Douglas Irwin
About
Economist, author of 'Free Trade Under Fire'
Claims by Douglas Irwin (20)
Because the nominal price of gold is fixed under the standard, an abundance of gold cannot lower gold's price directly; instead the relative price of gold falls by raising the prices of all other goods (inflation), as the excess gold flows into central bank reserves when people exchange it for transaction-usable paper currency.
China (on a silver standard) and Spain (on a fiat money standard) were not on the gold standard during this period and, while they suffered recessions because trading partners went into depression, they did not experience the great deflation, the great rise in unemployment, or the great reduction in output that gold-standard countries did.
Countries left the gold standard at different times (Australia/Argentina late 1929, Britain September 1931 pulling ~18 others, the US April 1933, Belgium 1935, France and the gold bloc late 1936), and this time variation provides a way to identify the economic impact of leaving gold, since leaving allowed reflationary policies, bank stabilization, and recovery as prices rose.
The single most important thing FDR did was to take the US off the gold standard in April 1933, which marks the trough of the Depression with industrial production and wholesale prices bouncing back in a sharp V; the New Deal's other policies (e.g., the NRA) were largely secondary, if not counterproductive.
Because each currency is pegged to a fixed quantity of gold, triangular arbitrage fixes all bilateral exchange rates between gold-standard currencies; maintaining that peg requires adjusting domestic monetary policy, so a country cannot run an independent monetary policy without violating the standard or triggering gold flows.
The gold standard functioned as a self-imposed discipline device on central banks and politicians: it prevented running the printing presses because excess paper relative to gold stocks would raise the risk of a speculative run, and this credibility was reinforced by gold's independent uses and the impossibility of inflating its supply.
If one country prints more money than gold rules permit, inflation prices out its exports and cheapens imports, creating a trade deficit that (absent capital flows) must be financed by gold outflows, which then forces the central bank to slow money growth and raise rates—David Hume's price-specie-flow mechanism returning the system to equilibrium.
Gustav Cassel argued world gold production needed to grow about 3% a year to ensure price stability, matching average global output growth from productivity and labor supply; growth below that produces deflationary pressure, while growth above it (as in the 1890s Australian discoveries) produces mild inflation.
The chief drawback of the gold standard is the loss of independent monetary policy: a country ties the short-term fate of its economy to the world gold supply, so it cannot use monetary policy to cushion shocks like crop failures and must instead endure tight money, high rates, and gold loss—making its fate hostage to events in gold producers like South Africa and Russia.
Britain (under Churchill as Chancellor) chose to deflate prices and return to gold at the pre-war parity in the mid-1920s, but since prices had not fully fallen, British goods were overpriced internationally, forcing further painful deflation—a decision Keynes attacked in 'The Economic Consequences of Mr. Churchill.'
France's accumulation of gold without inflating its money supply (sterilization) disabled the self-correction of the price-specie-flow mechanism, so instead of France inflating to offset others' deflation, France drained gold from the rest of the world and forced other countries into a worldwide deflationary spiral.
France raised its share of world gold reserves from 7% in 1927 to 27% by 1932, and its cover ratio (gold reserves per central bank liability) rose from about 35% in 1928 to nearly 80% within three or four years, demonstrating it was literally pulling gold out of the rest of the world and holding far more than needed.
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