Who anticipated the Great Depression?

Here’s the abstract from a paper by Doug Irwin in the February issue of the Journal of Money, Credit, and Banking:

The intellectual response to the Great Depression is often portrayed as a battle between the ideas of Friedrich Hayek and John Maynard Keynes. Yet both the Austrian and the Keynesian interpretations of the Depression were incomplete. Austrians could explain how a country might get into a depression (bust following a credit-fueled investment boom) but not how to get out of one (liquidation). Keynesians could explain how a country might get out of a depression (government spending on public works) but not how it got into one (animal spirits). By contrast, the monetary approach of Gustav Cassel has been ignored. As early as 1920, Cassel warned that mismanagement of the gold standard could lead to a severe depression. Cassel not only explained how this could occur, but his explanation anticipates the way that scholars today describe how the Great Depression actually occurred. Unlike Keynes or Hayek, Cassel analyzed both how a country could get into a depression (deflation due to tight monetary policies) and how it could get out of one (monetary expansion).

22 thoughts on “Who anticipated the Great Depression?

  1. Hugo André

    From the abstract: “Austrians could explain how a country might get into a depression”.

    This is a bit odd since the author then go on to explain that the gold standard (and the deflation it caused in the 20’s) is commonly accepted as the main reason why the 30’s crisis was so severe. Hayek was of course a strong supporter of the gold standard and his modern-day disciples still believe that we should return to it.

    My guess is that be that Doug Irwin, like many of todays economists and pundits, prefers to blame both sides equally to order to appear neutral and avoid criticism.

    Even so I will say that it looks like a very interesting paper.

  2. BC



    Depressions occur when private debt to wages and GDP reaches a cumulative differential order of exponential magnitude at which point debt must grow at a super-exponential rate. But the net debt service to wages and GDP precludes further growth of additional private debt, resulting in defaults and a crash in the price of assets dependent upon the maintenance of existing debt and its service.

    Japan reached the critical private debt threshold in 1989-94, and the US in 2008, 1929-30, 1892-93, and 1836-37. In the previous historical cases, private debt deflated 30-40% to clear the decks, including in Japan in 1998-2003 when bank loans fell 30%, and in the US in 1893-98 and 1930-33 when bank loans fell 50% and 40% respectively. The US$ devaluation of 40% and New Deal spending by FDR in, and after, 1933 occurred AFTER the debt-deflationary clearing of the decks in 1930-33.

    The actions by the Fed/TBTE banks from 2008 to date liquefied domestic and foreign primary dealer banks’ balance sheets while allowing banks to avoid a standard debt-deflationary clearing of the decks via a 30-50% decline in bank loans, despite the US$ declining some 85-90% vs. the price of gold in real, US$-adjusted terms, not unlike the decline in the US$ that occurred in 1980-82, similarly adjusted.

    But the result of the Fed’s bank reserve expansion and banks’ cash hoarding has been no growth in bank lending and the largest global financial asset bubble in world history, including record non-financial corporate debt to GDP (primarily to buy back shares and fund acquisitions) at the level of 1929-30. Nothing has been structurally fixed, as it were, and now incipient deflation is again emerging, with US bank deposits/money supply less bank cash hoarding now contracting yoy since last summer for the first time since 2009-10 and 1937-42, and three times in Japan since 1998, including recently.

    Today the US is burdened by a total imputed compounding interest to total credit market debt outstanding to average term that is equivalent to private US GDP in perpetuity. Banks’ annual net interest margin less bank charge-offs and delinquencies now exceeds incremental annual growth of nominal GDP.

    There will be no acceleration in the growth of US real final sales per capita from the ~0% 5-year rate until a sufficient share of private debt to wages and GDP is forgiven, defaulted on, paid down, or some combination, including a 30-50%+ decline (or run-off) of bank loans and in the price of overvalued equity assets in the years ahead. The longer the corrective process takes to occur and thereafter persist, the longer the period of “secular stagnation” for which there are the precedents of the 1830s-40s, 1880s-90s, 1930s-40s, and Japan since the 1990s.

    Economists have not been taught economic and banking history and about the private debt cycle dynamics since the 1970s-80s; and even then it was a cursory review, leaving out the work of the likes of Kondratiev, Kuznets, Juglar, Kitchin, Schumpeter, Minsky, Fisher, and other notables.

    Moreover, to critically examine the debt cycle dynamics requires scrutinizing the assumptions, values, motives, activities, and disproportionate influence and power enjoyed by the private int’l banking syndicate, the principals of which are largely unexamined and thus increasingly untouchable, protected from political appeals and popular challenges to their motives, actions, privilege, legitimacy, influence, and power.

    Capitalism requires debt-deflationary regimes to correct the excesses of private debt that leads to gross misallocation of resources and savings, mispricing of assets, and extreme wealth and income concentration that results in no growth and plunging money velocity.

    Again, until there is a clearing of the decks of private debt, a 40-50% correction of overvalued asset prices to wages and GDP that persists, and an acceleration of returns to labor’s share of GDP (or some means by which non-capital-owning bottom 90% experiences AT LEAST no further decline in real, after-tax purchasing power as a share of GDP) vs. returns to financial capital’s share, little or no growth of real final sales per capita will occur indefinitely, and labor’s share of GDP will continue to decline at the increasing cost to the bottom 90%+ of US households. The longer the situation persists, the less viable the mass-consumer economy becomes.

  3. Lord

    The problem with the gold standard being everyone must manage it correctly, anyone that doesn’t damages everyone, so for a country to succeed, they must forego it.

  4. Paul Mathis

    The Keynesian Model Explains the Great Depression

    “In the 1919 fiscal year, the federal government spent $18.5 billion. In 1920 this fell to $6.4 billion, in 1922 to $3.3 billion and in 1924 to $2.9 billion. The government ran a budget surplus every year from 1920 to 1930.” –Forbes, 4/22/11

    Demand failure has nasty consequences.

    1. BC

      Paul, ever hear of the imperial “arms race” and the “Scramble for Africa/Race for Africa” of the 1890s to 1910s and the culminating “War to End All Wars”, that little skirmish in Europe? Think that might have had something to do with gov’t spending before 1919 . . . ? Nah, coincidence, surely.


      Anglo-American empire tried imperial never-ending wars since 9/11 (and before that going back to the Spanish-American War), and take a look at the link above to see the result. Some argue the US is (has been) turning Japanese, and they’re correct, only US real GDP per capita has been slower (negative) than that of Japan when taking into account Anglo-American empire’s squandering of treasure on imperial wars for oil.

      Now we’re in the process of “pivoting to Asia” (and Africa) to pick a fight with the Middle Kingdom after building up the imperial competitor, which is what empires do. After all, war is the business of empire, and war is good business (for the state and war-profiteering clients).




      But we’ve been here before, and that includes “globalization” (British Empire), Afghan Wars, Gilded Age (similar to our Gilded Age II era), White Lotus Rebellion, Opium Wars, Boxer Rebellion, Mao’s revolution, and, yes, even QEternity (see the link above).

      There really is “nothing (much) new under the sun”, only we don’t study history (or do so only selectively to affirm our biases) to know this; and the most advantaged and clever among us do study history and are rewarded for their advantage of knowing what the rest of us do not, i.e., the close-in knowledge of the self-selected imperial ministerial intellectuals and all that.

      Now, how often in world history have monarchs and emperors desperately tried borrowing, spending, and debasing the currency for wars of imperial expansion and land and resource expropriation? Are there any economists left who are learned in the economic history of Babylon, Persia, Greece, Sparta, Rome, China, Portugal, Netherlands, Spain, France, Britain Russia, and Prussia-Germany? Oh, yeah, right.

      1. JBH


        Brilliant! The first time I ever used this word on Econbrowser. I’ve reached the same conclusion out of native curiosity and wide reading. The path went like this. Doctorate in economics. But early on as an undergrad, questioned the macro core. Along the way developed an eclectic view. Then the recent crisis was the big eye-opener. It got me thinking about the US as a nation. And that economic growth has declined at the rate of 4/10ths of a percent per decade since the 60s. Anyone whose eyes are open can see where this is going.

        From nation, I moved to empire. All empires have fallen. Why was that? I went back and read Gibbon, Decline and Fall of the Roman Empire. And other works like Naill Ferguson’s Civilization and Piers Brendon’s The Decline and Fall of the British Empire: 1781-1997. Then another jump. From empire to civilization. Like Russian dolls, nation is nested in empire, empire in civilization. It’s evident that between the two wars the mantle got handed from the British to the US. And led by the Anglo-American empire, the reigning civilization is until now Western.

        Then came Carroll Quigley. Where had he been all my life? His Evolution of Civilizations (1961) was a burst of light. All civilizations prior to Western had crumpled. Quigley applied the scientific method to understanding why. He put methodology up front in chapter one: Scientific method and the social sciences. He took great care to tell readers how he proceeded to answer the very question I’d been asking. Quigley found the crucial stage of a civilization to be its era of expansion. This of course is the milieu of the economy. When growth goes into decline, it is the beginning of the end. Quigley uncovered three necessary conditions for growth – the most important being the surplus. I’d pretty much reached this conclusion myself, the anti-saving core of Keynesian ideology being contrary to the common sense of mankind.

        I’d thought I’d reached the pinnacle then, as civilization is the outermost ring containing all the rest down to the atomistic family and individual. Not so. There was one more! Intimations of a behind the scenes puppeteer pulling the strings of late Western Civilization. After 7000 years, the globe has been unified by technological advances. And a force is at work attempting to bring about a one world order. This is the endpoint objective. The first foray was Wilson’s League of Nations. An idea that did not originate with him. The League of Nations and successor United Nations are a principle avenue through which this objective is to be attained. Purported ultimate aim is abolition of the nation-state. Problem being, and I am not alone in this, this leads straight to tyranny. Thus it has always been. Human nature has changed little if any at the archetypal level since prehistoric times.

        Let me move past other critical works including Quigley’s second, Tragedy and Hope (1975), to the just published Milner-Fabian Conspiracy. A 2012 copyright not available on Amazon.us. I had to go to Amazon.uk. Shades of the suppression of Quigley’s Tragedy and Hope. The MF Conspiracy is copiously referenced with lengthy bibliographies for each chapter. Filled with more names than Tolstoy’s War and Peace. The Milner Group, so named by Quigley, is a secret society formed in Great Britain in the last decade of the 1800s. The Fabian society was largely the brainchild of George Bernard Shaw started also at that time. It has propagated globally.
        Let me sketch a chronology. But first, say that in the 80s I got metaphor about the economy from a skilled forecaster – introduced to me by Bob Eggert (originator of the BLUE CHIP consensus) who told me this was the most accurate forecaster in the business. Metaphor: the economy is like the rails of a train track. Only as good as the roadbed beneath. If the roadbed washes out, the train will have to slow or even be derailed. That roadbed is the broad society and its values. Anglo-American society has been covertly manipulated by the application of great wealth and power to its own end for over a century now. A deliberately planned and ongoing subversion of social values and mores in public education, media, and politics. (Readers wanting firm ground on this, can start with Quigley who was a distinguished and highly-respected professor at Georgetown. Bill Clinton took his courses.)

        Your post hammers down a baker’s dozen nails on this very thing! Yuppies rail against George W Bush’s wars. Yet have no comprehension they are part of a larger web inclusive of drawing the US into WWI. The chronology runs from Marx, Toynbee, Cecil Rhodes, Milner, Shaw, and a number of British prime ministers as well as President Wilson – hence Milner-Fabian and the Rhodes scholarship at Oxford – right up to prominent present day Rhodes scholars like: Paul Sarbanes, Lester Thurow, David Souter, R. James Woolsey, Bill Bradley, Wesley Clark, Robert Reich, Bill Clinton, Strobe Talbott, Ira Magaziner, James Fallows, Franklin Raines, Michael Kinsley (founder of Slate and editor of New Republic), E.J. Dionne, Richard Haass, Walter Isaacson (editor of Time and CEO of CNN), Nancy-Ann Min DeParle (director of White House Office of Health Reform 2009- and pointwoman for Obamacare), Nicholas Kristof (NYTimes), Barton Gellman (Washington Post and Time magazine), George Stephanopoulos, Naomi Wolf, Susan Rice, Jacob Weisberg (editor of Slate), Cory Booker, Peter Beinart (editor New Republic), and Rachel Maddow. A Rhodes social science degree at Oxford is grounded in Milner-Fabian ideology.

        Edmund Burke, the eloquent British Parliamentarian and contemporary of Adam Smith wrote Reflections on the Revolution in France. “Reflections is best known for its critique of the pernicious role of intellectuals in political life. Less well known is the sustained contention that ‘men of money’ were undermining the institutions of state and Church.” Elsewhere he said about newspapers just coming into vogue in the 1700s: [Their circulation is] “infinitely more efficacious and extensive than ever they were. And they are a more important instrument than generally imagined. They are a part of the reading of all, they are the whole of the reading of the far greater number … Let us only suffer any person to tell us his story, morning and evening, but for one twelvemonth, and he will become our master.” Elsewhere he said: “When, therefore, I am told that a war is a war of opinions, I am told that it is the most important of all wars.” (Quotations from Jerry Muller’s The Mind and the Market: Capitalism in Western Thought.)

        1. Paul Mathis

          “The anti-saving core of Keynesian ideology” Really?

          Keynes was all about increasing investment in order to increase economic growth and jobs.

          Keynes also recognized the obvious: savings = investment.

          Might help if you read The General Theory carefully.

  5. Tom

    To make sense of the Great Depression you need to talk of it in at least three stages. There was the bust, the protracted slump, and the recovery.

    The Austrians and Fisher best explained the bust. As they explained there was a massive boom in credit. The Austrians get credit for pointing to it before it busted. Fisher saw it only in hindsight, but wrote already in the 1933 what still stands as the most detailed exposition of the 1920s boom and bust in corporate and margin credit. This was a very severe bust, which would still stand as the greatest in US history even if there hadn’t been a protracted slump.

    Fisher best explained, already in 1932, how the sharp deflation that appeared already in late 1929 was driven by the destruction of broad money as credit was revoked or written off. Although this effect can be used as an argument against the gold standard, neither Cassel nor Keynes did so. Although Austrians had long warned that all broad money expansions were inherently doomed to bust, they did not foresee deflationary spiral.

    Keynes’ “animal spirits” was a sensible point, but not all unique. His best insight was that any very rapid expansion of productive capital, as had happened in the US, carried the risk of severe downturn due to the great amount of depreciation that it obligated companies to fund relative to income. Keynes railed against the gold standard as much as Cassel, but neither the gold standard nor overly tight monetary policy can be blamed for the bust. The record is clear that the gold standard did not force the Fed to tighten. The Fed tightened voluntarily specifically because it was worried by the asset bubble. More generally, the fact that the vast majority of recessions are preceded by tightening merely shows that monetary policy is generally intended to be counter-cyclical. Central banks tighten when they see inflation or to pop asset bubbles and recessions usually follow. To blame tightening for recessions is the same as to advocate permanently loose monetary policy. Which in my opinion is daft idealism, not prescient insight. To blame fixed exchange rate regimes for recessions also lacks all plausibility: floating regimes have proved to be no less susceptible.

    Moving on to the protracted slump, economists on all sides made good points.

    The Austrians and others on the right were first to point to sticky wages, a major part of just about every contemporary school’s understanding of the Depression and of post-recession slumps generally. They saw the phenomenon in a very reactionary light, blaming the failure of wages to adjust downward on the “extortion” of labor unions and pining for a very old-school right-wing ideal of a labor market in which large numbers of workers offer their labor on a brutally honest daily spot market. In hindsight they were on the wrong side of history: labor markets would become more long-contract-based, even as unions receded. But, although labor unions were far from entirely to blame, it was nonetheless true that a recent increase in labor market inflexibility greatly exacerbated unemployment and prolonged and worsened the slump.

    Opponents of the gold standard / advocates of looser (Cassel, Keynes) or more aggressively countercyclical (Fisher) monetary policy were I think right that maintaining a fixed exchange rate of currency with gold prevented the Fed from counteracting the deflation. I think Fisher explained best in 1933 how the fixed exchange with gold led to international runs on banks and currencies and precipitated and aggravated the waves of bank failures. Friedman added nothing on this issue except the completely wrong argument that adherence to the gold standard had caused the 1929 crash. The recent Greek experience where currency union prevented devaluation and exacerbated capital flight was quite similar to albeit not nearly as severe as the Depression gold standard problem. Which shows that even today arguments for maintaining fixed exchange rates can win out despite the well-known disadvantages. The gold standard is really not much different from an FX peg or currency union.

    On this point Austrians can claim another I told you so, though they’ve been entirely ignored. If the base money supply were fixed to that of the gold reserves and broad money was banned as they advised, there could be no collapses of broad money and thus no debt deflation spirals. The argument with them becomes one of costs/benefits of fractional reserve banking and floating currencies. They’ve entirely lost the debate on fractional reserves, but have seen something like a revival of the gold standard with the Euro and attendant constraints on monetary and fiscal policies. The Euro has just taken a bad beating and survived. If what doesn’t kill it makes it stronger, the modern equivalent of the gold standard is still going strong.

    Moving on to the recovery, the debate remains wide open. One camp firmly believes that Roosevelt’s fiscal and monetary policies accelerated the recovery. Another camp just as doggedly maintains that Roosevelt and even Hoover delayed recovery by obstructing creative destruction. This debate seems to me impossible to settle. Where one stands has usually nothing at all to do with one’s knowledge of 1930s events and everything to do with where one stands on current political policy. Personally I think monetary and fiscal stimulus lessen contractions but slow recovery. They may be worth doing for social welfare reasons, but they don’t add anything to long-term growth.

    1. Paul Mathis

      “Personally I think monetary and fiscal stimulus lessen contractions but slow recovery. They may be worth doing for social welfare reasons, but they don’t add anything to long-term growth.”

      So the Federal government’s funding of the Interstate Highway System did not add anything to long-term growth? Really? How is that even possible in any sense?

      1. Tom

        You’ve misunderstand terms. Fiscal stimulus refers to public borrowing. Public infrastructure can be very good for growth, but funding it with public borrowing is not any better in the long run than funding it with taxes.

  6. Ricardo

    I am still going though Irwin’s paper (he makes many of the same mistakes he made in his earlier 2010 paper DID FRANCE CAUSE THE GREAT DEPRESSIO?) but I had to post this comment from his third paragraph because it made me burst right out laughing when I read it.

    While debt and reparations from World War I made the international financial system fragile throughout the 1920s, the real problems began in the late 1920s when the United States and France began attracting large amounts of gold from the rest of the world. This deprived other central banks of the gold reserves that they needed to back the currency they issued….” [My emphasis]

    Nearly every country in the world entered into massive expansions of their money supplies during WWI. Most of those countries never allowed their money supplies to return to normal levels. These countries attempted to return to the pre-WWi gold standard with money supplies massively higher than pre-WWI. The US and France both gained control of their money supplies and maintained their gold parities. France exhibited the most economic wisdom by devaluing the franc to its market price so that they returned to the gold standard at a reasonable level. Knowing this history Irwing then blames the US and France for not massively increasing their money supplies so that national like the UK did not have to make the hard decisions France made.

    The phrase “…the gold reserves that they needed to back the currency they issued…” assumes that countries should be able to expand their money supplies to any level they want and the US and France should bail them out. The phrasing is so absurd because it gets it exactly backward. The gold standard was not intended to provide countries with all the gold they needed to issue as much currency as they wanted. The gold standard was to control governments from spending beyond their means by printing excessive amounts of currency.

    Irwin’s statement powerfully demonstrates his bias and misunderstanding of the gold standard. The statement is laughable and I appreciate the laugh.

    More later. Professor thanks for posting this piece. I did a lengthy analysis of Irwin’s last paper and it opened my eyes to so many fallacies perpetuated today about France and the gold standard. I am sure this paper will do the same.

    1. bellanson


      I know you like the gold standard. There is one thing I don’t understand with that concept: Doesn’t a gold standard preclude the expansion of money, beyond the amount of available gold (by a given country/issuer of currency)?

      Assuming I’ve gotten that right, then my question is: Isn’t a fixed amount of money supply a bad thing? i.e. imagine that the economy doubles, or triples (more population and more economic activity would drive this). Wouldn’t it stand to reason that an economy that is 3 times larger would need an amount of currency that is 3 times greater?
      As far as I can see, a gold standard would limit this – and thus limit economic growth. I don’t see how that is a good thing. Please explain

  7. MarkS

    Thanks BC for providing arguments for the real source of depression in the capitalistic business cycle. I particularly appreciated your link to Adair Turner’s Goethe University speech. My two cents are that unsustainable credit can be ameliorated several ways:
    1. Force bad credit default – (Supports market discipline, repairs excessive credit, causes severe short-term pain, but promotes rapid recovery).
    2. Inflate the currency – (Causes asset price instability, reduces volume of credit defaults, may increase “recovery” speed but does little to repair excessive credit unless exercised to excess.)
    3. Financial Represssion , a.k.a. QE – (Long-term pain, long-term recovery, reduces volume of credit defaults, degrades market discipline.)

  8. Mark A. Sadowski

    What I find most interesting about the paper is how Keynes’ analysis of the cause, and consequently his recommended cure for the depression, was different from Cassel’s.

    Here is another edition of the same paper. Pages 28-32 are most relevant. Here are some highlights:


    “…In a January 1929 article on the League of Nations gold inquiry, Keynes found himself coming around to Cassel’s view of the international gold problem. Keynes (1981 [1929], 776) wrote that “Professor Cassel has been foremost in predicting a scarcity” of gold, adding that “I confess that for my own part I did not, until recently, rate this risk very high.”…”

    “…Although this article demonstrates Keynes’s familiarity with Cassel’s arguments, in his subsequent writings Keynes hardly mentioned the international gold problem at all. Keynes rightly believed that the international monetary cooperation that Cassel had always demanded was simply not going to happen, so he looked for other solutions. However, these solutions did not including leaving the gold standard. Despite the fact that he had been an opponent of the gold standard in the early 1920s – calling it a “barbarous relic” in his Tract on Monetary Reform (1923) – and although he welcomed Britain’s departure from the gold standard when in finally occurred, Keynes steadfastly refused to advocate a British devaluation or departure from the gold standard.19 In his testimony before the Macmillan Committee in 1930, Keynes concluded that the costs of departing from the gold standard outweighed the benefits because the burden of servicing Britain’s short- term foreign currency debts would increase by the amount by which the pound fell in value. Furthermore, he argued, abandoning the gold standard would be a breach of faith with Britain’s creditors, a violation of trust that would damage London’s reputation as a financial center…”

    “…However, Keynes began to change his view when monetary policy was no longer handicapped by golden fetters: after Britain left the gold standard in September 1931, interest rates came down but unemployment remained high. According to Patinkin (1982), this is when Keynes became a monetary policy skeptic and began to push for increased government spending on investment as a way to get the economy moving again. As Keynes stated in late 1931, after Britain left gold, “I am not confident . . . that on this occasion the cheap money phase will be sufficient by itself to bring about an adequate recovery of new investment. . . . . If this proves to be so, there will be no means of escape from prolonged and perhaps interminable depression except by direct State intervention to promote and subsidize new investment” (Keynes 1982, 60)…”

    “…Because Keynes judged the stance of monetary policy largely if not exclusively by interest rates, with low rates indicating to him monetary ease, he became skeptical of the value of monetary policy as a stabilization tool when nominal rates were so low.

    By contrast, Cassel never lost faith in the power of monetary policy to improve economic conditions…”

    To me it seems like deja vu all over again. Today Krugman is similarly influential, and is supportive of unconventional monetary policy after the fact, but never really advocates it, because his belief that monetary policy mainly works through the traditional interest rate channel makes him skeptical of unconventional monetary policy’s benefits in a liquidity trap.

  9. Ricardo


    Great questions! And I appreciate your honesty.

    Doesn’t a gold standard preclude the expansion of money, beyond the amount of available gold (by a given country/issuer of currency)?

    No. As a matter of fact one of the criticisms of the gold standard is that it does not preclude a government from over-issuing its currency if it wants to. Consider France after the French Revolution. Consider the UK during the 1930s. Consider the US after Bretton Woods. At Bretton Woods the US agreed to hold the dollar at $35/oz of gold but almost immediately began expanding the money supply. This led to a crisis when France and the UK began to demand gold for the dollars they were being forced to hold. You see, the US had purchased hard assets with dollars and then refused to exchange the dollar for gold as they had promised. (This is very similar to what the UK did when it left gold in 1931. The nations of Europe were left holding pound sterling “IOUs” that the UK refused to honor. To quote Sen. Gore to FDR: “Why, that’s just plain stealing, isn’t it Mr. President?”)

    But what a gold standard does is make it difficult for a country to expand its money supply and stay on the gold standard. Let’s once again look at the US and the Bretton Woods example. If the US had honored its word to France and the UK gold would have flowed out of the US and into Europe. Actually, in 1971 when Nixon faced his monetary crisis, there may not have been enough gold in the US to honor all the dollars in Europe so the US couldn’t honor its promise. But the problem was not that there was not enough gold. The problem was that too much currency had been issued. The mismanagement of the US money supply destroyed Bretton Woods.

    Assuming I’ve gotten that right…

    I hope you see from my answer above that you do not have that right.

    Isn’t a fixed amount of money supply a bad thing?

    Yes, I believe it is. That kind of system is called monetarism.

    imagine that the economy doubles, or triples (more population and more economic activity would drive this). Wouldn’t it stand to reason that an economy that is 3 times larger would need an amount of currency that is 3 times greater? As far as I can see, a gold standard would limit this – and thus limit economic growth. I don’t see how that is a good thing.

    You are correct. That would not be a good thing and that is one of the most serious problems with monetarism. I love Friedman but on this he was dead wrong.

    I believe you misunderstand a gold standard. A gold standard is simply that, a standard for the value of the currency. Now let’s assume that there is an increase in the demand for currency. What would happen to the market price of gold? The currency would increase in value. There are a number of signals that would be triggered by this but let’s only look at the market price. In this case to maintain the parity of the currency to gold the monetary authority would need to increase the amount of money substitutes, currency. A properly managed gold standard will actually signal very accurately when the monetary authority should add or subtract currency from the system to maintain the gold parity. The problem with a floating currency is the monetary authority has no idea whether the money supply is too much or too little.

    Let me give you a little homework exercise. Find the money supply in the US in 1800, and then find the money supply in the US in 1900. Compare the two. Then find the market price of gold in 1800 and the market price of gold in 1900. A good source is Jastrum. (Hint: the money supply in 1900 was significantly higher than in 1800 (about 4 times if my memory is correct. I don’t have it in front of me) but the price of gold in 1800 was ~$20/oz just as it was in 1900.

    I do appreciate the questions. There is so much misinformation out there that few people actually know what a true gold standard is today.

    1. baffling

      ricardo, one problem you have is that you allow the government to issue more currency when needed, without a change in the gold reserve. if you allow this, then you are not adhering to a strict gold standard and you are creating money that is now backed by the full faith and credit of the government. if you do not allow the issuance of more currency without a corresponding increase in gold standards, then you are constraining your economy to the productivity of the gold diggers and gold trade. which side are you on? faith of the government or gold industry? you cannnot have it both ways. you can’t say you are on a gold standard but then allow the amount of currency to fluctuate with growth. it appears you want a gold standard backed by fiat money? please clear this up, because i hear from alot of gold bugs but none truly explain their stance on these details.

  10. 2slugbaits

    Interesting paper. Thanks for posting it. I found a lot of it convincing, but other parts…not so much. For example, it’s not entirely clear whether a contractionary monetary policy as a consequence of hoarding gold and sterilizing the monetary base caused the Depression, or if it was just a large contributor. Was it a sufficient condition? Afterall, Irwin concedes that economic doom kept on not happening up until there was a downturn in the business cycle in the summer of 1929. So was contractionary monetary policy a necessary condition, or a sufficient condition? The argument in the paper implies the latter, but the example cited in the paper suggests the former. And I don’t think all of the conclusions necessarily follow from what is argued in the paper. The thrust of the paper is that the Depression was primarily a monetary phenomenon. Okay, that may well be true, but that does not mean monetary policy should be the cure. That’s a different point that needs to be argued on its own merit. Instead Irwin gives us a “hair of the dog” kind of argument. He’s also a bit too hard on Keynes’ emphasis on money holdings for liquidity purposes rather than other purposes. At the time Keynes wrote the General Theory liquidity was the main reason for demanding money. That’s what a flat LM curve in the old Hicks framework means.

    Part of the problem with Keynes’ The General Theory of Employment, Interest, and Money is that it isn’t a “general theory” at all, but rather a special theory for a unique set of problems. So in that sense Keynes invited a lot of Cassel’s criticisms.

    And what can we say about poor old Hayek? Irwin is right. The Austrians are forever spinning theories about how the next crash is right around the corner because of malinvestment, roundabout, concertina effects, blah, blah, blah. But Austrians have never had a theory of recovery.

  11. Tom

    Reading comments here, I’m remind how many misperceptions exist around the 1920s and the 1929 crash.

    The 1920s was neither an inflationary era in the usual sense of the word nor an era of tight monetary policy. The confusion largely stems from the non-standard lingo of Austrian theory, and its focus on central banks as drivers of credit and money supply growth. Austrians call any credit \ money supply growth “inflation”, even if consumer prices don’t rise. They also tend to see the central bank as pushing any credit \ money supply growth even in situations where most people would describe the central bank as passively permitting a privately driven credit expansion.

    The 1920s began with a short but severe deflationary recession as the Fed sought to end the inflation, depreciation pressure and reserves outflows caused by its financing of the war. Unlike Europe the US never suspended its peg to gold, and law required the Fed to keep gold reserves equal to at least 40% of base money. Thus as war-financing inflation reduced the market value of the dollar to gold, the dollar gold peg became an arbitrage opportunity. The gold peg was challenged by outflows of gold reserves, which came close to breaching the 40% legal minimum before the Fed reacted by sharply increasing rates. If this reminds you of a modern crisis of a developing country with a dollar or euro peg, it should. Probably the best comparison is the Baltics in 2009, as the US, acting roughly in line with most of Europe, refused to devalue and instead undertook harsh austerity resulting in a huge contraction. Europe was moving towards restoring gold pegs, enforcing its own post-war deflation, and gold was flowing to the more deflationary currencies. The Fed rate hike more than did its job, causing banks to contract their lending to pay down credit to the Fed, contracting broad and base money supply.

    The 1921 recession was short partly because underlying economic conditions were very strong. The production line, automobiles and other innovations were making production and distribution much more efficient. There was a genuine supply boom. The Fed loosened and base and broad money soon recovered, but without price inflation, because goods supply was also increasing. This was not a case of static prices, but of mixed inflation and deflation resulting in a roughly flat aggregate. Think of the deflation of computer and television prices in the past decade, but affecting a much greater proportion of the consumer basket.

    As the 1920s progressed, Fed policy was on the whole neither tight nor loose. On the tight side, as economic ouperformance and strong investment inflows attracted gold inflows, the Fed sterilized them, producing a roughly stable base money supply. On the loose side, the Fed was relatively permissive of credit growth, which was increasingly circumventing the banking system through corporate bond sales to non banks and vendor financing. Broad money grew at ~6%/year, but corporate and security credit grew much faster than that. There was a massive building boom.

    The Fed moderately tightened and loosened and tightened repeatedly during the decade, and the tightening of 1928 was not seen as anything special at the time. There isn’t a hint in the record of it having anything to do with preventing gold outflows, which were not an issue. The debate of the era was whether and how the Fed could specifically regulate credit flows to the increasingly obviously inflated stock market, which banks successfully resisted. Meanwhile, growth slowed as net flows of credit overall peaked and declined, but that went little noticed in part because flows into stocks were enough to sustain the bull market. In August 29 the Fed tightened further, and everything went to hell very quickly. Again there is no hint in the record that the tightening was motivated by concern about the gold peg.

    So the story doesn’t precisely fit the Austrian model of central-bank-fueled credit excess. The Fed held base money supply roughly stable except for the 21 contraction and subsequent rapid recovery. But there was a surge in credit creation and over-investment in long-term assets. The Austrians warned of it in advance. On the other hand, since then as now they were policy dissidents – they wanted an inelastic, 100% gold-backed money supply, not merely a gold peg and 40% minimum reserves – they tended as now to always see pending doom.

  12. Tom

    Indeed, I think Austrians and Keynesians are failing to see how much they agree on a crucial point: an elastic money supply and a gold peg are incompatible.

  13. Ricardo


    I agree with you concern modern Austrians in the Rothbard model but you are not correct concerning Austrians who follow Mises. Mises wrote a whole book on monetary policy long before the Great Depression and he definitely does not define inflation as an increase in the money supply.

    Consider this from Mises’ THE THEORY OF MONEY AND CREDIT chapter 7

    The central element in the economic problem of money is the objective exchange value of money, popularly called its purchasing power. This is the necessary starting point of all discussion; for it is only in connection with its objective exchange value that those peculiar properties of money that have differentiated it from commodities are conspicuous.

    This must not be understood to imply that subjective value is of less importance in the theory of money than elsewhere. The subjective estimates of individuals are the basis of the economic valuation of money just as of that of other goods. And these subjective estimates are ultimately derived, in the case of money as in the case of other economic goods, from the significance attaching to a good or complex of goods as the recognized necessary condition for the existence of a utility, given certain ultimate aims on the part of some individual.

  14. Ricardo


    Once again thank you for generating the discussion of a topic many ignore. I have been delinquent in replying because I wanted to be clear and accurate.

    To properly understand Cassel and his influence we must recognize that his theories were significant in creating the conditions of the Great Depression. It started at the International Economic Conference at Genoa in 1922. Cassel was the most important economist at the convention. Cassel’s view was the mercantilist view that a gold standard required central banks to hold a significant supply of gold to function and he had made an error in judgment that the world was running out of gold. Irwin tells us in his paper about Cassel’s failure in predicting the level of gold production in the 1920s. This error reveals much about Cassel’s bias. Irwin tells us that Cassel saw the fall in gold production from 1916 through 1922 and assumed it was the trend of the future.

    Actually Cassel went farther back than 1916 to analyze gold production. From the mid-19th Century the world was in the golden age, when the gold standard was run most efficiently. If a currency is as good as gold it is much more convenient and so will more often be used by traders; therefore, a properly functioning gold standard needs virtually no gold at all. During the golden age gold demand declined significantly, but then came WWI and the golden age ended abruptly. The nations of the world (with perhaps the exception of the US) left the gold standard to use currency inflation to finance their war efforts.

    After the war, the world’s monetary system was in shambles and chronic even hyper inflation were rampant. In an attempt to deal with this (and the international trade situation but that is another discussion) the 1922 Genoa Conference was convened. At Genoa the world (excluding the US, who did not attend) took the fateful step of replacing the gold standard with the bastardized gold exchange standard. The world mistakenly accepted the pound and dollar as equals to gold. This was Cassel’s monetary theory and in Genoa it was put into practice. The nations should have known from history that paper standards always ended in disaster but “hope springs eternal.”

    Ironicly the UK in the 19th Century led the world into the golden age with the pound sterling firmly managed by the gold standard, and now, in the 20th Century, the UK was leading the world off of the gold standard and down the path toward the Great Depression.

    Prior to the Genoa Conference major currencies used only gold as their reserve. At the conference the United Kingdom convinced the other attendees to include the pound sterling and the dollar in their gold reserves because “the pound and the dollar were as good as gold.” After Genoa the UK used the agreement as a weapon to refuse to exchange its gold for pounds. The UK forced countries to hold pounds in their reserves allowing England to buy products with pounds that would never be redeemed for gold freeing the UK monetary authorities from the restraint of the gold standard. At Genoa Cassel’s theory was perfect justification for UK intransigence.

    Now we fast forward to 1931. Thanks to the gold exchange standard, the nations of Europe are holding massive amounts of pounds in their foreign reserves with France holding the largest amount (though only about half of their total foreign reserves). Many times the French had attempted to exchange their excess pounds for gold but the UK always found a way to refuse. Suddenly in September the UK defaulted on its commitment to honor the pound sterling and as a result the UK stole massive wealth from the rest of the world. This action was central to the greatest part of the downturn in the international economic crisis. Keynes actually made a very good assessment of the impact as Irwin recounts in note 22, “abandoning the gold standard would be a breach of faith with Britain’s creditors, a violation of trust that would damage London’s reputation as a financial center.” Keynes was correct because this event more than any other shifted world financial leadership from London to New York. London was no longer the world’s monetary power and the pound sterling no longer the world’s reserve currency.

    Now, Cassel was immersed in the heady world of monetary politics and celebrity. He was appointed to League of Nation’s boards and every significant monetary conference. The UK insured their economist Cassel was present to represent their interests.

    To Irwin’s credit he does present Hayek’s analysis of the monetary conditions of the 1920s, but he editorializes and distorts Hayek’s meaning. As Irwin notes Hayek gave Cassel credit for being “the outstanding representative” of the view that adjusting the quantity of money helped keep the general level of prices constant, but then Irwin mischaracterizes Hayek’s point by saying, “This implied [Hayek supported] a discretionary policy” of monetary manipulation. Hayek never took such a position and both Hayek and Mises spoke strongly against those who promoted the theory of price stabilization. Mises specifically called out Fisher who Irwin connected with Cassel. It is important to understand that Hayek and Mises were not in favor of the stabilization of prices but in the stabilization of the purchasing power of money. There is a huge difference. Irwin misleads on Hayek’s position.

    My independent study of monetary policy of the interwar period brought me to the understanding that France was the only county to maintain a properly operating gold standard (a view I later found agreed with Hayek). It is instructive to note that in the latter half of the 1920s even US gold was beginning to flow to France. Under Benjamin Strong US monetary policy mistakenly assisted Montagu Norman in perpetuating and covering the mismanagement of the pound. Shortly before Strong died in 1928, he finally realized his error, and ended his monetary manipulations. He refused to visit Norman on his trips to Europe and essentially cut off communication.

    But, still, isn’t it undeniable that the US and France accumulated much of the world’s gold during the 1920s? Of course it is! The statistics are clear. But that says nothing about who mismanaged the currency.

    To understand let’s look at one of the characteristics of the gold standard. A properly managed gold standard clearly tells the monetary authority when either too much or too little currency is being issued. If currency is over-issued, it will be returned to the monetary authority in exchange for gold and gold will flow out of the country. This principle of the gold standard had been understood for centuries. But Irwin still makes the fallacious statement, “Hayek even turned Cassel’s analysis on its head…” On the contrary, it was Irwin who argues against centuries of accepted gold standard truth, turning it on its head.

    Hayek was absolutely correct when he stated, “it was by no means the economically strong countries such as America and France whose measures rendered the gold standard inoperative, as is frequently assumed, but the countries in a relatively weak position, at the head of which was Britain, who eventually paid for their transgression of the ‘rules of the game’ by the breakdown of their gold standard.”

    But is there evidence who engaged in mismanagement? Was it the UK or France? That has a very simple answer that is recognized by all monetary economists. What was the market rate of exchange between the pound with gold and the franc with gold? Then, how did that exchange rate compare to the parity chosen by each? If the chosen gold parity was close to the market rate then the currency was being properly managed, but if it was not, it was being mismanaged. Every economist (even Paul Krugman) accepts that the UK returned to parity far below the market exchange rate of the pound to gold. But what is then totally ignored is that France, under the leadership of Emile Moreau, Charles Rist, Pierre Quesnay, and the young Jacques Rueff, spent years stabilizing the franc. In 1928 when France finally announced they were returning to the gold standard, France had actually been on the gold standard because the franc had maintained nearly 3 years of a 25:1 exchange rate versus the dollar. Any honest student of history has to recognize that the UK mismanaged monetary policy while management of the monetary policy of France was excellent.

    Space and attention limit the comments I can make about Irwin’s paper. There is so much more that could and probably should be said about it, but suffice it to say that Irwin is correct. Not only did Cassel anticipate the Great Depression, his ideas were significant contributing causes and increased its length and depth.

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