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The Great Depression’s Patsy

[This article originally appeared in the January 4 edition of]

The culprit responsible for the Wall Street crash of 1929 and the Great Depression can be easily identified—the government.

To protect fractional reserve banking and generate a buyer for its debt, the US government created the Federal Reserve System in 1913 and put it in charge of the money supply. From July 1921 to July 1929, the Federal Reserve inflated the money supply by 62 percent, resulting in the crash in late October. The US government, following an aggressive do something” program for the first time in American history, intervened in numerous ways throughout the 1930s—first under Herbert Hoover, then more heavily under Franklin D. Roosevelt. The result was not an easing of pain or an acceleration of recovery but a deepening of the Great Depression, as Robert Higgs explains in detail.

The preceding is not, of course, the generally accepted explanation. In conventional discourse, one of the main culprits behind the Depression—or at least responsible for exacerbating it—was the international community’s adherence to a gold standard. Economist Barry Eichengreen popularized this view. The Wikipedia entry for Eichengreen includes Ben Bernanke’s summary of Eichengreen’s thesis:

The proximate cause of the world depression was a structurally flawed and poorly managed international gold standard. . . . 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 1920’s—a contraction that was transmitted worldwide by the gold standard.

Why would a contractionary monetary policy be harmful? Because fractional reserve banking is a house of cards, and such policy risked toppling it. When inflation is exposed and the gold is not there, bankers do the Jimmy Stewart scramble. In Bernanke’s words, “what was initially a mild deflationary process began to snowball when the banking and currency crises of 1931 instigated an international ‘scramble for gold.’”

The States Classical Gold Standard

The classical gold standard that operated throughout the West from the 1870s to 1914 was in fact a fiat gold standard—meaning it operated at the pleasure of the state. When the state was not pleased with the gold standard’s operation, gold convertibility was suspended to allow banks to break their promise to redeem paper currency and deposits in gold coins on demand.

But even under the auspices of the state, the classical gold standard kept a lid on inflation. Gold was money, and national currencies were named after certain weights of gold; a dollar was the name for one-twentieth of an ounce of gold for example. A dollar was not backed by gold because a dollar was not money. A dollar was a conditional substitute for the real thing. The only thing governments and their central banks could directly inflate was their currencies, but if governments and their central banks inflated their currencies too much, they would lose gold to countries that inflated less. In other words, they could not stay on the classical gold standard and print a lot of money.

With the arrival of World War I, the belligerent governments ordered their central banks to stop redeeming their currencies in gold. The gold standard would not permit a long war; unlike currencies, gold could not be created on demand. By inflating their currencies, governments not only killed millions of people but also the classical gold standard. As I’ve said previously, “Sound money had to die before men could die in such large numbers.”

After the war, the inflated money supplies and price levels presented governments with a choice: return to the classical gold standard at lower exchange rates or return to the pars existing before the war. Britain, in an attempt to reestablish London as the world’s financial center, chose to go back to its prewar par of $4.86. To make this work, monetary concessions were required from other countries—especially the United States.

The New Gold Standard

At the Genoa Conference of 1922, with the architecture of the monetary order firmly in the governments’ hands, representatives from thirty-four countries met to discuss what to do about money. The problem was obvious. When governments had needed money the most (to engage in war), gold had let them down. Gold had proved exceedingly unpatriotic. On the other hand, paper money, like the “girl from Oklahoma,” could not say no. Paper money saluted whatever plans the government devised. The problem, therefore, was not too much paper; it was too little gold.

Gold’s scarcity was now its fatal flaw. But the economists in charge of its fate were not ready to announce that the money people had been using for twenty-five hundred years had suddenly become dangerous to their economic well-being. So gold was given a small supporting role, but its name was displayed prominently on the marquee of the economists’ new scheme, the gold exchange standard. Here was the deal they cut:

  1. The United States would stay on the classical gold standard. This meant people could exchange $20.67 in currency and coin at the Treasury for a one-ounce gold coin. The gross inconvenience was intentional.
  2. Britain would redeem pounds in gold and US dollars while other nations would pyramid their currencies on pounds.
  3. Britain would redeem pounds only in large gold bars. Gold was thereby removed from the hands of ordinary citizens allowing a greater degree of monetary inflation.
  4. Britain also pressured other countries to remain at overvalued parities.

To summarize, the US pyramided on gold; Britain, on dollars; and other European countries, on pounds. When Britain inflated, other countries inflated on top of pounds instead of redeeming them for gold. Britain also induced the US to inflate to keep Britain from losing its stock of dollars and gold to the US.

This international inflationary arrangement brought gold along for the ride to give it the appearance of stability and prestige. When the arrangement collapsed, as it was bound to do, gold served as the scapegoat.

Gold Gets a Prison Sentence

Keynesians and other monetary scientists claim to have a smoking gun.

Source: Barry Eichengreen, “The Origins and Nature of the Great Slump Revisited,” Economic History Review 45, no. 2 (May 1992): 213–39.

In this chart, taken from a paper by Barry Eichengreen and reproduced by Robert Murphy, the output for each country is set to one hundred. Subsequent measures are a percentage of deviation from the 1929 benchmark.

The chart reflects the order in which countries went off gold. Japan was first; then Britain, Germany, the US, and finally France went off gold. The chart superficially appears to support the connection between prosperity and an irredeemable currency. But look closer. In Germany and the US, industrial output experienced a significant rebound from 1932 to 1933. The US did not go off gold” until almost mid-1933, yet industrial output was already rising in 1932.

As Murphy notes, whatever the discrepancies in the chart, it allegedly shows the beneficial effects of devaluation over time. Yet the Great Depression lasted well beyond 1937, with double-digit unemployment rates persisting throughout the 1930s.

Previous depressions had ended in two or three years and without the confiscation of people’s gold. Why did gold suddenly become a major culprit in the 1930s?

And what did it mean to “go off gold”? It meant that US citizens who disobeyed Roosevelt’s order to turn in gold were subject to a ten-thousand-dollar fine and a ten-year prison sentence. This was the punishment for possessing the money chosen by tens of millions of market participants. Roosevelt’s order meant people around the world holding dollar-denominated assets and thinking they could redeem them in gold got stiffed.

Also, is it really surprising that economic conditions improved after going off gold”? Murphy likens going off the gold standard to a homeowner’s declaring he is going off his mortgage.” He says to his mortgage holder, I’m not paying you anymore. And I have more guns than you, so tough.”

With no mortgage to pay, it is unsurprising that the homeowner’s standard of living rises. Achieving short-term prosperity by relieving yourself of certain contractual obligations does not prove those obligations were unfounded.


The government never wants to lose the ability to inflate (counterfeit). As we have seen, a gold standard frustrates the government’s ability to inflate.

A free-market monetary system, which would be devoid of a central bank, is the only way to restrict the government’s ability to affect us.

[This article originally appeared in the January 4 edition of]

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