Douglas Irwin on the Great Depression and the Gold Standard
Oct 11 2010

Douglas Irwin of Dartmouth College talks with EconTalk host Russ Roberts about the role the gold standard played in the Great Depression. Irwin argues that France systematically accumulated large amounts of gold in the late 1920s and 1930s, imposing massive deflation on the rest of the world. Drawing on a recent paper of his, Irwin argues that France's role in worldwide deflation was greater than that of the United States and played a significant role in the economic contraction that followed.

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Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


ric caselli
Oct 11 2010 at 9:07am

I recommend reading “Lords of finance” by L. Ahamed. The decision makers of the 20’s were not all clueless. The extended money supply was a lot more flexible than depicted – think high leverage on Wall Street and consumer credit. Interest rates changes happened relatively regularly.

The important “conundrum” then was that all large economies faced prices deflation in real terms no matter what the monetary policy.

It is obvious that the real issue was overcapacity!
After WWI US production capability flooded the world economy just like China and India are doing now.

France did what she had to do to stay competitive.

My guess is that nobody wants to look at overcapacity since no one knows what to do about it!

Oct 11 2010 at 10:06am

Great podcast.

The episodes of Econtalk that focus on monetary policy always leave me wondering what the historical relationship between governments’ debt/gdp ratios and tendency to inflate is.

Oct 11 2010 at 10:24am

This is why central banking doesn’t work very well, with OR without a gold standard.

Free Banking, FTW.

Oct 11 2010 at 10:48am

Just out of my curiosity, does anybody out there know if there was a big increase in gold mining and selling jewelry in response to falling prices and joblessness during the Great Depression?

Oct 11 2010 at 11:54am

A listener to this podcast might conclude that banks are in the business of printing money to buy gold. Russ tried several times to steer the discussion away from this conclusion without much success.

“The rules of the gold standard are: if you gain more reserves, you have to print more money; if you lose gold reserves, you have to pull back in terms of how much money you can issue.”

These rules are a little simplistic. Banks don’t just print money and hand it out (we hope). Banks adhering to a gold standard extend credit leveraging gold. The pressure on their gold reserves depends upon the quality of credit they extend, because a bank’s assets are its loans, which are claims on real resources like houses and people’s labor, not the gold in its vaults.

“What happens if the Central Bank is getting all this gold but decides not to print money?”

The question is: “What happens if the Central Bank getting gold doesn’t extend more credit?”

Ideally, banks extend credit to reorganize resources more productively, seeking profit. Suppose I’m an enterpreneur. I believe I can employ some labor, plant and equipment to add more value than the current organization of these same resources, so I’ll borrow to buy the resources from the current owners and reorganize them. In one sense, “printing money” is code for extending me credit for this purpose.

Of course, some established factors of production could object to my reorganization. They might deny that a new organization of resources is more productive, but they also might feel threatened by the new organization, expecting their own contribution to new modes of production to be less valuable than their contribution to old modes of production. A maker of wagon wheels could object to extending credit to Henry Ford. The owner of a coal mine could object to extending credit to an oil driller.

So one story goes like this. The French monetary authority set a low exchange rate for the Franc, and demand for French exports expanded, but the French monetary authority then did not threaten established proprietors of productive resources in France by extending credit to entrepreneurs who wanted to reorganize resources in France. At the same time, entrepreneurs in other economies couldn’t reorganize resources more productively either, because their banking systems were losing gold, and systems losing gold extended less credit. The systems losing gold didn’t even extend enough credit to organize idle resources, much less reorganize employed resources more productively.

Another story goes like this. France was already ahead of the game, or further along an economic development trajectory, when it set its exchange rate following the first world war. Entrepreneurs really didn’t have many opportunities to improve resource organization, so extending credit to them would not have increased productivity. It would only have increased inflation in France by dragging productivity down. Other banking systems needed to extend credit anyway, leveraging (and thus risking) their gold reserves more, but they didn’t, because they were more concerned with protecting established proprietors than with catching up with the French. The French presumably told this story at the time.

Ed Hanson
Oct 11 2010 at 12:32pm

My comment are questions.

The given mechanism for the flow of gold into France was increase in exports and a decrease of imports. Makes sense. So in an era when increasing tariffs was certainly popular, why did not Great Britain and the United States simply place tariffs on all French goods imported to those countries to counter the ‘cheap’ price of those goods.

If the dire nature of the French accumulation of the worlds gold is as presented, the trade off of reduced trade to one country seems minor in comparison. Did the world leaders completely miss what was going on?

Oct 11 2010 at 12:41pm

Hi, Reston.

I think your comment might confuse Central Banks and private banks, referring to both as “banks.”

You wrote

A listener to this podcast might conclude that banks are in the business of printing money to buy gold.

I thought the podcast was pretty clear that it was talking about Central Banks (official banks of a country, such as the Federal Reserve in the United States), not private banks; and specifically during the historical period during the 1920s and 1930s, when the gold standard was reinstated after the conclusion of WWI. The United States and the rest of the developed world went on and off the gold standard during the period. Most recently, the United States and the world along with it went entirely off the gold standard in 1971-72 under President Nixon.

Any familiarity with a gold or other metallic standard is likely unfamiliar to listeners who are under the age of 30 or even 50. Even fixed or pegged exchange rates, which are similar, are eye-glazingly difficult and unfamiliar for modern readers. Central Banks used to spend a lot of their time devoting resources to managing their gold and other international reserves, exchange rates, and the balance of payments. Nowadays one never hears about that.

You also wrote:

Banks don’t just print money and hand it out (we hope). Banks adhering to a gold standard extend credit leveraging gold.

Banks–private banks–don’t ever print money. If they did so, it would be deemed counterfeit and would be confiscated. Only the Central Bank of a country can do that (since the late 1800s or before WWI for most countries).

Moreover, banks–private banks–don’t and wouldn’t choose to adhere to a gold standard. Only a country’s Central Bank would make that choice. Any private bank that tried to adhere to a gold standard when the Central Bank does not would go out business in 30 seconds flat. Any citizen could make millions off any private bank that tried to adhere to a gold standard when the Central Bank is not standing by to offload the excess of either the bank’s gold or cash.

You are right, though, that private banks extend credit to reorganize resources more productively.

Central Banks, on the other hand, never extend credit to reorganize resources more productively. If the government-owned Central Bank of a country did that, it would drive the country’s private banks out of existence.

I think what matters with regard to your comment is clearing up when you are referring to the Central Bank of a country (e.g., the Federal Reserve) and when you are referring to a private bank (e.g., the bank where you deposit your paycheck, write checks, and go to for a loan for your kid in college or your home).

VA Classical Liberal
Oct 11 2010 at 1:15pm


Any comments on China’s alleged currency manipulation? The parallel between France in the 20s and China today is striking.

Since Don has convinced me that cheap Chinese imports help me, how could cheap French imports have hurt Britain?

Oct 11 2010 at 4:58pm

Flocina asked:

Just out of my curiosity, does anybody out there know if there was a big increase in gold mining and selling jewelry in response to falling prices and joblessness during the Great Depression?

I’m not sure about jewelry.

There was an increase in gold mining. It became very profitable.

In the twenties and thirties dollars were pegged to gold, today they both float. Regardless, we have to accept conceptually ‘the real price of gold,’ which would be the price of gold against a basket of goods, services, and commodities.

For more on this, somewhere on
Jay Taylor interviews Bob Hoye.

Bob Hoye is a market historian (apparently self taught). He would be an excellent guest for econtalk.

Oct 11 2010 at 10:08pm

Hi Lauren,

Thanks for the clarification. I did confuse “central bank” and “banks” or “banking system”.

The podcast addressed central banks. A central bank extends credit to less central (private) banks that in turn extend credit to the public, but even with a central bank, less central banks create most money. They don’t literally print currency, but they expand the money supply beyond the base created by the central bank.

At a given time, most money exists only on the books of banks, and a single dollar created by a central bank can end up on the books of many banks simultaneously. My bank borrows a dollar from the central bank and lends it to me. I spend the dollar, and someone else deposits it in a second bank (or even the same bank). The second bank lends the dollar and so on. Even with a reserve requirement, a central bank dollar multiplies many times this way, so less central banks create most money as they extend credit to the public.

A central bank doesn’t lend directly to reorganize resources, but when a central bank lowers interest rates, it encourages less central banks to lend for this purpose.

Private banks can (and in the past have) more literally “print money” in a decentralized, free banking system, i.e. the banks issue promissory notes to extend credit, and these notes circulate as currency. The notes can promise gold, but they don’t represent gold. They represent the value of collateral securing loans. The notes can promise gold, because collateral is valued relative to gold and can be exchanged for gold in principle. EconTalk featured George Selgin on free banking a couple of years ago. A free banking system doesn’t require a lender of last resort, but a central bank essentially polices a system of this sort.

With a central bank, under a gold standard, a central bank’s notes promise gold, but the central bank is a not a gold warehouse issuing warehouse receipts. If the standard prices a gram of gold at one dollar, the central bank need not have a gram of gold for every dollar it creates, but if its reserve runs short, it must call loans, i.e. it must require less central banks to find gold for it by calling their loans.

The selling required to raise gold in this scenario can be deflationary. Irwin discussed this point in the podcast. The price of gold is fixed, and other values are measured relative to gold. When demand for gold rises, the price cannot rise, so other prices must fall. In terms of the banking system, banks suffering runs on their gold reserves drive down prices by calling loans (or refusing to roll over credit). A central bank suffering a run on its gold reserve does the same thing, but a central bank calls loans to less central banks.

If a central bank’s money is legal tender and people must pay taxes only in the central bank’s money, a free banking system probably couldn’t coexist with it, so I agree that no private bank would operate a gold standard (issuing promissory notes for gold to extend credit) these days, only because the state has effectively outlawed it. A gold standard might not be the best basis for a free banking system anyway. I like the idea of a calorie standard (based on agricultural commodities), but that’s another (purely academic or utopian) discussion.

Oct 12 2010 at 12:36am

Great podcast as always. Great comments — I apologize in advance for my ignorance:

Reston: Good point that a fractional reserve gold standard in which the central bank sets reserve requirements is quite a different thing entirely from a gold standard in which the central bank is only a warehouse of gold receipts—perhaps with no fractional banking allowed at all.

I’d be curious what you think about private financial institutions drastically expanding credit through modern derivative instruments like the credit default swap? If we consider the Austrian view that

1.) Expansions in the money supply/expansion of credit/very low interest rates are the same thing by definition.

2.) This explains the business cycle. Easy credit causes artificial booms which lead to busts.

Wouldn’t this expansion of credit through private derivative instruments possibly lead to the same sort of problems as a bad central bank—too loose monetary policy in good times—a rapid expansion of credit? Or is the idea that this sort of expansion of credit is too small compared to the effect that a central bank can have and the government shouldn’t worry about regulating this kind of derivative? How would economists measure the effect derivatives have had? Can anyone point me in the right direction of something to read/watch/listen to?

Or do derivatives only create reasonable credit the way traditional loans do?

VA Classical Liberal: Sure, lots of folks, governments and especially people in the manufacturing business freak out about cheap imports all the time even though in the long run it’s a good thing.

The easiest way to think of the France did is in terms of the quantity theory of money. If folks essentially use gold pieces for money–and France hordes most of the gold suddenly other countries have less, i.e. “burning” money. Less gold means less money in circulation for the same amount of goods and services—causing deflation. Suddenly 1 gram of gold buys a Porche automobile instead of two. There is less money bidding up the price–even though the economy has the same amount of wealth. It’s like if you burned half the money in the United States.

If instead an enormous gold meteorite crashed in the center of Paris and France had an enormous new supply of gold. Suddenly the world had much more gold in circulation. There would be a much larger quantity of money and an inflation–now a Porsche would cost 3 grams of gold instead of two i.e. “printing money”. This all assumes of course that governments are keeping there exchange rates (and reserve requirements) fixed I.e. 1 gram of gold = one dollar ect.

Here is where I am confused:

China would not be able to do that to the US dollar because it couldn’t suddenly reduce or increase the money supply–unless we were bizarrely pegged to their exchange rates–Twilight Zone Bretton Woods.

Am I missing something? Can they do this by buying up massive amounts of US bonds? Wouldn’t all China be doing would to lower the US Governments cost of capital by buying US treasury bonds? as well as the cost of capital to our firms since the prime rate of interest is lower? i.e. all for the good. Unlike France they are actually trading real capital assets not “printing money” or “burning money”

Quite different from the France situation.

What am I missing?

Oct 12 2010 at 4:52am

Excellent and helpful clarification, Reston. Thanks so much.

For those interested, the EconTalk podcast Reston mentioned with George Selgin on Free Banking is at

Patrick L
Oct 12 2010 at 7:11am

Russ Roberts made a question of ‘who knew about this’, and as an aside suggested maybe the Austrians III,Ch.20

Henry Bowman
Oct 12 2010 at 9:43am

Interesting podcast. A small correction: Irwin alluded to Russia/USSR and South Africa as the principal gold producers. Certainly that was the case in 1970; Russia has much less production now, in part due to the fact that many of the mines are no longer in Russia, but in other countries. However, the U.S., China, and Australia are all major producers now (see these charts). Overall, world gold production peaked in 2000, though of course it could increase again if additional sources are located.

As others have noted above, the whole idea of having a small number of “experts” control a nation’s (or the world’s) money supply is central planning run amok. They do not understand the system, in part because it is always changing. Hence, mistakes will be made, and sometimes those mistakes will lead to disaster. As others have noted, free banking might offer a way out of this mess.

Oct 12 2010 at 10:27am

Re: Ric Casselli’s observations about overcapacity

Ric is right on all three counts: that “overcapacity” — or what non-economists might call “non-scarcity” (or even “abundance”) — was likely a major contributor to the first Great Depression; that present-day economists generally take great pains to avoid discussing (or even acknowledging) this condition, and that this same phenomenon continues to be among the most serious challenges facing the current and future economy. If anything, Ric grossly underestimates the forces behind this phenomenon, as the assimilation of even large formerly marginal economies into the system of world trade and financial flows (e.g., US in the early 20th c., China and India today) is not as significant as the impact of productivity-enhancing technology advances that have touched almost everyone everywhere. Those advances continue to drive down the marginal cost of production for an ever-increasing share of everything we produce and consume at a rate that, for the overwhelming majority of working people, vastly exceeds the corresponding rate of growth in earnings. In recent times, much of the resulting production gap has been closed with debt-fueled consumption — occasionally foolish and frivolous consumption (esp. those enjoying good times), often reluctant but unavoidable consumption for everyone else.

This problem of overcapacity was first recognized during the Great Depression, and the widely adopted solution was the production strategy known as “planned obsolescence,” which encompasses a range of practices including the selective rationing of access to new, superior technologies, and the packaging of marginal improvements in forms that are intentionally designed to rapidly degrade if not fail entirely. While the practice and the goal itself — keep consumers coming back regularly, whether they like it or not — may be inherently unethical (as well as tremendously wasteful), it was at least made sustainable for a long while by the simultaneous modulation of wage levels by the same industrial decision makers who needed wage earners to keep spending.

Given the success that this two-pronged strategy had in assuring a continuous revenue stream and a comfortable longevity for most large manufacturers, it should have come as no surprise that other industries would want to get in on the game. But if you’re not a manufacturer — if, for example, you’re just an intermediary providing safe storage for past earnings and liquidity for aspiring individual and corporate buyer-investors — what can you do to assure and maximize your own continuous revenue flow?

Douglas Irwin may be right to claim (after Friedman) that deflation, like inflation, is always and everywhere a “monetary” phenomenon — but the mechanism of causation that give that claim credence is not “government policy” but rather the private interests and private preferences of key decision-makers in the monetary liquidity industry, i.e., bankers.

Oct 12 2010 at 11:46am


A system of warehouse receipts for gold is not a gold standard in my way of thinking. Under a gold standard, gold is the standard of value, not the money. Money is a credit I accept in lieu of something else I will exchange for my goods later. Carrying around gold (or warehouse receipts) to bargain is still barter, a system of trade that hasn’t reached the monetary stage. Some people dispute my way of thinking, but I’m sticking to it.

A financial system (including a free banking system without a central bank) can overextend credit (expand the money supply too much). A low interest rate and a low price for a credit default swap are essentially the same thing in this respect.

Excessive monetary expansion does not fully explain the business cycle, because booms and busts occur for many reasons. Loose money could contribute to a boom/bust cycle, but I don’t expect any regulation of the monetary system to prevent booms and busts, not central banking regulation or market regulation or any other regulation. Markets are dynamic and should be dynamic. Capital markets are risky and should be risky.

Market regulation is my preference, but market regulation exists only while creditors bear risks, and “creditors” includes bank depositors, pensioners and anyone else expecting to exchange current production for future consumption (or risk for currency). We have an excess of credit in the world, but we can’t simply blame central bankers for this problem. The historically unprecedented, demographic transition is a more fundamental reason, and other fundamental reasons exist.

Many people now want to exchange currency for entitlement to future consumption. No law of economics requires enough future consumption for sale currently to meet this demand. If the birth rate fell to zero, we’d all have lots of spare cash (with no children to support), and we’d all compete for entitlement to the dwindling output from the dwindling labor force. In this scenario, all investment is malinvestment, ultimately, because in a generation, no young labor is left for any of the business models.

In our monetary system, entitlement to tax revenue (Treasury securities) plays the role of gold in a monetary system with a gold standard, i.e. central bankers exchange entitlement to tax revenue for currency in open market operations. This chart suggests why the Chinese, Japanese and Europeans pay high prices for bits of entitlement to U.S. tax revenue (and other rents imposed on U.S. citizens).

Any analysis of booms, busts and financial imbalances should consider economic fundamentals of this kind. A focus on “quantity of money” and other strictly financial considerations is much too narrow.

France hoarding gold need not imply too little money in circulation, because gold is not money. If France hoarding gold leads to a contraction of money and credit, all else being equal, the monetary system is broken. The problem was not that France hoarded gold. The problem was that particular states imposing a particular monetary system with a particular gold standard effectively forbade extensions of credit.

In our monetary system, entitlement to tax revenue (Treasury securities) plays the role of gold in a monetary system with a gold standard, i.e. central bankers exchange Treasaury securities for currency in open market operations. In a conventional gold standard, monetary authorities fix the price of gold. In our system, the Fed varies the price of Treasury securities, and the Treasury also varies the supply.

Pardon my politics here, but “U.S. government’s cost of capital” is a little misleading. The U.S. government’s cost of capital is the cost of a gun pointed at my children’s head. The U.S. government promises to tax my children in the future and sells entitlement to the tax revenue. We call this process “government borrowing”, but the process is very different from a conventional credit market. Also, as a monetary authority, the U.S. government can inflate, so it can always lower the price of its capital if not the real cost.

The U.S. goverment’s sale of entitlement to tax revenue (including its bailout of creditors through the purchase of “private” securities) does encourage China’s mercantilist monetary policy. Without these “safe investments”, a mercantilist monetary policy is more costly to the mercantilist state, because the state can’t invest its surplus of foreign currency effectively, for the same reason that a central planning bureaucracy can’t organize an economy effectively.

Lee Kelly
Oct 12 2010 at 2:13pm

This really was an excellent podcast. Thank you. I thoroughly enjoyed it and learned a lot.

Oct 12 2010 at 3:00pm

surprised there were no questions comparing/contrasting monetary policy of current day china to 1930s france.

irwin and eichengreen commented on this today

How to Prevent a Currency War
Barry Eichengreen and Douglas Irwin

Oct 12 2010 at 4:58pm


Thanks so much for taking the time to write such a long thoughtful post. I found it very interesting. That all makes a lot of sense. Yes, the problem is certainly central banks holding to a fixed exchange with gold–certainly anyone has the right to buy as much gold as they would like. To be clear France did this just by simply buying huge quantities of gold?

Based on your definition if central bankers can at any time automatically change the exchange rate to gold, or reserve requirements or –heck– put treasury bonds on the books “magically” with out paying anything. That would just be a thiat currency and gold standard in name only? Although the currency would be pegged to gold commodity even if that exchange rate changed depending on the whim of the central banker all the time.

Sort of like how in ancient Rome 45 coins to a pound of gold under Augustus. 85 under Denarius–do that enough it’s not really a gold standard.

I agree the term “cost of capital” is misnomer when applied to government. Your insight that a more appropriate terms would be theft by force for mostly unproductive purposes is an important point–just thought I’d try to sound unpolitical.

I was especially intrigued by your last paragraph? Can you point me where I can learn
about how sovereign wealth funds buying treasury securities allow them to enact mercantilist policies? how does this work?


Interesting—but I still don’t understand the excess capacity argument.

I understand that when an economy is in a recession there is plenty excess capacity hanging around–empty factories and office buildings, unemployed workers. But couldn’t excess capacity only come about through an expansion of credit? I.e. excess capacity is a symptom not a cause. After the fact. Correlation but not causation.

A firm makes toasters. Sells toasters for $10 costs them $8. People no longer need that many toasters so they can only sell them for $4. But the firms cost of capital becomes so low due to easy credit that it only costs $2 per toaster. Now a bust occurs. There is a bust and there are a lot of extra toasters around and extra toaster factories—excess capacity.

Certainly productivity isn’t only improved through technological innovation— trade with poorer countries improves productivity due to comparative advantage.


Best, Luke

Oct 13 2010 at 2:03am

Hi Luke,

Your toaster example fits the transient/episodic/isolated historical conditions that originally gave rise to the notion of planned obsolescence (and also makes me think that you’ve already seen the online references that I might have pointed you to). By contrast, the phenomenon I’m describing is systemic, increasingly ubiquitous, and likely cumulative (or in this case, increasingly harmful) over time. It’s a product of the increasing superlinear returns to incumbency — or rather to subsequent incremental additions to original/first mover capital stocks — that exist in many of the industries where information and communication technologies (and hence Moore’s Law) play a central role. Territorial, asset-based network industries like telecommunications, where incumbency is protected not only by information asymmetries but also by privileged access to critical but largely non-reproducible and non-substitutable inputs, were the earliest and most readily identifiable industries to exhibit this pattern. However the recent unpleasantness in the financial sector suggests that Moore’s Law + information asymmetries alone may be more than sufficient to drive adoption of this strategy by a much broader range of industries.

If the above sounds too abstract, consider these “hypothetical” examples:

1. Technological advances in financial data collection, storage and analysis enable credit risk to be assessed with ever increasing precision, permitting bank capital to be multiplexed progressively more efficiently — i.e., more lending on equivalent terms per unit of bank capital with no increase in overall risk. What do banks do with this risk-neutral expansion in lending capacity? They develop increasingly exploitive and opaque lending instruments — including loans that are literally designed to fail after a few years — which they aggressively push on consumers, including many who would be eligible for more traditional (i.e., transparent and predictable) loans if the concept of “objective eligibility criteria” still had any referent. [Note: they also chose to venture far beyond that new risk-neutral lending horizon, but that’s another story.]

2. Advances in optical multiplexing technologies enable owners of fiber optic transmission facilities to boost the capacity of their systems by many, many orders of magnitude with relatively modest additional investments. That additional capacity could enable a variety of new services for consumers and businesses, but continues to be largely withheld by facilities owners who hope to eventually trade in their current utility-like business model for one that assures them an ever-expanding relative share of the total economic gains that information and communications technologies have made possible… in other words, a business model more like the one that now prevails in the financial sector.

Eric Delph
Oct 13 2010 at 10:05am

Question: What if a country is on a gold standard and all the monetary exchange rates are fixed, what would be the effect of one country (say USA) having a large population increase (high birth rates and immigration for USA was 1-2% from 1900-1930) together with productivity increases (industrial revolution) on the money supply, when other countries on the gold standard (and so with fixed exchange rates) do not have population increases (or even loses) and have much smaller productivity increases? Do the small increases in gold for the world due to mining really have any impact on these larger trends (population and productivity growth)?

Seems to me that if gold monetary supply was increasing at 5%, population at 2%, and productivity at 7% (WAG), then there would be a 4% deflation pressure. That is a lot of deflation.

Oct 13 2010 at 10:48am

Re: Eric Delph’s question about the gold standard

FWIW, I agree that gold’s scaling properties make it increasingly unattractive as a monetary base control mechanism for the modern economy. An article in the July 2010 Institutional Investor (Americas) quotes Adrian Ash, head of research at BullionVault of London:

“New reserves are becoming ever harder to find and at greater expense, too. GFMS [London-based precious metals consultancy] now puts the all-in cost of a new mine (including infrastructure, schools, hospitals and other essentials) at $950 an ounce. Instead the action is in mergers and acquisitions. It’s difficult to find the ore but easier to buy a gold company…”

Also, given the wildly uneven geographic distribution of gold reserves (see for ex., and the disjunction between that pattern and 20th c.-21st c. national economic growth rates, it’s hard to imagine a gold *standard* working ever again — not without triggering the emergence of something like an OGEC and/or a revival of colonialism.

Oct 13 2010 at 10:56am

Re: Eric Delph’s question about the gold standard

Better still, this brief report on “World Gold Production (2010),” which first appeared in the 14-May 2010 ResourceInvestor newsletter:

JP Koning
Oct 13 2010 at 2:23pm

This conclusion is supported by two compelling observations: countries not on the gold standard managed to avoid the Great Depression almost entirely, while countries on the gold standard did not begin to recover until after they left it.

The problem I have with the above statement from Irwin’s paper is that the US *did not* leave the gold standard. It temporarily unhinged the dollar from gold convertibility in March 1933. The dollar floated (a dirty float) for about 9 months. In January 1934 the dollar was again fixed to gold, albeit at a different rate. So I’m not sure you can say the US benefited from leaving the gold standard, after all, it went right back on the thing less than a year after leaving it. If anything, it was devaluation that helped, but devaluation is different from forsaking the gold standard.

JP Koning
Oct 13 2010 at 3:19pm

One issue which is glossed over in this podcast (probably because it is a hard concept to understand) is how the Bank of France actually accumulated such a large hoard of gold without being disciplined by the physics of the gold standard.

This point comes up here in the podcast, “What happens if the Central Bank gets more gold but decides not to print more money? Then you are really not playing by the rules of the gold standard game. That’s known as sterilization, where you are taking some sort of offsetting action–you are not monetizing the gold you have in your Central Bank vaults.”

There are a few points worth exploring here. Gold was flowing into France because the franc was revalued in 1928 at an undervalued rate; French exports were rendered extremely competitive. French banks would have received this gold from their customers and deposited it with the Bank of France in exchange for notes (francs). These notes would have been spent locally, driving prices up. French exports would have become less price competitive and imports more competitive, and gold inflows would have stopped and eventually reversed so that the Bank of France’s gold hoard began to shrink. This is what should have happened.

This didn’t happen because of sterilization. Government debt issues soaked up a large portion of the Bank of France’s notes. Rather than spending these notes, the government exchanged them for deposits at the Bank of France (thereby canceling the notes). Thus the initial inflationary effect of the issuance of notes (those printed for the banks in return for imported gold) was partially compensated for by the deflationary effect of the government removing money and depositing it at the central bank. The higher prices that were necessary to equilibrate gold flows and thereby draw down the Bank of France’s gold hoard were prevented from emerging.

Oct 13 2010 at 7:02pm

Thanks for the reply Max. Good clarification JP very helpful.

JP Koning
Oct 13 2010 at 7:54pm

One last point and then I’ll hush up. In addition to sterilization, the Bank of France built up its hoard of gold by re-balancing the composition of its portfolio towards the yellow metal.

In 1928, the Bank held more US dollars & British pounds than gold. It steadily sold off its entire portfolio of foreign exchange for the metal. This is analogous to modern China, whose reserves are composed of different currencies and asset classes; like France, China is selling off dollars for gold (among other assets).

John Thurow
Oct 14 2010 at 7:31am

Great pod cast and I really appreciate thoughtful comments and discussion by everyone afterward.

I am somewhat confused, however, why trade tariffs are always dismissed as a major reason for unemployment in the great depression when according to this discussion the devaluing of currency was due primarily from trade imbalances brought about by non-adjusting exchange rates between France etc.. If everyone’s currency is getting stronger then relative domestic prices are staying the same even if prices are falling ( I suppose though that even if it costs you the same to live when you receive a smaller salary you don’t necessarily see it as being the same and thus might stop some consumption). However, I would think that one of the major factors effecting production then would be trade and other countries not buying what you are producing because of the exchange rate difference (unless of course you can offset the price differential via productivity gains). Then right at this moment you introduce a tariff bill that is broad based and everyone retaliates and it doesn’t have a major effect with unemployment? If everyones prices dropped by 30% (due to France’s US actions) wouldn’t this be directly proportional to the drop of export production and thus be directly proportional to unemployment as well?

Shivagurunathan Ram
Oct 14 2010 at 9:53am

Lively podcast. Comprehensive and thought provoking discussions.

But with its known limitations, is there a more economically stable alternative to gold standard?

The pivotal standard need not be consigned away merely because South Africa and Russia hold sway over its production. This would only afford a temporary reprieve to these countries. In the long term, the other vital eco-statistics of these countries would really matter in the global scenario.


Oct 14 2010 at 4:39pm

@xian I really enjoy your insights on this and other threads, do you have a blog? I’d enjoy reading more.

(…sorry this is totally off-topic I hope I’m not violating any forum rules, I luv the great discussions and thoughts shared here)

Oct 14 2010 at 5:39pm

Re: Shivagurunathan Ram’s doubts about the significance of Russia and South Africa

Correct me if I’m wrong, but the logic that you employ here would seem to be either tangential to Irwin’s observations about France (and also tangential to the Friedman/Schwartz thesis more generally), or else equally destructive of both. After all, if Russia and South Africa’s discretionary power to strategically manipulate the global stock and flow of the sole global monetary base material would “not matter” — or would matter only in the short-term — then doesn’t that imply that the actual exercise of such discretion by the USFRB and the French central bank also shouldn’t have mattered/didn’t matter much back in the 1930s? This raises the question of what it is that “doesn’t matter” — central bank discretion or global depressions?

As previous comments should make clear, I’m no fan of the Pure Manichean Theory of Discretion that seems to motivate so much of economics from the pre-Austrians through the post-Friedmanites, but I can appreciate internal logical consistency even when I happen to disagree with the argument in question (and vice versa).

paul vreymans
Oct 16 2010 at 5:53pm

Fascinating story about France’s role in causing the Great Depression. Even more fascinating is the remarkable similarity I found with today’s currency war. The Dollar being today’s reserve currency (as opposed to gold then), China is playing the identical role in today’s currency war as France played then: by steadily accumulating Dollars and refusing to re-invest them in the Chinese home market, and thereby sucking away Dollars from the rest of the world. The more the FED prints them, the more China accumulates.
Is that not one of the causes why despite all the FED’s Quantitative Easing no inflation has occurred so far ?

It was Roubini’s story about the present currency war which made me think about the remarkable similarity.

Does anyone make the same interpretation?

Oct 16 2010 at 6:58pm

Ok, here’s what I don’t get: Why are we terrified of deflation? Things get cheaper. Why is that bad? I understand that a stable dollar leads to easier planning. Stability would be good. But we’ve never had stability. We are living with constant inflation now. On the gold standard, we had regular deflation. Why is deflation more scary than inflation? It seems to me that inflation destroys the value of what we have and makes it harder to get more. Deflation makes everything cheaper and reflects REAL conditions. Costs of productions go down due to new technologies, economies of scale, etc. I love EconTalk, but I just don’t get the premise of this one.

Oct 17 2010 at 12:44am


Outstanding podcast!! I too am wondering if Professors Irwin and Roberts see parallels with China and France. I remember Greenspan (and I hope I’m reflecting his comments accurately) stated that there were considerable downward pressures on bonds as a result of a large influx of investment dollars from China. In the 20’s France’s policies led the rest of the world to follow contractionary policies. However, Greenspan did not follow a contractionary policy and has been criticized for not. Does the experience of the 20’s mean the outcome would have been the same for us even if Greenspan had raised interest rates….(I’m a Greenspan fan and am skeptical of his ability to have prevented the meltdown)?

As well, on a microeconomic scale there were many dumb decisions being made both in the 20’s and now (e.g loans to people who couldn’t pay if the stock market crashed or mortgages to people without proof of income). I’m curious, are the bad marcroeconomic decisions sufficient cause for a crash or do there also have to be concurrent microeconomic abnormalities? Or do you think the macroeconomic policies lead to poor microeconomic decision making? For example, the downward pressure on bond interest rates could result in the perceived need to take greater risks by financial institutions.

paul vreymans
Oct 17 2010 at 4:54am

Besides France’s deflationary monetary policy, also the treaty of Versailles must have played a major role in the monetary disturbance leading to the Depression. War dammages for WW1 imposed on Germany amounted to 269 billion gold marks ( ±100,000 tonnes gold). Several economists had warned that such amount was economical nonsense. It contributed to the rise of fascism in Germany. By 1933 (when Hitler took power and interrupted payments) some 1/8th of the war debt was paid.

Oct 17 2010 at 2:18pm

Which is all fine but it just goes and stirs up the supply-side covey again and makes them again have hope that somebody will pay attention to their gold standard fantasies. Best to let sleeping dogs lie and concentrate on real solutions for the dismal future we face.

paul vreymans
Oct 17 2010 at 4:02pm

@ monty:

Do You find the present fiat monetary system, which leads us from the one bubble into another, with ever increasing debt sustainable ?

The Gold standard may not be perfect, but to my opinion at least had a better track record. Unless of course You know a better alternative.

Mr Econotarian
Oct 17 2010 at 4:30pm

Indeed, I was struck by the comparison of France collecting gold reserves but not monetizing them, the same way China collects dollars and “sterilizes” them by purchasing mainly US Federal debt.

I suppose the difference is that the US government can put those dollars back into circulation, whereas gold in a vault isn’t going anywhere.

The other issue that was missed was the concern by Hoover about leaving the Gold Standard and having debtors locked in to “payable in gold” clauses in debt contracts, which FDR was able to get around by the “Gold Clause Ban” of 1933 where the Federal Government nullified private contracts “payable in gold”.

This was a pretty amazing expansion of Federal power, yet probably one of the better things FDR did for the US economy to allow a change in our dollar/gold peg.

Oct 17 2010 at 11:00pm

Thanks Dr. Roberts,

I am usually a little distressed, when many of your commentors on past podcasts have promote the gold standard, as a remedy from central banking problems. This podcast did a great job of addressing the issues of the pros and cons of the gold standard at the beginning.

I have to admit that the complexity of the issues after 20 minutes were beyond my understanding from my first listening. I appreciate your patient presentation of great economic topics.

David B. Collum
Oct 18 2010 at 6:06am

Here are my thoughts in no particular order. (I am typing while listening and simultaneously reading comments. I also owe a thanks to Lauren for a little assistance.)

(1) Russ asks why is deflation due to gold limitation bad? (A commenter askes this too.) Virulent deflation resulting from bad monetary policy should not be confused with innovation-driven drops in prices. (Computers!) The case for the evils of deflation has not been made. Deflation is not the boogey man, flawed central banking policies causing catastrophic deflation may be. With that said, fractional reserve banking with annual interest rates above zero is an inherently inflationary system; the interest payments have to come from somewhere. If you have deflation, you must have some defaults, and bankers don’t like that. It seems that the demand for inflation acknowledges this.

(2) Post-war economics is amazingly interesting. I think the gold standard post-WWI was problematic because they tried to go back on it in a ham-fisted way. The war caused huge wealth destruction, yet the sovereigns attempted to fix the price of gold ignoring this little detail. They set the exchange rates way too low.

(3) Why is a run on the gold supply due to bad monetary and fiscal policies considered a flaw with the gold standard? A country acts innappropriately, starts to lose its stash, and then has its come-to-Jesus (or come-to-Zeus) moment: What’s not to like about this model? (That is not to say, however, that we will go back to a gold standard.)

(4) In ancient Rome, an ounce of gold bought a month’s worth of manual labor. Still true (within an error bar) today. Hard to argue with gold as a standard. In response to the notion that maybe there is another standard that is more appropriate to avoid having countries “holding sway” over us, I would say that any sound monetary standard would hold sway over the bankers. If it does not, then it is not a standard at all. South African gold production is not relevant. Production of gold could cease and it would not matter.

(5) Total aside-Truman (Yale) raised some eyebrows last week by suggesting we liquidate our gold stash. Gordon Brown did this with less-than-stellar results. Greenspan was asked recently if we should dump the stash and said no. (Seems to retain a little of tha libertarianism.)

(6) “The Lords of Finance” (recommended above) presents an incomplete but still very interesting treatise on the challenges faced by post-WWI banking system. I also recommend “Banking and the Business Cycle (1937) by Nelson, MeManus, and Phillips for a discussion of poor policy in the 1920s. (These guys submit that the great depression was a post-war deflation that had been pushed down the road, but eventually had to occur.) Adam Fergusson’s “When Money Dies” will cause sleepless nights as well. (He was just interviewed this week over at Financialsense.)

(7) At this point, central bankers make me nervous. Dudley’s speech describing “unacceptably low” inflation last week provided an excellent example of risky thinking. The kind that gold standards protect against. When did we agree that the most important market in the world–the market in which lenders and borrowers meet to exchange capital for a price–should be controlled by a committee?

(8) I think the big problem going forward–the epic battle–is to wrestle control of the Debt-to-GDP ratio (mentioned above). It can’t keep going up; that would be mathematical nonsense. How it flattens and turns down is the huge unknown. Whether we have a Minsky moment (straight down), a Havenstein moment (straight up), or a combo (soar then crash) is unclear. We are, however, on a collison course with destiny.

(9) Who saw the Great Depression coming? Hard to say, but the speculative fever was so obvious that there were Congressional hearings prior to the collapse. There were a lot more people than Kennedy (thanks to his shoeshine boy) who could see serious issues. (Roger Babson was giving speeches on the coming crisis starting as early as 1925.)

(10) My profound irritation with current central bankers is that they are trying to spur consumption and debt acquisition at precisely the time that consumers should and are having a revulsion to debt. There is no “paradox of thrift” IMO. We have to stop spending until our balance sheets get cleaned up, and that will take a very long time.

(11) Economics seems like an inherently messy business, with wild stretches away from equilibrium invariably followed by big resets. We also never seem to learn how to stabilize the system because the perception of stability seems lead, with little delay, to destablizing speculations: stability breeds instability as they say. Austrians rock.

(12) The current “currency war” in the news is so curious to me. Can anybody name a another kind of war in which the primary goal is to blow your own head off? The battle to destroy one’s own currency is surreal. (Even Lenin knew that was a road to destruction.) Alas, I have never bought into either Keynesian or monetarist policies, so I am generally clueless on this stuff. (I also think Keynes may be rolling in his grave given what his name is being attached to.)

(13) I totally disagree with the notion that inflation is tame. Oil is up 7-fold in a dozen years. Gold is up 5-fold in less than a decade. Soft commodities have run like crazy and are starting to show lock-limit-up days akin to those in the 1970’s. State and municiple taxes are soaring. Just because the poor assets that Wall Street traffics in are deflating, doesn’t mean that price inflation is dead. There are a lot of dead canaries being ignored. I think their whole paradigm is wrong (although I am also not sure that their motives are as stated.)

(14) Next week I get to see Dudley in an open forum and gotta hope he takes questions. I am locking and loading, trying to come up with questions that he simply cannot wiggle away from. (This is not trivial.) I used to be a Dudley fan.

paul vreymans
Oct 18 2010 at 6:31am

@ Mr Econotarian

One has of course to investigate to what extend “US government putting those dollars back into circulation” does amount to freezing them. I fear much of the present public spending into the housing market and low-productive public initiatives such as Obamacare, rescuing bankers and unproductive car makers…. may not be very helpful in improving the world’s productivity (=growth).

Is depriving the private sector from those funds in fact not similar to what France did in the 20s ?

Oct 20 2010 at 3:24am

This was a disappointing episode from the usually Hayekian (not this time) Russ on such a timely topic. Invite a Keynesian to discuss gold and guess what? He’ll trash it.

I did enjoy the gold -> rise of Hitler theory that was introduced here. I suspect we can look forward to hearing more of this once the shiny stuff hits $5000 or so. (“Gold party extremists” and such…)

Mike Laursen
Oct 21 2010 at 12:42am

Irwin talked about the effects of France’s monetary policies on other countries, but I was hoping you would ask how it affected its internal economy. Did the French people suffer because of the gold-hoarding and intentional devaluation of their currency? Was it hard for them to buy goods, especially imported goods?

Oct 22 2010 at 1:25pm


thanks a lot…

Charles Stampul
Oct 24 2010 at 2:12pm

This interview illustrates the need to insist that the terms inflation/ deflation not be used to describe rising and falling prices. Price increases resulting from increases in the supply of gold are not comparable to price increases resulting from inflation (increases in credit or a fiat money supply.) Increases in the supply of gold only come about through productive activity. There is an actual increase in wealth.

If there is a credit inflation, as there was in the late 1920s, followed by a contraction of credit, there is going to be a deflationary depression. It should be obvious that staying on the gold standard is going to keep prices falling. I don’t see how this was a point necessary to research. It’s not an indictment of the gold standard, it is an indictment of the credit inflation. And the reality is that going off the gold standard in such situations can only prevent a deflation/ depression in nominal terms.

Mr. Irwin again illustrated the need to insist that the word inflation be used correctly at the close of the interview when he suggested that inflation is not a threat today, so the federal government should continue to buy its own debt. The fact that prices are not rising drastically is actually reason for alarm. It suggests that, rather than hyperinflation and dramatic rise in interest rates, we are more likely to see an overnight bond market and currency collapse, precipitated most probably by a natural disaster or act of war.

Richard W. Fulmer
Oct 26 2010 at 12:31pm

Unlike Professor Irwin, I do not believe that further increasing the country’s money supply will ease the current financial crunch. There is plenty of money out there, it’s just that people are sitting on it because of the current Administration’s policies – those already passed and those still pending.

Looking at it in terms of MV=PY, all the while the Fed has been cranking up M, the Administration has been hacking away at V. The result is a stalemate between conflicting fiscal and economic policies.

Richard Taylor
Oct 28 2010 at 2:20am

Fascinating discussion. Until your podcast, I had not appreciated the issues with gold being both a commodity and a standard for currency and exchange. There is a lot of gold in the ground that is uneconomic to mine because the cost of extracting it is more than it is worth. If gold is a commodity whose price can vary, when the price of gold increases, more gold mines are opened up to meet the increased demand. I lived in Colorado during the late 80’s and saw them reopening old gold mines for this reason.

If gold is a currency standard, its price cannot change by definition and therefore its production cannot react to changes in demand. Perhaps, if all the nations of the world had remained on the gold standard, the rise in world trade that has taken place over the last 30 years could not have taken place because there would not be enough gold backed currency to finance it.

The question that interests me most at the moment is the claim by the Chinese that because the US is expanding its money supply (printing dollars), this is causing the inflation in China. A discussion of this issue would be most timely.

Nov 4 2010 at 9:57am

I just want to say that I love the EconTalk podcasts. They are the best on the net. I encourage all my friends to subscribe. The clarity with which Russ is able to keep the dialog accessible to non-economists (I am an IT professional) is perfect. I never miss an episode. Thanks again!

Nov 6 2010 at 2:26am

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Podcast Episode Highlights
0:36Intro. [Recording date: October 6, 2010.] Mysterious way that monetary policy, particularly the gold standard, contributed to the Great Depression, and the underappreciated role--detective story--that France played in the Post-WWI economy. Opening paragraph from Irwin's paper:
A large body of economic research has linked the gold standard to the length and severity of the Great Depression of the 1930s. The gold standard's fixed-exchange rate regime transmitted financial disturbances across countries and prevented the use of monetary policy to address the economic crisis. This conclusion is supported by two compelling observations: countries not on the gold standard managed to avoid the Great Depression almost entirely, while countries on the gold standard did not begin to recover until after they left it.
Talk about what some of those countries were that weren't on the gold standard or that left it. Two examples of countries that were not on it during this period. While they suffered recessions because their trade partners went into recession, they themselves did not see the great deflation, rise in unemployment, or production and output that most countries experienced during the Great Depression. Those two countries are China, which was on a silver standard, and Spain, which I believe was on a fiat money standard--had not yet gotten its act together to get back on the gold standard after WWI. Both did reasonably well during the 1930s, as other countries were imploding. Countries that left it, left it at different times. Most countries were on the gold standard in 1928, 1929; then they began to peel off at various times. Business cycle peaked for most countries in 1929, but because of the pressures of deflation and rising unemployment, put pressure on most countries to leave at various points of time. Australia, Argentina left in late 1929. Britain pulled off in September of 1931 and pulled about 18 countries with it. Scandinavia and some of its former colonies; then the United States left in April 1933; Belgium in 1935; France and remainder of what was known as the Gold Block, which had stuck on the gold standard for the longest period left in 1936. Eichengreen and Sachs have famous paper on this; earlier work; a lot of followup work on the economic impact of going off gold. It allowed countries to pursue more reflationary monetary policies; they were able to stabilize their banking systems; their economies started to recover as prices rose. So, for example United States went off in April 1933; was one of the first decisions that Franklin Delano Roosevelt (FDR) put in place. You see industrial production bouncing back, wholesale prices begin to recover; a "V" around April 1933. One of the issues that's going to run through this conversation: monetary policy underlies to a large extent the modern economy. But there are all these real things going on, hard to disentangle, hard to know which is more relevant. In 1933, a whole bunch of other stuff was going on as Roosevelt was trying to get the economy going. May be that the gold standard was the single most important thing he deal. Podcasts on the New Deal and the National Recovery Act (NRA)--mixed bag of policies, some counterproductive, certainly the NRA. Wonder if they had pushed monetary policy harder in 1933, and we'd been able to accelerate the economy earlier, maybe all those other policies wouldn't have had to be tried. Was the New Deal a good or bad thing? It's a potpourri of a lot of policies, some good, some bad, some ugly. The best thing they did was to change the stance of monetary policy, get off the gold standard. All the other stuff I suspect was largely secondary, if not counterproductive.
6:05Set the stage for this mysterious role that France played, fascinating and extraordinary, how France might have contributed, talk about how the gold standard itself worked. Gold standard was suspended in WWI; in the post-war era, put back in place for most countries. What does it mean to say a country was on the gold standard? Means your monetary base and your monetary policy is dictated by how much gold reserves are held by the Central Bank. If gold reserves are increasing and a country has more and more gold in its vaults, it can issue more currency and expand the money supply. If the country is losing gold reserves, it has to raise interest rates, tighten monetary policy to prevent that outflow, and pursue more contractionary policies. Why is there a connection between how much gold they have and how much money they are issuing or why they have to respond with interest rates? With the gold standard, the Central Bank is obligated to exchange domestic currency in terms of a certain amount of gold. As countries do that, exchange rates across countries become fixed. So, the dollar/pound exchange rate will be fixed because both countries are linked to a certain quantity of gold. To maintain that fixed exchange rate, you have to adjust your monetary policy to make sure it always holds; otherwise there is going to be pressure on you--you can be accumulating a lot of reserves or losing a lot of reserves. All actually goes back to David Hume's price-specie-flow mechanism in his famous 1752 essay on money, where he talks about when one country is on a metallic standard, monetary policy is dictated by flows of gold across countries. Let's explain that in a little more detail, particularly why an adherence to the gold standard leads to a fixed exchange rate. We're back in the mid-1920s now; there's a certain promise that the Bank of England has made that if you bring in a pound (the British paper currency), you are going to get a certain amount of gold in return. As a result, they have to have a certain amount of gold sitting in the vault because people can come in and get it. They don't want to run out. Why not? If people began to think they were running it, it would cause a speculative attack against the currency because if you are just holding a pound note, a piece of paper, you don't know what the value or worth of that paper is. Under a metallic standard, supposedly you trust the paper because there is a certain amount of gold behind it; you use gold to buy goods or other currencies. So, if you think the country is losing gold reserves and the credibility to exchange paper for gold is brought into question, you might say: For safekeeping, I'd better get that gold now and exchange this paper, because if nothing happens, I can always get the paper back again, but if something does happen, at least I've got the gold, not just this worthless piece of paper. One reason countries really wanted to get back on the gold standard, to provide stability for the currency, is that Germany had had a hyperinflation after WWI. A lot of countries had very high rates of inflation when their currencies became untethered to gold. There is something that Barry Eichengreen and Peter Temin call the gold standard mentality of this period: that if your currency is not tied to gold, you are going to have the Central Bank run the printing presses and you will have inflation or hyperinflation. The gold standard is a discipline that the Central Bank imposed on itself. The reason you couldn't run the printing press was that if you did, people would start to worry there was too many pieces of paper out there for how much gold the Central Bank was holding. If you ran the printing press without additional gold stocks you increase the risk that people would have that speculative run. Disciplining device to prevent that. You could also argue that exchanging your ultimately worthless piece of paper with a picture of a dead politician on it for a yellow metal isn't that much more comforting. Part of the reason the gold standard was actually not just a second leap of faith is that there are actually uses for gold independent of wallpapering your wall with dollar bills. And also, you can't inflate gold away. Unless we have the California gold rush or discover enormous gold mine we hadn't discovered before, gold is going to keep its value. It may fluctuate in price a bit, but you can't run up the supply of it like you can run a printing press. Some confidence, long-term inherent value. Now let's talk about how England has made a promise to its citizens that it would really like to keep. They made a promise that says: If you bring pounds to the Central Bank, we will exchange them for gold. The United States has made a similar promise: If you bring a dollar bill to the Central Bank, we'll exchange it for gold. They picked an exchange--gold/dollar ratio. Why does that imply a fixed exchange rate? Because if each currency is pegged to a certain amount of gold, then by triangular arbitrage it implies something about the price of pounds in terms of price of dollars. As long as everyone is connected to a certain amount of gold, that implies that all those bilateral exchange rates are fixed unless countries change their gold parity. Example of what would happen if one country tries to print a little more money? What's going to happen? If one country violates the rules of the gold standard or tries to push it by printing more money, things are going to heat up. Prices are going to rise in that country because of inflation. That will begin to price out its exports--its exports are going to be less competitive on world markets. The prices of foreign goods are going to be a little cheaper because the foreign prices haven't gone up, and that country will start to run a trade deficit--its exports will go down relative to its imports. The only way the country can finance that, in capital flows, is by gold flows. Gold will start to leave the country, which reins the Central Bank in: you can't increase the money supply as fast as you thought; gold is leaving and that's going to force you to reduce your rate of monetary growth or maybe raise interest rates to stop the gold from going out and bring you back into equilibrium. Going back to that triangular arbitrage: if someone in England sells that good in America, that British exporter now holds a dollar, he can do two things with it. He can take it to the Central Bank in America for gold, or he can swap it for pounds. The fact that the pound rate is fixed in gold or the dollar rate is fixed in gold means that the dollar/pound exchange rate is fixed as well. The standard way I was taught this in graduate school was that when you have this fixed exchange rate regime and a gold standard, your domestic monetary policy is highly limited. Talk about that. For exactly the example we were talking about before. A country can't just get away with printing money because gold will start leaving the country. Either it will have to sever that previous relationship between the paper currency and gold, or it will have to tighten up its monetary policy, undo what it just did. Handcuff device on the Central Bank. Look at developing countries: they--and they try to keep their exchange rates fixed--are not really on a gold standard, but they peg their currencies, say, to the dollar. Sometimes they don't adhere to that strict discipline, and then they are forced to devalue or there is a speculative attack on their currency. Happened in Mexico in 1994-95; some Asian countries in the mid-1990s. In the 1920s, countries were tying their currencies to gold.
16:39We're going to shortly be talking about what's bad about the gold standard; let's start by talking about what's good about it--why anybody would tie their hands this way. World gold production, as you point out, barring a new discovery and massive supply--which happened a couple of times: when the Old World got linked to the New World; late 1840s in the United States in California--but in general throughout most of the modern era, the amount of gold in the world is rising at a slow but fairly predictable rate. Means two things: world price stability, and stable exchange rates, which allowed importers and exporters to plan for the future because exchange rates weren't expected to change a lot. That's one reason why the world economy did pretty well in the late 19th century: Victorian period, big era of globalization, labor moved across countries, capital is mobile because the gold standard/fixed exchange rate facilitated trade flows: very little uncertainty about what exchange rates are going to be the next year or so. Allowed for a smoothly functioning world economy, price stability around the world. Looked great, but some people started to worry that gold production started to decline, or grew more slowly than the world economy: might get deflation. Explain that; and other negatives of the gold standard. Swedish economist, one of the most famous in the world in the 1920s, Gustav Cassel, needed world production to grow at 3% a year or so to ensure price stability. Found that number of 3%: that's the average number for growth of output around the world in terms of labor productivity, supply expansion. If you had growth rates and the supply of gold less than that, then you are not keeping up with the transactions demand for gold, and that will put downward pressure on prices. In the 1990s, big controversy in the United States about monetary policy. William Jennings Bryant thought the money supply wasn't growing rapidly enough; interest rates too high; said "You will not crucify us on this cross of gold." Wanted to get the United States off the gold standard. There was price deflation in the 1890s until big discoveries in Australia, started to increase the price of gold more than 3%; had a rise in worldwide inflation, modest one, from the mid-1890s or so. More gold than you needed to finance world trade activity; put upward pressure on prices. Can you explain why, if gold discoveries are growing, why does that have anything to do with prices? Doesn't that just make gold cheaper? What's going on in the Central Bank story? Does make gold cheaper: more gold around. Gets back to that gold parity. The nominal price of gold is fixed, so the nominal price of gold can't go up or down. So gold should fall, because there is a greater abundance of gold. But when the nominal price of gold is fixed, it can't go down. The prices of all other goods adjust. You get a fall in the relative price of gold because the prices of other goods has to go up--and that's inflation. Why does that have to happen? What's going on in that Central Bank window story that has to happen? Central Bank reserves normally grow at a rate of, say, 3%; and now there's, say, a 10% increase in gold reserves of a given Central Bank. Not just one Central Bank, but a whole bunch of central banks because there is a lot more gold in the world. But why does that increase their holdings? Somebody finds a whole bunch of gold in Australia; what does that have to do with me as a Central Bank in England or the United States? What will happen is gold is not the easiest medium of exchange. You don't pay your workers in gold, buy products with gold. So you want to exchange that gold. You want to get the paper currency--can pay workers in the gold mine, servants, products you want to buy. So all that gold will eventually get into Central Bank reserves. People actually want paper to make economic transactions. They literally bring gold to the Central Banks? Yes. South Africa, big gold producer at that time: they mine the gold, ship it to Britain in exchange for British pounds. Link to British financial market--firms' financial market, want it secure; give it to the Central Bank for safekeeping. The Central Bank just holds onto it? The larger gold stock lets them print a larger amount of money than they otherwise would have. Trying to help listeners and myself understand: the price of gold had to fall. What's going on? Getting to a good point, which will bring us to the France story: What happens if the Central Bank gets more gold but decides not to print more money. Then you are really not playing by the rules of the gold standard game. That's known as sterilization, where you are taking some sort of offsetting action--you are not monetizing the gold you have in your Central Bank vaults. That plays a big part in the story of the Great Depression, both in France and the United States. The rules of the gold standard are: if you gain more reserves, you have to print more money; if you lose gold reserves, you have to pull back in terms of how much money you can issue. Tightly close-knit relationship between money and gold. But countries could deviate from that; could lead to problems. Anything else about well-understood problems with the gold standard. You mentioned one: gold production is slow and caused deflation on the world economy. What other policy challenges are there for a country on the gold standard? The main policy challenge is that by losing an independent monetary policy, you are tying the short-term fate of your economy to the amount of gold in the world. Odd thing to do. If a country has a recession due to say a crop failure or what have you, it can't accommodate that or grease the wheels of commerce through monetary policy. It's going to endure tight monetary policy and the loss of gold reserves. So it takes away from government authorities' potential adjustment mechanisms. When we get to the Great Depression, countries couldn't cut interest rates when you are on the gold standard. The fate of your country is tied to how much gold there is in the world. What happens if there is a strike in South Africa, not as much production? Big impact on your country just because you are tied to gold. If people thinking about we need a gold standard today, what that means is we are going to tie our monetary policy to events in Russia and South Africa, the two major gold producers. Is there any reason why we would want to do that rather than have monetary policy in our own hands? Can think of a few reasons. It's a tradeoff. Monetary policy has been an abject failure in many, many countries where the discipline has obviously failed--Zimbabwe an obvious example. Here in the United States where we supposedly have great economists and wise policy makers and democratic process--current mess we are in. Tradeoff.
26:57One of the issues: you are stuck with the world gold supply. Would make you think, if there isn't that strike in Russia or South Africa, no new giant discovery, things should be pretty smooth. But countries on their own can do some things that are not just some natural changes in physical supply. Big shock that happened between 1920s and 1930s was WWI. Most countries went off the gold standard; experienced very high rates of inflation. Then the question asked after the war: how do we get back to the gold standard? Restore monetary discipline. The price level had risen a lot; countries faced with: Do we try to get prices back down to the way they were before the war or do we accept that inflation and say we need a new exchange rate between our domestic currency and gold? Just add a zero, or two or three. Or do we pull our money out of the system? Britain decides to do the latter: decides to deflate prices to where they were before the war and go back on the gold standard at the rate where they were before the war. All right in principle, except when they went back on gold--and this was Winston Churchill's decision as Chancellor of the Exchequer--prices hadn't gone all the way back down. So when they went on the gold standard, the price of British goods relative to the rest of the world was a bit too high, which meant they had to suffer some more deflation to get prices back down. John Maynard Keynes, pamphlet, "The Economic Consequences of Mr. Churchill," excoriated that decision. Identified that as being an unwise policy move. France had much more inflation than Britain, and said: We can't deflate prices, not an easy process, so we are just going to change the exchange rate. What they also did was say they were not going to just change the exchange rate to the extent their prices had changed, but do a little bit more: undervalue the French franc, which will make French goods very price-competitive on world markets, make imports seem much more expensive to French consumers; run a trade surplus in that way. Thought they couldn't adjust their exchange rate? When they were not on the gold standard, basically choosing at what exchange rate they will go back on the gold standard. At what rate will they exchange francs for gold--which in turn would set the exchange rate. They picked a rate of exchange of gold for francs which in turn implied a relatively attractive rate between pounds and francs for their exporters, and therefore a relatively unattractive rate for Britain's exporters. What should have happened? What did happen? Britain would have trade deficits; France would have a trade surplus; Britain would have to finance its trade deficit by sending gold to France; Britain would have a tighter monetary policy; because it was attracting gold, France could have a more expansionary monetary policy. What that would do, as Hume said: France would get more gold, print more money; that would raise prices--would automatically correct the trade imbalance. Natural mechanism if a country tried to pick a bad rate of francs for gold--natural equilibrating mechanism through the flow of specie across countries. Might persist for a little bit, but British prices would fall; French prices would rise; things would go back to equilibrium.
32:12Didn't work that way. What happens if the Central Bank is getting all this gold but decides not to print money? Then they are not playing by the implicit rules of the game, even though those rules are not formally written down. So France began accumulating gold, but not inflating its money supply. No natural self-correction; the process will just continue. France will continue to attract gold, because the exports will be competitive relative to other countries; those trade imbalances won't naturally correct themselves. Temptation to say: No big deal--just yellow metal going back and forth. It's not like France is getting wealthy by accumulating all this gold and others are getting poor. Problem was with effect on economic activity elsewhere. Deflationary effect in the rest of the world. It wasn't just Britain that was losing gold, but other countries as well. France was draining gold from the rest of the world, and not inflating, but causing other countries to deflate. If there had been this balance, France inflating and other countries deflating, balance: prices won't change. But if France staying put and other countries pursuing deflationary policies, you get worldwide deflationary spiral. First question that comes to mind: Talking about this in a casual way, but horrible tragedy here. This decision by France helped precipitate a worldwide depression that has never been rivaled in modern times, which in turn, as Robert Mundell talked about: rise of the Nazis, stress on political system, ultimately WWII. Not just a parlor game of economic parlor minutiae. At the time--was this the first time a nation had not played by the rules? Was France punishing its neighbors? Surely this was not a surprise. How hidden was it. The magnitude--these sound like small technical decisions. France, one small country--how could they drain gold from the rest of the world. Mundell quote: "Had the price of gold been raised in the late 1920s, or alternatively had the major Central Banks pursued policies of price stability instead of the gold standard, there would have been no Great Depression, no Nazi revolution, and no World War II." Magnitude of the worldwide impact, astounding to think how history would have been rewritten. Milton Friedman famously said "Inflation is always and everywhere a monetary phenomenon." Converse: Deflation is always a monetary phenomena. World prices fell 30% within two or three years from their peak in 1929. France started out as a very small player. In 1927 they only had 7% of the world's gold reserves. By 1932, they had 27% of the world's gold reserves. Really were truly and literally pulling gold out from the rest of the world. How much were they responsible? Did people know this was going on? Took a little while. One reason I wrote this paper and got into this is, is we in the present crisis ask: Who saw this coming? Couldn't we have averted this disaster? Great question with respect to the Great Depression. Who in 1927-29 was saying we are going to experience tremendous deflation, this great decline in output, rise in unemployment? Keynes didn't see it coming. A lot of famous economists at the time didn't see it coming. Yet, Cassel did. He had this view about the potential flaws of the gold standard. A few others. Austrians aware of it. The United States was shedding gold in those two years, lending a lot to the rest of the world, somewhat offsetting the French action. But--and this comes from Friedman and Schwartz, the United States began to tighten monetary policy in 1928, A Monetary History of the United States, 1867-1960,--began to reinforce what France was doing. That's why the policy decisions of 1928 in terms of the gold flows really had an impact in 1929. Remarkable that you see in Britain, France, the United States, all prices began to fall in mid-1929, synchronized shock, and I think it's because of what's happening in gold reserves at this time.
38:59Digress for a minute. Not obvious. A little inflation is not the worst thing in the world. It is if it leads to bigger inflation and if it leads to wide swings in the inflation rate because it makes it hard to plan for the future. Why is a little deflation and what ultimately became a lot such a bad thing? Why did that by itself precipitate a problem? In modern terms: people are very worried, embarrassing to the state of economics today, that people can't decide if inflation or deflation is the biggest thing to worry about. We should be able to agree on that. One reason it's hard to know is the Federal Reserve (the U.S. Central Bank) has massively increased reserves; not being put into circulation. People worried about deflation then. What's wrong with deflation? Nothing's wrong with a little deflation, particularly if it's anticipated. Michael Bordo has done a lot of work on this. We did experience periods of deflation in the 19th century, and real output continued to go up and unemployment remained relatively low. People either anticipated what was happening to prices because they knew what was happening to gold stocks, or it just wasn't that much of a problem. But when prices fall 10% a year and no one expects them to, and you introduce some nominal rigidities or nominal debt burdens, that can lead to problems. Let's consider those two in turn. If a firm suddenly discovers the price of its output has fallen by 10%, but it can't cut wages by 10%, then it's going to not be as profitable and it's going to have to reduce output. Until the wages catch up to the prices, playing a losing game--shed output or workers. Presumes there is some rigidity--either some contract with their workers so they literally can't adjust wages, or workers struggle to accept a lower wage even though they've got lower prices--going to be better off with a lower wage when wage drop isn't as big as the price drop. So there has to be some rigidity there. And a lot of economic historians and economists have said that the reason the 19th century worked out in terms of deflation is that wages were pretty flexible. But by the 1920s, less so. Think that's a little bit anecdotal. Economists have tried to pin that down, but hard to find the mechanism. Obviously unions would be one mechanism: contracts, strike and resist wage movements. That was the case in Britain. One of the reasons Keynes didn't want deflation is there is the general strike in 1926, which he said was directly the result of what Keynes said was the decision to re-peg at the wrong rate. Not because workers would strike and not accept wage cuts. But even if we put the wage issue aside, Irving Fisher, great Yale economist of this time, had the debt-deflation theory of the depression, which said all sorts of nominal debts are incurred, mortgages, loans--nominal meaning the amount is fixed contractually--borrowed $200,000. If prices of your output go down, your wages go down, maintaining, paying that debt off becomes much more difficult. If you have a $200,000 mortgage and your wages drop, all of a sudden paying off that mortgage becomes much more difficult for you. Puts people under financial distress. Get defaults. Puts pressure on the banks, non-performing loans; they want to increase their (bank) reserves, cut back on lending, raise lending standards--tightness in financial system taht reinforces the initial downward turn. So, the 1920s, which were a time of great economic growth after the short, sharp recession of 1921-22--in the mid- to late-1920s, the roaring '20s, we have a big expansion of debt, big increase in stock market investment; people, not unlike recent times, living beyond their means because they figure: We'll be able to handle it. Parallels with the recent housing mortgage crisis: if people's incomes fall, stagnate, can't afford to refinance or make payments. Housing prices don't adjust instantaneously. Much more widespread, not just one sector.
44:46Earlier question: What was France thinking? Why did they do this? You do give examples where people said: You've got to stop. The British were very much aware of this. They were putting pressure on France to change its policies. Little hard to know. Books on French economy during this period, Kenneth Mouré: French politicians had been traumatized by the inflation they endured in 1924-25, till they stabilized things in 1926. Political problems, social unrest. They absolutely wanted to make sure they didn't repeat that. Strong anti-inflation stance. What from our current vantage point might seem extreme, because prices actually began to fall a lot in the early 1930s, but they still were worried about inflation. Very cautious about how they treated their gold reserves. Restricted the ability of the Central Bank to undertake open market operations and expand the money supply--legal restrictions. Didn't want the Central Bank monetizing the government's debt. Partly as a result of policy choices, partly as a result of legal restrictions, they found it very difficult to monetize. Didn't want to monetize the gold they got. Is there perhaps a public choice story here--political pressure by French exporters may have played a role? Don't know that much about the details in this period; would have to look at the books by Mouré to figure that out. Always a public choice lurking behind any major policy decision. Certainly the French decision to undervalue the franc initially reflected some of that. But the British thought the French were being pigheaded, and the French thought the British weren't willing to deflate enough. They thought: if you are worried about gold outflows, they raise your interest rates, cut back on your issuance of credit and money. British said: We're already in a pretty severe recession; we don't want to intensify that; why don't you ease up a bit. Little cooperation between the two. Few economists on the outside were aware of this. Keynes didn't learn about it until he had read Cassel; then he was brought into these discussions but he didn't think these discussions would get very far in terms of trying to get France to change its policies. How was France doing in this period--1928-1932? France was doing all right, because they didn't go through a serious deflation yet because they had these gold reserves and didn't have to contract their money supply. They had excess reserves. Striking picture, writing this paper, is something called the cover ratio, which is how many gold reserves do you have per Central Bank liability or how much money you've issued. Started out at about 35-40% for France, about 1928--in other words, for every franc they had issued, they had 35% of that in the Central Bank vaults, due to fractional money system. But that rose to almost 80% within three-four years. Holding more gold reserves than they needed.
48:59Economic perspective: Friedman and Schwartz in 1963 come out with A Monetary History of the United States, 1867-1960, and they point the finger, correctly, at a failure of U.S. monetary policy starting in 1928--it was highly contractionary; and then a failure in the subsequent years to recognize that there was deflation and that the Central Bank failed to respond by loosening. A lot of people, correctly I think though there is debate about it still, blame the United States for precipitating the worldwide depression through pigheadedness or stupidity or whatever you'd want to call it. Failure to fully understand the ramifications of the decisions they were making. Your story is that although true, it's not as big a part of the story as we thought. Buy the broad contours of that story, and I'm a huge fan of Friedman and Schwartz; but reason I wrote this paper is: How could the United States single-handedly cause this worldwide economic disaster due to a little bit of tightening of monetary policy in 1928--or perhaps a major tightening? Is that credible? What I discovered on reading more on this--people have already known France was doing similar things, but they tend to downplay or ignore the French contribution relative to the U.S. contribution. So in histories of the Great Depression, there will be 5 or 10 pages on this initial Federal Reserve decision of 1928 and how that caused all sorts of problems, and then maybe in a footnote or a sentence or two saying France was doing this, too. What I was able to calculate was that the impact coming from France matched if not exceeded that of the United States. It might have been a small player in 1926-27, but by 1928-29 it had accumulated such a large quantity of the world's gold reserves that it actually was a major player in terms of world prices. Before we got on the phone, we talked about Milton Friedman, in the early 1990s, read the memoirs of the Central Bank governor of France during this period, and he actually wrote in a Foreword to the reissue of those memoirs that if he had been fully focused and aware of what France was doing, his Monetary History would have been a little bit different--would have laid equal blame on France and not just put the burden on the Federal Reserve of the United States. So, what this implies is that the pursuit of policies imposed by the French government imposed a massive deflation on the rest of the world, massive contraction in world output. Want to add anything to that? One link: the focus of my paper is who is putting the downward pressure on prices, and who is responsible for the great contraction in world money supply and prices--and try to apportion that between France and the United States and other factors. Next link: just because prices fall by 20-30%, why does output fall by 20-30%? That's still open--or fruitful work to be done. Does every country that experiences a massive deflation experience a massive decrease in real output and increase in unemployment? China and Spain, not on the gold standard, had mild recessions because their trading partners are crippled. Did they have deflation? They did not--Spain, did not have a big deflation, and did not have a big reduction in output. Industrial production flat or slightly up during this period, whereas collapsing in the rest of the world. Clear there is a link between deflation and output, but the question is how is that taking place. Is it nominal rigidities, disintermediation in the credit system--Bernanke's done some work on that--what exactly are the interactions that bring this about?
54:17Talk about this interaction with the real side effects. There are a lot of other things happening. You've got the Smoot-Hawley tariff act; set of moves by the United States and other countries to limit trade, which is impoverishing. You have Keynesian story about animal spirits--people suddenly got scared and decided to save more, and that was the reason we suffered a contraction. How do you deal with the fact that there was lots of other stuff going on? Maybe this monetary stuff was the result of these other real-side effects? To just explain the deflation per se, go back to Friedman's aphorism that deflation is always and everywhere a monetary phenomenon. Certainly animal spirits and Smoot-Hawley tariff, which was slightly deflationary in the sense that it was attracting gold to the rest of the world--but when you look at the magnitude of the effect at the time, the size of the trade balance was relatively small. Impact on trade not enough to cause a 30% implosion of world prices. Come back to the gold standard and Central Bank policies of the time. What other real shocks are countries enduring that might be pushing down real output as well, besides just the deflation? We still don't have a solid answer on that. Tom Rustici podcast on Smoot-Hawley tariff--while small, may have contributed to monetary issue because farmers couldn't export goods, couldn't repay loans on equipment they borrowed; banks in agricultural states had trouble staying solvent; spiraled down further to worsen the monetary situation. Allan Meltzer sort of proposed that, too, as sort of the real way that Smoot-Hawley brought harm to the U.S. economy. There was a sharp rise in bank failures: Smoot-Hawley takes effect in June of 1930; crops harvested in fall of 1930; a bunch of bank failures in the south and agricultural regions in late 1930. But there is also a severe drought during that year, so you have to disentangle the drought effect from the tariff effect. A little skeptical of that argument in terms of its empirical power to explain a lot is that when we look at cotton, for example, cotton production fell presumably because of the drought, but demand fell a lot more because of the recession, so our share of crops we were exporting went up. In other words, our share in world didn't decline as much as domestic demand. Probably something there, but not sure it's going to be strong enough to have this huge effect on monetary policy stance. Doug's paper tries to estimate impact of France.
58:22Come to the present. Inflation and deflation may be always and everywhere a monetary phenomenon. Question arises as I think about depression and the current crisis: Is depression always and everywhere a monetary phenomenon? How much of swings in economic activity and the malaise we are in the middle of right now--how much of that is due to bad monetary policy and failure to fully understand the consequences of policy mistakes? Hugely important question; I'm not a macroeconomist; focus on international trade policy. But my waffling answer is there has got to be some of both involved--in the current episode and in the Great Depression as well. When the stock market crashed in 1929, Christina Romer has showed that consumers got a little bit spooked and held back on their consumption of consumer-durable goods. Independent of monetary policy. But question is: how big is that relative to the size of the fluctuations observed during that period? Role for both, but whenever you get really enormous shocks, such as a 30% deflation, appealing to non-monetary explanations is going to be very difficult. Any implications you want to suggest for monetary policy going forward? Struck by the--1920s economist Cassel who said the ideal would be for gold to grow at a 3% rate because that would be roughly equal to the increase in productivity, which would thereby lead to stable prices; stable prices are good because that lets people plan for the future and then nominal/real changes don't have the impact you were talking about earlier. Inflation spiral. Thought of Milton Friedman, who through much of his life advocated a 3% money rule: Federal Reserve should effectively be run by a computer, keeping the monetary base or some monetary aggregate within a range close to 3%. John Taylor, podcasts, has a different program--says the Fed should follow a policy that is response to changes in growth and changes in inflation. All of these--wouldn't it be nice if prices were stable? We can't seem to get there, either because politically we can't restrain ourselves or it's too difficult. Any ideas on how we might do better down the road? Think we have done reasonably well through this crisis as opposed to the Great Depression because we've managed to avoid a huge deflation. A lot of people are worried about inflation and the costs of inflation; think the historical record shows big deflations are just as disruptive, just as nasty as big inflations. Obviously you want to avoid the wide swings, the extremes; that's why Friedman, Cassel, others have always counseled monetary stability. It's a shame Milton Friedman isn't here to comment. Trying to talk to some of his students trying to get a feel for if he would have thought monetary policy is too tight today or too loose. Divides some of his students and scholars of his work. I tend to lean toward Scott Sumner's view that things are too tight--consumer price inflation that is basically zero over the past 9 months; the year-over-year rate is only about 1% and it's been falling. As Sumner points out, low nominal interest rates don't indicate monetary ease--they indicate tight money. Maybe there is still room for the Fed to help the economy out. Others look at the balance sheet and get spooked--pent up inflation here and in the future if we don't begin to tighten now. Not an expert in this area but fascinating debate to watch. Sumner and Meltzer podcasts. What I find difficult as a non-macro economist as well: we were taught as if there were almost an hydraulic--goes back to Irving Fisher--relationship between monetary policy and prices. After all, inflation is always and everywhere a monetary phenomenon. That's true. There's no economist who will dispute that. What seems to me to be difficult is that there is slip between the cup and the lip that we like to sort of wave our hands over, which is sometimes the citizenry has an idea about how much money they want to hold. We see it too late. Second problem--right now--reality--idea that monetary expansion can always stimulate the economy; and yet the monetary expansion we've seen is not stimulating the economy. People argue about this, but there is no doubt that banks are not lending the money the Fed has injected into the system. They are holding excess reserves and so that's why we are not getting the inflation we usually expect from the enormous injection of reserves we've seen. Calls into question the very mechanism that monetary economists argue can offset the business cycle swings. Don't understand how that's going to be repaired. Don't think we fully understand that mechanism. We are in an economic extreme situation. We aren't in these very often. Don't have a lot of historical experience with that. I tend to not think we are in a liquidity trap; think there is still scope for the Fed to do a lot more. But I can also see why people see why that's not going to be the case. Robert Hetzel, Federal Reserve Bank of Richmond, Scott Sumner, Bentley, and others have looked at nominal interest rates in the 1930s. Even though they were low, there is still scope for monetary expansion and the Fed doing well. Congress essentially forced the Fed to start monetary operation in early 1932, even though interest rates were very low. Lo and behold, they were able to increase the money supply and monetary base. Seem to be signs of a recovery. But they aborted this effort to expand the money supply in the summer of 1932. Only lasted for a few months. Then the economy started to slip back. That's something Friedman and Schwartz have noted, and a lot of other people--natural experiment. Couldn't monetary help the economy? Answer is yes. Tremendous slack in the system, no inflation now or on the horizon. M2 growth is very low rate historically speaking. Scope for more action. Question then would be, since unemployment is extremely high--why isn't the Fed doing anything? Keep saying: We can! We could. We have plenty of bullets left. Why aren't they? That's exactly the question asked in the 1930s--why aren't you doing something? Answer of the Bank of France was: We're worried about inflation. Answer of the Federal Reserve was: there's no demand for credit. The Fed, as Allan Meltzer shows, was adhering to a Real Bills doctrine, where they weren't going to issue more credit if there wasn't what they perceived as demand for it. Excuse for inaction. Recurring to some extent today.