Friedman and Schwartz, Eichengreen and Temin, Hawtrey and Cassel

Barry Eichengreen and Peter Temin are two of the great economic historians of our time, writing, in the splendid tradition of Charles Kindleberger, profound and economically acute studies of the economic and financial history of the nineteenth and early twentieth centuries. Most notably they have focused on periods of panic, crisis and depression, of which by far the best-known and most important episode is the Great Depression that started late in 1929, bottomed out early in 1933, but lingered on for most of the 1930s, and they are rightly acclaimed for having emphasized and highlighted the critical role of the gold standard in the Great Depression, a role largely overlooked in the early Keynesian accounts of the Great Depression. Those accounts identified a variety of specific shocks, amplified by the volatile entrepreneurial expectations and animal spirits that drive, or dampen, business investment, and further exacerbated by inherent instabilities in market economies that lack self-stabilizing mechanisms for maintaining or restoring full employment.

That Keynesian vision of an unstable market economy vulnerable to episodic, but prolonged, lapses from full-employment was vigorously, but at first unsuccessfully, disputed by advocates of free-market economics. It wasn’t until Milton Friedman provided an alternative narrative explaining the depth and duration of the Great Depression, that the post-war dominance of Keynesian theory among academic economists seriously challenged. Friedman’s alternative narrative of the Great Depression was first laid out in the longest chapter (“The Great Contraction”) of his magnum opus, co-authored with Anna Schwartz, A Monetary History of the United States. In Friedman’s telling, the decline in the US money stock was the critical independent causal factor that directly led to the decline in prices, output, and employment. The contraction in the quantity of money was not caused by the inherent instability of free-market capitalism, but, owing to a combination of incompetence and dereliction of duty, by the Federal Reserve.

In the Monetary History of the United States, all the heavy lifting necessary to account for both secular and cyclical movements in the price level, output and employment is done by, supposedly exogenous, changes in the nominal quantity of money, Friedman having considered it to be of the utmost significance that the largest movements in both the quantity of money, and in prices, output and employment occurred during the Great Depression. The narrative arc of the Monetary History was designed to impress on the mind of the reader the axiomatic premise that monetary authority has virtually absolute control over the quantity of money which served as the basis for inferring that changes in the quantity of money are what cause changes in prices, output and employment.

Friedman’s treatment of the gold standard (which I have discussed here, here and here) was both perfunctory and theoretically confused. Unable to reconcile the notion that the monetary authority has absolute control over the nominal quantity of money with the proposition that the price level in any country on the gold standard cannot deviate from the price levels of other gold standard countries without triggering arbitrage transactions that restore the equality between the price levels of all gold standard countries, Friedman dodged the inconsistency repeatedly invoking his favorite fudge factor: long and variable lags between changes in the quantity of money and changes in prices, output and employment. Despite its vacuity, the long-and-variable-lag dodge allowed Friedman to ignore the inconvenient fact that the US price level in the Great Depression did not and could not vary independently of the price levels of all other countries then on the gold standard.

I’ll note parenthetically that Keynes himself was also responsible for this unnecessary and distracting detour, because the General Theory was written almost entirely in the context of a closed economy model with an exogenously determined quantity of money, thereby unwittingly providing with a useful tool with which to propagate his Monetarist narrative. The difference of course is that Keynes, as demonstrated in his brilliant early works, Indian Currency and Finance and A Tract on Monetary Reform and the Economic Consequences of Mr. Churchill, had a correct understanding of the basic theory of the gold standard, an understanding that, owing to his obsessive fixation on the nominal quantity of money, eluded Friedman over his whole career. Why Keynes, who had a perfectly good theory of what was happening in the Great Depression available to him, as it was to others, was diverted to an unnecessary, but not uninteresting, new theory is a topic that I wrote about a very long time ago here, though I’m not so sure that I came up with a good or even adequate explanation.

So it does not speak well of the economics profession that it took nearly a quarter of a century before the basic internal inconsistency underlying Friedman’s account of the Great Depression was sufficiently recognized to call for an alternative theoretical account of the Great Depression that placed the gold standard at the heart of the narrative. It was Peter Temin and Barry Eichengreen, both in their own separate works (e.g., Lessons of the Great Depression by Temin and Golden Fetters by Eichengreen) and in an important paper they co-authored and published in 2000 to remind both economists and historians how important a role the gold standard must play in any historical account of the Great Depression.

All credit is due to Temin and Eichengreen for having brought to the critical role of the gold standard in the Great Depression to the attention of economists who had largely derived their understanding of what had caused the Great Depression from either some variant of the Keynesian narrative or of Friedman’s Monetarist indictment of the Federal Reserve System. But it’s unfortunate that neither Temin nor Eichnegreen gave sufficient credit to either R. G. Hawtrey or to Gustav Cassel for having anticipated almost all of their key findings about the causes of the Great Depression. And I think that what prevented Eichengreen and Temin from realizing that Hawtrey in particular had anticipated their explanation of the Great Depression by more than half a century was that they did not fully grasp the key theoretical insight underlying Hawtrey’s explanation of the Great Depression.

That insight was that the key to understanding the common world price level in terms of gold under a gold standard is to think in terms of a given world stock of gold and to think of total world demand to hold gold consisting of real demands to hold gold for commercial, industrial and decorative uses, the private demand to hold gold as an asset, and the monetary demand for gold to be held either as a currency or as a reserve for currency. The combined demand to hold gold for all such purposes, given the existing stock of gold, determines a real relative price of gold in terms of all other commodities. This relative price when expressed in terms of a currency unit that is convertible into gold corresponds to an equivalent set of commodity prices in terms of those convertible currency units.

This way of thinking about the world price level under the gold standard was what underlay Hawtrey’s monetary analysis and his application of that analysis in explaining the Great Depression. Given that the world output of gold in any year is generally only about 2 or 3 percent of the existing stock of gold, it is fluctuations in the demand for gold, of which the monetary demand for gold in the period after the outbreak of World War I was clearly the least stable, that causes short-term fluctuations in the value of gold. Hawtrey’s efforts after the end of World War I were therefore focused on the necessity to stabilize the world’s monetary demands for gold in order to avoid fluctuations in the value of gold as the world moved toward the restoration of the gold standard that then seemed, to most monetary and financial experts and most monetary authorities and political leaders, to be both inevitable and desirable.

In the opening pages of Golden Fetters, Eichengreen beautifully describes backdrop against which the attempt to reconstitute the gold standard was about to made after World War I.

For more than a quarter of a century before World War I, the gold standard provided the framework for domestic and international monetary relations. . .  The gold standard had been a remarkably efficient mechanism for organizing financial affairs. No global crises comparable to the one that began in 1929 had disrupted the operation of financial markets. No economic slump had so depressed output and employment.

The central elements of this system were shattered by . . . World War I. More than a decade was required to complete their reconstruction. Quickly it became evident that the reconstructed gold standard was less resilient that its prewar predecessor. As early as 1929 the new international monetary system began to crumble. Rapid deflation forced countries to  producing primary commodities to suspend gold convertibility and depreciate their currencies. Payments problems spread next to the industrialized world. . . Britain, along with United State and France, one of the countries at the center of the international monetary system, was next to experience a crisis, abandoning the gold standard in the autumn of 1931. Some two dozen countries followed suit. The United States dropped the gold standard in 1933; France hung on till the bitter end, which came in 1936.

The collapse of the international monetary system is commonly indicted for triggering the financial crisis that transformed a modes economic downturn gold standard into an unprecedented slump. So long as the gold standard was maintained, it is argued, the post-1929 recession remained just another cyclical contraction. But the collapse of the gold standard destroyed confidence in financial stability, prompting capital flight which undermined the solvency of financial institutions. . . Removing the gold standard, the argument continues, further intensified the crisis. Having suspended gold convertibility, policymakers manipulated currencies, engaging in beggar thy neighbor depreciations that purportedly did nothing to stimulate economic recovery at home while only worsening the Depression abroad.

The gold standard, then, is conventionally portrayed as synonymous with financial stability. Its downfall starting in 1929 is implicated in the global financial crisis and the worldwide depression. A central message of this book is that precisely the opposite was true. (Golden Fetters, pp. 3-4).

That is about as clear and succinct and accurate a description of the basic facts leading up to and surrounding the Great Depression as one could ask for, save for the omission of one important causal factor: the world monetary demand for gold.

Eichengreen was certainly not unaware of the importance of the monetary demand for gold, and in the pages that immediately follow, he attempts to fill in that part of the story, adding to our understanding of how the gold standard worked by penetrating deeply into the nature and role of the expectations that supported the gold standard, during its heyday, and the difficulty of restoring those stabilizing expectations after the havoc of World War I and the unexpected post-war inflation and subsequent deep 1920-21 depression. Those stabilizing expectations, Eichengreen argued, were the result of the credibility of the commitment to the gold standard and the international cooperation between governments and monetary authorities to ensure that the international gold standard would be maintained notwithstanding the occasional stresses and strains to which a complex institution would inevitably be subjected.

The stability of the prewar gold standard was instead the result of two very different factors: credibility and cooperation. Credibility is the confidence invested by the public in the government’s commitment to a policy. The credibility of the gold standard derived from the priority attached by governments to the maintenance of to the maintenance of balance-of-payments equilibrium. In the core countries – Britain, France and Germany – there was little doubt that the authorities would take whatever steps were required to defend the central bank’s gold reserves and maintain the convertibility of the currency into gold. If one of these central banks lost gold reserves and its exchange rate weakened, fund would flow in from abroad in anticipation of the capital gains investors in domestic assets would reap once the authorities adopted measures to stem reserve losses and strengthen the exchange rate. . . The exchange rate consequently strengthened on its own, and stabilizing capital flows minimized the need for government intervention. The very credibility of the official commitment to gold meant that this commitment was rarely tested. (p. 5)

But credibility also required cooperation among the various countries on the gold standard, especially the major countries at its center, of which Britain was the most important.

Ultimately, however, the credibility of the prewar gold standard rested on international cooperation. When the stabilizing speculation and domestic intervention proved incapable of accommodating a disturbance, the system was stabilized through cooperation among governments and central banks. Minor problems could be solved by tacit cooperation, generally achieved without open communication among the parties involved. . .  Under such circumstances, the most prominent central bank, the Bank of England, signaled the need for coordinated action. When it lowered its discount rate, other central banks usually responded in kind. In effect, the Bank of England provided a focal point for the harmonization of national monetary policies. . .

Major crises in contrast typically required different responses from different countries. The country losing gold and threatened by a convertibility crisis had to raise interest rates to attract funds from abroad; other countries had to loosen domestic credit conditions to make funds available to the central bank experiencing difficulties. The follow-the-leader approach did not suffice. . . . Such crises were instead contained through overt, conscious cooperation among central banks and governments. . . Consequently, the resources any one country could draw on when its gold parity was under attack far exceeded its own reserves; they included the resources of the other gold standard countries. . . .

What rendered the commitment to the gold standard credible, then, was that the commitment was international, not merely national. That commitment was achieved through international cooperation. (pp. 7-8)

Eichengreen uses this excellent conceptual framework to explain the dysfunction of the newly restored gold standard in the 1920s. Because of the monetary dislocation and demonetization of gold during World War I, the value of gold had fallen to about half of its prewar level, thus to reestablish the gold standard required not only restoring gold as a currency standard but also readjusting – sometimes massively — the prewar relative values of the various national currency units. And to prevent the natural tendency of gold to revert to its prewar value as gold was remonetized would require an unprecedented level of international cooperation among the various countries as they restored the gold standard. Thus, the gold standard was being restored in the 1920s under conditions in which neither the credibility of the prewar commitment to the gold standard nor the level of international cooperation among countries necessary to sustain that commitment was restored.

An important further contribution that Eichengreen, following Temin, brings to the historical narrative of the Great Depression is to incorporate the political forces that affected and often determined the decisions of policy makers directly into the narrative rather than treat those decisions as being somehow exogenous to the purely economic forces that were controlling the unfolding catastrophe.

The connection between domestic politics and international economics is at the center of this book. The stability of the prewar gold standard was attributable to a particular constellation of political as well as economic forces. Similarly, the instability of the interwar gold standard is explicable in terms of political as well as economic changes. Politics enters at two levels. First, domestic political pressures influence governments’ choices of international economic policies. Second, domestic political pressures influence the credibility of governments’ commitments to policies and hence their economic effects. . . (p. 10)

The argument, in a nutshell, is that credibility and cooperation were central to the smooth operation of the classical gold standard. The scope for both declined abruptly with the intervention of World War I. The instability of the interwar gold standard was the inevitable result. (p. 11)

Having explained and focused attention on the necessity for credibility and cooperation for a gold standard to function smoothly, Eichengreen then begins his introductory account of how the lack of credibility and cooperation led to the breakdown of the gold standard that precipitated the Great Depression, starting with the structural shift after World War I that made the rest of the world highly dependent on the US as a source of goods and services and as a source of credit, rendering the rest of the world chronically disposed to run balance-of-payments deficits with the US, deficits that could be financed only by the extension of credit by the US.

[I]f U.S. lending were interrupted, the underlying weakness of other countries’ external positions . . . would be revealed. As they lost gold and foreign exchange reserves, the convertibility of their currencies into gold would be threatened. Their central banks would be forced to  restrict domestic credit, their fiscal authorities to compress public spending, even if doing so threatened to plunge their economies into recession.

This is what happened when U.S. lending was curtailed in the summer of 1928 as a result of increasingly stringent Federal Reserve monetary policy. Inauspiciously, the monetary contraction in the United States coincided with a massive flow of gold to France, where monetary policy was tight for independent reasons. Thus, gold and financial capital were drained by the United States and France from other parts of the world. Superimposed on already weak foreign balances of payments, these events provoked a greatly magnified monetary contraction abroad. In addition they caused a tightening of fiscal policies in parts of Europe and much of Latin America. This shift in policy worldwide, and not merely the relatively modest shift in the United States, provided the contractionary impulse that set the stage for the 1929 downturn. The minor shift in American policy had such dramatic effects because of the foreign reaction it provoked through its interactions with existing imbalances in the pattern of international settlements and with the gold standard constraints. (pp. 12-13)

Eichengreen then makes a rather bold statement, with which, despite my agreement with, and admiration for, everything he has written to this point, I would take exception.

This explanation for the onset of the Depression, which emphasizes concurrent shifts in economic policy in the Unites States and abroad, the gold standard as the connection between them, and the combined impact of U.S. and foreign economic policies on the level of activity, has not previously appeared in the literature. Its elements are familiar, but they have not been fit together into a coherent account of the causes of the 1929 downturn. (p. 13)

I don’t think that Eichengreen’s claim of priority for his explanation of the onset of the 1929 downturn can be defended, though I certainly wouldn’t suggest that he did not arrive at his understanding of what caused the Great Depression largely on his own. But it is abundantly clear from reading the writings of Hawtrey and Cassel starting as early as 1919, that the basic scenario outlined by Eichengreen was clearly spelled out by Hawtrey and Cassel well before the Great Depression started, as papers by Ron Batchelder and me and by Doug Irwin have thoroughly documented. Undoubtedly Eichengreen has added a great deal of additional insight and depth and done important quantitative and documentary empirical research to buttress his narrative account of the causes of the Great Depression, but the basic underlying theory has not changed.

Eichengreen is not unaware of Hawtrey’s contribution and in a footnote to the last quoted paragraph, Eichengreen writes as follows.

The closest precedents lie in the work of the British economists Lionel Robbins and Ralph Hawtrey, in the writings of German historians concerned with the causes of their economy’s precocious slump, and in Temin (1989). Robbins (1934) hinted at many of the mechanism emphasized here but failed to develop the argument fully. Hawtrey emphasized how the contractionary shift in U.S. monetary policy, superimposed on an already weak British balance of payments position, forced a draconian contraction on the Bank of England, plunging the world into recession. See Hawtrey (1933), especially chapter 2. But Hawtrey’s account focused almost entirely on the United States and the United Kingdom, neglecting the reaction of other central banks, notably the Bank of France, whose role was equally important. (p. 13, n. 17)

Unfortunately, this footnote neither clarifies nor supports Eichengreen’s claim of priority for his account of the role of the gold standard in the Great Depression. First, the bare citation of Robbins’s 1934 book The Great Depression is confusing at best, because Robbins’s explanation of the cause of the Great Depression, which he himself later disavowed, is largely a recapitulation of the Austrian business-cycle theory that attributed the downturn to a crisis caused by monetary expansion by the Fed and the Bank of England. Eichengreen correctly credits Hawtrey for attributing the Great Depression, in almost diametric opposition to Robbins, to contractionary monetary policy by the Fed and the Bank of England, but then seeks to distinguish Hawtrey’s explanation from his own by suggesting that Hawtrey neglected the role of the Bank of France.

Eichengreen mentions Hawtrey’s account of the Great Depression in his 1933 book, Trade Depression and the Way Out, 2nd edition. I no longer have a copy of that work accessible to me, but in the first edition of this work published in 1931, Hawtrey included a brief section under the heading “The Demand for Gold as Money since 1914.”

[S]ince 1914 arbitrary changes in monetary policy and in the demand for gold as money have been greater and more numerous than ever before. Frist came the general abandonment of the gold standard by the belligerent countries in favour of inconvertible paper, and the release of hundreds of millions of gold. By 1920 the wealth value of gold had fallen to two-fifths of what it had been in 1913. The United States, which was almost alone at that time in maintaining a gold standard, thereupon started contracting credit and absorbing gold on a vast scale. In June 1924 the wealth value of gold was seventy per cent higher than at its lowest point in 1920, and the amount of gold held for monetary purposes in the United States had grown from $2,840,000,000 in 1920 to $4,488,000,000.

Other countries were then beginning to return to the gold standard, Gemany in 1924, England in 1925, besides several of the smaller countries of Europe. In the years 1924-8 Germany absorbed over £100,000,000 of gold. France stabilized her currency in 1927 and re-established the gold standard in 1928, and absorbed over £60,000,000 in 1927-8. But meanwhile, the Unitd States had been parting with gold freely and her holding had fallen to $4,109,000,000 in June 1928. Large as these movements had been, they had not seriously disturbed the world value of gold. . . .

But from 1929 to the present time has been a period of immense and disastrous instability. France has added more than £200,000,000 to her gold holding, and the United Statesmore than $800,000,000. In the two and a half years the world’s gold output has been a little over £200,000,000, but a part of this been required for the normal demands of industry. The gold absorbed by France and America has exceeded the fresh supply of gold for monetary purposes by some £200,000,000.

This has had to be wrung from other countries, and much o of it has come from new countries such as Australia, Argentina and Brazil, which have been driven off the gold standard and have used their gold reserves to pay their external liabilities, such as interest on loans payable in foreign currencies. (pp. 20-21)

The idea that Hawtrey neglected the role of the Bank of France is clearly inconsistent with the work that Eichengreen himself cites as evidence for that neglect. Moreover in Hawtrey’s 1932 work, The Art of Central Banking, his first chapter is entitled “French Monetary Policy” which directly addresses the issues supposedly neglected by Hawtrey. Here is an example.

I am inclined therefore to say that while the French absorption of gold in the period from January 1929 to May 1931 was in fact one of the most powerful causes of the world depression, that is only because it was allowed to react an unnecessary degree upon the monetary policy of other countries. (p. 38)

In his foreward to the 1962 reprinting of his volume, Hawtrey mentions his chapter on French Monetary Policy in a section under the heading “Gold and the Great Depression.”

Conspicuous among countries accumulating reserves foreign exchange was France. Chapter 1 of this book records how, in the course of stabilizing the franc in the years 1926-8, the Bank of France accumulated a vast holding of foreign exchange [i.e., foreign bank liabilities payable in gold], and in the ensuing years proceeded to liquidate it [for gold]. Chapter IV . . . shows the bearing of the French absorption of gold upon the starting of the great depression of the 1930s. . . . The catastrophe foreseen in 1922 [!] had come to pass, and the moment had come to point to the moral. The disaster was due to the restoration of the gold standard without any provision for international cooperation to prevent undue fluctuations in the purchasing power of gold. (pp. xiv-xv)

Moreover, on p. 254 of Golden Fetters, Eichengreen himself cites Hawtrey as one of the “foreign critics” of Emile Moreau, Governor of the Bank of France during the 1920s and 1930s “for failing to build “a structure of credit” on their gold imports. By failing to expand domestic credit and to repel gold inflows, they argued, the French had violated the rules of the gold standard game.” In the same paragraph Eichengreen also cites Hawtrey’s recommendation that the Bank of France change its statutes to allow for the creation of domestically supplied money and credit that would have obviated the need for continuing imports of gold.

Finally, writers such as Clark Johnson and Kenneth Mouré, who have written widely respected works on French monetary policy during the 1920s and 1930s, cite Hawtrey extensively as one of the leading contemporary critics of French monetary policy.

PS I showed Barry Eichengreen a draft of this post a short while ago, and he agrees with my conclusion that Hawtrey, and presumably Cassel also, had anticipated the key elements of his explanation of how the breakdown of the gold standard, resulting largely from the breakdown of international cooperation, was the primary cause of the Great Depression. I am grateful to Barry for his quick and generous response to my query.

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37 Responses to “Friedman and Schwartz, Eichengreen and Temin, Hawtrey and Cassel”


  1. 1 James Beckman January 23, 2019 at 8:01 pm

    An enormous comment, with which I agree within the confines of orthodox economic theory. As an American long resident in Germany & Denmark, I see sequestered gold often not being used effectively to support product pricing & overall economic activity. Working in the opposite direction naturally is the re-pricing of gold itself.
    On the Central Bank issue one notices that European culture mitigates against massive additional economic activity as many adhere to the general German credo of earn & save. US borse culture on the other hand is closer to speculate…and speculate. Witness IT stock valuations for example. With China the equal in competence in most IT sectors, the US has met China to share in global company valuations. Amazon/FB/Google for example hardly exist in China, while Apple is falling & Microsoft remains weak. Amazon does not look promising in India. So from where does money appear from a rampant stock market or actual investment programs? All-electric mobility, autonomous driving & cloud storage are three reasons for massive real investment as all probably are aware.
    The attack by the US upon Huawei seems as much as an attempt to reduce a competent competitor as it might be a concern about future spying activity, when the US itself is by far the world’s greatest spy–even to tapping the phones of Germany’s political leadership.

  2. 2 Philip George January 24, 2019 at 3:21 am

    The price of gold went up from $ 21 in 1929 to $ 35 in 1935. It went up from $ 500 in 2005 to $1,000 in 2009 (rough figures). But no one has suggested that gold is in any way responsible for the Great Recession.

    The far more obvious explanation follows from the fact that both recessions were accompanied by a collapse in asset markets: the stock market in the Great Depression and the housing and stock markets in the Great Recession.

    The increase in the demand for gold was simply a consequence of the collapse of other asset markets. In the next recession, too, the price of gold will behave the same way.

    Friedman was right in saying that the Great Depression was set off by a monetary contraction. But both his view of money as an asset and his measurement of money were incorrect, which is also why he concluded that in the years before the Great Crash, when stock prices soared, the quantity of money had remained steady. Also, as you rightly pointed out, he was incorrect in thinking that a central bank could control money supply.

    Keynes was right in thinking that the Depression was caused by a fall in effective demand. Where he was wrong was in believing that it was caused by a fall in investment demand, which in turn was caused by a depletion of animal spirits among capitalists.

    Friedman’s money (with the caveats mentioned above) and Keynes’s effective demand amount to roughly the same thing. A dollar of money can buy a dollar of effective demand.

    The fall in stock prices set off a fall in consumption demand. The fall in investment demand was a consequence of the fall in consumption. What capitalist would continue to produce goods that could not be sold or make investments when even current production could not be sold.

  3. 3 citizencokane January 24, 2019 at 8:48 am

    The essential problem leading up to the Great Depression is that there had been too little world gold production in the preceding decades relative to the expansion of the world’s broad money supply. How can national governments collectively continue to credibly promise to back that broad money supply with at the old ratio of redemption for gold when world gold production is not keeping up? Sure, an individual country like France can always find a way to do so, but it comes at the cost of depriving other countries of the gold they need for backing. It becomes a zero-sum game if the world gold stockpile has not been growing fast enough. And true, the world gold stockpile’s growth does not show drastic swings in that period. But there is a big accumulated difference if it has been growing at 2% for year for the preceding 20 years vs. 3% per year for the preceding 20 years.

    This author portrays the demand for gold around the time of the Great Depression as anomalous, but there was nothing anomalous about it. If anything, the demand for gold was anomalously low in the 1920s as people had unwarranted confidence in the boom. Their ownership of gold had declined as a relative percentage of their total assets. The sudden demand for gold during the Great Depression was merely a reversion to the mean (or a slight overshoot of it, as happens in turbulent systems). The problem was too little gold supply.

    If there is too little gold on the world market to support the existing backing ratios, then why can’t everyone devalue their currencies vs. gold at once? Aside from the obvious political problems with coordinating this among distrustful national governments, there is also the problem that the anticipation of this devaluation always produced its own problems—problems that the gold standard existed to prevent in the first place! It was Roosevelt’s ambiguous comments about the U.S. gold standard just before his inauguration that provoked the final bank panic in early 1933 as depositors rushed to cash out their deposits while they could still get 1/20th an oz. of gold for each dollar as opposed to 1/35th an oz. gold (or whatever they feared Roosevelt might end up devaluing the dollar to).

    To have a devaluation and avoid these horrible complications, you’d need to not only coordinate this with all the other major national governments, but also keep word of it completely under wraps from the world public and spring it upon them as a sudden fait accompli, kind of like Modi’s recent demonetization of certain Indian currency bills. And boy would any such governments participating in this sudden devaluation be unpopular! It would be little solace to tell your constituents that devaluing their dollar savings vs. gold was for their own good to prevent a world economic depression…kind of like how Modi’s excuse of wanting to fight tax evasion and organized crime fails to satisfy everyone’s grievances with the hassle of the recent demonetization in India.

    What about closing the gold window entirely, as Nixon did in 1971? Well, that’s just a more extreme version of devaluation. Once again, if any word leaks out ahead of time that governments are considering this, a bank run will gather steam out ahead of the event. And then even once it is accomplished, governments must, like in the 1970s, then deal with the inevitable ensuing “revolt of the bondholders” as creditors to the national government, consumers, and businesses suddenly demand much higher interest rates to compensate for the fact that they could otherwise just buy gold and get 20%+ yearly returns. (This problem can also emerge to a lesser extent even after a mere devaluation as both debtors and creditors wonder, now that the government has shown its promises to be bunk, whether additional devaluations are coming in the near future, and whether both parties should thus price in this devaluation risk into their interest rates they charge or are willing to accept).

    So, if devaluation or even an exit from the gold standard altogether were problematic options, what else could national governments have done? Encourage more world gold production. How could they have done that? By moderating the preceding expansion of credit and broad money supply, which kept commodity prices elevated (or during WW1 even forced those commodity prices to rise). This meant gold mining faced relatively higher-priced inputs and, since the currency-price of gold was itself fixed, less profitability to be found in the mining of gold, which discouraged gold mining and made it unlikely that the world gold stockpile would keep growing at the same pace as the world broad money supply. WW1, of course, was the worst offender in this regard, by spiking inflation and decreasing world gold production.

    So, my advice for how to avoid the Great Depression would be: don’t have WW1 in the first place. After WW1, a severe financial dislocation was assured, whether it took the form of a depression (if governments tried to keep with the old gold/currency standards), or bank runs and creditor revolts if governments devalued or left the standard entirely. Sorry, it’s not a pleasant conclusion. It’s not something people will want to hear (which is why I suspect this interpretation of the Great Depression will fail to catch on. People like to always imagine that something could have been done. Nope, sorry).

  4. 4 daniel berg January 24, 2019 at 9:40 am

    what do you think of Richard Koo’s argument that the Great Depression was really about debt; ie paying down debt – and Friedman only looked at one side of the balance sheet?

  5. 5 Nick Rowe January 24, 2019 at 10:55 am

    Lovely post David.

    Two typos, the second of which is very minor but important for understanding what happened.

    1. “I’ll note parenthetically that Keynes himself was also responsible for this unnecessary and distracting detour, because the General Theory was written almost entirely in the context of a closed economy model with an exogenously determined quantity of money, thereby unwittingly providing [Friedman?] with a useful tool with which to propagate his Monetarist narrative.”

    2. “But from 1929 to the present time has been a period of immense and disastrous instability. France has added more than £200,000,000 to her gold holding, and the United States more than $800,00,000. ”

    Is there a missing 0 in that figure for the US, or is the first comma in the wrong place? My guess is the comma, but you can see why it matters.

  6. 6 Nick Rowe January 24, 2019 at 10:57 am

    On second thoughts, it’s maybe a missing 0, because I just noticed one is in $ and the other in pounds.

  7. 7 David Glasner January 24, 2019 at 11:01 am

    Phillip, The effects of an increase in the value of gold are entirely different under a gold standard when nominal prices are in terms of a fixed amount of gold and under a fiat standard when nominal prices are completely disconnected from the value of gold. That’s kind of basic.

    citizencokane, The amount of reserves necessary to maintain convertibility is actually extremely small. The reason that gold reserves tended to increase nearly proportionately with the amount of demand liabilities convertible into gold was not because of the requirements of convertibility but because of legal reserve requirements. Required reserves are essentially held idle in bank vaults and are unavailable to those seeking to redeem liabilities in terms of gold. Excess reserves over and above legally required reserves had to be held to satisfy demands for redemption. It’s like forcing fire departments to hold water in tanks but not allowing them to draw the water levels down when there’s a fire.

    daniel, Koo is confused between the cause of the Depression, which was deflation, and the effect of deflation which was to increase the debt burden and force reduced consumption in a futile attempt to maintain solvency.

  8. 8 David Glasner January 24, 2019 at 11:12 am

    Nick, Many thanks for your kind words and for catching the typo. It is a missing zero. I was also confused by the passage when I read it the first time, until I realized that there were pounds and dollars and that a pound was worth nearly $5 in those days.

  9. 9 Henry Rech January 24, 2019 at 2:57 pm

    Citizencokane,

    During the 1920s, gold production was about US$400M pa, enough to meet the level that Cassel argued was sufficient to meet monetary requirements. There was no shortage of gold.

  10. 10 Henry Rech January 25, 2019 at 5:58 am

    David,

    Hawtrey may have been a critic of the French accumulation of gold. He was also a trenchant opponent of the high bank rate used by the British in defence of the pound’s parity to gold.

    In past discussions we’ve had, you have been dismissive of my claim that the British transferred deflation to the rest of the world. Hawtrey before the Macmillan Committee made the following comments:

    “The effect of dear money in England was to lower world price levels (by restricting the credit available for the purchase of goods)…. due the the position of London as… the centre from which a great part of the international trade of the world is financed…”

    He also wrote in his “A Century of the Bank Rate” (p.141):

    “It is, I think not unreasonable to hold that a policy of cheap money and credit relaxation from the beginning would have had a favourable effect on economic activity throughout the world in 1925….”

    In other words, Hawtrey is saying the the British transferred their deflation to the rest of the world as a result of defending an overvalued pound.

    I haven’t read “Golden Fetters” as yet, but from what I can see Eichengreen has paid little attention to the notion that the British contributed to the deflation of the mid to late 1920s and the destruction of the world monetary system. (Perhaps you can correct this misapprehension if it is such.)

    You rate the French accumulation of gold as the prime contributor to the demise of the international monetary system and the cause of the Great Depression, with the US Fed a close second.

    It is clear that Hawtrey would argue that the other side of the mild undervaluation of the Franc coin was the deeper overvaluation of the pound.

    Given the importance of the British economy to the world economy at the time, I would argue that it was the insane British policy of stubbornly defending the pound’s parity that wrought considerable damage to and structural weakening of the world economy during the mid to late 1920s. The British were determined to preserve the primacy of London as the world financial centre at all costs – at the cost of high unemployment at home and the cost of world deflation.

  11. 11 David Glasner January 28, 2019 at 9:34 am

    Henry, You make a good point in referring to Hawtrey’s view that Britain (i.e., the Bank of England) could have helped to counteract the disastrous effects of insane policy of the Bank of France had it been courageous enough to take the unconventional approach of reducing instead of increasing Bank rate in 1929-31 despite the risk that in doing so, it would lose a substantial part of its modest gold reserves. Hawtrey’s position was based on the assumption that if the Bank of England reduced Bank rate and was willing to tolerate a loss of reserves, other central banks would have followed the British lead and reduced their lending rates and would have been less eager to accumulate gold reserves, thereby counteracting the deflationary effects of the insane policy of the Bank of France. Hawtrey may have been right, but his assumption was entirely speculative and may have overestimated the influence of the Bank of England in the 1920s. Before World War I, The Bank of England certainly had enormous influence on the other central banks of the world. Whether it retained that influence after World War I is not so clear. Hawtrey assumed that the Bank of England retained that influence, or at least that was worth taking the gamble that it retained that influence. Here is how Hawtrey put it in his response to a question put to him by the Chairman Macmillan during his testimony to the Macmillan Committee

    MACMILLAN. . . . the course you suggest would not have been consistent with what one may call orthodox Central Banking, would it?

    HAWTREY. I do not know what orthodox Central Banking is.

    MACMILLAN. . . . when gold ebbs away you must restrict credit as a general principle?

    HAWTREY. . . . that kind of orthodoxy is like conventions at bridge; you have to break them when the circumstances call for it. I think that a gold reserve exists to be used. . . . Perhaps once in a century the time comes when you can use your gold reserve for the governing purpose, provided you have the courage to use practically all of it.

  12. 12 Henry Rech January 28, 2019 at 2:54 pm

    David,

    Hawtrey also believed that world prices would rise if the UK bank rate was reduced, easing pressure on the pound and while there would be an initial run on British gold, it would turn around as relative prices adjusted. The policy hardnuts in Treasury (Niemeyer, Leith-Ross) and the Bank (Norman) would have none of this. They were intent on preserving the City of London’s primacy as a finance centre – a strong sterling was key to this policy. In the end, the overvaluation of the pound drove the UK to the wall and encouraged the opposite – who in their right mind would park funds in a centre whose currency was obviously overvalued (actually the French did for a time, intent on easing the pressure on British gold and the pound – the French accumulated huge balances of foreign exchange, some of it in sterling held in City of London banks).

    Your incessant talk of the “insane policy of the Bank of France” is laughable. There was no such policy. The French did endeavour to return their gold holdings to levels prewar prior to the stabilization of the franc in the mid 1920s. That having been accomplished, confidence in the franc burgeoned both in France and abroad. Repatriated French capital and foreign capital began to pour in (the balance of trade was also positive), in preference to sterling. In the year 1928, the holdings of foreign exchange went from 535M SF (swiss francs) to 6,657M SF. So not all inflows were converted to gold – the French exhibited great restraint. In June 1931, just prior to the crisis in the pound, the French still held 5,317M SF in foreign exchange. The French had progressively reduced their discount rate to 3.5%, yet the inflows continued. The 1928 annual report of the Bank of France said the Bank was powerless to halt the flow of speculative funds and the increasing purchase of offered foreign bills became “more and more embarrassing”. Through all of this the French were desperate to forestall the revival of inflation which had destroyed the economy and the franc in the early to mid 1920s.

    The French government removed the restriction on the export of domestic capital (put in place I think in earlier years to stabilize the franc). In 1930, the French significantly reduced stamp taxes on foreign securities and reduced tax on foreign earned interest, all designed to ease the inflows of capital and encourage the outflow of capital. When the crisis on the continent emerged in mid 1930, the French accepted requests for loan assistance from the British.

    Not converting their foreign exchange balances to gold, enabled credit conditions in the major finance centres to remain unchanged. A fact I have not seen acknowledged in the literature.

    If the British pound was not held at the level it was, the French predicament would have been entirely reversed.

  13. 13 Henry Rech January 28, 2019 at 2:57 pm

    ” When the crisis on the continent emerged in mid 1930….”

    That should be 1931.

  14. 14 nottrampis January 28, 2019 at 3:20 pm

    Another great article David. Well done. I might have learnt almost as much in the comments made as well

  15. 15 David Glasner January 28, 2019 at 5:03 pm

    Henry,

    Thanks for this reply. I’m glad to learn that you find my description of the Bank of France amusing. If I can’t be educational, at least I’m entertaining, which in these sordid times is no small thing.

    You’re correct that Hawtrey hoped that a loosening of Bank of England policy would raise the world price level in terms of gold. There would not necessarily be a run on British gold but there would be an efflux of gold from the Bank of England. That efflux would not have much effect on the world price level, but Hawtrey believed that other cental banks would reduce their interest rates in response to the cut in Bank rate, as gold flowed into their vaults. There was no relative price adjusment just a rise in the world price level thereby reducing the modest overvaluation of sterling. The French did indeed hold a sizeable amount of foreign exchange rather then gold until 1928 when upon reestablishing convertibility began converting foreign exchange (British and US balances) into gold. There was no reason not to hold foreign exchange in terms of sterling until the 1931, because no one believed that Britain would gol off the gold standard, and until rampant deflation started in 1930, there was no reason why it would have made sense for Britain to go off the gold standard.

    You are just repeating the nonsensical apologetics of the Bank of France in justifying their insane policy. French gold holdings more than quadrupled between December 1926 and June 1932. In relative terms French holdings of gold in December 1926 were 7.7% of the total amount of gold held by central banks; in Juen 1932 France held 28.4% of all the gold held by central banks. The apolgetics of defenders of the Bank of France were thoroughly debunked by Hawtrey in his essay on French monetary policy reprinted as chapter one of The Art of Central Banking, and have subsequently been further discredited by studies by Eichengreen, Bernanke, Moure, and Johnson. So you are not only arguing against me, you are arguing against Hawtrey, Eichengreen, Bernanke, Moure, and Johnson and for all I know any number of other scholars who have studied the insane policy of the Bank of France. We have been through all this before, but evidently I have not made any progress in persuading you. So be it, but I will try to at least keep you laughing.

  16. 16 Henry Rech January 28, 2019 at 5:31 pm

    “Having explained and focused attention on the necessity for credibility and cooperation for a gold standard to function smoothly, Eichengreen then begins his introductory account of how the lack of credibility and cooperation led to the breakdown of the gold standard that precipitated the Great Depression…..”

    Not having read “Golden Fetters” I will tread carefully.

    Eichengreen may have argued the that there was little credibility and cooperation. However, what was the point of credibility and cooperation if the cause of the disequilibrium in the world monetary system was the gross overvaluation of sterling and those that were responsible for the overvaluation were obdurate and implacable to any change.

    That sterling was clearly overvalued was demonstrated by Britain being forced to end convertibility in 1931 and the currency collapsing by c. 10%. The imbalances and the pressures in the world monetary system came to a head. The markets eventually had their way.

    “Moreover, on p. 254 of Golden Fetters, Eichengreen himself cites Hawtrey as one of the “foreign critics” of Emile Moreau, Governor of the Bank of France during the 1920s and 1930s “for failing to build “a structure of credit” on their gold imports. By failing to expand domestic credit and to repel gold inflows, they argued, the French had violated the rules of the gold standard game.””

    What exactly does this mean? As foreign capital flowed into France, it was exchanged for franc notes or balances. The French monetary aggregates grew accordingly. There was no need to expand domestic credit directly. Additionally, given the strength of inflows, the French had to be careful not to set off another inflationary episode. The French fear of inflation was pathological.

    “In the same paragraph Eichengreen also cites Hawtrey’s recommendation that the Bank of France change its statutes to allow for the creation of domestically supplied money and credit that would have obviated the need for continuing imports of gold.”

    Ditto.

    Hawtrey should have concentrated his efforts on having the British reflate their economy.

  17. 17 Henry Rech January 28, 2019 at 7:35 pm

    “You are just repeating the nonsensical apologetics of the Bank of France in justifying their insane policy.”

    Equally I’m not making any progress the other way.

    The point is there was no policy. Private individuals/organizations/governments decided where to put their money. They overwhelmingly decided it was to be Paris. The reason was that the franc was undervalued and sterling overvalued. The fact that these flows occurred counters your comments below:

    “There was no reason not to hold foreign exchange in terms of sterling until the 1931, because no one believed that Britain would gol off the gold standard, and until rampant deflation started in 1930, there was no reason why it would have made sense for Britain to go off the gold standard.”

    The point is these flows did occur. Why did they occur? Speculators and holders of capital could see the pound was overvalued. You would have to have rocks in your head if you put your money in London.

    Hawtrey was a high level, long term, paid employee of the British Treasury – I can’t imagine he would have had much room to move in his public opinions, even though he was at odds, at times, with his superiors.

    Through the period of the mid to late 1920s, the US Fed gathered a great deal of gold, but essentially no foreign exchange holdings. It obviously chose to convert all inflows into gold. The French held, for several years, half their reserves in foreign exchange. As the inflows continued they progressively increased their gold holdings. At least they attempted to show restraint.

    “So you are not only arguing against me, you are arguing against Hawtrey, Eichengreen, Bernanke, Moure, and Johnson ”

    You inadvertently forgot Irwin. 🙂

    These people have done incomplete scholarship. They have only looked at the question of what France could have done given the huge influx of capital, as far as I can see. They seem to not have addressed the question of why these flows occurred at all. They essentially occurred because of the gross overvaluation of sterling. If the pound had of been sensibly valued, London would have had its share of hot money flows. Had the Brits reflated their economy, the rest of the world would have remained safe, as Hawtrey rightly argued.

  18. 18 David Glasner January 29, 2019 at 8:31 am

    nottrampis, Thanks so much.

  19. 19 David Glasner January 29, 2019 at 9:43 am

    Henry, For the nth time, the cause of the disequilibrium was not the overvaluation of the pound. The overvaluation of the pound was a drag on the British recovery from the disastrous 1920-22 depression, but it had minimal significance for the rest of the world, as evidenced by the fact that the world economy with a short pause in 1927 continued to grow briskly after Britain rejoined the gold standard in March 1925. The magnitude of sterling overvaluation steadily decreased in the interim as evidenced by the relative decline in the British price level to the US price level and by steady growth and declining unemployment in Britain between 1925 and 1929, and by a modest increase in the gold reserves held by the Bank of England. So your assertions about the British role in the Great Depression are flatly contradicted by the basic, and well-known, facts. To be sure, Hawtrey was critical of British monetary policy, arguing that more rapid growth could have been achieved had the Bank of England been more daring in its monetary policy and reduced Bank rate, tolerating an eflux of gold in the expectation that other central banks would have loosened their monetary policies as well. Whether he was right or wrong in that assessment, I am not in a position to judge.

    That Britain abandoned the gold standard in 1931 was an eminently sound decision that had almost nothing to do with overvaluation of sterling and everything to do with stopping a deflation in terms of gold. Again for the nth time, those are two very different reasons for abandoning convertibility, and it is a category mistake to confuse them.

    You said:

    “As foreign capital flowed into France, it was exchanged for franc notes or balances. The French monetary aggregates grew accordingly. There was no need to expand domestic credit directly. Additionally, given the strength of inflows, the French had to be careful not to set off another inflationary episode. The French fear of inflation was pathological.”

    Again for the nth time, the flow of foreign capital into France was not spontaneous. There may have been a spontaneous influx immediately after Poncare stabilized the franc in 1926 as French citizens repatriated balances they had sent abroad during the preceding inflation, but after that, the influx of capital reflected either the liquidation by the Bank of France of its foreign exchange reserves for gold or an export surplus caused by the fact that the only way available to increase cash holdings was to import gold inasmuch as the Bank of France was issuing banknotes or creating bank reserves only in exchange for gold. Normal central banks issue banknotes and create bank reserves in exchange for domestic assets. When that mechanism for increasing the amount of cash in the economy is suppressed as it was in France, the only method for increasing the amount of cash in the economy is to import gold. If domestic credit were expanded, there would have been no need or occasion for gold imports. That domestic credit was not increased meant that the increased demand for money was identical to an increased demand for gold, causing the world value of gold to increase imposing deflation on the entire world. I call insanity!

    You said:

    “The point is there was no policy. Private individuals/organizations/governments decided where to put their money. They overwhelmingly decided it was to be Paris. The reason was that the franc was undervalued and sterling overvalued. The fact that these flows occurred counters your comments below:”:

    No, the point is that what you call the inflow of capital into France was the result of policies deliberately chosen by France that had hugely negative consequences for the rest of the world. Under a gold standard, prices adjust to the gold parities that are chosen, so that overvaluation or undervaluation is a temporary phenomenon. The extent of British overvaluation was gradually diminishing, but the French undervaluation was maintained by a monetary policy that made it impossible for additional cash to be created in France except upon the shipment of foreign gold into the Bank of France. Again I call insanity!

    The only reason Britain went off the gold standard in 1931 is because the willingness of the British government to inflict pain on the British population had reached its limit. That was not the result of overvaluation of sterling. It had to do with the fact that prices in terms of gold everywhere where falling at a 10% annual rate.

    You said:

    “Through the period of the mid to late 1920s, the US Fed gathered a great deal of gold, but essentially no foreign exchange holdings. It obviously chose to convert all inflows into gold. The French held, for several years, half their reserves in foreign exchange. As the inflows continued they progressively increased their gold holdings. At least they attempted to show restraint.”

    The US accumulation of gold peaked in 1924-25. Afterwards it declined somewhat, except in the late 1928 and 1929, when the Fed in its panicky response to a rising stock market perversely raised interest rates ad induced an inflow of gold even as the French were busily liquidating their foreign exchange reserves and undertaking the greatest gold-accumulation binge in human history. You call it restraint; I call it insanity!

    You said:

    “You inadvertently forgot Irwin. 🙂”

    I did indeed. My apologies to Doug and to Scott Sumner whom I should have mentioned as well.

    You said:

    “These people have done incomplete scholarship. They have only looked at the question of what France could have done given the huge influx of capital, as far as I can see. They seem to not have addressed the question of why these flows occurred at all.”

    Please don’t impugn the scholarship of “these people.” If they have not looked into the question of what France could have done given the huge influx of capital, it is because, unlike you, they don’t accept the self-serving assertions of the Bank of France and their apologists that the huge influx of capital just happened because people were so fond of France and its undervalued currency. Instead, they actually explained why these flows occurred at all, which is exactly what Hawtrey had done already in 1932 in chapter 1 of The Art of Central Banking, identifying the cause of the influx of gold as deliberate policy of the Bank of France to make it impossible for the stock of money in France to grow unless gold was deposited into the Bank of France. For the nth time, normal central banks exchange currency and bank reserves for domestic assets, not just gold. Insane central banks exchange domestic currency and bank reserves for gold and nothing else.

  20. 20 Henry Rech January 30, 2019 at 3:59 am

    David,

    Your comments in quotes unless otherwise mentioned.

    “…….declining unemployment in Britain between 1925 and 1929”

    Unemployment hovered around 7-8%, hardly a comfortable level.

    “Hawtrey was critical of British monetary policy, ………Whether he was right or wrong in that assessment, I am not in a position to judge.”

    It seems that you are happy to accept most things Hawtrey writes as holy writ except on this point. If you were to accept it, it would mean you would have to go along way in the direction of agreeing with me.

    “….. the influx of capital reflected either the liquidation by the Bank of France of its foreign exchange reserves for gold …….”

    How were these foreign exchange balances accumulated in the first place?

    “That was not the result of overvaluation of sterling. It had to do with the fact that prices in terms of gold everywhere where falling at a 10% annual rate.”

    This is two ways of saying the same thing.

    “the influx of capital reflected either the liquidation by the Bank of France of its foreign exchange reserves for gold or an export surplus caused by the fact that the only way available to increase cash holdings was to import gold inasmuch as the Bank of France was issuing banknotes or creating bank reserves only in exchange for gold. ”

    You may not believe the annual reports of the Bank of France and the rhetoric of Rist, Moreau et al. Aftalion (League of Nations, Report of Gold Delegation) claims, as I have attempted to explain, that the inflows were the result of capital repatriation, the positive balance of payments and speculative capital inflows. Perhaps he was duped by these “apologists” for the Bank of France.

    “Please don’t impugn the scholarship of “these people.”

    This is going a tad overboard. The people you named are all eminent and accomplished scholars.

    Seemingly concurring with the points I have been trying to make over several discussions with you (and read for the first time today), Clark Johnson in his book said the following (p184 – 185), my note in parenthesis:

    “…..the overvaluing of sterling weakened both currency and the influence of the Bank of England upon world reserve movements and prices in the longer period more than a devaluation would have.”

    And,

    “After their error of 1925 (i.e. return to prewar parity), the British could only hope for effective economization of gold by the United States and France. Had sterling instead been devalued in 1925, the Bank of England might have had more influence upon the distribution of world reserves. This might have been enough to slow the descent of prices and output that occurred after 1928; almost certainly, the Bank of France would have drawn less gold.”

    He went on to add,

    “However, this argument will be too conjectural for most readers: no one writing in 1925 – and certainly no one in a decision making role – showed that amount of prescience.”

    I would say that Hawtrey, perhaps, did have that prescience.

  21. 21 David Glasner January 30, 2019 at 11:41 am

    Henry, I agree that unemployment in Britain was high, too high. But the trend was slowly downward from 1925 to 1929. Unemployment did not rise until the international situation worsened. Economic conditions in Britain deteriorated as conditions worsened in all gold standard countries. Britain was not the source of the deterioration.

    Your remark about my taking Hawtrey’s word as holy writ except about British monetary policy as holy writ misconstrues what I said. When I said that whether Hawtrey’s assessment was right or wrong, I was not referring to his criticism of British monetary policy, I was referring to his conjecture that if the Bank of England would have eased its monetary policy, other central banks would have followed the B of E’s lead and eased their monetary policies, thereby reducing the monetary demand for gold. I agree with Hawtrey that the B of E could have reduced Bank rate and promoted a faster recovery; whether such a step would have induced other CBs to follow suit is not so clear. Hawtrey himself only speculated that that would have been the case. It was only concerning that speculative conjecture about the reaction of other CBs to an easing by the B of E that I withheld judgment. I only accept Hawtrey’s positions when I have a basis upon which to assess those positions. Since I consider him to have been the greatest monetary economist who ever lived, it is not surprising that I would usually agree with him; that doesn’t mean that I accept anything he ever wrote or said on faith.
    My agreement or disagreement with him on that speculative conjecture has no bearing on the validity of my criticism of the insane policy of the Bank of France.

    The foreign exchange balances accumulated by the Bank of France after the Poincare stabilization in 1926 did indeed reflect a considerable repatriation of balances held by French citizens in foreign bank accounts. Most of those balances were probably repatriated within a year or so of the stabilization, so you can’t assume that there was a continuing flow of cash from abroad into France simply because everyone in the world with a spare banknote or deposit was trying to deposit it into a French banking institution. That’s just silly. On top of the initial repatriation of French balances held abroad, there was also a temporary export surplus owing to the deliberate undervaluation of the franc by Poincare on the advice of Emile Morreau, the Governor of the BoF. Under normal banking policies, French prices would have adjusted to the international level, and the competitive advantage enjoyed by the French tradable goods sector would have diminished and eventually disappeared. But the insane policy of creating French banknotes and deposits only upon the deposit of gold implied a continuing subsidy to the French tradable goods sector generating the export surplus that enabled France to accumulate the gold required to supply the additional banknotes and deposits demanded by the French economy. This in the context of a gold standard was an example of what Max Corden described as exchange rate protection. You can search for the posts I have written about exchange rate protection and currency manipulation for further elaboration on the theory of exchange rate protection.

    You assert that to say that Britain left the gold standard because of the rapid appreciation of gold in 1931 was causing massive deflation in Britain while it remained on the gold standard is just another way of saying that Britain left the gold standard because its currency was overvalued. No it is not. You continue to make the same category error that I pointed out to you in my previous response. If a country has an overvalued currency in terms of gold, then there is pressure on that country’s price level to fall relative to prices in other the price levels of other countries on the gold standard. But if gold is appreciating, then the price levels of all countries on the gold standard are falling. The price levels of all countries on the gold standard were falling in 1931, and all countries on the gold standard were suffering as a result. Britain rightly left the gold standard so that it would not continue to suffer from the deflation caused by the rapid appreciation of gold. Enough already.

    Aftalion was an eminent economist, but he was not primarily a monetary theorist, and he certainly cannot be considered a match for Hawtrey as a monetary theorist. Hawtrey in fact reviewed Aftalion’s writings on the economic crisis, and found them to be seriously wanting.

    The passages from Johnson that you quote don’t contradict what I have been saying. The overvaluation of sterling as a result of 1925 decision to restore the prewar dollar/sterling parity certainly had undesirable consequences that Johnson describes. If Britain had accepted a modest devaluation of sterling, the insane policy of the Bank of France might have had less disastrous consequences than they ultimately had. That in no way mitigates the responsibility that the Bank of France bears for the policies it deliberately undertook in light of the circumstances as they existed at the time.

  22. 22 Henry Rech January 30, 2019 at 2:09 pm

    David,

    “..so you can’t assume that there was a continuing flow of cash from abroad into France simply because everyone in the world with a spare banknote or deposit was trying to deposit it into a French banking institution. That’s just silly.”

    I don’t think it is silly given the then state of the world economy and monetary system. And Hawtrey’s account of this is very narrow and partisan. My point is that a great more work has to be done on this point. I’m not saying it’s cut and dry either way, unlike you.

    “Hawtrey in fact reviewed Aftalion’s writings on the economic crisis, and found them to be seriously wanting. ”

    I can’t imagine that a prominent economist of Aftalion’s standing would risk his reputation by providing an unprofessional submission to the Gold Delegation. Do you have any references for Hawtrey’s comments on Aftalion?

    “The passages from Johnson that you quote don’t contradict what I have been saying. ”

    I’m afraid they do. You have been adamant that sterling’s overvaluation had little if no impact on the world deflation and the accumulation of gold by France. Johnson’s statement contradicts your view entirely and supports my ongoing contention in these discussions.

    “That in no way mitigates the responsibility that the Bank of France bears for the policies it deliberately undertook in light of the circumstances as they existed at the time.”

    You say the BOF’s policy was insane. Given it had to deal with a huge influx of gold and that it had a pathological fear of inflation, I believe it is understandable why the French did what they did. The French economy was sound and inflation well under control. To allow credit and money circulation to get out of control would have been total anathema to the French given the horrendous period of economic dislocation that they had endured and pulled themselves out of prior to the stabilization of the franc. Given Johnson’s end of book comments, which were supported to some extent by Hawtrey, the world and the British themselves were the victims of British obduracy.

    All I have said all along is that French policy was understandable and that the other side of the franc undervaluation coin was the overvaluation of sterling.

  23. 23 David Glasner February 4, 2019 at 8:27 am

    Henry,

    The state of the world economy was not obviously in jeopardy between March 1925 after Britain rejoined the gold standard and the middle of 1929 when the first signs of deflation appeared. There were only a few policy makers and experts paying attention to the warnings of Hawtrey and Cassel that things could deteriorate rapidly, and the financial press was not writing about the risks of deflation until 1929 a few months before the crash. So yes it is silly to suggest that hot money was pouring into France because it was viewed as a safe haven in a collapsing world economy. And to suggest that the Bank of France was blameless because people were pouring their spare cash into France because it was safe haven in the catastrophe that France was creating is just, well, perverse.

    Economists risk their reputations all the time by making ridiculous statements, like Milton Friedman warning of the return of double digit inflation because the rate of growth in M2 was running at or near 10% for a while during the mid-1980s. Friedman’s reputation for better or for worse survived that little debacle. Aftalion’s less exalted reputation did not take a major hit either despite his mistake. We economists are generally a pretty forgiving bunch. For Hawtrey’s review of Aftalion’s Monnaie et Industrie, see Journal of Political Economy October 1929 37(5):617-21. https://www.jstor.org/stable/pdf/1821858.pdf?refreqid=search%3Ad392aa32002082160d846d49671a61d1

    On Clark Johnson’s remarks about the overvaluation of sterling, you are persisting in your category mistake of identifying overvaluation of one currency which causes deflationary pressure in a single country with the rapid accumulation of gold by one country because of a monetary policy that promotes the accumulation of gold which causes deflation in all countries on the gold standard. Johnson’s point about sterling concerns the former. That was a problem for Britain that had little effect on the world economy. The deliberate, reckless and insane accumulation of gold by the Bank of France starting in 1928 caused deflation in all gold standard countries. Had sterling not been overvalued, Britain might have been slightly better positioned to counteract or accommodate the French madness, but it is doubtful that it would have made much difference. In 1930, Hawtrey thought that a courageous easing of monetary policy by the Bank of England might have made a difference. As I have said already. That was simply conjecture on his part. I place great weight on his conjectures but we have no way of knowing how things would have worked out in the alternative universe.

    To suggest that it was necessary to allow additional cash (banknotes or deposits) to be created only by way of the importation of gold to prevent inflation is to make an absurd statement. To conduct a national monetary policy on the basis of that absurdity was insane.

  24. 24 Henry Rech February 5, 2019 at 2:34 am

    David,

    “On Clark Johnson’s remarks…”

    You are splitting hairs and sliding off the point. Johnson was categoric – the UK could have mitigated the deflation after 1928 and “almost certainly” France would have attracted less gold.

    Hawtrey wrote the following in “The Gold Standard In Theory and Practice” (p. 136 – 137, 1933 edition):

    “In virtue of the economic power of London as a financial centre, credit restriction in London was felt throughout the world. When Bank rate was raised, the effect was contraction not only in Great Britain but in a greater or lesser degree everywhere else……It hastened the fall in the world price level…….

    ……….The catastrophic fall in the world price level that occurred was the cause of the breakdown of the gold standard.”

    It is pretty clear what Hawtrey believed.

    He also said (ibid p.119), in contradiction to your comments on the matter:

    “Thus by the middle of 1928……Great Britain had failed to emerge from the state of depression, which people were beginning to regard as chronic.”

    There was little to cheer about the British predicament.

    “To suggest that it was necessary to allow additional cash (banknotes or deposits) to be created only by way of the importation of gold to prevent inflation is to make an absurd statement. ”

    I did not suggest that at all. Please reread what I said.

    Thanks for the Aftalion reference.

  25. 25 David Glasner February 5, 2019 at 9:23 am

    Henry, You quoted the following from Johnson’s book.

    “Had sterling instead been devalued in 1925, the Bank of England might have had more influence upon the distribution of world reserves. This might have been enough to slow the descent of prices and output that occurred after 1928; almost certainly, the Bank of France would have drawn less gold.”

    He is making a conjecture about the possible effects of a devaluation of sterling. The Bank of England might have had more influence on the distribution of gold reserves, which might have slowed the descent of prices and output after 1928. Almost certainly, the Bank of France would have drawn less gold. He doesn’t say how much less. French gold reserves more than quadrupled between the end of 1926 and the middle of 1932. So, instead of rising by 350% they would have risen by say a mere 300%.

    Ok, I stand corrected, but it is puzzling that Johnson mistitled his book “Gold, France, and the Great Depression, 1919-1932” when he obviously meant to call it “Gold, Britain, and the Great Depression, 1919-1932.”

    Hawtrey’s book “The Gold Standard in Theory and Practice” is a splendid book, one of his best. Unfortunately, I don’t own a copy and don’t have one handy. The passage you quote reflects his judgment that London’s position as the world’s financial center endowed the Bank of England with enormous influence over the policies of other central banks, and that had the Bank of England been less timid and reduced Bank rate and promoted economic expansion, other central banks would have adjusted their policies accordingly. I respect that opinion, and he might have been right. But it is essentially a conjecture that could have only been tested had it been followed up by actions taken by the Bank of England, and those actions were not taken, so we will never know if Hawtrey was right or wrong in his conjecture. But we know exactly what actions the Bank of France took and we know what the consequences of its actions were. Worldwide disaster.

    Hawtrey’s comments do not contradict my comments about the state of the British economy before 1929. It is a question whether the glass was half full or half empty. The British economy was not contracting. It was growing, but not fast enough to restore full employment which remained excessive until the start of the Great Depression. After the start of the Great Depression in late 1929, British unemployment, which had been slowly falling since 1925, nearly doubled before suspension of sterling convertibility mercifully eased the catastrophic consequences of gold deflation and allowed the British economy to start another slow recovery.

  26. 26 Henry Rech February 5, 2019 at 10:01 am

    David,

    Yes of course, Johnson’s and Hawtrey’s claims are conjectural but they do deserve consideration.

    Equally, it seems to me, that it could be argued that Hawtrey’s claim that the French accumulation of gold was due to a shortage of currency (and not driven by capital repatriation, speculative capital flows, balance of payments) is conjectural.

    He applies (in the Art of Central Banking) prewar monetary ratios to estimate French currency needs in the 1920s. This is very speculative. I believe his argument borders on the specious. Many factors which determine currency needs, such as institutional arrangements and might come under the general heading of the velocity of circulation, may have changed radically from prewar time to the 1920s. He makes bald statements like “People found themselves short of cash…..” (ibid p.17) without offering any hard evidence.

  27. 27 David Glasner February 6, 2019 at 8:30 am

    Henry,

    I absolutely do not dismiss the conjectures of Hawtrey or Johnson. But even giving them full credit would not absolve the Bank of France for its policies which were undertaken with full knowledge of the policies that the Bank of England had adopted. That Britain might have adopted policies that would have rendered the policies of the Bank of France less disastrous than those policies turned out to be cannot mitigate the responsibility of the Bank of France for executing the policies that it took or the specious arguments that it and its apologists presented in its defense.

    Hawtrey’s arguments about the causes of gold accumulation by the Bank of France are not conjectural in the sense that they speculate about how other central banks might have reacted if another central bank had made a different policy choice than the choice that was actually made. Hawtrey’s arguments were analytical statements about implications of the actions that actually were taken by the Bank of France, namely that the Bank of France liquidated its holdings of foreign exchange and demanded redemption in gold, and refused to issue banknotes or create bank reserves in exchange for domestic bills and securities, but only in exchange for gold. As a matter or logic that policy meant that the stock of money (banknotes plus bank deposits) in France could not increase unless gold was imported. The French economy was growing rapidly in the late 1920s, so it is entirely plausible that the demand to hold cash in France was increasing, because undervaluation of the franc provided a cushion the immediate effects of the Great Depression that started at the end of 1929 were milder in France than elsewhere so the downturn in France was somewhat delayed. After the downturn hit, it is again entirely plausible that the precautionary demand for money would increase and that the public, distrusting bank deposits, would choose to shift some of their deposit holding into banknotes again increasing the demand for gold to cover an equivalent amount of banknotes to replace deposits.

  28. 28 Henry Rech February 6, 2019 at 9:48 am

    David,

    “But even giving them full credit would not absolve the Bank of France for its policies which were undertaken with full knowledge of the policies that the Bank of England had adopted. ”

    So why should the BOF wear the responsibility for decisions taken by the BOE? The BOF were protecting the interests of the French people just as the BOE was protecting what it considered to be the interests of the British people.

    It seems to me everything to do with matter under discussion is conjectural. And as far as Hawtrey’s claims that the French were short of currency, I would like to see hard evidence.

    Here’s another conjecture for you. Johnson (p.5 of his book) claims that had the US devalued the US$ by 30 – 40% in the early 1920s “the systemic cause of the deflation would have been removed at a stroke”.

    Then there is the claim that the French and US gold accumulations caused the deflation of the late 1920s. So who actually lost gold in the relevant period, say January 1929 to June 1931? As I have reported before (using League of Nation’s statistics), below is an account of world gold stock movements in that period:

    World Total +US$1026M
    France +US$940M
    US +US$972M
    UK +US$29M
    Germany -US$317M
    Second European 4* +US$174M
    Rest of Europe -US$4M
    Japan -US$117M
    India +US$27M
    Total Primary Goods Producers** -US$670M
    Rest of World -US$8M

    * Belgium, Switzerland, Netherlands, Italy
    ** Australia, New Zealand, Asia (excl. Japan and India), South America, Africa, Canada.

    The main features are the more or less equivalent French/US accumulation, the significant loss by Germany owing to reparations, the significant increase in gold stocks by the rest of Europe, the huge losses incurred by Japan and the primary producing countries.

    In all the literature I have read on the subject, the huge losses by Japan and the primary producing countries and the significant increase in rest of Europe stocks have never been noted, noticed or made much of.

    So the industrialized countries of the West gained gold at the expense of Japan and the main primary goods producing countries.

    So just how pressured were the industrialized economies of the West by the French/US gold accumulation?

    The deflation of the late 1920s is usually measured by changes in the world level of wholesale prices. Wholesale prices are mainly comprised of the prices of primary goods (agricultural and mineral products). The deflating primary goods prices are deleterious to primary goods producers and beneficial to the industrialized countries who use these goods. The huge gold losses of the primary producing countries are probably due to falling commodity prices. These falling commodity prices were in large part due to the huge increases in world primary goods production on the back of fast paced technological change post war. It may well be that the measured deflation of the late 1920s was in large part due to non-monetary factors.

  29. 29 David Glasner February 6, 2019 at 7:15 pm

    The Bank of France is responsible only for the decision that it made. But the possibility that the Bank of England might have made a decision that would have induced the Bank of France not to make the catastrophic decision that the Bank of France freely and willfully made cannot absolve the Bank of France for responsibility for its own disastrous decision.

    The assertion that there was a shortage of currency in France means simply that to increase the amount of currency in circulation in France it was necessary to deposit gold at the Bank of France. In growing economies, it is to be expected that as additional transactions are being made, more currency will be demanded. It therefore follows that unless there was some extraordinary reason why residents of France wanted to hold less currency even though income and expenditure were rising in France, it would be reasonable to expect that the French demand to hold currency was increasing in the late 1920s and early 1930s. If so, that demand to hold additional currency could have been satisfied by no other method than an inflow of gold from outside France. There were no surveys taken of desired holdings of currency in France in the period of interest, so there is no direct evidence that one could sight, but one can make reasonable inferences about whether the demand to hold currency was increasing or decreasing. You may call that conjecture if you like, but it is a conjecture informed by basic and reliable propositions of economic and monetary theory.

    Johnson’s conjecture is an interesting one, and it would be worth playing out that scenario, but again the possibility that such an action might have changed the subsequent course of events cannot be used to mitigate the responsibility of the Bank of France for its decisions under the conditions as they actually existed when those decisions were being made.

    It is interesting to inquire about which countries were losing gold as France was accumulating gold. But that question has little if anything to do with whether the rapidly increasing demand for gold by France was the cause of deflation that began shortly after the French started their gold accumulation binge. It is true that the US was accumulating gold along with France in 1928-1930, and the Fed deserves total condemnation for its role in the catastrophe. But the US economy was much larger than the French economy at that time, and the US gold accumulation at least stopped in 1930 while French gold accumulation continued unchecked. The value of gold is internationally determined, so the gold lost in any single country was irrelevant to the extent of deflation in that country owing to gold appreciation. Deflation and inflation typically don’t occur uniformly across all prices, so it isn’t surprising that there were relative price shifts along with the deflation in the Great Depression. The existence of such relative price changes does not imply that the deflation that did occur was [not] caused by the dynamics of the gold market.

  30. 30 Henry Rech February 6, 2019 at 9:28 pm

    David,

    “…but it is a conjecture informed by basic and reliable propositions of economic and monetary theory….”

    And what about changing institutional arrangements over time having an impact on the velocity of circulation?

    ” The value of gold is internationally determined, so the gold lost in any single country was irrelevant to the extent of deflation in that country owing to gold appreciation.”

    It’s not that straight forward is it?

    The pressure (either way) on a nation’s gold reserve forces the local central bank to make decisions about protecting or not the reserve which will have an impact on local economic and financial conditions. Given that the industrialized West (including the UK) gained gold through the relevant period, it is difficult to tell what the pressures on the relevant central banks might have been. Perhaps the relevant central banks had to tighten monetary policy to keep gold moving in and /or not leaving thereby keeping deflationary pressures alive. Without a case by case study, the question is moot?

    “The existence of such relative price changes does not imply that the deflation that did occur was caused by the dynamics of the gold market.”

    I am not arguing that at all. I am suggesting there may have been non monetary forces at play.

  31. 31 David Glasner February 8, 2019 at 10:43 am

    Henry, Your reference to institutional changes that affected the velocity of circulation is too vague for me to offer a response.

    I think it is very straightforward that gold is an internationally traded commodity whose value in any country cannot deviate by more than the cost of transportation from its value in any other country. Under a gold standard in which all prices are quoted in terms of gold, prices of all tradable goods are closely correlated and cannot deviate from one another by more than the cost of transportation. So under a gold standard inflation as a first approximation is basically the same in every country on the gold standard. I agree that’s just a first approximation and that local differences can be important in some cases, but for purposes of our discussion, I don’t think it’s disputable that deflation was a worldwide phenomenon affecting every country under the gold standard and the only way to avoid deflation was to suspend convertibility.

    I apologize for mistakenly writing “that the deflation that did occur was caused by the . . . gold market” when I meant to write “was NOT caused by the . . . gold market.”

  32. 32 Andreas Hoffmann March 6, 2019 at 1:16 pm

    I love your posts even when I disagree (slightly). Thanks for the insights you provide and your great work!

  33. 33 David Glasner March 6, 2019 at 3:37 pm

    Thanks for your kind words, Andreas. I’m just wondering what do we (slightly) disagree about?

  34. 34 SD March 21, 2019 at 8:43 am

    I’m re-reading Sumner’s Midas Paradox. It’s pretty great and lines up very well with a lot of your writing. One area where I wish he had delved deeper: the non-gold Fed assets. Seems to me that the prewar BOE (and the Fed during the 1920-21 deflation) would let loans/discounting expand during recessions. A lot of monetary commentary just focuses on the total Balance Sheet or on the gold reserve ratio, but I’m not sure that Treasuries/gilts are macroeconomically interchangeable with loans/discounting during recessions. Obviously I’m influenced by the Great Recession where we had trouble meeting inflation targets via Treasury purchases (although that’s complicated by overpaying IOER). Any thoughts?

    I think your conversation with Henry might’ve touched on this, but with all apologies I couldn’t get through the whole exchange given time constraints.

    Thanks!


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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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