Larry White on the Gold Standard and Me

A little over three months ago on a brutally hot day in Washington DC, I gave a talk about a not yet completed paper at the Mercatus Center Conference on Monetary Rules for a Post-Crisis World. The title of my paper was (and still is) “Rules versus Discretion Historically Contemplated.” I hope to post a draft of the paper soon on SSRN.

One of the attendees at the conference was Larry White who started his graduate training at UCLA just after I had left. When I wrote a post about my talk, Larry responded with a post of his own in which he took issue with some of what I had to say about the gold standard, which I described as the first formal attempt at a legislated monetary rule. Actually, in my talk and my paper, my intention was not as much to criticize the gold standard as it was to criticize the idea, which originated after the gold standard had already been adopted in England, of imposing a fixed numerical rule in addition to the gold standard to control the quantity of banknotes or the total stock of money. The fixed mechanical rule was imposed by an act of Parliament, the Bank Charter Act of 1844. The rule, intended to avoid financial crises such as those experienced in 1825 and 1836, actually led to further crises in 1847, 1857 and 1866 and the latter crises were quelled only after the British government suspended those provisions of the Act preventing the Bank of England from increasing the quantity of banknotes in circulation. So my first point was that the fixed quantitative rule made the gold standard less stable than it would otherwise have been.

My second point was that, in the depths of the Great Depression, a fixed rule freezing the nominal quantity of money was proposed as an alternative rule to the gold standard. It was this rule that one of its originators, Henry Simons, had in mind when he introduced his famous distinction between rules and discretion. Simons had many other reasons for opposing the gold standard, but he introduced the famous rules-discretion dichotomy as a way of convincing those supporters of the gold standard who considered it a necessary bulwark against comprehensive government control over the economy to recognize that his fixed quantity rule would be a far more effective barrier than the gold standard against arbitrary government meddling and intervention in the private sector, because the gold standard, far from constraining the conduct of central banks, granted them broad discretionary authority. The gold standard was an ineffective rule, because it specified only the target pursued by the monetary authority, but not the means of achieving the target. In Simons view, giving the monetary authority to exercise discretion over the instruments used to achieve its target granted the monetary authority far too much discretion for independent unconstrained decision making.

My third point was that Henry Simons himself recognized that the strict quantity rule that he would have liked to introduce could only be made operational effectively if the entire financial system were radically restructured, an outcome that he reluctantly concluded was unattainable. However, his student Milton Friedman convinced himself that a variant of the Simons rule could actually be implemented quite easily, and he therefore argued over the course of almost his entire career that opponents of discretion ought to favor the quantity rule that he favored instead of continuing to support a restoration of the gold standard. However, Friedman was badly mistaken in assuming that his modified quantity rule eliminated discretion in the manner that Simons had wanted, because his quantity rule was defined in terms of a magnitude, the total money stock in the hands of the public, which was a target, not, as he insisted, an instrument, the quantity of money held by the public being dependent on choices made by the public, not just on choices made by the monetary authority.

So my criticism of quantity rules can be read as at least a partial defense of the gold standard against the attacks of those who criticized the gold standard for being insufficiently rigorous in controlling the conduct of central banks.

Let me now respond to some of Larry’s specific comments and criticisms of my post.

[Glasner] suggests that perhaps the earliest monetary rule, in the general sense of a binding pre-commitment for a money issuer, can be seen in the redemption obligations attached to banknotes. The obligation was contractual: A typical banknote pledged that the bank “will pay the bearer on demand” in specie. . . .  He rightly remarks that “convertibility was not originally undertaken as a policy rule; it was undertaken simply as a business expedient” without which the public would not have accepted demand deposits or banknotes.

I wouldn’t characterize the contract in quite the way Glasner does, however, as a “monetary rule to govern the operation of a monetary system.” In a system with many banks of issue, the redemption contract on any one bank’s notes was a commitment from that bank to the holders of those notes only, without anyone intending it as a device to govern the operation of the entire system. The commitment that governs a single bank ipso facto governs an entire monetary system only when that single bank is a central bank, the only bank allowed to issue currency and the repository of the gold reserves of ordinary commercial banks.

It’s hard to write a short description of a system that covers all possible permutations in the system. While I think Larry is correct in noting the difference between the commitment made by any single bank to convert – on demand — its obligations into gold and the legal commitment imposed on an entire system to maintain convertibility into gold, the historical process was rather complicated, because both silver and gold coins circulating in Britain. So the historical fact that British banks were making their obligations convertible into gold was the result of prior decisions that had been made about the legal exchange rate between gold and silver coins, decisions which overvalued gold and undervalued silver, causing full bodied silver coins to disappear from circulation. Given a monetary framework shaped by the legal gold/silver parity established by the British mint, it was inevitable that British banks operating within that framework would make their banknotes convertible into gold not silver.

Under a gold standard with competitive plural note-issuers (a free banking system) holding their own reserves, by contrast, the operation of the monetary system is governed by impersonal market forces rather than by any single agent. This is an important distinction between the properties of a gold standard with free banking and the properties of a gold standard managed by a central bank. The distinction is especially important when it comes to judging whether historical monetary crises and depressions can be accurately described as instances where “the gold standard failed” or instead where “central bank management of the monetary system failed.”

I agree that introducing a central bank into the picture creates the possibility that the actions of the central bank will have a destabilizing effect. But that does not necessarily mean that the actions of the central bank could not also have a stabilizing effect compared to how a pure free-banking system would operate under a gold standard.

As the author of Free Banking and Monetary Reform, Glasner of course knows the distinction well. So I am not here telling him anything he doesn’t know. I am only alerting readers to keep the distinction in mind when they hear or read “the gold standard” being blamed for financial instability. I wish that Glasner had made it more explicit that he is talking about a system run by the Bank of England, not the more automatic type of gold standard with free banking.

But in my book, I did acknowledge that there inherent instabilities associated with a gold standard. That’s why I proposed a system that would aim at stabilizing the average wage level. Almost thirty years on, I have to admit to having my doubts whether that would be the right target to aim for. And those doubts make me more skeptical than I once was about adopting any rigid monetary rule. When it comes to monetary rules, I fear that the best is the enemy of the good.

Glasner highlights the British Parliament’s legislative decision “to restore the convertibility of banknotes issued by the Bank of England into a fixed weight of gold” after a decades-long suspension that began during the Napoleonic wars. He comments:

However, the widely held expectations that the restoration of convertibility of banknotes issued by the Bank of England into gold would produce a stable monetary regime and a stable economy were quickly disappointed, financial crises and depressions occurring in 1825 and again in 1836.

Left unexplained is why the expectations were disappointed, why the monetary regime remained unstable. A reader who hasn’t read Glasner’s other blog entries on the gold standard might think that he is blaming the gold standard as such.

Actually I didn’t mean to blame anyone for the crises of 1825 and 1836. All I meant to do was a) blame the Currency School for agitating for a strict quantitative rule governing the total quantity of banknotes in circulation to be imposed on top of the gold standard, b) point out that the rule that was enacted when Parliament passed the Bank Charter Act of 1844 failed to prevent subsequent crises in 1847, 1857 and 1866, and c) that the crises ended only after the provisions of the Bank Charter Act limiting the issue of banknotes by the Bank of England had been suspended.

My own view is that, because the monopoly Bank of England’s monopoly was not broken up, even with convertibility acting as a long-run constraint, the Bank had the power to create cyclical monetary instability and occasionally did so by (unintentionally) over-issuing and then having to contract suddenly as gold flowed out of its vault — as happened in 1825 and again in 1836. Because the London note-issue was not decentralized, the Bank of England did not experience prompt loss of reserves to rival banks (adverse clearings) as soon as it over-issued. Regulation via the price-specie-flow mechanism (external drain) allowed over-issue to persist longer and grow larger. Correction came only with a delay, and came more harshly than continuous intra-London correction through adverse clearings would have. Bank of England mistakes boggled the entire financial system. It was central bank errors and not the gold standard that disrupted monetary stability after 1821.

Here, I think, we do arrive at a basic theoretical disagreement, because I don’t accept that the price-specie-flow mechanism played any significant role in the international adjustment process. National price levels under the gold standard were positively correlated to a high degree, not negatively correlated, as implied by the price-specie-flow mechanism. Moreover, the Bank Charter Act imposed a fixed quantitative limit on the note issue of all British banks and the Bank of England in particular, so the overissue of banknotes by the Bank of England could not have been the cause of the post-1844 financial crises. If there was excessive credit expansion, it was happening through deposit creation by a great number of competing deposit-creating banks, not the overissue of banknotes by the Bank of England.

This hypothesis about the source of England’s cyclical instability is far from original with me. It was offered during the 1821-1850 period by a number of writers. Some, like Robert Torrens, were members of the Currency School and offered the Currency Principle as a remedy. Others, like James William Gilbart, are better classified as members of the Free Banking School because they argued that competition and adverse clearings would effectively constrain the Bank of England once rival note issuers were allowed in London. Although they offered different remedies, these writers shared the judgment that the Bank of England had over-issued, stimulating an unsustainable boom, then was eventually forced by gold reserve losses to reverse course, instituting a credit crunch. Because Glasner elides the distinction between free banking and central banking in his talk and blog post, he naturally omits the third side in the Currency School-Banking School-Free Banking School debate.

And my view is that Free Bankers like Larry White overestimate the importance of note issue in a banking system in which deposits were rapidly overtaking banknotes as the primary means by which banks extended credit. As Henry Simons, himself, recognized this shift from banknotes to bank deposits was itself stimulated, at least in part, by the Bank Charter Act, which made the extension of credit via banknotes prohibitively costly relative to expansion by deposit creation.

Later in his blog post, Glasner fairly summarizes how a gold standard works when a central bank does not subvert or over-ride its automatic operation:

Given the convertibility commitment, the actual quantity of the monetary instrument that is issued is whatever quantity the public wishes to hold.

But he then immediately remarks:

That, at any rate, was the theory of the gold standard. There were — and are – at least two basic problems with that theory. First, making the value of money equal to the value of gold does not imply that the value of money will be stable unless the value of gold is stable, and there is no necessary reason why the value of gold should be stable. Second, the behavior of a banking system may be such that the banking system will itself destabilize the value of gold, e.g., in periods of distress when the public loses confidence in the solvency of banks and banks simultaneously increase their demands for gold. The resulting increase in the monetary demand for gold drives up the value of gold, triggering a vicious cycle in which the attempt by each to increase his own liquidity impairs the solvency of all.

These two purported “basic problems” prompt me to make two sets of comments:

1 While it is true that the purchasing power of gold was not perfectly stable under the classical gold standard, perfection is not the relevant benchmark. The purchasing power of money was more stable under the classical gold standard than it has been under fiat money standards since the Second World War. Average inflation rates were closer to zero, and the price level was more predictable at medium to long horizons. Whatever Glasner may have meant by “necessary reason,” there certainly is a theoretical reason for this performance: the economics of gold mining make the purchasing power of gold (ppg) mean-reverting in the face of monetary demand and supply shocks. An unusually high ppg encourages additional gold mining, until the ppg declines to the normal long-run value determined by the flow supply and demand for gold. An unusually low ppg discourages mining, until the normal long-run ppg is restored. It is true that permanent changes in the gold mining cost conditions can have a permanent impact on the long-run level of the ppg, but empirically such shocks were smaller than the money supply variations that central banks have produced.

2 The behavior of the banking system is indeed critically important for short-run stability. Instability wasn’t a problem in all countries, so we need to ask why some banking systems were unstable or panic-prone, while others were stable. The US banking system was panic prone in the late 19th century while the Canadian system was not. The English system was panic-prone while the Scottish system was not. The behavioral differences were not random or mere facts of nature, but grew directly from differences in the legal restrictions constraining the banks. The Canadian and Scottish systems, unlike the US and English systems, allowed their banks to adequately diversify, and to respond to peak currency demands, thus allowed banks to be more solvent and more liquid, and thus avoided loss of confidence in the banks. The problem in the US and England was not the gold standard, or a flaw in “the theory of the gold standard,” but ill-conceived legal restrictions that weakened the banking systems.

Larry makes two good points, but I doubt that they are very important in practice. The problem with the value of gold is that there is a very long time lag before the adjustment in the rate of output of new gold will cause the value of gold to revert back to its normal level. The annual output of gold is only about 3 percent of the total stock of gold. If the monetary demand for gold is large relative to the total stock and that demand is unstable, the swing in the overall demand for gold can easily dominate the small resulting change in the annual rate of output. So I do not have much confidence that the mean-reversion characteristic of the purchasing power of gold to be of much help in the short or even the medium term. I also agree with Larry that the Canadian and Scottish banking systems exhibited a lot more stability than the neighboring US and English banking systems. That is an important point, but I don’t think it is decisive. It’s true that there were no bank failures in Canada in the Great Depression. But the absence of bank failures, while certainly a great benefit, did not prevent Canada from suffering a downturn of about the same depth and duration as the US did between 1929 and 1933. The main cause of the Great Depression was the deflation caused by the appreciation of the value of gold. The deflation caused bank failures when banks were small and unstable and did not cause bank failures when banks were large and diversified. But the deflation  was still wreaking havoc on the rest of the economy even though banks weren’t failing.

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20 Responses to “Larry White on the Gold Standard and Me”


  1. 1 citizencokane December 11, 2016 at 11:54 am

    The periods of suddenly higher demand for gold were not a fault of the gold standard, but of the fractional reserve banking model. If all banknotes had been 100% backed by gold deposits in the vaults, there would have been no reason for depositors to exercise the redemption option. But they could have still chosen to anyways, at a minor inconvenience to themselves, and it would have made no difference. Banks would have lost assets (gold), but also to the same degree lost liabilities (their banknotes). The net status of their balance sheet would have been unaffected.

    Indeed, we will get the same problems today even though we are no longer on the gold standard. In 2008, there was a sudden spike in the demand for base money because people woke up to the fact that there was not enough base money backing the credit money that had been issued in various forms in the economy, whether through mortgages or other instruments. And credit money is, at the end of the day, the promise to pay in some sort of base money, whether that is gold or dollars.

    More dollar loan creation doesn’t solve the problem because, even if it creates dollars today (which can seemingly act as base money—after all, individual dollars in the banking system aren’t tagged with a label that says whether they were originally “base dollars” or “credit dollars,” it also in aggregate creates an even bigger promise of repayment in dollars down the line, postponing the problem and elevating it to an even higher level.

    And there are practical limits on how much the central banks can increase the actual base money supply without being hit with problems on other fronts. The 1970s are a testament to that. So, really, once a round of fractional reserve lending has run its course, there is nothing to do but let the credit supply and the apparent money supply contract and let there be a painful recession or depression.

    There is literally nothing that the central banks can be expected to do in these situations. Trying to compensate for the contraction of credit by increasing the base money supply only unleashes inflation. You can question theoretically why it should do that, and that’s actually a very interesting question. But, empirically from the 1970s, we know that there is no combination of fiscal or monetary policy that can prevent an oncoming recession that is caused by expansion of unsustainable fractional-reserve lending without unleashing even worse problems.

    Of course, we could avoid these credit cycle recessions by banning the use of credit in the first place. Yes, to transition to this equilibrium, we would have to put up with a huge one-time deflation in prices. If mortgages were not an option, and people had to buy based on their actual savings on hand, then how much could the median house reasonably be sold for? $20,000? But once we made the drastic deflation (including in wages), people would get psychologically used to the new price level.

    Banks could still make money by safely storing wealth in exchange for fees.

  2. 2 JP Koning December 12, 2016 at 8:48 am

    Would it be fair to say that one of the main differences between you and Larry White is that he believes that a monopoly issuer of a convertible currency can issue too much currency, leading to large macroeconomic fluctations, whereas you believe that reflux will quickly remedy any overissuance?

  3. 3 David Glasner December 12, 2016 at 1:02 pm

    Citizencokane, The monetary demand for gold may rise suddenly owing to fears of bank insolvency, but that is certainly not the only reason why people could suddenly want to increase their holdings of money, which under a 100% reserve gold currency, would constitute an increased demand to hold gold.

    In case you haven’t been paying attention, the 1970s came to an end 37 years ago, without substantial inflation and inflation has been running at the lowest levels since the early 1960s even as the monetary base has expanded by huge amounts, so may want to reconsider some of your presuppositions about money and inflation.

    JP, Yes, I think that would be fair. Another is that he thinks that the value of gold is pretty stable, and I think it is potentially very unstable.

  4. 4 Henry December 12, 2016 at 4:44 pm

    Bagehot’s “Lombard Street” gives some insight into the functioning of the British monetary system during the 1800s. From what I can gather, Bagehot argues that the stability of the system required an adequate level of Bank of England cash reserves, a judicious flexibility in the level of reserves and a need for the Bank of England to be clear about on what collateral it would lend in the event of a panic. He was not in favour of a fixed level of reserves. His emphasis was on the impact of the level of cash reserves on domestic manias and panics, not the impact of gold reserves. Surprisingly, he only mentions convertibility a handful times, in relation to foreign exchange matters. And he was clear that the Act of 1844 had little impact on the stability of the system.

    So perhaps the simple way to look at this is that the banking system rules govern the management of domestic markets and gold convertibility rules govern the management of foreign exchange markets, being ever cognizant of the interrelation between the two.

  5. 5 Henry December 13, 2016 at 12:35 am

    “The main cause of the Great Depression was the deflation caused by the appreciation of the value of gold. ”

    Is it that simple?

    Gold outflows in the US did not begin in earnest until around mid to late 1931.

    However, US bank failures more than doubled in 1930. US real investment declined by 25% in 1930 compared to 1929. US unemployment went from under 5% in 1929 to just under 10% in 1930 and to over 15% in 1931. Price indices had started to fall in 1930. Nominal short term interest rates peaked in 1929 and fell thereafter. So it doesn’t look as if the bank rate was being used to prop up gold reserves at that stage.

    “But the absence of bank failures, while certainly a great benefit, did not prevent Canada from suffering a downturn of about the same depth and duration as the US did between 1929 and 1933.”

    The Canadian banking system comprised of a small number of large banks whereas the US banking system comprised of a large number of small banks. Perhaps this differential structure protected the Canadian banks. However, 25% of Canadian GDP came from primary commodity exports, the price of which declined 50%. The Smoot-Hawley Tariff Act of mid 1930 hurt Canada heavily.

    So the slump was well under way by 1931, before the ructions began to hit monetary gold flows.

  6. 6 JP Koning December 13, 2016 at 6:46 am

    “Another is that he thinks that the value of gold is pretty stable, and I think it is potentially very unstable.”

    The implication being that a gold standard needs to be managed, with large central banks cooperating to avoid buying or selling too much metal so as to avoid moving its price (i.e. to avoid the insane Bank of France effect)? White, on the other hand, would probably believe that the gold standard can work automatically, without central bank cooperation?

  7. 7 Henry. December 13, 2016 at 8:08 am

    France was not the only country accumulating gold in the late 1920s and early 1930s. The US, because of its strong trade position was accumulating gold also. Normally, this would require the US to stimulate its economy and stem the outflow. However, it already had an overly strong economy driven by a powerful investment boom founded on the commercializing of new technologies and production systems. Because of the accumulation of gold by the US, it could not be argued that gold was a deflationary force in the US. The standard classical gold theory said that countries receiving gold would see their internal price structure rise. So the US price level should have been rising through the early 1930s. However, price indices in the US began to fall after 1929 as the slump took hold.

  8. 8 Henry December 13, 2016 at 8:27 am

    “Normally, this would require the US to stimulate its economy and stem the outflow.”

    Sorry, should have said “stem the inflow”.

  9. 9 David Glasner December 13, 2016 at 9:25 am

    Henry, Bagehot was clear that the Bank Charter Act had little impact on the stability of the system when he was writing around 1870. By then the Bank Charter Act no longer mattered, because deposits had overtaken banknotes as the primary medium of exchange, thereby making the restrictions on the issue of banknotes embodied in the Bank Charter Act effectively irrelevant. He actually explained clearly that it was fear that the Bank Charter Act would prevent the Bank of England from extending credit that had precipitated financial crises in 1847, 1857 and 1866, crises which were alleviated only after the government suspended the provisions of the Act preventing the Bank of England from issuing additional banknotes except in exchange for gold.

    In 1927, the Fed reduced the discount rate to 3.5% and allowed a modest gold outflow from its colossal gold hoard. The efflux of gold from the US accommodated the rapid increase in gold holdings of the Bank of France which began in 1927 and accelerated in 1928, and continued through 1929. In late 1928, responding to concern about stock market speculation, the Fed began increasing rates, as the stock market continued to rise, the Fed continued to raise rates until it raised rates to 6.5% in the spring of 1929. In 1929, as France continued its gold accumulation binge, liquidating foreign exchange reserves and converting them to gold, the US also began accumulating gold. The combined pressure of US and French gold accumulation in 1929 meant that the overall world demand for gold was increasing rapidly forcing gold to appreciate in real terms, which under the gold standard is synonymous with deflation. The deflation was only reflected with a lag in the price indices, but wholesale prices peaked in mid-1929 and started falling afterwards. Once the stock market crashed, interest rates fell, but falling interest rates in response to worsening economic conditions don’t necessarily indicate a change in monetary policy. All countries were still trying to protect their gold reserves which meant that the demand for gold was not lessening but still increasing, which is why prices kept falling instead of rising.

    JP, Yes, I think that you have described what the issue is

    Henry, The US holdings of gold were fairly stable for most of the 1920s, but there was a sharp burst of US gold accumulation in 1929, perhaps already starting late in 1928. So rather than act as a safety valve, the Fed in 1929 was intensifying the pressure that the French were placing on the gold reserves of the rest of the world, forcing other central banks to raise their interest rates to protect their dwindling gold reserves. What you call the standard classical gold standard theory is nonsensical, because a) it ignores the fact that, under the gold standard, national price levels in all countries on the gold standard moved in the same, not the opposite, directions and b) it assumes that gold flows are passive responses to balance of payment deficits or surpluses when in fact gold flows reflected primarily the demand of central banks for gold reserves.

  10. 10 Henry December 13, 2016 at 8:38 pm

    David,

    ” under the gold standard, national price levels in all countries on the gold standard moved in the same, not the opposite, directions”

    Which period are you referring to?

  11. 11 David Glasner December 13, 2016 at 8:53 pm

    I am referring to any period in which one or more countries had currencies that were convertible into gold or one more countries maintained fixed exchanges rates between their currencies and another currency that was convertible into gold. But the classical gold standard as an international system existed from the late 1870s to the start of World War I. The post-World War I gold standard period functioned functioned as a coherent international system for less than 10 years.

  12. 12 Henry December 14, 2016 at 3:39 am

    David,

    I am interested in your statement that “The main cause of the Great Depression was the deflation caused by the appreciation of the value of gold.”

    Now I am not arguing that the gold exchange standard did not impose a deflationary bias on the world economy. The reason for the deflationary bias is that the level of world payments were growing much faster than world gold production. What I have trouble with is that it was the main cause of the deflation that gripped the world economy post 1929.

    Post WWI there was an inflationary binge in many countries. I am sure there are better sources, but what I have immediately to hand is a chart of British wholesale prices produced in the 1933 BIS annual report. It shows a sharp peak culminating in 1920 (index value 350) and thereafter declining rapidly into c. 1922 where it stabilizes until c. 1925 when Britain returned to gold – another rapid decline setting in thereafter – seemingly stabilizing again as Britain leaves gold.

    A similar chart for the US for the “implicit price index” (found in Wheelock – Monetary Policy in the great Depression: What the Fed did, and Why – Reserve Bank St Louis) shows a similar pattern except that the index stabilizes around 1922 and flatlines until 1929 and begins a precipitous decline into 1933.

    The first thing I would say is that the general level of prices in the US and the UK were due to reset to more normal levels after the post war inflationary binge. So I would firstly argue that this had a part to play in the secular decline of the general price level in both countries over the 1920s.

    Secondly, in the case of Britain, the return to an overvalued par value was seriously deflationary of itself. Britain spent most of the mid to late 1920s defending sterling and preventing gold loss (to New York which was competing to set itself up as a world money centre), maintaining downward pressure on the British economy. And of course, at the same time, the US was enjoying an investment boom.

    Thirdly, then comes the Fed tightening in early 1929 to quell a stock market boom which eventually precipitates a collapse of the market. Immediately prices in both countries begin a sharp decline as did prices in other countries. Industrial production begins to decline, followed by the progressive and violent collapse of the US banking system.

    While I agree that the gold exchange standard carried a deflationary bias, there was the natural return to normal price levels post the WWI inflation, the boom-bust scenario in the US and the already weakened state of a British economy, trying to live with an overvalued exchange rate imposing severe deflationary forces, which did the serious damage to those two economies and the world economy at large.

    And the French and British need to enhance/maintain their position in the international financial order was not inherent in the design of the gold standard – their behaviour would be have been the same no matter what the reserve system – added destabilizing forces to the system.

    I would appreciate your comments.

  13. 13 Henry December 14, 2016 at 3:44 am

    And bringing the discussion back to the topic of rules vs discretion, I wonder whether international commercial and political interests and considerations of international prestige will always override and trump rules put in place to manage a monetary system – this being evident in the behaviour of the British and the French.

  14. 14 David Glasner December 16, 2016 at 12:34 pm

    Henry, An inflationary boom can come to an end without a corrective deflation. Deflation is not the natural result of a prior deflation, so your basic premise that there was something inevitable about the two bursts of deflation at the beginning and end of the 1920s is without foundation unless you place those two episodes into the context of the gold standard. And by placing the two episodes into the context of the gold standard you have to understand that the key to explaining the movements of the price level under the gold standard is what is happening to the demand for gold. And the main factor affecting the demand for gold during World War I and the 1920 was the behavior of central banks and monetary authorities, which first reduced the demand for gold by removing gold coinage from circulation to finance war time expenditures, thereby making more gold available in general, though most of the demonetized gold found its way into the coffers of the US Federal Reserve and Treasury to pay for US exports to Europe during the first three years of World War I. The 1920-21 deflation was the deliberate result of Fed monetary policy which raised interest rates to 7 percent causing a rapid inflow of gold from the rest of the world, forcing most other countries to deflate to prevent their currencies from depreciating against the dollar. The 1925 restoration of the prewar dollar sterling parity required a modest further deflation in Britain relative to the US but the deflation, though unnecessary, did not prevent a modest economic expansion and a slowly falling rate of unemployment in Britain until the catastrophic deflation began in late 1929 triggered by the Fed’s intensification of its attempt to suppress the stock market boom.

    See my posts on the dearly beloved depression of 1920-21. (Here here and here.)

  15. 15 Henry December 16, 2016 at 5:19 pm

    “Deflation is not the natural result of a prior deflation, so you basic premise that there was something inevitable about the two bursts of deflation at the beginning and end of the 1920s is without foundation unless you place those two episodes into the context of the gold standard.”

    I don’t understand the reasoning here. The crash of 2008 was preceded by an unsoundly financed and corruptly promoted property boom. The crash of 1929 was preceded by an investment boom. As markets fall apart one thing leads to another. In the US 30% of the banks disappeared along with 30% of monetary reserves.

    “The 1920-21 deflation was the deliberate result of Fed monetary policy which raised interest rates to 7 percent causing a rapid inflow of gold from the rest of the world, forcing most other countries to deflate to prevent their currencies from depreciating against the dollar.”

    If the reserve system was other than a gold standard, the same thing would happen. The US puts its interest rates up, US flood in from around the globe. This is not something peculiar to gold.

    “….until the catastrophic deflation began in late 1929 triggered by the Fed’s intensification of its attempt to suppress the stock market boom.”

    I think this supports my argument.

  16. 16 David Glasner December 17, 2016 at 7:13 pm

    Henry, You said:

    “The crash of 2008 was preceded by an unsoundly financed and corruptly promoted property boom. The crash of 1929 was preceded by an investment boom. As markets fall apart one thing leads to another. In the US 30% of the banks disappeared along with 30% of monetary reserves.”

    The 2008 crash was preceded by what may have been a property bubble, but the rise in property prices peaked in 2006. The recession did not begin till the end of 2007 and the crash did not start till September of 2008. The crash was precipitated by an overly tight monetary policy that was mistakenly focused on temporary run up in oil and commodity prices in summer of 2008 rather than a rapidly deteriorating economy and rising unemployment. The investment boom of the 1920s was not the cause of the downturn. In repeating that misconception you are endorsing one of the classical myths perpetrated by Austrian business cycle theory with whom I am shocked and surprised to find you associating yourself.

    Other countries besides the US also experienced deflation and depression even without suffering nearly as many bank failures as the US did. Bank failures exacerbated the depression in the US but did not cause it. The rate of deflation was determined by the international forces that determined the international value of gold, so the rate of deflation was roughly equal in all countries on the gold standard.

    You quoted me:

    “The 1920-21 deflation was the deliberate result of Fed monetary policy which raised interest rates to 7 percent causing a rapid inflow of gold from the rest of the world, forcing most other countries to deflate to prevent their currencies from depreciating against the dollar.”

    and responded:

    “If the reserve system was other than a gold standard, the same thing would happen. The US puts its interest rates up, US flood in from around the globe. This is not something peculiar to gold.”

    I agree, the 1920-21 deflation and depression was the result of a Fed monetary policy that was determined to force deflation to reverse, in part at least, the rise in the price level that had occurred since the start of World War I, and especially the rapid post-war inflation. But it was the expectation that there would be a restoration of the gold standard that would entail restoration of the prewar parities of various national currencies with the dollar, the caused other countries to deflate along with or even faster than the US in order to keep the parities of those national currencies from depreciating against the dollar.

    You quoted me:

    “….until the catastrophic deflation began in late 1929 triggered by the Fed’s intensification of its attempt to suppress the stock market And boom.”

    and responded:

    “I think this supports my argument.”

    You made several arguments. I was responding to the idea that I understood you to be articulating there was some natural force that caused deflation in the 1920s. I was pointing out that there was no necessary reason for a deliberate policy by the Fed to try to suppress stock market speculation by raising interest rates to unsustainable levels. A byproduct of that policy was to cause an inflow of gold into the US that raised the real value of gold, which under a gold standard, is synonymous with deflation.

  17. 17 Henry December 17, 2016 at 9:56 pm

    “…you are endorsing one of the classical myths perpetrated by Austrian business cycle theory with whom I am shocked and surprised to find you associating yourself.

    I also shocked that you found me in bed with the Austrians. I must have walked into the wrong bedroom in the dark.

  18. 18 JP Koning December 19, 2016 at 10:02 am

    Off topic, but here’s a recent gold standard post from Cecchetti & Shoenholtz:

    http://www.moneyandbanking.com/commentary/2016/12/14/why-a-gold-standard-is-a-very-bad-idea

    I believe they invoke the price-specie-flow mechanism rather than the classical Smithian mechanism.

  19. 19 David Glasner December 19, 2016 at 7:25 pm

    Henry, Can’t be too careful.

    JP, Thanks for the link.


  1. 1 Golden Misconceptions | Uneasy Money Trackback on December 25, 2016 at 7:26 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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