Gold Confiscation - An Unlikely Scenario

Includes: GLD, IAU, PHYS, UDN, UUP
by: Alex Canahuate

The specter of confiscation has haunted gold investors for some time, but with increasing persistence as a legitimate "recovery" fails to materialize. Unscrupulous metal dealers will unflinchingly try to capitalize on these insecurities by pushing "confiscation-proof" products on unsuspecting consumers. It goes without saying that these items invariably command a larger premium than standard bullion products. The most important thing to bear in mind is that no one, save the pen-wielding legislators, can know what form and function a possible gold confiscation could take. While anything is possible, I am inclined to think that a re-imagining of FDR's gold confiscation is unlikely. The fundamental differences between 1933 America and today have given us more reason to fear exchange controls than an across-the-board confiscation.

On April, 5 1933, when President Franklin Delano Roosevelt penned into law executive order 6102 -- allowing for the confiscation of gold -- America was mired in a deflationary depression. Deflation is characterized by cash hoarding, which results in a rising dollar value while companies are forced to slash prices in an effort to drum up business. The inevitable squeeze on corporate profit margins precipitates layoffs, which further compound deflationary pressures as rising unemployment is followed by shrinking consumption. In a fiat currency system, the common economic response to deflation is to print more money in a bid to stem the currency's appreciation.

However, in 1933 the U.S. dollar was convertible to gold, rendering the government incapable of printing more money as it is apt to do today. With fiscal discipline enforced by this convertibility, our faithful politicians did the next best thing -- they promptly confiscated American citizens' gold, via executive order 6102, while remunerating them for the then fair market value of $20.67 an ounce. Upon the successful completion of its gold confiscation, the U.S. government adopted the Gold Reserve Act in January 1934, which revalued the nominal price of gold from $20.67 to $35 per troy ounce.

By increasing the gold price, the government effectively increased the number of dollars required to purchase an ounce. As dollars were directly convertible into gold, this measure allowed the government to successfully devalue the dollar without printing more. For instance, if a foreign government wanted to convert $1,000,000 worth of U.S. dollars into gold, suddenly those dollars were purchasing less gold than they could before the revaluation.

Below is an excerpt from the "General Purpose of the Bill" section that is provided by the Gold Reserve Act link above:

The upward flight of the American dollar meant a correspondent decline in commodity prices, the debtor was at a distinct disadvantage. Commodities were his only source of income. If he borrowed in high commodities and had to pay in low commodities his task became exceedingly difficult. This led to repudiation on the part of the debtor and bankruptcy for the creditor. To meet this situation the Congress, through the medium of what is commonly called the "Thomas amendment" empowered the President to save the debtor and creditor alike by vesting in him the authorization to cut the gold content of our monetary unit providing he did not exceed a 50 percent limitation. The succeeding events now make it advisable to once more make the American dollar a constant unit. One cannot definitely say what that value should be at the moment. It is the opinion of the administration however that its proper value lies somewhere between 50 and 60 percent of its former value.

If the gold dollar is revalued at 50 percent, this will double the statutory value of our monetary gold and broaden the basis for our currency and credit system. It will raise the price level and restore the normal purchasing power of the dollar. The salutary effect of this must be appreciated by everyone who has considered that we are staggering under an enormous public and private indebtedness, aggregating approximately $200,000,000,000, incurred principally when the purchasing power of the dollar was much less than now prevails. The purpose of this bill is not to depreciate the dollar below the normal purchasing power that prevailed when these debts were contracted, but to merely restore the dollar from its enhanced and appreciated purchasing power to normalcy. This bill will not only lighten and make bearable our public and private debts, but it will stimulate domestic and foreign trade by permitting the dollar to seek a level that will more nearly approximate the purchasing power of foreign currencies.

There it is, in no uncertain terms -- the true motivation behind the confiscation of gold and subsequent revaluation of the gold price was to devalue the dollar. If we can accept the nature of the confiscatory actions back in 1933, we can apply the associated considerations to the framework of today's economic environment.

The Fed has set an observable precedent, evidencing that it has no qualms running the printing presses. As such, the necessity of gold confiscation as a way of combating deflation is no longer pertinent. While we are arguably faced with a deflationary cycle, Bernanke and his brethren will have no problem devaluing the dollar via printing in the face of widening deflationary concerns. There is no need for controversial legislation, complex logistical considerations, and the host of other inconveniences that would be invariably associated with another gold confiscation.

As mentioned earlier, the 1933 confiscation involved compensating U.S. citizens for the fair market value, and then subsequently re-pricing gold higher. Due to President Nixon "closing the gold window" in 1971, thereby ending the U.S. dollar's convertibility into gold, the U.S. no longer has the capacity to adjust prices. With this in mind, a modern day gold grab (which would presumably still entail fair compensation) would be nothing more than a gamble on the metal's value going forward. Without the ability to revalue gold higher, Uncle Sam would have to cross his fingers as he watched the market along with the rest of investors.

While I certainly won't argue the upside potential of gold, a bet of this nature would certainly not have the stabilizing effects that the government would be hoping for. If anything, a gold confiscation would display a vote of no confidence by the U.S. government with regards to the dollar. In an economic environment characterized by funding pressure - as evidenced by Europe's peripheral nations - the last thing the government wants to do is erode confidence in the dollar and US Treasuries. A gold confiscation would highlight our government's fiscal indiscretions and inability to effectively manage its sovereign balance sheet.

Upon a more detailed review, it is obvious that the circumstances which precipitated the 1933 gold confiscation are not applicable today. While debt concerns were prevalent then -- and are even more so today -- the reality is that the government will always prefer to manipulate the fiat currency system rather than engage in the operational nightmare that would be a current-day gold confiscation. Besides difficulty, the government can affect economic changes via policy tweaks more surreptitiously than by using more overt measures like confiscation. In an era of record low Congressional approval and an atmosphere of political fatigue amongst the general public, the likelihood of our policymakers passing unpopular confiscatory policies remains unlikely at best.

As I initially said, anything is possible. However, a more plausible concern is the adoption of exchange controls, which ultimately limit citizens' ability to move money and assets in and out of a country and currency. In a hypothetical, future environment of hemorrhaging dollar value and slumping demand, the U.S. government may find itself in a position where it has to implement exchange controls to keep Americans from dumping dollars in favor of other currencies and non-dollar denominated assets. Exchange controls have been utilized by countries throughout history to maintain an artificial base under their currency's value by forcing citizens to remain vested. Such draconian measures are a last resort for a cornered nation -- hopefully, we will never be subject to policies of this kind.

While I would by no means submit that exchange controls are an imminent concern, this possibility seems like a more reasonable reason to lose sleep at night -- as opposed to fretting over a possible gold confiscation.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.