The Great, but Misguided, Benjamin Strong Goes Astray in 1928

In making yet further revisions to our paper on Hawtrey and Cassel, Ron Batchelder and I keep finding interesting new material that sheds new light on the thinking behind the policies that led to the Great Depression. Recently I have been looking at the digital archive of Benjamin Strong’s papers held at the Federal Reserve Bank. Benjamin Strong was perhaps the greatest central banker who ever lived. Milton Friedman, Charles Kindleberger, Irving Fisher, and Ralph Hawtrey – and probably others as well — all believed that if Strong, Governor of the New York Federal Reserve Bank from 1914 to 1928 and effectively the sole policy maker for the entire system, had not died in 1928, the Great Depression would have been avoided entirely or, at least, would have been far less severe and long-lasting. My own view had been that Strong had generally understood the argument of Hawtrey and Cassel about the importance of economizing on gold, and, faced with the insane policy of the Bank of France, would have accommodated that policy by allowing an outflow of gold from the immense US holdings, rather than raise interest rates and induce an inflow of gold into the US in 1929, as happened under his successor, George Harrison.

Having spent some time browsing through the papers, I am sorry — because Strong’s truly remarkable qualities are evident in his papers — to say that the papers also show to my surprise and disappointment that Strong was very far from being a disciple of Hawtrey or Cassel or of any economist, and he seems to have been entirely unconcerned in 1928 about the policy of the Bank of France or the prospect of a deflationary run-up in the value of gold even though his friend Montague Norman, Governor of the Bank of England, was beginning to show some nervousness about “a scramble for gold,” while other observers were warning of a deflationary collapse. I must admit that, at least one reason for my surprise is that I had naively accepted the charges made by various Austrians – most notably Murray Rothbard – that Strong was a money manager who had bought into the dangerous theories of people like Irving Fisher, Ralph Hawtrey and J. M. Keynes that central bankers should manipulate their currencies to stabilize the price level. The papers I have seen show that, far from being a money manager and a price-level stabilizer, Strong expressed strong reservations about policies for stabilizing the price level, and was more in sympathy with the old-fashioned gold standard than with the gold-exchange standard — the paradigm promoted by Hawtrey and Cassel and endorsed at the Genoa Conference of 1922. Rothbard’s selective quotation from the memorandum summarizing Strong’s 1928 conversation with Sir Arthur Salter, which I will discuss below, gives a very inaccurate impression of Strong’s position on money management.

Here are a few of the documents that caught my eye.

On November 28 1927, Montague Norman wrote Strong about their planned meeting in January at Algeciras, Spain. Norman makes the following suggestion:

Perhaps the chief uncertainty or danger which confronts Central Bankers on this side of the Atlantic over the next half dozen years is the purchasing power of gold and the general price level. If not an immediate, it is a very serious question and has been too little considered up to the present. Cassel, as you will remember, has held up his warning finger on many occasions against the dangers of a continuing fall in the price level and the Conference at Genoa as you will remember, suggested that the danger could be met or prevented, by a more general use of the “Gold Exchange Standard”.

This is a very abstruse and complicated problem which personally I do not pretend to understand, the more so as it is based on somewhat uncertain statistics. But I rely for information from the outside about such a subject as this not, as you might suppose, on McKenna or Keynes, but on Sir Henry Strakosch. I am not sure if you know him: Austrian origin: many years in Johannesburg: 20 years in this country: a student of economics: a gold producer with general financial interests: perhaps the main stay in setting up the South African Reserve Bank: a member of the Financial Committee of the League and of the Indian Currency Commission: full of public spirit, genial and helpful . . . and so forth. I have probably told you that if I had been a Dictator he would have been a Director here years ago.

This is a problem to which Strackosch has given much study and it alarms him. He would say that none of us are paying sufficient attention to the possibility of a future fall in prices or are taking precautions to prepare any remedy such as was suggested at Genoa, namely smaller gold reserves through the Gold Exchange Standard, and that you, in the long run, will feel any trouble just as much as the rest of the Central Bankers will feel it.

My suggestion therefore is that it might be helpful if I could persuade Strakoosch too to come to Algeciras for a week: his visit could be quite casual and you would not be committed to any intrigue with him.

I gather from the tone of this letter and from other indications that the demands by the French to convert their foreign exchange to gold were already being made on the Bank of England and were causing some degree of consternation in London, which is why Norman was hoping that Strakosch might persuade Strong that something ought to be done to get the French to moderate their demands on the Bank of England to convert claims on sterling into gold. In the event, Strong met with Strakosch in December (probably in New York, not in Algeciras, without the presence of Norman). Not long thereafter Strong’s health deteriorated, and he took an extended leave from his duties at the bank. On March 27, 1928 Strong sent a letter to Norman outlining the main points of his conversation with Strakosch:

What [Strakosch] told me leads me to believe that he holds the following views:

  • That there is an impending shortage of monetary gold.
  • That there is certain to be a decline in the production by the South African mines.
  • That in consequence there will be a competition for gold between banks of issue which will lead to high discount rates, contracting credit and falling world commodity prices.
  • That Europe is so burdened with debt as to make such a development calamitous, possibly bankrupting some nations.
  • That the remedy is an extensive and formal development of the gold exchange standard.

From the above you will doubtless agree with me that Strakosch is a 100% “quantity” theory man, that he holds Cassel’s views in regard to the world’s gold position, and that he is alarmed at the outlook, just as most of the strict quantity theory men are, and rather expects that the banks of issue can do something about it.

Just as an aside, I will note that Strong is here displaying a rather common confusion, mixing up the quantity theory with a theory about the value of money under a gold standard. It’s a confusion that not only laymen, but also economists such as (to pick out a name almost at random) Milton Friedman, are very prone to fall into.

What he tells me is proposed consists of:

  • A study by the Financial Section of the League [of Nations] of the progress of economic recovery in Europe, which, he asserts, has closely followed progress in the resumption of gold payment or its equivalent.
  • A study of the gold problem, apparently in the perspective of the views of Cassel and others.
  • The submission of the results, with possibly some suggestions of a constructive nature, to a meeting of the heads of the banks of issue. He did not disclose whether the meeting would be a belated “Genoa resolution” meeting or something different.

What I told him appeared to shock him, and it was in brief:

  • That I did not share the fears of Cassel and others as to a gold shortage.
  • That I did not think that the quantity theory of prices, such for instance as Fisher has elaborate, “reduction ad absurdum,” was always dependable if unadulterated!
  • That I thought the gold exchange standard as now developing was hazardous in the extreme if allowed to proceed very much further, because of the duplication of bank liabilities upon the same gold.
  • That I much preferred to see the central banks build up their actual gold metal reserves in their own hands to something like orthodox proportions, and adopt their own monetary and credit policy and execute it themselves.
  • That I thought a meeting of the banks of issue in the immediate future to discuss the particular matter would be inappropriate and premature, until the vicissitudes of the Dawes Plan had developed further.
  • That any formal meeting of the banks of issue, if and when called, should originate among themselves rather than through the League, that the Genoa resolution was certainly no longer operative, and that such formal meeting should confine itself very specifically at the outset first to developing a sound basis of information, and second, to devising improvement in technique in gold practice

I am not at all sure that any formal meeting should be held before another year has elapsed. If it is held within a year or after a year, I am quite certain that it I attended it I could not do so helpfully if it tacitly implied acceptance of the principles set out in the Genoa resolution.

Stratosch is a fine fellow: I like him immensely, but I would feel reluctant to join in discussions where there was likelihood that the views so strongly advocated by Fisher, Cassel, Keynes, Commons, and others would seem likely to prevail. I would be willing at the proper time, if objection were not raised at home, to attend a conference of the banks of issue, if we could agree at the outset upon a simple platform, i.e., that gold is an effective measure of value and medium of exchange. If these two principles are extended, as seems to be in Stratosch’s mind, to mean that a manipulation of gold and credit can be employed as a regulator of prices at all times and under all circumstances, then I fear fundamental differences are inescapable.

And here is a third document in a similar vein that is also worth looking at. It is a memorandum written by O. E. Moore (a member of Strong’s staff at the New York Fed) providing a detailed account of the May 25, 1928 conversation between Strong and Sir Arthur Salter, then head of the economic and financial section of the League of Nations, who came to New York to ask for Strong’s cooperation in calling a new conference (already hinted at by Strakosch in his December conversation with Strong) with a view toward limiting the international demand for gold. Salter handed Strong a copy of a report by a committee of the League of Nations warning of the dangers of a steep increase in the value of gold because of increasing demand and a declining production.

Strong responded with a historical rendition of international monetary developments since the end of World War I, pointing out that even before the war was over he had been convinced of the need for cooperation among the world’s central banks, but then adding that he had been opposed to the recommendation of the 1922 Genoa Conference (largely drafted by Hawtrey and Cassel).

Governor Strong had been opposed from the start to the conclusions reached at the Genoa Conference. So far as he was aware, no one had ever been able to show any proof that there was a world shortage of gold or that there was likely to be any such shortage in the near future. . . . He was also opposed to the permanent operation of the gold exchange standard as outlined by the Genoa Conference, because it would mean by virtue of the extensive credits which the exchange standard countries would be holding in the gold centers, that they would be taking away from each of those two centers the control of their own money markets. This was an impossible thing for the Federal Reserve System to accept, so far as the American market was concerned, and in fact it was out of the question for any important country, it seemed to him, to give up entirely the direction of its own market. . . .

As a further aside, I will just observe that Strong’s objection to the gold exchange standard, namely that it permits an indefinite expansion of the money supply, a given base of gold reserves being able to support an unlimited expansion of the quantity of money, is simply wrong as a matter of theory. A country running a balance-of-payments deficit under a gold-exchange standard would be no less subject to the constraint of an external drain, even if it is holding reserves only in the form of instruments convertible into gold rather than actual gold, than it would be if it were operating under a gold standard holding reserves in gold.

Although Strong was emphatic that he could not agree to participate in any conference in which the policies and actions of the US could be determined by the views of other countries, he was open to a purely fact-finding commission to ascertain what the total world gold reserves were and how those were distributed among the different official reserve holding institutions. He also added this interesting caveat:

Governor Strong added that, in his estimation, it was very important that the men who undertook to find the answers to these questions should not be mere theorists who would take issue on controversial points, and that it would be most unfortunate if the report of such a commission should result in giving color to the views of men like Keynes, Cassel, and Fisher regarding an impending world shortage of gold and the necessity of stabilizing the price level. . . .

Governor Strong mentioned that one thing which had made him more wary than ever of the policies advocated by these men was that when Professor Fisher wrote his book on “Stabilizing the Dollar”, he had first submitted the manuscript to him (Governor Strong) and that the proposal made in that original manuscript was to adjust the gold content of the dollar as often as once a week, which in his opinion showed just how theoretical this group of economists were.

Here Strong was displaying the condescending attitude toward academic theorizing characteristic of men of affairs, especially characteristic of brilliant and self-taught men of affairs. Whether such condescension is justified is a question for which there is no general answer. However, it is clear to me that Strong did not have an accurate picture of what was happening in 1928 and what dangers were lying ahead of him and the world in the last few months of his life. So the confidence of Friedman, Kindelberger, Fisher, and Hawtrey in Strong’s surpassing judgment does not seem to me to rest on any evidence that Strong actually understood the situation in 1928 and certainly not that he knew what to do about it. On the contrary he was committed to a policy that was leading to disaster, or at least, was not going to avoid disaster. The most that can be said is that he was at least informed about the dangers, and if he had lived long enough to observe that the dangers about which he had been warned were coming to pass, he would have had the wit and the good sense and the courage to change his mind and take the actions that might have avoided catastrophe. But that possibility is just a possibility, and we can hardly be sure that, in the counterfactual universe in which Strong does not die in 1928, the Great Depression never happened.

58 Responses to “The Great, but Misguided, Benjamin Strong Goes Astray in 1928”


  1. 1 lewisb2014 June 24, 2015 at 7:59 pm

    Very interesting post, and I certainly understand why you’re surprised that Strong turned out not to know this so well. My own nominee for a better central banker would be Marriner Eccles, who chaired in parts of the Roosevelt and Truman administration. In his book Beckoning Frontiers, Eccles displays an astonishing understanding of what we needed to get out of the Depression, IMHO, and he got there through observing and participating. Of course, he would never have been in Strong’s position to stop something because he was not brought to Washington until the Roosevelt administration came to power.

  2. 2 Marcus Nunes June 25, 2015 at 3:28 am

    David, marvelous post. History is so full of “surprises”!
    @Lewisb, Marriner Eccles was behind the 1937 monetary error that caused the recession within the depression. He was for the increase in required reserves and did not alert for the dangers of gold sterilization by the Treasury.

  3. 3 Frank Restly June 25, 2015 at 4:42 pm

    “However, it is clear to me that Strong did not have an accurate picture of what was happening in 1928 and what dangers were lying ahead of him and the world in the last few months of his life.”

    Or he knew exactly what was going on and decided to publicly down play the risks.

    Should he have shouted fire and ran for the exits?

    One nice thing about being an academic, if you cry wolf and are wrong, the worst you get is maybe a slap on the wrist and a little humble pie.

  4. 4 David Glasner June 25, 2015 at 5:01 pm

    Frank, I suppose that you may be right about not wanting to cause a panic, but the papers I am quoting from are all private communications between Strong and his colleagues at the Fed or at other central banks, so I don’t see why we should assume that he was not expressing himself candidly in these communications.

  5. 5 csissoko June 25, 2015 at 6:10 pm

    I’m confused by this sentence: “A country running a balance-of-payments deficit under a gold-exchange standard would be no less subject to the constraint of an external drain, even if it is holding reserves only in the form of instruments convertible into gold rather than actual gold, than it would be if it were operating under a gold standard holding reserves in gold.”

    Surely if the gold exchange standard is operable so the reserve instrument issuing country is not in practice being asked to convert the instrument into gold, then this only applies to countries that hold reserves issued by other countries and not to the reserve-issuing country. Am I missing something here?

  6. 6 JP Koning June 25, 2015 at 6:43 pm

    Fascinating. This definitely catches me by surprise. Hoping that you and Ron Batchelder stumble on more interesting material that you can share with us. This and your recent IBoF post have been excellent.

  7. 7 JP Koning June 25, 2015 at 7:23 pm

    Off topic, but do you take requests? I’m wondering if there is a Hawtrey/Cassel explanation for the 1937 recession.

  8. 9 David Glasner June 26, 2015 at 9:04 am

    csissoko,

    You said:

    “Surely if the gold exchange standard is operable so the reserve instrument issuing country is not in practice being asked to convert the instrument into gold, then this only applies to countries that hold reserves issued by other countries and not to the reserve-issuing country.”

    I’m having trouble parsing this. Why do you assume that the reserve-issuing country is not in practice being asked to convert the instrument into gold? If the dollar is the only currency directly convertible into gold and all other currencies are convertible into dollars, then all FX reserves will be denominated in dollars convertible into gold. What’s the problem?

    JP, Thanks for the kind words. Hawtrey may mention the 1937 episode in his Century of Bank Rate, but I would have to check. It’s quite possible that he referred to it in other writings that I’m not aware of. I’m also not aware of anything that Cassel wrote after 1936, but I’ll keep on the lookout.

  9. 10 Miguel Navascués June 26, 2015 at 10:58 am

    A very good, excellent post, David

  10. 11 sumnerbentley June 26, 2015 at 1:11 pm

    Excellent post, but I’d be careful drawing policy conclusions. I think it quite likely that Fed policy during 1930 under Strong would have been far more expansionary than under the actual leadership, based on both his actions and his statements during the 1920s. He was a fan of “fine-tuning” the business cycle, with a countercyclical monetary policy. He was also opposed to trying to pop stock market bubbles. The Fed only began trying to do so in late 1928, after he died.

    The more difficult question is whether a more expansionary policy by the Fed would have been enough.

  11. 12 csissoko June 26, 2015 at 6:33 pm

    My understanding is that the purpose of the gold exchange standard is to be more flexible than the gold standard. This flexibility is created by relying on a country’s “reputation” for good fiscal management to provide an alternative to actual gold as a reserve. If “reputation” does not play an important role in the system, I don’t understand how a gold exchange standard provides any advantage over a gold standard. In short, my understanding is that the purpose of a gold exchange standard is to exploit the distinction between the theory of convertibility and the practice of rare conversion to introduce flexibility into the money supply.

    Indeed, this understanding of the gold exchange standard, I think, underlies Norman’s consternation at the behavior of the French.

  12. 13 csissoko June 26, 2015 at 6:38 pm

    One way to think of the gold exchange standard is that it applies at a national level the basic principle of banking, to whit, that the money supply can be expanded by promises issued by trusted intermediaries.

  13. 14 Fed Up June 27, 2015 at 10:42 pm

    Let me try this on this post.

    “Fed Up, A 100% reserve requirement of 1 ounce of gold per dollar issued would not necessarily keep the value of a dollar equal to an ounce of gold.”

    I am not getting that one at all.

    Assume 1 oz of gold = $1 of currency (fixed exchange rate by the central bank). AND, assume a 100% reserve requirement for gold and currency. 1,000 oz of gold means there can be no more than $1,000 in currency.

    “The gold standard operates by a convertibility requirement, not a reserve requirement. Convertibility could be maintained virtually no reserves.”

    If I am reading that correctly, the fixed exchange rate may be in jeopardy of being broken. Let’s relax the above example by lowering the reserve requirement to 50%. Now 1,000 oz of gold means there could be $2,000 in currency. If something changes so that entities want to redeem more than $1,000 in currency for gold, the fixed exchange rate is going to have to give (some entity or entities are going to be defaulted on).

    Is there something I am missing?

  14. 15 David Glasner June 28, 2015 at 7:36 am

    Miguel, Thanks so much.

    Scott, You may be right, but the documents that I saw and quoted from as well as others that I didn’t quote from don’t seem to support your confidence that he would have done the right thing. What are the statements of his that you would cite to show that he believed in fine-tuning the business cycle. I agree that his easing of policy in 1927 to avoid a downturn displayed good judgment. And I think that he did sincerely want to facilitate Britain’s resumption of the gold standard by easing policy, but I don’t think that shows that he was really taking in the big picture. And don’t forget that he was the architect of the 1920-21 depression.

    csissoko, It’s not clear to me what “flexibility” is supposed to mean in this context. From the point of view of a small open economy, there is no (first-oder) difference between being on a gold standard or a gold exchange standard. Any difference is second-order limited largely to the composition of the central bank’s balance sheet and its earning (holding gold is more costly than holding foreign exchange). The first-order difference relates to the total system monetary demand for gold, which implies that the value of gold is greater (and the equilibrium price level lower) under a gold standard than a gold exchange standard. Although I have been accepting that there is a real distinction between a gold standard and a gold exchange standard, I think that the distinction is actually illusory. The only important issue is the implied system wide monetary demand for gold. Attaching a name to one realization of gold standard and another name to a different realization is analytically unimportant. Perhaps I will try to spell this out more systematically in a separate post.

    Fed Up, What matters is the conversion rate between gold and dollars, not the reserve requirement. On your first try you specified a reserve requirement, but you didn’t specify a conversion rate. You just posited a value. My point was that the reserve requirement by itself would not constrain the value.

    Holding reserves is never important for a solvent institution. In a crisis, when solvency becomes problematic, a legal reserve requirement becomes suicidal, because it’s like telling a fire department that they must always keep their water tanks full. What are they supposed to do in case of fire. They can’t touch the water in the tanks, so they have to get the water from some place else. The idea that holding gold reserves (other than till cash which normally amounts to a fraction of one percent of liabilities) is necessary for a gold standard to operate is one of the oldest and worst fallacies in monetary economics. The limitation on how much currency can be issued under a gold standard is the amount of currency that the public is willing to hold.

  15. 16 Fed Up June 28, 2015 at 9:51 am

    “On your first try you specified a reserve requirement, but you didn’t specify a conversion rate. You just posited a value.”

    I would say 1 oz of gold = $1 of currency is a (fixed) conversion rate, not just a value.

    Do I need to say 1 oz of gold = $1 of currency AND $1 of currency = 1 oz of gold?

    “The limitation on how much currency can be issued under a gold standard is the amount of currency that the public is willing to hold.”

    The amount of currency that the public is willing to hold can change. If the public wants less currency and more gold, they are going to expect the fixed exchange rate to work both ways. From my example above, the public holds $1,000 in currency. It changes to $2,000 in currency and then changes to $0 in currency. If there is only $1,000 oz of gold, there is going to be problem at the end (public wants $0 currency and 2,000 oz of gold).

  16. 17 Fed Up June 28, 2015 at 9:54 am

    EDIT: “If there is only $1,000 oz of gold,”

    TO: “If there is only 1,000 oz of gold,”

  17. 18 David Glasner June 28, 2015 at 10:03 am

    Fed Up, If the bank is solvent, it can buy all the gold it needs to satisfy the demands of currency holders to convert their notes for gold.

  18. 19 Fed Up June 28, 2015 at 1:21 pm

    Let me try to get my scenario where I want it.

    There is only one central bank. There are 1,000 oz of gold. No more.

    1 oz of gold = $1 of currency is a (fixed) conversion rate, not just a value.

    1 oz of gold = $1 of currency AND $1 of currency = 1 oz of gold.

    At first, the reserve requirement for gold is 100%. The public wants to hold $750 in currency, so the central bank holds 750 oz of gold.

    Next, the public wants to hold $1,500 in currency. The reserve requirement for gold is lowered to 50%, so the central bank still holds 750 oz of gold.

    Next, the public wants to hold $250 in currency. $1,250 in currency can’t be redeemed for 1,000 oz of gold at the fixed exchange rate.

  19. 20 csissoko June 28, 2015 at 6:10 pm

    Thank you for the replies. I actually brought this up, because I picked up a copy of Free Banking and Monetary Reform a few months ago and realized that it was precisely on this issue (that is, your view — as I understand it — that theoretic convertibility should be treated as de facto convertibility) where my understanding of 19th and early 20th c. banking differs from yours.

    I understand where you are coming from, but at least in the British banking tradition (and I recognize that the American tradition is very different), i think there was an understanding that economic value can be derived from periodically relaxing the converitbility requirement (cf. the repeated suspension of the 1844 Banking Act).

    Thank you again for your replies.

  20. 21 David Glasner June 29, 2015 at 8:53 am

    Fed Up, I am guessing that you mean that the total stock of gold in your model is 1000 oz, not just the amount of gold held by the central bank. You can assume that almost all the gold in the world is used as reserves for money, but even in the heyday of the gold standard the total amount of gold used for monetary purposes was just a small fraction of the total stock of gold in the world, so your assumption, if I am understanding it correctly, seems disconnected from reality.

    You assume that the central bank accepts 750 oz of gold and issues $750 of currency. There are still 250 oz of gold held outside the central bank. Now you say that the bank issues an additional $750 of currency without holding any additional reserves of gold. You don’t explain how the currency was issued. Was the currency just handed out randomly to people who happened to walk past the central bank office, or did they have to give the bank something in return, like, say, an IOU? The question, in other words, is: did the central bank just issue $750 in additional liabilities, or did it obtain assets worth $750 in exchange for the liabilities issued. If the bank just gave out liabilities without getting any assets in return, the bank is insolvent, unless the owners of the bank invested enough capital so that the liabilities can be redeemed using the capital invested. If the bank exchanged currency for assets of equal value, the bank is not insolvent. If the public decides that it no longer wants to hold dollars but prefers holding gold, the bank can use the assets it has on its balance sheet to buy gold as needed to redeem currency. You seem to be suggesting that people who redeem currency only want to hold gold. If that’s the case, the value of gold is rising, so the price of everything else is falling. As the relative value of gold rises, people are likely to demand less of it, so eventually the excess demand for gold that you have posited will be eliminated by way of a sufficiently steep fall in the gold price of everything else. Of course the transition could be very messy, which is just one reason why gold convertibility is a potentially unstable monetary system.

    csissoko, Thanks for reading my book.

    I am afraid I don’t understand your distinction between “theoretic convertibility” and “de facto convertibility.” I also don’t understand why you think there is a distinction between American and British views of how the gold standard works. The differences go back, it seems to me, to the Banking and Currency Schools, and before that to Smith and Hume who had very different ideas about banking and the international adjustment mechanism under gold convertibility. The followers of the Currency and the Banking Schools were geographically dispersed and were not concentrated in either the US or Great Britain. Or have I misunderstood what you were getting at?

  21. 22 csissoko June 29, 2015 at 10:30 am

    re: British vs American views. The concept of real vs. finance bill was meaningful in Britain (and Europe more generally) where a real bill was created by a commercial transaction, whereas a finance bill was a real bill that was rolled over or any bill that was did not originate in a commercial transaction at all. One job of the central bank was to police the growth of finance bills (and thus the degree to which commercial bills were rolled over).

    In the U.S. over the developmental period there was no central bank, so there was no one to police the quality of the bill circulation and rolling over of bills became the norm. As a result when the Federal Reserve Act was drafted, finance bills — at least as the concept was understood in Europe — were explicitly discountable at the Fed (although the Fed was also granted the discretion to determine the bills that it was willing to discount). Thus, the common view that the FRA exemplifies the “real bills doctrine” is based on a completely different definition of “real bill” than that which was in use in Britain.

    While the FRA by granting discretion to the Fed, made it possible for the Fed to become a European-style central bank with the duty not just of managing the gold standard, but also of managing the bill market, and while Strong (along with others) sought to establish a European style bill market in the U.S. through which the central bank could act, they failed completely in this effort. For this reason, the U.S. tradition of central banking has never really been comparable to the British tradition. Because the Fed had no “two-name” bill market to act through, it was forced to use open market operations (which had been in use in Britain at least since the early 19th century, but were considered a secondary tool) to implement policy.

    By the second half of the 19th century the Banking and Currency School debates had been left behind in Britain (indeed it seems that U.S. scholars are the ones who are constantly trying to resurrect this ancient framework). Britain settled on a pragmatic solution to the debate: the currency school had its law (the Banking Act of 1844), but the realities that had always been understood by the banking school were recognized by the suspension of the Act as necessary. Acknowledgment of these realities was also furthered by the neutering of the Act through the growth of checking accounts. In short, by the late 19th century the debates had ended, and the relevance of both the banking and the currency school views (speaking very roughly at different points in the credit cycle) was understood in Britain.

    I guess my main point is that the “gold standard” was only one aspect of the Bank of England’s duties, and that its role in monitoring and controlling the growth of credit in the bill market was recognized by all British contemporaries (and certain U.S. bankers such as Strong) as equally important. (See King’s London Discount Market if you want some details on the evolution of the Bank of England’s role. Strong has some congressional testimony that makes clear his understanding of European central banking and the desirability of emulating it in the U.S.)

  22. 23 financewhiz June 29, 2015 at 12:58 pm

    Great post! It’s interesting to wonder “what if?”

  23. 24 Frank Restly June 29, 2015 at 6:39 pm

    David,

    “If the public decides that it no longer wants to hold dollars but prefers holding gold, the bank can use the assets it has on its balance sheet to buy gold as needed to redeem currency.”

    Yes, but can the central bank force you to sell your gold to them at the fixed exchange rate? I think that is what “Fed Up” is getting at. Sure, if the central bank wants to buy gold to satisfy redemptions, it can try to buy it off the market, but I don’t think it can dictate price.

    The central bank can tell the market what price it will buy and sell gold at, it can’t force the market to acquiesce to it’s offers.

    The gold standard with fractional reserve banking was a single direction standard – the central bank would buy any amount of gold that you wanted to sell them at a fixed exchange rate. They would not (and could not) sell off all of their gold holdings at that fixed rate.

  24. 25 sumnerbentley June 29, 2015 at 7:02 pm

    David, If you haven’t read “Lords of Finance” you should definitely do so. There are lots of quotes from Strong about wanting to stabilize a combination of prices and output (which sounds like NGDP) and also opposition to those at the Fed who wanted to raise rates to stop stock prices from rising. He was definitely a progressive by interwar standards and his reputation was gained for a reason.

    Strong opposed Fisher’s plan because Strong wanted to do this in the context of the gold standard.

    I don’t know if Strong would have been able to prevent the Depression, but the views of Hawtrey, Fisher and Friedman are certainly plausible.

  25. 26 David Glasner June 29, 2015 at 8:14 pm

    Scott, I did read it soon after it came out in 2009 or 2010 I think, and enjoyed it a lot. Thanks for reminding me of it. I realize that it is dangerous to rely on just one document in assessing what Strong’s position was, so I wasn’t flatly asserting that Strong would not have taken more decisive action to counter the contraction than his successors did. But the documents that I did see were surprising to me in how strongly opposed he seemed to be to the Genoa resolutions and how supportive he seemed to be of the French desire to build up their own gold reserve.

  26. 27 David Glasner June 30, 2015 at 9:47 am

    Frank, No the bank cannot force anyone to sell gold at the conversion rate. If the bank wants more gold it would have to offer a premium over the official price. The point is that if the bank is solvent, it would be able to pay off creditors holding its liabilities. In the extreme case Fed Up is positing, in which all creditors demand payment in gold, and the market in gold is so thin, that the bank cannot buy the gold it needs on the market at the going market price for gold, the system would be forced into a deflationary spiral as the excess demand for gold forced up the real value of gold. Do you think there would not be a deflationary spiral with a 100% gold reserve requirement if there were suddenly an excess demand for gold?

  27. 28 Frank Restly June 30, 2015 at 2:10 pm

    David,

    “Do you think there would not be a deflationary spiral with a 100% gold reserve requirement if there were suddenly an excess demand for gold?”

    No, as long as both paper currency and gold are equally accepted as a means of exchange, there would be not deflationary spiral.

    A sudden excess demand for gold could lead to a credit crunch and bankruptcies if debt contracts are written such that payments must be made in gold. If those bankruptcies led to a sudden shortage of produced goods while demand for those goods remained the same, you might see an inflationary spiral instead of a deflationary spiral.

  28. 29 David Glasner June 30, 2015 at 7:10 pm

    Frank, If there is an excess demand for gold, economic theory tells us that there must be an increase in the value of gold to restore equilibrium. And if gold is the standard of value or the medium of count, meaning that there is a fixed conversion rate between gold and currency, then the only way in which an increase in the value of gold can be expressed is for the price of all other goods to fall in terms of gold. That is deflation. The demand for other goods cannot stay the same inasmuch as the whole exercise is predicated on the assumption that the demand for gold is increasing. For the demand for gold to increase, the demand for other goods must be decreasing. So there is no way of avoiding the deflationary implications of the assumptions underlying this discussion.

  29. 30 Frank Restly July 1, 2015 at 8:31 am

    David,

    “meaning that there is a fixed conversion rate between gold and currency”

    There is not a fixed conversion rate between gold and currency, that’s the point.

    A fixed conversion rate means the central bank will and can swap gold for currency and currency for gold in infinite quantities at that conversion rate.

    But the central bank cannot do this under a fractional reserve system.

  30. 31 Frank Restly July 1, 2015 at 8:33 am

    David,

    “For the demand for gold to increase, the demand for other goods must be decreasing.”

    No. The demand for gold can rise while the demand for paper currency can decrease, irrespective of what is happening in the markets for other goods.

    If that was an implicit assumption that you are making, that is fine, but it need not be the case.

  31. 32 David Glasner July 2, 2015 at 9:04 am

    Frank, You said:

    “The demand for gold can rise while the demand for paper currency can decrease, irrespective of what is happening in the markets for other goods.”

    The original assumption was that there was 750 currency and 750 gold in reserve. Then there was an increase in the demand to hold currency, but it was accommodated by reduced reserve requirement so that there was 1500 in currency with only 750 gold in reserve. I asked Fed Up to explain how the additional 750 in currency came into existence, but he didn’t reply to the question. So I am assuming that the additional currency was lent out in exchange for IOUs of the public. The IOUs of the public can’t circulate as cash, but the currency can circulate as cash. So the private sector has not experienced any change in its net asset position because the additional currency is offset by an equal increase in indebtedness. People want to hold cash, and they have been accommodated, but they are not increasing their consumption of real goods and services. Then the example posits that the public wants to cash in their currency for gold. That implies a real increase in the demand for gold, and that real increase in demand can’t be financed just by cashing in currency because the currency didn’t represent net asset holdings of the public, there having been an equal increase in indebtedness corresponding to the additional currency. If the public wants to actually hold additional gold they have to finance it by liquidating other asset holdings or they must restrict their consumption. Either way there has to be a corresponding reduction in demand for goods and services or assets.

    You said:

    “There is not a fixed conversion rate between gold and currency, that’s the point.

    “A fixed conversion rate means the central bank will and can swap gold for currency and currency for gold in infinite quantities at that conversion rate.

    “But the central bank cannot do this under a fractional reserve system.”

    You are working with a very quirky definition of a fixed exchange rate. Under your definition, I don’t think that there has ever in history been a fixed exchange rate. Certainly there was none under the gold standard as it operated from 1870 to 1914.

  32. 33 Frank Restly July 2, 2015 at 12:18 pm

    David,

    “that real increase in demand can’t be financed just by cashing in currency because the currency didn’t represent net asset holdings of the public, there having been an equal increase in indebtedness corresponding to the additional currency.”

    The debtor and the holder of currency are not likely the same person.

    I borrow $1500 in currency from central bank even though central bank only holds $750 of gold at the official dollar / gold exchange rate. I spend that $1500 on a horse. Former horse owner (now with $1500 in currency) demands $1500 in gold from the central bank at the official rate. Where does the extra gold come from?

  33. 34 David Glasner July 3, 2015 at 1:27 pm

    I am not assuming that the debtor and the holder of currency are the same person. The point is that the real demand for gold has to come from somewhere. For the private sector as a whole, the additional currency lent out does not represent an increment in their purchasing power, it represents an increase in liquidity. If they make a purchase with the borrowed money it has to be paid back, while if they decide not to hold the cash anymore they just cancel their IOU. If they use cash to buy gold, the purchase has to be financed somehow, because their indebtedness to the bank doesn’t go away by demanding that the bank convert the cash into gold.

  34. 35 Fed Up July 3, 2015 at 7:39 pm

    “I asked Fed Up to explain how the additional 750 in currency came into existence, but he didn’t reply to the question.”

    Sorry, I have not replied sooner.

    “So I am assuming that the additional currency was lent out in exchange for IOUs of the public.”

    I was going to say the banking system, but I can work with bonds from the public.

    “For the private sector as a whole, the additional currency lent out does not represent an increment in their purchasing power, it represents an increase in liquidity. If they make a purchase with the borrowed money it has to be paid back, while if they decide not to hold the cash anymore they just cancel their IOU. If they use cash to buy gold, the purchase has to be financed somehow, because their indebtedness to the bank doesn’t go away by demanding that the bank convert the cash into gold.”

    I believe you need to deaggregate here. Someone borrows $750 in currency from the central bank with an interest only loan (I believe they came into existence in the 1920’s). The reserve requirement is lowered to 50%. The central bank gets the loan. The borrower spends the $750 in currency. The next person takes the $750 in currency to the central bank for redemption along with the other people taking $750 for redemption. There is not enough gold. The bond is still there, but it could be defaulted on lowering the value of the assets of the central bank.

    “If the bank wants more gold it would have to offer a premium over the official price.”

    That should be considered a default of some sort. That is what the austerians would say.

    From David’s post:

    “You said:

    “There is not a fixed conversion rate between gold and currency, that’s the point.

    “A fixed conversion rate means the central bank will and can swap gold for currency and currency for gold in infinite quantities at that conversion rate.

    “But the central bank cannot do this under a fractional reserve system.”

    You are working with a very quirky definition of a fixed exchange rate. Under your definition, I don’t think that there has ever in history been a fixed exchange rate. Certainly there was none under the gold standard as it operated from 1870 to 1914.”

    I do not know if that is true, but the austerians would say that is the problem. A true gold standard has not existed. One austerian was saying this to me one time.

    A lot of people say gold standard should mean fixed exchange rate between gold and currency both ways with a 100% reserve requirement on the central bank and a 100% reserve requirement on the commercial banks so that the amount of gold limits the amount of “money”.

    I do not think Frank’s definition is really that quirky.

  35. 36 Fed Up July 3, 2015 at 7:42 pm

    “If the bank just gave out liabilities without getting any assets in return, the bank is insolvent, unless the owners of the bank invested enough capital so that the liabilities can be redeemed using the capital invested. If the bank exchanged currency for assets of equal value, the bank is not insolvent.”

    Do you think the solvency of the central bank matters?

  36. 37 Frank Restly July 5, 2015 at 9:56 am

    David,

    “…if they make a purchase with the borrowed money it has to be paid back…”

    It has to be paid back by the borrower, not necessarily by the current holder of that currency. If the borrower cannot pay it back and defaults, that increase in liquidity is permanent and the central bank cannot redeem all demands for gold at the fixed price.

  37. 38 David Glasner July 5, 2015 at 12:37 pm

    Fed Up, In the real world, no holder of currency has 50% of the central bank’s outstanding stock of currency, it’s only because of that very extreme assumption that it seem to you that disaggregating makes a difference here. In the real world, the probability that any single currency holder would demand a quantity of gold that the central bank would not have enough gold on hand, or accessible, to pay out is zero. The concept of the demand for money is an aggregate concept, because people are buying and selling all the time, and their cash balances are fluctuating correspondingly. To say that the demand for money is a certain amount does not mean that they will not hold a penny more than that amount; it means that they are trying on average to keep a certain percentage of their income or wealth in liquid form. So the idea that someone who has been holding roughly the amount of money that he wanted to hold will immediately demand redemption of cash that he has just received implies that he really was not holding the amount of money that he wanted previously.

    The assumption that we started from was that the public wanted to hold 1500 in cash instead of 750. I then asked you how the extra 750 got into circulation. You didn’t respond, so I said that it was lent out to someone (or it would have been more accurate to say to a lot of people). You can’t then say that the extra 750 is no long wanted after a single transaction has taken place without saying that the demand to hold the extra 750 has been extinguished as soon at the 750 was issued. So it doesn’t make sense to me to say that the additional 750 goes away immediately after a single transaction, because that just means that there was no demand for the additional 750 in the first place. But that’s what you are really assuming. You are saying that one person got the money not hold, but to buy something and the person who got the money didn’t want to hold the money, but just wanted to have gold. To me that means that there was an increase in the demand for gold. If the demand for gold increases so that the public wants to hold more gold than is in existence, the value of gold will rise. If the price of everything is measured in gold, that means that the prices of everything but gold will fall.

    It’s true that when someone borrows money from a bank, the bank can’t be sure whether the additional money will be held or will come back to the bank. That’s why no bank would lend an amount equal to 50% of its total assets to a single borrower or simultaneously lend that amount to many borrowers at the same time.

    I also don’t understand why anyone would think that it would be a default for the bank to offer a premium on gold above the official price if it found that it needed more gold than it had on hand. And I don’t understand why you would think that I care what the Austerians (whoever they are) would say?

    You said:

    “A lot of people say gold standard should mean fixed exchange rate between gold and currency both ways with a 100% reserve requirement on the central bank and a 100% reserve requirement on the commercial banks so that the amount of gold limits the amount of “money”.

    “I do not think Frank’s definition is really that quirky.”

    Fed Up, trust me it’s quirky.

    You asked:

    “Do you think the solvency of the central bank matters?”

    Of course it matters, but when the bank is a quasi-government institution backed by the full faith and credit of the state, its solvency cannot be determined by simply looking at its balance sheet.

    Frank, Any bank that is engaged in commercial transactions runs a risk of having assets that it acquires lose value. That’s why it relies (or ought to rely) not just the assets that it acquires in the process of making loans but also on the capital invested by its owners.

  38. 39 Fed Up July 7, 2015 at 4:00 pm

    “In the real world, the probability that any single currency holder would demand a quantity of gold that the central bank would not have enough gold on hand, or accessible, to pay out is zero.”

    I’d say there could enough currency holders (more than one) where that is possible, if not likely. My example was to be simple.

    “If the demand for gold increases so that the public wants to hold more gold than is in existence, the value of gold will rise.”

    And, “I also don’t understand why anyone would think that it would be a default for the bank to offer a premium on gold above the official price if it found that it needed more gold than it had on hand.”

    You have defaulted against the fixed exchange rate both ways.

    I said: ““A lot of people say gold standard should mean fixed exchange rate between gold and currency both ways with a 100% reserve requirement on the central bank and a 100% reserve requirement on the commercial banks so that the amount of gold limits the amount of “money”.”

    I stand by that not being quirky.

    “Of course it matters, but when the bank is a quasi-government institution backed by the full faith and credit of the state, its solvency cannot be determined by simply looking at its balance sheet.”

    I do not want it backed by the state. For example, having the federal gov’t give gov’t bonds to the central bank to restore solvency.

  39. 40 Fed Up July 7, 2015 at 4:46 pm

    “You are saying that one person got the money not hold, but to buy something and the person who got the money didn’t want to hold the money, but just wanted to have gold. To me that means that there was an increase in the demand for gold.”

    I think so and sort of. The first person borrowed currency from the central bank by issuing a bond (a loan) to the central bank. The first person spends the currency by buying a radio from the manufacturer directly. The radio manufacturer accepts the currency. It then changes its mind about what it wants to hold. It wants to hold gold, not currency.

    At first, there is an increase in the demand for currency, and I think there is no change (not a decrease) in the demand for gold. When the currency gets to the radio manufacturer, there is a decrease in the demand for currency and an increase in the demand for gold.

  40. 41 David Glasner July 9, 2015 at 5:26 pm

    Fed Up, Yes obviously if the amount of currency outstanding exceeds the amount of gold reserves available for redemption, they could by showing up all at the same time make it impossible for the bank to redeem all the outstanding banknotes. But that is a highly unlikely occurrence, because it implies that all of them would suddenly decide at the same moment to increase their demand for gold. That’s a much different scenario from one in which a single individual is holding more currency the total gold reserves of the central bank.

    You said “you have defaulted against the fixed exchange rate both ways.”

    I’m sorry, but I have no idea what you are talking about. You are in default when you don’t pay an obligation when it comes due. The convertibility requirement requires the central bank to pay out 1 oz of gold for $1 and to pay out $1 for 1 oz of gold. If the central bank offers to pay more than it is obligated to pay for 1 oz. of gold, it is not defaulting on any obligation. That’s like saying that if I write you an IOU for $10 and pay you $11 instead because I want to be your best friend that I have defaulted on my obligation to you.

    A lot of people say a lot of things that are quirky.

    I can guess that you are unhappy with a lot of things that the state may be doing. You are entitled to be as unhappy as you feel like being, I was just explaining to you why it is difficult to ascertain at what point a central bank becomes insolvent.

    The point about the demand for gold is simply that the scenario that you posited is problematic because it involves an implicit assumption that the demand for gold increases. And I am explaining to you that under any gold standard scenario, a very significant increase in the demand for gold will have very unpleasant consequences. That was what the Great Depression was all about.

  41. 42 Fed Up July 15, 2015 at 8:39 pm

    “But that is a highly unlikely occurrence, because it implies that all of them would suddenly decide at the same moment to increase their demand for gold.”

    I would not say highly unlikely.

    “That’s like saying that if I write you an IOU for $10 and pay you $11 instead because I want to be your best friend that I have defaulted on my obligation to you.”

    Let’s call a default a “negative promise”, a normal payback a “neutral promise”, and paying more a “positive promise”. A negative promise for a bond/IOU will decrease demand for the bond. A positive promise will increase the demand for the bond.

    If/when entities figure out there will be a “positive promise” for gold, they will increase their demand for gold.

    “I can guess that you are unhappy with a lot of things that the state may be doing.”

    If I choose not to go into debt, I do not want the gov’t doing it for me by issuing a gov’t bond.

    “And I am explaining to you that under any gold standard scenario, a very significant increase in the demand for gold will have very unpleasant consequences. That was what the Great Depression was all about.”

    I would not say a significant increase in the demand for gold is what the Great Depression was *all* about. I see it as an increase in the demand for demand deposits. Banks and bank-like entities meeting the increase in demand for demand deposits. The demand for demand deposits fell, while the demand for currency rose. The demand for gold also rose.

    The demand for gold also went up because I would say some entities tried to anticipate the “positive promise” for gold. If the reserve requirement for gold is 100%, there should not be any “positive promise” for gold.

  42. 43 David Glasner July 17, 2015 at 12:26 pm

    Fed Up, I don’t see this conversation leading anywhere. You respond either by defining terms in a way that is unique to yourself or simply asserting that you disagree with me. You are entitled to do both, but I don’t see what the point is.

    You said:

    “I would not say a significant increase in the demand for gold is what the Great Depression was *all* about. I see it as an increase in the demand for demand deposits. Banks and bank-like entities meeting the increase in demand for demand deposits. The demand for demand deposits fell, while the demand for currency rose. The demand for gold also rose.”

    I’m sorry but that’s incoherent. If you are going to comment, then, please, at least try to put your thoughts together so that they make some sense.

  43. 44 Fed Up July 17, 2015 at 3:52 pm

    The point is if the exchange rate between gold and currency needs to be changed that is not a gold standard the way most people would define it.

    A fixed exchange rate between gold and currency with a 100% reserve requirement will limit currency.

    You have verified one thing I thought. Lowering the gold reserve requirement to below 100% for the central bank is probably about wanting to add something else to the central bank balance sheet with gov’t debt and/or banking system debt topping the list.

    Not incoherent at all. In the 1920’s, the banks or bank-like entities issued a lot of demand deposits to buy private bonds (private debt increased). In a few years when the bonds (assets) fell in value, the banks became insolvent. The demand deposits could be directly marked down ($1,000 in demand deposits could easily become $800). People rush to get currency, something that is not directly marked down.

    Lastly, if entities think gold will be revalued to their favor, the demand for it will go up.

  44. 45 Fed Up July 18, 2015 at 10:53 am

    http://www.nber.org/chapters/c11482.pdf

    p. 64 (p. 33 of the .pdf)

    Here is Ben Bernanke (one of the chapter authors)

    “We define abandonment of the gold standard broadly as occurring at the first date in which a country imposes exchange controls, devalues, or suspends gold payments; see table 2.1 for a list of dates. An objection to this definition is that some countries continued to try to target their exchange rates at levels prescribed by the gold standard even after “leaving” the gold standard by our criteria; Canada and Germany are two examples. We made no attempt to account for this, on the grounds that defining adherence to the gold standard by looking at variables such as exchange rates, money growth, or prices risks assuming the propositions to be shown.”

  45. 46 David Glasner July 19, 2015 at 12:32 pm

    Fed Up, You said,

    “The point is if the exchange rate between gold and currency needs to be changed that is not a gold standard the way most people would define it.”

    Please tell me exactly how you think that most people would define the gold standard. I’m also curious how you came to know how most people define the gold standard.

    You said:

    “A fixed exchange rate between gold and currency with a 100% reserve requirement will limit currency.”

    So tell me: what happens with a fixed exchange rate between gold and currency and a 100% gold reserve requirement when people want to hold more currency than is in existence?

    You said:

    “You have verified one thing I thought. Lowering the gold reserve requirement to below 100% for the central bank is probably about wanting to add something else to the central bank balance sheet with gov’t debt and/or banking system debt topping the list.”

    Um, when was there ever a 100% gold reserve requirement?

    You said:

    “Not incoherent at all. In the 1920’s, the banks or bank-like entities issued a lot of demand deposits to buy private bonds (private debt increased). In a few years when the bonds (assets) fell in value, the banks became insolvent. The demand deposits could be directly marked down ($1,000 in demand deposits could easily become $800). People rush to get currency, something that is not directly marked down.”

    And before you said:

    “I would not say a significant increase in the demand for gold is what the Great Depression was *all* about. I see it as an increase in the demand for demand deposits.”

    So you started by saying that the Great Depression was about an increase in the demand for demand deposits, and then you say it’s people trying to exchange their demand deposits for currency, which sounds like a decreased demand for demand deposits. Is the problem an increase in demand for demand deposits or a decrease in demand deposits? If the problem is a decrease in demand for demand deposits, it’s irrelevant whether there was a prior increase in demand for demand deposits, so why are you even saying anything about the previous increase in demand for demand deposits? And do you think that the fall in the value of assets that led to bank insolvency was just some random event? Have you considered that it might have had something to do with what was happening to the value of gold? And what does it mean for demand deposits to be “directly marked down” (from $1000 to $800)?

    Your quote from Bernanke is interesting, and I don’t necessarily disagree with his criterion for identifying when a country leaves the gold standard, but I think the real point that he making is that there is no single criterion for determining when a country is on the gold standard. Under certain circumstances, however, it is certainly correct to say that if a country maintains a fixed exchange rate against a currency that is convertible into gold at fixed conversion rate, it is on the gold standard. I might also mention that two or three years ago I wrote a post pointing out that Bernanke had trouble explaining what was wrong the with gold standard.

    https://uneasymoney.com/2012/03/23/bernanke-has-trouble-explaining-whats-wrong-with-the-gold-standard/

  46. 47 Fed Up July 22, 2015 at 1:24 pm

    Most people would define a gold standard as some fixed quantity.

    Say 1 oz of gold = $1 and $1 = 1 oz of gold. It would not have to be 1 to 1. It should stay that way. No changing it / no abandonment.

    Various economic blogs. This is the only economics blog I have seen where the fixed exchange rate can be changed and it could still be considered a gold standard. Everywhere else would call that some type of default (maybe abandonment is a better term). If it is changed once, then entities will expect that it could change in the future again.

    Some entity is not going to get as much currency as desired. That could lead to price deflation. Now whether real AD = real AS at full employment with price deflation is a different question. Maybe yes or maybe no.

    Maybe there has not been a gold standard with a 100% reserve requirement. Some people claim there should be. With a 100% reserve requirement, there is only currency and gold on the balance sheet, right? I think that is what the 100% reserve requirement with a gold standard people want.

    In the mid-1920’s, I believe there was a big increase in real AS from electricity and other things. I believe there was also a big increase in real AD. A lot of it was from private debt. I assume a lot of this came from a bank or bank-like entity. Some of these demand deposits were spent on goods/services while prices remained about the same. Some of the demand deposits were spent on financial assets with those prices rising.

    There was an increase in the demand for demand deposits to spend. The banks met this demand. Some entity must have been willing to hold these demand deposits or something CD like from the banks.

    There was an increase in the demand for bonds as a savings vehicle by the banks. The people met this demand by issuing bonds to the banks.

    Say around 1929, the borrowers started defaulting. The banks went insolvent. This hit the demand deposits of the banks (see below). The demand for demand deposits fell, while the demand for currency rose.

    Notice the increase in demand for demand deposits to spend and then spent probably prevented price deflation in the mid-1920’s. That is why the increase is important.

    “Have you considered that it might have had something to do with what was happening to the value of gold?”

    I assume gold standard here. If so, Japan in the 1990’s and the USA 2007-2008 should not have happened. They did.

    “And what does it mean for demand deposits to be “directly marked down” (from $1000 to $800)?”

    You have $1,000 in demand deposits in your checking account. The bank shuts down. The next time it opens your account says $800 in demand deposits. You want to avoid that.

  47. 48 Fed Up July 22, 2015 at 1:50 pm

    “What Bernanke probably had in mind was something like the following. Suppose people get nervous for whatever reason about the state of the economy. When they get nervous, they want to increase the amount of money they have on hand rather than tying up their wealth in illiquid form. In such situations, an effective central bank could increase the money supply, providing the public with the added liquidity that they want, thereby allowing the economy to keep functioning, without serious disruption, because the money supply was increased to match the increased demand to hold money. However, if the money supply is fixed, because under a gold standard the amount of money is determined or set by the supply of gold, the only way that the money supply can increase is by obtaining additional gold. But it takes a long time to mine more gold out of the ground, so in the meantime, people will have less money on hand than they want to hold, and the only way they can increase their cash holdings is to spend less. But in the aggregate people can’t increase their holdings of money by reducing their spending; they just reduce money income, forcing prices and output to fall. In other words the gold standard causes a recession.”

    I am going to mostly agree. Definitions of money supply could be different. The how’s of increasing the money supply could be different. Skip that for now.

    I believe there could a scenario where prices fall, but output stays the same or increases.

    With a 100% reserve requirement and a gold standard, the money supply is fixed, right (unless the amount of gold from mining increases)?

    “Some (maybe most) people mistakenly believe that the reserve requirement is what constitutes a gold standard. But it’s not; the gold standard is defining the value of a monetary unit as a fixed weight of gold. That definition is consistent with any reserve requirement from zero to 100 percent.”

    The problem is as you get closer to a 0% reserve requirement, the more likely the fixed exchange rate is in jeopardy (see just below).

    “The second possibility is that the general feeling of uncertainty that causes people to want to increase their holdings of money also causes them to want to increase their holdings of gold, because they think that the money issued by governments or banks may have become more risky.”

    The demand for currency goes up. The further from a 100% reserve requirement the central bank is the more likely entities holding currency will increase their demand for gold because they think a revaluation (abandonment) of the fixed exchange rate for gold could be on the way.

  48. 49 David Glasner July 27, 2015 at 11:52 am

    Fed Up, You said:

    “Most people would define a gold standard as some fixed quantity.
    Say 1 oz of gold = $1 and $1 = 1 oz of gold. It would not have to be 1 to 1. It should stay that way. No changing it / no abandonment.”
    Well under your definition, the gold standard was never in force because it was abandoned. That doesn’t sound like a very useful definition.

    “Various economic blogs. This is the only economics blog I have seen where Everywhere else would call that some type of default (maybe abandonment is a better term). If it is changed once, then entities will expect that it could change in the future again.”

    “Various economic blog” doesn’t sound overly authoritative to me, but we can let that pass. I’m not sure what you mean by saying that, according to this blog, “the fixed exchange rate can be changed and it could still be considered a gold standard.” The meaning of a “fixed-exchange rate” is that it is not changed. Is it conceivable that the fixed exchange rate could ever be changed in the future? Yes. It’s also conceivable that a meteor will collide with the earth and we’ll all be toast within the next 10 years. Whether anyone expects that to happen, or the fixed exchange rate to be changed depends on a lot of circumstances. Does that mean that there is no gold standard unless there is an iron-clad guarantee that the conversion rate will never be changed. I don’t think so; there is no such thing as an iron-clad guarantee of anything in this world. The US was not officially on the gold standard till about 1878. In the 1890s there was a whole political movement devoted to taking the US off the gold standard. William Jennings Bryan ran for President in 1896 and was nominated by the Democratic Party on a platform of taking the US off the gold standard. Monetary historians believe that US interest rates were higher than interest rates in the UK in the 1890s because lenders were demanding and borrowers were paying a premium to reflect the risk that the US would go off the gold standard before the loans cam due. Does that mean that the US was not on the gold standard until after Bryan was defeated for President in 1896?

    Maybe you think that, because I said that a central bank could operate on the gold standard with minimal reserves, because if it was short of reserves it could always go out and purchase gold on the market, and if necessary pay a premium, I was suggesting that the official gold price was being changed. That’s not what I was saying. The official gold price would not be changed, but that doesn’t mean that the central bank could not make special arrangements with certain sellers to provide reserves at a premium when the bank required additional reserves to meet a temporary demand for gold. The premium per ounce would be small, but the suppliers of gold to the central bank would reap a tidy profit. Nowadays similar transactions take place in what is called the Repo market. But the underlying assumption here is that the total amount of gold in existence is many times the total outstanding liabilities of the central bank, so there is always gold available on the open market if the central bank feels that it needs to hold more reserves than it has on hand. As an empirical matter, that was probably the case in the 19th and early 20th centuries when there was a functioning gold standard. The hypothetical numerical example you constructed obviously was based on a very different assumption, so I don’t think it has much relevance either to a discussion of the historical gold standard or how a gold standard could operate.

  49. 50 Fed Up July 31, 2015 at 11:46 am

    “The meaning of a “fixed-exchange rate” is that it is not changed. Is it conceivable that the fixed exchange rate could ever be changed in the future? Yes.”

    If you are willing to change it (the fixed exchange rate) in the future, that is going to change how the system works.

  50. 51 David Glasner August 4, 2015 at 7:21 pm

    Fed Up, The meaning of fixed-exchange rate” is obviously that it is not changed until it is changed. Which exchange rate has never been changed?

  51. 52 Fed Up August 8, 2015 at 7:57 pm

    “Fed Up, The meaning of fixed-exchange rate” is obviously that it is not changed until it is changed.”

    If that is the way it works out, entities will “ignore” the fixed exchange rate. Applying this to the gold standard means entities will demand gold over currency. They will either try to time when the “fixed” exchange rate will change or just hold gold and wait for it to change. This may create an excess demand for gold when you are trying to avoid that.

    “Which exchange rate has never been changed?”

    That is a good question. Some people say changing the fixed exchange rate of gold is the problem.

    I will say the fixed exchange rate between demand deposits of the commercial banks and currency has lasted for a good while now.

  52. 53 David Glasner August 14, 2015 at 10:17 am

    Fed Up, Obviously, it matters whether people think that there is a substantial risk of a change in the fixed exchange rate or a theoretical possibility that it will change. There is no possible way of eliminating that theoretical possibility.

    You said:

    “Some people say changing the fixed exchange rate of gold is the problem.”

    Almost every idiotic statement in history has been said by some people. What does that prove?

  53. 54 Fed Up August 17, 2015 at 4:08 pm

    “Fed Up, Obviously, it matters whether people think that there is a substantial risk of a change in the fixed exchange rate”

    Exactly. If the change happens once, entities will expect it again. They will look for the same type of conditions and try to exploit that. There will be financial asset speculation, probably with debt.

  54. 55 David Glasner August 18, 2015 at 6:56 pm

    Fed Up, How do you know what entities — whoever or whatever they are — will expect? What makes you think that anyone forms expectations based on a single criterion? After World War I, the United States kept the legal conversion rate of the dollar into gold at the prewar parity; England allowed the value of sterling relative to gold to depreciate by about 25 percent before restoring the prewar parity of sterling relative to gold and the dollar in 1925; France allowed the value of the franc to depreciate by about 90 percent before stabilizing the value of the franc relative to gold at about 80 percent of the prewar parity when it restored the gold standard in 1926 de facto and in 1928 de jure. According to you “entities” should have expected that France would be the first country to go off the gold standard, but England left the gold standard in 1931 and the US in 1933 while France stayed on the gold standard till 1936. So your entity theory has it pretty much backwards.


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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.

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