Developing countries today peg their currencies to the dollar rather than gold, and when they fail to adhere to the required discipline they are forced to devalue or face speculative attacks, as happened to Mexico in 1994 and Asian countries in the late 1990s.

After the 1929 stock market crash, Christina Romer has shown consumers got spooked and held back consumption of durable goods, an effect independent of monetary policy, but it is doubtful such non-monetary effects are large enough to explain the size of the observed fluctuations.

The gold standard underpinned the late-Victorian era of globalization with high labor and capital mobility and abundant trade, because fixed exchange rates removed uncertainty about future rates and provided price stability, allowing the world economy to function smoothly.

The gold standard was suspended during World War I and restored for most countries by 1928-1929, with the business cycle peak for most countries in mid-1929.

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.

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, which is supported by the observations that countries not on the gold standard avoided the Great Depression and gold-standard countries only recovered after leaving it.

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.

Being on the gold standard means a country's monetary base and policy stance are dictated by central bank gold reserves: rising reserves permit expanding the money supply, while falling reserves force higher interest rates and contractionary policy to stop gold outflow.

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.

Sterilization—when a central bank gains gold reserves but declines to print more money—violates the implicit rules of the gold standard and removes the self-correcting mechanism, and it played a major part in the Great Depression in both the United States and France.

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.

Discretionary monetary policy with 'open hands' has been an abject failure in many countries (e.g., Zimbabwe's hyperinflation) and even in the US has been indicted for the low rates of 2002-2004 precipitating the current crisis, so choosing between gold and discretion is a genuine trade-off rather than a clear win for either.

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, after worse post-war inflation, chose to re-peg at a deliberately undervalued franc rather than deflate, making French goods highly competitive and imports expensive, which let France run a persistent trade surplus and attract gold from trading partners like Britain.

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.

Had the price of gold been raised in the late 1920s, or had major central banks pursued price stability instead of adhering to the gold standard, there would have been no Great Depression, no Nazi revolution, and no World War II (quoting Robert Mundell).

World prices fell about 30% within two or three years of their 1929 peak, and the deflation was synchronized across Britain, France, and the US starting in mid-1929—a monetary shock consistent with Friedman's dictum that inflation (and its converse, deflation) is always and everywhere a monetary phenomenon.

France's deflationary impact in 1927-28 was masked because the US was simultaneously shedding gold and lending abroad, offsetting France; but when the US began tightening in 1928, it reinforced France's effect, and the combined gold flows drove world prices down starting mid-1929.

A little anticipated deflation is not harmful (the 19th century saw deflation with rising output and low unemployment), but large unanticipated deflation (~10%/year) is destructive when combined with nominal rigidities: firms facing falling output prices that cannot cut wages proportionally must shed workers and contract.

Irving Fisher's debt-deflation theory holds that nominal debts (mortgages, bank loans) become harder to service as prices and wages fall, producing defaults that stress banks into raising reserves, cutting lending, and tightening standards, which reinforces the initial downturn into a self-reinforcing financial contraction.

French central bankers and politicians were traumatized by the 1924-25 inflation (stabilized only in 1926), giving them an extreme anti-inflation stance; combined with legal restrictions on open market operations and a refusal to monetize government debt, this made them unwilling to monetize their gold inflows even as prices fell sharply in the early 1930s.

Friedman and Schwartz (Monetary History, 1963) correctly identified contractionary US monetary policy beginning in 1928 and subsequent failure to respond to deflation, but they downplayed France's contribution; Irwin calculates that France's deflationary impact on the world economy matched, if not exceeded, that of the United States.

Milton Friedman himself, after reading the memoirs of the French central bank governor in the early 1990s, wrote that had he been fully aware of what France was doing, his Monetary History would have laid equal blame on France rather than putting the burden on the Federal Reserve.

The Smoot-Hawley Tariff was only slightly deflationary (by attracting gold to the US) but its effect was too small to cause the 30% world price implosion, because the trade imbalance at the time was relatively small; the deflation must be traced primarily to gold-standard central bank policies.

The link from deflation to output collapse remains an open puzzle: while prices fell ~30%, why output fell 20-30% is not fully established, though the contrast with Spain (no big deflation, flat or rising industrial production) shows a clear link, with candidate mechanisms being nominal rigidities and credit-system disintermediation (per Bernanke's work).

In the present crisis the US has done reasonably well compared to the Great Depression because it avoided a huge deflation; big deflations are just as disruptive as big inflations, so the goal should be monetary stability avoiding both extremes (per Friedman, Cassel and others).

Monetary policy today (circa 2010) is likely too tight (per Scott Sumner): consumer price inflation has been roughly zero over nine months and ~1% year-over-year and falling, and low nominal interest rates indicate tight money rather than easy money, so the Fed has scope to do more.

The standard transmission mechanism from monetary expansion to stimulus is in question because banks are holding the injected reserves as excess reserves rather than lending them, so the enormous reserve injections have not produced expected inflation—calling into doubt the Fed's ability to offset business-cycle swings.

There was probably no liquidity trap in the 1930s: when Congress forced the Fed into open market operations in early 1932 despite low rates, the monetary base and money supply rose with signs of recovery, but the Fed aborted the effort by summer 1932 and the economy slipped back—a natural experiment showing monetary expansion can help even amid deep deflation and slack.

Central bank inaction in both the 1930s and today stems from the same two rationales: fear of inflation (the Bank of France's worry) and a belief in central bank impotence/lack of credit demand (the Fed's real bills doctrine, per Meltzer), which together served as an excuse for failing to pursue expansionary policy.

The Smoot-Hawley Tariff may have exacerbated the monetary crisis through a credit channel (per Rustici and Meltzer): farmers unable to export couldn't repay equipment loans, stressing agricultural-state banks into insolvency and worsening the monetary contraction, though a severe 1930 drought confounds this and cotton data show export shares actually rose as domestic demand fell more.

The Roaring Twenties featured a large expansion in debt and stock market investment, with people living beyond their means expecting to manage it—paralleling the recent housing crisis where high mortgages became unaffordable as prices fell and incomes stagnated, though the 1930s problem was more widespread than a single sector.