The Gold Standard and The Great Depression
There are multiple economic
theories of why the Great Depression occurred. This blog will explain one
theory describing how the international gold standard set the stage for the
Great Depression. The gold standard heightened the vulnerability of the
international financial system. It was the mechanism that transmitted the
destabilizing signal from America to the rest of the world. The gold standard
was the binding constraint preventing policymakers from containing the spread
of financial panic and averting the failure of banks. It was the principal
obstacle preventing offsetting actions. Exploring these reasons allows one to
understand how the gold standard was the central factor for the Great
Depression.[1]
For over a quarter of a century
prior to the Great War, the gold standard stipulated the basis for domestic and
international monetary relations. Global currencies were convertible into gold
on demand. This was linked universally at fixed rates of exchange. The balance-of-payments
settlement was an ultimate means of gold shipments. The gold standard was a remarkably
effective structure for organizing financial affairs. As early as 1929, the
international monetary system started to crumble. Rapid deflation spread
throughout the world. Nations that produced primary commodities were forced to
suspend gold convertibility and depreciate their currencies. Payment problems
then spread to the industrialized world. By the mid-1930s most of the
industrialized world had abandoned the gold standard. The collapse of the
international monetary system caused the financial crisis that altered a modest
economic downturn into an unmatched slump.[2]
It did not take long for
economists to realize the tie between the gold standard and the great
depression. In 1935 Professor Genung described how the gold standard was the
cause for the current depression. Genung highlights how the international gold
standard changed after the Great War. After the war, countries tried to return
to the gold standard that many had abandoned. This caused the price of gold to
increase based on the simple economic ideology of supply and demand. With the
rise in gold price, not all countries could achieve the gold standard. Countries
adjusted their currency due to shifts in the economic world. Ergo, their
currency was not transferable to gold. Genung explains the direct correlation between
gold and commodities. The ratio of the world’s monetary gold stock impacts the
price output of commodities. If a country’s currency is not based on gold, then
it directly impacts the cost of their import and exports.[3]
The gold standard was
viewed throughout the late nineteenth and early twentieth century as the
essential source of prosperity. However, when the Great War broke out in Europe
countries suspended the gold standard to support war efforts. Suspension of the
gold standard during wartime was not unusual. This allowed a country to adjust
funds for national security. Typically, during postwar periods countries can
return to the gold standard close to the prewar price level. However, there were
chaotic monetary and financial conditions that followed the Great War. There
was a strong desire for nations to return to the gold standard after the war. However,
there was a large concern that there was not enough gold available to cover the
world money demands without deflation. Leaders gathered at the Economic and
Monetary Conference at Genoa in 1922 to address these concerns. The recommendation
from the conference was convertible foreign exchange reserves as well as gold
would be used to back national money supplies. This allowed most developed
nations to return to the gold standard. However, some countries overinflated
their currency. The prewar gold standard functioned smoothly for over 3
decades. However, the interwar gold standard substantially broke down and disappeared
by 1936.[4]
The gold standard was the
internal economic factor that triggered the Great Depression. A leading European
economist, Professor Woytinsky, highlighted the impact of the Great Depression from
his perspective in 1937. Woytinksy explains that the world suffered greater
loss during 1930-1934 than during the Great War. the economic losses to
countries ranged between 149 and 179 billion dollars based on the currency
value of the dollar at the time. Prior to the Great Depression the United States
was the richest country. America had a higher monetary value than all of Europe
put together. However, with the failure of the gold standard, America suffered
terrible losses. There was a large amount of unemployment and poverty,
difficulties with farming, disorganization of public finance, decline in volume
of international exchange, and various political and social disturbances. This compiled
the impact of the Great Depression on the economy. The government made no
intelligent effort to stop employers from cutting down employment or machines. This
caused the purchasing power of Americans to fall to the lowest levels imaginable.[5]
The gold standard heightened
the vulnerability of the international financial system. The gold standard was
the binding constraint preventing policymakers from containing the spread of
financial panic and averting the failure of banks. It was the principal
obstacle preventing offsetting actions. The gold standard was viewed throughout
the late nineteenth and early twentieth century as the essential source of
prosperity. However, when the Great War broke out in Europe countries suspended
the gold standard to support war efforts. There was a strong desire for nations
to return to the gold standard after the war. This caused the price of gold to
increase based on the simple economic ideology of supply and demand. With the
rise in gold price, not all countries could achieve the gold standard. Countries
adjusted their currency due to shifts in the economic world. The government
failed to react in a timely manner. Payment problems spread to the
industrialized world. By the mid-1930s most of the industrialized world had abandoned
the gold standard. The collapse of the international monetary system caused the
financial crisis that altered a modest economic downturn into an unmatched slump.[6]
[1] Barry
Eichengreen. Golden Fetters: The Gold Standard and the Great
Depression, 1919-1939. (New York: Oxford University Press, 1992). 1-15
[3] A.
B. Genung. "What About the Tariff?" The Newburgh News, (September
27, 1935). 5.
[4] Ben
Bernanke and Harold James. "The Gold Standard, Deflation, and Financial
Crisis in the Great Depression: An International Comparison." Financial
Markets and Financial Crisis, (1990, 33-68. doi:10.3386/w3488). 33-60
[5] The
Spartanburg Herald. "The High Cost of Depression." The
Spartanburg Herald, February 16, 1937, 4.
[6] Barry
Eichengreen. Golden Fetters. 385-400
Bibliography
Eichengreen, Barry. Golden Fetters: The Gold
Standard and the Great Depression, 1919-1939. New York: Oxford University
Press, 1992.
Genung, A. B. "What About the
Tariff?" The Newburgh News, September 27, 1935, 5.
The Spartanburg Herald. "The High Cost of
Depression." The Spartanburg Herald, February 16, 1937, 4.
U.S. Mint. "Gold Bricks." U.S. Mint. 2020.
West Point Mint. "Gold Bricks Stacked on Wall." West Point Mint. n.d.
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