At the Point of Panic

Most of the reasons for the gold crisis are rooted in the U.S. The country's continuing balance of payments deficit, its constantly out-of-balance domestic budget and its rising outflow of money to finance the war in Viet Nam are basically responsible for global concern about the soundness of the dollar. Concern has led to the belief that the U.S. would soon have to stop selling gold to all buyers at $35 an ounce and somehow raise the price. The possibility of a price increase touched off the worldwide run on gold.

That being the case, the U.S. had the responsibility of doing what it could to provide the remedies that would end the crisis and restore sanity to the gold markets. Treasury Secretary Henry Fowler and Federal Reserve Board Chairman William McChesney Martin last week invited the central bankers of Britain, West Germany, Italy, Belgium, The Netherlands and Switzerland to a weekend meeting in the massive, paneled board room of the Federal Reserve Board in Washington.

The six, along with the U.S., are members of the international Gold Pool; the pool members, in an effort to hold the price of gold close to the official rate, have been drawing on their own governmental gold reserves--now down to about $25 billion. France, because it is no longer an active member of the pool, was conspicuously missing from the invitation list. Piqued because of the omission, Charles de Gaulle decided to keep the Paris Bourse open last week after London's gold market had shut down at Washington's suggestion. The result (see THE WORLD) was wild trading and a rise in the speculation price per ounce of gold to $44.36.

Steps Taken. Alarmed by earlier buying of gold, the same central bankers, only six days before their Washington conference, had held a similar session in Basel. There the Fed's Martin reasserted the U.S. intention of maintaining a $35-an-ounce price on gold, persuaded his peers to keep the pool going. In spite of their agreement to do so, rumors spread--and were vigorously denied--that both Belgium and Italy were dropping out of the pool; the rumors only fanned the flames of speculation. Martin emerged from the Basel meeting to describe himself as "satisfied" with its decisions. Bank of England Governor Sir Leslie O'Brien added that "I am very pleased with the results and I hope the world will be too."

Back home, the U.S. last week took steps to put its economic house in order. The Fed, to dampen the U.S. economy and provide some antidote to the balance of payments deficit, decided on an increase in the discount rate. The rate, which represents the cost to commercial banks of borrowing Federal Reserve money and thus affects their own rates to customers, went from 41 to 5%. The increase meant higher interest rates on loans, less available mortgage money and, just as the Fed intended, a hold-down on all but necessary spending because borrowed money would be more costly. That, for now, was the extent of the gold panic's effect on the U.S. man in the street.

The Federal Reserve, as is its custom, waited until the stock markets closed on Thursday to announce the new rate. The move was wise. Already that day, on news of the growing gold crisis, the Dow-Jones industrial average had fallen 11.32 points for its sharpest drop in 18 months; on the New York Stock Exchange, declines in stock prices outnumbered gains by 10 to 1. Next day, while London's market was shut down, New York opened on schedule, and in an equally busy day the industrials regained half of what they had lost. Most of the activity was caused by nervous small investors. Wall Street regulars took the gold panic with remarkable calm in the knowledge that while the situation could turn into a dis aster for the international monetary system, it was unlikely to have catastrophic effects in the U.S.

Removing the Cover. In Washington, the crisis helped to swing a critical vote. The Senate, after considerable debate, heeded Majority Leader Mike Mansfield's warning during an evening session that "tonight is important in the history of this country." It passed the legislation that Martin insisted on to remove the "gold cover" that has been in force since 1934. But the vote was close (39 to 37), as conservative Senators who want deeper cuts in non-military spending and liberals who oppose increased spending on Viet Nam joined together in a coalition of protest. Under the bill, to be signed by President Johnson this week, the U.S. need no longer keep $10.4 billion in gold--or most of the total $11.4 billion gold supply the country currently holds--on hand as backing for 25% of the $41.6 billion in paper dollars presently in circulation. Henceforth, all the U.S. gold can be used if necessary to support the Gold Pool, in which the U.S. puts up 59% of the gold.

Two Tiers. The bill to remove the gold cover seemed to come almost too late to be of use--if only because the Gold Pool itself is likely to be revamped as one result of last week's emergency. The Europeans arriving in Washington--Britain's O'Brien, Hubert Ansiaux of Belgium, Karl Blessing of Germany, Guido Carli of Italy, Jelle Zijlstra of The Netherlands, and Edwin Stopper of Switzerland--favored the view that the time has come to try the "two-tier" system of gold prices that many an economist has been urging. Under the two-tier idea, the U.S. and its economic allies would continue central-bank exchanges of gold and dollars at the $35-an-ounce price. But "mercantile" gold--that which is bought by speculators and industrial users--would be left free to seek its own price. The advantage of the system is that the open-market price might very well drop low enough to finally put some risk into speculating. Up to now, with the U.S. maintaining a bottom on prices, the trading has been a heads-I-win, tails-you-lose proposition in favor of the gold buyers. One disadvantage of the plan, however, could be a temptation among smaller central banks to buy gold officially at the $35 price, then turn around and sell it in the open market at a profit.

The two-tier system, like the foundering Gold Pool, would be used as merely a short-term solution to the gold drain. Before long the central bankers hope to implement the idea of special drawing rights that could be used as reserves along with gold and dollars. The S.D.R.s would be certificates representing members' credits in the International Monetary Fund. They would make it less necessary for other governments to hold so many dollars in reserve--and less burdensome for the U.S. to redeem these dollars with gold.

The War Tax. For all its problems, the dollar will continue to be the world's most important currency, if only because the U.S. economy has safeguards --bank insurance, market regulations, progressive tax rates--built in to cushion it even in hard times. But only the U.S., by putting its affairs in order, can protect the dollar. One way, which House Ways and Means Committee Chairman Wilbur Mills is demanding, is for the Administration to cut back domestic spending more sharply than it wants to, as long as it is faced with large outlays for Viet Nam. Last week Lyndon Johnson agreed to reductions of as much as $9 billion.

In return, L.BJ. wants higher taxes. The Administration, since summer, has asked for a 10% surtax on incomes in order to ease inflation. To convince Congress that the surtax is urgent, Fowler and Martin spent much of last week on Capitol Hill. Fowler described the surtax as a "war tax," said that the Administration was even willing to raise taxes back to their levels before the 1964 reduction. The move would real ize $22 billion, rather than a previously estimated $10 billion.

Congress also heard from a blue-ribbon Treasury advisory panel headed by former Secretary Douglas Dillon and including Bankers David Rockefeller and Robert Roosa and Economists Walter Heller and Kermit Gordon. "In the interests of our nation's economic strength and stability," they warned, "enactment of the surcharge must be delayed no longer."

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