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Finally, we come to the last of what I find are the primary theories of some
kind of monetary problem contributing to the Great Depression: the idea that
there was some kind of dramatic rise in the value of gold.
As I've said before, this is something of a minority theory. It was not part
of the Keynesian narrative; not part of the Monetarist narrative; not part of
the Austrian narrative; and mostly not part of the Blame France narrative,
except in a small way. It was most memorably expressed by Gustav Cassel.
However, Cassel mostly formed his ideas before 1930; even, I would say,
before 1910. So, even Cassel was something of a broken clock on that issue.
He applied his conclusions, reached decades earlier, to the matters at hand.
To summarize some of the arguments presented in earlier pieces:
1) The term "deflation" is unfortunately applied
to a variety of very different situations. One is a situation where the value
of the currency rises; for example, its value compared to gold or other
currencies. Another is a variety of situations which might produce falling
nominal prices, but where the value of the currency actually does not change.
2) If a currency value is linked to gold, then the only way to get a rise in
the value of a currency is for the value of gold itself to rise.
Now, I should probably stop here and make some remarks about what I mean by
"a rise in value." This is NOT A RISE IN "PURCHASING
POWER". "Purchasing power" is basically the inverse of nominal
prices. Rather, it is a change in the market value of the currency, as
expressed in the foreign exchange market for example. If a currency was
$20.67/oz. of gold at one point, and then $35/oz. gold a little later, then
the value of the currency has obviously declined vs. gold.
Unfortunately, we really don't have a definitive measure of the value of
gold. There is nothing that anyone has found, that is a better measure of
this "absolute value" than gold itself. We would expect that, if
the value of gold declined substantially, that it would naturally take more
and more gold to buy other things; "rising prices" in terms of
gold. However, the real market values of other things can also rise for their
own reasons, even when measured in a standard of value of perfect stability.
Now, let's postulate that the value of gold rose suddenly, perhaps beginning
around 1929 and going into 1933 or so.
First, this is a sudden rise. It is a period of only about four years,
perhaps less. That is very different than a rise that might take place over
twenty or fifty years.
Second, the magnitude of the rise must be very large, to cause, by itself,
anything like the effects witnessed during those years. How much of a rise in
the value of the dollar today, vs. the euro perhaps, would it take for U.S.
nominal GDP to decline by 43%, and Industrial Production by 54%, in the
absence of any other factors? I would say that it would take at least a rise
of 100% -- for example, a rise from $1.20 per euro to $0.60 per euro,
assuming no great change in the value of the euro. We actually have seen
rises of that magnitude, such as the rise of the Japanese yen from 260/dollar
to 120/dollar in 1985-1987. This was less than three years. It was certainly
problematic -- but it definitely did not cause anything resembling the
1929-1933 period of the Great Depression. So, maybe even a 100% rise would
not really do it. Maybe we are talking about a 200% rise here.
 
Just to give a comparison for
the magnitude of the economic collapse of the 1929-1933 period, here's
nominal Gross National Income (similar to GDP) for Japan for 1985-2015. This
is after the 100%+ rise in the yen vs. the dollar after 1985 (the yen later
went to 80/dollar), plus a great many other factors including a long period
of recession beginning in 1990, demographic issues, and all the rest (tax
hikes, among other things) that have contributed to Japan's 25+ years of poor
economic performance.
As we can see, there is nothing comparable to the 40%+ decline in nominal GDP
that the U.S. experiened -- even with the gigantic rise in the yen's value.
So, if we are going to blame a rise in the value of gold for the downturn of
1929-1933, we are talking about a very big rise indeed, to produce the kinds
of effects witnessed.
This is a longer-term look at the yen, showing the rise to 80/dollar and even
beyond.
This is a chart of the yen vs. gold, showing a rough tripling of the yen's
value vs. gold between about 1984 and 2000.
Now, to give an idea of what was going on in terms of prices, here is a
Producer Price Index for 1913-1940. It is close to a commodity price index,
although a little more broad.
We can see a big rise related to World War I, and then a decline soon after
the end of the war. Besides the supply/demand issues of wartime, there was an
issue with a weak dollar that was corrected in 1920-1922, which doubtless
contributed both to the rise and decline of nominal commodity prices around
WWI. We talked about that here:
August
25, 2012: The U.S. Dollar During WWI and the Recession of 1920
Then, we have a nice flat plateau during the 1920s, at a relatively high
level -- prices were generally much higher than they were in 1913. There's a
decline of roughly 38% beginning in late 1929 (and not before), although this
brings prices actually to just a little below where they were in 1913.
Beginning in 1933, there is a rise in prices, which is closely related to the
devaluation of the dollar from $20.67/oz. to $35/oz. during that year.
When you look at measures of commodity prices such as this, I have to remind
you again that you must not make the assumption that the value of gold is the
inverse of commodity prices. Our desire to have some definitive measure of
gold's value is so great, that it is all to easy to press one or another
thing into that role, for which it is not at all suited. For example, we
might postulate that the higher commodity prices of the 1920s reflected a
lower real market value of gold, and no real change in commodity value. Or, it
might just mean higher prices, as measured in a unit of account (gold) with
no real change in value. Or, it might even be a combination of the two.
As David Ricardo explained in 1817:
It has been my endeavor carefully to distinguish between a
low value of money and a high value of corn, or any other commodity with
which money may be compared. These have been generally considered as meaning
the same thing; but it is evident that when corn rises from five to ten
shillings a bushel, it may be owing either to a fall in the value of money or
to a rise in the value of corn. . . .
The effects resulting from a high price of corn when producedby the rise in
the value of corn, and when caused by a fall in the value of money, are
totally different.
Here's Ludwig von Mises on the same topic:
It is a popular fallacy to believe that perfect money
should be neutral and endowed with unchanging purchasing power, and that the
goal of monetary policy should be to realize this perfect money. It is easy
to understand this idea as a reaction against the still more popular
postulates of the inflationists. But it is an excessive reaction, it is
itself confused and contradictory, and it has worked havoc because it was
strengthened by an inveterate error inherent in the thought of many
philosophers and economists. . . .
Changes in the purchasing power of money, i.e., in the exchange ratio between
money and the vendible goods and commodities, can originate either from the
side of money or from the side of the vendible goods and commodities. The
change in the data which provokes them can occur either in the demand for and
supply of money or in the demand for and supply of the other goods and
services.
(Both of these quotes are from Gold: the Once and Future
Money.)
Why might commodity prices (real commodity values as represented by a stable
measure of value) be higher in the 1920s than in 1913? For one thing, a lot
of commodity production was destroyed in WWI. Less supply. Second, there
might have been a lot of demand for commodities, both due to postwar
rebuilding, and also due to the generally booming economies of "the
Roaring Twenties," especially in the United States.
This is a topic that I would like to treat in much more detail sometime. For
now, I've made only some early investigations. It appears to me that the
decline of commodity prices into the 1890s, and the rise into the 1920s, was
in both instances closely related to the supply of commodities. There was a
vast expansion in commodity supply worldwide in the 1870-1890 period. For the
first time ever, railroad expansion and steamships allowed vast swathes of
land to be planted for agricultural commodities to be shipped and sold
elsewhere. Before the era of rail and steam, most agricultural commodities
were consumed within the local area, unless they had close access to rivers
or canals. The result of the railroad expansion was a gigantic increase --
more than a doubling -- of land under cultivation in the U.S. after 1870.
Much the same thing was happening in vast areas elsewhere, notably South
America including Argentina and Brazil; all of southern Africa; some of Asia;
and Canada, Australia and New Zealand. A flood of agricultural commodities
hit the world markets, driving down prices.
I looked into it here.
February 26, 2012: The 1890s
This is a chart of production of the twelve largest crops in the U.S. In this
time, the yield per acre was basically stable; so the chart of land under
cultivation looks much the same.
We can see the gigantic rise in production after 1870, an increase of about
three times to 1905. Then, after 1905, production is basically flat until
after 1940. From this alone, it should be no surprise that when the growth
rate of production was the highest (1870-1890), prices were falling, and flat
production after 1910 led to higher prices in the 1920s.
Despite the difficulty of coming to definitive conclusions, I think it is
pretty clear that the evidence does not suggest that there was any meaningful
rise in gold's value, between 1913 and 1928. A rise in gold's value would
suggest lower nominal commodity prices, and probably a moribund economy. What
we have is higher nominal commodity prices, and a booming economy. The exact
opposite.
So, if there was any factor potentially causing a rise in gold's value, we
can see that it was definitely not effective before 1929. (The drop in
commodity prices after 1919 can be completely explained by the end of
hostilities, and also the monetary adjustments of 1919-1922.) So, if there
was something that caused a gigantic rise in gold's value -- a rise of
perhaps 100%, 200% or even more -- it seems reasonable to expect that it must
have appeared around the end of 1929, and was not extant earlier.
I haven't really even warmed up on this topic, but already I think we will
have to resume it next week.
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