The Dollar-Gold Ratio

March 1, 1954

One of the most serious hurdles in the path of a return to the gold standard is the wide disagreement, even among those who favor such a return, regarding the exact dollar-gold conversion rate at which that return should be made.

The gold-standard supporters are divided into three main groups: (1) those who think we could safely return to a full gold standard at $35 an ounce; (2) those who urge return to a full gold standard at some specific higher price for gold (e.g., $70 an ounce) which they claim they already know to be the “correct” one; and (3) those who recommend that we permit a temporary free market in gold for the guidance it will provide in fixing a final dollar-gold conversion rate.

I have already discussed (Newsweek, Jan. 18) the main arguments of those who urge a return to gold at $35 an ounce, and what I consider to be some of the shortcomings of those arguments. Those who are urging that we set the price of gold at a higher figure, and who claim to know already what that figure should be, commonly base their conclusion on some comparison of price levels. For example, since 1932, the last full year in which we were on a real gold basis (at $20.67 an ounce), wholesale prices have increased 162 percent. On the argument that only a corresponding increase in the price of gold could prevent a fall in prices if we went back to a full gold standard, the new price of gold would have to be about $54. Again, the price of gold was set at $35 an ounce on Jan. 31, 1934. For the next seven years wholesale prices averaged only 47 percent of their present level. If we assume that $35 was the “right” price of gold in those seven years—1934–40—then the price of gold necessary to maintain the present wholesale price level might have to be about $75.

The dubious nature of the assumptions behind such calculations is clear. But the rate at which we return to a full gold standard is not a matter of indifference. Charles Rist, one of the world’s leading monetary economists, argued in a powerful article in Foreign Affairs in April 1934 that one of the major causes of the world crisis of 1929–33 was the attempt of leading countries, including the United States, to maintain or return to gold convertibility at their prewar rate for gold after having enormously multiplied their paper currency circulation.

The case of Great Britain is clear. It had gone off gold in the first world war. The pound had dropped from a gold parity of $4.86 to a low of $3.18 in February 1920, and had returned in late 1924 to approximately 10 percent below the gold parity. But wholesale prices in Britain in 1924 were still 70 percent above their prewar level. The British Government decided to resume the gold standard at the old par in 1925. The result was a steady fall in wholesale prices over the next seven years from an index number of 171.1 (1913 equals 100) in January 1925 to 99.2 in September 1931, the month in which England abandoned the gold standard. As the British all during this period were unwilling to make corresponding cuts in retail prices and wage rates, the result was falling exports, stagnation, and unemployment. And it was the gold standard itself, not the false rate (or the internal inflexibility of wages), that got the popular blame.

The British repeated this pattern in essence in the summer of 1947, when they tried to make the pound convertible into the dollar at the wholly unrealistic rate of $4.03. When that experiment broke down within a few weeks, the British once more blamed convertibility itself, and not the false rate, for the breakdown.

It is of the highest importance not only to our own economic future, but to the future of the world, that we do not repeat the British errors by trying to return to gold convertibility at an overvaluation of the paper dollar (which would mean an undervaluation of gold). A temporary free market in gold would give us more guidance regarding what the new conversion rate should be than either an adamant insistence on $35 an ounce or some dubious calculation based on a pure theory.