I’ve heard that the Great Depression was largely caused by the U.S. being on the gold standard. I know I could google it, but I’m preoccupied. Can anyone encapsulate the argument(s) supporting this claim?
The short answer is that being on the gold standard essentially prevents countries from increasing their money supply. Increasing the money supply can have the negative effect of currency devaluation and inflation (or hyperinflation), but that is usually not a problem in a recession or depression. During a downturn, increasing the money supply can encourage lending and help stimulate the economy.
You will note that countries came out of the Great Depression roughly around the time they abandoned the gold standard.
Also, the GD wasn’t caused be being on the gold standard.
Nixon abandoned the gold standard in the USA in 1971. A long while after the GD passed.
The answer to the OP is that one of the most effective ways to help fight a recession is to increase the money supply, usually by cutting interest rates. But if your country is on the gold standard, policy makers have no control over the money supply - money is just worth whatever gold happens to be worth.
FDR did move away strongly from the gold standard in 1933, despite the fact the gold standard was not completely jettisoned until 1971.
The U.S. went off gold in 1934 when the Gold reserve Act called in all gold notes. This was after several other restrictions on gold. What Nixon did was a technical move that changed basically nothing. The U.S. was not on a gold standard in any meaningful way between 1934 and 1971.
msmith537 is right is all details. The Depression was not caused by the gold standard, although the limitations it put on expanding the money supply made it much more difficult to recover. Germany, France, and the UK all did this first and started recovering first.
Yes. For example Wikipedia states “According to Keynesian analysis, the earliness with which a country left the gold standard reliably predicted its economic recovery from the great depression. For example, Great Britain and Scandinavia, which left the gold standard in 1931, recovered much earlier than France and Belgium, which remained on gold much longer.” (France abandoned the gold standard in 1936.)
Well, FDR did sign the Gold Reserve Act of 1934 which increased the price of gold by 69% and imposed restrictions. Nevertheless you have a point: the U.S. Treasury offered to buy gold from and sell gold to foreigners in unlimited amounts until Nixon’s move.
The short explanation of why the U.S. was able to stay on a Gold standard 35 years longer than France is the enormous wealth and prestige of America compared with the rest of the world, ravaged by two horrific wars. (The Bretton-Woods Agreement is an interesting part of the full story).
(ETA: I take my time composing posts and two others beat me to this mention between “Reply” and “Send.”)
In the 1920’s and 1930’s the Republic of China was one of the few countries that used the silver standard (i.e., the Chinese currency was backed by silver). At the same time, the USA (mostly Nevada) was a big producer of silver. The US government had a fixed price (at which it would buy silver)-this was kept in law by a certain senator from Nevada.
The Chinese Government bitterly complained that the USA support for silver kept the chinese currency artificially high-and thus kept China in recession-is this so?
China had very minor exports at this toime-so why was the USA price of silver so critical to keeping them in recession?
There is a good episode of NPR’s Planet Money about just this:
Basically when the depression hit people want to trade in their paper money for gold, as it was seen as more secure. This was a problem as the government didn’t have enough gold on hand to meet demand. In order to counter this they had to raise interest rates in order to discourage people from trading in their money for gold.
I do recall listening to that story:
INSTR that an economist on an NPR interview claimed that the gold standard ‘caused’ the Great Depression. I was driving at the time, so I may have misheard.
Bretton Woods wasn’t a gold standard in any typical market sense, but the death of the system was nevertheless a big hairy deal.
It ended the era of fixed exchange rates and removed what was left of the expectation that inflation could remain anchored. Obviously, the oil shocks of the 70s were notably unpleasant, but long-term, inflation is based on expansion of the money supply, and closing the gold window allowed the continued expansion of said supply in the absence of competent management at the Fed. Inflation had started earlier, yes, but the Nixon shock let everyone know that the changes were permanent. It took more than 10 years after that for Volcker to get the money supply back under control.
This is a big mistake, and it’s the typical mistake that well-meaning finance people make when they start talking about the economy as a whole.
The interest rate filter drives me nuts. Nominal rates were dropping during the first couple years of the Great Contraction. Deflation was even more aggressive, so real rates were increasing, but it can’t be argued that the Fed consistently raised rates to maintain its gold reserves. Eventually, they did raise rates – the idiots – and the US financial system started to buckle under the stress, but the Depression was in full force even as rates were dropping.
At core, it’s not about interest rates. It’s about money more generally. “Recessions are always and everywhere a monetary phenemenon.” Blind attachment to gold prevented Hoover and Company from doing the right thing in response to a massive increase in money demand.
Recessions can have many parents, but the most accurate thing to say is that a recession is caused by an increase in money demand, which is equivalent to saying a decrease in aggregate demand for current goods and services.
Gold is limited in supply, and therefore inherently deflationary during times of economic expansion. Expected deflation can increase money demand – i.e. cause recessions – and in that sense, the gold standard can perhaps be blamed. But more important than that is policy response. There was nobody pointing a gun to the people in charge saying they had to stick with gold. They did so on their own volition. When money demand spiked, they could have responded to that. But they didn’t, not for several years.
The countries that were quickest to drop gold were the quickest to recovery.
Just lost a long post and I should be in bed.
Quickly: My line referred to the gold standard and nothing more. Bretton Woods had its own separate importance. As for the timeline, Inflation had been going down since 1969 and was at 4.62% in August 1971. It wouldn’t break 4% again until March of 1973, six months before the first oil crisis. What happened? George Schultz announced a dollar devalued by 10%. That set inflation rising until December 1974 before it dropped again for four years, went up for three years and then dropped again. A second oil crisis and a huge panic among the countries in the Euro Zone somewhat similar to today overwhelmed any the Fed attempts. It was a complicated time, from my perspective the first post war case of other currencies making our fixes less efficacious. So not all Volcker’s fault. And I doubt how much effect gold could have brought to the table.
The closing of the gold window was the death of Bretton Woods. At core, that is what Bretton Woods was. Without dollar convertibility, there was no way to enforce and maintain fixed exchange rates. Now, it didn’t happen overnight. Some corpses take a while to stop moving. But the attempts to maintain some sort of stable exchange rate couldn’t last long without an open gold window.
I don’t see how you regard that as “separate”. The gold window was closed in '71 precisely because the US had printed too many dollars. Gold coverage had dropped to around 20%. They put together a hasty attempt to maintain some sort of fixed money organization, but that was a larf. As soon as the gold mechanism was taken down, devaluation of the dollar internationally was inevitable. The fixed rate couldn’t be maintained.
Nor should it have been maintained, in my estimation, though I generally try to keep opinions out of GQ. The connection between gold and money should have been dissolved decades earlier.
Which was, to say it again, inevitable.
Without a mechanism to enforce a fixed exchange rate regime, a dollar devaluation – and eventually floating currencies – could not be avoided. Nor should that have been avoided.
And that would be a relevant comment if anybody had blamed Volcker. Saying that he was the one who stopped the inflation is not blaming him for anything.
Yes, inflation was up and down over the decade. And why was that? Lots of reasons. It was complicated, just as you say. Oil shocks, continual devaluations from the new international money system, the works. But one of the main reasons is, simply, that stopping the expansion of the money supply (jacking up interest rates) is extremely painful. No one at the Fed had the will to hit the brakes and then keep hitting the brakes despite the pain. No one until Volcker was put in charge.
Gold had a real role in the Bretton Woods system, silly as it might have been. The fixed exchange rate system was built on a foundation of shiny yellow metal, and the system died when the metal was taken away. From the perspective of the average American, you’d be right that it “changed basically nothing” – citizens didn’t have the right to redeem anyway – but from the standpoint of the international money system as a whole, the end of gold was the death knell of the entire fixed rate regime.
To which I say: good riddance.
The Great Depression was a worldwide phenomenon. This was because practically every nation was on the gold standard and the end of WW1 caused gold hoarding among the nations of europe(mostly france). This gold hoarding led to deflation. The rational response to deflation is to cut wage and prices but the money illusion makes wages and prices sticky (especially wages). Since wage cuts are impractical, the only alternative is unemployment. In the US Hoover’s high wage policies exacerbated the problem. When nations started going off the gold standard markets could adjust and a new equilibrium could be reached.
While it’s hard to say whether the Great Depression was caused by the gold standard, I definitely agree that abandoning the system would have allowed us to recover earlier from the Great Depression. Even then if it weren’t for WWII, we would not have recovered the way we did.
Reported.