Did FDR Default on U.S. Debt?

• Author: Richardson, Gary

American Default: The Untold Story of FDR, the Supreme Court, and the Battle over Gold

By Sebastian Edwards

288 pp.: Princeton University Press, 2018

The risk-free rate of return on investments is often considered to be the yield on U.S. government debt. "The risk-free rate is hypothetical," Investopedia states, "as every investment has some type of risk associated with it. However, T-bills [U.S. Treasury debt obligations with a maturity of 52 weeks or less] are the closest investment possible to being risk-free." One of the reasons for this is "the U.S. government has never defaulted on its debt obligations, even in times of severe economic stress." Similar statements appear in Wikipedia's entry on the risk-free interest rate as well as in scores of economics and finance textbooks used around the world.

University of California, Los Angeles economist Sebastian Edwards's new book, American Default: The Untold Story of FDR, the Supreme Court, and the Battle over Gold, challenges this assertion. Edwards argues that the United States defaulted on federal debt during the 1930s when it withdrew monetary gold from circulation and abrogated the gold clause in both public and private contracts.

Overview/ Before I delve into the details of Edwards's insightful study, I want to give you an overall assessment of the book: It is fascinating, well-written, and thoroughly researched. It provides new perspective on an important era of American history. It discusses the ideas, personalities, politics, economics, and finance underlying the principal policies by which the Franklin D. Roosevelt administration resuscitated the U.S. economy after the catastrophic contraction of 1929-1933. An academic press published the book, but the clarity of its prose and vividness of its narrative make it accessible to a general audience. The book should and will be read widely. It's worth pondering and debating, and I will debate some aspects of it later in this review.

Edwards's book asks provocative questions about fundamental features of the U.S. and international financial systems. The author lists these questions at two points in the book: the end of the introduction and the beginning of the conclusion. The lists contain 15 total queries, which I condense into five:

* Did the United States default on federal government debt in 1934 when it abrogated the gold clause for government bonds (particularly the fourth Liberty Bond)?

* Why did the federal government abrogate the gold clause? Was this action necessary?

* Who made the key decisions during this episode and how did they justify their actions?

* What were the consequences for investors and the economy as a whole, both in the United States and abroad?

* Could this happen again?

Edwards answers these questions over the course of 17 chapters plus an introduction, an appendix, a timeline, and a list describing the people around whom the story revolves. The introduction lays out the issues of interest. Chapters 1 through 15 narrate the story. The narrative revolves around such policymakers as Roosevelt, Sen. Carter Glass, and members of the Supreme Court, as well as the people who advised them. Among those advisers were Roosevelt's Brain Trust, whose initial members included Raymond Moley, a law professor from Columbia University, Rexford Tugwell, an economics professor at Columbia, and Adolf Berle, another law professor from Columbia. The narrative describes the decisions that these men made (or had to make), their rationales for those decisions, and the state of knowledge and state of the world at the times those decisions were made.

Fearing devaluation / The narrative starts in March 1932, during the economic downturn now known as the Great Depression. A few pages describe the poverty and desperation imposed upon people from all walks of life. Nearly a quarter of the labor force experienced unemployment. Commodity prices declined by more than half. These declines proved particularly hard on people running small businesses, such as family farmers who made up a quarter of the U.S. population. Declining farm prices accentuated farmers' debt burden because the nominal value of debts remained fixed, forcing 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). Some farmers (and eventually almost all farmers) stopped paying their debts, defaulted on their loans, and faced 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 those last five months of the Herbert 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 because they anticipated that the Roosevelt administration would lower the gold content of U.S. currency or leave the gold standard altogether, 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...