Alfred M. Mthimkhulu
“I have come to see the President, and I am going to stay here until I see him”. That was John Pierpont Morgan at the United States Whitehouse in February 1894. JP Morgan was one of the leading bankers in frontier America, evidenced even today by a global bank bearing his name. As he sat waiting for President Cleveland who was clearly avoiding the meeting, Morgan played solitaire to keep calm.
“These were rough days. A financial crisis was raging across the country. He was here to stop it.
The US had seen two notable crises since the end of the Civil War but this one was already being called the Great Depression, a title it ceded in 1929. It ravaged the US well into 1895. Some 600 banks had collapsed by 1894. Workers’ strikes were rife. In December 1893, President Cleveland sent troops to Chicago to quell a strike. Seven were shot dead. Their leader was arrested. A serious crisis indeed.
What triggered it? Deflation? Yes, but a better answer would be that this was a currency crisis which explained the deflation.
It was a currency crisis the country would only get to decisively deal with during the Great Depression of 1929 but would, in doing so, inadvertently export it to Europe a decade later with consequences that linger today.
In 1879, the US had committed Treasury to accept a dollar for a set amount of gold whenever the bearer chose to claim. To show commitment, some $100 million worth of gold was kept by Treasury.
Locals, especially farmers who constituted most businesses in that era, resented the dollar-gold link. Why? It kept their costs high while the prices of their produce were falling.
They were losing money. This accelerated calls for the use of silver alongside gold as a currency anchor.
Of course, discoveries of silver deposit were also behind this lobbying. Silver, being more available than gold would amount to creation of new money to boost demand, inflate prices a bit thus making local firms profitable.
Then the trigger was pulled from far away in Argentina. The Argentine wheat crop failed in the early 1890s causing unrests that culminated in a coup. Argentina’s London-based investors became nervous and pulled out their money.
For Londoners, the US was as risky as the rest of the colonies so they presented their dollars to Treasury and shipped gold across the Pacific.
In those day, European finance was critical for the US. Europe had to be kept sweet. By the time Morgan got to meet President Cleveland, the $100 million of gold reserves had dropped to a measly $9 million.
Europe was not only concerned with “emerging markets risk” but that the US could succumb to the pressure of using silver such that dollars would be swapped for an inferior metal.
Indeed, in 1890 the Sherman Silver Purchase Act allowed Treasury to buy silver for reserves such that dollars could in future be redeemed in gold or silver.
Although the Act had been repealed early 1893 it justified Europeans’ concerns. With $9 million of gold left, the President had no choice but to let Morgan take charge along with the Rothschilds in London.
Some $65 million 30-year gold bonds were issued to buy gold (3,5 million ounces) with a strange promise to the government by Morgan that the gold would not leave US.
The legality of the bond issue was questioned and refuge found in the Civil War emergency powers Abraham Lincoln had used.
Although the floatation was a success, gold still left US a few months later. A further $67 million floatation was done early 1895.
Gold would linger as a currency anchor until being kicked out during the Great Depression to allow for flexibility in incentivising industry, funding public works, providing social safety or in short: to empower the central bank to use monetary policy to grow the economy.
This US crisis of 1893 when gold backed the dollar is similar to the situation in Zimbabwe when the USD was the main currency. As many have argued, the USD rendered Zimbabwe an expensive producer as was the US local industry then.
Treasury was constrained in helping firms because of a hard and finite money supply dictated by the gold standard. On the other hand, the fear of silver chasing away European capital was real.
Government was in a fix: to please London by keeping the gold standard or to flex things up with silver.
As with gold in the US of the mid-1890s, the USD in Zimbabwe was always going to flee.
The USD, as gold then, is the world’s foremost reserve asset. Even with a perfect domestic environment, some trouble in any neighbouring country would make the then Zimbabwe a perfect escape route for capital: simply sell in Zimbabwe and ship dollars out.
Other than gushing wells of crude oil and river banks naturally replenished with diamonds and gold each morning, it is difficult to conceive a fantasy that can sustain use of USD by a small poor country in Africa.
The anchor was too firm for the fishermen to set off for a catch such that they would have been forever stuck in the boat knowing the boat would someday disintegrate and sink with them.
With space, we could have stretched this discussion to modern times. We would have discussed the Second World War settlements at Bretton Wood and how most of Europe’s currencies were almost worthless as their industry was near ruin.
We would empathise with the rationale of pegging all such currencies then to the USD, a peg ultimately linked to gold redeemable at $35 per ounce.
We would discuss how as the gold price increased it became expensive for the US to subsidise Europe hence President Nixon abandonment of the peg in 1971.
We would note how the advent of the Euro was accelerated by this decision by President Nixon which would have been unthinkable in 1894: dumping Europe having even saved it in 1944.
We would talk of the rise of the Deutsche Mark as the anchor currency in the run-up to the Euro and marvel at Germany’s industrial productivity and exports.
And here we would stop for the message would be clear: what underpinned the might of London in the 1890s and of
Washington DC post-Second World War was this superior industrial productivity and exports.
No other anchor is more enduring than these. But what comes first, productivity and exports or a stable currency?
It runs both ways an economist must scream. There is a symbiotic relationship between both meaning that each grows the other.
Managing both is what building trust and confidence in a system is all about — not just gold or a war chest of foreign currency reserves in a central bank’s vaults which, though important, must come from somewhere and be replenished from somewhere.
◆ Alfred Mthimukulu is a Senior Lecturer at the Graduate School of Business, NUST. Email: [email protected]; Twitter: @mthimz