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Wednesday, August 01, 2012



A)The Gold Standard, Deflation, and Financial Crisis in the Great Depression:

An International Comparison

With its accumulation of gold. France should have been expected to inflate;

but in part because of the restrictions on open market operations discussed

above and in part because of deliberate policy choices, the impact of the gold

inflow on French prices was minimal. The French monetary base did increase

with the inflow of reserves, but because economic growth led the demand for

francs to expand even more quickly, the country actually experienced a wholesale  price 

deflation of almost 11% between January 1929 and January 1930.

Hamilton (1987) also documents the monetary tightening in the United

States in 1928, a contraction motivated in part by the desire to avoid losing

gold to the French but perhaps even more by the Federal Reserve's determination

to slow down stock market speculation. The U.S. price level fell about

4% over the course of 1929. A business cycle peak was reached in the United

States in August 1929, and the stock market crashed in October.

The initial contractions in the United States and France were largely selfinflicted

wounds; no binding external constraint forced the United States to

deflate in 1929, and it would certainly have been possible for the French government

to grant the Bank of France the power to conduct expansionary open

market operations. However, Temin (1989) argues that, once these destabilizing

policy measures had been taken, little could be done to avert deflation and

depression, given the commitment of central banks to maintenance of the gold

standard. Once the deflationary process had begun, central banks engaged in

competitive deflation and a scramble for gold, hoping by raising cover ratios

to protect their currencies against speculative attack. Attempts by any individual

central bank to reflate were met by immediate gold outflows, which forced

the central bank to raise its discount rate and deflate once again. According to

Temin, even the United States, with its large gold reserves, faced this constraint.

Thus Temin disagrees with the suggestion of Friedman and Schwartz

(1963) that the Federal Reserve's failure to protect the U.S. money supply was

due to misunderstanding of the problem or a lack of leadership; instead, he

claims, given the commitment to the gold standard (and, presumably, the absence

of effective central bank cooperation), the Fed had little choice but to

let the banks fail and the money supply fall.

For our purposes here it does not matter much to what extent central bank 
choices could have been other than what they were. For the positive question

of what caused the Depression, we need only note that a monetary contraction

began in the United States and France, and was propagated throughout the

world by the international monetary standard.4

If monetary contraction propagated by the gold standard was the source of

the worldwide deflation and depression, then countries abandoning the gold

standard (or never adopting it) should have avoided much of the deflationary

pressure. This seems to have been the case. In an important paper, Choudhri

and Kochin (1980) documented that Spain, which never restored the gold

standard and allowed its exchange rate to float, avoided the declines in prices

and output that affected other European countries. Choudhri and Kochin also

showed that the Scandinavian countries, which left gold along with the United

Kingdom in 1931, recovered from the Depression much more quickly than

other small European countries that remained longer on the gold standard.

Much of this had been anticipated in an insightful essay by Haberler (1976).

Eichengreen and Sachs (1985) similarly focused on the beneficial effects of

currency depreciation (i.e., abandonment of the gold standard or devaluation).

For a sample of ten European countries, they showed that depreciating

countries enjoyed faster growth of exports and industrial production than

countries which did not depreciate. Depreciating countries also experienced

lower real wages and greater profitability, which presumably helped to increase

production. Eichengreen and Sachs argued that depreciation, in this

context, should not necessarily be thought of as a "beggar thy neighbor" policy;

because depreciations reduced constraints on the growth of world money

supplies, they may have conferred benefits abroad as well as at home (although

a coordinated depreciation presumably would have been better than

the uncoordinated sequence of depreciations that in fact took place).5

Some additional evidence of the effects of maintaining or leaving the gold

standard, much in the spirit of Eichengreen and Sachs but using data from a

larger set of countries, is given in our tables 2.2 through 2.4. These tables

summarize the relationships between the decision to adhere to the gold standard

and some key macroeconomic variables, including wholesale price inflation

(table 2.2), some indicators of national monetary policies (table 2.3), and

industrial production growth (table 2.4). To construct these tables, we divided

our sample of twenty-four countries into four categories6:
1) countries not on 
the gold standard at all (Spain) or leaving prior to 1931 (Australia and New  Zealand);
2) countries abandoning the full gold standard in 1931 (14 countries);

3) countries abandoning the gold standard between 1932 and 1935 (Rumania

in 1932, the United States in 1933, Italy in 1934, and Belgium in  1935); and 4) countries still on the full gold standard as of 1936 (France, Netherlands, Poland).7
 Tables 2.2 and 2.4 give the data for each country, as 
well as averages for the large cohort of countries abandoning gold in 1931,

for the remnant of the gold bloc still on gold in 1936, and (for 1932-35, when

there were a significant number of countries in each category) for all gold
standard and non-gold standard countries. Since table 2.3 reports data on four

different variables, in order to save space only the averages are shown.8

The link between deflation and adherence to the gold standard, shown in

table 2.2, seems quite clear. As noted by Choudhri and Kochin (1980),

Spain's abstention from the gold standard insulated that country from the general

deflation; New Zealand and Australia, presumably because they retained

links to sterling despite early abandonment of the strict gold standard, did

however experience some deflation. Among countries on the gold standard as

of 1931, there is a rather uniform experience of about a 13% deflation in both

1930 and 1931. But after 1931 there is a sharp divergence between those

countries on and those off the gold standard. Price levels in countries off the

gold standard have stabilized by 1933 (with one or two exceptions), and these

countries experience mild inflations in 1934-36. In contrast, the gold standard

countries continue to deflate, although at a slower rate, until the gold standard's

dissolution in 1936.

With such clearly divergent price behavior between countries on and off

gold, one would expect to see similarly divergent behavior in monetary policy.

Table 2.3 compares the average behavior of the growth rates of three monetary

aggregates, called for short MO, Ml, and M2, and of changes in the

central bank discount rate. MO corresponds to money and notes in circulation,

Ml is the sum of MO and commercial bank deposits, and M2 is the sum of

Ml and savings bank deposits.9
The expected differences in the monetary polices

of the gold and non-gold countries seem to be in the data, although somewhat

less clearly than we had anticipated. In particular, despite the twelve

percentage point difference in rates of deflation between gold and non-gold

countries in 1932, the differences in average money growth in that year between

the two classes of countries are minor; possibly, higher inflation expectations

in the countries abandoning gold reduced money demand and thus

became self-confirming. From 1933 through 1935, however, the various monetary

indicators are more consistent with the conclusion stressed by Eichengreen

and Sachs (1985), that leaving the gold standard afforded countries

more latitude to expand their money supplies and thus to escape deflation.

The basic proposition of the gold standard-based explanation of the

Depression is that, because of its deflationary impact, adherence to the gold

standard had very adverse consequences for real activity. The validity of this

proposition is shown rather clearly by table 2.4, which gives growth rates of

industrial production for the countries in our sample. While the countries

which were to abandon the gold standard in 1931 did slightly worse in 1930

and 1931 than the nations of the Gold Bloc, subsequent to leaving gold these

countries performed much better. Between 1932 and 1935, growth of industrial

production in countries not on gold averaged about seven percentage

points a year better than countries remaining on gold, a very substantial effect.

In summary, data from our sample of twenty-four countries support the
view that there was a strong link between adherence to the gold standard and

the severity of both deflation and depression. The data are also consistent with

the hypothesis that increased freedom to engage in monetary expansion was a

reason for the better performance of countries leaving the gold standard early

in the 1930s, although the evidence in this case is a bit less clear-cut.

Author: Ben Bemanke, Harold JamesConference Date: March 22-24,1990

Ben Bemanke is professor of economics and public affairs at Princeton University and a research
associate of the National Bureau of Economic Research. Harold James is assistant professor
of history at Princeton University.

The authors thank 
David Fernandez, Mark Griffiths, and Holger Wolf for invaluable research
assistance. Support was provided by the National Bureau of Economic Research and the National
Science Foundation.

4. Temin (1989) suggests that German monetary policy provided yet another contractionary

5. There remains the issue of whether the differences in timing of nations' departure

from the gold standard can be treated as exogenous. Eichengreen and Sachs (1985)

argue that exogeneity is a reasonable assumption, given the importance of individual

national experiences, institutions, and fortuitous events in the timing of each country's

decision to go off gold. Strong national differences in attitudes toward the gold standard

(e.g., between the Gold Bloc and the Sterling Bloc) were remarkably persistent

in their influence on policy.

6. The countries in our sample are listed in table 2.1. We included countries for

which the League of Nations collected reasonably complete data on industrial production,

price levels, and money supplies   (League of Nations'  Monthly Bulletin of Statistics 
and Yearbooks, various issues; see also League of Nations, Industrialization and  1945).  


Foreign Trade,Latin America, however, was excluded because of concerns
about the data and our expectation that factors such as commodity prices would play a

more important role for these countries. However, see Campa (forthcoming) for evidence

that the gold standard transmitted deflation and depression to Latin America in a

manner very similar to that observed elsewhere.

7. We define abandonment of the gold standard broadly as occurring at the first date

in which a country imposes exchange controls, devalues, or suspends gold payments;

see table 2.1 for a list of dates. An objection to this definition is that some countries

continued to try to target their exchange rates at levels prescribed by the gold standard

even after "leaving" the gold standard by our criteria; Canada and Germany are two

examples. We made no attempt to account for this, on the grounds that defining adherence

to the gold standard by looking at variables such as exchange rates, money

growth, or prices risks assuming the propositions to be shown.

8. In constructing the grand averages taken over gold and non-gold countries, if a 
country abandoned the gold standard in the middle of a year, it is included in both the

gold and non-gold categories with weights equal to the fraction of the year spent in

each category. We use simple rather than weighted averages in the tables, and similarly

give all countries equal weight in regression results presented below. This was done

because, for the purpose of testing hypotheses (e.g., about the relationship between

deflation and depression) it seems most reasonable to treat each country (with its own

currency, legal system, financial system, etc.) as the basic unit of observation and to

afford each observation equal weight. If we were instead trying to measure the overall

economic significance of, for example, an individual country's policy decisions,

weighted averages would be more appropriate.

9. The use of the terms Ml and M2 should not be taken too literally here, as the

transactions characteristics of the assets included in each category vary considerably

among countries. The key distinction between the two aggregates is that commercial

banks, which were heavily involved in commercial lending, were much more vulnerable

to banking panics. Savings banks, in contrast, held mostly government securities,

and thus often gained deposits during panic periods.

SOURCE The National U.S.A. Bureau of Economic Research,chapter parts from the book
Financial Markets and Financial Crises

B)Why the U.S. Has Launched a New Financial World War -- and How the Rest of the World Will Fight Back

Finance is the new form of warfare -- without the expense of a military overhead and an occupation against unwilling hosts.

What is to stop U.S. banks and their customers from creating $1 trillion, $10 trillion or even $50 trillion on their computer keyboards to buy up all the bonds and stocks in the world, along with all the land and other assets for sale in the hope of making capital gains and pocketing the arbitrage spreads by debt leveraging at less than 1 per cent interest cost? This is the game that is being played today.
Finance is the new form of warfare - without the expense of a military overhead and an occupation against unwilling hosts. It is a competition in credit creation to buy foreign resources, real estate, public and privatized infrastructure, bonds and corporate stock ownership. Who needs an army when you can obtain the usual objective (monetary wealth and asset appropriation) simply by financial means? All that is required is for central banks to accept dollar credit of depreciating international value in payment for local assets. Victory promises to go to whatever economy's banking system can create the most credit, using an army of computer keyboards to appropriate the world's resources. The key is to persuade foreign central banks to accept this electronic credit.
U.S. officials demonize foreign countries as aggressive "currency manipulators" keeping their currencies weak. But they simply are trying to protect their currencies from being pushed up against the dollar by arbitrageurs and speculators flooding their financial markets with dollars. Foreign central banks find them obliged to choose between passively letting dollar inflows push up their exchange rates - thereby pricing their exports out of global markets - or recycling these dollar inflows into U.S. Treasury bills yielding only 1% and whose exchange value is declining. (Longer-term bonds risk a domestic dollar-price decline if U.S interest rates should rise.)
"Quantitative easing" is a euphemism for flooding economies with credit, that is, debt on the other side of the balance sheet. The Fed is pumping liquidity and reserves into the domestic financial system to reduce interest rates, ostensibly to enable banks to "earn their way" out of negative equity resulting from the bad loans made during the real estate bubble. But why would banks lend more under conditions where a third of U.S. homes already are in negative equity and the economy is shrinking as a result of debt deflation?
The problem is that U.S. quantitative easing is driving the dollar downward and other currencies up, much to the applause of currency speculators enjoying a quick and easy free lunch. Yet it is to defend this system that U.S. diplomats are threatening to plunge the world economy into financial anarchy if other countries do not agree to a replay of the 1985 Plaza Accord "as a possible framework for engineering an orderly decline in the dollar and avoiding potentially destabilizing trade fights." The run-up to this weekend's IMF meetings saw the United States threaten to derail the international financial system, bringing monetary chaos if it does not get its way. This threat has succeeded for the past few generations.
The world is seeing a competition in credit creation to buy foreign resources, real estate, public and privatized infrastructure, bonds and corporate stock ownership. This financial grab is occurring without an army to seize the land or take over the government. Finance is the new form of warfare - without the expense of a military overhead and an occupation against unwilling hosts. Indeed, this "currency war" so far has been voluntary among individual buyers and the sellers who receive surplus dollars for their assets. It is foreign economies that lose, as their central banks recycle  this tidal wave of dollar "keyboard credit" back into low-yielding U.S. Treasury securities of declining international value.

Michael Hudson is a former Wall Street economist. A Distinguished Research Professor at University of Missouri, Kansas City (UMKC), he is the author of many books, including Super Imperialism: The Economic Strategy of American Empire (new ed., Pluto Press, 2002) and Trade, Development and Foreign Debt: A History of Theories of Polarization v. Convergence in the World Economy . He can be reached via his website, mh@michael-hudson.com




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