The Last Attempt to Return to the Gold Standard

Tuesday, December 28th, 2010

The last attempt to return to the gold standard was a bit disastrous, an anonymous commenter suggests, and Nick Szabo responds:

Anonymous, you are probably referring to the attempt by European national governments, practically bankrupt after WWI, to return to the gold standard, often at pre-WWI levels, while they and others tried to pay the interest on the debts (and Germany tried to pay its war reparations) with the deflated currency. The problem here was not the gold standard, it was war debts beyond the ability of taxpayers to pay (causing governments to go off gold during WWI and later causing taxation higher than the Laffer maximum, which lowered tax revenues and made the situation even worse) and a massive deflation that Britain for example felt was needed to get back to the pre-WWI standard.

The U.S. Federal Reserve colluded with Britain in this regard, causing destructive deflation in the U.S. At the time of the October stock market crash, the real Fed funds rate was an extraordinary 14%: 6% + an 8% deflation rate. Today, the real rate is probably negative. The Fed itself seems to be subject to great mood swings.

The extreme debts wracked up during the war, the war inflation, and the subsequent forced deflation were all big mistakes. Using inflation during the war as a hidden tax had already destroyed the integrity of the gold standard. It was too late to return to the pre-war exchange rate of pounds for gold — they should have chosen a new exchange rate reflecting the inflation. Both the war inflation and the subsequent forced deflation seriously screwed up price signals and wreaked havoc on debt contracts.

Along with the extreme deflation caused by attempting to reverse the entire massive war inflation, it was Germany, Austria, Britain and a bunch of other countries defaulting on their debts, coming off the gold standard (a de facto default), or both,and the resulting massive gold flow into the U.S., and the idiocy of the Federal Reserve to sterilize this flow to maintain the deflation, that turned a recession into the Great Depression. There were also massive tax hikes in the U.S., Hoover using his Big Stick to promote wage stickiness which caused excess layoffs, Hoover and then FDR throwing up barriers to markets in farm produce, and other problems that also helped cause and prolong the Depression. To pin it on the gold standard itself is a red herring: civilization had been using gold for thousands of years without a Great Depression.

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