May 30, 2007
Economics of the Great Depression
The book is a sequel to Parker's Reflections on the Great Depression, in which he interviewed a number of the prominent economists who lived through the U.S. Great Depression of 1929-39. In the new book, Parker talked with some of us who tried to go back and make sense of the episode a half-century later. The book includes interviews with luminaries such as Ben Bernanke, Robert E. Lucas, Jr., and Allan Meltzer.
Here's a brief snippet of my discussion with Randy:
PARKER: Are Kitson's assumptions pertaining to the gold standard also correct? He goes through four different things about what is needed for the gold standard to function. First of all, the gold standard assumes the law of one price. Second, it assumes that the demand for money is stable. Third, it assumes that the monetary authorities do not intervene to prevent increased gold reserves adding to the money supply. And fourth, it assumes that the burden of adjustment will be borne by prices and not by quantities. This is the pre-Keynesian assumption that the economy tends toward full employment-- an assumption that is so obviously inappropriate to the interwar period. Are these really limiting assumptions of how the gold standard functions?
HAMILTON: Well, let me say I think he's leaving out what I regard as one of the key issues of this time, and that is a gold standard means that the price of gold, in terms of dollars, is fixed. Therefore, if the price of gold in terms of potatoes goes up, the price of potatoes in terms of dollars must go down. An increase in the relative price of gold must mean deflation in the overall price level. That's just an accounting identity and it says as long as you're on the gold standard, if you have explained why the relative price of gold went up, you have explained why the overall price level fell. Now, a lot of people talk about deflation in the Depression just in its own right, just looking at the overall price level and implicitly they are assuming that what goes on with gold is some kind of residual, that there is no demand and supply for this commodity and the relative price could be any old thing. I don't think that's the right way to view it economically, I think there is a demand and supply of gold. Now, it's fundamentally coming in part from the monetary system, the international payments mechanism, and a lot of that demand is in fact from central banks wanting to hold gold for purposes of reserves. So, I would, I guess, amplify Kitson's remarks to say I think why that mattered was that there was an increase in the demand for gold coming from the financial instability, that there was an increase in the relative price of gold. I take that as a fundamental.
PARKER: This is from your 1988 Contemporary Policy Issues paper when you talk about hoarding on the part of the public.
HAMILTON: Yes. So I would add to these assumptions that there's an implicit view that the relative price of gold isn't going to move very much, that it is basically limited by the supply of mining and so the relative price doesn't change. If the relative price of gold is kind of volatile and wild, it's a terrible system to use because then you're imposing all of this same volatility and wildness on the aggregate price level and we pretty clearly don't want that. So I would say that's an important thing he's left out. All the other aspects he discusses, the maldistribution of gold and problems with cooperation, all of that I would translate into the factors that were causing the relative price of gold to go up and therefore any country that was sticking to the gold standard to experience a severe deflation.
Or perhaps you're also interested in what Fed Chair Ben Bernanke had to say on this topic:
PARKER: If I may, I'll break the depression down into several different questions. What started it? Why was it so deep? Why did it last so long? Why did it spread so completely? Why did recovery come when it did? Is there any one of those segregating questions that you think remains a mystery today?
BERNANKE: I don't think of any of them as a complete mystery. I think we have ideas about all of them. I think we still may be missing some complete explanations in terms of the quantitative magnitudes. For example, there's a good monetary story that explains why the initial downturn occurred and secondly why the decline in the early 1930s was severe. We are only beginning to get a sense of what we would need to understand and see why these effects were as large as they were quantitatively in an economy that was presumably more flexible than the one we have today. With respect to the recovery, the gold standard had a lot to say about that. We know from Eichengreen and Sachs (1985) that leaving the gold standard was very strongly correlated with the recovery process. But once again, there is quite a bit of variation across countries in the speed of recovery. We need to better understand why, once the monetary contractionary forces were removed, the recovery was not more powerful than it was. In the case of the United States some scholars like Cole and Ohanian (2004) and others have argued that the National Industrial Recovery Act, which reduced the flexibility of wages and prices, was a significant contributor.
The Fed Chair seems to be a bit more articulate speaking extemporaneously than I am-- big surprise there. By the way, if you're curious to hear more about the research Bernanke mentioned in that passage, Barry Eichengreen and Lee Ohanian are also among those interviewed in this new book. Thanks much to Randy for putting this all together.
Update: Arnold Kling has some further remarks about the book.
Posted by James Hamilton at May 30, 2007 05:41 AMdigg this | reddit
An interesting topic for an essay would be your thoughts on the causes of the great depression. Various books and essays I've read point towards excessive credit growth, high debt levels, highly unequal income distribution, asset (equity and real estate) bubbles, trade protectionism and the gold standard as causes. What's rather troubling to me is that, with the exception of the gold standard, you could just as easily be writing that about today as the late 1920's.
Posted by: Anonymous at May 31, 2007 09:01 AM
My view is that the initial downturn was in many respects just like any other recession, in the sense that, if recovery had begun in mid-1930 (as there were some preliminary indications it might), it really would not have appeared that different from other downturns. As for what caused the initial downturn, I personally feel that a monetary contraction was quite important, as I believe it has been for many other recessions as well.
I am further persuaded that it was other events in 1930-31 that turned an otherwise typical downturn into the Great Depression. I assign a key role there to the gold standard.
Posted by: JDH at May 31, 2007 09:16 AM
Monetary contractions or a slowing of monetary growth does accompany recessions but is it the core cause? We know deflation was present but it was present in the early part of the 20's. Agriculture was already in a depression that started in the early 20's. This I assume was driven by speculation as many bubbles are. I think expectations have much to do with deflation. If consumption is funded with yields on investments and not wages then it wouldn’t matter if they were sticky
To stop deflation I must create an expectation of inflation.
In 1929 the Federal Reserve prohibited bank loans for margins. That’s the pin but the bubble was already there.
The Friedman view is that monetary contraction is the culprit. With Friedman inflation is always and everywhere a monetary phenomenon. Too many dollars chasing too few goods. So in his view deflation would be too little money chasing too many goods.
I’d say we have to look at the entire post WW1 era. I suspect you will find that too easy credit created a bubble and that bubbles always deflate. And, because consumption was driven by the investment wealth effect, consumption fell and the stage was set for deflation.
So there is the reasoning
1) Unregulated Credit growth fueled speculation
2) That speculation created the bubble
3) The regulation of credit removed the fuel
4) The bubble deflated and the recession began
5) The deflating bubble contracted consumption
6) Unregulated loans defaulted and Banks failed
7) Monetary contraction is a symptom
I suppose that preventing a bubble would have prevented the depression.
The newly industrialized economy of the US has some but not much correlation to the Chinese economy of today. The Chinese 10+% growth coupled with productivity growth has also created a bubble. The Chinese have experienced a substantial correction however this speculative bubble has re-flated. In response, the govt has placed a tax on stock trades. Not a bad idea. The only problem is how do you know you are in a bubble?
Posted by: ken at May 31, 2007 10:40 AM
Professor, I read Bernanke's 'Essays on the Great Depression' and have, until recently, toed the 'monetary contraction caused the Depression' line.
Unfortunately, I cannot put my hands on data from the '20s on household debt, personal income, etc.
But, what few data points that I have seen along those lines lead me to agree with ken's line of reasoning, that it was excessive credit and consumption that set the stage for the Depression, and that monetary contraction is only correlated.
I wish I could find the data to replicate this chart, which I find convincing and scary:
Posted by: jg at May 31, 2007 12:27 PM
I saw a chart of market rates for the 20's somewhere but I will be damned if I can find it again. If memory serves there is an uptick just prior to the 29 crash. Similar to the 2000 uptick
Posted by: ig at May 31, 2007 01:04 PM
ig, we had a plot of commercial paper rates from 1857 to 1937 right here. But jg is looking for total debt as a fraction of GDP, and I'm not sure how that's calculated.
Posted by: JDH at May 31, 2007 01:33 PM
Thanks much for the info.
Posted by: ig at May 31, 2007 02:51 PM
"The Friedman view is that monetary contraction is the culprit. With Friedman inflation is always and everywhere a monetary phenomenon. Too many dollars chasing too few goods. So in his view deflation would be too little money chasing too many goods."
The post WW1 era saw double digit deflation in the early 20's a slight recovery of prices in the mid 20's and then a return to moderate deflation leading up to the 1929 crash. This would reflect productivity gains which can be the ability to produce over and above wage gains. The excess built would either have to exported or consumed through govt or personal debt.
Technological innovation tends such as the tech boom of the 80's and 90's can create higher rates of productivity. This also demands higher business capx expenditures. This should also increase stockholder equity as the returns on these investments are realized. Assets and Earnings should outpace liability growth.
In such and environment (mid to late 20's) investor expectations come into play. If the investor supports consumption through gains made by trading or dividends they will pay close attention to short term gains in stock value or EBITDA. A pressure will arise for companies to focus on stock price. Audit risks rise due to the tendency to understate expenses and overstate revenues. This phenomenon does not offer an explanation for "irrational exuberance" as PE ratios become astronomical relative to historic norms. If investors were rationally paying attention to earnings, stock prices would not rise to the levels of the 20's or the 90's.
In this case Friedman’s traditional "too much money chasing too few investment opportunities would hold" however on the liability side "crowding out" should increase interest rates to a point where the yield on debt instruments would be more attractive than stock purchases. Why would this be?
The answer is that bubbles by themselves are "self inflating" As the value of a stock rises, its ability to colaterize other debt increases. Traditional valuations of debt to liability are unrealistic in that the future value of these instruments are based on prior value growth. When the prior growth rate is excessive compared with to current growth rate, the motivation to sell the asset to realize the valuation gain is high. In the case of the 29 crash the fuel for the prior growth rate was removed via the Federal Reserve action on Margin trades. A majority of investors were sellers and the minorities were purchasers with decreased access to capital. The result was a stock price deflationary spiral. Banks, whose customers held assets at market prices, would have seen significant declines in asset to debt ratios as the default rate rose. This would further choke debt expansion.
But what about the debt markets at the time? If debt was rising the law of supply and demand in that market would hold. If consumers and corporations were looking to leverage via debt the supply of debt to the markets would invariable rise. Bond prices would fall and market yields would rise. Eventually yields would rise and begin to pull money from stocks to bonds until a new equilibrium was reached. A look at markets yields shows that this did not happen in the 20’s or the 90’s. A possibility is that corporate and govt debt did not increase because of
A rise in govt revenues due to taxes on stocks sales or cap gains
A rise in corporate profits due to increased gains from productivity.
Posted by: ig at June 3, 2007 11:50 AM
sorry for the typos here. Im just spit balling
Posted by: ig at June 3, 2007 11:53 AM
There is a sinilarity in bubbles and a strange phenomena in the debt markets. The spread between market yields and the (yield) on stocks (I am calling gain in value a yield) is very large.
Margin borrowing should push yields higher.
Posted by: ig at June 3, 2007 03:55 PM
PARKER: Are Kitson's assumptions pertaining to the gold standard also correct? He goes through four different things about what is needed for the gold standard to function. First of all, the gold standard assumes the law of one price. Second, it assumes that the demand for money is stable. Third, it assumes that the monetary authorities do not intervene to prevent increased gold reserves adding to the money supply. And fourth, it assumes that the burden of adjustment will be borne by prices and not by quantities.
You missed this one. The correct answer is NO.
Posted by: DickF at June 4, 2007 12:45 PM
...a gold standard means that the price of gold, in terms of dollars, is fixed. Therefore, if the price of gold in terms of potatoes goes up, the price of potatoes in terms of dollars must go down. An increase in the relative price of gold must mean deflation in the overall price level.
This was an extremely disappointing answer. First, you are correct about the gold-dollar ratio under a gold standard, but in theory it is the dollar that is defined by gold, not gold defined by the dollar. This may seem to you to be a semantic argument, but actually it is important. The dollar and dollar substitutes can be used by the market to adjust to supply and demand while gold, real money, being virtually fixed in supply, is the anchor, the definition of the dollar unit. Just as a carpenter uses an inch to determine how to build a house, an economic actor must have some fixed frame of reference to properly “build” his business. If an inch is 2.54 cm today but 3.1 cm tomorrow how can the carpenter do his job? But the dollar, the unit of measure for exchange, seems to cause no concern if it fluctuates constantly so that every business man must include a hedge to protect from loses.
Then to define deflation as a decrease in the price of potatoes is fallacious. Inflation and deflation are always and everywhere monetary events. But in a gold standard only in rare cases does the value of gold change in relation to other goods, so if the gold-potato exchange ratio changes it will be potatoes that change in value not gold.
Now I am sure you will say that you mean the general price level but since the supply of gold is virtually constant such a general decrease is extremely rare. But a decrease in the general price level could be seen under a gold standard if some enhancement improves productivity in the whole economy generally, such as the use of computers and the internet in all segments of the economy, reducing all costs of production, but this is not a monetary event.
An increase in the relative price of gold does not mean there must be deflation.
This kind of confusion of terms has seriously corrupted economics and led us into the chronic inflation of the 1970s.
Posted by: Anonymous at June 4, 2007 01:24 PM
Sorry, I am Anonymous
Posted by: DickF at June 4, 2007 01:25 PM
...there's a good monetary story that explains why the initial downturn occurred
Oh really? Then why don't you tell us what it is? The closest to addressing this question in Parker's first book was Milton Friedman but his was incomplete. Hopefully it will be addressed in this second one, but looking at the cast of characters I doubt it.
Posted by: DickF at June 4, 2007 01:39 PM
DickF, for the role of monetary factors in the initial downturn, Bernanke may have been referring to my research, among others. As for your previous point, I apologize that I don't understand what you're saying. By "deflation" I mean not that the real value of potatoes fell, but rather that the dollar price of potatoes fell. Surely you're not denying that the dollar price of potatoes, the dollar price of wheat, the dollar price of just about everything you can buy with a dollar (except gold) fell dramatically between 1929 and 1933, throughout which period the U.S. remained on the gold standard. 1929-33 marked a period of substantial and dramatic deflation, which also, by the argument quoted in the book, necessarily coincided with a substantial and dramatic appreciation of the relative price of gold. Are you denying that this deflation occurred, or are you disagreeing that this deflation was a destabilizing force?
Posted by: JDH at June 4, 2007 03:10 PM
DickF and Prof Hamilton, when I was looking at the work of Christina Romer I came across this paper by Hsieh and Romer which argues that the Fed was not constrained by the gold standard but instead screwed up because of flawed monetary policy and internal Fed conflicts:
This paper was also published in the Journal of Economic History (2006) 66: 140
Posted by: Charlie Stromeyer at June 4, 2007 03:47 PM
As for your previous point, I apologize that I don't understand what you're saying.
1. The gold standard assumes the law of one price.
The gold standard does not assume "the law of one price." It only defines the dollar, a money substitute, in terms of a quantity of gold. This allows commodities to change real value without changing the monetary standard. The changes will be reflected in changes in prices.
2. It assumes that the demand for money is stable.
The gold standard does not assume that money is stable. On the contrary it is the gold standard that maintains the stability of money and money substitutes allowing monetary demand to change without changing the monetary standard. It appears that Kitson is confusing the gold standard with monetarism.
3. It assumes that the monetary authorities do not intervene to prevent increased gold reserves adding to the money supply.
The gold standard exists because the monetary authorities, throughout history, have intervened in monetary matters. The gold standard places constraints on the monetary authorities restricting their intervention. Because the quantity of gold is limited and highly stable, when the monetary authorities intervene in the gold market it quickly obvious. Absent a gold, or other commodity, standard the monetary authorities are free to intervene totally without restraint.
4. It assumes that the burden of adjustment will be borne by prices and not by quantities.
Again the gold standard is just the opposite. Changes in fiscal conditions are seen in the quantity flows of gold. If the currency is over valued or under valued, gold flows will arbitrage the difference, and balance international monetary values without favoring one currency or economy over another. This allows maintains the accuracy of price signals when commodity quantities change. The gold standard facilitates economic calculation by businesses using prices to communicate scarcity.
Posted by: DickF at June 5, 2007 06:12 AM
Thanks for the reference. I am not sure the paper addresses the constraint of the gold standard. It addresses a lack of confidence in the monetary authorities to break with the gold standard. Most people did not believe the US would break with the gold standard, but it is still a consideration that the FED moved to a contractionary stance believing that was the only way to maintain the gold standard.
After WWI the dollar replaced the pound as the world currency because we steadfastly maintained the gold standard (though we did suspend payments). The world expected us to continue to maintain the standard and that is what made the dollar king.
Of course the world assumed the same thing with Bretton Woods and we totally violated our fudiciary duty.
Posted by: DickF at June 5, 2007 06:36 AM
DickF, what I didn't understand were your statements such as those in the paragraph beginning "Then to define deflation as a decrease in the price of potatoes is fallacious".
Posted by: JDH at June 5, 2007 06:58 AM
Sorry, I misunderstood what you were referring to. I am not sure I can say it any more clearly than in the sentence you quoted. Deflation is monetary. You can have increasing or decreasing prices and still have deflation. If prices rise or fall but the monetary standard is stable there is no inflation or deflation. There is only inflation or deflation when there is an appreciation or depreciation in the monetary standard. An inflation or deflation often effects prices but price changes and inflation/deflation are totally different things.
Posted by: DickF at June 5, 2007 10:00 AM
DickF, between 1929 and 1933, the dollar price of everything fell. The implicit GNP deflator was down 22%, the wholesale price index was down 32%, and the consumer price index was down 24%. That's what we mean by deflation, and that happened while the U.S. was on a fixed gold standard.
Another way to say the same thing is that the relative price of gold went up between 1929 and 1933. The number of potatoes (for example) that you'd have to give up to get one ounce of gold went up. That's a necessary consequence of the facts that (a) the number of potatoes you'd have to give up to get one dollar went up, and (b) the number of dollars you'd have to give up to get one ounce of gold was fixed.
This was a problem, for example, if you were a potato farmer, who had promised to repay a certain number of dollars (i.e. gold) in order to honor your debt. Many farmers went bankrupt, and that was a problem.
It would have been better to have had a unit of account for the monetary system (or "yardstick", as you describe it) whose meaning in terms of purchasing power was more stable. Inflation is bad, and deflation is bad. The gold standard from 1929-33 meant deflation, and that was bad.
Posted by: JDH at June 5, 2007 10:37 AM
I may be leaving a wrong impression. I understand that the FED followed a deflationary policy after 1929, and I also understand that congress and the president followed a contractionary policy of taxes and regulations, but we must not confuse price declines with deflation.
Some time ago I scanned your paper on Monetary Factors in the Great Depression and have reviewed it once again. It is interesting that your numbers do show the actual seeds of the GD but no one seems to want to comment on it, choosing rather to begin their discussion in 1928-29. You document the huge run-up in prices for commodities prior to the declines in prices in the 1930-33 period. With a combination of price supports, regulations, and expanded credit the period of the 1920 was a period of inflation and malinvestment.
When the crash of 1929 hit there were simply too many dislocations in the economy to sustain the illusion and the house of cards came tumbling down. What no one in Parker’s book notes is that this huge dislocation was caused by FED inflation that hurled us into the crash.
Then after the crash intervention by government prevented the recovery. Every time the economy began to rebound businesses were hit with more costs in the guise of tax cuts, price supports, regulations, not to discount jawboning to keep wage costs high for those few who had a job.
The crash was not just deflation and the length of the economic decline had virtually nothing to do with deflation falling right at the feet of Hoover and FDR (especially FDR).
WWII was so drastic that it overwhelmed FDR's errors and brought us out of the GD, but we must never speak of this lightly. Never lose sight of the fact that the cost was horrible: 72 million deaths and the virtual destruction of Europe and Asia.
But notice that none of these things were caused by the gold standard. Most were caused by government. Condemning gold is like blaming the law for crime. If we do away with the gold standard we have no constraint by gold; if we do away with the law we will have no criminals.
Posted by: DickF at June 5, 2007 12:18 PM
DickF, the Hsieh and Romer paper examines empirical and narrative evidence to see if the Fed was constrained by the gold standard and concludes that the Fed was not constrained, and that most of the blame for the Great Depression lies with the Fed. See the bottom of this summary written by Romer:
Posted by: Charlie Stromeyer at June 5, 2007 02:12 PM
And I must make sure that I mention one of the most important and devastating causes of the crash and the longlasting effects of the GD, the Smoot-Hawley tariff that started a worldwide trade war bringing international trade to a halt.
Posted by: DickF at June 5, 2007 09:43 PM
Thanks Charlie. Romer suggests more aggresive action by the FED. I am not sure that was actually needed.
From the very beginning of the FED it began to create money and credit. One of the most glaring examples was using cotton credits to back the currency it was creating, so as long as gold convertability was maintained this currency created by cotton credits increased the pressure on gold.
The FED was a significant part of the cause of the GD but it started long before 1929. 1929 was just when the other shoe fell and the money illusion was revealed.
Posted by: DickF at June 5, 2007 09:51 PM
Charlie, I will accept what you are saying about Romer stating that the gold standard was not the cause of the GD. I agree with that premise. It was gross government intervention and mismanagement.
Posted by: DickF at June 5, 2007 09:56 PM
DickF, between 1929 and 1933, the dollar price of everything fell. The implicit GNP deflator was down 22%, the wholesale price index was down 32%, and the consumer price index was down 24%. That's what we mean by deflation, and that happened while the U.S. was on a fixed gold standard.
Perhaps we can come closer to an understanding by answering this question.
Assuming a general deflation, that the deflation was monetary, was the deflation cause by a decrease in the goods/gold ratio, the goods/money substitutes ratio (currency, etc.), or some other change (inflationary expectations, gold hoarding, other)?
Posted by: DickF at June 6, 2007 04:55 AM
sorry to but in but since money is fixed to Gold prices fell with respect to both gold and money at an identical rate.
so expectations would have one hold or hoard and wait for prices to fall further which casues the inventory clearing price to fall further.
OK Ill shut up now
Posted by: ig at June 6, 2007 12:57 PM
...since money is fixed to Gold prices fell with respect to both gold and money at an identical rate.
No, don't shut up.
You are exactly correct and since the quantity of gold did not decrease during this period the deflation had to be due to a significant decrease in money substitutes, currency etc. This is exactly my point. In nearly every incidence when the gold-haters claim that gold failed you will find that the government or a psuedo-governmental agency manipulated the money substitutes to create the problem. Gold did not change. The government always attempts to fix a problem either real or imaginary and distorts the monetary signals creating a real and more serious crisis. It is not the rule that creates the criminal.
Posted by: Anonymous at June 7, 2007 05:25 AM
...expectations would have one hold or hoard and wait for prices to fall further which casues the inventory clearing price to fall further.
Bad money (excess paper) drives out good (gold).
Posted by: DickF at June 7, 2007 05:27 AM
DickF, the relative price of gold depends on both the supply and demand for gold. You are correct that it was not a change in the supply, but rather a change in the demand for gold, that was responsible for the real appreciation of gold values during 1929-33.
One of the things I think you may be overlooking is that the demand for gold is influenced not just by concerns about inflation, but also by concerns about overall financial stability. The more chaotic the world appears, the more people want gold. There were concerns about chaos in the late twenties and early thirties and that prompted an increased demand for gold. In particular, if you are fearful that various countries will abandon the gold standard and reflate (a totally rational fear, as all countries eventually did just that), then you want your portfolio to be more heavily weighted in gold than before. If you're a central bank worried about defending your currency from such speculation, then you need to hold more gold reserves than before.
There was an increase in the demand for gold from 1929-1933 and that played a role in the increase in the relative price of gold.
Insofar as the relative price of gold is subject to these large variations, it is a poor anchor for the monetary unit of account.
Posted by: JDH at June 7, 2007 05:45 AM
Og course I am not olde enough to remember the GD and I was but a wee child in 71. And I do remember something about my father being stuck in an airport holding greenbacks trying to get home.
There was a significant flight to Gold then. A shock that stabilized at a lower equilibrium rate many attribute to the petro-dollar relationship. Of course that was a very different economy.
29-33, a break would have caused a similar panic and a flight to Gold. With so much faith lost in the economy after the 29 crash I suppose that a delinking from Gold would have caused a similar flight driving prices higher. I suppose at this point Banks are free to release their reserve (gold) at market rates. At this point I suspect the dollar would be plunging via gold but deflating vs goods and services creating the inflation expectation we want to reverse market behavior.
How severe would the shock be? Of course none of this would be necessary had the investment bubble not happened in the first place.
Posted by: ig at June 7, 2007 09:45 AM
I agree with you that gold demand played a significant role in extending and deepening the GD. The level of government intervention and mismanagement was so great that only the blind would not have seen it. As you mention most people in the world expected their national monetary authorities to break with gold.
The the horror of Smoot-Hawley caused one of the greatest trade wars in the history of the world. This alone would have created a serious increase in demand driving gold out of circulation.
The initial crash came when the markets began to see that the inflation could not sustain the spending binge of the 1920s. Had the stock market and wages/prices been allowed to simply correct to the new equilibrium there would have been some economic dislocation but no GD.
As it is the market crash of '29 was followed with Smoot-Hawley, then Hoover jawboning to counter "deflation" by encouraging companies to not lower their prices and wages (Hoover made the common error of equating deflation with price and wage changes). When none of this reversed the decline, Hoover raised taxes, the absolute worst thing that could have happened. Businesses began to find themselves paying for high priced factors of production with higher valued dollars a double hit, and they found themselves paying for the credit excesses of the 1920s with dollars worth much more than the dollars they borrowed. The monetary errors began to suck the life out of marginal businesses and they began to fail. Bankruptcies took away the ability of banks to repay their depositors and because the government had forced them to stand alone (branch banking, that could have allowed them to pool funds, was prevented) and the banks began to fail. The failure of the banks then took more money out of circulation.
And all of this was before FDR, who was worse than Hoover (he even rejected Keynes), took over.
I could go on and on but I think you get the picture. The GD was caused by government failure not by the gold standard. Those like Bernanke who blame the gold standard see only half of the picture.
Posted by: DickF at June 7, 2007 12:00 PM
what govt failure? Margin trading can destroy a Bank's balance sheet quickly and that i suspect would contract money supply. If the data were available I would like to see the impact of that.
To say that all we need to to is provide more liquidity to the system seems a little short sighted to me.
I do see the linkage between gold and money being a problem though. From my previous post I write about the intial delinkage from gold and the inflationary bias (a good thing at the time) created. The demand for gold would rise and foreign currecies linked to it would also rise as they are still linked. The dollar would further depreciate and it would follow that exports would rise as importers still linked to gold would see their dollar appreciate vs. the dollar.
The system would require that all break from Gold.
Now if you enacted Smoot Hawley you'd be an idiot.
you'd stii have the banking problem. Then of course you are relying on a trade surplus to turn the economy. If a significant surplus is developed the dollar would stabilize or devaluate.
as others would have to break the link from gold
Kind of like we are demanding a reval from China.
Posted by: ig at June 7, 2007 03:17 PM
From my previous post I write about the intial delinkage from gold and the inflationary bias (a good thing at the time) created. The demand for gold would rise and foreign currecies linked to it would also rise as they are still linked. The dollar would further depreciate and it would follow that exports would rise as importers still linked to gold would see their dollar appreciate vs. the dollar.
You are makeing the same argument that was made to Nixon in the early 1970s. In theory it might sound good but in practice it is disastrous. The result was chronic inflation with double digit unemployment (first since the GD), double digit interest rates and double digit inflation.
Posted by: ig at June 8, 2007 04:51 AM
I the short run there were of course problems but it hardly created disasterous results. Expansions have been much longer and downturns subsatntially less severe. We have seen growing problems with capital inefficiency with respect to the stock market and Banking but for the most part, the fed has functioned adequately. Its the market that creates bubbles. The yen carry trade and currency manipulation.
Posted by: ig at June 9, 2007 02:02 PM
1. The highest unemployment since the GD ws a disasterous result.
2. The 1970s was not an expansion. Adjusted for inflation the stock market lost value, businesses lost value, wages were down. The 1970s showed classic chronic inflation, btw causing other countries who tied their currencies to the dollar, such as Brazil and Argentina, with economies less able to absorb the mistakes to have hyper-inflation.
3. The FED did not cause the problem, Nixon and Burns did that by choosing to break with gold, but neither did the FED help. The FED did not function adequately under Burns as was demonstrated by the need for Volker to take drastic steps to curb inflation.
4. Governments create bubbles. Markets clear.
Posted by: DickF at June 11, 2007 05:56 AM
Way back in the mid 90's I did an interesting paper that killed two birds with one stone(econometrics and econ history) in grad school.
The gist of the paper was that agricultural commodities collapse preceded the Great Depression by several years. Essentially prices paid and volume exported of grain totally collapsed beginning in 1927, with near zero export of grains at sharply lower prices already evident in the 1929 data. Strangely enough, there was good data in the US Customs reports of volume of grain exported and prices paid. My professor later commented to me that the paper was good enough for an A, but that if I wanted to do any monetarist work I should keep my mouth shut;-}
The thesis was that the agricultural sector went into a depression well ahead of stock market crash, and subsequent farm foreclosures were the result of this collapse, not the initial stages of the great depression is also born out by a couple other papers showing large increases in farm foreclosures starting in 1927- citations forgotten, but some were from the 1950's.
One must not forget the agricultural sector still was quite significant in the 1920's in terms of GNP.
Posted by: AllenM at June 13, 2007 10:33 AM