We’ve been looking at the history of “nonmonetary interpretations of the Great Depression” — the idea that the onset of the Great Depression was not caused by some kind of monetary factor. This was actually the most common view, until the 1960s, and remains a common view today among academics.
Now let’s look at Monetary Interpretations of the Great Depression (1995), by Frank Steindl. This comes twenty years after Temin (1976), and again is an explicit effort to offer a survey of the range of thought, not just one person’s view. The book is generally celebratory of the supposed new insights of those offering “monetary interpretations.”
[T]he inquiry concentrates on the analyses of economists who, in their attempts to understand the causes and depths of that severest of the twentieth century’s economic crises, looked principally to monetary considerations. Notable here are those who employed the quantity-theory-of-money paradigm as their preferred engine of analysis for understanding the unfolding influence of changes in monetary conditions. Those attempts are termed monetary interpretations of the Great Depression, hence the title of this book. (p. 1)
Here we are, in the second sentence of the book, and already it is clear that the various “monetary intepretations” are focused on the quantity theory of money. This is one of the most popular ways in which, I say, the Classical “small government free market” economists contorted their monetary understanding, so they could apply a “monetary interpretation” to a great economic disaster. Here they must depart from base money — the only kind of money there actually is, as I describe in Gold: the Monetary Polaris — because base money generally expanded in the early 1930s, at least in the U.S. and France, while it was essentially unchanged in Britain.
Instead, they adopt a measure of bank credit, “M2”, which, as Temin suggested, is not actually monetary. A decline in M2 is Temin’s “banking collapse,” and also Irving Fischer’s “debt-deflation.” I used the recent example of Greece, which uses the euro. M2 in Greece declined about 40% between 2010 and 2015, as the economy there collapsed. But, it didn’t have anything to do with the money — the euro — which was basically fine. “Banking collapse”? Yes. “Debt-deflation”? Yes. But no monetary problem. I always focus on the value of money, since this expresses the balance between supply and demand. You can have a very big increase in the supply of money (base money supply), as we have certainly seen among central banks since 2008, without a decline in currency value if demand also increases. The result is that there is no adjustment of prices (“inflation”) in response to a change in currency value, because it didn’t change. On the other hand, you can also have a situation where the base money supply doesn’t change much at all, but there is a collapse in currency value basically related to a decline in demand. The result is “monetary inflation.” This happened at Thailand in 1997 and Russia in 1998, and also Britain in 1931, as I’ve documented.
Actually, the same was true during the U.S. dollar devaluation of 1933 — base money was basically flat during that time.
Similarly, you can have a substantial decline in base money supply (quite common in Britain during the 19th century) and there will be no “monetary deflation” if the value of the currency does not rise. (The decline in base money supply was basically a response to a decline in demand, via the automatic operating principles of a gold standard system.)
Thus, “monetary inflation” and “monetary deflation” are expressed as changes in currency value. This was common understanding at the time of the publication of Ludwig von Mises’ Theory of Money and Credit in 1913:
In theoretical investigation there is only one meaning that can rationally be attached to the expression inflation: an increase in the quantity of money … that is not offset by a corresponding increase in the need for money … so that a fall in the objective exchange value of money must occur. Again, deflation (or restriction, or contraction) signifies a diminution of the quantity of money … which is not offset by a corresponding diminution of the demand for money … so that an increase in the objective exchange value of money occurs.
Practical examples of “monetary deflation” would include any time a currency rises in value significantly. In the past, this was typically after wartime, when currencies were returned to their prewar gold parities. This was the case in the U.S. 1865-1879, and in more minor form in 1816-1819, 1919-1922 and 1951-1953. In Britain, it was 1815-1821 and 1919-1925. A more contemporary example is Japan 1985-2000. We know exactly what this looks like, and so did Keynes, who described it rather well in a series of writings around 1925.
The policy of reducing the ration between the volume of a country’s currency and its requirements of purchasing power in the form of money, so as to increase the exchange value of the currency in terms of gold or commodities, is conveniently called deflation.
John Maynard Keynes, A Tract on Currency Reform, 1923.
Thus, we cannot say that Keynes was simply sloppy or ignorant of a geniune monetary deflation in the early 1930s. He was one of the premier experts on the topic, and I think he understood it pretty well — although he tended to blame it excessively because he didn’t understand the problems of tax policy that Britain was undergoing at the time. But Keynes did not perceive any “monetary deflation” during the 1929-1933 period, because the value of currencies didn’t rise vs. gold, although he still recommended a devaluation to address problems that came from other, nonmonetary sources.
Under a gold standard system, this change in value can only take two forms: one is a change in the value of the currency vs. gold, which is to say, the abandonment of the gold standard system. The other is a change in the value of gold itself.
September 25, 2016: The “Giant Rise in the Value of Gold” Theory of the 1930s 3: Supply and Demand
September 18, 2016: The “Giant Rise in the Value of Gold” Theory of the 1930s 2: Never Happened Before
September 11, 2016: The “Giant Rise in the Value of Gold” Theory of the 1930s
These issues could be sidestepped by focusing on quantity rather than value. Thus, the quantity theory of money, and also the use of credit measures rather than monetary ones, represented the primary avenue by which certain people tried to invent a monetary problem where one didn’t exist.
With the possible exception of Lauchlin Currie, Irving Fischer, and Clark Warburton, economists with a monetary interpretation of the 1929-1933 tailspin are for the most part unknown. Though names such as James Harvey Rogers, James W. Agnell, and Arthur W. Marget may draw some nodding acquaintanceship, those of Edwin W. Kemmerer, Harold L. Reed, and Lionel D. Edie, for instance, are more likely to be met with blank expressions. In their stead, Milton Friedman and Anna J. Schwartz are the ones identified with the monetary interpretation. (p. 1)
Here we find the early history of “monetary interpretations,” and also that these notions were not widely held until Friedman and Schwartz published their Monetary History of the United States, 1867-1960 in 1963. I would say that some of these are not even really monetary, notably Irving Fischer who we already looked at. But, confusion between banking/credit and “monetary” factors characterizes this entire genre, so it is no suprise to find Fischer on the list.
In the book’s conclusion, Steindl explains:
When the Monetary History appeared, it caused a fundamental rethinking and widespread reevaluation of the role of monetary factors in the Great Depression. For at least a quarter-century after the Depression’s nadir, the prevailing interpretation concluded that monetary factors, specifically the actions of the Federal Reseve, were quite simply unable to stem the decline, and that interpretation, held with virtual unanimity, was widely accepted as the product of careful, thoughtful analysis. (p. 171)
“Unable to stem the decline” is certainly not a cause. It is an expression of impotence vs. nonmonetary factors. The Federal Reserve, and other central banks worldwide, could not do very much, because they were on a gold standard system. The value of the currency — which is ultimately the only important thing — was precisely defined. It was much like the relationship between Greece and the euro. Base money was basically a residual of the mechanisms that maintained the currency’s value at its gold parity, much the same as any automatic currency board today. However, central banks did have a little bit of discretion, related to their operations as a “lender of last resort” in the 19th-century meaning of the term. This was to address systemic liquidity shortage issues, which were expressed as very high interbank lending rates between banks of high solvency. This was in no way contrary to the principle of a gold standard. The Bank of England served as the example of how to combine this “lender of last resort” function with gold standard discipline in the 19th century. However, lending rates were very low during the Great Depression, among borrowers of high solvency, so there wasn’t much more central banks could do there. They had already done a good job.
The problem of the Great Depression simply was not a 19th-century style “liquidity shortage crisis;” nor was it a deviation of currency value from gold parity. These were the only two jobs of central banks at the time, which explains the prevailing interpretation before 1963.
At this point in the discussion, it is common that a great many people will wriggle and squirm. The basic reason is that they are attached to the idea that the Federal Reserve should have “done something,” and they are thus devoted to inventing a million and one justifications why. Whether these justifications make any sense (are true) is not relevant; the important thing is that they are effective in performing the role of backing up the conclusion of devaluation and fiat currencies.
We can get an idea of why people were so attached to this idea. The basic Keynesian version of things seemed much too vacuous. It bothered Temin, even though he continued to uphold it. As Steindl relates, in a thirtieth-anniversary celebration of Friedman’s Monetary History in 1994, Robert Lucas wrote:
Friedman and Schwartz [painted] a picture that is consistent with our instinct that the depression of the 1930s was an event that should not have happened, a preventable disaster.
The Keynesian idea that the flap of a butterfly’s wings was “multiplied” into a world-economy-destroying catastrophe made people uncomfortable — as it should have. The Classical idea that the correct response to this horrifying vortex of collapse was “do nothing” was equally unacceptable. There must have been a cause commensurate with the effect … and there must have been something that could have been done about it. This was a valid instinct. The desire for something that was “consistent” with this instinct was great enough that people were willing to believe any sort of nonsense, without asking too many questions.
Lastly, here’s a line from Anna Schwartz, Friedman’s collaborator:
In the ’30s, ‘40s, and ‘50s, the prevailing explanation of 1929-1933 was essentially modeled on Keynesian income-expenditure lines. A collapse in investment as a result of earlier overinvestment, the stock market crash, and the subsequent revision of expectations induced through the multiplier process a steep decline in output and employment. … Try as the Federal Reserve System might, its easy money policies … did not stabilize the economy.
Schwartz, Anna J. 1981. “Understanding 1929-1933.” In Bruner, Karl ed. The Great Depression Revisited, Martinus Nijhoff Publishing, Boston. pp. 5-6
This reiterates all the themes we’ve been laying down here.
We should also consider the possibility that much of this is propaganda. The business of central banking, and fiat currency manipulation, is bad for many people, but good for some. Those people — the people who established central banks in the first place, and who can profit from their actions — certainly have a motive to propagandize, and certainly have the means. Billions and billions of dollars at their disposal, with which to produce and then popularize certain notions. In other words, “manufacturing consensus.” I hear that a lot of money is going into the promotion of “nominal GDP targeting” these days. What kind of person writes million-dollar checks for the promotion of “nominal GDP targeting”? Having brought up that possibilty, I will leave it for others to investigate, and perhaps come to some conclusion one way or another. We will now go back to our usual practice of acting as if these people are simply earnest, if perhaps mistaken, strivers for truth.
Despite the success and influence of the Monetarist idea — or other money-focused notions that came later, particularly the Blame France variations — there remained a substantial Keynesian contingent that stuck with the original idea that the cause of the Great Depression did not lie in monetary matters. These people, like Keynes himself, saw devaluation as a solution to the problems of the day (which they did not really understand except to call their effects a “decline in aggregate demand”), and thus, like Keynes himself, blamed the “golden fetters” of the gold standard as preventing the solution that they advocated.
Golden Fetters: the Gold Standard and the Great Depression, 1919-1939 (1992), by Barry Eichengreen, represents one of the more comprehensive works in this regard. I include it here to show that the Monetarist view, or money-focused views in general, were not accepted universally. In 1992, things still tended to break into the Keynesian camp and the Monetarist camp, not so different than Temin described in 1976. Actually, there has been some blending in the 25 years since Eichengreen’s book. The fact of the matter is, the Keynesian remedy and the Monetarist remedy are exactly the same — devaluation and floating fiat currencies. Thus, it should be no surprise that they would eventually find that they had a lot in common. Keynesians also recommend expanded government spending, while the Monetarists tend to favor smaller government. Besides that, however, they are basically Tweedle-Dee and Tweedle-Dum.
Eichengreen has a lot of detail about the trend toward increasing interest in discretionary monetary fiddling during the 1920s. I agree that central bankers had already, by 1930, adopted a sort of playacting of floating fiat currencies and activist/discretionary monetary policy. This naturally caused the gold standard systems of the time to be somewhat under speculative pressure. People were concerned, rightly so, that one of these days this playacting might turn real. However, if that was a major problem, then certainly the outcome would have been a breakdown of the gold standard system, just as similar issues led to a breakdown of the gold standard in 1971. Indeed, it was a major factor in the British devaluation of 1931, which, as we have seen, came about because of the refusal of the Bank of England to do what was required (contract the monetary base in response to gold outflows) to support the value of the pound at its gold parity. However, Eichengreen later focuses on those gold standard systems that did not break down, but rather remained operative, blaming them for preventing his devaluation/floating fiat solution.
In 1992, things hadn’t really progressed much since 1976 regarding initial causes. Eichengreen summarizes:
The initial downturn in the United States enters this tale as something of a deus ex machina, lowered from the rafters to explain the severity and persistence of difficulties in other parts of the world. To some extent this is inevitable, for there is no consensus about the causes of the downturn in the United States. The tightening of Federal Reserve policy in 1928-29 seems too modest to explain a drop in U.S. GNP between 1929 and 1930 at a rate twice as fast as typical for the first year of a recession. Hence the search for other domestic factors that might have contributed to the severity of the downturn, such as structural imbalances in American industry, an autonomous decline in U.S. consumption spending, and the impact of the Wall Street crash on wealth and confidence.
The debate over the role of such factors remains far from resolution. …
None of this explains why governments were so slow to respond as the Depression deepened. If wages failed to fall, officials could have used monetary policy to raise prices. If private spending collapsed, they could have used public spending to offset it. Yet monetary policy in the United States, France, and Britain remained largely passive. Fiscal policy turned contractionary, as governments raised taxes and reduced public spending. Policy thereby reinforced rather than offset the decline in demand.
The response may have been perverse, but it was not paradoxical. It is hard to see what else officials in these countries could have done individually given their commitment to gold. … So long as they remained unwilling to devalue, governments hazarding expansionary initiatives were forced to draw back. Britain learned this lesson in 1930, the United States in 1931-33, Belgium in 1934, France in 1934-35. (p. 12-17)
Once again, we have the same kind of listless tossing out of a few hypotheses regarding the cause of the initial downturn — none of which includes any monetary factors, and which Eichengreen, like Temin before him, admits are rather unsatisfying. The “search for other domestic factors” does not progress beyond the sentence here. Again the Keynesian version is based on an “autonomous decline in consumption spending,” which means “a recession for no reason.” (This is not entirely silly — minor recessions, such as those of the 1950s, can seem to happen “for no reason.”) Eichengreen beats the drum relentlessly for the idea that a devaluation would have helped solve the problems — the problems caused by we-know-not-what — but recognizes that the gold standard prevented any such action.
Note that Eichengreen, by implication, disagrees with all the blame-money types that the Federal Reserve or other central banks could have or should have done this, that or the other. Rather, he says that they couldn’t do much at all, while they remained on a gold standard system — exactly the pre-1963 consensus that Steindl describes. The Monetarist or other interpretations are really just cloaked justifications for devaluation and floating fiat currencies.
In his final, concluding chapter, Eichengreen has a lot of argle-bargle about the “balance of payments” during the 1920s, which he hints and implies led to an overly restrictive monetary policy. (The phrase “balance of payments” often means gold outflows caused by a weak currency, so in that sense, the “balance of payments” did indeed restrain any expansionary tendency of central banks.) Yet, he also admits that central banks actually tried to be as accommodative and expansionary as they could within the constraints of the gold standard system — indeed, it was this “playacting” that was causing a bit of friction and bother during the 1920s. We saw an example of central banks’ efforts to “do something” with the Federal Reserve’s $1,000 million bond-buying operation in 1932. The result, as Eichengreen relates, is that central banks again and again experienced gold outflows, and had to halt any such shenangigans if they were to remain on the gold standard. Clearly, central banks, rather than being “restrictive” in some unnatural and contrived Great-Depression-causing way, were pushing things to the easy-money limit, within the context of a system that didn’t allow them to do very much at all. We saw already that the Federal Reserve’s 1932 open-market operations resulted in absolutely nil, nothing, nada in terms of base money expansion. Also, the contraction of Fed Credit in 1928-1929 was completely offset by gold inflows, resulting in no change in base money. Once these elements canceled out, there was no “tight money” in 1928 and no “easy money” in 1932. It was all just neutral money — money linked to gold.
September 4, 2016: What Is “Sterilization”? 2: The Complexity of Central Bank Activity
August 28, 2016: What Is “Sterilization”?
February 7, 2016: Blame Benjamin Strong 2: So Obvious It’s Hard To Believe
That is probably more than enough on the topic for now. As I’ve related, the only way you can get a “monetary deflation” while on a gold standard is if gold itself rises in value. Note that this claim is nowhere made in any of these descriptions, Keynesian or Monetarist. It has been made from time to time, but for the most part, it is quite rare and unusual.
We will continue with this topic soon.