O
ne of the most pervasive myths about the United States is that the federal government has never defaulted on its debts. Every time the debt ceiling is debated in Congress, politicians and journalists dust off a common trope: the U.S. doesn’t stiff its creditors.
There was a time, decades ago, when the U.S. behaved more like a “banana republic” than an advanced economy. gold clauses in past and future contracts. The door was opened for devaluation – and for a political fight. Republicans were dismayed that the country’s reputation was being put at risk, while the Roosevelt administration argued that the resolution didn’t amount to “a repudiation of contracts.” On January 30, 1934, the dollar was officially devalued. The price of gold went from $20.67 an ounce – a price in effect since 1834 – to $35 an ounce. Not surprisingly, those holding securities protected by the gold clause claimed that the abrogation was unconstitutional. Lawsuits were filed, and four of them eventually reached the Supreme Court. In January 1935, justices heard two cases that referred to private debts, and two concerning government obligations. The underlying question in each case was essentially the same: did Congress have the authority to alter contracts retroactively?
There’s just one problem: it’s not true. There was a time, decades ago, when the U.S. behaved more like a “banana republic” than an advanced economy, restructuring debts unilaterally and retroactively. And, while few people remember this critical period in economic history, it holds valuable lessons for leaders today. In April 1933, in an effort to help the U.S. escape the Great Depression, President Franklin Roosevelt announced plans to take the U.S. off the gold standard and devalue the dollar. But this would not be as easy as FDR calculated. Most debt contracts at the time included a “gold clause,” which stated that the debtor must pay in “gold coin” or “gold equivalent.” These clauses were introduced during the Civil War as a way to protect investors against a possible inflationary surge. For FDR, however, the gold clause was an obstacle to devaluation. If the currency were devalued without addressing the contractual issue, the dollar value of debts would automatically increase to offset the weaker exchange rate, resulting in massive bankruptcies and huge increases in public debt. To solve this problem, Congress passed a joint resolution on June 5, 1933, annulling all
92 June 2018
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