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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.
October
16, 2016: Nonmonetary Perspectives on the Great Depression
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.
July
31, 2016: Blame France 2: Balance Sheet Peeping
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.
Gold: the Monetary Polaris
May
22, 2016: The Devaluation of the British Pound, September 21, 1931
June
5, 2016: Irving Fisher and "Debt Deflation"
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.)
August
28, 2016: What Is "Sterilization"?
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.
June
5, 2016: Irving Fisher and "Debt Deflation"
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.
February
7, 2016: Blame Benjamin Strong 2: So Obvious It's Hard To
Believe
January 31, 2016: Blame Benjamin Strong
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.
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