"Far from being synonymous with stability, the gold
standard itself was the principal threat to financial stability and
economic prosperity between the wars."
-Barry Eichengreen, Golden Fetters (1992), p. 4
Berkeley Professor Barry Eichengreen has fueled the
flames of anti-gold in his recent historical work, Golden Fetters: The
Gold Standard and the Great Depression, 1919-1939 (Oxford University
Press, 1992). Essentially, the author argues that (1) the international
gold standard caused the Great Depression and (2) only after abandoning
gold did the world economy recover. The book has been praised by
colleagues, further dampening enthusiasm for the precious metal as an
ideal monetary system.
It should be noted at the outset that Eichengreen, a
Keynesian, is extremely biased against gold. In 1985, while teaching at
Harvard, he edited a collection of essays entitled The Gold Standard in
Theory and History (New York: Methuen, 1985), which pretends to offer a
"complete picture" of how an international gold standard would operate,
with pro's and con's. Yet he failed to include a single article by a
gold supporter! His last chapter, "Further reading," makes no reference
to Mises, Hayek, Ropke, Rothbard, Sennholz, Laffer, and other noted
defenders of gold. So much for objectivity and what MIT professor Peter
Temin calls "the best collection of readings on the gold standard
available today."
Despite his extensive research and history, Eichengreen
cannot crucify mankind upon a cross of gold. In reality, the blame for
the Great Depression must be laid at the feet of Western leaders who
blundered repeatedly in re-establishing an international monetary system
following the First World War. Their mistake was establishing a fatally
flawed mixture of gold, fiat money, and central banking, known as the
"gold exchange standard," instead of returning to the "classical gold
standard" that existed prior to the Great War.
Eichengreen rightly points out that the mischief began
during the First World War, when the European nations went off the gold
standard and resorted to massive inflation to pay for the war. Following
the Armistice, European nations desired to return to gold-convertible
currencies, but they created a weak monetary system known as the "gold
exchange standard," where currencies were pegged primarily to the
British pound and the American dollar rather than to gold itself. The
gold exchange standard created a pyramid of paper claims upon other
paper claims, with gold playing a far lesser role.
Austrian economists, such as Ludwig von Mises and F. A.
Hayek, and the American sound-money school, led by Benjamin Anderson and
H. Parker Willis, recognized that the fractional-reserve, fixed-exchange
gold standard was a recipe for disaster. They predicted an eventual
economic crisis under the gold exchange standard.
Monetary troubles worsened when, in 1925, Britain made
the fateful error of pegging the pound at the exchange rate that
prevailed before World War I at $4.86, clearly an artificially high
rate. As a result, Britain suffered a deflationary depression for the
rest of the 1920s, Moreover, to help Britain return to gold at the
prewar exchange level, the Federal Reserve pushed down interest rates in
1924 and 1927, igniting a fateful inflationary boom in the U.S.
Eichengreen blames the gold standard, but the real
fault lies in Britain's nationalistic zeal to return to gold at an
artificially high rate. A more sensible solution would have been for all
European nations, including Britain, to return to gold at a redefined
rate that recognized the increased supply of money and price levels
following the war. In Britain's case, this would have meant a new
exchange rate of approximately $3.50.
Eichengreen also blames the gold standard for the
monetary crises of the 1920s and 1930s, but it was really a gradual
movement away from a genuine gold standard that caused the economic
debacle of the 1930s.
Eichengreen even admits that the prewar classical gold
standard worked well. He writes, "For more than a quarter of a century
before World War I ... the gold standard had been a remarkably efficient
mechanism for organizing financial affairs. " (p. 3) Eichengreen
attributes exchange-rate stability and prosperity to international
cooperation, but the underlying reason was that industrial nations
largely avoided inflation and strictly linked their monetary policy to
gold flows during this period.
The classical gold standard required issuers of money
to hold sufficient gold reserves to handle the demands of anyone who
wished to redeem their currencies into lawful money. National banknotes
and bank reserves were redeemable in gold coins or bullion at any time.
For example, each gold certificate issued by the U.S. Treasury contained
the following declaration: "This certifies that there has been deposited
in the Treasury of the United States of America TWENTY DOLLARS IN GOLD
COIN payable to the bearer on demand." Although the U.S. Treasury did
not maintain 100 percent specie reserves for all its legal obligations
under the classical gold standard, it did hold more than 100 percent
reserves to cover its gold certificates.
Auburn University economist Leland Yeager explains the
virtues of a fully-backed commodity standard: "Under a 100 percent
hard-money international gold standard ... the government and its
agencies would not have to worry about any drain on their reserves....
There would be no danger of gold deserting some countries and piling up
excessively in others . . ."l Because of monetary stability
under the prewar gold standard, Milton Friedman and Anna J. Schwartz
conclude, "The blind, un-designed, and quasi-automatic working of the
gold standard turned out to produce a greater measure of predictability
and regularity - perhaps because its discipline was impersonal and
inescapable -than did deliberate and conscious control exercised within
institutional arrangements intended to promote monetary
stability.2
Was the Depression Inevitable Under Gold?
Eichengreen and other gold critics have pointed out
that in a crucial time period, 1931-33, the Federal Reserve raised the
discount rate for fear of a run on its gold deposits. If only the U.S.
had not been on a gold standard, the critics say, the Fed could have
avoided this reckless credit squeeze that pushed the country into
depression and a banking crisis. However, Friedman and Schwartz demur,
pointing out that the U.S. gold stock rose during the first two years of
the contraction. But the Fed reacted ineptly. "We did not permit the
inflow of gold to expand the U.S. money stock. We not only sterilized
it, we went much further. Our money stock moved perversely, going down
as the gold stock went Up" 3
In short, even under the defective gold exchange
standard, there may have been room to avoid a devastating worldwide
depression and monetary crisis.
How should we solve our continuing monetary problems?
After recounting the chaotic events between the world wars, Eichen-green
opposes the strict discipline of gold. Amazingly, he calls for more
international cooperation between central banks, which even he admits is
"weak soup for dinner at the end of a bitter cold day. " (p. 398) A much
better solution would be to return the classical gold standard.
At the time of the original publication, Dr. Skousen
was an economist at Rollins College, Winter Park, Florida 32789, and
editor of Forecasts & Strategies, one of the largest investment
newsletters in the country
1. Leland Yeager, "An Evaluation of Freely
Fluctuating Exchange Rates," quoted in Mark Skousen, Economics of a Pure
Gold Standard, 2nd ed. (Mises Institute, 1988), pp. 81-82. 2. Milton
Friedman and Anna J. Schwartz, A Monetary History of the United States,
1867-1960 (Princeton University Press, 1963), p. 10.
3. A Monetary History, pp. 360-61.
Reprinted with permission from The
Freeman, a publication of the Foundation for Economic Education, Inc.,
May 1995, Vol. 45, No. 5.
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