Archive for March, 2021

Monetarism v. Hawtrey and Cassel

The following is an updated and revised version of the penultimate section of my paper with Ron Batchelder “Pre-Keynesian Theories of the Great Depressison: What Ever Happened to Hawtrey and Cassel?” which I am now preparing for publication. The previous version is available on SSRN.

In the 1950s and early 1960s, empirical studies of the effects of money and monetary policy by Milton Friedman, his students and followers, rehabilitated the idea that monetary policy had significant macroeconomic effects. Most importantly, in research with Anna Schwartz Friedman advanced the seemingly remarkable claim that the chief cause of the Great Depression had been a series of policy mistakes by the Federal Reserve. Although Hawtrey and Cassel, had also implicated the Federal Reserve in their explanation of the Great Depression, they were unmentioned by Friedman and Schwartz or by other Monetarists.[1]

The chief difference between the Monetarist and the Hawtrey-Cassel explanations of the Great Depression is that Monetarists posited a monetary shock (bank failures) specific to the U.S. as the primary, if not sole, cause of the Depression, while Hawtrey and Cassel considered the Depression a global phenomenon reflecting a rapidly increasing international demand for gold, bank failures being merely an incidental and aggravating symptom, specific to the U.S., of a more general monetary disorder.

Arguing that the Great Depression originated in the United States following a typical business-cycle downturn, Friedman and Schwartz (1963) attributed the depth of the downturn not to the unexplained initial shock, but to the contraction of the U.S. money stock caused by the bank failures. Dismissing any causal role for the gold standard in the Depression, Friedman and Schwartz (359-60) acknowledged only its role in propagating, via PSFM, an exogenous, policy-driven, contraction of the U.S. money stock to other gold-standard countries. According to Friedman and Schwartz, the monetary contraction was the cause, and deflation the effect.

But the causation posited by Friedman and Schwartz is the exact opposite of the true causation. Under the gold standard, deflation (i.e., gold appreciation) was the cause and the decline in the quantity of money the effect. Deflation in an international gold standard is not a local phenomenon originating in any single country; it occurs simultaneously in all gold standard countries.

To be sure the banking collapse in the U.S. exacerbated the catastrophe. But the collapse was the localized effect of a more general cause: deflation. Without deflation, neither the unexplained 1929 downturn nor the subsequent banking collapse would have occurred. Nor was an investment boom in the most advanced and most productive economy in the world unsustainable as posited, with no evidence of unsustainability other than the subsequent economic collapse, by the Austrian malinvestment hypothesis.

Friedman and Schwartz based their assertion that the monetary disturbance that caused the Great Depression occurred in the U.S. on the observation that, from 1929 to 1931, gold flowed into, not out of, the U.S. Had the disturbance occurred elsewhere, they argued, gold would have flowed out of, not into, the U. S.

Table 1 shows the half-year changes in U.S., French, and world gold reserves starting in June 1928, when the French monetary law re-establishing the gold standard was enacted.

TABLE 1: Gold Reserves in US, France, and the World June 1928-December 1931 (measured in dollars)
Date World ReservesUS ReservesUS Share (percent)French ReservesFrench Share (percent)
June 19289,7493,73238.31,13611.7
Dec. 192810,0573,74637.21,25412.4
2nd half 1928 change31214-1.11180.7
June 192910,1263,95639.11,43614.2
1st half 1929 change692101.91821.8
Dec. 192910,3363,90037.71,63315.8
2nd half 1929 change210-56-1.41971.6
June 193010,6714,17839.21,72716.2
1st half 1930 change3352781.5940.4
Dec. 193010,9444,22538.72,10019.2
2nd half 1930 change 27347-0.53733.0
June 193111,264459340.82,21219.6
1st half 1931 change3203682.11120.4
Dec. 193111,3234,05135.82,69923.8
2nd half 1931 change59-542-5.04874.2
June 1928-Dec. 1931 change1,574319-2.51,56312.1
Source: H. C. Johnson, Gold, France and the Great Depression

In the three-and-a-half years from June 1928 (when gold convertibility of the franc was restored) to December 1931, gold inflows into France exceeded gold inflows into the United States. The total gold inflow into France during the June 1928 to December 1931 period was $1.563 billion compared to only $319 billion into the United States.

However, much of the difference in the totals stems from the gold outflow from the U.S. into France in the second half of 1931, reflecting fears of a possible U.S. devaluation or suspension of convertibility after Great Britain and other countries suspended the gold standard in September 1931 (Hamilton 2012). From June 1928 through June 1931, the total gold inflow into the U.S. was $861 billion and the total gold inflow into France was $1.076 billion, the U.S. share of total reserves increasing from 38.3 percent to 40.6 percent, while the total French share increased from 11.7 percent to 19.6 percent.[2]

In the first half of 1931, when the first two waves of U.S. bank failures occurred, the increase in U.S. gold reserves exceeded the increase in world gold reserves. The shift by the public from holding bank deposits to holding currency increased reserve requirements, an increase reflected in the gold reserves held by the U.S. The increased U.S. demand for gold likely exacerbated the deflationary pressures affecting all gold-standard countries, perhaps contributing to the failure of the Credit-Anstalt in May 1931 that intensified the European crisis that forced Britain off the gold standard in September.

The combined increase in U.S. and French gold reserves was $1.937 billion compared to an increase of only $1.515 billion in total world reserves, indicating that the U.S. and France were drawing reserves either from other central banks or from privately held gold stocks. Clearly, both the U.S. and France were exerting powerful deflationary pressure on the world economy, before and during the downward spiral of the Great Depression.[3]

Deflationary forces were operating directly on prices before the quantity of money adjusted to the decline in prices. In some countries the adjustment of the quantity of money was relatively smooth; in the U.S. it was exceptionally difficult, but, not even in the U.S., was it the source of the disturbance. Hawtrey and Cassel understood that; Friedman did not.

In explaining the sources of his interest in monetary theory and the role of monetary policy, Friedman (1970) pointedly distinguished between the monetary tradition from which his work emerged and the dominant tradition in London circa 1930, citing Robbins’s (1934) Austrian-deflationist book on the Great Depression, while ignoring Hawtrey and Cassel. Friedman linked his work to the Chicago oral tradition, citing a lecture by Jacob Viner (1933) as foreshadowing his own explanation of the Great Depression, attributing the loss of interest in monetary theory and policy by the wider profession to the deflationism of LSE monetary economists. Friedman went on to suggest that the anti-deflationism of the Chicago monetary tradition immunized it against the broader reaction against monetary theory and policy, that the Austro-London pro-deflation bias provoked against monetary theory and policy.

Though perhaps superficially plausible, Friedman’s argument ignores, as he did throughout a half-century of scholarship and research, the contributions of Hawtrey and Cassel and especially their explanation of the Great Depression. Unfortunately, Friedman’s outsized influence on economists trained after the Keynesian Revolution distracted their attention from contributions outside the crude Keynesian-Monetarist dichotomy that shaped his approach to monetary economics.

Eclectics like Hawtrey and Cassel were neither natural sources of authority, nor obvious ideological foils for Friedman to focus upon. Already forgotten, providing neither convenient targets, nor ideological support, Hawtrey and Cassel, could be easily and conveniently ignored.

[1] Meltzer (2001) did mention Hawtrey, but the reference was perfunctory and did not address the substance of his and Cassel’s explanation of the Great Depression.

[2] By far the largest six-month increase in U.S. gold reserves was in the June-December 1931 period coinciding with the two waves of bank failures at the end of 1930 and in March 1931 causing a substantial shift from deposits to currency which required an increase in gold reserves owing to the higher ratio of required gold reserves against currency than against bank deposits.

[3] Fremling (1985) noted that, even during the 1929-31 period, the U.S. share of world gold reserves actually declined. However, her calculation includes the extraordinary outflow of gold from the U.S. in the second half of 1931. The U.S. share of global gold reserves rose from June 1928 to June 1931.

The Hawley-Smoot Tariff and the Great Depression

The role of the Hawley-Smoot Tariff (aka Smoot-Hawley Tariff) in causing the Great Depression has been an ongoing subject of controversy for close to a century. Ron Batchelder and I wrote a paper (“Debt, Deflation and the Great Depression”) published in this volume (Money and Banking: The American Experience) that offered an explanation of the mechanism by which the tariff contributed to the Great Depression. That paper was written before and inspired another paper “Pre-Keynesian Theories of the Great Depression: What Ever Happened to Hawtrey and Cassell“) I am now revising the paper for republication, and here is the new version of the relevant section discussing the Hawley-Smoot Tariff.

Monetary disorder was not the only legacy of World War I. The war also left a huge burden of financial obligations in its wake. The European allies had borrowed vast sums from the United States to finance their war efforts, and the Treaty of Versailles imposed on Germany the obligation to pay heavy reparations to the allies, particularly to France.

We need not discuss the controversial question whether the burden imposed on Germany was too great to have been discharged. The relevant question for our purposes is by what means the reparations and war debts could be paid, or, at least, carried forward without causing a default on the obligations. To simplify the discussion, we concentrate on the relationship between the U.S. and Germany, because many of the other obligations of the allies to the U.S. were offset by those of Germany to the allies.[1]

The debt to the U.S. could be extinguished either by a net payment in goods reflected in a German balance-of-trade surplus and a U.S. balance-of-trade deficit, or by a transfer of gold from Germany to the U.S. Stretching out the debt would have required the U.S., in effect to lend Germany the funds required to service its obligations.

For most of the 1920s, the U.S. did in fact lend heavily to Germany, thereby lending Germany the funds to meet its financial obligations to the U.S. (and its European creditors). U.S. lending was not explicitly for that purpose, but on the consolidated national balance sheets, U.S. lending offset German financial obligations, obviating any real transfer.

Thus, to avoid a transfer, in goods or specie, from Germany to the U.S., continued U.S. lending to Germany was necessary. But the sharp tightening of monetary policy by the Federal Reserve in 1928 raised domestic interest rates to near record levels and curtailed lending abroad, as foreign borrowers were discouraged from seeking funds in U.S. capital markets. Avoiding an immediate transfer from Germany to the U.S. was no longer possible except by default. To effect the necessary transfer in goods, Germany would have been required to shift resources from its non-tradable-goods sector to its tradable-goods sector, which would require reducing spending on, and the relative prices of, non-tradable goods. Thus, Germany began to slide into a recession in 1928.

In 1929 the United States began making the transfer even more difficult when the newly installed Hoover administration reaffirmed the Republican campaign commitment to raising U.S. tariffs, thereby imposing a tax on the goods transfer through which Germany could discharge its obligations. Although the bill to increase tariffs that became the infamous Hawley-Smoot Act was not passed until 1930, the commitment to raise tariffs made it increasingly unlikely that the U.S. would allow the debts owed it to be discharged by a transfer of goods. The only other means by which Germany could discharge its obligations was a transfer of gold. Anticipating that its obligations to the U.S. could be discharged only by transferring gold, Germany took steps to increase its gold holdings to be able to meet its debt obligations. The increased German demand for gold was reflected in a defensive tightening of monetary policy to raise domestic interest rates to reduce spending and to induce an inflow of gold to Germany.

The connection between Germany’s debt obligations and its demand for gold sheds light on the deflationary macroeconomic consequences of the Hawley-Smoot tariff. Given the huge debts owed to the United States, the tariff imposed a deflationary monetary policy on all U.S. debtors as they attempted to accumulate sufficient gold to be able to service their debt obligations to the U.S. But, under the gold standard, the United States could not shield itself from the deflationary effects that its trade policy was imposing on its debtors.[2]

The U.S. could have counteracted these macroeconomic pressures by a sufficiently expansive monetary policy, thereby satisfying the demand of other countries for gold. Monetary expansion would have continued, by different means, the former policy of lending to debtors, enabling them to extend their obligations. But preoccupied with, or distracted by the stock-market boom, U.S. monetary authorities were oblivious to the impossible alternatives that were being forced on U.S. debtors by a combination of tight U.S. monetary policy and a protectionist trade policy.

As the prospects that protectionist legislation would pass steadily improved even as tight U.S. monetary policy was being maintained, deflationary signs became increasingly clear and alarming. The panic of October 1929, in our view, was not, as much Great Depression historiography describes it, the breaking of a speculative bubble, but a correct realization that a toxic confluence of monetary and trade policies was leading the world over a deflationary precipice.

Once the deflation took hold, the nature of the gold standard with a fixed price of gold was such that gold would likely appreciate against weak currencies that were likely to be formally devalued, or allowed to float, relative to gold. A vicious cycle of increasing speculative demand for gold in anticipation of currency devaluation further intensified the deflationary pressures (Hamilton, 1988). Moreover, successive devaluations by one country at a time increased the deflationary pressure in the remaining gold-standard countries. A uniform all-around devaluation might have had some chance of quickly controlling the deflationary process, but piecemeal deflation could only prolong the deflationary pressure on nations that remained on the gold standard.


[1] The United States, as a matter of law, always resisted such a comparison, contending that the war debts were commercial obligations in no way comparable to the politically imposed reparations. However, as a final matter, there was obviously a strict correspondence between the two sets of obligations. The total size of German obligations was never precisely determined. However, those obligations were certainly several times the size of the war debts owed the United States. Focusing simply on the U.S.-German relationship is therefore simply a heuristic device.

[2] Viewed from a different perspective, the tariff aimed at transferring wealth from the foreign debtors to the U.S. government by taxing debt payments on debt already fixed in nominal terms. Moreover, deflation from whatever source increased the real value of the fixed nominal debts owed the U.S.

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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