GOLDEN FETTERS: THE GOLD STANDARD AND THE GREAT DEPRESSION, 1919-1939

By Barry Eichengreen

GK Chesterton delivered a wise warning to reformers: Never tear down a wall until you understand why it was put up. He might have balanced his advice with an equal warning to nostalgics: Never attempt to rebuild a structure until you understand why it was ripped down.

Case in point: the gold standard.

Through the editorial columns of the Wall Street Journal, store the late Bob Bartley taught two generations of conservatives to regret the final end of gold’s monetary role in 1971.

Bob’s associate, healing Jude Wanniski, argued for resurrecting the classical gold standard of the pre-Depression era, terminated in the US in 1933 and in Britain in 1931.

Now former presidential candidate Ron Paul is selling tens of thousands of copies of a book that calls for turning back the clock even further — to back before the creation of the Federal Reserve in 1913.

Before signing onto any of these ideas, however, intelligent conservatives would do well to grapple with the reasons for the overthrow of gold. No book on the subject is more learned and important than Barry Eichengreen’s Golden Fetters: The Gold Standard and the Great Depression, published by Oxford University Press in 1992.

Golden Fetters is a narrative history, not a work of economic theory, and Eichengreen is a perfectly serviceable writer. Still, I have to deliver the warning: reading Golden Fetters is serious labor, because of the book’s huge scope (Eichengreen studies the Swedish monetary system with the same care he pays to the French or British) and monumental accumulation of information. Yet the labor more than repays itself in better understanding of an important and difficult subject.

Some background first.

Although human beings have used gold as a store of value for hundreds if not thousands of years, the “gold standard” — meaning the use of gold as money — was a relatively modern development. Until comparatively recently, not enough gold existed above ground. The coins that liquefied commerce in ancient Rome and pre-Civil War America were silver, not gold.

The shift to gold began in Britain, and it began by accident, in the course of a 1695 currency reform intended to improve the state of Britain’s silver-coinage. The reform slightly under-priced silver and slightly over-priced gold. The result was an ironic working of Gresham’s law, whereby the bad (gold) money drove out the good (silver) money. Intended to improve silver coinage, Britain found itself with only gold. To cope, the Mint began to use copper for lower-value coins, especially the money of the poor, the penny. The rich used paper money backed by the gold backs accumulated in lieu of the silver they could no longer get. Britain stumbled along through the 18th century on this informal gold standard. The role of gold was at last formalized with the return of peace after the Napoleonic wars: the Coinage Act of 1816 fixed the pound’s value in terms of gold. Nicholas Mayhew’s Sterling: The Rise and Fall of a Currency is a lively and entertaining history of British monetary developments.)

From 1816 until 1914, the Bank of England stood ready to redeem paper money for the equivalent in gold coin.

But through the larger part of the period, no other bank on earth would do the same. Gold coins existed of course everywhere. But if you took paper money to the bank in the America of the 1830s, you’d expect it to be redeemed in silver dollars. In Berlin, you’d get silver marks from the Prussian authorities. Not until the 1870s did the world’s leading economic powers join Britain in defining their money as a certain weight of gold: The United States did not formally do so until 1900, although the demonetization of silver in 1873 made the US a gold standard country in all but time.

This “classical” gold standard lasted barely more than a generation. Eichengreen’s book opens by debunking some of the myths surrounding gold’s operations.

Theoretically, the gold standard was self-balancing — this is much of its appeal to modern libertarians. If business accelerated in any gold-standard country to a point that seemed to threaten inflation, gold would begin to withdraw from circulation. If any country ran a persistent trade deficit, gold would have to be exported to rectify the balance. The country would go into recession or slump until monetary values were restored and gold returned.

In practice, it did not work that way. The gold standard was maintained by a system of international cooperation, coordinated by a Bank of England that held surprisingly little gold in its own vaults but that could mobilize resources from other banks — especially France’s and Germany’s — who shared the British commitment to the stability of the system. This coordination succeeded in large part because of the weakness of democratic processes in the three countries: Everybody understood that the central bankers would accept very high levels of unemployment to protect the gold value of money — and there was not much short of revolution that voters could do to change their minds.

The United States did not fully participate in this system. Before 1913, the U.S. lacked a central bank. It was private American bankers, and most famously J.P. Morgan, who worked with the European central banks. Being the most democratic country, America’s commitment to gold was also least credible. The result was that the U.S. financial system was uniquely susceptible to panics and the risk of being forced off gold, as nearly happened in 1893 and again in 1907.

It’s super hilariously ironic that modern monetary cranks of the Ron Paul variety now combine enthusiasm for gold with opposition both to an American central bank and hatred of international monetary cooperation — the two ingredients absolutely essential to sustaining the ancient currency regime for which they claim to yearn.

International monetary cooperation broke down during the First World War and could not be restored thereafter. Here lay the origin of all the financial and economic woes of Europe after 1919. Eichengreen describes and analyzes these minutely and intelligently, his section on the German and other inflations most especially thought-provoking. I want to skip over that to address the sections of his book most immediately challenging.

1) When we today look back on the Depression era, we see decisions so catastrophically bad that we wonder how anybody could have made them. Yet it’s not that they were so stupid and that we are so smart. They were trapped by the imperative — or the perceived imperative — to defend the gold standard. Why did President Hoover raise taxes in 1932? He had known enough to cut them in 1930. But by 1932, he was facing deficits so colossal as to raise doubts about the credibility of the US commitment to gold. We know now that recovery began as soon as a country quit gold: Britain in 1931, the US in 1933, Germany tragically too late to avert the Nazi seizure of power. Seventy years ago, decision-makers did not know that, and their peoples suffered badly for it. It’s humbling to consider that we too may be suffering because of our inability to transcend the limits of our knowledge and imagination.

2) One reason that policymakers clung so fiercely to gold was their terrible recent memories of inflation, not only in Germany, but also in France, Austria, Italy and other continental countries. In 1932 as today, our most recent experiences have disproportionate sway over our thinking.

3) Even after decision-makers took the steps that enabled recovery, they continued to pair good decisions with lethal errors. President Roosevelt counter-acted his bank and financial measures of March 1933 with his disastrous price-fixing National Recovery Act. He stimulated employment with his WPA and PWA jobs programs, then depressed employment with the Wagner Act changes to labor law. The Social Security Act of 1935 was a welcome innovation, introduced at the wrong time — the new taxes to finance pushed the economy back into another steep decline in 1937.

The Roosevelt administration was acting in the spirit of Rahm Emanuel’s famous warning against allowing a crisis to go to waste. They used the Depression to achieve other cherished projects — and in so doing, often aggravated the crisis that gave them their opportunity. Will the Obama administration succumb to similar temptation? The question echoes ominously.