Mises’s Unwitting Affirmation of the Hawtrey-Cassel Explanation of the Great Depression

In looking up some sources for my previous post on the gold-exchange standard, I checked, as I like to do from time to time, my old copy of The Theory of Money and Credit by Ludwig von Mises. Mises published The Theory of Money and Credit in 1912 (in German of course) when he was about 31 years old, a significant achievement. In 1924 he published a second enlarged edition addressing many issues that became relevant in the aftermath the World War and the attempts then underway to restore the gold standard. So one finds in the 1934 English translation of the 1924 German edition a whole section of Part III, chapter 6 devoted to the Gold-Exchange Standard. I noticed that I had dog-eared the section, which presumably means that when I first read the book I found the section interesting in some way, but I did not write any notes in the margin, so I am not sure what it was that I found interesting. I can’t even remember when I read the book, but there are many passages underlined throughout the book, so I am guessing that I did read it from cover to cover. Luckily, I wrote my name and the year (1971) in which I bought the book on the inside of the front cover, so I am also guessing that I read the book before I became aware of the Hawtrey Cassel explanation of the Great Depression. But it seems clear to me that whatever it was that I found interesting about the section on the gold-exchange standard, it didn’t make a lasting impression on me, because I don’t think that I ever reread that section until earlier this week. So let’s go through Mises’s discussion and see what we find.

Wherever inflation has thrown the monetary system into confusion, the primary aim of currency policy has been to bring the printing presses to a standstill. Once that is done, once it has at last been learned that even the policy of raising the objective exchange-value of money has undesirable consequences, and once it is seen that the chief thing is to stabilize the value of money, then attempts are made to establish a gold-exchange standard as quickly as possible.

This seems to be reference to the World War I inflation and the somewhat surprising post-war inflation of 1919, which caused most countries to want to peg their currencies against the dollar, then the only major country with a currency convertible into gold. Mises continues:

This, for example, is what occurred in Austria at the end of 1922 and since then, at least for the time being, the dollar rate in that country has been fixed. But in existing circumstances, invariability of the dollar rate means invariability of the price of gold also. Thus Austria has a dollar-exchange standard and so, indirectly, a gold-exchange standard. That is the currency system that seems to be the immediate aim in Germany, Poland, Hungary, and many other European countries. Nowadays, European aspirations in the sphere of currency policy are limited to a return to the gold standard. This is quite understandable, for the gold standard previously functioned on the whole satisfactorily; it is true that it did not secure the unattainable ideal of a money with an invariable objective exchange value, but it did preserve the monetary system from the influence of governments and changing policies.

Yet the gold-standard system was already undermined before the war. The first step was the abolition of the physical use of gold in individual payments and the accumulation of the stocks of gold in the vaults of the great banks-of-issue. The next step was the adoption of the practice by a series of States of holding the gold reserves of the central banks-of-issue (or the redemption funds that took their place), not in actual gold, but in various sorts of foreign claims to gold. Thus it came about that the greater part of the stock of gold that was used for monetary purposes was gradually accumulated in a few large banks-of-issue; and so these banks became the central reserve-banks of the world, as previously the central banks-of-issue had become central reserve-banks for individual countries.

Mises is leaving out a lot here. Many countries were joining gold standard in the last quarter of the 19th century, when the gold standard became an international system. The countries adopting the gold standard did not have a gold coinage; for them to introduce a gold coinage, as Mises apparently would have been wanted, was then prohibitively costly. But gold reserves were still piling up in many central banks because of laws and regulations requiring central banks to hold gold reserves against banknotes. If gold coinages would have been introduced in addition to the gold gold reserves being accumulated as reserves against banknotes, the spread of gold standard through much of the world in the last quarter of the 19th century would have drastically accentuated the deflationary trends that marked most of the period from 1872 to 1896.

The War did not create this development; it merely hastened it a little.

Actually a lot. But we now come to the key passage.

Neither has the development yet reached the stage when all the newly-produced gold that is not absorbed into industrial use flows to a single centre. The Bank of England and the central banks-of-issue of some other States still control large stocks of gold; there are still several of them that take up part of the annual output of gold. Yet fluctuations in the price of gold are nowadays essentially dependent on the policy followed by the Federal Reserve Board. If the United States did not absorb gold to the extent to which it does, the price of gold would fall and the gold-prices of commodities would rise. Since, so long as the dollar represents a fixed quantity of gold, the United States admits the surplus gold and surrenders commodities for gold to an unlimited extent, a rapid fall in the value of gold has hitherto been avoided.

Mises’s explanation here is rather confused, because he neglects to point out that the extent to which gold was flowing into the Federal Reserve was a function, among other things, of the credit policy adopted by the Fed. The higher the interest rate, the more gold would flow into the Fed and, thus, the lower the international price level. Mises makes it sound as if there was a fixed demand for gold by the rest of the world and the US simply took whatever was left over. That was a remarkable misunderstanding on Mises’s part.

But this policy of the United States, which involves considerable sacrifices, might one day be changed. Variations in the price of gold would then occur and this would be bound to give rise in other gold countries to the question of whether it would not be better in order to avoid further rises in prices to dissociate the currency standard from gold.

Note the ambiguous use of the term “price of gold.” The nominal price of gold was fixed by convertibility, so what Mises meant was the real price of gold, with a fixed nominal price. It would have been less ambiguous if the term “value of gold” had been used here and in the rest of the passage instead of “price of gold.” I don’t know if Mises or his translator was at fault.

Just as Sweden attempted for a time to raise the krone above its old gold parity by closing the Mint to gold, so other countries that are now still on the gold standard or intend to return to it might act similarly. This would mean a further drop in the price of gold and a further reduction of the usefulness of gold for monetary purposes. If we disregard the Asiatic demand for money, we might even now without undue exaggeration say that gold has ceased to be a commodity the fluctuations in the price of which are independent of government influence. Fluctuations in the price of gold are nowadays substantially dependent on the behaviour of one government, viz. that of the United States of America.

By George, he’s got it! The value of gold depends mainly on the Fed! Or, to be a bit more exact, on how much gold is being held by the Fed and by the other central banks. The more gold they hold, the more valuable in real terms gold becomes, which means that, with a fixed nominal price of gold, the lower are the prices of all other commodities. The point of the gold-exchange standard was thus to reduce the world’s monetary demand for gold, thereby limiting the tendency of gold to appreciate and for prices in terms of gold to fall. Indeed, Mises here cites in a footnote none other than the villainous John Maynard Keynes himself (Tract on Monetary Reform) where he also argued that after World War I, the value of gold was determined by government policy, especially that of the Federal Reserve. Mises goes on to explain:

All that could not have been foreseen in this result of a long process of development is the circumstance that the fluctuations in the price of gold should have become dependent upon the policy of one government only. That the United States should have achieved such an economic predominance over other countries as it now has, and that it alone of all the countries of great economic importance should have retained the gold standard while the others (England, France, Germany, Russia, and the rest) have at least temporarily abandoned it – that is a consequence of what took place during the War. Yet the matter would not be essentially different if the price of gold was dependent not on the policy of the United States alone, but on those of four or five other governments as well. Those protagonists of the gold-exchange standard who have recommended it as a general monetary system and not merely as an expedient for poor countries, have overlooked this fact. They have not observed that the gold-exchange standard must at last mean depriving gold of that characteristic which is the most important from the point of view of monetary policy – its independence of government influence upon fluctuations in its value. The gold-exchange standard has not been recommended or adopted with the object of dethroning gold. All that Ricardo wanted was to reduce the cost of the monetary system. In many countries which from the last decade of the nineteenth century onward have wished to abandon the silver or credit-money standard, the gold-exchange standard rather than a gold standard with an actual gold currency has been adopted in order to prevent the growth of a new demand for gold from causing a rise in its price and a fall in the gold-prices of commodities. But whatever the motives may have been by which the protagonists of the gold-exchange standard have been led, there can be no doubt concerning the results of its increasing popularity.

If the gold-exchange standard is retained, the question must sooner or later arise as to whether it would not be better to substitute for it a credit-money standard whose fluctuations were more susceptible to control than those of gold. For if fluctuations in the price of gold are substantially dependent on political intervention, it is inconceivable why government policy should still be restricted at all and not given a free hand altogether, since the amount of this restriction is not enough to confine arbitrariness in price policy within narrow limits. The cost of additional gold for monetary purposes that is borne by the whole world might well be saved, for it no longer secures the result of making the monetary system independent of government intervention. If this complete government control is not desired, there remains one alternative only: an attempt must be made to get back from the gold-exchange standard to the actual use of gold again.

Thus, we see that in 1924 none other than the legendary Ludwig von Mises was explaining that the value of gold had come to depend primarily on the policy decisions of the Federal Reserve and the other leading central banks. He also understood that a process of deflation could have terrible consequences if free-market forces were not operating to bring about an adjustment of market prices to the rising value of gold. Recognizing the potentially disastrous consequences of a scramble for gold by the world’s central banks as they rejoined the gold standard, Hawtrey and Cassel called for central-bank cooperation to limit the increase in the demand for gold and to keep the value of gold stable. In 1924, at any rate, Mises, too, recognized that there could be a destabilizing deflationary increase in the demand for gold by central banks. But when the destabilizing deflationary increase actually started to happen in 1927 when the Bank of France began cashing in its foreign-exchange reserves for gold, triggering similar demands by other central banks in the process of adopting the gold standard, the gold standard started collapsing under the weight  of deflation. But, as far as I know, Mises never said a word about the relationship between gold demand and the Great Depression.

Instead, in the mythology of Austrian business-cycle theory, it was all the fault of the demonic Benjamin Strong for reducing the Fed’s discount rate from 5% to 3.5% in 1927 (and back to only 4% in 1928) and of the duplicitous Montagu Norman for reducing Bank Rate from 5% to 4.5% in 1927-28 rather than follow the virtuous example of the Bank of France in abandoning the cursed abomination of the gold-exchange standard.

11 Responses to “Mises’s Unwitting Affirmation of the Hawtrey-Cassel Explanation of the Great Depression”


  1. 1 Nick Rowe July 4, 2015 at 2:11 am

    Good post David. I think I agree with your main point.

    On a slight side issue, that might (or might not) help us understand why Mises did not join Hawtrey and Cassel:

    Right at the end of that last passage you quote, Mises sets up two options: either we go all the way off gold, or else we go back to a pure gold standard. Because the gold exchange standard does not prevent governments manipulating the price level.

    What was Mises own preference, between those two options? The second?

  2. 2 JKH July 4, 2015 at 5:57 am

    It seems that one of the takeaways is that the inflationary/deflationary consequences of a gold reserve policy were always an indirect but important function of interest rate policy – given that the effect depended on gold flows between monetary and non-monetary holdings, which were a function of interest rate policy.

    I think you make this point in your comment about Mises’ misinterpretation of the mechanics behind the Fed’s role as super central banker for gold.

    And with your earlier post, I think you make the point that it’s not the setting of policy for the gold reserve stock but rather the management of the gold reserve flow in or out of that stock that is key to maintaining parity. And managing the flow means managing the interest rate set by the central bank.

    And setting gold loose means there is a change in whatever it is that is being targeted (e.g. CPI instead of gold) for monetary policy, but really means no change in the role that the management of the central bank interest rate plays in aiming for that target.

  3. 3 numawan July 4, 2015 at 8:12 am

    Always reading David’s posts with great pleasure!

  4. 4 David Glasner July 5, 2015 at 12:47 pm

    Nick, Thanks, I hope you will become sure that you do agree.

    No question that Mises wanted a gold standard not a fiat standard. Which is fine, but he understood that going to a gold standard would be deflationary, but he refused to attribute the deflation of the Great Depression to an increase in the demand for gold even after he said that that is what would happen. Instead, he blamed it all on a reduction in the interest rate in 1927-28.

    JKH, I think that is a generally accurate summary of what I have been saying, but I would have to think more carefully about the details.

  5. 5 Fed Up July 5, 2015 at 2:01 pm

    JKH said: “And setting gold loose means there is a change in whatever it is that is being targeted (e.g. CPI instead of gold) for monetary policy”

    I would say a gold standard is a fixed exchange rate between “currency” and gold both ways by the central bank.

    I would say a CPI target is not a CPI standard. There is no fixed exchange rate between “currency” and goods and services prices by the central bank.

    So, a CPI target is not a CPI standard, right?

  6. 6 JKH July 6, 2015 at 12:23 pm

    A post from Nick Rowe several years ago that describes a sort of evolutionary model from a pure gold standard to fiat:

    http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/04/from-gold-standard-to-cpi-standard.html

    At the end, he asks the question:

    “At what point in the above steps did monetary theory need to fundamentally change?”

    I think my point above concerns the role of interest rates as part of that question.

    Fed up, maybe that depends on the assigned meaning of the term “standard”. Nick actually refers to “CPI standard” in his post.

  7. 7 Fed Up July 7, 2015 at 9:14 am

    JKH, I do not like the term “cpi standard”. To me it means there is some fixed exchange rate.

    Also, to me it implies there is some kind of buying/selling going on.

    Pre-2008 for the fed and if cpi was below target, it gives the impression the fed would buy a bond and sell reserves.

    It seems to me if cpi was below target, the fed would hope market interest rates would come down. The fed would then agree by lowering the fed funds rate with an “announcement” effect. No buying/selling would have to happen.

  8. 8 Carlos Novais (@CN_) July 23, 2015 at 3:14 am

    Mises probably wanted a sooner and lighter deflationary crises, whcich could be possible still en 1927. Thats what makes sense.

  9. 9 David Glasner July 23, 2015 at 6:02 pm

    Carlos, Mises certainly wanted to bring on a depression as soon as possible, but my point is that at the theoretical level he affirmed the relationship between the demand for gold by central banks and the international price level. However, despite the obvious role of central bank demand for gold in causing the 1929 downturn and the subsequent deflation, Mises and his followers never acknowledged the role of an increase in the value of gold, brought on by that sharp increase in central bank demand for gold, in the deflation of the Great Depression.


  1. 1 Economy News July 11th 2015 | TheFinancial's Weblog Trackback on July 11, 2015 at 3:04 am
  2. 2 Exposed: Milton Friedman’s Cluelessness about the Insane Bank of France | Uneasy Money Trackback on July 16, 2015 at 1:03 pm

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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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