Great Depression: A Fistful of Francs


Did France cause the Great Depression? Dartmouth economist Douglas A. Irwin asks about French gold hoarding and the breakdown of the gold standard:

While France's role is sometimes acknowledged (usually briefly, if at all, however), the impact of French policies is often believed to have been much smaller than the United States because of the country's smaller size. Yet these findings suggest that the French role deserves much greater prominence than it has thus far received for having transmitted a tightening of monetary policy to other countries and thus beginning the worldwide deflationary spiral…

Over the entire period from 1928 to 1932, France had a greater deflationary impact than the United States: it could have released 13.7 percent of the world's gold stock, while the United States could have released 11.7 percent, and still have maintained their 1928 cover ratios.

Irwin's study [pdf] argues that the Bank of France spent the late twenties acquiring gold at such a rate that it caused a perceived global gold shortage, forcing other countries' central banks to tighten their own monetary policies and turning a deep recession into one of the formative tragedies of the 20th Century. Warning: This is a lengthy argument fortified by equations with Greek letters, and to follow it you've got to posit that Ben Bernanke's reading of the Great Depression – that leaving the gold standard and allowing rampant inflation was the ticket to prosperity in the thirties – is correct.

Both the Bank of France and our own Federal Reserve were guilty not only of building up gold reserves but of "sterilizing" gold: i.e., leaving it in a vault and not monetizing it (by creating francs or dollars at an appropriate ratio). As it happened, Franklin Roosevelt would do something similar later in the thirties, but by that point the international gold standard had broken down. The crucial period came during the late twenties and early thirties:

By 1932, France held nearly as much gold as the United States, though its economy was only about a fourth of the size of the United States. Together, the United States and France held more than sixty percent of the world's monetary gold stock in 1932…

The fact that the two countries kept such a large proportion of the world's gold stock inert and withdrawn from world circulation in 1929 and 1930 explains most of the massive worldwide deflation in 1930 and 1931 and may be indirectly responsible for some of the remainder.

Extreme goldbugs can only look with envy at the ratio of gold to money France eventually built up:

By 1932, the cover ratio had risen to the amazing level of nearly 80 percent! France was well on its way to having 100 percent base money, in which all of the central bank liabilities were backed one-for-one with gold in its vault.

There are some interesting questions here. If the United States and France had monetized instead of sterilizing, would we have seen price inflation, or just a slower decline in prices?

And why are we still assuming that deflation is a disease rather than a symptom? I'm just a simple caveman, but it seems to me Bernanke's catastrophic mismanagement of the Federal Reserve in our own time should make us cautious about assuming inflating the monetary base can bring about a recovery. We are seeing instead continuing deflation of those items Americans think of as assets expected to appreciate (real estate above all) while the actual cost of living (i.e., everything that's not counted by the phony-baloney CPI and PCE indexes) goes up and unemployment stays up.

As it happens, Irwin ends on just this question:

An important question that has been left unanswered here is the reason for the non-neutrality of money; that is, why this deflation was associated with declining output. While falling prices need not imply contracting output and higher unemployment, recent research has shown that the Great Depression of the 1930s is somewhat unique in linking the two (Atkeson and Kehoe 2004, Bordo, Lane, and Redish 2004).

One thing that never loses value: MGM's vintage inflation propaganda: