Money: Gold Clauses


With the restoration of the right of American citizens to own gold, it would be well to consider the availability of "gold clauses" in contracts as a means of inflation protection.

A gold clause in a contract calls for payment in gold, gold coin, or its equivalent. This device was developed in the United States in response to the "Greenback inflation." Greenbacks were unbacked banknotes issued by the Union to finance the Civil War. By 1864, the greenbacks had declined to about one-third the value of gold dollars.

As a consequence of this phenomenon, a number of cases were brought. The best known of these, The Legal Tender Cases, were decided by the Supreme Court in 1884. In these cases the plaintiffs had challenged the authority of the Federal Government to issue notes unbacked by gold or silver and declare them "legal tender," that is, to declare that they must be accepted in payment of legal obligations. The principal contention of the challengers was that the provision of Article I, Section 10 of the Constitution, "No State shall…make any Thing but gold and silver Coin a Tender in Payment of Debts…," applied as well to the Federal Government and prohibited the issuance of the unbacked notes.

While the Supreme Court held that the issuance of such notes was lawful, they had in an earlier case also held that a contract which called for payment in gold dollars, rather than banknotes, was enforceable. This ruling formed the basis for upholding the validity of "gold clause" contracts.

Gold clauses continued in use until the Roosevelt reforms of 1933, when gold ownership was outlawed and American citizens were required to turn in their gold coins. At this time gold clauses were declared unenforceable by Congress.

Various suits were brought to challenge these actions, but in 1935 the Supreme Court ruled, in The Gold Clause Cases, that the Government had had authority to invalidate these contract provisions.

This decision was by a Court split 5-4 and some of the language, which could be taken to mean that the parties had not actually suffered a loss, gave rise to the hope that the cause was not completely lost. However, in 1937, the Court made its position even clearer by refusing to enforce a contract which specified payment in a specific type of gold coin. A good overview of the legal history and related problems is Wormser and Kemmerer, "Restoring 'Gold Clauses' in Contracts," 60 ABA Journal 942 (1974).

With the legalization of gold ownership, the question naturally arises as to the availability of gold clause contracts to protect parties from the current round of inflation.

The "public policy" grounds allegedly present in 1933 no longer appear compelling. Whereas in those days it was claimed that the Government's constitutional power to "regulate the value" of money permitted regulation of what was then a prime monetary asset, the much-heralded decline in the official monetary role of gold should obviate that argument. It might also be argued that the widespread acceptance of cost-of-living and escalator clauses demonstrate that there is no "public policy" against contractual hedging against loss in the value of money.

There are, however, two possible "policy" barriers to overcome. It is possible that a contract which may call for repayment of substantially more dollars than were borrowed may run afoul of state usury laws. These laws already have become a serious obstacle to the use of higher nominal interest rates to offset inflation. There seems to be no clear precedent on this point and, in the absence of legislation (or, in some cases, amendment of state constitutions), there is the possibility of a need to await a state-by-state resolution through decisions of the various state supreme courts. A good discussion of the current status of usury laws is Bowsher, "Usury Laws: Harmful When Effective," Bulletin, Federal Reserve Bank of St. Louis, August 1974.

A second possible "public policy" attack on the enforceability of gold clauses stems from the present judicial hostility toward freedom of contract. Under the influence of curious social and economic notions, courts have begun striking down contracts in whole or part in which they perceive an unequal bargaining strength of the parties. Given the propensity of certain courts to re-write contracts to reflect their own ideas of social justice, it is not beyond the range of possibility that a gold clause calling for repayment of a significantly larger number of dollars than the original obligation will be declared invalid as between a corporate creditor and an individual debtor because the debtor lacked equal bargaining power. A summary and criticism of the current law on this point is Schwartz, "Seller Unequal Bargaining Power," 49 Indiana Law Journal 367 (1974).

In the event such agreements are upheld, the question will arise as to the tax consequences. The Treasury has been adamant on the position that a dollar is a dollar for tax purposes and that any nominal dollar gain in a transaction will be taxed without reference to any effects of inflation. If this rule is followed, it is likely that the nominal dollar increase will be taxed as a capital gain, either long or short term as the underlying transaction may dictate. Even this result, of course, will permit a significant degree of inflation protection and will likely result in creditors seeking higher prices to offset the tax penalty.

Another impediment to the widespread use of gold clauses is the legal rule that in order to be negotiable an instrument must be for a "sum certain." The potential revaluation inherent in the gold clause would apparently run afoul of this provision. Since negotiable instruments are widely used in commerce, the inability to employ a gold clause in such instruments may restrict the range of uses to which the clause is applicable.

There has been an upsurge of interest in this problem and we may hope that the legal status of these gold clause contracts may be clarified. A workable gold clause would undoubtedly lower nominal interest rates as lenders would no longer need to demand an inflation factor in their rates. Without these protective arrangements, lenders will be increasingly hesitant to enter long-term transactions.

Since the principal impediment to the introduction of these clauses seems to be uncertainty as to the willingness of the government courts to enforce freely-entered-into private agreements, we see once again the disruptive nature of the state. Private parties, if left free to order their own affairs by contract, should be able to adapt even to the disruption inherent in irresponsible government monetary policy. It is ironic, though by no means unheard of, that they should be restrained from doing so by uncertainty as to how much some court will determine their freedom of contract to be consistent with a court's "evolving" notion of good public policy.

Davis Keeler's Money column alternates monthly in REASON with John J. Pierce's Science Fiction column. Copyright 1974 by Davis Keeler.