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(c)1975 Committee for
Monetary Research and
Restoring "Gold Clauses" In Contracts
René A. Wormser
Donald L. Kemmerer
ABOUT THE AUTHORS:
René A. Wormser is a well-known lawyer, lecturer and author. He
is the senior partner of Wormser, Kiely, Alessandroni & McCann of
New York, and an authority on taxes, estate planning and
international law. He is the author of numerous books including
Wormser's Guide to Estate Planning; The Planning and
Administration of Estates, The Law; Foundations, Their Power and
Influence, and The Story of Law. Donald L. Kemmerer is Professor of Economics (Emeritus) at the
University of Illinois and has been the President of CMRE since
its founding in 1970. He received his BA, MA, as well as his Ph.D.
from Princeton University. A well-known authority on American
financial history, he has published many articles, and is the
author or co-author of six books, including The ABC of the
Federal Reserve System (with E. W. Kemmerer) and American
Economic History (with C. G. Jones). He has held Fullbright
lectureships at the University of Montpellier and at the
University of Munich.
PUBLIC LAW 93-373
93rd CONGRESS, S. 2665
AUGUST 14, 1974
To provide for increased participation by the United States in
the International Development Association and to permit United
States citizens to purchase, hold; sell, or otherwise deal with
gold in the United States or abroad. Be it enacted by the Senate and House of Representatives of the
United States of America in Congress assembled, That the
International Development Association Act (22 U.S.C. 284 et seq.)
is amended by adding at the end thereof the following new section:
"Sec. 14. (a) The United States Governor is hereby authorized to
agree on behalf of the United States to pay to the Association
four annual installments of $375,000,000 each as the United
States contribution to the Fourth Replenishment of the Resources
of the Association.
"(b) In order to pay for the United States contribution, there is
hereby authorized to be appropriated without fiscal year
limitation four annual installments of $375,000,000 each for
payment by the Secretary of the Treasury."
Sec. 2. Subsections 3 (b) and (c) of Public Law 93-110 (87 Stat.
352) are repealed and in lieu thereof add the following
"(b) No provision of any law in effect on the date of enactment
of this Act, and no rule, regulation, or order in effect on the
date subsections (a) and (b) become effective may be construed to
prohibit any person from purchasing, holding, selling, or
otherwise dealing with gold in the United States or abroad.
"(c) The provisions of subsections (a) and (b) of this section
shall take effect either on December 31, 1974, or at anytime
prior to such date that the President finds and reports to
Congress that international monetary reform shall have proceeded
to the point where elimination of regulations on private
ownership of gold will not adversely affect the United States'
international monetary position." Sec. 3. The International Development Association Act (22 U.S.C.
284 et seq.) is amended by inserting at the end thereof the
"Sec. 15. The United States Governor is authorized and directed
to vote against any loan or other utilization of the funds of the
Association for the benefit of any country which develops any
nuclear explosive device, unless the country is or becomes a
State Party to the Treaty on the Non-Proliferation of Nuclear
Weapons (21 UST 483)." Approved August 14,1974.
Restoring "Gold Clauses" In Contracts
The current and frightening rate of price inflation calls for
some method by which American citizens can protect their savings
and be assured of inflation-resistant contracts. The right of the
American people to buy, own, or sell gold, a recognized store of
value, was restored as of December 31, 1974. But the right to
make contracts in gold also is needed to protect creditors.
A Congressional joint resolution of June 5, 1933 deprived
Americans of the right to hold gold, and even of the right to use
gold as a measure-of-value in contracts. Before that time, "gold
clauses" were to be found in many agreements, requiring payment
or repayment in dollars in gold coin of the United States "of or
equal to the present standard of weight and fineness". The basic
purpose was to protect the seller or creditor against having to
accept a depreciated medium of payment. In August of 1974,
despite strong opposition from various quarters, Congress decided
that, beginning on December 31, 1974, the American people should
again have the right to own gold. But Congress said nothing about
making the "gold clause" legal again in future contracts.
SOME MONETARY HISTORY Some monetary history will be useful in explaining how the gold
clause came into existence; why its use grew; why Congress
removed the right to use it; and why it should now be given back
to the American people. In 18th century America price inflation was rampant, culminating
in a very severe inflation during the Revolution. When issuing
paper money was resumed in some states after the War's end, the
founders of our country, fearing the consequences of unsound
money, felt the need for a stable monetary system. Article I,
Section 10 of the Constitution says, in part, "No State shall ***
make any Thing but gold and silver Coin a Tender in Payment of
Debts ***". This was generally interpreted at the time as binding
the Federal government as well. In 1792, Congress adopted a
monetary system based on gold and silver. Prices, then, remained
remarkably stable until the Civil War, with two moderate
exceptions, 1814 -17 and 1835 - 37.
During the Civil War, fought at the cost of one million dollars per day in the first year and more later, the government had to suspend gold convertibility. It issued three successive batches of "Legal Tender Notes", soon scathingly referred to as "Greenbacks". This un-backed paper money precipitated an inflation amounting to 24 per cent in 1862, and by 1864 the dollar had declined to one-third its value in terms of gold.
In a series of cases, the constitutional right of Congress to issue legal tender paper was challenged. Eventually, in 1884, in Juilliard vs. Greenman (110 U.S. 421) the Supreme Court voted 8 to 1 that Congress had the power to issue legal tenders even in peacetime.
Meanwhile, however, in an important case, Bronson vs. Rodes (7 Wall 229), in early 1869, the Court had ruled that if the contract specified that the debtor must repay in gold dollars of the same weight and fineness as those loaned to him, he had to do so. Henceforth a growing number of contracts carried such a "gold clause".
On January 2, 1879 the United States returned to the gold coin standard. The 30 years following the Civil War were a period of tremendous economic growth and also of falling prices. A depression in the early 1890s and then a bitterly fought presidential election in 1896, McKinley vs. Bryan, raised grave doubts whether the nation would remain on the gold coin standard or would shift onto a depreciated silver coin standard. The clause then became a normal inclusion in many carefully drawn contracts.
Perhaps the strangest devaluation of all times took place in the United States in 1933 - 34. It was intended to raise the price level rather than (as is usual with devaluations) to constitute a belated recognition of a price rise that had already occurred. In the spring of 1933, President Franklin D. Roosevelt first imposed a mild embargo on the export of gold, then ordered all citizens to turn their gold coins and gold certificates over to the government, and finally applied a strict embargo on gold exports, which order led to a floating of the dollar. On May 12, Congress gave the President authority to devalue the dollar by as much as 50 per cent and on June 5, it forbade ownership of gold and the use of the "gold clause" in contracts.
The President set the new price of gold at $35 an ounce on January 31, 1934 thereby debasing the dollar by 41 per cent. This was intended to raise the price level by 69 per cent (1.69 being
the reciprocal of .59). Various aggrieved citizens challenged the authority of Congress to declare the gold clause inoperative, but in October of 1934 in Norman vs. Baltimore and Ohio (294 U.S. 240), and in other cases, the Supreme Court ruled, 5 to 4, that Congress had the power to set aside the gold clause, emphasizing especially that the plaintiffs had not, at that point anyway, suffered any financial loss. Justice James C. McReynolds, speaking for the dissenting minority, said, ". . . the enactments here challenged will bring about confiscation of property rights and a repudiation of national obligations . . ." and he added, "... we cannot believe the farseeing framers, who labored with hope of establishing justice and securing the blessings of liberty, intended that the expected government should have authority to annihilate its own obligations and destroy the very rights which they were endeavoring to protect..." (294 U.S. 361-62). Subsequently in 1937 in the Holyoke Water Co. case (300 U.S. 324) the Court made the majority position even plainer, refusing to uphold any contract calling for repayments in any specific kind of gold coin.
Down to the spring of 1933 American citizens had an economic vote" of which they could make use at any moment, as well as the political vote they might exercise on election days. If a citizen distrusted the government's management of its finances or its "regulation" of the money, he could protect himself by demanding gold for his dollars. He would lose interest by holding gold, but at least he would protect his principal. If many individuals acted in this fashion, the effect would be to reduce central bank reserves. Such a decline would act like a burnt-out fuse in a house. It would cause the manager, the central bank, to realize there was an overload (of credit) somewhere that needed looking into. But because American citizens lost their "economic vote" they can no longer make their feelings felt in this way.
Meanwhile the inflation noose grows tighter around the neck of the average citizen, as the consumer price level has risen every year. At the 1973 rate of inflation, it would take only eight years for the dollar to lose half its value, and at the 1974 rate about six years.
Wages and salaries for most individuals do not keep pace with prices. Moreover, any significant rise in income is offset by the fact that this simply pushes the individual into a higher bracket of our graduated income tax. The buying power of his life insurance principal and of his prospective retirement pension is steadily eroded. Higher interest rates on government bonds or savings accounts are never sufficient to offset the loss of purchasing power of the principal. Often the taxable capital gain
on property he sells is unreal, since the tax laws make no
allowance for any loss in purchasing power of the dollar. Any
depreciation program on home, buildings, equipment, machinery,
etc., may restore the original purchase price but, because of
price inflation in the interim, does not accumulate enough funds
to buy an equivalent replacement.
POSSIBLE GOLD CLAUSES We cannot protect ourselves fully in all respects against the
ravages of inflation. However, when our right to hold and deal in
gold is restored, we can hope to protect ourselves as sellers and
lenders through an acceleration clause based on gold values.
Since 1933 when the gold clause was outlawed, we have been using
two methods of protecting sellers, lenders and others against
price inflation. Neither of them has been wholly satisfactory.
One, employed in real estate leases, for example, escalates the
rental as the landlord's taxes and costs of operation increase.
The other uses a form of escalation related to the cost of living
index or some other scale. This latter method has been used in
labor and other contracts, and even in adjusting bequests and
income interests under wills and trusts.
Useful as these methods may have been, they do not give the full
protection which a gold clause might provide.
The Gold Coin Clause A gold clause calling for repayment in some kind of gold coins,
whether American or foreign, might not be satisfactory. It would
run into the problem of separating the value attributable to gold
and the value attributable to the scarcity of the coin, its
numismatic value. These two values vary widely.
The Gold Ingot Clause To overcome that problem one might use small gold ingots such as
European banks sell, their weight and fineness guaranteed by the
bank. These could be minted in any quantity desired. The lender
might make his loan to the borrower in the form of such ingots,
requiring a return (even installment return) of ingots of the
same weight and fineness. Because gold is a fungible thing the
lender probably could not enforce specific performance, i.e.,
insist on getting a return of gold itself. However, as in
"futures" transactions on commodity markets, he would be entitled
to damages in the form of repayment in dollars equivalent to the
value of gold at the time of payment. This would provide
There would be an inconvenience in using this last procedure, but it would only be a slight one. The lender need not actually deliver gold ingots. He could, in place of doing so, deliver the equivalent of a warehouse receipt for the necessary amount of bullion. Indeed, it is possible that banks might come to store gold and to sell warehouse receipts against it.
The Gold Measure-Of-Value Clause
The gold ingot method might be the best to use. However, there is still another approach, one which would avoid an actual dealing in gold, should this turn out to be undesirable. The other method would be using a measure-of-value clause. In accordance with the August 14, 1974 law, the American people regained the right to own and to deal in gold as of January 1, 1975, which would seem to imply that they also regained the right to use gold as a measure-of-value, although this conclusion is contested in some government quarters. This being the case, we propose a clause which would not require payment in gold but which would use the value of gold to measure the required payment.
Under such a plan, the lender, or the seller under a long term sales or loan contract, would require payment of an escalated or de-escalated amount in dollars, reflecting the free market price of gold at the time of payment. To illustrate, suppose X is to lend Y $100,000 payable in ten years with interest at 6 per cent. The contract would provide that the amount payable at the end of the ten year period would be $100,000 adjusted to an increase or decrease, as the case might be, in the free market price of gold. This would not only protect the lender against a loss from inflation in the interim but also, as is only fair, protect the borrower against an overpayment in purchasing power because of a deflation in the interim.
The contract would provide two points of reference. The first would be the free market price of gold as of the day before the date of the contract, or perhaps as the average price over a previous period of a week or a month. Suppose that to be $200 an ounce. The stipulated $100,000 would then be able to purchase 500 ounces of gold. The second factor would be the free market price of gold determined as of the day before the contract payment date. Suppose this turned out to be $250 an ounce. It would then take, at that time, $125,000 to purchase 500 ounces of gold, and the borrower would be required to pay this sum. Or contrariwise, suppose the price of gold fell to $160 an ounce by the contract payment date, then the borrower would have to repay only $80,000.
A similar procedure could be made to apply to the determination
of a required interest payment.
The contract would have to identify the "free market" to be used to establish the respective gold prices. Today it would be London or Zurich; tomorrow it might be New York.
GOLD PRICE FLUCTUATIONS
If the borrower's obligation to pay and the lender's prospects of getting back the buying power of the loan are to be affected by the price of gold, both parties are going to look closely at how well the price of gold reflects general price levels. At first glance it may seem to have done so very poorly. From 1837 to 1861, and from 1879 to 1933 the "price" of gold was $20.67, yet wholesale prices ranged from 53 (on a 1913 base of 100) in 1851 to 204 in 1920 according to W. Randolph Burgess. And from 1934 to 1971 the "price" of gold remained at $35 while wholesale prices tripled. But these gold "prices" were mint prices, i.e., the number of gold dollars the Mint could (if and when it did so) manufacture from an ounce of pure gold. When the dollar was 13.71 grains of pure gold, the mint price was $35 (480/13.71 is 35). They were not market prices albeit because of the Treasury's vast holdings of gold overhanging the market, these mint prices set the market price too. These mint prices tell us almost nothing about how well the price of gold reflects the general price level when a nation is on a paper money standard.
The paper money era, 1862 - 1878, when gold was freely traded in the Gold Room adjoining the New York Stock Exchange, can tell us best how well the price of gold reflects other price changes. The late Dr. Don C. Barrett shows in his book, The Greenbacks and Resumption of Specie Payments, 7862 - 7879, pp.97 - 98, that the correlation was fairly good. The worst departure was in the summer of 1864, the war's darkest hour, when the price of gold exceeded that of wholesale prices by one-third. In a national crisis people may bid for gold, that age-old best store of value, more vigorously than they otherwise would. The only other experiment that we have is the most recent one since the nation departed from the gold standard on August 15, 1971. In three years the consumer price index rose about 24 per cent whereas the price of gold on the London "free market" quadrupled. One must ask at least three questions about this dramatically sharp rise in the price of gold. To what extent is it now at a higher price than can be maintained? To what extent does this quadrupling of price really reflect the tripling of consumer prices that have taken place since 1933 when the government forbade its citizens to own gold? To what extent does it reflect mounting concern over the very sharp rise in consumer and wholesale prices during 1973
and 1974, and the fact that there are still no signs of an end to
the growing price inflation. It is too soon to draw any firm
While there has been almost frantic speculation in gold since
1972, it seems unlikely that the fluctuations will continue
indefinitely and thus distort the gold market. Eventually,
changes in the free market price of gold ought probably in
general merely reflect the impact of inflation.
PROBLEMS Careful consideration must be given to several problems which may
attend the future use of a gold clause.
Could the courts hold that the use of gold clauses would be
against public policy? The alleged justification for the
Congressional obliteration of our right to hold and deal in gold
was that the metal played a part in our monetary system, (i)
because an official gold value was attributed to the dollar; (ii)
gold was still used in international exchange; and (iii) dollars
could still be redeemed (converted into U.S. gold) by foreign
banks. Therefore, it was held that gold still played a part in
our monetary system and Congress, under the Constitution, was
entitled to regulate its use.
When, however, convertibility came to be rejected on August 15,
1971 even in the case of foreign holders of dollars, the last
genuine tie of gold to our monetary system was obliterated. True,
in an official way, we continued to define the value of gold in
terms of dollars, but this valuation was wholly artificial and
bore no relationship whatsoever to the true, free market value of
gold. It became a pretense to assert that gold continued to play
a part in our system. Therefore, after out right to hold and deal
in gold has been restored, no vestige of principle would seem to
remain justify preventing us from using gold as a measure-of-
value. Gold would seem to have become a commodity like zinc and
wheat. Taxation The test of whether or not we have sustained a taxable profit
should not be whether we have gained in a mere number of dollars,
but rather whether we have gained a true economic benefit, that
is, one reflecting an increase in purchasing power. It is to be
hoped that the courts will arrive at this realistic principle, in
recognition of the devastating impact of inflation. However, even
if the present unjust principle continues, under which there is no relief from the impact of inflation, it would seem worthwhile to use a gold clause, despite the tax risk.
If an alleged (though false) "profit" were taxed as a long term capital gain, there would still remain a substantial net protection against inflation. If the false "profit" were taxed as ordinary income, there would even then be some net benefit in the use of a gold clause, though a far smaller one.
Under present law, and without any recognition of the principle that true economic benefit should be the test, the Internal Revenue Service might claim that any gain in the number of dollars returned to the creditor would constitute income, taxable in one way or another. The nature of the tax would depend on the nature of the underlying transaction. If it were one normally taxed on a long term capital gain basis, any dollar accretion should be taxed, if at all, as an additional long term capital gain. On the other hand, if the transaction were one normally taxed as a short term capital gain or as an ordinary income transaction, the accretion could be taxed, if at all, as ordinary income.
Of course, interest payable either on a loan or in connection with a sale would be taxed as ordinary income. Moreover, there is the possibility that the I.R.S. might go so far as to contend that any accretion in dollar value would constitute the equivalent of ordinary interest and be taxable as such. This would be an illogical and unfair contention, and should be rejected by the courts.
Usury The danger of usury must be avoided. If the transaction were held to be usurious, then the contract could be voidable - that is, the payor-borrower might be able to repudiate repayment. We would have to be sure that usury would not apply.
Usury is determined by state law and the varying statutes of the particular states involved would have to be examined carefully. In general, usury cannot be asserted as a defense by a corporation, though there may be some limits on this rule in some state laws. So, in general, we need not worry too much about usury if the payor is a corporation. If no other certainty of protection exists, a lender might well insist that a loan be made only to a corporation, perhaps created for the purpose. A personal endorsement of the loan by an individual concerned could be demanded to guarantee payment.