Hayek’s 1932 Defense of the Insane Bank of France

In my post last Monday, I suggseted that Hayek’s attachment to the gold standard led him to recommend a policy of deflation during the Great Depression even though his own neutral-money policy criterion of stabilizing aggregate monetary expenditure would have implied aggressive monetary expansion during the Great Depression. Forced to choose between two conflicting principles, Hayek made the wrong choice, opting for defense of the gold standard rather than for stabilizing nominal GDP. He later changed his views, disavowing support for the gold standard as early as 1943 in a paper (“A Commodity Reserve Currency”) in the Economic Journal (reprinted as chapter 10 of Individualism and Economic Order) and reaffirming his opposition to the gold standard in The Constitution of Liberty (p. 335). I cited his 1932 paper “the Fate of the Gold Standard” translated from the original German and republished in his collected works and quoted his opening paragraph lamenting that Britain had abandoned the gold standard because (in September 1931 as the Great Depression was rapidly spiraling downward) Britain found the discipline of the gold standard “irksome.”

I also referred to Hayek’s defense of what I called “the insane French policy of gold accumulation.” I did not want to burden readers of an already long post with further quotations from Hayek’s article, so I just left it there without giving another quotation. But I think it may be worth analyzing what Hayek wrote, not because I want to make Hayek look bad, but because his defense of the Bank of France betrays a basic misunderstanding of the theory of international monetary adjustment and how the gold standard worked that is characteristic of many discussions of the gold standard.

Here is what Hayek wrote (F. A. Hayek, The Collected Works of F. A. Hayek, Good Money, Part 1, p. 160).

The accusation that France systematically hoarded gold seems at first sight to be more likely to be correct [than the charge that the US Federal Reserve had been hoarding gold, an accusation dismissed in the previous paragraph]. France did pursue an extremely cautious foreign policy after the franc stabilized at a level which considerably undervalued it with respect to its domestic purchasing power, and prevented an expansion of credit proportional to the amount of gold coming in. Nevertheless, France did not prevent her monetary circulation from increasing by the very same amount as that of the gold inflow – and this alone is necessary for the gold standard to function.

Hayek made a fundamental error here, assuming that a small open economy (which France could be considered to have been in the late 1920s) had control over its money supply and its price level under the gold standard. The French price level, once France pegged the franc to the dollar in 1926 at $0.0392/franc, was no longer under the control of French monetary authorities, commodity arbitrage requiring commodity prices quoted in francs to equal commodity prices quoted in dollars adjusted for the fixed dollar/franc parity. The equalization was not perfect, because not all commodities enter into international trade and because there are differences between similar products sold in different countries that preclude full price equalization. But there are strict limits on how much national price levels could diverge under a gold standard. Similarly, the money supply in a country on the gold standard could not be controlled by the monetary authority of that country, because if people in that country wanted to hold more money than the monetary authority made available, they could increase their holdings of money by increasing exports or decreasing imports, thereby generating an inflow of gold, which could be converted into banknotes or deposits.

So Hayek’s observation that France did not prevent her monetary circulation from increasing by the very same amount as that of the gold inflow means only that the Bank of France refused to increase the French money supply at all (or even attempted to decrease it), forcing the French to increase their holdings of cash by acquiring gold through an export surplus. Hayek’s statement thus betrays a total misunderstanding of what “is necessary for the gold standard to function.” All that was necessary was that France maintain a fixed parity between the dollar and the franc, not that the Bank of France achieve a particular change in the money supply governed by the amount that its holdings of gold had changed. Hayek wrongly assumed that the French monetary authorities had control over the French money supply and that the inflow of gold was somehow determined by real forces independent of French monetary conditions. But it was just the opposite. The French money supply increased because the French wanted to increase the amount of cash balances they were holding. The only question was whether the French banking system would be allowed by the Bank of France to accommodate the French demand for money by increasing the French money supply, or whether the desired increase in the money supply would be permitted only through gold imports generated by an export surplus. Refusing to allow the French money supply to increase except through the importation of gold meant that the increase in the French demand for money was transformed into an equivalent increase in French (and, hence, the world) demand for gold, thereby driving up the value of gold, the proximate source of the deflation that produced the Great Depression.

As I said, this misconception of money supply adjustment under the gold standard was not unique to Hayek.  In some ways it is characteristic of many orthodox treatments of the gold standard and it can be traced back at least to the British Currency School of the 1830 and 1840s, if not even further back to David Hume in the 18th century.  Milton Friedman was similarly misguided in many of his discussions of the gold standard and international adjustment, especially in his discussion of the Great Depression in his Monetary History of the United States.  Ralph Hawtrey, as usual, got it right.  But the analysis was much later articulated in more conventional model by Harry Johnson and his associates in their development of the monetary approach to the balance of payments.


27 Responses to “Hayek’s 1932 Defense of the Insane Bank of France”

  1. 1 ginnireduction December 17, 2011 at 11:55 pm

    What’s wrong with making Hayek look bad? he was the thinking man’s Ayn Rand and did even more damage. In 1982 he was telling Thatcher to use the sort of brutality used by Allende. Even she seems to have been shocked.


  2. 2 W. Peden December 18, 2011 at 8:06 am


    “he was the thinking man’s Ayn Rand”

    No he wasn’t.

    “In 1982 he was telling Thatcher to use the sort of brutality used by Allende”

    I very much doubt that.


  3. 3 David Glasner December 18, 2011 at 8:23 am

    ginnireduction, I didn’t say that there was anything wrong with making Hayek look bad, I just said that my intention in analyzing his defense of the indefensible policy of the Bank of France in 1928-31 was not to call further attention to his policy error but to explain why his defense was analytically incorrect and based on a misunderstanding of the underlying theoretical principles, a widely shared misunderstanding, which is why it is worth dredging up and criticizing. To call Hayek the thinking man’s Ayn Rand is — sorry to be so blunt — just silly. Rand despised Hayek, as has been documented by her recent biographers and is plain from her letters. Some of Hayek’s remarks about Pinochet (not Allende) were certainly unfortunate, but I don’t believe that lapse in judgment discredits his whole life’s work.


  4. 4 I Miss Nixon December 19, 2011 at 1:41 pm

    not because I want to make Hayek look bad

    Why not?


  5. 5 Will December 19, 2011 at 7:11 pm

    I am astonished to see that Greg Ransom has not been here yet!

    Many of the anti-Hayek comments show the same simplemindedness as those blasted rap videos. It’s beyond silly to suggest that just because a given economist was fallible, or was capable of rudeness and unsavory behavior, s/he deserves to be totally condemned and disregarded. And much of the innuendo reveals a middle-school-gossip level of sophistication. I tend to blame all of this on Murray Rothbard, for whom ad hominem smears and misrepresentations were common practice in dealing with intellectual foes, although the Keynesians out there are often just as guilty. Blech.


  6. 6 David Glasner December 20, 2011 at 8:56 am

    I Miss Nixon, If you read enough of the posts on this blog, you should have no trouble figuring out how I feel about Hayek

    Will, Hayek was the most polite and mild-mannered of people, so it is remarkable how much hostility he seems to have evoked from his ideological opponents as well as from many with apparently similar ideologies who regarded him as a sell-out and a traitor.


  7. 7 Greg Ransom February 13, 2012 at 11:29 am

    Meltzer’s history of the Fed suggests Hayek was equally wrong about similar claims made about the United States in the 1920s:

    Hayek claimed:

    “France did not prevent her monetary circulation from increasing by the very same amount as that of the gold inflow”

    These are contrary to fact factual/statistical relationship which lie at the bottom of what Hayek is claiming.

    We don’t’ even know what data Hayek was working with, or how much of his day he was spending on such numbers. It couldn’t have been more than minutes.


  8. 8 Greg Ransom February 13, 2012 at 11:39 am

    If folks want to be serious, we have to sort and and sharply distinguish between what is strictly theory and what are strictly contingent empirical assumptions / guesses about facts on the ground.

    This isn’t easy. But it makes a hash of things to conflate mistakes about empirical numbers with mistakes about causal mechanisms.

    The problem is that explications of stuff often uses a mush of combined elements to “illustrate” particular understandings.

    And folks like DeLong purposely conflate and muddle these things to trash and marginalize alternative scientific paradigms simply to advance his personal particular political ends.

    Another difficult thing is to separate out theory neutral empirical “facts” from theory laden empirical constructions that are NOT shared across scientific paradigms.

    Economics is filled with social constructs which are deeply contaminated with question-begging theory.

    It takes hard work to do this, but we get no-where if we don’t make the effort.

    And we can’t make honest assessments of theory “compared against the data” unless we do so.


  9. 9 Greg Ransom February 13, 2012 at 11:41 am

    I should say, economics is filled with socially constructs economic “data” which is deeply theory laden or contaminated with question-begging theory.


  10. 10 Greg Ransom February 13, 2012 at 11:45 am

    Is it a theoretical error or an empirical error which has Hayek claiming that gold was not being sterilized in France or the United States?

    There is a mass of complexity on both sides of this — it isn’t by any stretch of the imagination either simple theory or a simple set of numbers that are implicated in the claim, e.g. relative productivity and equilibrium wage rates and liabilities and all sorts of other elements are part of the “data” not simply gold reserves and national price levels — and great complexity could be described on the theory side as well.


  11. 11 David Glasner February 14, 2012 at 9:30 am

    Greg, As I have just explained in a reply to a comment on another post, Hayek’s problem was not with a faulty understanding of what the Bank of France was doing, but with how the gold standard works. He did not understand that, to a first approximation, the monetary authority of a country on an international gold standard, does not control the quantity of money in circulation in that country; it controls the amount and composition of its reserves. So it was completely irrelevant and beside the point for Hayek to point out that the quantity of money in France had increased by more than France’s holdings of gold had increased.


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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