Career[ edit ] Eichengreen has done research and published widely on the history and current operation of the international monetary and financial system. He received his B. He was a senior policy advisor to the International Monetary Fund in and , although he has since been critical of the IMF. In , he served as a fellow of the American Academy of Arts and Sciences. For a variety of reasons, including among others a desire of the Federal Reserve to curb the US stock market boom, monetary policy in several major countries turned contractionary in the late s—a contraction that was transmitted worldwide by the gold standard.
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In his book Golden Fetters, published in , Eichengreen builds the explanation that the interwar gold standard system failed to adjust the economic imbalance and limited policy responses to offset the business downturn, which eventually caused the Great Depression. In the first chapter, Eichengreen explains the classic mechanism of the Gold Standard, and the reason for its malfunction during the interwar period.
Contrary to the conventional account that the Bank of England monopolized the international financial system, Eichengreen specifies that the prewar gold standard was a decentralized, multi-polar system, whose stability laid on credibility and cooperation. Since this government credibility is beyond reproof, the international currency market would function as a self-stabilizing system.
Supposing the sterling weakened, foreign funds would flow into Britain, expecting capital gains when the Bank of England intervened to strengthen the rate. In his theory, when this stabilizing speculation failed to accommodate a disturbance, international cooperation would be the next step.
When global credit conditions were overly restrictive, central banks would follow the Bank of England to reduce discount rate simultaneously. In major crises, central banks would react in different ways to adjust balance-of-payment. With these signals from central banks and sometimes the government, private funds would also flow to countries in distress. Rather than depending on a single resource for gold, the implicit international cooperation ensured that the lender-of-last resort function was provided on a collective basis.
However, both credibility and cooperation failed to function after World War I, and Eichengreen indicates that this set the stage for the Depression. The interwar gold standard also failed to adjust balance-of-payment surplus and deficit, with the United States and France ending up with the most gold by the eve of the Depression. In the meantime, international capital transaction was heavily dependent on US lending.
Germany was starved for gold to pay reparations; Central and Eastern Europe shifted from Berlin to New York after the war for accommodation; and U. Hence, with the US and France possessing the most gold and the former financing most countries, the interwar gold standard system was no longer a decentralized system. Since late , the deteriorated business conditions were visible in Central Europe, Latin America and the Orient. Though the US economy continued to grow, the Federal Reserve was alert with investments in the stock market and started to adopt increasingly stringent policies.
The rising interest rate and discount rate curtailed the U. Eichengreen suggests that this effect was channeled through the gold standard to other countries. According to his data analysis, with a 30 percent net-portfolio lending decline between and , indebted exporting countries choked on the sharply shrinking loans to finance the balance-of-payment deficit and even basic investment.
Debtor nations had to adopt stringent monetary and fiscal policy to defend gold reserve and maintain the service on debts. Many tightened government spending while raising taxes, especially import duties. Eichengreen shows that when the international price level went down, such actions prevented the US producers from diverting their sales from the deteriorating domestic market to foreign markets.
This eventually forced them to curtail production and put everyone into the vicious cycle. Under the gold standard, even when a single country chose to inject liquidity into the banking system disregarding the threat to the exchange rate, such unilateral action was doomed to fail. Eichengreen implies that once the central banks injected liquidity into the banking system to stem bank runs, investors would realize that convertibility might be compromised and money might devaluate.
They had to get their money out from the banks and the banking crisis was reinforced. In such a situation, the only way out was international cooperation. As the crisis spread around the world for nearly two years, the gold standard system was supposed to self-stabilize through international cooperation, as Eichengreen has previously explained. Nonetheless, the Bank of International Settlement, established in to facilitate central bank cooperation and manage German reparation, did not suffice.
The Congressional opposition excluded the Federal Reserve from the B. S; political disputes prevented further international cooperation. Without liquidity injected on a collaborative basis, central banks of indebted countries in Latin America and Central Europe were forced to maintain high interest rates to confine the demand for gold and discourage capital flight.
Financial difficulties in Germany and Austria forced the government to reconsider the priority attached to convertibility. Nevertheless, as the economy crumbling, the most stringent policies evidenced inadequate , especially in Latin America. Such debtor countries were forced to default, reducing the income of creditors, notably Britain, which in turn worsened international lending. Countries suspending convertibility further increased the doubt on the credibility.
Eichengreen analyzes the Bank of England as a classic example of how central banks reacted in the depression. As Britain continued losing profit in foreign loans, doubts mounted on the convertibility of the sterling.
Attempting to repeat history, the Bank of England tried to stem capital flight and defend the sterling by raising interest rates to attract foreign gold. However, seeing that the action of other central banks indicated the likelihood for Britain to suspend convertibility, capital flowed in the opposite direction in , even when the Bank of England had raised Bank rate twice in succession.
Paul Krugman further proved the influence of increasing gold coverage on the demand for gold mathematically , showing that the increase in gold coverage would aggravate gold runs rather than capital inflow.
Hence, both cooperation and credibility were undermined, and the depression amplified in the absence of sufficient policy intervention. Countries were forced off the gold standard one after another, and this opened the door for unilateral pursuit of reflationary initiatives. Eichengreen takes Denmark and New Zealand as models. Dependent on the British market for exporting dairy product, both Denmark and New Zealand pegged their currencies to the sterling after Britain went off the gold standard.
Yet, without the gold coverage limitation, both devaluated their currencies against the sterling at a 25 per cent discount, restoring their bilateral exchange rate to the gold standard level. On the other hand, countries that still committed to the gold standard were facing a deteriorating situation. The lingering memory of post-war inflation and fewer political pressures from exporters kept countries like France and the US on gold.
With little space to maneuver in monetary and general fiscal policies, most gold standard countries adopted high tariffs and quotas to protect manufacturing and agriculture, even before the U. Not surprisingly, even countries like France managed to narrow the trade deficit; however, as long as the economic performance in rest of the world continued to recede, French GNP still suffered a 7 per cent decline in Eichengreen makes another case for the benefit of leaving the gold by presenting countries like Czechoslovakia, which had previously remained in the gold bloc.
As its economy crumbled with orthodox policies of reducing prices and cost, Czechoslovakia had to leave the gold standard in After the devaluation, though domestic prices moved upward and the inflation affected its economy, it could not eliminate the competitive exports resulting directly from devalued currency. By comparing the economic performance of two groups of countries, those who had broken the golden fetters and those who kept committed to the gold standard, Eichengreen reaches the conclusion that it was the gold standard that prevented the automatic economic adjustment in the first place, and eventually threw the world into the abyss of depression.
He suggests that until countries had left the gold standard and abandoned the ethos attached to it could they see the reflation. Admittedly, Eichengreen has provided a convincing analysis for the cause of the Great Depression. Nonetheless, some phenomena did not perfectly fit into his theory.
At the initial stage, when the economy weakened in Latin America and Central Europe, which ignited the Great Depression, countries saw nothing more than an ordinary recession. These export-oriented economies, especially those dependent on primary products exportation, had to suffer a price decline during the agricultural production summit in As Eichengreen has shown, after falling steadily from the peak, the average price of agricultural exports fell by 20 per cent between and , followed by another 25 per cent decrease between and Such collapse of commodity prices would surely devastate the economy of exporting countries.
When most were relying on similar consumers, price competition would provide little help. Eventually, these heavily indebted countries would be forced to default. Through the channel of international business and financial transaction, defaulting would threaten creditors like Britain. In this sense, history would repeat itself even without the gold standard. The unbalanced international economic structure was another crack on the eggshell.
Loaded with the high reparation to the Allies, Germany turned to the U. This money circulation led to uneven balance-of-payments for all sides: the Latin Americans and Germany ended up with constant deficit in capital account, while the U. The post-war international economic circulation largely depended on U. Even without the price crash in the agricultural commodity market, the seemingly smooth transaction would have choked when any route of the circle had broken.
Especially when the U. The Great Depression thus was a definite ending, regardless of the presence or absence of the gold standard. Similar to the current economic crisis in many countries, commercial banks were not innocent in the s. Commercial banks in the U. Bank failure swept the U. Those frightened domestic depositors rushed to get their money--not necessarily gold--out from the banks. The financial sector was heavily hit in the s because of their own risky assets and malfunctioned interdependence, without explicit relations to the gold standard.
As Eichengreen argues throughout his book, it was the fixed convertibility ratio of the gold standard that prevented central banks and governments from taking proper action. However, even after suspending gold convertibility, central banks sat idly for around half a year before they started to pump money into the system.
However, with the lingering memory of the post-war hyperinflation in many European countries, the fear of inflation linked to increased money supply undoubtedly reached the phobic level, and thus was hard to imagine any European government taking the initiative to expand money supply. However, devaluation was unlikely to happen in the interwar period, either collectively or unilaterally.
Taking the linkage between German reparation and Allied debt payment into account, even reducing the Allied capital inflow by devaluating the mark singularly was not acceptable to the U. Since the U. France, though it already possessed a large amount of gold, also had little political or economic incentive to reduce any reparation payment. Under such political and economic condition, even without the golden fetters that trapped unilateral devaluations and threatened central banks with capital flight, it was hard for any country to devaluate the currency separately.
Currency speculators would be reassured if the free reserves of the entire group of central banks were made available to the weak currency country. The domestic lender of last resort could inject reserves into the banking system without undermining confidence in its gold parity.
When there is only a small fire in one part of the house, presenting the bucket of water could reassure the owner that he or she would be able to control the fire; when the whole house is on fire, such action is far from convincing.
Unfortunately, this was the case during the Depression, when most countries could barely satisfy the 40 per cent gold coverage ratio, and even financial centers like London were facing continuous runs on the gold, it was unlikely that the collective gold parity support would suffice. When confidence was the main variable concerning bank runs, this cooperation would not persuade depositors from draining their money out of banks, regardless of political tensions that might break the cooperation at any time.
Eichengreen argues that devaluation of currency was necessary for reflation, taking Czechoslovakia as an example. Yet, countries abandoning the gold standard first benefited from those who stick to the gold convertibility, even when the retaliating tariffs and quotas were increasing recurrently.
The example of Denmark and New Zealand actually proved that this process would work only when countries do not devalue simultaneously: both Denmark and New Zealand benefited from devaluating against the sterling, the currency of their major customer, while maintaining the same exchange level.
If other countries cooperatively devaluated at the same time to the same extent, there would be no advantage for Denmark or New Zealand to occupy the British market and thus pull themselves out from the depression.
Countries going off gold later then switched their sales from domestic markets to the foreign market, and thus reflected from the economic abyss. Though simultaneous devaluation would provide room for expansionary policies, it would work only in countries with sufficient domestic markets, which was not the case in most cases during the Great Depression. Barry Eichengreen has provided a detailed and consistent argument concerning the interwar gold standard operation, and how this financial linkage channeled the crisis around the world.
However, though the golden fetter did limit expansionary policies to save the economy, even without the gold standard, the world is not free from boom-and-bust cycles, as we are experiencing now.
Golden Fetters: The Gold Standard and the Great Depression, 1919-1939
In his book Golden Fetters, published in , Eichengreen builds the explanation that the interwar gold standard system failed to adjust the economic imbalance and limited policy responses to offset the business downturn, which eventually caused the Great Depression. In the first chapter, Eichengreen explains the classic mechanism of the Gold Standard, and the reason for its malfunction during the interwar period. Contrary to the conventional account that the Bank of England monopolized the international financial system, Eichengreen specifies that the prewar gold standard was a decentralized, multi-polar system, whose stability laid on credibility and cooperation. Since this government credibility is beyond reproof, the international currency market would function as a self-stabilizing system. Supposing the sterling weakened, foreign funds would flow into Britain, expecting capital gains when the Bank of England intervened to strengthen the rate. In his theory, when this stabilizing speculation failed to accommodate a disturbance, international cooperation would be the next step.
He might have balanced his advice with an equal warning to nostalgics: Never attempt to rebuild a structure until you understand why it was ripped down. Case in point: the gold standard. Now former presidential candidate Ron Paul is selling tens of thousands of copies of a book that calls for turning back the clock even further — to back before the creation of the Federal Reserve in Before signing onto any of these ideas, however, intelligent conservatives would do well to grapple with the reasons for the overthrow of gold. Golden Fetters is a narrative history, not a work of economic theory, and Eichengreen is a perfectly serviceable writer.
Summary of the Golden Fetters and the Depression