Eichengreen, Golden Fetters: The Gold Standard & the Great Depression, Federal Reserve, monetary policy

Theory confirmation bias:

A combined Keynesian - discretionary monetarism view of the Great Depression is provided by Barry Eichengreen in "Golden Fetters: The Gold Standard and the Great Depression, 1919-1939." Unsurprisingly, the book includes the combined weaknesses of those views.
?

Although they can be made more flexible than the rigid interwar gold standard, these rules-based fiat money systems similarly impose discipline that political leaders hate but badly need.

This book is highly regarded in certain Keynesian circles since it would reinforce their view of gold as the "barbaric metal." Keynesians hate fixed exchange rates of any kind since Keynesian policies always undermine currency pegs and cause monetary crises. They hate gold in particular, since gold is perhaps the most sensitive indicator of the failure of Keynesian and discretionary monetarism policies. Ironically, it was gold - and only gold - that made possible the only example of durable success for Keynesian policies. In the 1960s, the ability to export gold to support the dollar delayed the collapse of those policies until 1968.
?
Eichengreen's complaints about the gold standard would also apply to other forms of fixed exchange rates and the rules-based monetarism advocated by Friedman, Meltzer and Taylor. See, three articles beginning with Friedman & Schwartz, Monetary History of U.S. (I), "Greenbacks, & Gold;" eight articles beginning with Meltzer, History of Federal Reserve, v. 1,. Part I: "The Search for Monetary Stability (1913-1923);" and Taylor, "Getting off Track," Although they can be made more flexible than the rigid interwar gold standard, these rules-based fiat money systems similarly impose discipline that political leaders hate but badly need.
?
Profligate European governments have in recent years chaffed at the rules-based monetary policy of the European Central Bank. Keynesians ardently support their efforts to loot the bank's credit. The ECB has already more than tripled its balance sheet in the last few years, but that is clearly not enough to achieve Keynesian objectives. The ECB continues to give way to the political pressure, but no amount of monetary expansion will ever be enough as long as political spending proclivities remain essentially unconstrained.
?

Eichengreen accepts the Keynesian befuddlement as to the fundamental causes of the Great Depression economic contraction in the U.S. This permits him, like Keynes himself, to ignore the fundamental causes and look instead further along the infinite chain of economic cause and effect to focus on the intermediate factors that he finds convenient to deal with. See, Keynes, The General Theory, Part I, and Keynes, The General Theory, Part II covering Keynesian theory and policy.
?
The fundamental causes included WW-I, the war debts and reparations obligations, and the protectionist trade war that blocked the adjustment of trade flows. Trade flow adjustments could have minimized the burden on gold flows and facilitated debtor austerity efforts.
?
NOTE that all of these fundamental causes, as well as Federal Reserve monetary policies, were policies of governments, not weaknesses inherent in capitalist markets. Other notable monetarist works focus on monetary policy but mention these fundamental causes at most only briefly and in passing. To his credit, Eichengreen treats these causes seriously, but fails to acknowledge that they are the fundamental causes of the Great Depression.
?

Gold and the modern business cycle:

Eichengreen provides a fine analysis of the gold standard, the reasons for its success before WW-I and the reasons for its failure after WW-I. In fact, gold-based monetary systems had provided a monetary basis for non-inflationary economic growth, prosperity and strength for more than a century in the U.S. and more than three often tumultuous centuries in Great Britain.
?

He does join rules-based monetarists like Milton Friedman in acknowledging that substantial swings in grain harvests and international grain markets had demonstrated by themselves a capacity to substantially impact the U.S. business cycle.

The destruction of about 30% of the wheat market by the trade war in the first two years of the Great Depression reduced the value of the wheat crop not by 30% but by about 75%.

The automotive industry suddenly lost 10% of its market in the spring of 1929 when its exports were cut almost in half. The suddenness of this event resulted in a massive inventory buildup that the industry struggled with until February, 1930, ultimately dragging down the steel industry and much else with it.

The interwar gold standard had indeed been transformed after WW-I into a transmission mechanism for Great Depression economic contraction as Eichengreen explains. It was no longer the rules-based system involving central bank cooperation that generated broad public confidence in its success. Without the rules of the prewar system, it was fragile and unable to adjust to changing financial conditions. According to Eichengreen, it had become "the principal threat to financial stability and economic prosperity."
?
Like most Keynesians and monetarists, however, Eichengreen neglects to apply his Economics 101 supply and demand curve for the agricultural cash crops like wheat, corn and cotton, industrial commodities like copper and monetary silver, and the automotive industry, all of which were dependent on exports for a substantial portion of their markets prior to the Great Depression. He can thus join other liberal advocacy economists like John K. Galbraith in casually asserting that foreign trade was too minor a segment of total economic activity in the U.S. for protectionism to be a major factor in the Great Depression. At least he does mention the trade war several times but like the others he dismisses the broader impacts of the trade war in favor of his Keynesian and monetarist views.

"Exports were not a sufficiently large share of U.S. production for the deterioration of foreign market conditions to fully account for the weakening of the economy. But they were another nail in the coffin of American prosperity."

Oddly, he does join rules-based monetarists like Milton Friedman in acknowledging that substantial swings in grain harvests and international grain markets had demonstrated by themselves a capacity to substantially impact the U.S. business cycle. See, Friedman & Schwartz, Monetary History of U.S. Part I, Greenbacks and Gold (1867-1921), at segments on "The adjustment process of the gold standard" and "End of the Free Silver movement." How could wheat exports move the entire economy?
?
For example, the destruction of about 25% of the wheat market by the trade war in the first two years of the Great Depression reduced the value of the wheat crop not by 25% but by about 75%. Similar declines were experienced in the other great cash crops, corn and cotton. Agriculture was still the largest source of employment in those days. Similar declines occurred in silver and copper, and other commodities.
?
In those days, Detroit produced automotive products that the world wanted. The automotive industry suddenly lost 10% of its market in the spring of 1929 when its exports were cut almost in half. The suddenness of this event resulted in a massive inventory buildup that the industry struggled with until February, 1930, ultimately dragging down the steel industry and much else with it. While domestic sales remained above the good 1928 levels through the fourth quarter of 1929, production was running only about half the 1928 level at the end of 1929.
?
These losses undermined asset values and put the Keynesian "multiplier" in reverse. They provide a picture of economic collapse in the broad "flyover" section of the nation that Keynesians and monetarists apparently do not want to discuss. See, seven Great Depression Chronology articles beginning with Great Depression, The Crash of '29; and Great Depression Summaries and Facts; and, Blatt, "Understanding the Great Depression and the Modern Business Cycle" (Table of Contents and Introduction).
?
These international markets were not reopened until September, 1939, at the start of WW-II in Europe. Not just coincidentally, that was the moment when the private sector of the U.S. economy began to rapidly recover from the Great Depression. Prior periods of apparent recovery during the New Deal had all predominantly involved expansion of government economic activity.
?

Eichengreen fails to recognize the reopening of U.S. export markets with the onset of WW-II in Europe.

Many of the nations that broke away from the gold standard were also giving themselves in effect a discharge in bankruptcy by default on their WW-I financial obligations and other debt burdens. They were also breaking free of the destructive impacts of New Deal gold and silver purchase experiments.

In dealing with the end of the Great Depression in the U.S., Eichengreen fails to recognize the importance of the reopening of U.S. export markets with the onset of WW-II in Europe. Recovery was vigorous during the two years prior to Pearl Harbor. Unemployment dropped by almost 8 percentage points back into single digit territory prior to the great WW-II budget deficits. The surge in price inflation during 1941, while unemployment was still in double digits, is ignored by the author in typical Keynesian style.
?
The importance of breaking free of the "golden fetters" of the rigid interwar gold standard is the major theme of this book, and it is properly a point of emphasis. However, Eichengreen fails to also emphasize that many of the nations that broke away from the gold standard were also giving themselves in effect a discharge in bankruptcy by default on their WW-I financial obligations and other debt burdens. They were also breaking free of the destructive impacts of New Deal gold and silver purchase and other monetary policy experiments that played a major role in worldwide financial chaos and the breakdown of the gold standard.
?
New Deal trade war and monetary policies provide far more fundamental explanations for the duration and severity of the Great Depression than the weaknesses in the gold standard. See, Meltzer, History of Federal Reserve, Part III, "The Engine of Inflation (1933-1951)" at the "Destruction of the gold standard" segment. Moreover, trade policies differed from nation to nation in important ways. With the exception of Great Britain, which had the benefit of its vast empire, those nations that recovered fastest also happened to be those that were the least protectionist. See, "The Slide to Protectionism in the Great Depression: Who Succumbed and Why," NBER Working Paper No. 15142 (July 2009).
?

By comparing all subsequent economic history with the Great Depression and by ignoring the 1970s, Eichengreen can claim success for Keynesian policies in moderating the business cycle. Keynesians always take credit for avoiding another Great Depression, ignoring all the special circumstances and dysfunctional government policies without which the Great Depression was impossible.

The failure of Keynesian economics in the 1970s, with its widespread simultaneous disastrously high levels of price inflation, interest rates and unemployment and its vicious and volatile business cycle swings, is almost totally ignored by Eichengreen. Aside from mentioning the breakdown of the Bretton Woods arrangements in 1971, he has nothing to say about the 1970s. Keynesians would like everybody to simply forget about their gross failures during the 1970s. By comparing all subsequent economic history with the Great Depression and by ignoring the 1970s, Eichengreen can claim success for Keynesian policies in moderating the business cycle. Keynesians, even today, always credit their policies for avoiding another Great Depression, ignoring all the special circumstances and dysfunctional government policies without which the Great Depression was impossible.
?
Talk about setting the bar for success extraordinarily low! When Keynesians took charge during the Kennedy administration, they were far more ambitious, claiming the ability to stimulate economic expansion by half a percent or even a full percent above trend. Now, any result other than another Great Depression is claimed as another magnificent Keynesian success.
?

Keynesians are heroically unconcerned with the size of the debts they are bestowing on the economy.

As of the fall of 2012, unemployment remains stubbornly close to 8% despite the tripling of the Federal Reserve's balance sheet and maintenance of essentially zero basic interest rates and Keynesian "stimulatory" budget deficits in excess of a trillion dollars per year for four years. The Keynesians, as usual, are adroit at providing excuses for failure. They are heroically unconcerned with the size of the debts they are bestowing on the economy. Their eternal cry is: "It isn't enough." It never has been and it never will be!
?

As a result of WW-I political developments in many nations, a variety of economic interests had gained enough political power to block budget and central bank austerity policies needed to bring international trade and payments accounts back into balance.

Every economic contraction since WW-I has been caused in part - often in predominant part - by government policies sometimes of incredible stupidity mulishly continued amidst economic chaos.

The factors involved in the Great Depression are properly recognized by Eichengreen as problems of political economy rather than of just economics. See, Scott, "The Concept of Capitalism." These include the international factors from WW-I through the 1930s. For the U.S., export demand weakened first in the spring of 1929, ultimately reinforced by domestic decline. Eichengreen refutes the common assertion that the first stage of the Great Depression was just an ordinary economic contraction until the first banking crisis at the end of 1930. He points out that the 1929-1930 contraction was "at a rate twice as fast" as typical U.S. recessions.
?
Protectionism was a mere contributing factor in the initiation of the Great Depression, according to the author. "Protectionism in the United States and other industrial countries intensified the primary producers' balance-of-payments problems." However, it was efforts to stay on the gold standard that forced substantial austerity policies on foreign nations. There were "mutually reinforcing threats" within banking systems and the gold exchange standard. As a result of WW-I political developments in many nations, a variety of economic interests had gained enough political power to block budget and central bank austerity policies needed to bring international trade and payments accounts back into balance.
?
The political factors thus must be analyzed with the economic factors, Eichengreen wisely counsels. He recognizes that floating exchange rates have not freed monetary policy from the host of explicit and implicit conflicting interests that today constrains the Fed and other central banks.

Fed objectives continue to proliferate and to increasingly impose conflicting requirements on monetary policy. Among the multiple conflicting explicit and implicit Federal Reserve objectives are:

Maintain the purchasing power of the dollar;

Maintain low unemployment;

Fulfill financial industry regulatory oversight duties;

Manage the floating dollar exchange rate;

Maintain financial stability;

Maintain low interest rates;

Act as lender of last resort - now to the entire economy;

Guarantee the credit of too-big-to-fail corporations;

Support Treasury bond issues;

Boost the economy during election years;

Allocate credit into the housing market;

Act as scapegoat to shield political leaders when things go wrong.

In fact, the U.S. has not had a free market business cycle since WW-I. Every economic contraction since then has been caused in part - often in predominant part - by government policies sometimes of incredible stupidity mulishly continued amidst economic chaos. This is especially true of the Great Depression of the 1930s, the Great Inflation of the 1970s, and the recent Credit Crunch boom and bust recession and its anemic recovery phase. See, Lies, Damn Lies and Projections, at "The free market business cycle," and Understanding the Credit Crunch,

The gold standard:

The gold standard guided international monetary policy with remarkable success between about 1880 and WW-I.

"Currencies were convertible into gold on demand and linked internationally at fixed rates of exchange. Gold shipments were the ultimate means of balance of payments settlement."

Central banks and gold standard governments stood ready to support each other with loans and gold transfers when needed, and made monetary policy adjustments as indicated by gold flows.

Confidence that central banks would play by the rules greatly reinforced monetary policy efforts.

It was central bank cooperation, not Bank of England leadership, that was the essential factor.

Cooperation among gold standard nations and the credibility of central bank monetary policy are correctly emphasized by Eichengreen as primary factors in the success of the pre-WW-I gold standard. Central banks and gold standard governments stood ready to support each other with loans and gold transfers when needed, and made monetary policy adjustments as indicated by gold flows. Central banks retained considerable monetary policy discretion, but gold standard monetary policy was a rules-based system. Although the gold standard was under increasing attack in the U.S., the U.S. was still only of peripheral importance to the European powers.
?
Credibility and confidence played key roles in the system. Confidence that central banks would play by the rules greatly reinforced monetary policy efforts.

"In the countries at the center of the system--Britain, France and Germany--the credibility of the official commitment to the gold standard was beyond reproof. Hence market participants relieved central bankers of much of the burden of management. If sterling weakened, funds would flow toward Britain in anticipation of capital gains that would arise once the Bank of England intervened to strengthen the rate. Because the central bank's commitment to the existing parity was beyond question, capital flows responded quickly and in considerable volume. Sterling strengthened of its own accord, usually without any need for government intervention. Speculation had the same stabilizing influence in France, Germany, and other European countries at the center of the gold standard system."

The major European central banks frequently followed the lead of the Bank of England. They worked in harmony to make adjustments to their interest rates in response to international payments developments and gold flows that reflected shifts in economic and financial conditions. There were few political pressures that might get in the way. If one nation was in crisis, it could borrow from other central banks, thus reducing the need for gold reserves for any particular central bank. In 1890 and 1907, it was the Bank of England that had to draw financial support from other central banks. Thus, it was central bank cooperation, not Bank of England leadership, that was the essential factor.
?
By 1890, Eichengreen asserts that Britain was the only major free trade nation. Of course, the British Empire and its commonwealth nations were themselves a vast trading block, but trade rigidity still increased stress on the international system. As financial systems matured, the balance of payments became more important than the balance of trade in governing gold flows. The rise and fall of interest rates - which could be influenced by central bank discount rates - became a determinative factor in these payments flows.
?

Discount rate adjustments could deal with temporary imbalances, but permanent payments imbalances required fundamental economic adjustments sufficient to improve trade balance.

Labor interests lacked the political power to interfere with the labor market flexibility that facilitated this system.

Trade adjustments played a major role in payments adjustments, Eichengreen points out. Discount rate adjustments could deal with temporary imbalances, but permanent payments imbalances required fundamental economic adjustments sufficient to improve trade balance.

"Hence a rise in Bank rate could eliminate the imbalance created by a permanent disturbance only by altering domestic economic conditions."

An interest rate increase sufficient to slow domestic economic activity would increase unemployment, reduce domestic consumption and eliminate the "excess demand for traded goods." The result would be price deflation that "enhanced the competitiveness of domestic goods and restored balance to the external accounts." Labor, along with the rest of the economy, had to absorb a business cycle period of economic contraction. Labor interests lacked the political power to interfere with the labor market flexibility that facilitated this system.
?
Central banks did "sterilize" gold inflows by maintaining above-market interest rates to accumulate gold reserves from the resulting capital inflows. The extent, however, was far less than practiced especially by the U.S. and France after WW-I. Moreover, in England, by the end of the 19th century, financial markets had expanded sufficiently to limit the ability of even the Bank of England to push interest rates around.

"Discount rate increases might further erode the Bank's market share, at the expense of income for its stockholders. To the extent that the Bank relied on discount market operations for income, it might be forced to alter Bank rate in response to movements in market rates rather than the other way around. Knowing this, market participants speculated that movements in Bank rate away from market rates would have to be reversed, minimizing the impact of such movements on the market."

The Bank of England still retained significant monetary policy capability. Other central banks had far less monetary policy capabilities and required heavier reliance on gold and silver market activities. Nevertheless, the years just prior to WW-I were years of financial stability, the author explains, adequately managed predominantly with discount rate adjustments and central bank cooperation in dealing with any crises. Other adjustment mechanisms involved the waxing and waning of credit utilization in financial systems, and capital flows that increasingly included potentially volatile short term capital flows.
?
British commonwealth nations were the principle recipients of international loans and investments. Conditions within the "Anglosphere" were far more stable than within French and German spheres of influence and elsewhere. However, political stability outside Europe before WW-I limited the risks of capital flight and facilitated long term lending. Defaults were predominantly in the nature of suspensions of debt service rather than outright repudiation. After WW-I, instability in Latin America became a persistent problem.
?

Britain was the center of world finance. The pound was the primary currency for international reserves and commerce, and London was the world's financial center. Negative payments imbalances for the pound were often mitigated when payments surplus nations increased the balances left in London banks or used their funds to purchase British securities. The elasticity of British bank money also mitigated payments imbalances, but elasticity would decline at the top of the business cycle as bank reserves became fully committed to loans. Bank of England interest rate and monetary policy tools were generally effective in mitigating payments fluctuations. In the U.S. banking system, money was notoriously inelastic, so gold flows were notoriously substantial and consequential.
?
An understanding of the gold standard adjustment mechanism as it existed by 1890 requires inclusion of a complex of other factors..

"[It included] the combination current- and capital-account adjustments that accommodated balance-of-payments shocks, and in particular - - - the capital flows that were the new and distinctive feature of the late nineteenth-century gold standard. Those capital flows depended on the credibility and cooperation that, by the 1890s, had come to provide the foundation of the international system."

"Rather than being provided by the Bank of England, the lender-of-last resort function was provided collectively."

The Bank of England had to deal with periodic financial crises. The Bank's gold reserve was only about 3% of the money supply and sometimes as little as 2%. Foreign nations had to hold far more gold to maintain public confidence in their money. The Bank of England could rely on foreign central banks to assist in meeting crisis conditions.
?
Eichengreen describes the 1890 Baring Brothers crisis precipitated by revolution in Argentina and the collapse of Argentine bonds. Gold borrowed from Russia and France provided the resources to support the banking system, reorganize Baring Brothers, and restore financial confidence to end the panic. Similarly, Bank of France and Reichsbank support was instrumental in dealing with the 1906-1907 financial crisis precipitated by financial events in the United States. Eichengreen provides interesting details. "Rather than being provided by the Bank of England, the lender-of-last resort function was provided collectively."
?
France was the major repository of monetary gold. Its financial system was less sophisticated and more heavily reliant on gold and silver but was also less vulnerable to panic situations. The Reichsbank was in an intermediate position between the status of the French and British financial systems. It was correspondingly more heavily impacted by the 1907 crisis than was France.
?
By 1913, the United States had supplanted France as the major repository of monetary gold, with almost 25% of the world total. Monetary fluctuations in the U.S. were already disturbing the world gold standard system.
?

For many small nations - especially in Latin America - capital flows under the gold standard were pro-cyclical. They reinforced political pressures for devaluation and inflation on profligate heavily indebted nations. Eichengreen provides details for Argentina and Brazil. Instances of suspension of convertibility were forced and disastrous, leading to repeated if frequently short-lived efforts to restore gold standard fixed exchange rates.
?
British Commonwealth nations were far more successful, demonstrating from 1880 to 1914 that small nations with good governance could prosper under the gold standard.

"Political factors surely contributed to this singular success. Political stability and the prominence in government of British civil servants or expatriates, whether associated with formal colonial status or not, reassured British investors contemplating the purchase of overseas securities. Capital flowed more freely than to Latin America and was not interrupted by financial crises associated with political revolution. Social homogeneity suppressed the distributional conflicts associated with exchange rate policy in Latin America. In India, which underwent silver inflation until 1898, this was less the case. Even so, political stability in conjunction with a British budgetary orthodoxy that led the administration to faithfully run balanced budgets facilitated the maintenance of stable parities."

As in the U.S., there generally were no central banks in Commonwealth nations, but the systems were centralized with extensive branch networks and thus less subject to bank runs than in the highly fragmented U.S. system. Eichengreen explains some of the variations in monetary adjustment processes and their pro-cyclical or counter-cyclical impacts. Unlike in the U.S., Commonwealth banking practices kept gold flows to a minimum.
?

The gold standard did not prevent the business cycle. It worked through the business cycle and was in fact dependent on the business cycle as part of its adjustment process. When working smoothly, however, business cycle contractions could be kept short and shallow.

The rise and fall of the business cycle was naturally a primary and disturbing feature of the gold standard adjustment process in all gold standard nations. The gold standard did not prevent the business cycle. It worked through the business cycle and was in fact dependent on the business cycle as part of its adjustment process. When working smoothly, however, business cycle contractions could be kept short and shallow.
?
The Bank of England provided the lead in discount rate policy and the major central banks cooperated to provide gold reserves as needed to meet crisis conditions. Confidence in the system caused market speculators to bet in favor of success, thus reinforcing monetary policy. However, the approach of WW-I, Britain's declining status in international commerce and the rising influence of an uncooperative United States was straining and perhaps fatally undermining this system.
?

Financing the Great War:

As WW-I undermined the gold standard, the major Allied nations initiated a dollar exchange standard in its place, financed by a major loan from U.S. investors. Significant volatility in floating exchange rates was highly disruptive and was rapidly brought under control, stabilizing exchange rates for the rest of the war. Sale of wartime bonds was facilitated in the U.S. and Britain by public confidence that monetary stability at or close to prewar purchasing power and gold exchange rates would be restored after the war as it had after all previous British and U.S. conflicts.
?

All of the major European belligerents expected to impose reparations on their defeated adversaries to finance their war efforts. The reparations imposed on Germany were much heavier than the reparations readily paid by France after the Franco-Prussian War, but ultimately in line with what Germany expected to demand if it defeated the Allies. Postwar gold convertibility was persistently threatened by the need to finance war debts and reparations.

Germany imposed significant reparations obligations on Russia when Russia surrendered, but German defeat ended that. France did not face a trade war constrained international market after the Franco-Prussian war and so was able to meet her reparations obligations. Loans to Germany would exceed reparations payments during the 1920s, but capital flight from Germany driven by her reparations weakness was massive. The interwar trade war crippled the new small nations of Central Europe. Open markets permit them to prosper today.

All belligerents were slow to raise taxes, underestimated costs and duration, ultimately resorted to fiat currency and massive increases in debt, and suffered price inflation.

Nothing has changed! With the exception of the Korean war, this has remained the way the U.S. finances war.

Interwar economic turbulence:

WW-I shattered the gold standard system along with so much else. After WW-I, the gold standard as reestablished was not the pre-war rules-based standard. The U.S. Federal Reserve in particular preferred discretionary flexibility to rules-based discipline. Cooperation and credibility were both lacking.
?

By refusing cooperation, payments surplus nations imposed all the adjustment burdens on payments deficit nations.

The U.S. and France "sterilized" payments inflows instead of allowing them to have the impact on domestic money supply, prices and consumption that would have boosted the competitiveness of the deficit nations.

It is not enough to speculate about the financial feasibility of the gold standard. Analysis must include the rules essential to make the system work and whether those rules are a practical possibility. By refusing cooperation, payments surplus nations imposed all the adjustment burdens on payments deficit nations. Surplus nations like the U.S. and France "sterilized" payments inflows instead of allowing them to have the impact on domestic money supply, prices and consumption that would have boosted the competitiveness of the deficit nations. The author summarizes his main point:

"[Gold] and financial capital were drained by the United States and France from other parts of the world. Superimposed on already weak foreign balances of payments, these events provoked a greatly magnified monetary contraction abroad. In addition they caused a tightening of fiscal policies in parts of Europe and much of Latin America. This shift in policy worldwide, and not merely the relatively modest shift in the United States, provided the contractionary impulse that set the stage for the 1929 downturn. The minor shift in American policy had such dramatic effects because of the foreign reaction it provoked through its interaction with existing imbalances in the pattern of international settlements and with the gold standard constraints."

Instead of facilitating the exports of its debtors, Congress actually significantly increased its trade barriers, and then reacted with righteous indignation when other nations retaliated against U.S. exports. Congress insisted on the repayment of dollar debts while making it impossible for its debtors to earn the wherewithal to service their debts.
?
Today, the U.S. is the debtor nation and complains bitterly when its primary creditor, China, sterilizes dollar inflows.

Instead of capital inflows in anticipation of effective central bank action, capital tended to quickly flee nations experiencing monetary difficulties.

It was a different world after WW-I in every sphere - military, political, economic, geographic and societal. The rules of the gold standard were abandoned during the war and never restored.
?
Popular support for the war had been maintained by substantial expansions of the franchise. This heralded the rise of labor parties. Proportional representation assured old elites they would not be totally displaced politically, but this generally resulted in divided governments and coalition politics that could be weak and unstable when political differences became intense - as was usually the case in Europe during the 1920s. Nonbelligerent nations, including most of the Scandinavian states, faced less serious financial and distributional issues than the belligerents and so were not as unstable.
?
Wage levels and unemployment became grist for the political mill and quickly undermined the independence of central banks, their ability to cooperate with each other, and the credibility of their commitment to monetary stability. Inflationist pressures increased ominously. Instead of capital inflows in anticipation of effective central bank action, capital tended to quickly flee nations experiencing monetary difficulties. Political battles also intensified over taxation and budget issues.

However, far more important was the rise of a determinedly uncooperative United States as the primary creditor nation and holder of monetary gold.

By the end of the war, the U.S. had displaced Britain as the world's financial and commercial hub. The war altered trade patterns. There was widespread overcapacity as belligerents shifted back to peacetime production. Agricultural overcapacity was especially serious, especially for the United States which had tripled wheat exports and increased meat exports ten-fold during the war. After the war, the sharply declining prices during the 1920-1921 recession forced needed agricultural contraction that was often blamed on the gold standard.

Recovery from the 1920-1921 recession was especially rapid, assisted by agricultural exports, something that was no longer possible thereafter. Eichengreen credits the monetary flexibility abroad that existed before reestablishment of the gold standard, but this recovery was also before the 1922 Fordney-McCumber tariff initiated the trade war.
?
By 1923, the decline in agricultural prices and farm income had ended and rapid recovery had begun. Farm income remained well above pre-war levels until 1930, something left wing economists never mention. With vicious efficiency, the markets had successfully completed a massive rebalancing that no government could have matched. Mechanization and new crop technology was a threat to small farmers throughout the 1920s, but the market itself was healthy and kept expanding until the record wheat crops of 1928.

Successful restoration of the gold standard depended on whether the U.S. would step up to its new responsibilities for international financial leadership.

The vast financial and economic impacts of the Great War would have created imposing obstacles to restoration of the gold standard in any event. Successful restoration of the gold standard depended on whether the U.S. would step up to its new responsibilities for international financial leadership.

"More than ever, credibility hinged on international collaboration among governments and central banks--the harmonization of monetary policies in normal periods, the pooling of reserves in times of crisis. During the war, the British, French and U.S. governments had engaged in extensive and regular international financial cooperation. Germany had not been party to these consultations, of course. Now the web of reparations and war debts, by souring international relations, posed a threat to further collaboration. The change in the distribution of financial resources also implied a greatly expanded role for the United States in these arrangements. The restoration and smooth operation of the gold standard system required that policymakers acknowledge the change in circumstances and adapt accordingly."

Unfortunately, the United State was a heedless young financial giant. It remained heedlessly determined not to be constrained by any international responsibilities. With incredible stupidity, the U.S. thought it could prosper even while the rest of the world suffered. To its great credit, these mistakes and the mistakes of the Treaty of Versailles were not repeated after WW-II when the U.S. accepted its leadership responsibilities.

Stabilization didn't succeed in the U.S. and Britain after WW-I until after fiscal budgets moved back into surplus. Stabilization was more difficult in nations that could not bring their budgets closer to balance.

The Federal Reserve's new dominant international influence and lack of regard for the international implications of its actions proved a destabilizing influence in Europe. Stabilization didn't succeed in the U.S. and Britain after WW-I until after fiscal budgets moved back into surplus. Stabilization was more difficult in nations that could not bring their budgets closer to balance.
?
The economic and financial turmoil naturally experienced in the immediate wake of the Great War is extensively covered by Eichengreen. He correctly credits floating exchange rates for cushioning the European nations from the sharp 1920-1921 U.S. recession. However, he neglects to mention that U.S. markets were still open to their exports. From the beginning of 1921, currency weakness sent a flood of capital and gold into the safe haven of the U.S. and its gold-pegged dollar, undermining economic prospects in soft currency nations.
?

Budget deficits and exchange rate decline contributed to hyperinflation in Germany, and balanced budgets and exchange rate stabilization helped end it.

A vast increase in U.S. loans abroad supported stabilization efforts in Europe.

In both Belgium and France, the illusion that reparations would cover their deficits was used by politicians to justify their deficits until the inflationary pain could no longer be tolerated.

Commitment to austerity and fiscal prudence quickly restored financial confidence and was supported by substantial inflows of private capital that facilitated stabilization and economic recovery.

Labor and socialist interests in various nations demanded more from governments than governments could prudently provide. The result was the accumulation of substantial budget deficits and periods of sometimes disastrous rates of price inflation. Budget deficits and exchange rate decline contributed to hyperinflation in Germany, and balanced budgets and exchange rate stabilization helped end it. Eichengreen provides considerable detail of the domestic and international political conflicts involved. The 1924 Dawes Plan 800 million gold marks loan and a vast increase in other U.S. loans abroad supported stabilization efforts in Europe.
?
Such stability, however, could never be far from crisis. War debts and reparations obligations undermined all efforts at normal international monetary cooperation. "But even if other disputes had been resolved, disagreements about the nature of the gold standard system and the role for collective management would have continued to frustrate efforts to construct such a mechanism." For the nations that had experienced severe bouts of price inflation, the pain inflicted created a counterforce favoring monetary and price stability that politically constrained monetary policy options. It deterred resort to floating exchange rates when they became necessary after 1929.
?
As with Germany, a debilitating Belgian price inflation finally forced a government reorganization and resort to severe austerity measures to regain monetary stability. France followed a similar course, but with some differing characteristics. In both Belgium and France, the illusion that reparations would cover their deficits was used by politicians to justify their deficits until the inflationary pain could no longer be tolerated. In both nations, government commitment to austerity and fiscal prudence quickly restored financial confidence and was supported by substantial inflows of private capital that facilitated stabilization and economic recovery.
?
Austria, Hungary and Poland were other soft currency European nations that suffered extraordinary price inflation episodes that forced temporary abandonment of welfare policy dreams. Italy, Czechoslovakia and Portugal also suffered serious bouts of price inflation. In all of these nations, political leaders were stymied by domestic political conflicts in a manner similar to current experience in the U.S. and EU. They resorted to budgetary smoke and mirrors policies similar to those currently resorted to by Washington and several heavily indebted U.S. states.
?
Ultimately, none of these nations could endure the pain of chronic severe price inflation. Ultimately, it was the pain inflicted by ruthless market mechanisms that forced restoration of budgetary and monetary prudence on very reluctant political leaders and their conflicted domestic interests.

Ultimately, as always, it was money market fetters that proved far more constraining and ruthless than gold fetters.

Britain was determined to restore its credit by deflating enough to restore prewar currency parity as it had after all its previous wars. In 1924 and 1925, it was joined by non-belligerents Sweden and Netherlands in restoring gold convertibility at prewar parity. For the non-belligerents, there was little evidence of overvaluation in the effort.
?

Eichengreen points out that inflationist policies of currency devaluation and price inflation initially boosted economic growth between 1921 and 1927 by increasing the competitiveness of exports and reducing real wages. Wages failed to rise fast enough to keep pace with price inflation. These figures vary with the varying degree of WW-I disruption experienced by different nations, but Eichengreen still finds a considerable gain for inflationist policies.
?
But he recognizes that inflationist policies were not sustainable. There was always considerable misallocation of resources. As expectations for continued price inflation increased, wages and prices began to adjust with increasing speed.

"As in Germany in 1923, these adaptations eliminated the stimulus to recovery lent previously by inflation, and the depressing effects of price and exchange rate uncertainty became dominant."

That the initial stages of monetary inflation almost always bring pleasant results is nothing new. It has been known for all the 2500 years of monetary history. Floating exchange rates become essential when nations resort to monetary inflation, since monetary inflation inevitably undermines financial stability and fixed exchange rates.
?
The author admits that his evaluation of the benefits of monetary inflation is affected by the use of France and Belgium as two of the inflationist states. These two nations suffered the most physical destruction during the war in Western Europe. They were recovering from the most war-ravaged economic base. The U.S., Canada, Australia and Switzerland are included in the non-inflationist group. His reliance on regression analysis to compensate for their lack of wartime economic destruction is ludicrous. Mathematical economics is seriously flawed at the macro economic level and has no such analytical power.

Eichengreen thus correctly emphasizes that an analysis of the interwar gold standard is one of political economy rather than one focusing on economic factors.

In turbulent financial times, floating exchange rates facilitate adjustment to the ebb and flow of financial shocks. Devaluation can be an effective - even essential - mechanism for maintaining or regaining market share in international trade, Eichengreen points out. However, it can generate domestic political battles between those that are favored and those that are hurt.

However, it does not take much monetary volatility to become highly disruptive for commerce and to undermine financial systems. All nations ultimately find it necessary to stabilize the exchange rate of their money by limiting monetary inflation. For most nations, this involves some method of tying the exchange rate to a stronger, more creditworthy monetary system.

Eichengreen thus correctly emphasizes that an analysis of the interwar gold standard is one of political economy rather than one focusing on economic factors. Domestic interests blocked international cooperation, WW-I financial obligations dominated international financial flows, and variations in economic policy approaches blocked cooperative action. Nations that had experienced devastating levels of price inflation in the 1920s favored monetary discipline while some of those that had not had that experience were more willing to resort to monetary inflation as a remedy.
?

The interwar gold standard:

Most nations restored gold and/or silver convertibility during the 1920s.
?

Gold inflow sterlization was just one more dysfunctional policy of the ongoing trade war.

However, France and the U.S., the two major gold holders, refused to play by the prewar gold standard rules. They refused to allow their gold inflows to expand their base money supply. They were determined to avoid the cyclical domestic price increases that would facilitate the return of gold to nations that were in an austerity mode to combat gold losses. While there were substantial increases in wage rates in France and the United States, productivity advances were sufficient to prevent price increases, so their payments surpluses continued. By 1928, there was no monetary policy cooperation between the major central banks, so the credibility of the gold standard was fragile.
?
For Britain and many others, this was a gold bullion system. They did not circulate coins. For many nations, foreign exchange substituted in whole or in part for gold. But foreign exchange was available only if the two hard currency nations, the U.S. and Britain, ran balance of payments deficits. Eichengreen explains the tenuousness of this system.
?
Of course, payments deficits could ultimately undermine confidence even in the pound or dollar. Devaluations of the pound or dollar were intensely deflationary worldwide and could upset gold exchange standard systems - as happened when the pound was devalued in 1931.
?
Open market operations, consisting of open market purchases or sales of the vast amounts of government debt available after WW-I, could be and was used by the U.S. to counter the impact of gold inflow. By selling government securities from its portfolio, the Federal Reserve could pull money out of circulation.

The U.S. simply left a significant amount of gold in foreign accounts so it would not impact the domestic money supply.

Sterilization policies were pursued by both payments surplus and payments deficit nations as central banks fought over the world's approximately $10 billion in monetary gold, which had become the only completely reliable reserve asset. It was just one more dysfunctional policy of the ongoing trade war. Eichengreen estimates that gold standard rules were followed in only about 25% of the time between 1928 and 1931 - the high-water mark for interwar gold convertibility.
?

Before 1928, there were significant instances of cooperation among central banks. The N.Y. Federal Reserve Bank, under Benjamin Strong, assisted European stabilization efforts and the restoration of gold convertibility. This cooperation ended in 1928, the year of Strong's death.

"So long as collaboration was limited to the provision of stabilization loans, the leading central banks were willing to participate. These were exceptional loans for exceptional times. The amounts were small relative to the assets of the Bank of England or the Federal Reserve System. But once stabilization loans had helped to reconstruct the international monetary system, central bankers reverted to their preferred model of a decentralized gold standard in which each country was exclusively responsible for its own affairs."

The N.Y. Fed received some harsh Congressional criticism for apparently putting foreign interests ahead of domestic interests. A heedless Congress was determined to remain unconstrained by international considerations.

However, Eichengreen points out that the two most important instances of Fed cooperation, in 1924 and 1927, coincided with Fed domestic interests in lowering interest rates to fight recession. By 1928, the Fed was waging a losing battle with the Wall Street bull market and had no capacity to consider foreign needs for lower Fed interest rates.
?
Eichengreen discusses the legal restrictions on monetary policy for U.S., French and German central banks. In 1929, U.S. and French gold imports were twice as much as gold mine production. There was an average 4% increase in the money supplies of advanced nations during the last half of the decade. This was a rate of increase that was twice as much as could be covered with a one-third backing by new gold.
?

The Great Depression:

A very flawed view of the 1929 boom and bust, predominantly focused on monetary factors, is provided by Eichengreen.
?

He chooses to emphasize the constraints of the Federal Reserve monetary policy as it waged its futile battle to corral the Wall Street bull, and the widespread failure abroad of austerity efforts to stem the flow of gold and capital to the U.S. and maintain exchange rates.

"[Governments] raised taxes, especially import duties. They applied export bounties. This was the option pursued by virtually every debtor nation until 1929."

Like monetarists before him - and like Keynesians, too - the author ignores vital fundamental economic factors like the cumulating impacts of trade war protectionism. Protectionist policies thwarted austerity efforts to balance international accounts. They generated the vast overcapacity problems in international commodity markets that he attributes solely to increasing productivity. He totally ignores the summer 1929 boom in agricultural markets that was responsible for the last mighty surge of the bull stock market. Only briefly, he mentions the end of commodity price stabilization schemes, the intensification of trade war policies and "distress in the agricultural sector."
?
Ignored as well are the substantial Hoover administration stimulatory efforts typically denigrated by Keynesian economists. While considerably less than those of the New Deal, they were unprecedented up to that time, and the New Deal efforts at economic stimulation failed as well. The eternal Keynesian response is that the New Deal deficits and monetary inflation were simply not enough to get the job done. Mathematical models that purport to demonstrate better results for greater stimulus are based on Never-Never land economies. There Never has been enough and Never will be!

Austerity generated political unrest then as today. Eichengreen traces events in Australia, Argentina, Canada and Brazil.
?
After the stock market crash, Great Depression fears generated capital flight from debtor nations and rendered debtor austerity policies largely ineffective in drawing capital back from the U.S. and France. As capital flows in their favor persisted despite debtor nation austerity efforts, the U.S. and France were "winning" the trade war, but at the expense of destroying their commercial world. Canada was one of the few nations where austerity was largely effective in limiting the impact of trade and payments imbalances.
?

Eichengreen thus rejects the left wing myth that the Great Depression started in the U.S. and then spread to the rest of the world.

The Great Depression was "a global phenomenon" from the beginning, Eichengreen correctly points out. It was so severe "precisely because so many countries were affected simultaneously."
?
That capital flows from the U.S. dropped precipitously by about 50% during the last half of 1928 is properly recognized by Eichengreen as one of the earliest initiating factors in the Great Depression. Economic contraction began in Central Europe and Latin America in the latter part of 1928 and early 1929 when those nations could no longer get additional financing from the United States. The U.S. State and Commerce Departments issued warnings about the growth of debt burdens as a proportion of export earnings for Germany and other Central European nations and for Latin American nations. Economic contraction spread to the U.S. in the second half of 1929. Eichengreen thus rejects the left wing myth that the Great Depression started in the U.S. and then spread to the rest of the world.
?
The author attributes this sudden reduction in foreign lending to the Federal Reserve's restrictive monetary policy in 1928 and 1929 as it strove unsuccessfully to corral the Wall Street bull market. He recognizes that the economic impacts were actually quite modest. However, they had a disproportionate impact on the austerity policies of countries struggling to maintain gold standard exchange rates. He also recognizes the great attractiveness of the Wall Street bull market and the double digit yields of its call money market.

"In the summer of 1928, increasingly stringent Federal Reserve policy choked off U.S. foreign lending. Speculative investments at home were more attractive than those abroad. Double-digit interest rates on brokers' loans in New York were more appealing than foreign bond flotations on behalf of even the most creditworthy borrower for financial institutions with access to both markets. Net portfolio lending by the United States declined from more than $1000 million in 1927 to less than $700 million in 1928 and turned negative in 1929. The 30 percent drop between 1927 and 1928 understates the speed of the shift. Virtually all U.S. foreign lending in 1928 took place during the first half of the year.

However, Eichengreen fails to discuss the extent to which foreign states had been rendered dependent on these capital flows by U.S. protectionist trade war policies. U.S. tariffs and monetary policy were used to prevent dollar debtors from earning the dollars needed to service their dollar debts. It is axiomatic that gold flows are supposed to merely smooth out marginal imbalances of trade and international payments. There was never enough gold to substitute for restoration of trade balance. Even under floating exchange rates, permanent trade and payments imbalances have not been rendered harmless. Nations with chronically weak currencies do not prosper.
?
The Fed discount rate was only 4½% and 5% during the final stages of the bull market. The N.Y. Fed rate briefly hit 6% during the summer and fall of 1929. Obviously far more important in attracting capital to Wall Street were the double digit rates offered by Wall Street's short-term call money market. This attraction could only be reduced by the termination of the bull market. The author does not deign to speculate on the likely impacts if an easier Fed monetary policy had poured additional financial fuel into the Wall Street bull market.
?
Monetarists always point out that there was no price inflation to hinder expansive monetary policy during this period, but we now know from the recent credit crunch boom and bust that asset price inflation is an equally dangerous form of price inflation - and the Wall Street bull market was roaring into its third year by the end of 1928.
?
Eichengreen blames France for failing to adopt a Keynesian-style monetary inflation policy to satisfy its domestic demand for currency and reduce its gold sterilization efforts. However, France had just recently conquered a serious bout of price inflation and did not want to wage that painful economic battle again. Dollar debtor trade access to U.S. markets would have been a far more effective remedy.
?
The author relies on nominal monetary statistics to support the monetarist assertion that Fed monetary policy was restrictive in the first six months after the stock market collapse. However, he ignores the real - deflation adjusted - monetary aggregates. These were increasing due to the rapid pace of price declines through the first quarter of 1930.

The author recognizes the rapid decline in commodity prices beginning in the middle of August 1929 and its impact on commodity exporting nations.

However, here, again, he fails to recognize the role of the trade war in generating worldwide oversupply in protected commodity markets. The vast worldwide grain crops of 1928, 1930 and 1931 left world markets flooded with record grain carryovers. The U.S. cotton carryover grew to more than a full year's domestic consumption. Faster growth of the money supply was not going to make a dent in these vast surplus carryovers. Repeatedly during the 1930s, it was reports that European tariff-protected grain crops would again be sufficient to meet all European needs that ended periods of stock market recovery and hope for economic recovery in the U.S.

The U.S. economy failed to adjust fast enough to mitigate the economic contraction. Eichengreen attributes this failure to the many "sticky" economic factors such as mortgages, rents and bonds that ran for months or years. (However, these were far less important than the impact of the decade-long loss of export markets during the 1930s.)
?
As confidence and credit mechanisms contracted, monetary and fiscal authorities were forced to retrench to retain gold reserves. Efforts at monetary inflation quickly resulted in gold outflows - even for Britain and the United States. Financial globalization meant that capital flows moved quickly against any threat to gold convertibility.

"The interwar system was a gold-exchange standard with multiple reserve currencies. Central banks were authorized to hold, in addition to gold, a portion of the backing for domestic liabilities in the form of convertible foreign exchange. They held primarily U.S. dollars, French francs, and British pounds. Altering the foreign exchange portfolio entailed negligible costs. Central banks had every incentive to hedge their bets -- to sell a weak currency as soon as the country of issue experienced difficulties. A minor deterioration in the external position could be amplified quickly if foreign central banks chose to alter the composition of their foreign reserves."

Scandinavian nations that had floating exchange rates were able to energetically intervene to prevent banking collapses. However, by 1933, they had felt impelled to again fix their exchange rates, pegging them to the pound. Creditworthiness remained a vital concern, so there was soon a vast sterling bloc.

Europe's four major debtors - Germany, Britain, Austria and Hungary - collapsed like dominoes in 1931. The author provides details. Gold standard constraints and WW-I obligations, along with "domestic political constraints, international political disputes, and incompatible conceptual frameworks," prevented central bank cooperation to meet the initial Austrian and German financial crises and repeatedly undermined financial market equilibrium.
?
Banking crises were an inherent element in convertibility crises. Scandinavian nations that had floating exchange rates were able to energetically intervene to prevent banking collapses. However, by 1933, they had felt impelled to again fix their exchange rates, pegging them to the pound. Creditworthiness remained a vital concern, so there was soon a vast sterling bloc.

The exchange rate uncertainty of floating exchange rates was too great a burden on commerce to sustain. Moreover, most Scandinavian nations did not bear the financial burdens of WW-I and were far less protectionist - factors that Eichengreen and other Keynesians and monetarists generally ignore when invoking the Scandinavian example.

Smoot-Hawley protectionist measures "exacerbated the problem" for debtor nations, Eichengreen acknowledges with masterful understatement. Default and devaluation became inevitable, but at the cost of the collapse of international credit markets and an acceleration of capital flight. Devaluations, in turn, led to massive intensification of trade war protectionist measures.

England imposed harsh austerity measures when it devalued the pound, thus quickly limiting the substantial price inflation caused by the devaluation and turning its financial negatives into positives.

The Fed's $1 billion monetary inflation effort in the spring of 1932 was a quick failure. Eichengreen blames the failure on its temporary nature. Everyone knew it was a one-time shot. He recognizes that the interwar gold standard put limits on the reflation efforts even of France and the United States. The immediate market response was a vast capital flight from the U.S. that almost completely negated the spring 1932 monetary expansion effort.

Today, Fed chairman Bernanke assures all that the Fed's stimulatory effort will last for years - but the stimulatory impact nevertheless remains missing. It is fundamental factors, like the slow decline of excess housing inventory, that governs the pace of economic recovery. It is the reduction of housing inventories back close to normal levels that finally permits some economic recovery. The smothering deluge of new regulatory burdens is a fundamental factor in frustrating recovery.
?
Bernanke, to his credit, has so far recognized that he has no control and little influence over such fundamental factors. However, his temporary resistance since the end of "QE-II" to increasingly fervent inflationist pressures gave way during this 2012 election year. He and the Bernanke monetarists can be relied upon to claim credit for any quickening of the pace of recovery.

The typical Keynesian solution recommended by Eichengreen for the Great Depression is that all major nations should have engaged in monetary inflation together to neutralize capital flight. He provides a Keynesian critique of the limited use of monetary inflation as a remedy as nations left the gold standard. Initial reaction was to use monetary inflation cautiously, so recovery remained stymied, according to Eichengreen. He invokes the standard Keynesian excuse for failure: There simply wasn't enough deficit spending and monetary inflation to get the job done. (There never is, and there never will be!)

Eichngreen recognizes that price inflation was often associated with the devaluation and monetary inflation episodes despite the extent of Great Depression unemployment. There was an immediate surge in price inflation in Britain of about 10% as a result of its devaluation. Despite harsh austerity measures, prices were still up about 4% after a year. Surges of price inflation afflicted devaluations in France and Belgium, among others. He does not speculate on the long term consequences if such price inflation is not brought under control. He ignores the experience of the 1970s, when double digit unemployment, interest rates and price inflation all existed practically at the same time, and 1941 when price inflation surged despite unemployment that was just declining to under 10%.
?
The only thing worse than a Great Depression is a Great Depression with price inflation. The 1970s proved conclusively that depression unemployment levels do not prevent price inflation. Even during the Great Depression, most people were still working, but severe price inflation reduces purchasing power for the entire electorate.

Germany was in essence given a discharge in bankruptcy for its reparations obligations by the 1932 Lausanne Conference, and quickly began economic recovery.

In the summer of 1933, the New Deal was forced to control the volatility of the dollar exchange rate and, by January 1, 1934, the dollar was again pegged to gold.

Europe yet again produced huge grain harvests within its tariff protected markets, causing severe price declines and the aborting of initial New Deal stimulatory efforts.

There were international efforts to deal with the Great Depression financial crisis. Germany was in essence given a discharge in bankruptcy for its reparations obligations by the 1932 Lausanne Conference, and quickly began economic recovery. However, disagreements over war debts and exchange rate policies could not be resolved due primarily to U.S. intransigence that was intensified under the New Deal. All the major nations had domestic political impediments to wider substantive trade and exchange agreements. Widespread protectionist pressures were too powerful for broad meaningful agreements.
?
Several small nations signed liberalized trade agreements in Geneva, and most dollar war debts were defaulted by December, 1932. The British Empire adopted preferential access arrangements in the 1932 Ottawa Agreement rather than free trade. To restore essential exchange rate stability, separate currency blocs formed around gold and the pound.
?
The exchange rate volatility of floating exchange rates had quickly become commercially ruinous and had to be controlled. In the summer of 1933, the New Deal was forced to control the volatility of the dollar exchange rate and, by January 1, 1934, the dollar was again pegged to gold.
?
But Europe yet again produced huge grain harvests within its tariff protected markets, causing severe price declines and the aborting of initial gains from New Deal stimulatory efforts. International trade remained near Great Depression lows.

War debts and reparations obligations were removed by default. However, the trade war persisted throughout the decade as a fundamental cause of the Great Depression, and was soon accompanied by ruinous New Deal gold and silver purchase experiments and massive failures of what today would be called "industrial policy," which the author does not deign to discuss.

The New Deal:

Fear that FDR would devalue the dollar precipitated the ultimate run on U.S. banks and gold reserves before the banking holiday. Eichengreen blames the 40% minimum gold reserve requirement for Federal Reserve notes for constraining the ability of the Fed to support the banking system. However, capital flight was also being caused by the deteriorating commercial situation.
?

Capital flowed back into the U.S. and its banks when FDR showed no initial inclination to devalue. Confidence was restored to a substantial extent until mid April when devaluation intentions were leaked and markets became aware of the massive inflationist sentiment in the new Congress. Devaluation followed on April 19, 1933. While the New Deal eschewed some of the more extreme proposals, Eichengreen recognizes that the New Deal devaluation policies were greatly obstructive.
?
After the dollar was again pegged to gold in January, 1934, at about a 40% devalued rate, capital quickly flowed back into the U.S. Devaluations provided massive "capital gains" for governments that they used for monetary expansion, payment of debts, support for banks, and renewed efforts to stabilize their currencies. From this time on, capital flows were increasingly impacted by the approach of WW-II. It becomes difficult to distinguish what was contributing how much to capital flows.
?
The U.S. enjoyed increasingly substantial capital inflows. Eichengreen criticizes FDR and the Fed for not doing more to take full advantage of their new liberty from monetary constraints to inflate the money supply. He acknowledges that price inflation became noticeable in 1936 but ignores the price inflation surge in the first half of 1937 except with respect to a mention of commodity prices.
?
France failed to benefit from the monetary flexibility gained by devaluation. French politics forced rapid wage increases that discouraged production. Unions pushed up real wages fast enough to increase costs, undermine profitability, accelerate price inflation, and limit trade benefits. Other nations were able to enjoy the usual pleasant initial results of monetary inflation and credit expansion.

"In Britain and the United States, as in virtually every country to leave the gold standard, economic recovery got underway. Having severed their golden fetters, policymakers in these countries were able to adopt more expansionary monetary and fiscal policies designed to spur the recovery of the economies."

Except for a dead cat bounce during the initial five months after the reopening of the banks, there was almost no recovery from the New Deal dollar devaluation and monetary inflation. The vast majority of the New Deal expansion prior to the 1937 relapse occurred after the dollar was again pegged to gold at the beginning of 1934. Even that recovery was mostly due to government economic activity. Private investment remained depressed.

However, recovery was short lived in the U.S. Monetary restraint brought on a severe relapse in 1937. Joining other monetarists, Eichengreen is sharply critical of this period of monetary restraint. Like other monetarists, he does not concern himself with the need to contain the price inflation that appeared in 1936 and then surged in the first half of 1937 even as unemployment remained in excess of 14%. He points out that other nations successfully expanded after devaluation but fails to evaluate the many other factors involved. The 1937 economic relapse in the U.S. did not have a severe impact on a world no longer tied by golden fetters, Eichengreen emphasizes. The challenge was met abroad with currency inflation.

The most obstructive fetters were those that tied nations to the heedlessly obstructive policies of the New Deal. All of these fetters had been cut by 1937.

Among the last gold standard states, nobody was playing according to the rules. Trade flows had become so constrained that they could no long adjust towards an equilibrium. Trade war and budget pressures blocked efforts at cooperation and the restoration of confidence. Eichengreen tells of the political disruptions in France and elsewhere that prevented responsible fiscal and trade policies. Rising military spending further undermined budgets and trade balances. Remaining gold standard states greatly increased their trade war constraints in last ditch efforts to avoid devaluation.

When devaluation becomes inevitable, the effort to put it off is notoriously costly.

By 1937, the dollar was the only major currency pegged to gold. The pound was loosely stabilized in relation to the dollar so exchange rate turbulence among the expanding pound-bloc and dollar currencies was greatly reduced.

The vast majority of nations that abandoned the gold standard quickly opted for fixed exchange rates again by pegging their currencies to a hard currency like the pound or dollar. Fixed exchange rates have remained the rule for these nations ever since. Today, most nations peg their currencies to the dollar, pound or euro. Why should that be more desirable than gold? At least with gold reserves instead of dollars or pounds, nations would not be forced to finance considerable segments of U.S. or English deficits. They would not find themselves subject to the taxation characteristics of inflation when dollar and pound purchasing power declines or fails to increase in line with increases in economic productivity. See, Understanding Inflation,

There were a variety of bilateral trade agreements. A loose stabilization agreement between the U.S., Britain and France succeeded in bringing the period of competitive devaluations to an end. The reduction of this turbulence is recognized by Eichengreen as greatly facilitating commerce - but international commerce remained constrained by the trade war.

Floating exchange rates are essential when sovereign budget deficits are so chronic that they have to be monetized. It is hardly news that the initial result of monetary inflation is to stimulate an economy. That's why nations have repeatedly resorted to monetary inflation and plunged into the price inflation morass during the 2500 years of monetary history. That initial resort to devaluation and monetary inflation enabled economic expansion from the low base of devaluation crisis periods is neither surprising nor proof of effectiveness as a general monetary policy.
?
The ultimate constraint then is indeed price inflation, but that can be reduced by productivity increases and the degree to which other nations are willing to accept the domestic currency as a reliable reserve asset. It thus takes time and considerable monetary inflation to reach ruinous levels in hard currency nations like the U.S.
?
If the fundamental causes of economic contraction primarily involve government policies like the Great Depression trade war protectionist policies or the WW-I financial obligations, the markets will not be able to resolve them. Throwing money at the problems can have no more than palliative impact and will ultimately resemble "pushing on the end of a string." If pursued vigorously enough, monetary inflation produces exchange rate volatility and price inflation that can prove vastly disruptive in their own right.
?
According to Eichengreen, the stimulatory impact of monetary inflation policy must come at the expense of labor. Wholesale prices must rise faster than wage rates. When Unions pushed real wages up in France, there was little economic benefit from devaluation and monetary inflation. Real wages cannot long rise faster than productivity.
?
Ultimately, with the advent of rates of price inflation that are chronic and substantial, money market fetters come into play. Money market fetters can be far more unyielding than gold and other fixed exchange rate fetters - as the U.S. found out in the 1970s.
?
Writing in the late 1990s, Eichengreen is critical of the Bretton Woods arrangement established under U.S. leadership after WW-II. He was far more hopeful of the then current European Union efforts at monetary union. As we now know, no international system for monetary cooperation can survive the irresponsible budgetary policies of profligate and heavily indebted national governments. Bretton Woods was hardly optimal, but it was the profligate Keynesian policies of the U.S. government in the 1960s that broke it down.
?
The dollar currently - as of the fall of 2012 - remains strong because it remains reliable as a reserve currency. It is thus a service export that the U.S. provides to the world. Should the dollar ever lose this status because of over-supply, it would be a huge blow to the U.S. economy.
?
Fed Chairman Ben Bernanke, to his credit, responded to the surge in price inflation in 2011 by ending his monetary inflation efforts. The Fed's balance sheet expanded very little until the recent initiation of "QE III." He thus retained some ability to act without being constrained by price inflation. He was ultimately impelled to implement "QE III" by a continuation of high unemployment and a sluggish economy and the approach of an important election. Other monetary maneuvers - like "operation twist" - are of little impact but do cause vast market distortions.
?
The Fed thus must wait for market adjustment mechanisms to do the heavy lifting in eliminating the fundamental causes of the economic difficulties. At present, this includes the housing inventory surplus, which finally is declining closer to normal levels. To the extent that government policies - like the deluge of new regulations - are responsible for economic problems, market mechanisms cannot eliminate them until the markets deliver sufficient pain to remove the responsible governments. In the meantime, four years of artificially low interest rates create vast economic distortions and financial bubbles that the ultimate increase in interest rates back towards market levels will inevitably reveal.

Theory Confirmation Bias	Gold & the Modern Business Cycle	The Gold Standard
Financing World War I	Interwar Turbulence	The Great Depression