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Deflation

Pierre L. Siklos, Wilfrid Laurier University

What is Deflation?

Deflation is a persistent fall in some generally followed aggregate indicator of price movements, such as the consumer price index or the GDP deflator. Generally, a one-time fall in the price level does not constitute a deflation. Instead, one has to see continuously falling prices for well over a year before concluding that the economy suffers from deflation. How long the fall has to continue before the public and policy makers conclude that the phenomenon is reflected in expectations of future price developments is open to question. For example, in Japan, which has the distinction of experiencing the longest post World War II period of deflation, it took several years for deflationary expectations to emerge.

Most observers tend to focus on changes in consumer or producer prices since, as far as monetary policy is concerned, central banks are responsible for ensuring some form of price stability (usually defined as inflation rates of +3% or less in much of the industrial world). However, sustained decreases in asset prices, such as for stock market shares or housing, can also pose serious economic problems since, other things equal, such outcomes imply lower wealth and, in turn, reduced consumption spending. While the connection between goods price and asset price inflation or deflation remains a contentious one in the economics profession, policy makers are undoubtedly worried about the existence of a link, as Alan Greenspan’s “irrational exuberance” remark of 1996 illustrates.

Historical and Contemporary Worries about Deflation

Until 2002, prospects for a deflation outside Japan remained unlikely. Prior to that time, deflation had been a phenomenon primarily of the 1930s and inextricably linked with the Great Depression, especially in the United States. Most observers viewed Japan’s deflation as part of a general economic malaise stemming from a mix of bad policy choices, bad politics, and a banking industry insolvency problem that would simply not go away. However, by 2001, reports of falling US producer prices, a sluggish economy, and the spread of deflation beyond Japan to China, Taiwan, and Hong Kong, to name a few countries, eventually led policy makers at the US Federal Reserve Board to publicly express their determination at avoiding deflation (e.g. See IMF 2003, Borio and Filardo 2004). Governor Bernanke of the US Federal Reserve raised the issue of deflation in late 2002 when he argued that the US public ought not to be overly worried since the Fed was on top of the issue and, in any event, the US was not Japan. Nevertheless, he also stressed that “central banks must today try to avoid major changes in the inflation rate in either direction. In central bank speak, we now face “symmetric” inflation risks.”1 The risks Governor Bernanke was referring to stem from the fact that, now that low inflation rates have been achieved, the public has to maintain the belief that central banks will neither allow inflation to creep up nor permit the onset of deflation. Even the IMF began to worry about the likelihood of deflation, as reflected in a major report, released in mid-2003, that assessed the probability that deflation might become a global phenomenon. While the risk that deflation might catch on in the US was deemed fairly low, the threat of deflation in Germany, for example, was viewed as being much greater.

Deflation in the Great Depression Era

It is evident from the foregoing illustrations that deflation has again emerged as public policy enemy number one in some circles. Most observers need only think back to the global depression of the 1930s, when the combination of a massive fall in output and the price level devastated the U.S. economy. While the Great Depression was a global phenomenon, actual output losses varied considerably from modest losses to the massive losses incurred by the U.S. economy. During the period 1928-1933 output fell by approximately 25% as did prices. Other countries, such as Canada and Germany, also suffered large output losses. Canada also experienced a fall in output of at least 25% over the same period while prices in 1933 were only about 78% of prices in 1928. In the case of Germany, the deflation rate over the same 1928-1933 period was similar to that experienced in Canada while output fell just over 20% in that time. No wonder analysts associate deflation with “ugly” economic consequences. Nevertheless, as shall see, there exist varieties of deflationary experiences. In any event, it needs to be underlined that the Great Depression period of the 1930s did not result in massive output losses worldwide. In particular, seminal analyses by Friedman and Schwartz (1982), and Meltzer (2003), concluded that the 1930s represented a deflationary episode driven by falling aggregate demand, compounded by poor policy choices by the leadership at the US Federal Reserve that was wedded at the time to a faulty ideology (a version of the ‘real bills’ doctrine2). Indeed, the competence of the interwar Fed has been the subject of considerable ongoing debate throughout the decades. Disagreements over the role of credit in deflation and concerns about how to reinvigorate the economy were, of course, also expressed in public at the time. Strikingly, the relationship between deflation and central bank policy was often entirely missing from the discussion, however.

The Debt-Deflation Problem

The prevailing ideology treated the occasional deflation as one that acted as a necessary spur for economic growth, a symptom of economic health, not one indicative of economic malaise. However, there were notable exceptions to the chorus of views favorable to deflation. Irving Fisher developed what is now referred to as the “debt-deflation” hypothesis. Falling prices increase the debt burden and adversely affect firms’ balance sheets. This was particularly true of the plight faced by farmers in many countries, including the United States, during the 1920s when falling agricultural prices combined with tight monetary policies sharply raised the costs of servicing existing debts. The same was true of the prices of raw materials. The Table below illustrates the rather precipitous drop in the price level of some key commodities in a single year.

Table 1
Commodity Prices in the U.S., 1923-24

Commodity Group May 1924 May 1923
All commodities 147 156
Farm Products 136 139
Foods 137 144
Clothes and Clothing 187 201
Fuel and Lighting 177 190
Metals 134 152
Building Materials 180 202
Chemicals and drugs 127 134
House furnishings 173 187
Miscellaneous 112 125
Source: Federal Reserve Bulletin, July 1924, p. 532.
Note: Prices in 1913 are defined to equal 100

The Postponing Purchases Problem

Hence, a deflation is a harbinger of a financial crisis with repercussions for the economy as a whole. Others, such as Keynes, also worried about the impact of deflation on aggregate demand in the economy, as individuals and firms postpone their purchases in the hopes of purchasing durable goods especially at lower future prices. He actually advocated a policy that is not too dissimilar to what we would refer to today as inflation targeting (e.g., see Burdekin and Siklos 2004, ch. 1). Unfortunately, the prevailing ideology was that deflation was a purgative of sorts, that is, the price to be paid for economic excesses during the boom years, and necessary to establish to conditions for economic recovery. The reason is that economic booms were believed to be associated with excessive inflation which had to be rooted out of the system. Hence, prices that rose too fast could only be cured if they returned to lower levels.

Not All Deflations Are Bad

So, are all deflations bad? Not necessarily. The United Kingdom experienced several years of falling prices in the 1870-1939. However, since the deflation was apparently largely anticipated (e.g., see Capie and Wood 2004) the deflation did not produce adverse economic consequences. Finally, an economy that experiences a surge of financial and technological innovations would effectively see rising aggregate supply that, with only modest growth in aggregate demand, would translate into lower prices over time. Indeed, estimates based on simple relationships suggest that the sometime calamitous effects that are thought to be associated with deflation can largely be explained by the rather unique event of the Great Depression of the 1930s (Burdekin and Siklos 2004, ch. 1). However, the other difficulty is that a deflation may at first appear to be supply driven until policy makers come to the realization that aggregate demand is the proximate cause. This seems to be the case of the modern-day episodes of deflation in Japan and China.

Differences between the 1930s and Today

What’s different about the prospects of a deflation today? First, and perhaps most obviously, we know considerably more than in the 1930s about the transmission mechanism of monetary policy decisions. Second, the prevailing economic ideology favors flexible exchange rates. Almost all of the countries that suffered from the Great Depression adhered to some form of fixed exchange rates, usually under the aegis of the Gold Standard. As a result, the transmission of deflation from one country to another was much stronger than under flexible exchange rate conditions. Third, policy makers have many more instruments of policy today than seventy years ago. Not only can monetary policy be more effective when correctly applied, but fiscal policy exists on a scale that was not possible during the 1930s. Nevertheless, fiscal policy, if misused, as has apparently been the case in Japan, can actually add to the difficulties of extricating an economy out of deflationary slump. There are similar worries about the US case as the anticipated surpluses have turned into large deficits for the foreseeable future. Likewise the fiscal rules adopted by the European Union severely hinder, even altogether prevent some would say, the scope for a stimulative fiscal policy. Fourth, policy-making institutions are both more open and accountable than in past decades. Central banks are autonomous and accountable and their efforts at making monetary policy more transparent to financial markets ought to reduce the likelihood of serious policy errors as these are considered to be powerful devices to enhance credibility.

Parallels between the 1930s and Today

Nevertheless, in spite of the obvious differences between the situation today and the ones faced seven decades ago, some parallels remain. For example, until 2000, many policy makers, including the central bankers at the Fed, felt that the technological developments of the 1990s might lead to economic growth almost without end and, in this “new” era, the prospect of a bad deflation seemed the furthest thing on their minds. Similarly, the Bank of Japan was long convinced that their deflation was of the good variety. It has taken its policy makers a decade to recognize the seriousness of their situation. In Japan, the debate over the menu of needed reforms and policies to extricate the economy from its deflationary trap continues unabated. Worse still the recent Japanese experience raises the specter of Keynes’ famous liquidity trap (Krugman 1998), namely a state of affairs where lower interest rates are unable to stimulate investment or economic activity more generally. Hence, deflation, combined with expectations of falling prices, conspires to make the so-called ‘zero lower bound’ for nominal interest rates an increasingly binding one (see below).

Two More Concerns: Labor Market and Credit Market Impacts of Deflation

There are at least two other reasons to worry about the onset of a deflation with devastating economic consequences. Labor markets exhibit considerably less flexibility than several decades ago. Consequently, it is considerably more difficult for the necessary fall in nominal wages to match a drop in prices. Otherwise, real wages would actually rise in a deflation and this would produce even more slack in the labor market with the resulting increases in the unemployment rate contributing to further reduce aggregate demand, the exact opposite of what is needed. A second consideration is the ability of monetary policy to stimulate the economy when interest rates are close to zero. The so-called “zero lower bound” constraint for interest rates means that if the rate of deflation rises so do real interest rates further depressing aggregate demand. Therefore, while history need not repeat itself, the mistakes of the past need to be kept firmly in mind.

Frequency of Deflation in the Historical Record

As noted above, inflation has been an all too common occurrence since 1945. The table below shows that deflation has become a much less common feature of the macroeconomic landscape. One has to go back to the 1930s before encountering successive years of deflation.3 Indeed, for the countries listed below, the number of times prices fell year over year for two years or more is a relatively small number. Hence, deflation is a fairly unusual event.

Table 2: Episodes of Deflation from the mid-1800s to 1945

Country
(year record begins)
Number of
occurrences of
deflation
until 1945
Years of persistent deflation/Crisis
Austria (1915) 1
Australia (1862) 5 BC: 1893
CC: 1933-33
Belgium (1851) 9 1892-96
BC, CC: 1924-26
1931-35, BC: 1931
BC,CC: 1934-35
Canada (1914) 2 CC: 1891,1893, 1908, 1921, 1929-31
1930-33
Denmark (1851) 9 1882-86, BC: 1885, 1892-96, BC: 1907-08
1921-32, BC, CC: 1921-22, 1931-32
Finland (1915) 1 BC: 1900,1921 1929-34, BC, CC: 1931-32
France (1851) 4 CC, BC: 1888-89, 1907, 1923, 1926
1932-35, BC: 1930-32
Germany (1851) 8 1892-96, BC, CC:1893, 1901,1907
1930-33, BC, CC: 1931, 1934
Ireland (1923) 2 1930-33
Italy (1862) 6 1881-84, BC, CC: 1891, 1893-94, 1907-08, 1921
1930-34, BC: 1930-31, 1934-35
Japan (1923) 1 CC, BC: 1900-01, 1907-08, 1921
1925-31, BC, CC: 1931-32
Netherlands (1881) 6 1893-96, BC, CC: 1897, 1921
1930-32
CC, BC: 1935, 1939
Norway (1902) 2 BC, CC: 1891, 1921-23
1926-33, BC CC: 1931
New Zealand (1908) 1 BC: 1920, 1924-25
1929-33, BC, CC: 1931
Spain (1915) 2
Sweden (1851) 9 1882-87
1930-33
Switzerland (1891) 4 1930-34
UK (1851) 8 1884-87
1926-33
US (1851) 9 1875-79
1930-33

Notes: Data are from chapter 1, Richard C.K. Burdekin and Pierre L. Siklos, editors, Deflation: Current and Historical Perspectives, New York: Cambridge University Press, 2004. The numbers in parenthesis in the first column refer to the first year for which we have data. The second column gives the frequency of occurrences of deflation defined as two or more consecutive years with falling prices. The last column provides some illustrations of especially persistent declines in the price level, defined in terms of consumer prices. In italics, years with currency crises (CC) or banking crises (BC), are shown where data are available. The dates are from Michael D. Bordo, Barry Eichengreen, Daniela Klingebiel, and Maria Soledad Martinez-Peria, “Financial Crises: Lessons from the Last 120 Years,” Economic Policy, April 2001.

Is There an Empirical Deflation-Recession Link?

If that is indeed the case why has there been so much concern expressed over the possibility of renewed deflation? One reason is the mediocre economic performance that has been associated with the Japan’s deflation. Furthermore, the foregoing table makes clear that in a number of countries the 1930s deflation was associated with the Great Depression. Indeed, as the Table also indicates for countries where we have data, the Great Depression represented a combination of several crises, simultaneously financial and economic in nature. However, it is also clear that deflation need not always be associated either with a currency crisis or a banking crisis. Since the Great Depression was a singularly devastating event from an economic perspective, it is not entirely surprising that observers would associate deflation with depression.

But is this necessarily so? After all, the era roughly from 1870 to 1890 was also a period of deflation in several countries and, as the figure below suggests, in the United States and elsewhere, deflation was accompanied by strong economic growth. It is what some economists might refer to as a “good” deflation since it occurred at a time of tremendous technological improvements (in transportation and communications especially). That is not to say, even under such circumstances, that opposition from some quarters over the effects of such developments was unheard of. Indeed, the deflation prompted some, most famously William Jennings Bryan in the United States, to run for office believing that the Gold Standard’s proclivity to create deflation was akin to crucifying “mankind upon a cross of gold.” In contrast, the Great Depression would be characterized as a “bad” or even “ugly” deflation since it is associated with a great deal of slack in the economy.

Figure 1
Prices Changes versus the Output Gap, 1870s and 1930s

Notes: The top figure plots the rate of CPI inflation for the periods 1875-79 and 1929-33 for the United States. The bottom figure is an estimate of the output gap for the U.S., that is, the difference between actual and potential real GDP. A negative number signifies actual real GDP is higher than potential real GDP and vice-versa when the output gap is positive. See Burdekin and Siklos (2004) for the details. The vertical line captures the gap in the data, as observations for 1880-1929 are not plotted.

Conclusions

Whereas policy makers today speak of the need to avoid deflation their assessment is colored by the experience of the bad deflation of the 1930s, and its spread internationally, and the ongoing deflation in Japan. Hence, not only do policy makers worry about deflation proper they also worry about its spread on a global scale.

If ideology can blind policymakers to introducing necessary reforms then the second lesson from history is that, once entrenched, expectations of deflation may be difficult to reverse. The occasional fall in aggregate prices is unlikely to significantly affect longer-term expectations of inflation. This is especially true if the monetary authority is independent from political control, and if the central bank is required to meet some kind of inflation objective. Indeed, many analysts have repeatedly suggested the need to introduce an inflation target for Japan. While the Japanese have responded by stating that inflation targeting alone is incapable of helping the economy escape from deflation, the Bank of Japan’s stubborn refusal to adopt such a monetary policy strategy signals an unwillingness to commit to a different monetary policy strategy. Hence, expectations are even more unlikely to be influenced by other policies ostensibly meant to reverse the course of Japanese prices. The Federal Reserve, of course, does not have a formal inflation target but has repeatedly stated that its policies are meant to control inflation within a 0-3% band. Whether formal versus informal inflation targets represent substantially different monetary policy strategies continues to be debated, though the growing popularity of this type of monetary policy strategy suggests that it greatly assists in anchoring expectations of inflation.

References

Borio, Claudio, and Andrew Filardo. “Back to the Future? Assessing the Deflation Record.” Bank for International Settlements, March 2004.

Burdekin, Richard C.K., and Pierre L. Siklos. “Fears of Deflation and Policy Responses Then and Now.” In Deflation: Current and Historical Perspectives, edited by Richard C.K. Burdekin and Pierre L. Siklos. New York: Cambridge: Cambridge University Press, 2004.

Capie, Forrest, and Geoffrey Wood. “Price Change, Financial Stability, and the British Economy, 1870-1939.” In Deflation: Current and Historical Perspectives, edited by Richard C.K. Burdekin and Pierre L. Siklos. New York: Cambridge: Cambridge University Press, 2004.

Friedman, Milton, and Anna J. Schwartz. Monetary Trends in the United States and the United Kingdom. Chicago: University of Chicago Press, 1982.

Humphrey, Thomas M. “The Real Bills Doctrine.” Federal Reserve Bank of Richmond Economic Review 68, no. 5 (1982).

International Monetary Fund. “Deflation: Determinants, Risks, and Policy Options “Findings of an Independent Task Force.” April 30, 2003.

Krugman, Paul. “Its Baaaaack: Japan’s Slump and the Return of the Liquidity Trap.” Brookings Papers on Economic Activity 2 (1998): 137-205.

Meltzer, Allan H. A History of the Federal Reserve. Chicago: Chicago University Press, 2003.

Citation: Siklos, Pierre. “Deflation”. EH.Net Encyclopedia, edited by Robert Whaples. May 11, 2004. URL http://eh.net/encyclopedia/deflation/

Debt, Innovations, and Deflation: The Theories of Veblen, Fisher, Schumpeter, and Minsky

Author(s):Raines, J. Patrick
Leathers, Charles G.
Reviewer(s):Kaboub, Fadhel

Published by EH.NET (September 2010)

J. Patrick Raines and Charles G. Leathers, Debt, Innovations, and Deflation: The Theories of Veblen, Fisher, Schumpeter, and Minsky. Cheltenham, UK: Edward Elgar, 2008. xiii + 191 pp. $100 (hardcover), ISBN: 978-1-84542-785-6.

Reviewed for EH.NET by Fadhel Kaboub, Department of Economics, Denison University

J. Patrick Raines and Charles G. Leathers have produced a remarkable book on a very timely subject, namely the interplay between debt, innovations, and deflation. The authors recognize that little is being said about the causes of deflationary pressure in today?s economy. Therefore, they set out to provide a fresh critical assessment of the deflation theories of Thorstein Veblen, Irving Fisher, Joseph Schumpeter, and Hyman Minsky in light of the growing concern about deflation in the early 2000s in the United States.

For this purpose, the authors focus on three fundamental questions. First, Raines and Leathers determine the four economists? explanations of the causes of deflation and how those explanations relate to the historical context of their writings on deflation. Second, they establish the extent to which those four theories have common points and complementarities. Third, the authors lay out the analytical and policy lessons to be taken from this study to analyze the concerns about deflation in 2002-2003.

The book is organized in six main sections in addition to the introduction and a concluding section. Chapter 2 underscores the importance of the research question that Raines and Leathers are undertaking in this book. The authors provide a very concise analytical overview of the emergence of deflation as a monetary policy issue in the 2003-2004 period. They argue that the 1940-2000 period was dominated by concerns over inflation. Raines and Leathers point out that Alan Greenspan, however, began referring to deflationary tendencies as early as 1998, initially as an academic issue, and later as a matter of concern to policymakers. His main conclusion was that deflation is a monetary phenomenon in the long run. The authors highlight that in the brief period of concern over disinflation and deflation, neither Greenspan nor Ben Bernanke addressed the causes of deflation but merely focused on its likelihood and its consequences.

In chapter 3, Raines and Leathers review the mainstream theory of deflation based on the classical interpretation of the quantity theory of money. In addition to Fisher?s interpretation of the quantity theory, the authors assess the ?deflation? theories put forward by Adam Smith, John Stuart Mill, and Thomas Tooke. The chapter ends with an overview of the monetary theories of business cycles of R.G. Hawtrey and Friedrich von Hayek.

Chapters 4, 5, 6, and 7 respectively dissect the theories of Veblen, Fisher, Schumpeter, and Minsky. These chapters are excellent stand-alone readings for an advanced undergraduate or a graduate course on the four economists in question. Their scholarship is succinctly laid out, and the literature is thoroughly and critically reviewed. The strength of these chapters is the historical contextualization of the deflation theories developed by Veblen, Fisher, Schumpeter, and Minsky. Chapter 8 is where the entire book comes together in a meaningful way. It provides a comparative summary of the analysis made in chapters 4 through 7. This is by far the most interesting chapter of the book. Here, Raines and Leathers identify two main categories accounting for the differences among the four economists. First, there are evolutionary changes in the institutional structure of the economy that must be accounted for; and second, there are differences in methodologies and normative perspectives that cannot be reconciled. Veblen and Schumpeter are identified as the two extremes on the spectrum of the book, despite sharing an evolutionary analysis of the role of technological innovation in the development of capitalism; what sets them apart is the way they treat business values and institutions. Fisher and Minsky are placed somewhat in between, with Fisher?s descriptive theory of deflation closer to Schumpeter; and Minsky?s financial instability hypothesis closer to Veblen?s evolutionary analysis. The authors conclude that when taking all four theories together, we could have a better understanding of the causes of deflation and be able to develop the appropriate policies to deal with it. This is especially important in an era in which (technological and financial) innovation and debt play an increasing role in the structure of the U.S. economy.

The shortcomings of the book are mentioned here in the spirit of unsatisfied curiosity. First, the choice of Veblen, Fisher, Schumpeter, and Minsky remains somewhat unexplained. Why not Keynes or Marx? Second, the book is exclusively focused on the U.S. experience with deflation; one would have liked a discussion of Japan?s experience with deflation in the 1990s, for instance. Third, the focus on the Fed?s treatment of deflation seems to be the initial motivation for writing the book, but somehow it remains as an add-on theme, albeit an interesting one, that only appears in the beginning and at the very end of the book. This makes the thesis of the book a bit too broad, and suggests that there are perhaps two competing book ideas — one on the deflation theories of Veblen, Fisher, Schumpeter, and Minsky; and another on the Fed?s treatment of deflation concerns. In sum, the book is a valuable contribution to the literature on the causes of deflation, and how it has been treated by the Fed.

Fadhel Kaboub is an Assistant Professor of Economics at Denison University, and a Research Associate at the Levy Economics Institute, the Center for Full Employment and Price Stability, and the International Economic Policy Institute. His research focuses on the political economy of full employment policies, monetary theory and policy, and economic development.

Copyright (c) 2010 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator (administrator@eh.net). Published by EH.Net (September 2010). All EH.Net reviews are archived at http://www.eh.net/BookReview.

Subject(s):History of Economic Thought; Methodology
Geographic Area(s):General, International, or Comparative
Time Period(s):20th Century: Pre WWII
20th Century: WWII and post-WWII

Debt, Innovations, and Deflation: The Theories of Veblen, Fisher, Schumpeter, and Minsky

Author(s):Raines, J. Patrick
Leathers, Charles G.
Reviewer(s):Kaboub, Fadhel

Published by EH.NET (September 2010)

J. Patrick Raines and Charles G. Leathers, Debt, Innovations, and Deflation: The Theories of Veblen, Fisher, Schumpeter, and Minsky. Cheltenham, UK: Edward Elgar, 2008. xiii + 191 pp. $100 (hardcover), ISBN: 978-1-84542-785-6.

Reviewed for EH.NET by Fadhel Kaboub, Department of Economics, Denison University

J. Patrick Raines and Charles G. Leathers have produced a remarkable book on a very timely subject, namely the interplay between debt, innovations, and deflation. The authors recognize that little is being said about the causes of deflationary pressure in today?s economy. Therefore, they set out to provide a fresh critical assessment of the deflation theories of Thorstein Veblen, Irving Fisher, Joseph Schumpeter, and Hyman Minsky in light of the growing concern about deflation in the early 2000s in the United States.

For this purpose, the authors focus on three fundamental questions. First, Raines and Leathers determine the four economists? explanations of the causes of deflation and how those explanations relate to the historical context of their writings on deflation. Second, they establish the extent to which those four theories have common points and complementarities. Third, the authors lay out the analytical and policy lessons to be taken from this study to analyze the concerns about deflation in 2002-2003.

The book is organized in six main sections in addition to the introduction and a concluding section. Chapter 2 underscores the importance of the research question that Raines and Leathers are undertaking in this book. The authors provide a very concise analytical overview of the emergence of deflation as a monetary policy issue in the 2003-2004 period. They argue that the 1940-2000 period was dominated by concerns over inflation. Raines and Leathers point out that Alan Greenspan, however, began referring to deflationary tendencies as early as 1998, initially as an academic issue, and later as a matter of concern to policymakers. His main conclusion was that deflation is a monetary phenomenon in the long run. The authors highlight that in the brief period of concern over disinflation and deflation, neither Greenspan nor Ben Bernanke addressed the causes of deflation but merely focused on its likelihood and its consequences.

In chapter 3, Raines and Leathers review the mainstream theory of deflation based on the classical interpretation of the quantity theory of money. In addition to Fisher?s interpretation of the quantity theory, the authors assess the ?deflation? theories put forward by Adam Smith, John Stuart Mill, and Thomas Tooke. The chapter ends with an overview of the monetary theories of business cycles of R.G. Hawtrey and Friedrich von Hayek.

Chapters 4, 5, 6, and 7 respectively dissect the theories of Veblen, Fisher, Schumpeter, and Minsky. These chapters are excellent stand-alone readings for an advanced undergraduate or a graduate course on the four economists in question. Their scholarship is succinctly laid out, and the literature is thoroughly and critically reviewed. The strength of these chapters is the historical contextualization of the deflation theories developed by Veblen, Fisher, Schumpeter, and Minsky. Chapter 8 is where the entire book comes together in a meaningful way. It provides a comparative summary of the analysis made in chapters 4 through 7. This is by far the most interesting chapter of the book. Here, Raines and Leathers identify two main categories accounting for the differences among the four economists. First, there are evolutionary changes in the institutional structure of the economy that must be accounted for; and second, there are differences in methodologies and normative perspectives that cannot be reconciled. Veblen and Schumpeter are identified as the two extremes on the spectrum of the book, despite sharing an evolutionary analysis of the role of technological innovation in the development of capitalism; what sets them apart is the way they treat business values and institutions. Fisher and Minsky are placed somewhat in between, with Fisher?s descriptive theory of deflation closer to Schumpeter; and Minsky?s financial instability hypothesis closer to Veblen?s evolutionary analysis. The authors conclude that when taking all four theories together, we could have a better understanding of the causes of deflation and be able to develop the appropriate policies to deal with it. This is especially important in an era in which (technological and financial) innovation and debt play an increasing role in the structure of the U.S. economy.

The shortcomings of the book are mentioned here in the spirit of unsatisfied curiosity. First, the choice of Veblen, Fisher, Schumpeter, and Minsky remains somewhat unexplained. Why not Keynes or Marx? Second, the book is exclusively focused on the U.S. experience with deflation; one would have liked a discussion of Japan?s experience with deflation in the 1990s, for instance. Third, the focus on the Fed?s treatment of deflation seems to be the initial motivation for writing the book, but somehow it remains as an add-on theme, albeit an interesting one, that only appears in the beginning and at the very end of the book. This makes the thesis of the book a bit too broad, and suggests that there are perhaps two competing book ideas — one on the deflation theories of Veblen, Fisher, Schumpeter, and Minsky; and another on the Fed?s treatment of deflation concerns. In sum, the book is a valuable contribution to the literature on the causes of deflation, and how it has been treated by the Fed.

Fadhel Kaboub is an Assistant Professor of Economics at Denison University, and a Research Associate at the Levy Economics Institute, the Center for Full Employment and Price Stability, and the International Economic Policy Institute. His research focuses on the political economy of full employment policies, monetary theory and policy, and economic development.

Copyright (c) 2010 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator (administrator@eh.net). Published by EH.Net (September 2010). All EH.Net reviews are archived at http://www.eh.net/BookReview.

Subject(s):Financial Markets, Financial Institutions, and Monetary History
History of Economic Thought; Methodology
Geographic Area(s):Europe
North America
Time Period(s):20th Century: Pre WWII
20th Century: WWII and post-WWII

Deflation: Current and Historical Perspectives

Author(s):Burdekin, Richard C.K.
Siklos, Pierre L.
Reviewer(s):Mitchener, Kris James

Published by EH.NET (November 2005)

?

Richard C.K. Burdekin and Pierre L. Siklos, editors, Deflation: Current and Historical Perspectives. Cambridge: Cambridge University Press, 2004. xxii + 359 pp. $75 (cloth), ISBN: 0-521-83799-5.

Reviewed for EH.NET by Kris James Mitchener, Department of Economics, Santa Clara University,

With oil prices accelerating rapidly over the past year, housing prices “frothing” in coastal areas, and the Federal Reserve raising the federal funds rate twelve times since the end of the most recent recession, the timing of a new book addressing the topic of deflation seems somewhat inopportune. Nevertheless, it is worth remembering that, as little as two years ago, American policy makers were seriously pondering the possibility of deflation. Improvements in labor productivity and the expanding use of global supply chains to manage input costs were holding the lid on the overall price level, and short-term interest rates were approaching the zero bound in the wake of the 2001 recession and the collapse in spending on information technologies. Such circumstances warranted the consideration of the small-probability event of sustained deflation, given Alan Greenspan’s risk-management approach to central banking. Deflation and related issues such as asset price booms and busts, liquidity traps, and the operation of monetary policy in extremely low interest-rate environments consequently received renewed attention from domestic policymakers and economists. Moreover, policy debates over the effects of deflation and the appropriate response to it had been taking place for some time in other parts of the world. In particular, Japan was bearing witness to the first recorded deflation in an industrialized country since the Great Depression. These issues and policy debates form the backdrop for the edited volume by Richard Burdekin and Pierre Siklos, which offers a critical evaluation of historical episodes of deflation and some long-run perspective on more recent events.

The edited conference volume consists of twelve chapters that examine deflation by drawing on theory, history, and empirical evidence. The book features interesting contributions by many eminent financial and economic historians. This alone would make it appealing to specialists working in macroeconomic history, but it ought to attract a broader readership, including macroeconomists, central bankers, and policymakers, since the editors were careful to include papers that employ more recent data and theory. Indeed, one of the strengths of the volume is that the contributors employ a variety of methodological perspectives to analyze monetary phenomena and compare present issues with past episodes of deflation.

After an introductory chapter that provides a useful summary by the editors, the book is divided into four sections. The first part of the book, entitled “Fears of Deflation and the Role of Monetary Policy,” begins with an essay by Hugh Rockoff. He suggests that the U.S. bank failures of the 1930s exhibit characteristics that are similar to twin crises (banking and exchange rate crises) that have occurred more recently in national economies. Rural regions in the U.S. experienced “capital flight” because depositors feared that declining export prices and demand would undermine the ability of borrowers to repay; this eventually prompted runs on some banks and led authorities to impose restrictions on withdrawals (bank holidays). Rockoff contributes to the growing literature on regional differences in bank performance during the Great Depression by focusing on “silent runs” — the withdrawal of deposits from rural areas and their movement to Eastern financial centers — a process that was driven in part by declining prices and deflation. The interregional evidence is consistent with his argument, although individual bank data showing that losses of deposits had important consequences for the survival of banks would further strengthen his argument.

In the second chapter of this section, Forrest Capie and Geoffrey Wood take a longer-run perspective and examine whether debt-deflation had damaging effects on the British economy between 1870 and the 1930s. J.M. Keynes’ views on debt deflation suggested that expected real rates are important for generating real effects, whereas Fisher emphasized that rising realized rates produced dilatory effects on existing debtors. The authors use simple time-series analysis to produce price-expectation series and then construct real interest rates that take into account either expected inflation or actual inflation, according to the respective ideas of Keynes and Fisher. They use these series as well as bond spreads to assess the effects of debt deflation, and find little statistical evidence that debt-deflation in Britain created adverse effects for the real economy (or for financial stability). The authors rightly point out, however, that Britain’s experience with deflation was much milder than that which occurred in the U.S., so it is difficult to rule out the debt-deflation hypothesis in general.

Klas Fregert and Lars Jonung close out the first section of the book by examining two cases of interwar deflation in Sweden, 1921-23 and 1931-33. They use the relatively short interval of time between these two episodes to assess how policymaking and macroeconomic outcomes in the first episode were influenced by the inflationary period of World War I, and how this deflationary episode (and the persistent and high unemployment that emerged in the 1920s) in turn influenced beliefs and behavior ten years later. Fregert and Jonung employ qualitative evidence to argue that the large deflation in the early 1920s greatly influenced the thinking of economists, policymakers, and wage setters in the latter episode. Heterogeneous expectations across these groups limited the deflation of 1931-33 as wage contracts were shortened and, in some cases, abandoned.

The second section of the book, entitled “Deflation and Asset Prices,” provides new contributions to the growing literature examining the relationship between monetary policy and asset prices. The first, by Michael Bordo and Olivier Jeanne, develops a model to assess whether monetary policymakers should respond to an asset price “boom” — a term which, according to the authors, differs from a “bubble” in that it is not necessary for policymakers to determine if asset prices reflect fundamentals in order to act. If monetary policies decide not to lean against the wind, they run the risk of a boom being followed by a bust, and a collateral-induced credit crunch dampening the real economy. On the other hand, pursuing restrictive monetary policy implies immediate costs in terms of lower output and inflation. Although the model is very stylized, they find that a proactive monetary policy is optimal when the risk of a bust is large and the monetary authorities can let the air out at a low cost; moreover, they argue that such a policy rule will not look like a Taylor rule in that it will depend on the risks in the balance sheets of the private sector. They then present some preliminary empirical evidence that the boom-bust cycles of their model appear to be much more frequent in real property prices than in stock prices and more common in small countries than in large. (The obvious exceptions to this are Japan’s experience in the 1990s and the U.S. during the Great Depression.) Moreover, they suggest that such busts can create banking crises and lead to severe reductions in output.

The second chapter in this section also examines boom-bust cycles in credit markets, but focuses on the linkages between bank lending and asset prices. Using vector autoregressions, Charles Goodhart and Boris Hofmann argue that movements in property prices during the period 1985-2001 had significant effects on bank lending in a sample of twelve developed countries. Their impulse response functions, however, show that bank lending appears to be insensitive to changes in interest rates. On the other hand, asset prices seem to respond negatively to interest-rate movements. The authors provocatively conclude that there is limited scope for effectively using monetary policy as an instrument to provide financial stability in periods when there are asset-price swings, in part because the effects of interest rates on asset prices and bank lending are highly nonlinear. One challenge to their interpretation of the evidence is that monetary policy is treated in isolation from changes in bank regulation that also took place during this period. Regulatory changes likely also influenced bank lending decisions. One prominent example of this was the adoption of BIS capital-asset requirements in 1988 by Japanese banks, which strengthened the relationship between bank lending and equity prices. Banks could count 45 percent of latent capital as part of tier-II capital requirements; this ensured that increases in equity prices increased bank capital, which in turn, encouraged banks to lend more on real estate and supported rising asset prices.

The third part of the book provides additional case studies of deflation. Michael Bordo and Angela Redish point out that “good” deflations are often defined as periods when prices are falling as a result of positive supply shocks (like technological progress); hence, aggregate supply outpaces aggregate demand. “Bad deflations” are periods when prices fall because aggregate demand increases faster than aggregate supply; this can occur when there are money demand shocks. They suggest, however, that this simple classification can be difficult to square with empirical evidence. Examining the United States and Canada during the classical gold standard period, they find some evidence that both negative demand shocks and positive supply shocks drove prices downward between 1870 and 1896. Output growth was more rapid during the inflationary period of 1896-1913 than the preceding period of deflation, but their time series evidence suggests that there was no causal relationship: price changes were not driving the determination of output.

Michele Fratianni and Franco Spinelli look at Italian deflation and exchange-rate policy during the interwar period, and Michael Hutchinson analyzes Japan in the 1990s. These two chapters make use of a comparative historical approach. Fratianni and Spinelli compare and contrast the Italian deflation of 1927-33 with the disinflation that took place during the adoption of the EMS (1987-92) to argue that fixed exchange rates became unsustainable as economic fundamentals deteriorated. In particular, the interwar gold-exchange standard imparted a deflationary bias, which eventually led authorities to abandon the fixed exchange rate regime in order to pursue lender of last resort activities (thereby assisting failing banks and preventing banking panics) and stabilize the money supply. Hutchinson provides a nice overview of the most important recent episode of deflation, Japan, and shows how injections of liquidity by the central bank (which eventually reduced nominal rates to zero) have not been very effective at improving the growth in broad money aggregates (at least until the last few years). He examines both the liquidity trap and “credit crunch” views of the Heisei Malaise, and argues that, in spite of some policy mistakes that prolonged the deflation and made it more costly, Japan’s deflationary experience has been nowhere near as disastrous as the experience of the U.S. in the 1930s. However, Hutchinson suggests that Japanese policymakers could have made their commitment to zero-interest-rate policy more effective by also adopting an explicit inflation target.

The last section provides three studies that explore the behavior of asset prices during deflations. Lance Davis, Larry Neal, and Eugene White examine how the 1890s deflation affected the core financial markets of the time. Largely narrative in its treatment, this chapter examines how the corresponding financial crisis of that decade prompted different degrees of institutional redesign and regulation in the financial markets of Paris, Berlin, New York, and London. In the next chapter, Martin Bohl and Pierre Siklos study the behavior of German equity prices during the 1910s and 1920s. They argue that this period of German history is particularly useful for analyzing the long-run validity of the present value model of asset price determination because the model can be studied for periods of deflation and hyperinflation. Their empirical results suggest that, while the theory holds for the long run, German share prices exhibited large and persistent deviations in the short run, perhaps the result of noise trading or bubbles. The final chapter by Richard Burdekin and Marc Weidenmier suggests that gold stocks might be a useful hedge against asset price deflation. They find evidence of excess returns on gold stocks after the 1929 and 2000 equity-market declines, but scant evidence of excess returns after the 1987 crash, and interpret these results as indicating that gold stocks only serve a useful hedge if asset price reversals are prolonged.

Even though deflation has lost some of its immediate relevance to policymakers, there is much to be commended in the editors’ efforts to design a book that demonstrates the importance of developing a greater empirical and theoretical understanding of deflation. Although one can always quibble with the compromises that occur when assembling such a volume (for example, in this book, despite the fact that many of the chapters discuss the interwar period, there is no single chapter that attempts to examine deflation using a true panel-data approach), this book’s chapters certainly have enough thematic overlap that the sum of the articles still ends up being of greater value than the individual parts — something that is often difficult to achieve in conference volumes. In this respect, it is a welcome addition to the literature for those interested in monetary economics or those wanting an enhanced historical perspective on recent policy debates.

Kris James Mitchener is assistant professor of economics and Dean Witter Foundation Fellow in the Leavey School of Business, Santa Clara University, as well as a Faculty Research Fellow with the National Bureau of Economic Research. He is currently researching sovereign debt crises during the classical gold standard period and the effects of supervision and regulation on financial stability and growth. Recent publications include “Bank Supervision, Regulation, and Financial Instability during the Great Depression,” Journal of Economic History (March 2005) and “Empire, Public Goods, and the Roosevelt Corollary” (with Marc Weidenmier), Journal of Economic History (September 2005).

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Subject(s):Macroeconomics and Fluctuations
Geographic Area(s):General, International, or Comparative
Time Period(s):20th Century: WWII and post-WWII

Banks and Finance in Modern Macroeconomics: A Historical Perspective

Author(s):Ingrao, Bruna
Sardoni, Claudio
Reviewer(s):Rubin, Goulven

Published by EH.Net (June 2020)

Bruna Ingrao and Claudio Sardoni, Banks and Finance in Modern Macroeconomics: A Historical Perspective. Cheltenham, UK: Edward Elgar, 2019. vii + 281 pp. $145 (hardcover), $31 (ebook), ISBN: 978-1-78643-152-3.

Reviewed for EH.Net by Goulven Rubin, Sciences Économiques, Université Paris 1 (Panthéon-Sorbonne).

 

Banks and Finance in Modern Macroeconomics by Bruna Ingrao and Claudio Sardoni aims to explain the eviction of banks and finance from the mainstream of macroeconomics before the Great Recession occurred in 2008. The book begins with two chapters on the “giants” of pre-Keynesian revolution macroeconomics. Chapter 2 compares Knut Wicksell and Irving Fisher, two economists who analyzed the role of banks’ supply of credit in order to complete the quantity theory of money. Chapter 3 discusses the contributions of Joseph Schumpeter and Dennis Robertson who both argued that banks’ intervention in the economy is a precondition of innovation and growth. Chapter 4 shows how, in the early 1930s, John Maynard Keynes (1931) and Fisher (1933) analyzed the destabilizing effects of deflation on the financial structure of the economy. Chapter 5 opens the story of how the mainstream excluded banks and finance from its models. It argues that, from 1930 to 1936, Keynes progressively expelled commercial banks from his theoretical apparatus. Chapter 6 and 7 follow the evolution of mainstream Keynesian macroeconomics from 1937 to the 1970s. This mainstream is related first to John Richard Hicks’ “attempt to expound macroeconomic theory in the context of a general equilibrium model” (p. 114) in “Mr Keynes and the Classics” (1937) and in Value and Capital (1939). But the main focus is on the contribution of Don Patinkin and Franco Modigliani. Patinkin erased the financial structure of the economy by assuming away distributive effects and risks of default. A similar simplification of the financial sector is found in Modigliani (1963). In the 1960s, only two lines of research emerged from the wreckage. John Gurley and Edward Shaw (1960) showed the importance of financial intermediaries for the process of growth. James Tobin attempted to incorporate banks and equity markets in the IS-LM framework beginning in the 1960s. Chapter 8 discusses the contribution of Milton Friedman and ends up with the Real Business Cycle literature, which represent the last step in the “disappearance of money.” Chapter 9 surveys the macroeconomic literature spanning the last forty years that considered banks and finance from the perspective of imperfect information. The conclusion of the book explains the authors’ dissatisfaction with the current mainstream. If they credit the post-2008 DSGE literature with a rediscovery of banks and finance, they consider that “the general environment within which the analysis is carried out” (p. 243) remains unfit. The Arrow-Debreu intertemporal general equilibrium model that serves as a benchmark for macroeconomics is not consistent with models incorporating money and imperfections. Ingrao and Sardoni thus end up with a plea for a return to the insights of the giants of the inter-war and to practices less tied to mathematical modelling and more open to the complexities of history, the role of institutions and the reality of behaviors characterized by bounded rationality.

To my knowledge, Ingrao and Sardoni’s book is the first attempt to explore systematically the attention that macroeconomics has paid to banks and finance since its beginnings. It is history of ideas at its best, a practice of history that takes the time to assess the consistency of the theories under scrutiny and to discuss their limits, preparing the reader to “study the present state of economics from the standpoint of past authors” (Kurz, 2006: 468). In this respect it will probably remain a landmark. It provides simultaneously a big picture of the subject and a myriad of subtle case studies to which the above summary cannot do justice. The book is a must-read because of its breadth. But this breadth goes along with a lack of comprehensiveness that blurs the picture and leaves open questions.

Concerning the 1960s and the 1980s, Ingrao and Sardoni’s presentation is too selective. Where they conclude that banks and finance were absent from the mainstream, I would argue that these decades saw a boom of research on the topic. In the 1960s, the book ignores the works of Modigliani and his team to develop the first macroeconometric model at the Federal Reserve Board, the MPS, which featured a detailed finance sector (Acosta and Rubin, 2019). It also ignores the attempts of Karl Brunner and Alan Meltzer to propose an alternative to the IS-LM model with an equity market and financial intermediaries. Concerning the 1980s and 1990s, Ingrao and Sardoni fail to acknowledge the importance and the centrality of the burgeoning literature on credit market imperfections. What we need to explain is why, in spite of the waves of research on banks and finance that marked different periods, those key aspects of the market economy did not become part and parcel of all workhorse models before 2008. Ingrao and Sardoni put all the blame on the Arrow-Debreu model and on the “troubled marriage” of macroeconomics with it. But how exactly did the Walrasian benchmark influence the way banks were defined and modelled or the way they were excluded when it was the case? Was general equilibrium theory really the prime influence here? Matters of tractability or available empirical evidence should also be considered. On this score, I find the discussion too cursory. To take only one example, Ingrao and Sardoni present the version of IS-LM introduced by Hicks (1937) as a Walrasian model. As I have explained elsewhere (Rubin, 2016) following the contributions of Young (1987), Dimand (2007) or Barens (1999), IS-LM originates in the works of Keynes and is not Walrasian. What is lacking is a more careful discussion of the complex interaction between the pure theory of general equilibrium and the impure and simpler macroeconomic models.

References:

Acosta, Juan and Goulven Rubin (2019). “Bank Behavior in Large-scale Macroeconometric Models of the 1960s,” History of Political Economy, 51 (3): 471-491.

Barrens, I. (1999) “From Keynes to Hicks – an Aberration? IS-LM and the Analytical Nucleus of the General Theory,” in P. Howitt et al (editors) Money, Markets and Method: Essays in Honour of Robert W. Clower, Cheltenham: Edward Elgar.

Dimand, Robert (2007) “Keynes, IS-LM, and the Marshallian Tradition,” History of Political Economy, 39 (1): 81-95.

Fisher, Irving (1933). “The Debt Deflation Theory of Great Depressions,” Econometrica, 1(4): 337-357.

Gurley, John G. and Edward S. Shaw (1960). Money in a Theory of Finance, Washington: Brookings Institution.

Hicks, John R. 1937. “Mr Keynes and the Classics: A Suggested Interpretation,” Econometrica 5: 147-59.

Hicks, John R. [1939] 1946. Value and Capital. An Inquiry into Some Fundamental Principles of Economic Theory. Oxford: Clarendon Press.

Keynes, John Maynard (1931[1972]). “The Great Slump of 1930” in Essays in Persuasion, London, Macmillan, vol. 9 of The Collected Writings of John Maynard Keynes.

Keynes, John Maynard (1936). The General Theory of Employment, Interest and Money, vol. 7 of The Collected Writings of John Maynard Keynes: London: Macmillan.

Kurz, Heinz (2006). “Whither the History of Economic Thought? Going Nowhere Rather Slowly?” European Journal of the History of Economic Thought, 13(4): 463-488.

Modigliani, Franco (1963). “The Monetary Mechanism and Its Interaction with Real Phenomena,” Review of Economics and Statistics, 45 (1): 79-107.

Rubin, Goulven (2016) “Oskar Lange and the Walrasian Interpretation of IS-LM,” Journal of the History of Economic Thought, 38 (3): 285-309.

Young, Warren (1987) Interpreting Mr Keynes: The IS-LM Enigma, Cambridge: Polity Press.

 

Goulven Rubin is Professor at Sorbonne School of Economics, University Paris 1 Panthéon-Sorbonne, and Deputy Head of laboratory PHARE. He is a specialist of the history of macroeconomics and the author of articles on Don Patinkin, John Richard Hicks, Oskar Lange, Franco Modigliani and the IS-LM model.

Copyright (c) 2020 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator (administrator@eh.net). Published by EH.Net (June 2020). All EH.Net reviews are archived at http://www.eh.net/BookReview.

Subject(s):History of Economic Thought; Methodology
Geographic Area(s):General, International, or Comparative
Time Period(s):20th Century: Pre WWII
20th Century: WWII and post-WWII

The Story of Silver: How the White Metal Shaped America and the Modern World

Author(s):Silber, William L.
Reviewer(s):Richardson, Gary

Published by EH.Net (January 2020)

William L. Silber, The Story of Silver: How the White Metal Shaped America and the Modern World. Princeton: Princeton University Press, 2019. xx + 340 pp. $30 (cloth), ISBN: 978-0-691-17538-6.

Reviewed for EH.Net by Gary Richardson, Department of Economics, University of California at Irvine.

 

Silver’s “power to provoke passion and fury in the American heartland” should have convinced the Warren Commission to investigate whether John F. Kennedy was assassinated “for downgrading the silver subsidy” (p. 104). This provocative point and a series of stories about the precious metal appear in William Silber’s The Story of Silver: How the White Metal Shaped America and the Modern World.

Silber’s book on silver is entertaining and enlightening. It is published by a university press and has the apparatus of a technical tome, including 64 pages of footnotes and nine pages of bibliography. It should, however, appeal to a wide audience, including anyone interested in American or financial history or who likes to read a well-written story. Silber is an amazing architect of palatable prose. He grabs readers’ attention and keeps them turning pages by incessantly inserting intriguing anecdotes and amusing asides.

Silver’s story is worth telling. The white metal serves as a store of value and means of payment. It has important uses in electronics, photography, housewares, and jewelry. Silver coins and bullion formed the monetary foundation for many regions of the world, including Europe from the fifteenth through eighteenth centuries and China and the Middle East well into the twentieth century. Debates about silver’s monetary use played a large role in the history of the United States, beginning before the founding of the republic and continuing through Great Depression. Silber’s book focuses on the U.S. experience.

The first tenth of the text takes the tale from Alexander Hamilton through William Jennings Bryan. As the first Secretary of Treasury, Hamilton took the lead among the Founding Fathers constructing the U.S. monetary system. He established a bimetallic standard, in which gold and silver served as legal tender. He hoped both gold and silver would circulate. The latter’s abundance would promote economic growth and price stability, in an era when scarcity of coins often generated deflation. Increases in the mint price of the yellow metal, Gresham’s law, the Coinage Act of 1873, and the Gold Standard Act of 1900, however, meant that gold served as the medium of exchange in America throughout the nineteenth century and twentieth centuries.

William Jennings Bryan was the most famous of the politicians who urged returning to a bimetallic standard. Byran represented the mass of Americans living west of the Mississippi, who believed that more circulating currency would bring higher prices for crops, livestock, and farmland, helping them to pay the mortgages on their farms and machinery. Bryan’s “Cross of Gold” speech at the Democratic convention in July 1896 asserted that free coinage of silver would promote prosperity for the common man and free the U.S. from subservience to the gold-standard nations in Europe.

Silber’s concise coverage of nineteenth-century American monetary history is fun to read. I have decided to assign these chapters to the undergraduates in my class on American monetary history, because many of them refuse to read boring books on the topic. Silber’s treatment covers key historical points, clearly explains the forces underlying the monetary system, and rivets readers’ attention. The material is not novel and requires some caveats that I will discuss later, but nothing this entertaining has been written on the topic since Frank Baum penned The Wizard of Oz as a monetary allegory.

The second storyline spans Chapters 4 through 8, or about one-fifth of the book. It involves China, Japan, and the Roosevelt administration’s monetary policies. The historical information in these chapters is novel. You will not find the story told completely, or at all, in books and articles about this era or in widely used textbooks on American history. The story is also important, because it illuminates a clear case where political institutions set up long ago profoundly influenced world events in ways which could not have been anticipated at the moment of creation.

Franklin Roosevelt became president during the depths of the Great Depression. The economy had collapsed because a shortage of money lowered prices, raised interest rates, bankrupted households and firms, and dislocated industry and trade. Roosevelt campaigned on a promise to raise prices back to the level they had been before the onset of the contraction. To fulfill his promise, Roosevelt needed to resuscitate the banking system and expand the money supply, which would, in turn, raise prices, lower interest rates, encourage consumption, and increase investment. Roosevelt’s efforts focused on the financial system, the Federal Reserve, and the gold standard. Silber’s depiction of these events resembles that in standard history textbooks, although he keeps his account lively by gossiping about the personal lives of the protagonists. Roosevelt, for example, after being stricken with polio in 1921 and withdrawing from public life to battle the disease, failed at “a number of business ventures during the 1920s, but the outcomes were as predictable as if a crown prince were running a flea market. FDR’s misadventures included investing in a fleet of blimps to fly passengers from New York to Chicago, introducing vending machines that dispensed premoistened postage stamps, trading in the German mark, and trying to corner the live lobster market. His losses in lobsters should have restrained his foray into manipulating the silver market after he was elected president in 1932, but he never made the connection” (p. 39). In my opinion, self-adhesive stamps were actually a good idea, although perhaps ahead of their time. Given the difficulties of devising glue with suitable properties, the United States Postal Service introduced the its first successful self-adhesive stamp in 1989.

During Roosevelt’s race to resuscitate the American economy, silver was a sideshow. Roosevelt signed the Silver Purchase Act, which authorized the Treasury to buy huge quantities of the metal at gradually increasing prices, and then to use that silver to back currency in circulation. These purchases may have marginally increased the money supply but were not necessary for resuscitating the monetary system. Reforming the gold standard and rescuing the banking system accomplished that task. Silver purchases were, however, necessary to convince senators from Western, silver-mining states to support Roosevelt’s political program. These senators had political influence in Washington, where they chaired key Congressional subcommittees and controlled votes needed to pass the New Deal through Congress.

High school and college history textbooks mention Roosevelt’s silver policies in passing, if at all. The same is true for most scholarship on the subject. Silber shows that this minor event in America played a central role in world affairs and had a huge impact on the lives of one-quarter of humanity. Silver was the foundation of China’s monetary system. China’s currency was backed by silver, not gold as in most of the rest of the world. America’s campaign of massive silver purchases raised the price of silver on the world market. Silver’s skyrocketing price deflated China’s economy. High silver prices encouraged investors to withdraw silver from Chinese banks and sell it in London. China’s money supply declined, as did prices and incomes. Rising silver prices also increased the value of China’s currency, the yuan, in foreign exchange markets, which reduced China’s exports to the rest of the world where currency was not based on a silver standard.

The silver shock put China in desperate straits. China’s economy could not bear the strain from the silver drain. China’s central bank and financial system lacked the skills and knowledge to alleviate the affliction. China’s economic depression deepened. Unrest spread. China’s central government was already fighting on several fronts. A communist insurrection festered in the hinterland. Regional warlords sought to increase their authority at the expense of the national government. Japanese armies, which already occupied north-eastern China, renewed their advances in coastal, central, and southern China.

The Roosevelt administration was warned that its silver policies, which were put in place to purchase the allegiance of a few senators from silver-mining states and to appeal to Democratic voters who still believed in the mythical powers of silver touted by turn of the century populists such as William Jennings Bryan, would weaken China and facilitate Japan’s expansion. Domestic politics, however, overrode international possibilities. China’s weakened condition encouraged Japanese aggression. To protect China, the Roosevelt administration eventually embargoed shipments of oil and other raw materials destined for Japan. To break the embargo, Japan attacked Pearl Harbor, the Philippines, and United States and Allied possessions throughout the Pacific. Japan’s offensive brought the United States into World War II and eventually brought the Communist Party to power in China. This important and insightful story is the heart of Silber’s book. It should be more widely known and taught. The book convinced me that I should include this information in courses that I teach on economic history.

The next chapter discusses silver’s use during World War II. The take-away point is that silver conducts electricity well. The United States had lots of silver stockpiled at the United States Military Academy at West Point, New York. The Treasury lent much of this metal to the Manhattan District of the Corps of Engineers to help produce atomic bombs. So, Roosevelt’s silver purchase policies, which induced silver to flow from Beijing to New York and London, weakened China, and facilitated Japan’s expansion in Asia, also helped the United States build Little Boy and Fat Man, the atomic bombs dropped on Hiroshima and Nagasaki, which convinced Japan to withdraw its troops from China and surrender to the Allied coalition.

After the book discusses the demonetization of silver during the Kennedy administration and the role this had in the Kennedy assassination, the tone changes. The book stops discussing silver’s use as a means of payment and begins discussing its use as a speculative asset. A lot of information is packed in this portion of the text, which spans about forty percent of the book. These chapters describe how commodity markets function and the strategies of famous men who speculated in silver. They also provide investment advice.

A focus is the Hunt brothers, some of the richest men in America, who tried and failed to get even richer by cornering the market for silver. Another notable character is the investment sage from Omaha, Warren Buffett. These chapters are entertaining mainly for their gossip about and character studies of famous and infamous investors. These chapters remind me of the novel Crazy Rich Asians, but the cast of characters is a bunch of rich white men with colorful backstories, profligate tastes, and more greed than good sense (with the exception of Warren Buffett, who just has good sense). Another apt comparison would be the television franchise Real Housewives, but with a focus on rich husbands, their over-the-top investment antics, and their conspicuous consumption.

Overall, the book is entertaining, contains novel insights, and is well researched. I will recommend it to friends and assign portions to my undergraduate students. My students may need guidance, however, on how to interpret portions of the text. The book is filled with metaphors, analogies, funny phrases, wry humor, and outlandish conjectures. Silber writes, for example, that the tension leading to the duel between Aaron Burr and Alexander Hamilton “probably” began because one studied at the College of New Jersey, now Princeton University, and the other studied at King’s College, now Columbia University, making them “natural Ivy League rival[s].” When I read this, I understood it was a joke. Respected biographies of Burr and Hamilton do not indicate that college rivalries played a role in their animosity. Silber’s version of events could not be true, literally, since the Ivy League’s existence (and the use of the term) began in the twentieth century. An undergraduate with less knowledge of American history, however, might miss the humor, believe the statement, and remember it, because readers tend to remember the provocative over the mundane.

A similar danger lies in the hook that reels readers into the Kennedy chapter. I mentioned it at the beginning of this review: “the theory that Kennedy was murdered because he demonetized silver.” The chapter begins and ends with the theory. The last two sentences are: “However, murder for the sake of silver dollars seems excessive, a primitive response to a commercial conflict, perhaps understandable in the more violent nineteenth century but inconsistent with the more civilized twentieth. Or not?” (p. 118). Or not what, I wonder. The only place in this universe where the silver-policies-killed-Kennedy conspiracy theory exists is in the eleventh chapter of this book. The book cites no historical evidence of the idea. A footnote indicates the Warren Commission did not mention the theory among its catalogue of rumors, contentions, claims about, and potential causes of Kennedy’s assassination. The purpose of this provocative claim is to raise eyebrows and increase readership. It serves that purpose well, because it is not just untrue but absurd.

I worry, however, that readers who do not get the humor might take this claim seriously, particularly given its prominence and repetition in an academic book written by a famous scholar. We live in a world where conspiracy theories flourish. Fiction spreads faster than fact. The book contains numerous claims like the Kennedy conspiracy theory that could be misconstrued. As a reviewer (and a professor who will assign part of this text to his students), I want to give readers simple rules that will help them separate fact from fiction. I derive the rules from two observations. One, the author knows what is true and what is not. He indicates spuriousness with adverbs expressing uncertainty, such as perhaps, probably, and possibly. So, readers should be skeptical of all claims in sentences with adverbs like that. These claims are often false. Two, the author keeps readers’ attention by constructing paragraphs whose last sentences are intriguing and provocative. So, readers should also be wary of claims in the last sentences of paragraphs. They are often hyperboles or embellishments open to misinterpretation. Overall, readers should realize that when the last or second-to-last sentence in a paragraph contains an adverb expressing uncertainty, then the conjectures or claims in those sentences have no basis in fact. Ignore these sentences, I will instruct my students. Cross them out.

With that minor caution in mind, Silber’s book is insightful and enjoyable. It deserves to be widely read, particularly the chapters on Roosevelt’s silver policies and their impact on China. These chapters raise questions about the nature of the United States and why our political system at times pursues policies that benefit small groups of our citizens at the expense of not just the rest of our nation but the rest of the world.

 
Gary Richardson is the author (with Mark Carlson and Kris Mitchener) of “Arresting Banking Panics: Federal Reserve Liquidity Provision and the Forgotten Panic of 1929,” Journal of Political Economy.

This review was originally published in Regulation, Summer 2019.

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):General, International, or Comparative
North America
Time Period(s):18th Century
19th Century
20th Century: Pre WWII
20th Century: WWII and post-WWII

The Bretton Woods Agreements: Together with Scholarly Commentaries and Essential Historical Documents

Editor(s):Lamoreaux, Naomi
Shapiro, Ian
Reviewer(s):Wandschneider, Kirsten

Published by EH.Net (December 2019)

Naomi Lamoreaux and Ian Shapiro, editors, The Bretton Woods Agreements: Together with Scholarly Commentaries and Essential Historical Documents. New Haven: Yale University Press, 2019. xii + 496 pp. $29.50 (paperback), ISBN: 978-0-300-23679-8.

Reviewed for EH.Net by Kirsten Wandschneider, Department of Economics, Occidental College.

 
In times where countries are retreating to isolation and international cooperation is on the wane, this collection of essays and historical documents on the Bretton Woods system, edited by Naomi Lamoreaux and Ian Shapiro (both Yale University) serves as an important reminder of the challenges, and rewards of international economic cooperation. The book follows previous titles in the series “Basic Documents in World Politics” edited by Ian Shapiro and coauthors, which reissues foundational texts in world politics. The current title consists of a collection of key documents on the Bretton Woods agreements, paired with twelve academic articles written by scholars in the field that situate the texts in the context of today’s international monetary order.

The historical documents compiled in this volume include not only the International Monetary Fund (IMF) articles of agreement, the White Plan, the Keynes Plan and the French Plan, but also the Australian Employment Agreement, the Final Act as well as key speeches and debates surrounding the Bretton Woods system. An extensive glossary of key terms makes the volume accessible to newcomers in the field.

The articles in this book are grouped into four themes, ranging from the historical context in which the Bretton Woods system emerged, to its conception, a discussion of alternative visions of a post World War II monetary order, and a discussion of its dissolution and legacy. They incorporate a broad range of perspectives that summarize the current state of knowledge and interpretation of the Bretton Woods documents, but also raise questions and potentially map a future research agenda.

In the first essay, Jeffrey Frieden lays out the historical context for the Bretton Woods system, drawing on both the success of the classical gold standard and the challenges of the interwar years. Frieden also introduces the key figures that played a critical role in the Bretton Woods negotiations. The two most important delegations — the U.S. and the UK delegations, represented by Harry Dexter White and John Maynard Keynes — had fundamentally different visions for the Bretton Woods system. They stemmed from their countries’ status of being the most prominent surplus and the largest debtor country at the end of the war. Keynes’s and White’s disagreement mostly centered on the role of the IMF: the U.S. was concerned that the IMF would be too generous in its international support, while British feared that the IMF would be too insistent on restrictive economic policies. However, the bargaining power was firmly on the side of the U.S. There was considerable agreement on the role of the World Bank.

The next chapter, by Barry Eichengreen, focuses on the pegged but flexible exchange rates that were at the heart of the Bretton Woods System. It explores the question of why the creators of the Bretton Woods system maintained a role for gold at the center of the system, and did not contemplate alternate agreements. This is especially puzzling, given that Keynes had already termed gold as a “barbarous relic” two decades prior, and policy makers at the time were aware of the deflationary challenges introduced by the inflexibility of the gold supply. Likewise, Robert Triffin recognized flaws in the system as early as 1947, but was not able to articulate an alternative. Eichengreen considers these remaining ties to gold the “original sin” of Bretton Woods (p. 38), which ultimately brought about the demise of the system.

In Chapter 3, Douglas Irwin further explores why the case of floating exchange rates was not taken seriously as a model for the Bretton Woods system. While the classical gold standard had been unique in delivering both external stability in the form of fixed exchange rates and internal stability in terms of stable domestic prices, the dilemma between these two expanded to the classical trilemma in the interwar years. Experience with floating rates had been limited to the years immediately after World War I — which were characterized by hyperinflation and instability — and the mid 1930s immediately after the abandonment of the gold exchange standard by Great Britain. Both periods had left their scars that rendered flexible rates not a viable alternative. Recognizing the need to set domestic policies, policy makers favored fixed but adjustable rates with exchange controls.

The next three chapters deepen the reader’s understanding of the debates as well as the constraints set by contemporary political and economic conditions around the inception of the Bretton Woods system. In chapter 4, James Boughton highlights the similarities of both the Keynes and the White plans for Bretton Woods. He characterizes both plans as essentially “Keynesian” since they affirmed a reconstruction of a cooperative international monetary order. However, they differed in their motivations for achieving this goal: Keynes’s vision for Bretton Woods focused on providing deficit countries with funds to rebuild while restricting surplus countries from amassing reserves. In contrast, White’s motivation for the restoration of multilateral trade and finance stemmed from the objective of constraining Britain from using restrictive practices to gain trade advantages.

Chapter 5, by Andrew Bailey, Gordon Bannerman, and Cheryl Schonhardt-Bailey, discusses the parliamentary debates in the UK surrounding Bretton Woods between 1943 and 1945. The British were naturally concerned about a shifting world order and the rising dominance of the United States, but recognized the economic benefits of a renewed international monetary system. They therefore confirmed the policy objectives that motivated Keynes in the negotiations. They also supported the re-affirmation of national discretion with respect to policy regarding the asymmetric adjustment obligation on debtor countries.

Chapter 6, by Michael Graetz and Olivia Briffault, discusses the French commitment to reinstate gold at the center of the international financial system. This chapter emphasizes the Tripartite agreement of 1936 between the U.S., UK and France, which included a commitment to free trade and stable exchange rates, and set the tone for the post-war Bretton Woods negotiations.

The next section of the book, which explores alternative visions and “paths not taken” for the Bretton Woods system raises issues that are least known to financial historians. Chapter 7, by Martin Danton, on nutrition, food, and agriculture extends the perspective on the Bretton Woods monetary order beyond the immediate financial concerns. Its discussion around nutrition emphasizes the need for broader development policy. Even though it did not yield concrete results at Bretton Woods, it set the stage for subsequent international development talks.

In Chapter 8, Selwyn Cornish and Kurt Schuler describe Australia’s full employment proposal, which would have established full employment as an explicit goal of international economic cooperation. Similarly to the previously discussed proposals on food and agriculture, Australia was unsuccessful in making full employment a central issue in the negotiations, but the exploration of what a counterfactual monetary order with such an explicit goal might have looked like proves engaging.

Chapter 9 again emphasizes that despite the common narrative that international development was not the focus of the Bretton Woods discussions, Bretton Woods included conversations about an early commitment to economic development. The creation of the International Bank for Reconstruction and Development (IBRD, later World Bank), while focused on post-war reconstruction was also designed to promote economic development, building on early work by the League of Nations. In fact, White included the focus of a multilateral development aid framework in his original plans for the Bretton Woods system.

The last segment of articles focuses on the operation of the Bretton Woods system, its dissolution, and its legacies for today. In Chapter 10, Michael Bordo describes the operation of the Bretton Woods system, especially the challenges concerning the asymmetries of the adjustment mechanism and the measures taken to support its operation. He also describes the collapse of the system, which eventually led to the establishment of the dollar-based international financial order that in essence has lasted to this day. For Bordo, the continuation of the current system hinges on the Federal Reserve’s ability to credibly commit to low inflation rates, since no other currency currently presents an alternative to the popularity of international dollar reserves.

Frances McCall Rosenbluth and James Sundquist present an international perspective on the collapse of the Bretton Woods system through the lens of Japan in Chapter 11. Fast export-led growth in Japan and a growing trade surplus with the United States, brought growing pressure to devalue the yen, which neither Japanese exporters nor politicians could agree to. Would the end of Bretton Woods have taken a different turn had Japan agreed to earlier revaluation? Rosenbluth and Sundquist pose this question, but consistent with the other chapters in the book conclude that it would have had no fundamental impact.

In Chapter 12, Harold James concludes and synthesizes the academic texts of the book by emphasizing Bretton Woods multiple contexts: the classical gold standard and the interwar experience which shaped its inception, and its post-1971 interpretation. He lauds Bretton Woods — despite its failings — as the only successful example of true multilateralism to establish the world’s monetary order.

This reiterates the key theme of the book: the idea that despite all the disagreements and conflicting interests regarding the structure of the Bretton Woods system, there was overwhelming agreement to build a multilateral international monetary system, and the recognition that such a system would be vital for international peace and economic prosperity.

 
Kirsten Wandschneider’s research areas include European monetary and financial history, international macroeconomics, and particularly the development of financial institutions and markets, such as the emergence of mortgage markets in eighteenth century Prussia.

Copyright (c) 2019 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator (administrator@eh.net). Published by EH.Net (December 2019). All EH.Net reviews are archived at http://www.eh.net/BookReview.

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):General, International, or Comparative
Europe
North America
Time Period(s):20th Century: WWII and post-WWII

Gold, the Real Bills Doctrine, and the Fed: Sources of Monetary Disorder, 1922-1938

Author(s):Humphrey, Thomas M.
Timberlake, Richard H.
Reviewer(s):Thies, Clifford F.

Published by EH.Net (October 2019)

Thomas M. Humphrey and Richard H. Timberlake, Gold, the Real Bills Doctrine, and the Fed: Sources of Monetary Disorder, 1922-1938. Washington: Cato Institute, 2019. xix + 201 pp. $21.21 (hardcover), ISBN: 978-1-948647-55-7.

Reviewed for EH.Net by Clifford F. Thies, School of Business, Shenandoah University.

 
Thomas M. Humphrey was a long-time research economist for the Federal Reserve Bank of Richmond with a penchant for the history of thought concerning monetary economics, and Richard H. Timberlake is a professor emeritus at the University of Georgia whose writings on money mainly concern the constitution of money, money and the U.S. Constitution, and other institutional arrangements for money. Their book is meant to debunk the “well-established” view that a slavish devotion to the gold standard condemned the United States and much of the rest of the world to the Great Depression. Instead of gold, the authors argue, the problem was the Real Bills Doctrine. Regardless of how persuasive they are in shifting the blame from gold to the Real Bills Doctrine, they tell a tale delicious in its detail, naming the names of those responsible.

According to Humphrey and Timberlake, John Law’s Bank of Mississippi was the first attempt to implement the Real Bills Doctrine (pp. 9-11). This bank, and other land bank schemes such as characterized the U.S. colonial period, may have had some connection to the Real Bills Doctrine, such as antecedents. However, the doctrine says that an appropriate backing for bank demand liabilities is short-term, “self-liquidating” loans collateralized by goods in transit and other such evidences of real activity. Land, not being self-liquidating, would not be appropriate. In addition to the heterogeneity of land, the value of land is speculative because it is based on the present value of its future services. Speculative assets, according to the Real Bills Doctrine, are not appropriate to back bank demand liabilities. Nor would state-issued or railroad-issued bonds be good backing for banknotes, as was mandated by various states during the Free Bank Era, because their values, too, are speculative. Nor would U.S. Treasury bonds as was allowed during the National Bank Era. The market values of long-term bonds and mortgages, even those that are substantially free of the risk of default, are dependent on interest rates and, therefore, are not appropriate to back bank demand liabilities. The misadventure of John Law has been repeated many times since his day, sometimes with banks, sometimes with depository institutions, and most recently with “shadow banks.” But land banks are more like the opposite of the Real Bills Doctrine, than an example.

A good example of the Real Bills Doctrine in conjunction with an operational gold standard was the chartered banks of Louisiana from 1845 to 1861. These banks backed their demand liabilities with a specie reserve of one-third and the remainder by bills of exchange, discounted commercial paper, and other short-term loans. Crucially, as Humphrey and Timberlake repeatedly state in conjunction with the bank panics of the 1930s, the specie reserve of the Louisiana chartered banks was only an initial reserve. During a bank panic, banks could pay out the specie in their vault. If the run on the banks wasn’t directly ended by the paying out of specie, the coming-due of a bank’s short-term loans (which could be paid in the banknotes of that bank or in specie) would either sop up the remaining banknotes in circulation or provide the specie needed to redeem those banknotes. None of the chartered banks of Louisiana suspended during the Panic of 1857, while the several Free Banks of the state suspended (albeit for a short time). Of course, Louisiana being on the losing side of the Civil War couldn’t provide the model for the National Bank Era. New York with its Free Banking system (based on bond collateral) did. As Humphrey and Timberlake correctly argue, the Real Bills Doctrine by itself wasn’t the culprit for the Great Depression (p. xiii). When operated in conjunction with an operational gold standard, as the Louisiana chartered banks did, the doctrine is innocuous. It is when the Real Bills Doctrine operates in a vacuum, without a commodity-money anchor, that something bad will inevitably happen.

The reason something bad will inevitably happen with the Real Bills Doctrine detached from an operational gold standard is, at one level, obvious, and, at another level, sophisticated. The obvious problem with the doctrine is that it links one nominal variable (the money stock) to another nominal variable (the money-value of qualifying loans), leaving the price level indeterminant (p. 5). The sophisticated argument, captured in the one diagram in Humphrey and Timberlake’s book (p. 24), is that the system is unstable. A move to inflation brings about more inflation, and a move to deflation brings about more deflation. During a hyperinflation, because the velocity of money accelerates, there is a shortage of money, requiring more money to prevent recession. Knut Wicksell called this or something like it the accumulation process; Milton Friedman, the accelerationist hypothesis; and, Friedrich Hayek, a tiger by the tail. The book describes this instability in the case of the German hyperinflation of the 1920s (p. 22). We are currently seeing this instability in Venezuela. The key argument of the book is that this instability works in both directions, downward as well as upward, and explains the deflation that accompanied the Great Depression, as well as various episodes of hyperinflation.

Part of the reason the money supply spirals downward as well as upward is because of fractional reserve banking (p. 28). Every dollar withdrawn from a bank results in a multiple contraction of the money stock. At this point, it is important to distinguish between what is today called base money, or M0, and what is called the money stock or money supply, or M1. Humphrey and Timberlake use the term “common money” to refer to the latter (and perhaps something more). The Real Bills Doctrine justifies fractional reserve banking because it says that real bills and not merely base money can be used to back bank demand liabilities. During the 1920s and early ‘30s, the monetary base consisted of gold coins and Gold Certificates, Silver Certificates and U.S. Notes outside the Fed, Federal Reserve Notes, reserves of banks held on deposit at the Fed, and limited legal tender subsidiary coins, mostly silver. The U.S. Notes were fixed in their supply, as essentially were also the Silver Certificates and coins. The dynamics of the fractional reserve system played out in the fractional backing of Federal Reserve Notes and bank reserves by gold, and by the fractional backing of bank demand and time liabilities by the base money in their vaults and their reserves held on deposit at the Fed. During good times, there was a tendency for the banking system to increase the money multiplier, and during bad times, to decrease it. By tracking the monetary aggregates, central banks can counteract these destabilizing tendencies, but the Fed did not track the monetary aggregates at the time. William McChesney Martin during the 1950s characterized the practice of counteracting destabilizing tendencies by saying the Fed should “lean against the wind.” But, unabashed Real Bills-central bankers run with the wind, instead of lean against the wind.

The real culprit precipitating a downturn in the monetary aggregates, however, wasn’t an automatic tendency. It was an explicit decision to suppress “speculation” made by a narrow majority of the Board of Governors of the Federal Reserve led by Adolph C. Miller, overriding the Federal Reserve Bank Presidents, the Federal Advisory Council, and many prominent private bank presidents. Pages 77-85 are the most engaging part of the book. Although the authors do not say so explicitly, by using terminology such as “an evangelical crusade,” they imply that Miller was from the populist and anti-bank wing of the Democratic Party. From the diary of a member of the Federal Reserve Board who served with him, it appears Miller was self-righteous and dogmatic. This is the impression I got reading the referenced articles by Miller justifying the actions of the Fed. That and a whiff of a backstop defense that the Board was compelled to take the actions it took because of the Federal Reserve Act of 1913.

According to the authors, it was the Fed’s actions to suppress “speculation” that precipitated the Stock Market Crash of 1929, and it was the Fed’s slavish devotion to the Real Bills Doctrine that allowed the monetary aggregates to subsequently spiral downward, taking the economy with it. But, this story, even if its fixes the blame, might not fully exonerate gold. Historically, the problems of inflation and deflation have usually been associated with war. In this country, the problems of post-war adjustment include the messy resumption that followed the War of 1812, and the “Grow to Gold” policy following the Civil War that involved a protracted period of deflation and a series of financial panics. Following the Great War, subsequently renamed World War I, there was a significant post-war deflation, but prices were stabilized at a level higher than pre-war. A second bout of deflation might have been necessary or perhaps there was a more creative solution. As other nations sought to return to the Gold Standard, something was going to have to give. The unfinished job of post-war adjustment didn’t mean, however, that we were condemned to the utter calamity that was the Great Depression.

 
Clifford F. Thies is the Eldon R. Lindsey Chair of Free Enterprise and Professor of Economics and Finance at Shenandoah University. He has recently written on debt repudiation by Mississippi (The Independent Review).

Copyright (c) 2019 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator (administrator@eh.net). Published by EH.Net (October 2019). All EH.Net reviews are archived at http://www.eh.net/BookReview.

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):North America
Time Period(s):19th Century
20th Century: Pre WWII

American Default: The Untold Story of FDR, the Supreme Court, and the Battle over Gold

Author(s):Edwards, Sebastian
Reviewer(s):Richardson, Gary

Sebastian Edwards, American Default: The Untold Story of FDR, the Supreme Court, and the Battle over Gold. Princeton: Princeton University Press, 2018. xxxiii + 252 pp. $30 (cloth), ISBN: 978-0-691-16188-4.

Reviewed for EH.Net by Gary Richardson, Department of Economics, University of California at Irvine.

 
The risk-free rate of return on investments is often considered to be the yield on United States government debt. “The risk-free rate is hypothetical,” Investopedia indicates, “as every investment has some type of risk associated with it. However, T-bills [United States Treasury debt obligations with a maturity of 52 weeks or less] are the closest investment possible to being risk-free for a couple of reasons.” The first is “the U.S. government has never defaulted on its debt obligations, even in times of severe economic stress.” Similar statements appear in Wikipedia’s entry on the risk-free interest rate as well as in scores of economics and finance textbooks used around the world. Sebastian Edwards’ new book, American Default: The Untold Story of FDR, the Supreme Court, and the Battle Over Gold, questions this concept underlying modern financial markets by asserting that the United States defaulted on federal debt during the 1930s, when it withdrew monetary gold from circulation and abrogated the gold clause in contracts, both public and private.

Before I delve into the details of Edwards’ insightful study, I want to give you an overall assessment of the book It is fascinating, well-written, and thoroughly researched. It provides new perspective on an important era of American history. It discusses the ideas, personalities, politics, economics, and finance underlying the principal policies by which the Roosevelt administration resuscitated the United States economy after the catastrophic contraction of the early 1930s. An academic press published the book, but the clarity of its prose and vividness of the narrative make it accessible to a general audience. The book should and will be widely read. It’s worth pondering and debating, and I will debate some aspects of it later in this review.

Edwards’ book asks provocative questions about fundamental features of the U.S. and international financial systems. The author lists these questions at two points in the book: the end of the introduction and beginning of the conclusion. The lists contain fifteen total queries. A short summary is:
• Did the United States default on federal government debt in 1934 when it abrogated the gold clause for government bonds (particularly the fourth Liberty Bond)?
• Why did the federal government abrogate the gold clause? Was this action necessary?
• Who made the key decisions during this episode and how did they justify their actions?
• What were the consequences for investors and for the economy as a whole, both in the United States and abroad?
• Could this happen again?

Edwards answers these questions over the course of 17 chapters plus an introduction, an appendix, a timeline, and a list describing the men around whom the story revolves. The introduction lays out the issues of interest. Chapters 1 through 15 narrate the story. The narrative revolves around policymakers, such as President Franklin Roosevelt, Senator Carter Glass, and members of the Supreme Court, and the men who advised them, including Roosevelt’s Brain Trust, whose initial members included Raymond Moley and Adolf Berle, law professors from Columbia University and Rexford Tugwell, an economics professor at Columbia. The narrative describes the decisions that these men made (or had to make), their rationales for making these decisions, and the state of knowledge and state of the world at the times the men made these decisions.

The narrative starts in March 1932, during the economic downturn now known as the Great Depression. A few pages describe the poverty and desperation imposed upon people from all walks of life. Nearly a quarter of the labor force experienced unemployment. Commodity prices declined more than half. These declines proved particularly hard on men and women running small businesses, such as family farmers who made up a quarter of the United States population. Declining farm prices accentuated farmers’ debt burden, since the nominal value of debts remained fixed. This forced farmers who wanted to pay their mortgages and crop loans to double production (which was often impossible) or cut consumption (particularly of durable goods like cars, radios, and clothing) — and forced other farmers (and eventually almost all farmers) to stop paying their debts, default on their loans, and face bankruptcy, which often resulted in the loss of lands and livelihoods.

Chapters 1 through 4 cover Roosevelt’s campaign platform and policies and the economic turmoil from November 1932 through February 1933. During these last five months of the Hoover administration, a nationwide panic drained funds from the banking system and gold from the vaults of the Federal Reserve. The public feared for the safety of deposits, and rushed to convert their claims against banks into coins and cash. The public (particularly foreign investors) also feared for the value of the dollar, since they anticipated that the Roosevelt administration might lower the gold content of U.S. currency or leave the gold standard all together, as had Britain and numerous other nations. In March, gold outflows forced the Federal Reserve Bank of New York below its gold reserve requirement. To prevent the New York Fed from shutting its doors, the newly inaugurated President Roosevelt declared a national banking holiday. This segment of the story ends by describing the policies that the Roosevelt administration implemented as it resuscitated the financial system and sparked economic recovery.

This review will not go into details about decisions and the logic underlying them. For that information, you should read the book, which presents the materials cogently and clearly. You may also peruse other recent readable treatments on the topic, including The Defining Moment (Alter, 2006), FDR: The First Hundred Days (Badger, 2008), Nothing to Fear (Cohen, 2009), and Freedom from Fear (Kennedy, 1999). All of these cover similar material and reach similar conclusions. I also recommend the memoirs of Herbert Hoover and Roosevelt’s principal advisors. A list appears in Edwards’ bibliography. To it, I recommend adding the memoir of Jesse Jones, who was head of the Reconstruction Finance Corporation, Fifty Billion Dollars: My Thirteen Years with the RFC (1951).

Chapters 5 through 10 describe the Roosevelt administration’s efforts to help the economy recover from the spring of 1933 through the winter of 1934. The administration believed a key cause of the catastrophic contraction was the devaluation of the dollar and decline in prices — particularly of farm commodities — that occurred during the 1920s and early 1930s. Prices of wholesale goods fell an average of 25% between 1926 and 1933. Consumer prices fell by the same amount. The average price of farm crops fell more than 66%. Declining prices made it difficult for farmers and other producers to earn sufficient profits to pay their debts, which were fixed in nominal terms, forcing families and firms to cut consumption and investment, in order to avoid bankruptcy, or forcing families and firms to default on their debts, which was often worse for them and which also put banks out of business, restricting the availability of credit, triggering banking panics, and leading to further economic contraction. The administration sought to alleviate this cycle of debt-deflation by convincing (or forcing) individuals and firms to redeposit funds in banks, encouraging banks to lend, and refilling the Federal Reserve’s vaults with gold. All of these actions would expand the money supply and eventually raise prices.

The administration also sought to speed the process by directly influencing commodity prices, particularly those traded on international markets, which had fallen substantially due to foreign governments’ decisions to devalue their own currencies, usually by abandoning the gold standard and allowing the price of their currencies to be determined by market forces. The quickest way to raise commodity prices and alter the exchange rate was to change the dollar price of gold. The federal government had lowered and raised gold’s dollar price in the past. The constitution provided Congress with the power to do so. Congress authorized the president to act, by raising the dollar price of gold up to 100% (or synonymously by cutting the gold content of dollar coins up to 50%), with the Thomas Amendment to the Agricultural Adjustment Act in May 1933. The Roosevelt administration used these powers to the utmost, periodically and persistently raising gold’s dollar price from the spring of 1933 through the winter of 1934. Roosevelt’s gold program concluded in January 1934, with the passage of the Gold Reserve Act, which set gold’s official price at $35 per troy ounce.

Gold clauses in contracts impeded this policy. An example was printed on Liberty Bonds: “The principal and interest hereof are payable in United States gold coin of the present standard of value.” Clauses like this were common in public and private contracts. Their intent was to protect creditors from declines in the value of currency or inflation, which is the same phenomenon but stated as an increase in the average price of goods. Gold clauses ensured lenders that they would be repaid with currency or gold coins with the same real value, in terms of the goods and services that they could purchase, as the funds that they had lent.

Gold clauses had a pernicious effect, however, when deflations and devaluation decisions of foreign governments reduced prices and economic activity. Then, gold clauses prevented governments from quickly and effectively remedying the situation by altering the money supply, interest rates, exchange rates, and prices to push the economy back toward equilibrium. In Chapter 16, Edwards admits monetary expansion was the optimal policy to pursue. He “strongly” believes it was the “main force behind the recovery” (p. 188). He indicates, correctly, that this is the consensus of scholars who have studied the issue. He offers no alternative. The Roosevelt administration understood this problem, and on May 29, convinced Congress to void gold clauses in all contracts retroactively and in the future.

Chapters 5 through 10 do a good job of conveying this material and describing the thought-process of the Roosevelt administration as it struggled to make difficult decisions in real time with limited information. The chapters reflect the conventional wisdom found in canonical accounts of this period including Milton Friedman and Anna Schwartz’s (1960) Monetary History of the United States, Peter Temin’s (1989) Lessons from the Great Depression, and Barry Eichengreen’s Golden Fetters (1992). The chapters also do a good job of describing concerns and criticisms of Roosevelt’s recovery plans. Perhaps as a narrative device, the chapters do not tell you who was right. That material appears one hundred pages later in Chapter 16.

Chapters 11 to 15 contain the novel part of the narrative. They describe investors’ reactions to Roosevelt’s gold policies and the abrogation of the gold clause. Investors quickly sued in state and federal courts, demanding that borrowers repay debts with gold coin, as required by gold clauses, rather than currency, as determined by Congress. Courts consistently ruled against plaintiffs, usually indicating that the Constitution gave Congress the power “to coin money and regulate the value thereof” and to determine what was legal tender for the discharge of public and private debts. Plaintiffs appealed these decisions, and the cases quickly reached the Supreme Court.

American Default’s coverage of these court cases is seminal and stimulating. I know the literature on this topic well. As the official Historian of the Federal Reserve System, I wrote essays on “Roosevelt’s Gold Program” and the “Gold Reserve Act of 1934” which appear on the Federal Reserve’s historical web site. I have read much of what scholars have published on this topic. I know of no comparable source for information on these court cases, the arguments presented by the plaintiffs and defendants, and the rationale underlying the Supreme Court’s confusing decision that Congress’s abrogation of the gold in private contracts was constitutional while Congress’s abrogation of the gold clause for government bonds, particularly the Liberty Bonds, was constitutional in some ways but unconstitutional in others, did not harm the plaintiffs, and therefore would not be overturned by the courts.

Now, we get to one point on which I disagree with the author. Edwards clearly believes the United States federal government defaulted on its debts. The Supreme Court equivocated, but generally seemed to think that the United States did not default, and I agree with the Supreme Court. Let me explain.

Merriam-Webster’s dictionary defines a default as either a (1) failure to do something required by duty or law or (2) a failure to pay financial debts. The United States Supreme Court decision in the gold cases indicated that the federal government defaulted in the first sense. It did not fulfill a promise printed on the bonds, which was to literally repay bondholders with United States gold coins at the standard of value that prevailed when the bonds were issued in 1918. At that time, the basic gold coin was the Eagle. It was worth $10 and contained 0.48375 troy ounces of gold and 0.05375 troy ounces of copper. So, a Liberty Bond with a face value of $100 promised upon maturity payment of 10 gold Eagles containing a total of 4.8375 troy ounces of gold and 0.5375 troy ounces of copper. When Liberty Bonds matured in 1938, however, the government gave bondholders neither the Eagles nor the metals that they contained.

The Supreme Court ruled that the federal government did not default in the second sense. The government fully paid its financial debts. The latter conclusion requires explanation, particularly because the book emphasizes the “American Default” aspect of the Supreme Court’s decision. The Supreme Court justified this conclusion based upon two arguments originally advanced by the federal government. The first argument began with the fact that in 1933, the federal government had withdrawn all monetary gold from circulation and paid in return paper currency at the standard of value which had prevailed since 1900. This meant that an individual holding 10 Eagle coins had to give them to the government and accept $100 in paper currency in return. The government argued that Liberty bond holders could and should be treated the same way as everyone else in the United States. In a hypothetical scenario, when the bonds matured, the government would pay bondholders the gold coins as promised, but then the government would also immediately confiscate those coins and compensate the former bondholders with currency at the same rate as everyone else had been compensated a few years before. This hypothetical sequence of transactions was legal. The U.S. Constitution enumerated Congress’s power to determine the standards of coinage and legal tender. These enumerated powers enabled Congress to convert gold coins to paper currency and/or redefine the standards of value and objects accepted as payment for public and private debts. If the government executed this hypothetical sequence of transactions when the bonds matured in 1938, an individual who had purchased a $100 Liberty Bond in 1918 would in the end receive $100 in currency. The Supreme Court ruled that it was acceptable for the government to give that currency directly to the bondholders upon maturity, rather than go to the hassle of giving them gold coins, taking them back, and then paying the currency to them.

To understand the second argument that abrogating the gold clause did not involve a financial default, it may help to step back from the legal technicalities and think of the repayment in an economic sense. The purpose of the gold clause was the protect bond holders from a fall in the value of American currency, a phenomenon known as inflation. The clause promised that individuals who invested in the United States would be repaid with dollars whose real value in terms of goods and services was equivalent to the real value of the dollars with which they purchased the bonds. Did the United States government do this? The answer is yes. The purchasing power of the dollar rose four percent between 1918, when the fourth Liberty Bond was issued, and 1938, when the fourth Liberty Bond matured. So, an American citizen who in 1918 purchased a $100 Liberty Bond received in 1938 funds sufficient to purchase goods and services that would have cost $104 in 1918. The government also paid 4.5% interest each year along the way. So, the government did honor its pledge to maintain the purchasing power of the funds entrusted to it by purchasers of Liberty Bonds and return that to them plus interest.

What about foreigners? They owned many U.S. bonds. The largest group of foreign investors were English. Their position is worth considering. In October 1918, when the Liberty Bonds were issued, the dollar-pound exchange rate was 4.77. An English investor could exchange ₤1 for $4.77 and purchase a $100 Liberty Bond for ₤20.96. In October 1938, when the Liberty Bonds matured, the dollar-pound exchange rate was 4.77. So, an English investor who redeemed his bond for $100 in U.S. currency could convert that into ₤20.96, exactly what they had paid for it, and with those funds, they could buy goods which would have been valued at ₤46.69 in 1918, since the purchasing power of the pound had risen substantially since that time. So, English investors, like many others overseas, made large profits from investing in Liberty Bonds.

Plaintiffs in the gold clause cases before the Supreme Court hoped that their suit would allow them to reap even higher returns. They argued that the government should be required to pay them with old gold coins, like the Eagle, at the 1918 standard of value, and then they should be able to convert the Eagles to dollars at the price established by the Gold Reserve Act of 1934 ($35 per troy ounce of gold). The government countered that this plan was infeasible. There was not enough gold in the U.S. to pay gold to all Liberty Bond holders. That plan was also illegal. The law no longer allowed the public to own, save, or spend monetary gold. In that case, the plaintiffs argued, they should receive the amount which would result from a hypothetical sequence of transactions where the government gave them gold coins at the 1918 standard of value (as stated on the bonds) and then immediately converted that gold to currency at the 1934 standard of value. This sequence would pay $166.67 on a $100 Liberty Bond upon maturity in 1938, a sum sufficient to purchase goods and services which would have cost $174.19 in 1918. The majority of the Supreme Court rejected this claim and referred to it as unjust enrichment.

Chapter 16 discusses the consequences of the abrogation of the gold clause. At the time, opponents of the policy contended that its effects could be catastrophic. Contracts would not be trusted. Creditors would no longer want to extend loans. Interest rates would rise. Investment would fall. The economy would stagnate. Edwards looks for evidence of these ailments in data on investment, borrowing, bonds, stocks, prices, interest rates, and output and finds none. After abrogation, the government actually found it easier to borrow, rather than harder. Edwards concludes that there is “no evidence of distress or dislocation in the period immediately following the abrogation, or the Court ruling. … it is possible that if the gold clause had not been abrogated, output and investment would have recovered faster than they did, and that the costs of borrowing would have declined even more. Those outcomes are possible, but in my view, highly unlikely” (p. 195).

The reason abrogation had no detectable impact, Edwards concludes, was that it was an excusable default. Excusable defaults occur under circumstances “when the market understands that a debt restructuring is, indeed, warranted, and beneficial for (almost) everyone involved in the marketplace” (p. 197), when the restructuring is done according to existing legal rules, and when the default is largely a domestic matter, with few foreigners involved. Excusable defaults do not stigmatize sovereigns, since they do not change borrowers’ expectations of sovereigns’ probability of repaying future debts. I agree with Edwards that the abrogation of the gold clause fit these circumstances, and I argued, in the preceding paragraphs, that the abrogation fit another classic characteristic of an excusable default. Bondholders received payment equal to (or better than) what they expected when the debt was issued. Since past holders of Liberty Bonds received the repayments that they expected when they purchased the bonds on origination in 1918, despite the tremendous shocks to the United States and world economies between then and maturity in 1938, future bondholders had no reason to doubt that their expectations would not be met.

Could it happen again? The author asks that question at the beginning and end of the book (and in the title to Chapter 17), because he says “among all questions, [it was] the one that kept coming back again and again” (p. 201). In emerging economies, Edwards indicates, “situations that mirror what happened in the United States during 1933-1935 have occurred recently in a number of … countries, and it is almost certain that they will continue to arise in the future” (p 203). Examples from the recent past include Argentina, Mexico, Turkey, Russia, Indonesia, and Chile. Advanced economies are not immune from these economic forces. In 2008, Iceland faced “a gigantic external crisis with a massive devaluation and a complete collapse of the banking sector. It took almost ten years for Iceland to recover” (p. 205). Greece continues to struggle with a similar situation. So do other European nations, such as Portugal, Italy, and Spain. These nations may be tempted to leave the Eurozone, reintroduce independent currencies, and devalue their exchange rate in order to speed economic recovery. But, any nation that tries (or is forced) to do this will struggle with contracts, all of which are written requiring payment in Euros. If these are rewritten to permit repayment in new currencies of lesser value, the issue is sure to end up in domestic and foreign courts as well as the World Bank’s tribunal for international investment disputes.

While the rest of the world may be in danger of experiencing events similar to the U.S. abrogation crisis of the 1930s, Edwards argues that “it is almost impossible that something similar will happen again in the United States” (p. 201). The main reasons are the change in the monetary system and the exchange rate regime. The United States’ exchange rates are now determined by market forces. Gold no longer underlies the monetary system. Most contracts are denominated in lawful currency, not gold, commodities, or foreign currency. Even if a repeat is extremely unlikely, the chance of the United States restructuring its debt, Edwards argues, is not zero. The federal debt outstanding is now nearly equal to gross domestic product. A tenth of the debt is fixed in real terms, because upon maturity, bondholders receive a premium payment linked to increases in the Consumer Price Index. The implicit debt for future entitlement, particularly Medicare, Medicaid, and Society Security, exceeds 400 percent of gross domestic product. There is little agreement on how to pay for these promises, Edwards notes, and at some point in the not-too-distant future, the U.S. government may be forced to restructure these payments. This potential crisis, Edwards argues, differs from the crisis of the 1930s, because the abrogation crisis stemmed from deflation, exchange rates, and the structure of the monetary system. The modern problem arises from promises made in the present for the future delivery of services.

On all of these points, I agree with Edwards. I am, however, less hopeful for the future. The unsustainable federal debt is not an accident. It was consciously created by Republican politicians to justify reducing (or eliminating) future federal entitlements. With Republicans in control of all three branches [When the review was published by Cato, this was true. However, Republicans now control only half of Congress] of the federal government, taxes cut, deficits up, and a recession on the horizon, the day of reckoning may be upon us in the near future. I anticipate a massive abrogation of federal medical and retirement entitlements within the next decade and sooner if Republicans retain control of Congress and the Presidency through 2020.

The roots of the past and current crises may have more in common than Edwards indicates. Most payments for federal entitlement programs are indexed for inflation. Federal entitlement obligations are, in other words, guaranteed in real terms, just like payments for Liberty Bonds one hundred years ago. They cannot be adjusted on aggregate by monetary policies that generate inflation. The can only be adjusted through the legislature and the courts. On this point, Edwards’ American Default ends on a high note. The ability of the United States to deal with the crisis of the 1930s and the abrogation of the gold clause demonstrates the strength of our legislative and judicial institutions. Given these, it is likely that our nation will be able to overcome future federal financial restructurings. Memories of those events will fade. The will be forgotten just like the events that Edwards masterfully recounts in his book, and America’s federal debt will remain the risk-free standard for the rest of the world.

References:
Alter, Jonathan. The Defining Moment: FDR’s Hundred Days and the Triumph of Hope. Simon & Schuster, 2006.

Badger, Anthony J. FDR: The First Hundred Days. Hill and Wang, 2008.

Cohen, Adam. Nothing to Fear: FDR’s Inner Circle and the Hundred Days That Created Modern America. Penguin Press, 2009.

Eichengreen, Barry. Golden Fetters: The Gold Standard and the Great Depression, 1919-1939. New York: Oxford University Press, 1992.

Friedman, Milton and Anna J. Schwartz. A Monetary History of the United States, 1867-1960. Princeton: Princeton University Press, 1963.

Kennedy, David M. Freedom from Fear: The American People in Depression and War, 1929-1945. Oxford University Press, 1999.

Investopedia. “Risk-Free Rate of Return”. Retrieved June 21, 2018.

Investopedia. “How is the risk-free rate determined when calculating market risk premium?” https://www.investopedia.com/ask/answers/040915/how-riskfree-rate-determined-when-calculating-market-risk-premium.asp. Retrieved June 21, 2018

Richardson, Gary, Michael Gou, and Alejandro Komai. “Gold Reserve Act of 1934.” Federal Reserve History Web Site. Retrieved June 26, 2018. https://www.federalreservehistory.org/essays/roosevelts_gold_program.

Richardson, Gary, Michael Gou, and Alejandro Komai. “Roosevelt’s Gold Program.” Federal Reserve History Web Site. Retrieved June 26, 2018. https://www.federalreservehistory.org/essays/roosevelts_gold_program.

Temin, Peter. Lessons from the Great Depression. MIT Press, 1989.

Wikipedia. “Risk-Free Interest Rate.” https://en.wikipedia.org/wiki/Risk-free_interest_rate. Retrieved June 21, 2018

This review was originally published in Regulation, Fall 2018.
Gary Richardson was the editor of the Federal Reserve’s historical web site, https://www.federalreservehistory.org/, on which he wrote a series of articles about the Roosevelt Administration’s gold policies. He is the author of numerous academic articles on the history of money, banking, and the Federal Reserve.

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Government, Law and Regulation, Public Finance
Geographic Area(s):North America
Time Period(s):20th Century: Pre WWII

Crash! How the Economic Boom and Bust of the 1920s Worked

Author(s):Payne, Phillip G.
Reviewer(s):Parker, Randall

Published by EH.Net (September 2017)

Phillip G. Payne, Crash! How the Economic Boom and Bust of the 1920s Worked. Baltimore: Johns Hopkins University Press, 2015. viii +142 pp. $20 (paperback), ISBN: 978-1-4214-1856-8.

Reviewed for EH.Net by Randall Parker, Department of Economics, East Carolina University.

 

Crash! is a part of the “How Things Worked” series being published by Johns Hopkins University Press. The list of books included in this series is not particularly long (at least not yet) and includes books on Ellis Island, sod busting, and Union Army recruitment of U.S. colored troops, among other topics. I like the idea behind this series, and the editors have really done themselves proud by having Phillip Payne author this book on the boom and bust of the 1920s. It is the first entry in the series pertaining to economic history.

Payne is a professor of history at St. Bonaventure University. If the idea behind the “How Things Worked” series is to produce non-technical books that provide useful road maps that hit the high points of historical epochs and give undergraduates the fundamental knowledge they need to understand the basics of what went on and why, then Crash! accomplishes what it sets out to do. Payne provides an in-depth look at the 1920s and the emergence of speculation and how the culture and economy of the time promoted that unhealthy trait (that still afflicts us today and ever shall). All the usual suspects and their stories are told: James Riordan and Ivar Kreuger (and others who did themselves in), Richard Whitney and his attempt to save U.S. Steel share prices, J.P. Morgan and others. The roles they played in bringing about the unfortunate events of 1929 and the beginning of the Depression with the stock market crash are described with historical elegance and come alive in the words of Payne. The level of detail of the events and the actors that made them happen represent a new and fresh look at a familiar, and certainly guilty, culprit in helping to bring about the Great Depression.

The last thirty pages of the book are also a road map for the essential elements of the recovery from the Depression, the emergence and governance of Franklin Roosevelt and the New Deal, plus an Epilogue comparing the 1920s to the malaise we endured in 2008. Correctly saying “How This Time Is (Not) Different,” we are reminded that this pattern will almost certainly repeat sometime down the road.

There are some particularly enlightening parts of the book. The West Virginia Coal Wars in the early 1920s and the use of air power against American civilians is not something economists hear much about. But the shock I felt when I read about it cannot be overstated. Moreover, I had forgotten that Herbert Hoover blamed World War I for the Great Depression. Payne reminds us that it was not Peter Temin who originally made this connection, although Temin did it for the right reasons and blamed the establishment of the interwar gold standard in a changed world in which the gold standard no longer functioned well and was an agent of deflation and depression.

There are several spots where the economics of the era are just briefly mentioned and not discussed much. There is no mention of the major debate of whether there was a bubble in stocks or not in the 1920s. This is far from clear from the literature — and my judgment is that it never will be decided. Alas, there is only one sentence mentioning that both Irving Fisher and John Maynard Keynes thought stock prices would continue to grow and both lost their fortunes. Moreover, there is no discussion of how deflation and the gold standard were linked. The recession of 1920-21 is blamed on deflation with no mention of this necessity for the re-establishment of a gold-backed currency at antebellum prices. But I do not wish to overstate the case. Payne does what he sets out to do and he is to be credited for such a readable book (indeed I read it twice!).

There is one matter, however, that cannot be unmentioned. I joined this club many years ago when James Hamilton showed me the error of my ways in a working paper I had sent him. It is a club to which Phillip Payne now belongs — and he should delight in being a part of this club as the membership list is long . . . and now we have one more. In four different places, he refers to “the Bank of the United States.” Well, it is really “the Bank of United States,” there is no “the” between “of” and “United.” Welcome to the club Professor Payne. And thanks for this very useful historical description of the bumpy road during the interwar period.

 
Randall Parker is editor of The Seminal Works of the Great Depression (Edward Elgar, 2011) and co-editor (with Robert Whaples) of The Handbook of Modern Economic History and The Handbook of Major Events in Economic History (both from Routledge, 2013).

Copyright (c) 2017 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator (administrator@eh.net). Published by EH.Net (September 2017). All EH.Net reviews are archived at http://www.eh.net/BookReview.

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Macroeconomics and Fluctuations
Geographic Area(s):North America
Time Period(s):20th Century: Pre WWII