De Mortibus Aurum: The Gold Standard and the Propagation of Macroeconomic Shocks
The autumn of 2009 will see the eightieth anniversary of the Wall Street crash of 1929. Two-thousand and seven is also the centenary of the panic of 1907, which saw the value of the US equity market plummet by more than one-third and resulted in the collapse of at least 25 banks and 17 trust companies in the United States. Hence, the present time seems an appropriate occasion to peruse the extensive literature on the subject of the economic slump that followed the pricking of the bubble of the so-called roaring twenties. Eichengreen’s “Golden Fetters” should be one of the starting points of any attempt to arrive at an insightful accounting of the global economic contraction of the 1930s. This volume explores how the gold standard was instrumental in transmitting and amplifying the deleterious effects of contractionary economic and monetary policies, in the process establishing that the utter lack of international cooperation and policy coordination, which arose in part from the fragmentation of the post-1870 global polity in the wake of World War 1, derailed any and all efforts, exerted in the context of the inelasticity of the gold standard, to stabilize production, prices, and exchange rates. There was one major ‘escape clause’ under such a monetary regime—devaluation by abandonment or suspension of the gold standard, which, although not an ideal panacea, proved to be significantly less disagreeable than maintaining convertibility and paying its concomitant economic cost. A well-written volume with relatively minimal economic jargon, “Golden Fetters” makes the often-undervalued point that, in an economically interdependent world with nearly unrestricted capital flows, monetary and economic stability is attainable through multilateral, coordinated responses to exogenous, unanticipated shocks.

There is considerable discussion in the academic literature regarding whether the gold standard was unnecessarily ab initio restrictive, thereby preventing the implementation of expansionary policies at critical economic junctures. Instead of focusing only on the impact of capital flows on economic growth in exploring the dynamics of the gold standard, Eichengreen, recognizing the inevitable elasticity of global gold supplies, saw the antebellum gold standard regime as underpinned by the credibility of the system—which ensured that capital flows were self-equilibrating—and cooperation amongst governments and central monetary authorities in addressing systemic disturbances. Credibility emanated from the independence of central banks from political interference; such independence assured the public that the central banks at the time would, in the event of a pronounced withdrawal of gold balances by investors, employ corrective actions in reversing the depletion of gold from national coffers. With such countermeasures employed to full effect, or even with the mere threat of such countermeasures being brought into play, capital outflows would ultimately be reversed: investors would be keen to acquire assets in gold-outflow countries, because the corrective actions of the monetary authorities would have a positive, reinvigorating effect on asset values. Meanwhile, international cooperation underpinned the credibility of the central banks and greatly circumscribed policy variances—which tended to undermine the monetary machinery’s equilibrium—within the members of the central bank confederation. The unique dynamics of the prewar gold standard, together with the relatively benign political environment in which it operated, ensured that major financial crises, such as those that transpired in 1890 and 1907, were ultimately limited in duration and impact.

The First World War unleashed forces inimical to the gold standard. Convertibility was suspended. Cooperation amongst central banks became all but impossible as the global polity was altered irrevocably; entanglements over war reparations, transnational disagreements about conceptual frameworks, and the restructuring of the nature of societal cleavages all blocked efforts at establishing a new economic consensus. The fragmentation of the post-1870 polity consensus, resulting in the politicization of the determination of levels of wages and employment, the enfranchisement of workers, and the rise of the political influence of labor, also led to the adoption of policies aimed at generating employment. The politicization of fiscal policy and the resulting redistribution of fiscal burdens in turn damaged the credibility of central banks, because the independence of the monetary authorities from political exigencies seemingly evaporated in the face of trade-offs between employment targets and balance of payments objectives.

When the gold standard was reinstated after the war, it soon proved to be ineffectual in restoring the status quo antebellum. Money supply contracted as central banks sought to ‘sterilize’ international reserve flows, countries sought to substitute gold for foreign exchange reserves, and the public withdrew funds from banks. The global economy gradually entered into a deflationary spiral, as central banks restricted the availability of credit and pushed interest rates upward in order to increase their gold holdings. The issue of reparations to be paid by the aggressors and war debts rendered international monetary cooperation all but impossible. And the credibility of the official commitment to gold was undermined owing to uncertainty as to whether the balance of payments equilibrium—the foremost means of initiating economic adjustment between countries prior to World War 1—would continue as the focus of policy; indeed, in the words of Eichengreen, “[w]hen employment and balance-of-payments goals clashed, it was no longer clear which would dominate.”

Although the antebellum gold standard imposed monetary and budgetary discipline, it also established severe limits on discretionary monetary policy. As a fixed exchange rate system, the gold standard served to negate individual countries’ freedom of maneuver, especially in the post-war context. Expansion of the money supply, undertaken unilaterally in the context of the gold standard, would only result in balance-of-payments deficits; the same would hold true for increases in public spending. Thus, in order to break out of deflation and revivify economic activity, the optimal strategic algorithm at the time involved renouncement of the gold standard and the subsequent restoration of monetary stability.

In September 1936, the governments of France, the United States, and the United Kingdom signed the so-called Tripartite Agreement, the first major international monetary stabilization pact and a key precursor of the Bretton Woods system. The agreement, which sought to preclude competitive currency depreciation amongst the signatories, heralded a period of relative quiescence in the financial markets, which had been appallingly buffeted by exchange rate instabilities, and demonstrated how the world’s major monetary powers could work together to avoid the implementation of protectionist and mutually constrictive trade and monetary policies.

Eichengreen concludes that the economic cooperation between nation-states can be institutionalized by taking steps to curb international political disagreements, creating a mechanism within the political process to establish the primacy of international economic cooperation and mitigate the insularity of special interest groups involved in national policymaking, and developing a common conceptual agenda for economic management. Implicitly expressed is the hope that, with such ‘enhancements’ to the global economic structure, the negative effects of macroeconomic shocks, such as the ensuing breakdown of economic activity experienced in the 1930s, will be significantly mitigated. ( )