During the bank holiday and the weeks that followed, the Roosevelt administration prohibited transactions in gold. On April 5, 1933, it took the extraordinary step of ordering all holders of gold to deliver their gold (rare coins and other specialized holdings were exempt) to the Federal Reserve. These actions took the United States off the gold standard. For several months, the price of gold, and therefore of foreign currencies still linked to gold, fluctuated according to the dictates of supply and demand. The federal government, however, made a determined effort to increase the price of gold by purchasing gold. The idea was to raise the dollar price of commodities, particularly agricultural commodities, set on world markets. To some extent, the policy was successful; some of the inflation that occurred in this period, otherwise surprising because of the depressed state of the economy, can be attributed to the manipulation of the exchange rate.
On January 31, 1934, the United States recommitted itself to a form of the gold standard by fixing a price of $35 per ounce (the predepression price had been $20 per ounce) at which the Treasury would buy or sell gold. The new form of the gold standard, however, was only a pale reflection of the classical gold standard because ordinary citizens were not allowed to hold gold coins. As a result of these policies, production of gold in the United States and the rest of the world soared in the 1930s. World production rose from 25 million ounces in 1933 to 40 million ounces in 1940. After all, costs of production such as wages had fallen, but the price at which gold could be sold to the U. S. Treasury had risen. The result was a rapid increase in the Treasury’s stock of gold. When the government sets prices, it changes incentives and influences production. This is explained in Economic Reasoning Proposition 3, incentives matter. In addition, the rise of fascism in Europe created a large outflow of capital, including gold, seeking a safe haven and further augmenting U. S. gold holdings.
When the Treasury purchased gold, it created gold certificates that it could use as cash or deposit with the Federal Reserve. In effect, if the Treasury bought gold, it was allowed to pay for it by printing new currency. The result was a rapid increase in the monetary base, which, in conjunction with the redeposit of currency in the banking system, produced a rapid increase in the money supply.
World History
