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The Gold Clause Cases


Last night we wrapped up our discussion of the Gold Clause Cases in the informal law and economics seminar I’ve been conducting for economics students at George Mason University. The seminar is hosted by the GMU Econ Society, a great student-run libertarian group dedicated largely to Austrian economics.

What were the gold clauses? They were provisions in long-term bonds in the 1800s and early 1900s designed to protect creditors against the possibility of government debasement of money.

Americans living during those times were not naïve. They knew that throughout history governments had plundered and looted people through monetary debasement.

This was true even before the printing press enabled governments to issue paper money. One favorite way of looting people through inflation was called “clipping the coin.” As gold coins entered the government’s treasury for the payment of taxes, the king would shave the edges of the coin, making, say, a one-ounce gold coin now be a 9/10 ounce gold coin. The king would then take the shavings, melt them down, and create a brand-new one-ounce gold coin that he could use to finance his nice lifestyle or his foreign escapades.

Or another way was to simply punch a hole through the coin and then use the plugs to create the new coin. The one-ounce gold coins would continue to circulate as one-ounce gold coins albeit with a hole in them.

Our American ancestors were also familiar with how government used paper money to plunder and loot people. Most everyone was familiar with the Continental Congress’ massive inflation of the money supply during the Revolutionary War, which gave rise to the popular saying, “Not worth a Continental.”

So, it was not a surprise that when the U.S. Constitution called the federal government into existence, the Constitution established gold and silver coins as the official money of the United States. That’s why the federal government was given the power to coin money and was not given the power to issue paper money.

As the capital markets became increasingly sophisticated, railroad and other corporations were issuing long-term bonds, sometimes as long as 100 years. Why would someone loan anyone money for that length of time, especially given that the lender would be dead by the time the debt came due? Why wouldn’t people be concerned that the value of the bond would be wiped out with inflation?

People felt that the bonds were good investments. And they knew that their descendants would be protected from inflation owing to gold clauses within the bonds.

What the gold clauses essentially said was this: The debt would have to be repaid in money of the same standard as when the loan was made.

Let’s assume, just for simplicity’s sake, that John lends $1,000 in silver dollars to a railroad by purchasing a 100-year $1,000 bond. Let’s assume that each silver dollar consists of one ounce of silver. Let’s also assume that the bond contains a gold clause — or actually, under our hypothetical, a silver clause. It required the loan to be repaid in the same standard as when the loan was made — that is, with one-ounce silver dollars.

Suppose that over the succeeding decades, the government shaves off the edges of silver dollars so that they now weigh 9/10 of an ounce.

When the debt comes due, the railroad tenders 1,000 silver dollars to the lender, each of which weighs 9/10 of an ounce.

What will the lender say? He will point to the silver clause and say: No, under the terms of our contract, you must repay me in the standard that existed at the time the contract was entered into. You must compensate me with an additional amount of silver to cover the loss of weight due to the government’s debasement of the money when it shaved off the edges.

The same principle would apply if the government went to a paper money standard. The debtor would offer the paper money and, again, the creditor would point to the silver clause and say: No, our contract requires that you repay me in one-ounce silver coins, not paper money.

Enter the Franklin Roosevelt administration. It nationalized all the gold in the nation, requiring Americans, on pain of a felony conviction, to turn in their gold coins to the federal government, receiving devalued paper money in return. In itself, that was a phenomenal act, no different from the confiscations and nationalizations of private property that were being done by the Soviet Union and other tyrannical regimes.

FDR also decreed that from that day forward, irredeemable paper bills and notes, not gold and silver coins, would be the official money of the United States. That too was a phenomenal step, given that it totally changed the monetary system that the Constitution had established. Yet, it was accomplished without even the semblance of a constitutional amendment to authorize the revolutionary change.

FDR’s embrace of a paper-money standard, of course, now enabled federal officials to spend money to their heart’s content, which they did, both on the welfare state and the warfare state. It’s not a coincidence that today a bag of regular, circulated silver dollars sells for around $20,000 in paper money. That reflects how much the feds have debased the currency for the past several decades with their spending sprees.

But at least debtors were still protected with their gold clauses, right? Well, no, because the FDR administration nullified every single gold clause, in private bonds as well as government bonds.

Imagine that: In the one instance, private parties had voluntarily entered into a loan contract with each other. The federal government comes along and just nullifies a critically important provision of the contract.

Or here is the government lending money to people under an express assurance provided by a gold clause, and then simply tells people, “Sorry, but we’re not going to comply with our promise. Too bad for you.”

The U.S. Supreme Court, in a 5-4 decision, upheld the constitutionality of the law that nullified the gold clauses in private contracts. The Court held that the government’s power over money affairs, especially during an economic crisis, trumped negotiated contracts between private individuals.

Oddly, the Court held that FDR’s nullification of the gold clauses in government bonds was unconstitutional, given that the Constitution did not delegate power to the federal government to breach its own contracts. It was, however, a Pyrrhic victory because the Court, in strange analysis, held that the debtors hadn’t really suffered any damage given plummeting prices during the Great Depression.

Actually, the dissenters in the Gold Clause Cases had it right. As Justice McReynolds put it, “This is Nero at his worst. The Constitution is gone…. Loss of reputation for honorable dealing will bring us unending humiliation; the impending legal and moral chaos is appalling.”

This post was written by:

Jacob G. Hornberger is founder and president of The Future of Freedom Foundation. He was born and raised in Laredo, Texas, and received his B.A. in economics from Virginia Military Institute and his law degree from the University of Texas. He was a trial attorney for twelve years in Texas. He also was an adjunct professor at the University of Dallas, where he taught law and economics. In 1987, Mr. Hornberger left the practice of law to become director of programs at the Foundation for Economic Education. He has advanced freedom and free markets on talk-radio stations all across the country as well as on Fox News’ Neil Cavuto and Greta van Susteren shows and he appeared as a regular commentator on Judge Andrew Napolitano’s show Freedom Watch. View these interviews at LewRockwell.com and from Full Context. Send him email.