Explaining “Freaky Friday” — How the Gold Guys Became Their Own Worst Enemies
June 19, 2014
(This item originally appeared at Forbes.com on June 19, 2014.)
I noted before a rather strange oddity: that most self-proclaimed “gold standard advocates” actually label the monetary arrangements of the 1925-1931 period as a major cause of the Great Depression.
Oddly enough, the Keynesian Mercantilists generally do not. They claim an “inherent instability of capitalism” that requires government oversight and intervention, including funny-money currency manipulation by an unelected board of central bank bureaucrats. A gold standard system prevents this. But, the Keynesian Mercantilists generally do not lay blame on the gold standard system itself.
Why is this so? Alas, economics is a field of study heavily polluted by politics. One or another “explanation” for some past event is typically a justification for present and future policy. This has been as true of the Classical, right-leaning economists as it has been for the Mercantilist, left-leaning economists.
Why bring this up now?
I think we are naturally trending towards the replacement of today’s Mercantilist funny-money arrangement with a Classical hard-money system, which in practice means one based on gold. Probably, this will be accomplished with Russian, Chinese and perhaps German leadership, along with the participation of a number of allied states ranging from Iran to Brazil.
Unfortunately, there is still quite a lot of intellectual detritus to clear away, in my opinion, to best facilitate this political trend toward its natural conclusion. In other words: someone, somewhere, actually has to know what they are doing.
Here are some hypotheses for why the “gold guys” became their own worst enemies – actually inventing a series of rather fanciful arguments why the existing gold standard arrangements of 1925-1931 didn’t work, and in fact helped cause one of the biggest economic dislocations of the past two hundred years!
They don’t like “central banks.” What we call “central banks” today generally emerged in the latter 19th century worldwide, patterned on the model of the Bank of England. These were currency monopolies, in contrast to the distributed system used by the United States, which had a long history of opposition to currency monopoly. Alas, even the U.S. succumbed to the trend toward currency monopoly, enacting the Federal Reserve Act in 1913, under rather curious circumstances. The Federal Reserve became active in the 1920s, although the U.S. still used a competitive currency environment via the National Bank System, which remained viable until the late 1930s. Although the Federal Reserve certainly is to blame for a great many things, especially after 1965 or so, actually I find that it (and other central banks worldwide) adhered to gold standard principles rather closely in the 1920s and 1930s. The devaluation of 1933 was entirely due to executive order, and did not involve the Federal Reserve directly.
They don’t like the “gold exchange standard.” The “gold exchange standard” is a needlessly obscure term that simply refers to a currency board-like arrangement that targets a major international “reserve currency,” also based on gold, rather than having a direct link to gold bullion itself. In practice, these things tend to blur a bit, as many central banks had a somewhat loose operating procedure that included both transactions in bullion and also in foreign gold-linked currencies, and held both bullion and foreign government bonds as reserve assets. In any case, the “gold exchange standard,” when operated correctly, is little more than a currency board, which we use today with no particular problems, and which had been used in the late 19th century as well. Sometimes, a “gold exchange standard” might not be operated correctly, in which case it is simply a system that is not being operated correctly, with the usual bad consequences.
However, a “gold exchange standard” does have an inherent weakness – it is somewhat dependent on the quality of the reserve currency, in practice either the British pound or U.S. dollar. If the pound or dollar was itself devalued (as indeed happened in 1931 and 1933), this would tend to put at risk all subsidiary currencies linked to these “reserve currencies.” This indeed happened in the 1930s, and again in the 1970s.
Also, “gold exchange standards” often do not have a direct provision for “convertibility,” or the requirement that the currency issuer (central bank) trade banknotes for bullion, and vice versa, on demand. Although this is not a requirement for a properly functioning gold standard system, the historical record shows that the absence of such a requirement often leads fairly quickly to an erosion of the system itself due to what amounts to political corruption. In practice, the requirement to deliver a reliable international reserve currency (such as British pounds) on demand has served much the same purpose, but many think gold bullion redeemability would be much better.
Unfortunately, these worthy criticisms of reserve-currency currency-board-type systems tend to motivate the blaming of “gold exchange standards” for a wide variety of things that they really have nothing to do with.
They are inordinately attached to monetary explanations for everything. You have probably heard of the “Austrian explanation of the business cycle.” It is based entirely on funny-money manipulation by central banks. By itself, there’s nothing in particular wrong with it, and indeed variants of this pattern do occur. However, plenty of other things happen in economies also, and the self-proclaimed “Austrians” are forever trying to pound their square peg into round, triangular, and star-shaped holes. The formative experience in the actual used-to-live-in-Austria “Austrians” was of course the Austrian hyperinflation of the early 1920s, which was much like the better-documented German hyperinflation of the same time period, but which preceded the German example by about six months. So, there’s a reason for this intense focus on monetary affairs, and the consequent exclusion of everything else.
They have a blind spot for fiscal policy, in particular tax policy. Over a thousand U.S. economists expressed the belief that the U.S.’s Smoot-Hawley Tariff, and the consequent worldwide trade war as many governments passed retaliatory tariffs worldwide, would lead to an economic downturn. The House passed the bill in May 1929, and the Senate in March 1930. President Hoover signed the bill into law in June 1930. Some historians have identified September 1929 as the moment when the Senate moved from a majority in opposition to a majority in favor, which was accomplished by a radical expansion of the tariff to include many Senators’ home-state industries.
As the worldwide trade war ignited, trade and economies predictably sagged. It was exactly as those thousand-plus economists said would happen. Yet, oddly, nobody wants to lay blame on this as the initial instigator (but not the only or even primary cause) of the Great Depression, and would rather instead make up monetary fantasies.
This “blind spot” for influences such as tariff or tax policy in fact goes back several decades in the Classical tradition. If you read central texts such as Alfred Marshall’s Principles of Economics of 1890, or Ludwig Von Mises’ Human Action of 1949, there is hardly any discussion at all of tax policy.
They don’t want to accept the “capitalism is inherently unstable” arguments of the Keynesian-Mercantilists. Once you decide that capitalism is–in principle–inherently unstable, you are immediately drawn to the big-government funny-money arguments that the Keynesian-Mercantilists so enthusiastically embrace. In practice, “capitalism” (a convenient word for present arrangements) is in fact “unstable,” and does lead to things like the Great Depression or today’s crony-fascist debt bubble. However, I personally agree that capitalism in principle does work, and doesn’t just blow up for no reason at all.
Most big problems in “capitalism” (i.e., real life) are due to big mistakes–huge deviations from the principles of capitalism. Like a worldwide tariff war. You can’t get much more obvious. Even a thousand economists (no smarter then than today) could see it. However, due to the “blind spot” regarding all forms of government intervention and influence besides monetary affairs, the Classical economists were pressed to explain the Great Depression as some kind of deviation from the proper Classical monetary principles. In other words, it was another attempt to get the square peg to fit into a non-square hole.
Bizarrely, because they already signed on to the “capitalism is inherently unstable” argument, the Keynesian-Mercantilists, despite being lifelong haters of Classical gold-based monetary systems, did not have a motivation to blame the monetary arrangements of the time. So, they didn’t. They hated that the “golden fetters” prevented the swift application of their funny-money solutions. They had to wait all the way until September 1931, when devaluation by Britain set off a chain of similar devaluations worldwide. It didn’t work particularly well, and even Keynes himself signed on to the Bretton Woods Agreement of 1944, which put the world gold standard system back together.
They wanted to remain friendly with their political allies, who were making a big mess of things. The modern Republican party has long had a tension between the “austerity wing,” which often recommends tax rate increases as a way to deal with deficits, and the “growth and opportunity wing,” which often recommends tax rate reductions as a way to allow a healthier economy, which is–in practical terms–necessary for effective deficit reduction in any case. Both of these can come into conflict with the “protectionist/cartelist wing,” which has recommended protectionist tariffs since pre-Civil War days.
In the 1929-1932 period, the “growth and opportunity wing,” as represented by Treasury Secretary Andrew Mellon, was brushed aside, and the Republican/conservative/Classical political block was dominated by the “austerity wing” and the “protectionist/cartelist wing.” Mellon himself was marginalized by Hoover, who had acquiesced to the “protectionist-cartelist” wing by passing the Smoot-Hawley Tariff (which Hoover originally opposed). Mellon resigned in February 1932. Hoover then immediately crumbled before the “austerity wing” of the Republican Party, passing the Revenue Act of 1932, which included an explosion of personal and corporate income taxes, and a barrage of excise taxes (in effect, a sales tax).
Being an economist is like being a poet: you shouldn’t expect to get paid. Those who do seek remuneration (even in academia) are inevitably drawn toward one or another existing political bloc, where, if they expect to keep getting paid, they inevitably start making justifications for what the politicians wanted to do anyway. Even Andrew Mellon couldn’t keep his job, in opposition to the “austerity and protectionism” Republicans of that time. The message was clear–in the U.S., and also in other countries, which had much the same pattern. Thus, the Classical-leaning economists knew very well that there was no sinecure available for them if they were going to oppose the “austerity and protectionism” measures of the political conservatives of that time. (The political liberals all wanted big-government Keynesian-Mercantilists, and had no interest in Classical-leaning economists.)
Remember, it was the Great Depression. Nobody wanted to lose their job.
The “growth and opportunity wing” had a brief resurgence after WWII, but this was quashed by Eisenhower. Except for that, the Republican Party was dominated by the austerity-protectionist wings from 1929 to 1975. The Republican Party “growth and opportunity wing” didn’t make a comeback until Jack Kemp and Dick Armey led the tax-cutting Reagan Revolution beginning in 1975. Coincidentally (or not), this was also when Classical-leaning economists also began taking a closer look at the role of government fiscal and other policy in the Great Depression, abandoning the intense fixation on monetary explanations that dominated the 1950s and 1960s.
The “conservative funny money” idea turned into a big seller. The Classical ideals and principles of capitalism made a big recovery after World War II, but in a mutated and contorted form. All the small-government laissez-faire principles returned, but with one big exception: the introduction of a funny-money fiat currency element. This was exemplified most of all by Milton Friedman, whose “monetarism” is just a slightly different flavor of Mercantilist funny-money manipulation. Milton Friedman was a lifelong enemy of Classical monetary principles, including gold-based money. Friedman also blamed Fed negligence for the Great Depression, making essentially no mention of the catastrophic errors by the conservative “austerity wing” and “protectionist/cartelist wing” of that time, or later for that matter.
This was a big seller. Friedman was popular. He reached the highest levels of recognition and influence in the world of economic policy, despite being something of a ding-dong if you ask me. Those who wanted to make a living selling their economic poetry noticed.
Contrast Friedman’s professional success to the career of Ludwig Von Mises, who is acknowledged as one of the greatest economists of the twentieth century even by those who don’t agree with him. Mises couldn’t even get a regular job. He spent his postwar career (1945-1969) as a visiting professor at New York University, an unsalaried position that was funded by a friendly private businessman. He was, like Andrew Mellon, unemployable. Fifty years from now, I think Mises will still be recognized as one of the twentieth century’s greats, and Friedman will be considered just another Mercantilist nincompoop of the sort popular during that dark period. But, Friedman got paid, and Mises did not.
These things are understood at a subconscious, even limbic level by the vast majority of economic writers. They internalize it, churning out volumes of whatever happens to be politically expedient at the time, all the while remaining True Believers in everything they write. (It becomes difficult if you are not a True Believer, and the pay isn’t sufficient to tell lies all day.) This is simply the expected behavior of monkeys with an oversized brain, and has little to do with historical truth.
Thus, my personal conclusion is that the Keynesian-Mercantilist writers mostly have it right: there was no particular problem with the gold-based monetary system of the latter 1920s or early 1930s.
If we are going to properly rebuild a world monetary system along Classical lines in the future, it might help if others also took a fresh look at these issues.