Trying to Make Sense of the Insane Policy of the Bank of France and Other Catastrophes

In the almost four years since I started blogging I have occasionally referred to the insane Bank of France or to the insane policy of the Bank of France, a mental disorder that helped cause the deflation that produced the Great Depression. The insane policy began in 1928 when the Bank of France began converting its rapidly growing stockpile of foreign-exchange reserves (i.e., dollar- or sterling-denominated financial instruments) into gold. The conversion of foreign exchange was precipitated by the enactment of a law restoring the legal convertibility of the franc into gold and requiring the Bank of France to hold gold reserves equal to at least 35% of its outstanding banknotes. The law induced a massive inflow of gold into the Bank of France, and, after the Federal Reserve recklessly tightened its policy in an attempt to stamp out stock speculation on Wall Street, thereby inducing an inflow of gold into the US, the one-two punch knocked the world economy into just the deflationary tailspin that Hawtrey and Cassel, had warned would result if the postwar restoration of the gold standard were not managed so as to minimize the increase in the monetary demand for gold.

In making a new round of revisions to our paper on Hawtrey and Cassel, my co-author Ron Batchelder has just added an interesting footnote pointing out that there may have been a sensible rationale for the French gold policy: to accumulate a sufficient hoard of gold for use in case of another war with Germany. In World War I, belligerents withdrew gold coins from circulation, melted them down, and, over the next few years, exported the gold to neutral countries to pay for food and war supplies. That’s how the US, remaining neutral till 1917, wound up with a staggering 40% of the world’s stock of monetary gold reserves after the war. Obsessed with the military threat a re-armed Germany would pose, France insisted that the Versailles Treaty impose crippling reparations payments. The 1926 stabilization of the franc and enactment of the law restoring the gold standard and imposing a 35% reserve requirement on banknotes issued by the Bank of France occurred during the premiership of the staunchly anti-German Raymond Poincaré, a native of Lorraine (lost to Prussia in the war of 1870-71) and President of France during World War I.

A long time ago I wrote a paper “An Evolutionary Theory of the State Monopoly over Money” (which was reworked as chapter two of my book Free Banking and Monetary Reform and was later published in Money and the Nation State) in which, relying on an argument made by Earl Thompson, I suggested that historically the main reason for the nearly ubiquitous state involvement in supplying money was military not monetary: monopoly control over the supply of money enables the sovereign to quickly gain control over resources in war time, thereby giving states in which the sovereign controls the supply of money a military advantage over states in which the sovereign has no such control. Subsequently, Thompson further developed the idea to explain the rise of the gold standard after the Bank of England was founded in 1694, early in the reign of William and Mary, to finance rebuilding of the English navy, largely destroyed by the French in 1690. As explained by Macaulay in his History of England, the Bank of England, by substantially reducing the borrowing costs of the British government, was critical to the survival of the new monarchs in their battle with the Stuarts and Louis XIV. See Thompson’s article “The Gold Standard: Causes and Consequences” in Business Cycles and Depressions: An Encyclopedia (edited by me).

Thompson’s article is not focused on the holding of gold reserves, but on the confidence that the gold standard gave to those lending to the state, especially during a wartime suspension of convertibility, owing to an implicit commitment to restore the gold standard at the prewar parity. The importance of that implicit commitment is one reason why Churchill’s 1925 decision to restore the gold standard at the prewar parity was not necessarily as foolish as Keynes (The Economic Consequences of Mr. Churchill), along with almost all subsequent commentators, judged it to have been. But the postwar depreciation of the franc was so extreme that restoring the convertibility of the franc at the prewar parity became a practical impossibility, and the new parity at which convertibility was restored was just a fifth of its prewar level. Having thus reneged on its implicit commitment to restore the gold standard at the prewar parity, impairing its ability to borrow, France may have felt it had no alternative but to accumulate a ready gold reserve from which to draw when another war against Germany came. This is just theoretical speculation, but it might provide some clues for historical research into the thinking of French politicians and bankers in the late 1920s as they formulated their strategy for rejoining the gold standard.

However, even if the motivation for France’s gold accumulation was not simply a miserly desire to hold ever larger piles of shiny gold ingots in the vaults of the Banque de France, but was a precautionary measure against the possibility of a future war with Germany – and we know only too well that the fear was not imaginary – it is important to understand that, in the end, it was almost certainly the French policy of gold accumulation that paved the way for Hitler’s rise to power and all that entailed. Without the Great Depression and the collapse of the German economy, Hitler might well have remained an outcast on the margins of German politics.

The existence of a legitimate motivation for the insane policy of the Bank of France cannot excuse the failure to foresee the all too predictable consequences of that policy – consequences laid out plainly by Hawtrey and Cassel already in 1919-20, and reiterated consistently over the ensuing decade. Nor does the approval of that policy by reputable, even eminent, economists, who simply failed to understand how the gold standard worked, absolve those who made the wrong decisions of responsibility for their mistaken decisions. They were warned about the consequences of their actions, and chose to disregard the warnings.

All of this is sadly reminiscent of the 2003 invasion of Iraq. I don’t agree with those who ascribe evil motives to the Bush administration for invading Iraq, though there seems little doubt that the WMD issue was largely pretextual. But that doesn’t mean that Bush et al. didn’t actually believe that Saddam had WMD. More importantly, I think that Bush et al. sincerely thought that invading Iraq and deposing Saddam Hussein would, after the supposed defeat of Al Qaeda and the Taliban in Afghanistan, establish a benign American dominance in the region, as World War II had done in Japan and Western Europe.

The problem is not, as critics like to say, that Bush et al. lied us into war; the problem is that they stupidly fooled themselves into thinking that they could just invade Iraq, unseat Saddam Hussein, and that their job would be over. They fooled themselves even though they had been warned in advance that Iraq was riven by internal ethnic, sectarian, religious and political divisions. Brutally suppressed by Hussein and his Ba’athist regime, those differences were bound to reemerge once the regime was dismantled. When General Eric Shinseki’s testified before Congress that hundreds of thousands of American troops would be needed to maintain peace and order after Hussein was ousted, Paul Wolfowitz and Donald Rumsfeld could only respond with triumphalist ridicule at the idea that more troops would be required to maintain law and order in Iraq after Hussein was deposed than were needed to depose him. The sophomoric shallowness of the response to Shinseki by those that planned the invasion still shocks and appalls.

It’s true that, after the Republican loss in the 2006 Congressional elections, Bush, freeing himself from the influence of Dick Cheney and replacing Donald Rumsfeld with Robert Gates as Secretary of Defense, and Gen. George Casey with Gen. David Petraeus as commander of US forces in Iraq, finally adopted the counter-insurgency strategy (aka the “surge”) so long resisted by Cheney and Rumsfeld, thereby succeeding in putting down the Sunni/Al-Qaeda/Baathist insurgency and in bringing the anti-American Shi’ite militias to heel. I wrote about the success of the surge in December 2007 when that provisional military success was still controversial. But, as General Petraeus conceded, the ultimate success of the counter-insurgency strategy depended on implementing a political strategy to reconcile the different elements of Iraqi society to their government. We now know that even in 2008 Premier Nouri al-Maliki, who had been installed as premier with the backing of the Bush administration, was already reversing the limited steps taken during the surge to achieve accommodation between Iraqi Sunnis and Shi’ites, while consolidating his Shi’ite base by reconciling politically with the pro-Iranian militants he had put down militarily.

The failure of the Iraqi government to consolidate and maintain the gains made in 2007-08 has been blamed on Obama’s decision to withdraw all American forces from Iraq after the status of forces agreement signed by President Bush and Premier al-Maliki in December 2008 expired at the end of 2011. But preserving the gains made in 2007-08 depended on a political strategy to reconcile the opposing ethnic and sectarian factions of Iraqi society. The Bush administration could not implement such a strategy with 130,000 troops still in Iraq at the end of 2008, and the sovereign Iraqi government in place, left to its own devices, had no interest in pursuing such a strategy. Perhaps keeping a larger US presence in Iraq for a longer time would have kept Iraq from falling apart as fast as it has, but the necessary conditions for a successful political outcome were never in place.

So even if the motivation for the catastrophic accumulation of gold by France in the 1928-29 was merely to prepare itself to fight, if need be, another war against Germany, the fact remains that the main accomplishment of the gold-accumulation policy was to bring to power a German regime far more dangerous and threatening than the one that would have otherwise confronted France. And even if the motivation for the catastrophic invasion of Iraq in 2003 was to defeat and discredit Islamic terrorism, the fact remains that the invasion, just as Osama bin Laden had hoped, was to create the conditions in which Islamic terrorism could grow into a worldwide movement, attracting would-be jihadists to a growing number of local conflicts across the world. Although bin Laden was eventually killed in his Pakistani hideout, the invasion of Iraq led to rise of an even more sophisticated, more dangerous, and more threatening opponent than the one the invasion was intended to eradicate. Just as a misunderstanding of the gold standard led to catastrophe in 1928-29, the misconception that the threat of terrorism can be eliminated by military means has been leading us toward catastrophe since 2003. When will we learn?

PS Despite some overlap between what I say above and what David Henderson said in this post, I am not a libertarian or a non-interventionist.

18 Responses to “Trying to Make Sense of the Insane Policy of the Bank of France and Other Catastrophes”

  1. 1 nottrampis June 18, 2015 at 4:32 pm

    David, another interesting post but it seems to me why would the Frogs think they might go to war with Germany given who was in power there?

    It was after all the depression and absurd classical policies to combat it by Bruning that brought Hitler to power.


  2. 2 Elias Garcia June 18, 2015 at 10:52 pm

    Glad I rediscovered you blog on here, I’m currently working a summer fellowship with Independent Institute (no longer branded as THE Independent Institute) and Money and the Nation State is next on my summer reading list after I finish Lawrence White’s “The Theory of Monetary Institutions.” I really look forward to your essay in the book, and I have to extend my thanks for these fun and informational posts on economic history!


  3. 3 Ulysse Colonna June 20, 2015 at 10:35 am

    on a side note, but it may help explain part of the French policy, a seldom mentioned consequence of the post-WWI inflation was the total ruin of France’s welfare system which had been based on independent institutions functioning thanks to the return on their endowments (like US universities today). But in the second half of the 19th century, these endowment had been cajoled into abandoning their preference for real estate and into investing in state debt.
    A consequence of this lack of foresight, was that most medical facilities in the country as well as many school and poor-relief association were on the verge of bankruptcy. Revaluing the currency would thus have been an alternative to taking over the whole welfare system of the country and having to fund it through taxation.


  4. 4 sumnerbentley June 21, 2015 at 7:31 am

    Very interesting comparison between the French mistake and the later American mistake. Makes sense to me.

    I’ve sometimes argued for an analogy between the failure of the interwar gold standard, and the failures of American diplomacy during and after WWI. The problem with the gold standard was that there was enough government involvement to destabilize the system, but not enough to stabilize it. Go one way or the other; laissez-faire classical gold standard, or Bretton Woods.

    Ditto for the US involvement in Europe. Enough involvement to tip the balance of power against Germany in WWI, but not enough to stabilize the resulting situation. Either the US should have stayed out of WWI entirely, or it should have stayed around afterwards in a NATO-type structure to stabilize the peace. Does that analogy make sense?

    And then I wonder about the eurozone . . .


  5. 5 JKH June 22, 2015 at 8:28 am


    I’ve been reading your paper with great interest.

    The entire thing is fascinating, but just to pick on one passage from one of the footnotes:

    “The French money supply increased because the French wanted to increase the amount of francs they were holding. The only question was whether the French banking system would be allowed to accommodate the French demand for money by increasing the domestic supply of francs, or whether the desired increase in the quantity of francs could be achieved only through gold imports generated by an export surplus. Refusing to allow the French money supply to increase except via gold imports 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 international value of gold, the proximate source of the deflation that caused the Depression.”

    I think I understand the general idea here, but would appreciate it if you were able to provide a bit more detail on some of the mechanics of the flows – if possible.

    For example, regarding this:

    “The desired increase in the quantity of francs could be achieved only through gold imports generated by an export surplus”

    Can you describe how this works (roughly anyway) using a simple example?

    For example, suppose the entire French current account consists of a single export of amount X.

    I’m interested in what happens to balance sheets with respect to gold flows and with respect to the creation (or not) of other forms of money in francs.

    The balance sheets I’m interested in are:

    a) The Bank of France
    b) The commercial banking system
    c) The initial settlement of the payment on the exporter’s balance sheet

    I’ve never seen a clear exposition of this (maybe I haven’t looked hard enough), so no worries if it is not easily done.

    (It was nearly 100 years ago.)


    Regarding the Bank of France balance sheet – if the gold inflow ends up there, I would have thought the Bank would be selling securities to offset it, with no immediate effect on the liability side.


  6. 6 David Glasner June 22, 2015 at 9:17 am

    nottrampis, I think that after the war of 1870-71 and the unification of Germany under Bismark viewed Germany as an existential threat, and it didn’t really matter to them who happened to be in power at a particular moment. This is my amateur historian’s view and I don’t even qualify as an amateur historian, but that is what I was thinking.

    Elias, Sounds like you are keeping yourself pretty busy this summer. Hope my paper lives up to your expectations.

    Ulysse, Thanks very much for providing that interesting piece of historical detail. What do you mean by revaluing the currency?

    Scott, Glad to hear that I am making sense. I don’t think that the gold standard of the 1920s was doomed from the start, but the world was very unstable and there wasn’t much room for error. My amateur historian’s take on the US in Europe after WWI is that there could have been a deal between Wilson and Henry Cabot Lodge (who was very far from being an isolationist like some of the other Republicans at the time like Lafollette and Borah). But Wilson was too self-absorbed and willful to make the sort of deal that could have salvaged (and perhaps improved) the League of Nations and made the world less unstable. I wonder about the Eurozone too.

    JKH, Thanks, glad that you are liking it.

    The mechanism I am thinking of is the following. Suppose people want to hold more money. If the domestic banking system responds by increasing the amount of loans and to the public, the newly created deposits will be willingly held by the public since they want to hold more money rather than being brought back to the banking system. However, if the banking system can’t expand because they don’t have gold to satisfy the reserve requirements, then the only way for people to increase their holdings of cash will be to reduce spending which will mean that they country as a whole will export more and import less causing an inflow of gold which will allow more lending to take place. Does that clear things up for you?


  7. 7 JKH June 22, 2015 at 1:00 pm

    Thanks David. That helps.

    I’m used to thinking in terms of institutional detail, but visualizing historic versions of this can be challenging, particularly in the case of the gold standard.


  8. 8 Fed Up June 22, 2015 at 11:43 pm

    JKH, could I get an invitation to your wordpress site? Thanks!


  9. 9 Fed Up June 23, 2015 at 10:43 am

    “Suppose people want to hold more money.”

    And, suppose no entity wants to borrow from the banking system. Then what?


  10. 10 David Glasner June 25, 2015 at 8:42 am

    JKH, You’re welcome, glad to be of service.

    Fed Up, If no one wants to borrow from the banking system, then there will be no deposits created or bank notes issued. All money would be base money either coins under a metallic standard or fiat money issued by the state. If people want to hold more money they will spend less, generating an export surplus which will bring in either more metal or paper money to be converted into the local currency.


  11. 11 John July 14, 2015 at 2:38 pm

    What this ignores is that Gold served as a deterrent to German aggression. Without the fall of France, Germany would have been much more vulnerable to blockade in WWII then in WWI. They could sustain themselves for maybe two years before their situation would be hopeless, even with the trickle of Soviet trade. But in order to support the blockade, France needs a large land army. Gold allowed France to have a large land army by supplementing their industry with imports for the two years it would take to beat Germany economically. Historically Gamelin completely bungled the French strategy and screwed everything up but if it weren’t for Gamelin, the threat of “We will use this gold to finance a crippling blockade against you” would have been very credible. Sometimes an irrational actor like Hitler comes along however and bets everything on a longshot bet that attacking a superior force when you have only enough ammo for three months of war will work out.

    It seems convoluted to us so removed from the thinking of the time but to contempories, the power of the blockade was understood and Hitler’s war was seen as a longshot gamble in the face of the blockade.


  12. 13 Nathan Towne November 20, 2020 at 12:08 pm


    My question is how do you hypothesize that the larger deflationary event translated into the banking crises from 1930-33? What was the transmission mechanism and why would it have occured so catastrophically here, but did not occur in 1920-21?


  13. 14 Nathan Towne November 23, 2020 at 10:30 am

    Mr. Glasner,

    There was an increase in bank failures during the 1920-21 contraction. Per Friedman, Sixty-three banks failed in 1919. That number rose to one hundred and fifty five in 1920 and to five hundred and six in 1921. However, it never erupted in a full-scale liquidity crisis and the number of bank failures never reached anything like the levels seen during the banking crises in the Great Contraction.

    Do you have a larger theory as to why this is?


  1. 1 Gold Standard or Gold-Exchange Standard: What’s the Difference? | Uneasy Money Trackback on July 1, 2015 at 7:22 pm
  2. 2 Exposed: Milton Friedman’s Cluelessness about the Insane Bank of France | Uneasy Money Trackback on July 16, 2015 at 1:02 pm
  3. 3 Acumulación de reservas de oro de Francia en 1928 Trackback on August 24, 2015 at 11:58 pm
  4. 4 Skepticlawyer » Why there is so much nonsense spouted about fascism Trackback on April 24, 2017 at 6:13 am

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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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