDR loved to experiment, and he loved new ideas. He said, “Hey, let’s do that. Let’s devalue the dollar.” And he was about to do that, and he was also getting pressure by the agricultural members of Congress. But someone told him, “Hey, wait. All the debt is linked to gold. So if you devalue and now gold is more expensive, every railroad, every utility, and the government, and many mortgages, all that debt is going to just go through the roof. So you cannot devalue.” Wow.

Bob Zadek: Now let’s back up. Sebastian, I want the audience to understand that the value of gold, as you explained, it was last set in the 1830s at $20.87 an ounce for gold. That is a question simply of governmental action. It’s not value determined by a marketplace. Government in effect determines, because the Constitution allows them to, how much a dollar is worth in terms of gold. So government simply can devalue the dollar by governmental action raising the price of gold in terms of dollars. So in doing so, they were in effect undoing the benefits of the gold standard, were they not? It was an end run around the gold standard on debt.

Sebastian Edwards: Right. So the point you make is a very important one: that the government set that price. But it also committed itself to buying and selling infinite amounts of gold at that price. So if the government sets the price and if you want gold, I’ll sell it to you at that price, and if you have your gold, I’ll buy it from you at that price. Wait, Sebastian, you’re breaking up a little bit. If you could just repeat that sentence, please.

Yeah, so what it’s saying is that the government committed itself, as I said, to buying and selling infinite amounts at that ongoing price. So the government, as you said, has the ability to fix the price.

Bob Zadek: And so what Roosevelt came upon—this plan in effect to—he since he couldn’t undo the gold standard as such, it was in the contract and the government couldn’t impair contracts under the Constitution, but this was kind of an end run in order to give relief to the farmers and other debtors—and we were a debtor country at that time—in order to give relief to unlink the value of the debt to gold. Since he couldn’t do it directly, he came upon a plan, and the plan had two steps. Tell us the two steps and what the result of those two steps would be.

Step 1: Confiscating Gold [20:10]

Sebastian Edwards: Yeah, the first step was to unlink contracts from gold, and that is forbidding debt being issued either by the private sector or by the government to be linked to gold or to have the gold clause. And doing that going forward was not a legal problem. But what they decided to do, because the debt had already been issued, including a lot of government debt that was issued since World War I, the very controversial measure was to de-link debt from gold retroactively, debt that had been issued years and years before. And that’s what created a constitutional crisis. So that was the first step: abrogating the gold clause. And the second step was then to devalue the dollar, which eventually we did to $35 an ounce, a price that lasted until 1971 when President Richard Nixon brought that system to an end.

Bob Zadek: So what happened was in effect, now once Roosevelt bought back, he first said it’s illegal for individuals, for anybody outside of government to own gold. And by executive order—remember that, my friends? Executive order—he required everybody sell their gold back to the government.

Sebastian Edwards: That’s a very important step, Bob, which I detailed in this book, American Default. So FDR came in on March 4th. He’s the last president who is inaugurated in March as opposed to in January. And on April 5th, that is exactly one month or one month and one day afterwards, he issues this executive order obligating every individual to sell his or her gold to the Federal Reserve at the ongoing official price, $20.87. And then he abrogates the gold clause, and then he devalues the dollar. And that brings in all the lawsuits that finally the Supreme Court has to resolve, and the Supreme Court rules in February of ‘35.

Bob Zadek: Now the reason it was important for the government to first buy all the gold back under compulsion—it required it—is that if you have gold, probably you own gold because you don’t trust the government not to resort to inflation to devalue the dollar. And just imagine if you had a carton full of dollars and the government, whom you do not trust, can just by government action say that box of paper in underneath your bed is now worth less. If you believe the government might do that, you’re not going to put dollars in that carton underneath your bed. You’re going to put gold because gold has a value in the world market, and whatever the US does with the dollar, you still have gold which the government cannot alter the value of. So Roosevelt can’t succeed unless he first sucks up all the gold. Is that a fair analysis of what was going on in Step 1?

Sebastian Edwards: That’s a very fair analysis, Bob. And in addition, you have to remember what we said earlier, which is that the Fed has to back money with gold. So if the gold that the Fed has now goes down and it went to the private citizen, that meant that the Fed could not back as much money. And they wanted to be able to issue money, liquidity, credit, funds, and that made the situation worse. And that was the point that Milton Friedman made in his book, which was cited profusely when he got the Nobel Prize in ‘76.

Bob Zadek: So since the dollar was linked to gold, the only way the government could issue more dollars is by having more gold. And the way that it got more gold is to require it to be sold at the old price, the existing price of $20.87. So as the curtain goes down in Act 1 of this story, we now have Roosevelt who—and Roosevelt had just become president, this was his first term. Most presidents take a while to learn how to operate the levers of government, but Roosevelt didn’t lose a step. He gets elected and his first day sitting in the Oval Office is March of 1933. In one month later, he’s already issuing an executive order which had never been issued before, requiring Americans to return all their gold to the Treasury and accept dollars, which is fiat currency, which now holders of dollars can’t control the value of. That’s where we are when the curtain goes down on Act 1. This is Bob Zadek, I’m speaking with Sebastian Edwards, who has written a fascinating story, American Default: The Untold Story of FDR, the Supreme Court, and the Battle over Gold. It was published recently in 2018. We’ll return in 30 short seconds for Act 2 and Act 3 of this exciting gold drama. Please stay tuned. Back in 30 seconds.

[Commercial Break]

Step 2: The Joint Resolution [27:31]

Bob Zadek: Welcome back to the Bob Zadek Show, the longest-running live libertarian talk radio show in all of radio. This morning we are speaking with Sebastian Edwards, who has written a wonderful book, the untold story of FDR and his stealth default by America in the payment of its obligations. It’s a story involving FDR. He was a more active president quicker than probably any other president in American history other than perhaps George Washington. If ever there was a guy who apparently by his actions was born to be president, it was certainly FDR.

So Sebastian, we have now the government has sucked up all the gold and in return has given Americans in its stead pieces of paper. Albeit paper backed by gold, but paper nonetheless. Now what is the next step? Now the government has bought back gold at $20.87 an ounce. So far, all that’s happened is Americans have swapped out gold for paper, paper backed by the promise of the United States. What—now we still haven’t gotten in our story any relief to farmers or to the government or to other debtors. How does the relief come about and who takes it in the shorts as a result of that relief?

Sebastian Edwards: Yeah, the relief will come after the devaluation in January of ‘34. So the first act, as you say, when they force people to sell their gold, and the second act is the abrogation of the gold clause, which happens in June, on June 5th to be more precise, of 1933. And it’s done through a joint resolution of Congress. This resolution is common.

Bob Zadek: So Congress passes something called the Joint Resolution. Both houses of Congress join FDR. FDR of course controlled both houses of Congress. And what did the Joint Resolution declare?

Sebastian Edwards: That gold clauses or linking debt, any debt—wait, you’re breaking up a little bit, Sebastian, if you could repeat that, please. And that was true both for debt to be issued in the future and, as I said earlier, this is the controversial part, also for debt that had been issued already, including Liberty Bonds that had been issued starting in 1917 to finance World War I. Remember that Liberty Bonds, Bob, were bought by households, by families, $5 here, $50 there. So every American family owned some Liberty Bonds which were linked to gold. And now Sebastian, you’re breaking up, if you can just repeat that sentence, I’m sorry.

I’m sorry about that, the connection sometimes that happens. I’m saying that every family owned Liberty Bonds which had the gold clause, but at this point of course they—the clause was illegal, so people continued to have the bonds. The gold was still $20.87, but people could not have gold. So that’s the end of the third act—excuse me, the third act is the actual devaluation. And then actually we have a fourth act, which is the Supreme Court resolution.

Step 3: Devaluation [31:34]

Bob Zadek: Well, the third act, the third act is the government then declares by governmental action that the gold which was worth $20.87 an ounce is now by governmental action now worth $35. So the effect of it is the dollar has become less valuable because you need more dollars to buy the same ounce of gold. So once you reduce the value of a dollar, now the bargain that creditors negotiated for, whether it’s the family owning a Liberty Bond at $5 that they bought to support World War I or whether it’s a creditor who holds private bonds issued by a railroad or an oil company, those—those bonds which the creditor bargained for the right to be protected against inflation, that bargain was removed. And the effect on the creditor is the value of their debt in real terms went down. In effect, it allowed the government to pay their debts back with cheaper dollars than they bargained for, and the creditor who bargained for the right to be protected was—that protection was by governmental action pulled out from under them. Is that too dramatic a way to express it or is that exactly what happened?

Sebastian Edwards: No, no, that’s exactly the way it was. But let me add a wrinkle that’s very interesting because it links to today in US economic history. So remember April 1933, people are forced to sell all their gold to the government. So the government owns all the gold, which is valued in the government books at the official price, $20.87. Then the dollar is devalued with respect to gold in ‘34. This is Act 3. Act 2 is the abrogation of the clause. Act 3, and now gold is worth $35. So this means that in the books of the government, gold has devalued. So the government gained in terms of paper dollars. So what does it do with this money? Well, part of it goes into what is known as the Exchange Stabilization Fund. That the Treasury manages, and that fund was used in the 1990s to bail out Mexico. It was a very controversial measure. Mexico ended up paying everything with interest and so on and so forth. But because of the devaluation, the government who owned all the gold got a capital gain, and that capital gain was used to finance this stabilization fund, which decades later is used to bail out Mexico in 1994-1995.

Bob Zadek: Oh my goodness. And what’s really interesting is when the government raised the value of gold from $20.87 to $35, in simple terms, just imagine if you owned a home and you were able to make a rule: “I now make a rule that my house increases in value by 67%.” Imagine the windfall to you and how unfair it is to somebody else who might want the house. You realized a gain which you gave to yourself. And the government, having acquired all the gold, then passed the law that said, “This gold that we now have is now worth a lot more in dollars.” So the—it seems outrageous, but the effect—so Roosevelt did this in 1933.

The Supreme Court and “Necessity” [35:48]

Bob Zadek: Now what was the immediate effect upon all of the creditors who both held private debt and public debt? Immediately upon the action being taken, wasn’t it just this profound wealth transfer—a phrase we use today—from creditors to debtors simply by statute?

Sebastian Edwards: That’s exactly what happened, and that’s exactly what went to the Supreme Court cases, which were heard during January, four cases in January of ‘35. So the argument was that this was a huge transfer of wealth. Now the government said a number of—one reason and another reason was that it’s impossible to pay in gold because there was not enough gold in the world to pay for all the debt that had the gold clause. The plaintiffs said, “We don’t want physical gold; gold equivalent in dollars at $35 an ounce.” That was the—to the Supreme Court. Sebastian, I’m sorry, but you’re breaking up a little bit. If you could perhaps move a little closer to the phone, it might be better.

Yeah, what I was saying is the Supreme Court took these issues into account in ‘35.

Bob Zadek: So the Supreme Court, which was at that time quite unsympathetic to Roosevelt’s new approach to power of the federal government, that under the Commerce Clause and other broad clauses, the government can essentially do what is necessary. And “necessary” becomes an important concept, Sebastian, both in how you discovered this in Argentina’s approach to its default and Roosevelt’s approach to in the Supreme Court. So let’s divert a little bit. And Roosevelt, in defending this action, which was a wealth transfer simply by governmental action, says, “Okay, the government says okay, all you creditors, you have to transfer money to all the other debtors.” That’s what it was. Now Roosevelt defended it on the basis of necessity. And that’s a word that Argentina used as well. So tell us how the concept of necessity comes into play.

Sebastian Edwards: Right. So I’m not a lawyer and a constitutional expert, I’m just the economist and the author here. But in constitutional and in international law, there is this concept that there are justified contract breaches, and that happens if there is what lawyers call force majeure, and that means that there is some calamity that is imposed on the creditor and makes it impossible for the creditor to pay, or if in order to survive, the creditor needs to breach the contract. And Argentina in 2002 said, “We were—we had linked our debt and our contracts to the US dollar irrevocably, but this has—there’s a crisis and we need to breach those contracts because otherwise the state will disappear and there will be riots and there will be a revolution.” Roosevelt in ‘33 or more precisely in ‘35 when it goes to the Supreme Court makes a very similar argument and it says that in order for the United States to get out of the Depression, it needs to devalue the dollar, it needs to increase the price of gold in dollar terms. And then they added, “But we cannot do that if debt is linked to gold, because if we do that, every utility, every railroad, and many property owners will go bankrupt. So we have the necessity.” And that’s where the term comes in.

The Ruling: Unconstitutional but No Damages [39:50]

Bob Zadek: So now we have the Supreme Court, which starts off being unsympathetic to Roosevelt. There was a 5-4 split, just like today, there was a 5-4 split with the—if you can use the label, I don’t like it, but it’s useful—the conservatives had five votes, including Charles Evans Hughes, the Chief Justice of the Supreme Court. He was kind of a swing vote, something like Justice Roberts is today. And the Supreme Court had to decide if Roosevelt had all these implied powers to simply say the only way out of the Depression is to make in effect make creditors pay debtors money, and then we can get out of the Depression. So the Supreme Court has this decision to make, and what do they decide in the Supreme Court?

Sebastian Edwards: So the Supreme Court, as you said, Bob, is 5 to 4. Five of the justices had been appointed—well, they were appointed by both Republicans and Democrats, but they were conservative. And the Chief Justice, a very interesting man as you mentioned, Charles Evans Hughes, he had been presidential candidate for the Republican Party, was barely defeated in a very highly contested election by Woodrow Wilson. And he had been governor of New York. And the Supreme Court 5 to 4 looks at these cases, and there is a lot of anxiety in the financial markets. At that time, the Supreme Court ruled very soon after hearing the case, a few weeks after that, not like today where they hear the cases and then there is a period where they have the ruling. Finally, they have the ruling. And I explain in the book how this created a very exciting moment in Washington and how the room was full of all the dignitaries. And Roosevelt stays in the White House and is connected to the Capitol. The Supreme Court had not moved yet to its building, and it is connected. And Joe Kennedy, the patriarch of the Kennedys, is on the phone conveying to FDR what’s going on in the Supreme Court.

First comes the ruling of the private debt, because there were two cases, one for private debt and one for public debt. On private debt, the Supreme Court says, “Well, the Constitution gives Congress the right to coin money and determine the value thereof. And in order to have the constitutional mandate put in place and carry it forward, it needs to change contracts. That is okay.” So private contracts, it’s okay to abrogate the gold clause.

And then came the government contract. And this was the very controversial ruling. And the Supreme Court said, “It’s unconstitutional. It’s not okay, not okay for the government to abrogate contracts, to breach contracts retroactively.” So it is constitutional for private contracts, not for government debt. So then the question—then the Supreme Court says, “So what’s the argument?” The argument is that the Constitution gives government the power to coin money and determine the value thereof, to issue coins, to mint coin and determine the value thereof—that’s more or less I’m paraphrasing the Constitution, Article 1, Section 8—but it also says that Congress has the power to issue US debt, debt on the credit of the United States. The Supreme Court says issuing debt implicitly brings the obligation of paying it back. So that power is you issue debt and you pay it back. And the government cannot use one power to annul another power. So it’s not okay to breach contracts.

So FDR is very worried when he listens to this. But then there is the second part of this ruling, and they say, “However, there are no damages.” So although it’s unconstitutional, there are no damages. And there are no damages, they say, because of the deflation, the same amount of paper dollars allows people to buy more goods than before, or the same amount of goods than before. It’s true you cannot buy as much gold, but we are not going to use gold as the benchmark; we’re going to use the basket that people buy. And that’s that.

Bob Zadek: Well, it was brilliant in a way about the decision. What the Supreme Court said: even though, even though there was a increase in the devaluation of the dollar relative to gold, since the government is still paying back a thousand-dollar debt with a thousand dollars, even the repayment dollars are much less valuable than your obligated to do is a default, but the Supreme Court skipped over that. And it’s an 82-page decision, quite brilliant in its approach, but the action of Roosevelt stood even though it was in everyday terms a default.

The Ends Justifying the Means [46:00]

Bob Zadek: Now, as you mention in your book, Sebastian, what’s really important is by the time the Supreme Court heard the case, there was one year of commercial activity after Roosevelt increased the price of gold and went off the gold standard. And as you explain in the book, that was a pretty healthy year. So the country reacted positively to Roosevelt’s actions. Therefore, the Supreme Court, had they decided otherwise, would have taken away what seemed like a road back from the Depression. And wasn’t that, don’t you think, a significant consideration by the Supreme Court?

Sebastian Edwards: We will never know. I went through the archives of Supreme Court justices, and it seems that that is the case. They argue that they were just using legal arguments, but I think that the fact that the country was recovering was an important consideration.

Bob Zadek: So what we have learned from Sebastian’s book is that most assuredly, the United States in 1933 defaulted in its obligations. Most assuredly, by governmental action, government decreed that the way out of the Depression was to compel creditors to pay debtors money or relieve debtors of a third of their debt. Nothing is a default more clearly than that. What we also learned is Roosevelt’s action, forgetting about phrases like abuses of power, many observers believe that Roosevelt’s action did take a giant step towards getting us out of the Depression, even though we dropped back in in 1937 for other reasons. Sebastian, your book—we have about a minute or two left—your book is a fascinating read, and it helps all of the readers understand the relationship between obligations and inflation, how the government can affect how much it has to repay through inflation. It indicates the power of Roosevelt exercising the incredible power of the presidency, including a phrase we hear every day today, which is “by executive order.” We also understand how in effect, as you explain, Sebastian, three branches of government—the legislative, the judicial, and the executive—cooperated in what might be a questionable governmental activity, but which may have had a positive result. So the question is, does the ends justify the means? Sebastian, we have about a minute to go. Add to my summary of your book if you will. We have about a minute to go.

Sebastian Edwards: You just provided a fantastic summary, Bob. I couldn’t do it better. And I just want to thank you for having me in your show and for allowing me to tell the story to your many listeners. And thank you again.

Bob Zadek: Sebastian, I want to come up to LA and sit down with you for an hour or two. You do all the talking. Tell me about your time with Arnold Schwarzenegger and Milton Friedman and the others with all of these larger-than-life characters that you were lucky enough to spend part of your professional lives with. I am quite envious of you, Sebastian. And Sebastian, thank you very much for joining the show even under the stress of having to travel to Chicago. We wish you a safe flight, and thanks again, Sebastian.

Sebastian Edwards: Thank you very much. God bless you. Bye-bye.

Show prep notes

Bob’s own preparation for this episode.

Sebastian Edwards, 5/12 - AMERICAN DEFAULT

Sebastian Edwards

Topic: AMERICAN DEFAULT: dollar devaluation

Home Phone (Sunday):

Cell Phone (Friday):

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BIO

• UCLA Anderson School of Business Management

• Henry Ford II Professor of International Economics at the University of California, Los Angeles.

• His books include Toxic Aid: Economic Collapse and Recovery in Tanzania and Left Behind: Latin America and the False Promise of Populism.

• Expert on economic effects of populism

• He lives in Los Angeles.

Medium Article – Curing America’s Collective Amnesia

American Default: The Untold Story of FDR, the Supreme Court, and the Battle over Gold. Princeton University Press, 2018, Sebastian Edwards

The untold story of how FDR did the unthinkable to save the American economy

“The American economy is strong in large part because nobody believes that America would ever default on its debt. Yet in 1933, Franklin D. Roosevelt did just that, when in a bid to pull the country out of depression, he depreciated the U.S. dollar in relation to gold, effectively annulling all debt contracts. American Default is the story of this forgotten chapter in America’s history.

Sebastian Edwards provides a compelling account of the economic and legal drama that embroiled a nation already reeling from global financial collapse. It began on April 5, 1933, when FDR ordered Americans to sell all their gold holdings to the government. This was followed by the abandonment of the gold standard, the unilateral and retroactive rewriting of contracts, and the devaluation of the dollar. Anyone who held public and private debt suddenly saw its value reduced by nearly half, and debtors—including the U.S. government―suddenly owed their creditors far less. Revaluing the dollar imposed a hefty loss on investors and savers, many of them middle-class American families. The banks fought back, and a bitter battle for gold ensued. In early 1935, the case went to the Supreme Court. Edwards describes FDR’s rancorous clashes with conservative Chief Justice Charles Evans Hughes, a confrontation that threatened to finish the New Deal for good―and that led to FDR’s attempt to pack the court in 1937.

At a time when several major economies never approached the brink of default or devaluing or recalling currencies, American Default is a timely account of a little-known yet drastic experiment with these policies, the inevitable backlash, and the ultimate result.”

Amazon Reviews:

“Remembering the inflation of the Civil War greenback era, most creditors demanded gold clauses in debt contracts in which they would be repaid in in either gold or its paper money equivalent value.

…

This system worked fine until the onset of the Great Depression. It is here where Edwards begins his story as President Roosevelt adopts an inflationist policy by first abandoning the gold standard by requiring all citizens to turn in their physical gold at the then $20.67/ounce price. Then in June 1933 Congress adopts a joint resolution authorizing Roosevelt to increase the price of gold which he ultimately does to $35/ounce and the legislation abrogates the gold clause in all contracts. Indeed, most economists credit the early recovery from the depression directly to the monetary easing associated with Roosevelt’s gold policies.

…

If Congress hadn’t abrogated the gold clause all debts would have been written up to reflect the devaluation by 69%. Thus it would require a payment of approximately $1700 to repay a nominal debt of $1,000. Needless to say a host of bankruptcies would have ensued.

…

The Supreme Court ruled that it was in Congress’ power to alter private contracts, but it was not in its power to alter U.S. government debt. However, the court ruled that as of the date of the Joint Resolution gold was still trading at $20.67/ounce and Americans were not allowed to possess physical gold at that time. Hence there would be no damages. A brilliant 5-4 ruling by Chief Justice Hughes.

…

The reason why these cases have been forgotten is that if they went the other way all hell would have broken loose. Instead of rallying as the stock market did after the ruling, stocks likely would have crashed. It would have triggered a constitutional crisis with Court versus the other two branches of government. Indeed the lead up to the ruling was a precursor to the 1937 court fight that Roosevelt would have.”

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“a Cornell professor of agricultural economics, George Warren, convinced Roosevelt that the depressed price of agricultural commodities could be made to rise again if the dollar was devalued versus gold.

…

What I took away from reading this, basically, is that the biggest issue that legally differentiates the US default of 1933 from the Argentinian restructuring of 2005 (namely that the US default was purely domestic, whereas the Argentines chiefly defaulted on foreigners) not only helped FDR prevail when four plaintiffs took his policies to the Supreme Court, but also perhaps serves to explain why the US remains in a funk ten years after the financial crisis:

…

In the thirties, the US was prepared to abrogate the right of domestic gold-linked bondholders to a windfall; ten years ago, the Chinese government was made whole on its holdings of Fannie and Freddie, all while the rate of homeownership in the US was allowed to plummet from 69% to 61%.

It’s not that surprising we got Trump, is it?”

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“The Coinage Act of 1792, one of the first acts of the US Congress, actually provided the death penalty for monkeying with the gold or silver content of the coinage. No matter. All went out the window with FDR’s Executive Order and subsequent acts of Congress, culminating in the aggregated Gold Clause cases, narrowly decided 5-4, by the Supreme Court (with bitter dissents) in 1935.

…

Unfortunately, the precedents are used even today to justify modern sovereign defaults in Argentina, Venezuela, and others sure to come, all succinctly summarized by Prof. Edwards.”

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“American Default” blatantly describes how, despite not being a well-trained individual on economic affairs, the President had a “hunch” that the only way to get the US economy going and leave deflation behind was by engineering some level of controlled inflation for some time.”

Podcasts:

1. Free Thoughts, Ep. 247: When FDR took Americans’ gold (with Sebastian Edwards)

FDR set the price of gold himself from bed in the morning surrounded by his advisors.

2. Macro Musings with David Beckworth: 122 – Sebastian Edwards on FDR, Gold, and the Great Depression

3. UCLA Anderson School International Economist Sebastian Edwards | In the Green Room | Zócalo Public Square

Other audio:

Could the United States Default On the National Debt? - YouTube

• “We have a huge debt.”

• $22 Trillion ~100% of GDP. Rogoff and Reinhardt say that after you reach 90% of GDP is bound to default. In the current low interest rate environment we might be able to get away with more.

• We also have future entitlement debt. - $80 Trillion! 4x the maximum.

• Real possibility of default on social security.

Book Summary:

Excerpted from a review by the official Historian of the Federal Reserve System, Gary Richardson

Treasury debt is not as risk free as people claim. America once defaulted, although this has been largely forgotten.

“The narrative starts in March 1932, during the economic downturn now known as the Great Depression. …Nearly a quarter of the labor force experienced unemployment. Commodity prices declined more than half.. Declining farm prices accentuated farmers’ debt burden, since the nominal value of debts remained fixed. This forced farmers who wanted to pay their mortgages and crop loans to double production (which was often impossible) or cut consumption (particularly of durable goods like cars, radios, and clothing) — and forced other farmers (and eventually almost all farmers) to stop paying their debts, default on their loans, and face bankruptcy, which often resulted in the loss of lands and livelihoods.

…

Chapters 1 through 4 cover Roosevelt’s campaign platform and policies and the economic turmoil from November 1932 through February 1933. During these last five months of the Hoover administration, a nationwide panic drained funds from the banking system and gold from the vaults of the Federal Reserve. The public feared for the safety of deposits, and rushed to convert their claims against banks into coins and cash. The public (particularly foreign investors) also feared for the value of the dollar, since they anticipated that the Roosevelt administration might lower the gold content of U.S. currency or leave the gold standard all together, as had Britain and numerous other nations. In March, gold outflows forced the Federal Reserve Bank of New York below its gold reserve requirement. To prevent the New York Fed from shutting its doors, the newly inaugurated President Roosevelt declared a national banking holiday. This segment of the story ends by describing the policies that the Roosevelt administration implemented as it resuscitated the financial system and sparked economic recovery.

…

(424) BOB-SHOW // (424) 262-7469

Notes: Suja is pronounced Su-jay, not Su-jah.

Planning Call: Friday morning 8:30am PT, .

Live Show: .

Show Notes:

Headline: Juries: The Other Fourth Branch

This show has repeatedly drawn attention to administrative agencies – the so-called “fourth branch of government” – and their take-over of legislative and judicial functions. Before we do another show on this depressing erosion of checks and balances, we have some more hopeful news. Suja Thomas of the University of Illinois Law School speaks and writes of a different “fourth branch” that was actually intended by the founders: juries. The American tradition of jury trials, borrowed from English Common Law, is known throughout the world as one of the exceptional features of our government “of the people, by the people and for the people.” But with less than 4% of criminal case and around 1% of civil cases actually making it to a jury trial, this check on the other three branches of government is in need of resuscitation. Since the 1930s, the judiciary has come closer to literally serving as jury, judge and executioner, even though the Constitution is clear on the authority of juries. Thomas Jefferson was not exaggerating when he said, “The jury is the greatest anchor ever devised by human kind for holding a government to the principles of its constitution.” This Sunday, Suja joins Bob to discuss her book, *The Missing American Jury: Restoring the Fundamental Constitutional Role of the Civil, Criminal, and Grand Juries.* We encourage all listeners to call-in with whatever information they may have as to the whereabouts of these badly-needed missing persons: (424) BOB-SHOW.

>> Tune in to the Answer: SF Bay Area: 860AM // Sacramento: 1380AM // Seattle: 1590AM

>> Stream Online

>> Call in: (424) BOB-SHOW

Listen LIVE - 8-9 AM PACIFIC, on 860 AM - The Answer, or Streaming LIVE online

Links

• The Missing American Jury: Restoring the Fundamental Constitutional Role of the Criminal, Civil, and Grand Juries (Cambridge University Press) [Amazon]

• A Jury, Not the S.E.C., by Mark Cuban and Suja A. Thomas, October 16, 2013

• SujaThomas.com

Related Shows (Subscribe to the Podcast):

• 12 Citizens Have More Power Than The Entire Legislature with Clay Conrad, January 20, 2013

• Walter Olson, the “Guru of Tort Reform,” on Arbitration, December 6, 2015

[BIO]

• Professor of Law at the University of Illinois, focusing on the criminal jury, civil jury, grand jury, civil procedure, and employment law.

• Published in the Virginia Law Review, Notre Dame Law Review, Washington University Law Review, Minnesota Review, and Boston College Law Review, among other law reviews.

• Her opinion piece A Jury, Not the S.E.C., co-authored with Mark Cuban, was published in the New York Times.

• Cited in testimony to the U.S. Senate and House of Representatives. Upon the request of the United States Senate Committee on the Judiciary, she also submitted testimony on the access of Americans to courts.

• Practiced law for many years in New York City, including at Cravath, Swaine & Moore, Weil, Gotshal & Manges, and Vladeck, Waldman, Elias & Engelhard, participating in jury trials and arbitration. Her past experience also includes participating in several criminal trials on behalf of the federal public defender.

• Also an expert on the incorporation of the bill of rights. See, Nonincorporation: The Bill of Rights after McDonald v. Chicago, 2012, Notre Dame Law Review. Certain protections of the 5th, 6th and seventh amendment have not been “incorporated” against the states, meaning they are not enforceable against states

FIND HER WORK AT:

• New co-authored book Unequal: How America’s Courts Undermine Discrimination Law (Oxford Univ. Press May 2017)

• Twitter: @sujathomas3

On this Day in History: 5/14

Constitutional Convention Delegates Begin to Assemble

On this day in 1787, delegates to the Constitutional Convention begin to assemble in Philadelphia to confront a daunting task: the peaceful overthrow of the new American government as defined by the Article of Confederation. Although the convention was originally supposed to begin on May 14, James Madison reported that a small number only had assembled. Meetings had to be pushed back until May 25, when a sufficient quorum of the participating states—Massachusetts, New York, New Jersey, Pennsylvania, Delaware, Virginia, North Carolina, South Carolina and Georgia—had arrived.

As the new United States descended into economic crisis and inter-state quarrels, the new nation’s leaders had become increasingly frustrated with their limited power. When in 1785, Maryland and Virginia could not agree on their rights to the Potomac River, George Washington called a conference to settle the matter at Mt. Vernon. James Madison then convinced the Virginia legislature to call a convention of all the states to discuss such sticky trade-related issues at Annapolis, Maryland. The Annapolis Convention of September 1786 in turn called the Philadelphia Convention, to devise such further provisions as shall appear to them necessary to render the constitution of the Federal Government adequate to the exigencies of the Union.

Between Madison’s initial call for the states to send delegates to Annapolis and the presentation of Madison’s Virginia plan for a new government to the convention in Philadelphia, a fundamental shift in the aims of the convention process had taken place. No longer were the delegates gathered with the aim of tweaking trade agreements. A significant number of the men present were now determined to overhaul the new American government as a whole, without a single ballot being cast by the voting public.

Summary:

The Missing American Jury: Restoring the Fundamental Constitutional Role of the Criminal, Civil, and Grand Juries (Cambridge University Press) shows that the American jury hears few cases and has little authority. But it was not always this way. The book describes how authority has shifted to the [“traditional actors”] executive, the legislature, the judiciary, and the states and why this has occurred. It also shows how the jury can be restored to its position as essentially a “branch” of government.

Chapter 1 - The Missing American Jury

While the Founders established the jury as a check on the executive, the legislature, the judiciary, and the states, the Supreme Court presently does not recognize this function. (Kindle Locations 178-179)

This book investigates a new theory for the decline of the American jury. Disposing of the usual suspects of the inefficiency, cost, incompetence, and inaccuracy of the jury, it demonstrates that the traditional actors led by the Supreme Court have seized the domain of the jury. (Kindle Locations 200-202)

Offering a novel argument about the role of juries in the very fabric of our political system, the book argues that the jury should be recognized as a co-equal of the traditional actors and specifically as a significant check to balance their powers – essentially as a “branch.” (Kindle Locations 203-205)

Restoring the jury’s past role means preventing the executive, the legislature, the judiciary, and the states from usurping the jury’s authority. For example, judges should not be able to dismiss criminal and civil cases by assessing the evidence and deciding juries could find only one way. (Kindle Locations 216-218)

Chapter 2 - The Fall of the Criminal, Civil, and Grand Juries and the Rise of the Executive, the Legislature, the Judiciary, and the States

Chapter 2 begins the discussion by describing the vibrant role of the criminal, civil, and grand juries in the late eighteenth century in England and in America.

“Founders wanted juries, and wrote about this in several places. Declaration was drafted in part because the King had deprived them of trial by jury. (Kindle Locations 342-346)

“the Sixth Amendment contained further protections for the criminal jury trial such as rights to a speedy and public trial. 8 The Seventh Amendment preserved jury trials in suits at common law where the value in controversy exceeded twenty dollars. And the Fifth Amendment required a presentment or an indictment of a grand jury before a person could be formally accused of a capital or infamous crime.” (Kindle Locations 243-244)

Chapter 3 - The Missing Branch

Chapter 3 proceeds to explore why the jury has fallen. It first sets forth the traditional reasons offered for the declines of each of the criminal, civil, and grand juries.

“cost, incompetence, inaccuracy, and inefficiency are commonly touted as explanations for why all three juries hear few cases, and why, even when they do hear cases, their authority may be disregarded.…While defendants pled to different crimes at various rates, it appears that they generally pled guilty only about 20% of the time. By the early twentieth century, the proportion of defendants who took pleas grew to more than 90% – a figure that continues to climb.” (Kindle Locations 1903-1905)

Defendants are less likely to take a chance with a jury, since juries do not know the punishments associated with the charges they are convicting/acquitting.