My research career often focused on offbeat topics that no one else seemed to be interested in. Now it might be paying off. One of those topics was Roosevelt’s “gold-buying program” of October-December 1933. The only other article I’ve ever seen on this topic was published in an agricultural journal back in the 1950s. This program was the last time (and perhaps only other time) that the US government explicitly tried to raise the price level. Admittedly the entire April 1933-January 1934 dollar depreciation policy was aimed at reflation, but only during the gold-buying phase was the policy made explicit, and was a methodical policy followed to raise prices.
I did a long post on this in early 2009, and won’t repeat it all here. Check out the post if you want to know more about how it was done. Instead I’d like to discuss one very interesting aspect of the program that is relevant to what is going on right now. (The policy involved raising the dollar price of gold to devalue the dollar.) Here is a short passage from my Depression manuscript:
Then on November 20 and 21, the RFC price rose by a total of 20 cents and the London price of gold rose 49 cents. On November 22 the NYT headline reported “SPRAGUE QUITS TREASURY TO ATTACK GOLD POLICY” and on page 2, “Administration, Realizing This, Vainly Tried to Persuade Him to Silence on Gold Policy”. As with the Woodin resignation, Sprague’s resignation led to a temporary hiatus in the RFC gold price increases, this time lasting five days.
Over the next several days the controversy continued to increase in intensity. The November 23 NYTreported “RESERVE’S ADVISORS URGE WE RETURN TO GOLD BASIS; PRESIDENT HITS AT FOES” other stories reported opposition by J.P. Warburg, and a debate between Warburg and Irving Fisher (a supporter of the plan). Another story was headlined “WARREN CALLED DICTATOR”. The November 24 NYT headline suggested that “END OF DOLLAR UNCERTAINTY EXPECTED SOON IN CAPITAL; RFC GOLD PRICE UNCHANGED”. Nevertheless, over the next few days the NYT headlines showed the battle raging back and forth:
“ROOSEVELT WON’T CHANGE GOVERNMENT’S GOLD POLICY, IGNORING ATTACK BY [former New York Governor Al] SMITH” (11/25/33)
“SMITH SCORES POLICY . . . Says He Is in Favor of Sound Money and Not ‘Baloney’ Dollar . . . ASKS RETURN TO GOLD . . . Critical of Professors Who ‘Turn People Into Guinea Pigs’ in Experiments” (11/25/33)
“GOLD POLICY UPHELD AND ASSAILED HERE AT RIVAL RALLIES . . . 6,000 Cheer [Father] Coughlin as He Demands Roosevelt Be ‘Stopped From Being Stopped’” (11/28/33)
 Fisher regarded Roosevelt’s policy as being essentially equivalent to his Compensated Dollar Plan. Although there were important differences, the rhetoric used by Roosevelt to justify the policy was remarkably close to the rationale behind Fisher’s plan.
The Fed better fasten its seat-belt, as the previous price level raising policy was a bit controversial. Several FDR advisers resigned in protest.
George Warren was the FDR advisor behind the plan. Warren was to Irving Fisher roughly what I am to Milton Friedman—similar ideology but lacking the intellectual brilliance. Here’s a more important passage:
“It is indeed difficult to find out exactly what are Wall Street’s views with regard to the monetary question. When former Governor Smith made public his letter and stocks were going up, there seemed to be little doubt that Wall Street wanted sound money. But yesterday, faced with the sharpest break of the month, opinion veered toward inflation again. As one broker expressed it, it begins to appear as if Wall Street would like to see enough inflation to double the price of stocks and commodities, but little enough so that Liberty bonds can sell at a premium.” (NYT, 11/28/33, p.33.)
One explanation for this ambiguity is that investors distinguished between once and for all changes in the price level, and changes in the rate of inflation. During the early stages of the dollar depreciation, long term interest rates held fairly steady, and the 3 month forward discount on the dollar (against the pound) remained below 1.5 percent. The market apparently viewed the depreciation as a one-time monetary stimulus, which would not lead to persistent inflation. Investor confidence was shaken during November, however, when persistent administration attempts to force down the dollar were associated with falling bond prices and an increase in the forward discount on the dollar. Consistent with this interpretation, the Dow rose 4.6 percent in mid-January 1934, following the Administration’s announcement that a decision was imminent to raise, and then fix, the price of gold. The NYT noted that:
“The satisfaction found by stock and commodity markets in the inflationary implications of the program was nearly matched by the bond market’s enthusiasm for the fact that the government had announced limitations to dollar devaluation.” (1/16/34, p. 1).
The takeaway from all this is that markets seem to really want higher prices, but not higher inflation. You do that by switching from inflation targeting to level targeting, when inflation has recently run below target. Yesterday when the Fed minutes suggested the Fed was about to do that, equity markets responded strongly all over the world. I’d guess about $500 billion dollars in wealth was created worldwide in 24 hours by 13 words from the Fed’s minutes:
. . . targeting a path for the price level rather than the rate of inflation . . .
The markets already knew QE was likely, but now the Fed seems increasingly serious about level targeting.
In 1933, the markets were surprised when the gold buying program briefly pushed long term T-bond yields higher (Liberty bonds in the quotation.) Under the gold standard, the expected rate of inflation was generally roughly zero. Investors were used to a liquidity effect (easy money means low rates) but not a Fisher effect (easy money raises inflation expectations, and thus interest rates.) Even Keynes was pretty much oblivious to the Fisher effect:
“If you are held back [i.e. reluctant to buy bonds], I cannot but suspect that this may be partly due to the thought of so many people in New York being influenced, as it seems to me, by sheer intellectual error. The opinion seems to prevail that inflation is in its essential nature injurious to fixed income securities. If this means an extreme inflation such as is not at all likely is more advantageous to equities than to fixed charges, that is of course true. But people seem to me to overlook the fundamental point that attempts to bring about recovery through monetary or quasi-monetary methods operate solely or almost solely through the rate of interest and they do the trick, if they do it at all, by bringing the rate of interest down.” (J.M. Keynes, Vol. 21, pp. 319-20, March 1, 1934.)
Before we judge Keynes too harshly, recall that he lived in a time of near-zero inflation expectations, with the exception of clearly anomalous situations like the German hyperinflation. So when FDR’s policy of reflation briefly seemed to be raising long term bond yields in November 1933, bond market participants were rather shocked. And here’s what I find so fascinating; modern security markets are only now beginning to grapple with this distinction, which turns out to be pretty hard to wrap one’s mind around. Here’s something from today’s news:
Neil MacKinnon, global macro strategist at VTB Capital, said the worry in the markets is that the Fed’s attempt to raise inflation may not be as manageable and as controllable as it thinks.
“The bond market is alert to the potential contradiction in Fed policy of buying U.S. Treasuries to keep bond yields down and ideas such as price-level targeting that are likely to raise bond yields,” he said.
That’s the conundrum; what counts as “success,” higher nominal bond yields or lower nominal bond yields? Everyone seems to assume the Fed is trying to lower bond yields, but if the policy is expected to produce a robust recovery and higher inflation, how can bond yields not rise? I can’t answer these questions, but my hunch is that it has something to do with the higher inflation/higher price level distinction. If the Fed can convince markets that they can raise the price level without changing their 2% inflation target, it is likely that all markets will react positively. If they are seen as raising inflation in a semi-permanent way, stocks may still rise (albeit by a smaller amount), but bonds will sell off.
This is such an unusual circumstance that I don’t have much confidence in my own opinion, nor anyone else’s. I don’t even know of anyone else who bothered to study what happened the last time Uncle Sam tried to raise the price level. Too busy doing those VAR studies and DSGE models.
PS: Where did the $500 billion figure come from? I guesstimated world stock market valuation at about $50 trillion, with a 1% bump from the Fed move. The financial press reported that all the world’s stock markets were affected by the Fed action. I noticed that European stocks rose about 2%, and the Fed move was cited as the primary factor. So I think $500 billion is roughly the order of magnitude, although obviously the exact figure is unknowable. BTW, sometimes it is possible to get semi-accurate estimates, as when a huge market reaction following immediately upon a 2:15 Fed announcement and we have relevant odds from the fed funds futures markets. And in those cases the effect is often much bigger. I can’t wait for November 3rd.