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How Did the Gold Standard Contribute to the Great Depression?

How Did the Gold Standard Contribute to the Great Depression?

The causes of the Great Depression were numerous, and after the stock market crash of 1929, a number of complex factors helped to create the conditions necessary for the longest and deepest economic downturn in modern history. President Franklin D. Roosevelt’s decision to take the United States off the gold standard may have helped to ease the worst effects of the Depression.

What is the gold standard?

The gold standard is a monetary system in which a nation’s currency is pegged to the value of gold. In a gold standard system, a given amount of paper money can be converted into a fixed amount of gold. Countries on the gold standard can’t increase the amount of paper money in circulation without also increasing their reserves of gold.

From the late 1800s until the 1930s, most countries in the world—including the United States—adhered to an international gold standard. (Many European countries temporarily abandoned the gold standard during World War I so they could print more money to finance war efforts.)

Bank failures led ordinary citizens to hoard gold.

The U.S. economy boomed during the first part of the 1920s—the Roaring Twenties—with industries such as construction and automobiles driving the post-war recovery. In an effort to combat inflation, the Federal Reserve raised interest rates in 1928.

But European countries that had borrowed money from the United States during World War I had trouble paying off their debts. As a result, demand for U.S. exports slowed.

A slowing economy combined with the stock market crash of 1929 and a subsequent wave of bank failures in 1930 and 1931 led to crippling levels of deflation. Soon, the frightened public began hoarding gold.

READ MORE: Life for the Average Family During the Great Depression

European countries began to abandon the gold standard

The United States and other countries on the gold standard couldn’t increase their money supplies to stimulate the economy. Great Britain became the first to drop off the gold standard in 1931. Other countries soon followed.

But the United States didn’t abandon gold for another two years, deepening the pain of the Great Depression.

The Gold Reserve Act increased government gold reserves

In 1933, President Roosevelt took the U.S. off the gold standard when he signed the Gold Reserve Act in 1934. This bill made it illegal for the public to possess most forms of gold.

People were required to exchange their gold coins, gold bullion and gold certificates for paper money at a set price of $20.67 per ounce.

Abandoning the gold standard helped the economy grow

This exchange of gold for paper money allowed the United States to increase the amount of gold reserves at the United States Bullion Depository at Fort Knox. The government raised the price of gold to $35 per ounce, which allowed the Federal Reserve to increase the money supply.

The economy slowly began to grow again, but it would take the United States most of the 1930s to fully recover from the depths of the Great Depression.

READ MORE: Life for the Average Family During the Great Depression?

Was the Gold Standard the Cause of the Great Depression?

Whenever I talk about the gold standard, usually there is someone who stands up and says “what about the Great Depression?” -- like that is some kind of remark that trumps all possible replies.

The Great Depression was, undoubtedly, the time period when the conventional wisdom migrated from a Classical viewpoint, emphasizing money that is stable in value, to a Mercantilist viewpoint, emphasizing money that can be manipulated to cause short-term economic effects.

The main economic problem that they wanted to deal with was unemployment. So, they looked for a way to deal with unemployment via currency manipulation. Seems kind of silly when you put it in those terms, doesn’t it?

I think it is important to recognize that this was something of a political tide. Governments around the world had already fully embraced currency devaluation by the time that Keynes’ book The General Theory of Employment, Interest and Money came out in 1936. The title alone tells you where Keynes intends to get his employment from, which is good because the book itself is basically unreadable.

Actually, governments had already gotten rather tired of the “beggar thy neighbor” devaluation game by 1934, and refrained from any more developments there. The U.S. maintained the value of the dollar at $35/oz. of gold from 1934 to 1971.

People at the time, for the most part, didn’t have the idea that the gold standard system caused the Great Depression. They just wanted to be able to devalue their currencies, and the gold standard system prevented that.

The notion that the gold standard (or anyway, the monetary conditions of the time) was a cause of the Great Depression really came about in the 1960s. I see it mostly as a swipe at the Federal Reserve. The Federal Reserve has been unpopular among libertarian types since it was founded in 1913. So, if you don’t like Federal Reserve, then blame the Great Depression on it. I’m not sure there’s that much more to it than that.

The Fed actually did its job of serving as a “lender of last resort,” as the phrase was understood at the time. This is evidenced by the low and stable short-term interbank lending rates throughout the time period. This is exactly what the Fed was created to do, and it did it.

I looked at the 1914-1930 period in considerable detail in the past, and found nothing of any great importance. Currencies were pegged to gold. Thus, the only way for a gold standard to have caused an event of this sort would have been for gold’s value to change suddenly and by a very large degree – something which is historically unprecedented – and for this change to go unnoticed by people at the time.

And what supposedly caused this dramatic change in value? Some people have tried to blame France, which I find rather laughable if you look at the historical data. France didn’t do anything of any great importance. (One thing I’ve noticed is that almost nobody actually looks at the data, although it is available free online at the St. Louis Fed’s FRASER database.)

We know a few things about the Great Depression. We know that there was a dramatic, worldwide trade war, in retaliation for the U.S.’s Smoot-Hawley Tariff, which raised tariffs on over 20,000 products. Smoot-Hawley put a tariff of 60% on 3,200 items, many of which were not even manufactured in the U.S. This alone was enough to cause a worldwide recession.

As governments’ tax revenue faltered in the initial recession, and demands for welfare services and public works spending increased, very large domestic tax increases were implemented around the world according to the conservative conventional wisdom of the time, especially in Britain, Germany and the U.S. (France and especially Japan were much less aggressive here).

In the U.S., the big tax hike took place in 1932. The top income tax rate rose from 25% to 63%, and an explosion of excise taxes (in effect a national sales tax) were imposed. In Britain and Germany, this took place in 1930-33. Does this sound like today’s “austerity,” as Europe is experiencing, but multiplied several times? Just like today, it didn’t work then either.

In the midst of this, with unemployment exploding higher (much as it has exploded higher in Greece and Spain in response to “austerity” recently), governments began to devalue their currencies as a last-resort option. This happened as something of an accident in Germany in 1931, in the midst of a bank panic. Britain followed with an intentional devaluation in September 1931, and Japan in December 1931. The U.S. followed in 1933, and France in 1936.

The effect of these devaluations was just as you might imagine. Industry became more “competitive,” and debts became easier to repay because they could be paid in a devalued currency. The economies of the devaluers seemed to improve a little bit, and unemployment declined.

What about those countries that didn’t devalue, like the U.S. and France? They were worse off, because of the artificial “competitive advantage” enjoyed by the devaluers. Now their own industries were rendered artificially “uncompetitive,” while they were flooded by cheap imports. Thus it was called “beggar thy neighbor,” because whatever advantage gained was at the cost of economic deterioration in the non-devaluing countries.

Actually, the devaluers weren’t all that well off, because of course the “competitive advantage” ultimately came about because wages had been devalued, and bondholders suffered what amounted to a partial default. You can’t devalue yourself to prosperity, then or now, which is why this devaluation game was soon abandoned. All this currency devaluation introduced a new layer of financial chaos and uncertainly to an already rather grim picture. Having learned to their satisfaction just how much (and how little) you can really accomplish just by jiggering the unit of account, the world soon settled back into the gold standard system, which was formalized in 1944 as the Bretton Woods Agreement.

For the rest of the decade, governments mostly went back and forth between “stimulus” (wasting a lot of government money and running big deficits) and “austerity” (raising taxes), with much the same results as Europe or Japan today, with the same strategy.

And that, in short, was the Great Depression. What did it have to do with the gold standard system? The purpose of a gold standard system, then as now, was to produce a currency of stable value. I think it did this properly, just as it has done so for centuries.

Governments touched off a recession due to their tariff wars. Then, they made the problem worse with “austerity” and “stimulus” (deficit spending and tax hikes). Then, they made the problem even worse with currency chaos, although this did seem to help in the short term.

Of course it did. That’s why governments have been playing around with currency devaluation for over two thousand years. Do you think it is because it is politically unpleasant?

I say the proper response to the Great Depression was not currency devaluation. It was to deal with the problems directly. Undo the tariff wars, as Roosevelt’s Secretary of State Cordell Hull attempted valiantly. Don’t raise taxes – that only makes things worse. Spend on welfare programs to alleviate the distress, but don’t spend boatloads of taxpayer money in hopes of some “multiplier effect” that never seems to pan out.

You could even cut taxes, or better yet have a comprehensive tax reform like the flat tax plan that Russia implemented, in the depths of disaster in 2000.

The recession of 1921 is often cited as an example of what can happen if you “do nothing,” and let the economy recover. The downturn was almost as intense as the initial stages of the Great Depression, but the recovery was quick and the rest of the 1920s were boom years, especially in the U.S.

But the U.S. government didn’t “do nothing” in 1921. Republican Warren Harding won the presidential election in 1920, replacing Democrat Woodrow Wilson. Harding promised to reduce income tax rates dramatically, and he did. The top income tax rate fell from 73% in 1920 to 46% in 1924, and additional corporate taxes were reduced. Calvin Coolidge promised to reduce income tax rates still further in the 1924 election, with the top rate falling to 25%. He won, and delivered on his promise immediately afterwards.

Supposedly the Keynesians are great students of the Great Depression. What are they doing today? In Europe, it is “stimulus” and bloated government spending, “austerity” and higher taxes, and, following the predictable failure of this approach, various calls for individual countries like Greece or Spain to withdraw from the euro and devalue. This is exactly what governments did during the Great Depression, and it is having similar results today. Nobody learns nothing.

How Did the Gold Standard Contribute to the Great Depression? - HISTORY

I am pleased to be able to present the H. Parker Willis Lecture in Economic Policy here at Washington and Lee University. As you may know, Willis was an important figure in the early history of my current employer, the Federal Reserve System. While he was a professor at Washington and Lee, Willis advised Senator Carter Glass of Virginia, one of the key legislators involved in the founding of the Federal Reserve. Willis also served on the National Monetary Commission, which recommended the creation of the Federal Reserve, and he went on to become the research director at the Federal Reserve from 1918 to 1922. At the Federal Reserve, Willis pushed for the development of new and better economic statistics, facing the resistance of those who took the view that too many facts only confuse the issue. Willis was also the first editor of the Federal Reserve Bulletin, the official publication of the Fed, which in Willis's time as well as today provides a wealth of economic statistics. As an illustration of the intellectual atmosphere in Washington at the time he served, Willis reported that when the first copy of the Bulletin was presented to the Secretary of the Treasury, the esteemed Secretary replied, "This Government ain't going into the newspaper business."

Like Parker Willis, I was a professor myself before coming to the Federal Reserve Board. One topic of particular interest to me as a researcher was the performance of the Federal Reserve in its early days, particularly the part played by the young U.S. central bank in the Great Depression of the 1930s. 1 In honor of Willis's important contribution to the design and creation of the Federal Reserve, I will speak today about the role of the Federal Reserve and of monetary factors more generally in the origin and propagation of the Great Depression. Let me offer two caveats before I begin: First, as I mentioned, H. Parker Willis resigned from the Fed in 1922, to take a post at Columbia University thus, he is not implicated in any of the mistakes that the Federal Reserve made in the late 1920s and early 1930s. Second, the views I will express today are my own and are not necessarily those of my colleagues in the Federal Reserve System.

The number of people with personal memory of the Great Depression is fast shrinking with the years, and to most of us the Depression is conveyed by grainy, black-and-white images of men in hats and long coats standing in bread lines. However, although the Depression was long ago--October this year will mark the seventy-fifth anniversary of the famous 1929 stock market crash--its influence is still very much with us. In particular, the experience of the Depression helped forge a consensus that the government bears the important responsibility of trying to stabilize the economy and the financial system, as well as of assisting people affected by economic downturns. Dozens of our most important government agencies and programs, ranging from social security (to assist the elderly and disabled) to federal deposit insurance (to eliminate banking panics) to the Securities and Exchange Commission (to regulate financial activities) were created in the 1930s, each a legacy of the Depression.

The impact that the experience of the Depression has had on views about the role of the government in the economy is easily understood when we recall the sheer magnitude of that economic downturn. During the major contraction phase of the Depression, between 1929 and 1933, real output in the United States fell nearly 30 percent. During the same period, according to retrospective studies, the unemployment rate rose from about 3 percent to nearly 25 percent, and many of those lucky enough to have a job were able to work only part-time. For comparison, between 1973 and 1975, in what was perhaps the most severe U.S. recession of the World War II era, real output fell 3.4 percent and the unemployment rate rose from about 4 percent to about 9 percent. Other features of the 1929-33 decline included a sharp deflation--prices fell at a rate of nearly 10 percent per year during the early 1930s--as well as a plummeting stock market, widespread bank failures, and a rash of defaults and bankruptcies by businesses and households. The economy improved after Franklin D. Roosevelt's inauguration in March 1933, but unemployment remained in the double digits for the rest of the decade, full recovery arriving only with the advent of World War II. Moreover, as I will discuss later, the Depression was international in scope, affecting most countries around the world not only the United States.

What caused the Depression? This question is a difficult one, but answering it is important if we are to draw the right lessons from the experience for economic policy. Solving the puzzle of the Depression is also crucial to the field of economics itself because of the light the solution would shed on our basic understanding of how the economy works.

During the Depression years and for many decades afterward, economists disagreed sharply on the sources of the economic and financial collapse of the 1930s. In contrast, during the past twenty years or so economic historians have come to a broad consensus about the causes of the Depression. A widening of the geographic focus of Depression research deserves much of the credit for this breakthrough. Before the 1980s, research on the causes of the Depression had considered primarily the experience of the United States. This attention to the U.S. case was appropriate to some degree, as the U.S. economy was then, as it is today, the world's largest the decline in output and employment in the United States during the 1930s was especially severe and many economists have argued that, to an important extent, the worldwide Depression began in the United States, spreading from here to other countries (Romer, 1993). However, in much the same way that a medical researcher cannot reliably infer the causes of an illness by studying one patient, diagnosing the causes of the Depression is easier when we have more patients (in this case, more national economies) to study. To explain the current consensus on the causes of the Depression, I will first describe the debate as it existed before 1980, and then discuss how the recent focus on international aspects of the Depression and the comparative analysis of the experiences of different countries have helped to resolve that debate.

I have already mentioned the sharp deflation of the price level that occurred during the contraction phase of the Depression, by far the most severe episode of deflation experienced in the United States before or since. Deflation, like inflation, tends to be closely linked to changes in the national money supply, defined as the sum of currency and bank deposits outstanding, and such was the case in the Depression. Like real output and prices, the U.S. money supply fell about one-third between 1929 and 1933, rising in subsequent years as output and prices rose.

While the fact that money, prices, and output all declined rapidly in the early years of the Depression is undeniable, the interpretation of that fact has been the subject of much controversy. Indeed, historically, much of the debate on the causes of the Great Depression has centered on the role of monetary factors, including both monetary policy and other influences on the national money supply, such as the condition of the banking system. Views have changed over time. During the Depression itself, and in several decades following, most economists argued that monetary factors were not an important cause of the Depression. For example, many observers pointed to the fact that nominal interest rates were close to zero during much of the Depression, concluding that monetary policy had been about as easy as possible yet had produced no tangible benefits to the economy. The attempt to use monetary policy to extricate an economy from a deep depression was often compared to "pushing on a string."

During the first decades after the Depression, most economists looked to developments on the real side of the economy for explanations, rather than to monetary factors. Some argued, for example, that overinvestment and overbuilding had taken place during the ebullient 1920s, leading to a crash when the returns on those investments proved to be less than expected. Another once-popular theory was that a chronic problem of "under-consumption"--the inability of households to purchase enough goods and services to utilize the economy's productive capacity--had precipitated the slump.

However, in 1963, Milton Friedman and Anna J. Schwartz transformed the debate about the Great Depression. That year saw the publication of their now-classic book, A Monetary History of the United States, 1867-1960. The Monetary History, the name by which the book is instantly recognized by any macroeconomist, examined in great detail the relationship between changes in the national money stock--whether determined by conscious policy or by more impersonal forces such as changes in the banking system--and changes in national income and prices. The broader objective of the book was to understand how monetary forces had influenced the U.S. economy over a nearly a century. In the process of pursuing this general objective, however, Friedman and Schwartz offered important new evidence and arguments about the role of monetary factors in the Great Depression. In contradiction to the prevalent view of the time, that money and monetary policy played at most a purely passive role in the Depression, Friedman and Schwartz argued that "the [economic] contraction is in fact a tragic testimonial to the importance of monetary forces" (Friedman and Schwartz, 1963, p. 300).

To support their view that monetary forces caused the Great Depression, Friedman and Schwartz revisited the historical record and identified a series of errors--errors of both commission and omission--made by the Federal Reserve in the late 1920s and early 1930s. According to Friedman and Schwartz, each of these policy mistakes led to an undesirable tightening of monetary policy, as reflected in sharp declines in the money supply. Drawing on their historical evidence about the effects of money on the economy, Friedman and Schwartz argued that the declines in the money stock generated by Fed actions--or inactions--could account for the drops in prices and output that subsequently occurred. 2

Friedman and Schwartz emphasized at least four major errors by U.S. monetary policymakers. The Fed's first grave mistake, in their view, was the tightening of monetary policy that began in the spring of 1928 and continued until the stock market crash of October 1929 (see Hamilton, 1987, or Bernanke, 2002a, for further discussion). This tightening of monetary policy in 1928 did not seem particularly justified by the macroeconomic environment: The economy was only just emerging from a recession, commodity prices were declining sharply, and there was little hint of inflation. Why then did the Federal Reserve raise interest rates in 1928? The principal reason was the Fed's ongoing concern about speculation on Wall Street. Fed policymakers drew a sharp distinction between "productive" (that is, good) and "speculative" (bad) uses of credit, and they were concerned that bank lending to brokers and investors was fueling a speculative wave in the stock market. When the Fed's attempts to persuade banks not to lend for speculative purposes proved ineffective, Fed officials decided to dissuade lending directly by raising the policy interest rate.

The market crash of October 1929 showed, if anyone doubted it, that a concerted effort by the Fed can bring down stock prices. But the cost of this "victory" was very high. According to Friedman and Schwartz, the Fed's tight-money policies led to the onset of a recession in August 1929, according to the official dating by the National Bureau of Economic Research. The slowdown in economic activity, together with high interest rates, was in all likelihood the most important source of the stock market crash that followed in October. In other words, the market crash, rather than being the cause of the Depression, as popular legend has it, was in fact largely the result of an economic slowdown and the inappropriate monetary policies that preceded it. Of course, the stock market crash only worsened the economic situation, hurting consumer and business confidence and contributing to a still deeper downturn in 1930.

The second monetary policy action identified by Friedman and Schwartz occurred in September and October of 1931. At the time, as I will discuss in more detail later, the United States and the great majority of other nations were on the gold standard, a system in which the value of each currency is expressed in terms of ounces of gold. Under the gold standard, central banks stood ready to maintain the fixed values of their currencies by offering to trade gold for money at the legally determined rate of exchange.

The fact that, under the gold standard, the value of each currency was fixed in terms of gold implied that the rate of exchange between any two currencies within the gold standard system was likewise fixed. As with any system of fixed exchange rates, the gold standard was subject to speculative attack if investors doubted the ability of a country to maintain the value of its currency at the legally specified parity. In September 1931, following a period of financial upheaval in Europe that created concerns about British investments on the Continent, speculators attacked the British pound, presenting pounds to the Bank of England and demanding gold in return. Faced with the heavy demands of speculators for gold and a widespread loss of confidence in the pound, the Bank of England quickly depleted its gold reserves. Unable to continue supporting the pound at its official value, Great Britain was forced to leave the gold standard, allowing the pound to float freely, its value determined by market forces.

With the collapse of the pound, speculators turned their attention to the U.S. dollar, which (given the economic difficulties the United States was experiencing in the fall of 1931) looked to many to be the next currency in line for devaluation. Central banks as well as private investors converted a substantial quantity of dollar assets to gold in September and October of 1931, reducing the Federal Reserve's gold reserves. The speculative attack on the dollar also helped to create a panic in the U.S. banking system. Fearing imminent devaluation of the dollar, many foreign and domestic depositors withdrew their funds from U.S. banks in order to convert them into gold or other assets. The worsening economic situation also made depositors increasingly distrustful of banks as a place to keep their savings. During this period, deposit insurance was virtually nonexistent, so that the failure of a bank might cause depositors to lose all or most of their savings. Thus, depositors who feared that a bank might fail rushed to withdraw their funds. Banking panics, if severe enough, could become self-confirming prophecies. During the 1930s, thousands of U.S. banks experienced runs by depositors and subsequently failed.

Long-established central banking practice required that the Fed respond both to the speculative attack on the dollar and to the domestic banking panics. However, the Fed decided to ignore the plight of the banking system and to focus only on stopping the loss of gold reserves to protect the dollar. To stabilize the dollar, the Fed once again raised interest rates sharply, on the view that currency speculators would be less willing to liquidate dollar assets if they could earn a higher rate of return on them. The Fed's strategy worked, in that the attack on the dollar subsided and the U.S. commitment to the gold standard was successfully defended, at least for the moment. However, once again the Fed had chosen to tighten monetary policy despite the fact that macroeconomic conditions--including an accelerating decline in output, prices, and the money supply--seemed to demand policy ease.

The third policy action highlighted by Friedman and Schwartz occurred in 1932. By the spring of that year, the Depression was well advanced, and Congress began to place considerable pressure on the Federal Reserve to ease monetary policy. The Board was quite reluctant to comply, but in response to the ongoing pressure the Board conducted open-market operations between April and June of 1932 designed to increase the national money supply and thus ease policy. These policy actions reduced interest rates on government bonds and corporate debt and appeared to arrest the decline in prices and economic activity. However, Fed officials remained ambivalent about their policy of monetary expansion. Some viewed the Depression as the necessary purging of financial excesses built up during the 1920s in this view, slowing the economic collapse by easing monetary policy only delayed the inevitable adjustment. Other officials, noting among other indicators the very low level of nominal interest rates, concluded that monetary policy was in fact already quite easy and that no more should be done. These policymakers did not appear to appreciate that, even though nominal interest rates were very low, the ongoing deflation meant that the real cost of borrowing was very high because any loans would have to be repaid in dollars of much greater value (Meltzer, 2003). Thus monetary policy was not in fact easy at all, despite the very low level of nominal interest rates. In any event, Fed officials convinced themselves that the policy ease advocated by the Congress was not appropriate, and so when the Congress adjourned in July 1932, the Fed reversed the policy. By the latter part of the year, the economy had relapsed dramatically.

The fourth and final policy mistake emphasized by Friedman and Schwartz was the Fed's ongoing neglect of problems in the U.S. banking sector. As I have already described, the banking sector faced enormous pressure during the early 1930s. As depositor fears about the health of banks grew, runs on banks became increasingly common. A series of banking panics spread across the country, often affecting all the banks in a major city or even an entire region of the country. Between December 1930 and March 1933, when President Roosevelt declared a "banking holiday" that shut down the entire U.S. banking system, about half of U.S. banks either closed or merged with other banks. Surviving banks, rather than expanding their deposits and loans to replace those of the banks lost to panics, retrenched sharply.

The banking crisis had highly detrimental effects on the broader economy. Friedman and Schwartz emphasized the effects of bank failures on the money supply. Because bank deposits are a form of money, the closing of many banks greatly exacerbated the decline in the money supply. Moreover, afraid to leave their funds in banks, people hoarded cash, for example by burying their savings in coffee cans in the back yard. Hoarding effectively removed money from circulation, adding further to the deflationary pressures. Moreover, as I emphasized in early research of my own (Bernanke, 1983), the virtual shutting down of the U.S. banking system also deprived the economy of an important source of credit and other services normally provided by banks.

The Federal Reserve had the power at least to ameliorate the problems of the banks. For example, the Fed could have been more aggressive in lending cash to banks (taking their loans and other investments as collateral), or it could have simply put more cash in circulation. Either action would have made it easier for banks to obtain the cash necessary to pay off depositors, which might have stopped bank runs before they resulted in bank closings and failures. Indeed, a central element of the Federal Reserve's original mission had been to provide just this type of assistance to the banking system. The Fed's failure to fulfill its mission was, again, largely the result of the economic theories held by the Federal Reserve leadership. Many Fed officials appeared to subscribe to the infamous "liquidationist" thesis of Treasury Secretary Andrew Mellon, who argued that weeding out "weak" banks was a harsh but necessary prerequisite to the recovery of the banking system. Moreover, most of the failing banks were relatively small and not members of the Federal Reserve System, making their fate of less interest to the policymakers. In the end, Fed officials decided not to intervene in the banking crisis, contributing once again to the precipitous fall in the money supply.

Friedman and Schwartz discuss other episodes and policy actions as well, such as the Federal Reserve's misguided tightening of policy in 1937-38 which contributed to a new recession in those years. However, the four episodes I have described capture the gist of the Friedman and Schwartz argument that, for a variety of reasons, monetary policy was unnecessarily tight, both before the Depression began and during its most dramatic downward phase. As I have mentioned, Friedman and Schwartz had produced evidence from other historical periods that suggested that contractionary monetary policies can lead to declining prices and output. Friedman and Schwartz concluded therefore that they had found the smoking gun, evidence that much of the severity of the Great Depression could be attributed to monetary forces.

Friedman and Schwartz's arguments were highly influential but not universally accepted. For several decades after the Monetary History was published, a debate raged about the importance of monetary factors in the Depression. Opponents made several objections to the Friedman and Schwartz thesis that are worth highlighting here.

First, critics wondered whether the tightening of monetary policy during 1928 and 1929, though perhaps ill advised, was large enough to have led to such calamitous consequences. 3 If the tightening of monetary policy before the stock market crash was not sufficient to account for the violence of the economic downturn, then other, possibly nonmonetary, factors may need to be considered as well.

A second question is whether the large decline in the money supply seen during the 1930s was primarily a cause or an effect of falling output and prices. As we have seen, Friedman and Schwartz argued that the decline in the money supply was causal. Suppose, though, for the sake of argument, that the Depression was the result primarily of nonmonetary factors, such as overspending and overinvestment during the 1920s. As incomes and spending decline, people need less money to carry out daily transactions. In this scenario, critics pointed out, the Fed would be justified in allowing the money supply to fall, because it would only be accommodating a decline in the amount of money that people want to hold. The decline in the money supply in this case would be a response to, not a cause of, the decline in output and prices. To put the question simply, we know that both the economy and the money stock contracted rapidly during the early 1930s, but was the monetary dog wagging the economic tail, or vice versa?

The focus of Friedman and Schwartz on the U.S. experience (by design, of course) raised other questions about their monetary explanation of the Depression. As I have mentioned, the Great Depression was a worldwide phenomenon, not confined to the United States. Indeed, some economies, such as that of Germany, began to decline before 1929. Although few countries escaped the Depression entirely, the severity of the episode varied widely across countries. The timing of recovery also varied considerably, with some countries beginning their recovery as early as 1931 or 1932, whereas others remained in the depths of depression as late as 1935 or 1936. How does Friedman and Schwartz's monetary thesis explain the worldwide nature of the onset of the Depression, and the differences in severity and timing observed in different countries?

That is where the debate stood around 1980. About that time, however, economic historians began to broaden their focus, shifting from a heavy emphasis on events in the United States during the 1930s to an increased attention to developments around the world. Moreover, rather than studying countries individually, this new scholarship took a comparative approach, asking specifically why some countries fared better than others in the 1930s. As I will explain, this research uncovered an important role for international monetary forces, as well as domestic monetary policies, in explaining the Depression. Specifically, the new research found that a complete understanding of the Depression requires attention to the operation of the international gold standard, the international monetary system of the time. 4

As I have already mentioned, the gold standard is a monetary system in which each participating country defines its monetary unit in terms of a certain amount of gold. The setting of each currency's value in terms of gold defines a system of fixed exchange rates, in which the relative value of (say) the U.S. dollar and the British pound are fixed at a rate determined by the relative gold content of each currency. To maintain the gold standard, central banks had to promise to exchange actual gold for their paper currencies at the legal rate.

The gold standard appeared to be highly successful from about 1870 to the beginning of World War I in 1914. During the so-called "classical" gold standard period, international trade and capital flows expanded markedly, and central banks experienced relatively few problems ensuring that their currencies retained their legal value. The gold standard was suspended during World War I, however, because of disruptions to trade and international capital flows and because countries needed more financial flexibility to finance their war efforts. (The United States remained technically on the gold standard throughout the war, but with many restrictions.)

After 1918, when the war ended, nations around the world made extensive efforts to reconstitute the gold standard, believing that it would be a key element in the return to normal functioning of the international economic system. Great Britain was among the first of the major countries to return to the gold standard, in 1925, and by 1929 the great majority of the world's nations had done so.

Unlike the gold standard before World War I, however, the gold standard as reconstituted in the 1920s proved to be both unstable and destabilizing. Economic historians have identified a number of reasons why the reconstituted gold standard was so much less successful than its prewar counterpart. First, the war had left behind enormous economic destruction and dislocation. Major financial problems also remained, including both large government debts from the war and banking systems whose solvency had been deeply compromised by the war and by the periods of hyperinflation that followed in a number of countries. These underlying problems created stresses for the gold standard that had not existed to the same degree before the war.

Second, the new system lacked effective international leadership. During the classical period, the Bank of England, in operation since 1694, provided sophisticated management of the international system, with the cooperation of other major central banks. This leadership helped the system adjust to imbalances and strains for example, a consortium of central banks might lend gold to one of their number that was experiencing a shortage of reserves. After the war, with Great Britain economically and financially depleted and the United States in ascendance, leadership of the international system shifted by default to the Federal Reserve. Unfortunately, the fledgling Federal Reserve, with its decentralized structure and its inexperienced and domestically focused leadership, did not prove up to the task of managing the international gold standard, a task that lingering hatreds and disputes from the war would have made difficult for even the most-sophisticated institution. With the lack of effective international leadership, most central banks of the 1920s and 1930s devoted little effort to supporting the overall stability of the international system and focused instead on conditions within their own countries.

Finally, the reconstituted gold standard lacked the credibility of its prewar counterpart. Before the war, the ideology of the gold standard was dominant, to the point that financial investors had no doubt that central banks would find a way to maintain the gold values of their currencies no matter what the circumstances. Because this conviction was so firm, speculators had little incentive to attack a major currency. After the war, in contrast, both economic views and the political balance of power had shifted in ways that reduced the influence of the gold standard ideology. For example, new labor-dominated political parties were skeptical about the utility of maintaining the gold standard if doing so increased unemployment. Ironically, reduced political and ideological support for the gold standard made it more difficult for central banks to maintain the gold values of their currencies, as speculators understood that the underlying commitment to adhere to the gold standard at all costs had been weakened significantly. Thus, speculative attacks became much more likely to succeed and hence more likely to occur.

With an international focus, and with particular attention to the role of the gold standard in the world economy, scholars have now been able to answer the questions regarding the monetary interpretation of the Depression that I raised earlier.

First, the existence of the gold standard helps to explain why the world economic decline was both deep and broadly international. Under the gold standard, the need to maintain a fixed exchange rate among currencies forces countries to adopt similar monetary policies. In particular, a central bank with limited gold reserves has no option but to raise its own interest rates when interest rates are being raised abroad if it did not do so, it would quickly lose gold reserves as financial investors transferred their funds to countries where returns were higher. Hence, when the Federal Reserve raised interest rates in 1928 to fight stock market speculation, it inadvertently forced tightening of monetary policy in many other countries as well. This tightening abroad weakened the global economy, with effects that fed back to the U.S. economy and financial system.

Other countries' policies also contributed to a global monetary tightening during 1928 and 1929. For example, after France returned to the gold standard in 1928, it built up its gold reserves significantly, at the expense of other countries. The outflows of gold to France forced other countries to reduce their money supplies and to raise interest rates. Speculative attacks on currencies also became frequent as the Depression worsened, leading central banks to raise interest rates, much like the Federal Reserve did in 1931. Leadership from the Federal Reserve might possibly have produced better international cooperation and a more appropriate set of monetary policies. However, in the absence of that leadership, the worldwide monetary contraction proceeded apace. The result was a global economic decline that reinforced the effects of tight monetary policies in individual countries.

The transmission of monetary tightening through the gold standard also addresses the question of whether changes in the money supply helped cause the Depression or were simply a passive response to the declines in income and prices. Countries on the gold standard were often forced to contract their money supplies because of policy developments in other countries, not because of domestic events. The fact that these contractions in money supplies were invariably followed by declines in output and prices suggests that money was more a cause than an effect of the economic collapse in those countries.

Perhaps the most fascinating discovery arising from researchers' broader international focus is that the extent to which a country adhered to the gold standard and the severity of its depression were closely linked. In particular, the longer that a country remained committed to gold, the deeper its depression and the later its recovery (Choudhri and Kochin, 1980 Eichengreen and Sachs, 1985).

The willingness or ability of countries to remain on the gold standard despite the adverse developments of the 1930s varied quite a bit. A few countries did not join the gold standard system at all these included Spain (which was embroiled in domestic political upheaval, eventually leading to civil war) and China (which used a silver monetary standard rather than a gold standard). A number of countries adopted the gold standard in the 1920s but left or were forced off gold relatively early, typically in 1931. Countries in this category included Great Britain, Japan, and several Scandinavian countries. Some countries, such as Italy and the United States, remained on the gold standard into 1932 or 1933. And a few diehards, notably the so-called gold bloc, led by France and including Poland, Belgium, and Switzerland, remained on gold into 1935 or 1936.

If declines in the money supply induced by adherence to the gold standard were a principal reason for economic depression, then countries leaving gold earlier should have been able to avoid the worst of the Depression and begin an earlier process of recovery. The evidence strongly supports this implication. For example, Great Britain and Scandinavia, which left the gold standard in 1931, recovered much earlier than France and Belgium, which stubbornly remained on gold. As Friedman and Schwartz noted in their book, countries such as China--which used a silver standard rather than a gold standard--avoided the Depression almost entirely. The finding that the time at which a country left the gold standard is the key determinant of the severity of its depression and the timing of its recovery has been shown to hold for literally dozens of countries, including developing countries. This intriguing result not only provides additional evidence for the importance of monetary factors in the Depression, it also explains why the timing of recovery from the Depression differed across countries.

The finding that leaving the gold standard was the key to recovery from the Great Depression was certainly confirmed by the U.S. experience. One of the first actions of President Roosevelt was to eliminate the constraint on U.S. monetary policy created by the gold standard, first by allowing the dollar to float and then by resetting its value at a significantly lower level. The new President also addressed another major source of monetary contraction, the ongoing banking crisis. Within days of his inauguration, Roosevelt declared a "bank holiday," shutting down all the banks in the country. Banks were allowed to reopen only when certified to be in sound financial condition. Roosevelt pursued other measures to stabilize the banking system as well, such as the creation of a deposit insurance program. With the gold standard constraint removed and the banking system stabilized, the money supply and the price level began to rise. Between Roosevelt's coming to power in 1933 and the recession of 1937-38, the economy grew strongly.

I have only scratched the surface of the fascinating literature on the causes of the Great Depression, but it is time that I conclude. Economists have made a great deal of progress in understanding the Great Depression. Milton Friedman and Anna Schwartz deserve enormous credit for bringing the role of monetary factors to the fore in their Monetary History. However, expanding the research focus to include the experiences of a wide range of countries has both provided additional support for the role of monetary factors (including the international gold standard) and enriched our understanding of the causes of the Depression.

Some important lessons emerge from the story. One lesson is that ideas are critical. The gold standard orthodoxy, the adherence of some Federal Reserve policymakers to the liquidationist thesis, and the incorrect view that low nominal interest rates necessarily signaled monetary ease, all led policymakers astray, with disastrous consequences. We should not underestimate the need for careful research and analysis in guiding policy. Another lesson is that central banks and other governmental agencies have an important responsibility to maintain financial stability. The banking crises of the 1930s, both in the United States and abroad, were a significant source of output declines, both through their effects on money supplies and on credit supplies. Finally, perhaps the most important lesson of all is that price stability should be a key objective of monetary policy. By allowing persistent declines in the money supply and in the price level, the Federal Reserve of the late 1920s and 1930s greatly destabilized the U.S. economy and, through the workings of the gold standard, the economies of many other nations as well.

Bernanke, Ben (1983). "Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression," American Economic Review, 73, (June) pp. 257-76.

Bernanke, Ben (2000). Essays on the Great Depression. Princeton, N. J.: Princeton University Press.

Bernanke, Ben (2002a). "Asset-Price 'Bubbles' and Monetary Policy," before the New York chapter of the National Association for Business Economics, New York, New York, October 15. Available at www.federalreserve.gov.

Bernanke, Ben (2002b). "On Milton Friedman's Ninetieth Birthday," at the Conference to Honor Milton Friedman, University of Chicago, Chicago, Illinois, November 8. Available at www.federalreserve.gov.

Choudhri, Ehsan, and Levis Kochin (1980). "The Exchange Rate and the International Transmission of Business Cycle Disturbances: Some Evidence from the Great Depression," Journal of Money, Credit, and Banking, 12, pp. 565-74.

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

Eichengreen, Barry (2002). "Still Fettered after All These Years," National Bureau of Economic Research working paper no. 9276 (October).

Eichengreen, Barry, and Jeffrey Sachs (1985). "Exchange Rates and Economic Recovery in the 1930s," Journal of Economic History, 45, pp. 925-46.

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

Hamilton, James (1987). "Monetary Factors in the Great Depression," Journal of Monetary Economics, 34, pp. 145-69.

Meltzer, Allan (2003). A History of the Federal Reserve, Volume I: 1913-1951. Chicago: The University of Chicago Press.

Romer, Christina (1993). "The Nation in Depression," Journal of Economic Perspectives, 7 (Spring), pp. 19-40.

Temin, Peter (1989). Lessons from the Great Depression. Cambridge, Mass.: MIT Press.

1. My professional articles on the Depression are collected in Bernanke (2000). Return to text

2. Bernanke (2002b) gives a more detailed discussion of the evidence presented by Friedman and Schwartz. Return to text

3. There was less debate about the period 1931-33, the most precipitous downward phase of the Depression, for which most economists were inclined to ascribe an important role to monetary factors. Return to text

4. Critical early research included Choudhri and Kochin (1980) and Eichengreen and Sachs (1985). Eichengreen (1992, 2002) provides the most extensive analysis of the role of the gold standard in causing and propagating the Great Depression. Temin (1989) provides a readable account with a slightly different perspective. Return to text

Did The Gold Standard Cause The Great Depression?

When the gold standard — the principle by which the U.S. dollar was managed for nearly two centuries until 1971 — is brought up, it usually doesn’t take too long before someone asks: “But, didn’t the gold standard cause the Great Depression?” With noted gold standard advocate Judy Shelton recently in Senate hearings to be confirmed to the Federal Reserve Board of Governors, this question has recently been revived.

But, you probably guessed that. So, let’s see what other economists have said about it, over the past eighty years:

This might seem contrary to what you may have heard, so let me clarify. Many economists — in the 1930s and ever since then — have been of the opinion that a devaluation, or some other kind of “easy money” policy such as base money expansion, would have helped during that time. They thought a currency devaluation would help ameliorate a catastrophic downturn caused by things they didn’t understand. Or, that it did help, since most central banks did actually devalue, or use these various “easy money” schemes, eventually. It didn’t actually work that well, and the Great Depression dragged on throughout the decade. “Beggar thy neighbor” currency devaluations were later blamed for causing many of the problems of the 1930s. By the end of the decade, many currencies floated freely.

At the Bretton Woods conference in 1944, governments got together to create a new world gold standard system, with additional safeguards (the International Monetary Fund and the World Bank) to make sure that the sort of unilateral, unplanned devaluations and floating currencies of the 1930s would not take place again.

Obviously, if people thought the gold standard caused the Great Depression, they wouldn’t get together in 1944 to make a new world gold standard that was even more safe and secure (they thought) than the 1930s version. This was the consensus of the people that actually lived through the Great Depression and World War II. And it worked great: the Bretton Woods years, the 1950s and 1960s, are today considered the best decades for economic abundance worldwide since the Classical Gold Standard disintegrated in 1914.

What Is a Recession?

In 2016-2017, I undertook an extensive review of different views of monetary conditions during the 1930s. A summary of this is in my third book, Gold: The Final Standard (2017), which you can read here. But the meat of the details are on my website Newworldeconomics.com. This includes monthly balance sheet data for the Federal Reserve, Bank of England, Bank of France, Reichsbank, and Bank of Japan. Plus, there is info on interest rates and foreign exchange rates. I reviewed all the major “interpretations” of that period, including the Keynesian, Monetarist and Austrian, and also several others. A summary is here and here. So, you have all the tools to make up your own mind.

I know you still don’t believe me, so here is a quote from economist Peter Temin’s 1976 book Did Monetary Forces Cause the Great Depression?

[T]he proposition that monetary forces caused the Depression must be rejected. . This study has shown that the spending hypothesis fits the observed data better than the money hypothesis, that is, that it is more plausible to believe that the Depression was the result of a drop in autonomous expenditures, particularly consumption.

I categorize Temin as a “Keynesian,” who found that a “decline in aggregate demand” caused the downturn, with a monetary system that was basically functioning as it was supposed to. Here is economist Barry Eichengreen, from his influential 1992 book Golden Fetters: The Gold Standard and the Great Depression, 1919-1939:

The initial downturn in the United States enters this tale as something of a deus ex machina . The tightening Federal Reserve policy of 1928-29 seems too modest . Hence the search for other domestic factors that might have contributed to the severity of the downturn, such as structural imbalances in American industry, an autonomous decline in U.S. consumption spending, and the impact of the Wall Street crash on wealth and confidence.

Like other Keynesians, Eichengreen sees the problems as arising from unspecified factors, with no particular problems with the monetary system. Both Temin and Eichengreen recommended a currency devaluation (which Roosevelt did in 1933), to deal with these problems from unspecified causes. But, they never blamed the gold standard itself.

Monetarists have a similar view. In his Monetary History of the United States (1965), Milton Friedman barely mentioned the gold standard. Like the Keynesians, he recommended an “easy money” solution — in this case based on monetary quantity rather than currency devaluation, although it amounts to the same thing. In that book, look for any description of causes whatsover. There is none. It is, as Eichengreen called it, a “deus ex machina.”

There is actually a small minority that does blame the gold standard. They argue that large purchases of gold by central banks drove up the market value of gold, causing a monetary deflation. But, the briefest investigation of central bank gold-buying behavior (in aggregate, not just France) shows nothing out of the ordinary. Central banks accumulated gold, in a steady pace, from 1850 to 1960, with nothing unusual happening around 1930. They are grasping at vapor.

Gold, Money, and the Great Depression

What caused the Great Depression? There’s no shortage of popular theories. Some say it was an inevitable consequence of capitalism. Others claim it was the big stock market crash of October 1929 that started it. Yet another hypothesis says that the 1930 Smoot-Hawley Tariff, highest in U.S. history, turned a recession into a depression.

All these explanations are false. Economists have come to a near-consensus on the causes of the Great Depression, because the evidence closely fits a monetary explanation. This explanation essentially combines findings from Milton Friedman and Anna Schwartz’s 1963 book Monetary History of the United States and Barry Eichengreen’s 1992 book Golden Fetters, which adds an international dimension to the Friedman and Schwartz story.

Federal Reserve mismanagement caused the U.S. economy to turn from the “roaring Twenties” to a sharp recession in 1929-1930. Check out this chart of U.S. money supply growth from Barry Eichengreen’s article, “The Origins and Nature of the Great Slump Revisited.”

The Federal Reserve was responsible for providing a stable money supply, but as the chart shows, they failed at that task. The classical gold standard had led Americans to expect 1-4% money supply growth per year. After World War 1 and the establishment of the Federal Reserve, however, the central bank had massive gold reserves and discretion over the money supply. As Eichengreen’s chart shows, money supply growth was rapid in 1923, 1924, and 1925. It returned to relatively normal levels in 1926, 1927, and 1928, and then the Federal Reserve dramatically tightened the money supply in 1929 and 1930 out of fear that stock prices were “too high.” As Friedman and Schwartz put it, the Fed drove the economy into recession in order to pop a nonexistent stock market bubble.

That wasn’t the end of the story, though. The economic trouble in the U.S. spread to other countries. The reason was the international monetary system, called the “gold-exchange standard.” The gold-exchange standard differed from the classical, pre-WW1 gold standard in allowing central banks to maintain lower gold reserves and instead hold dollars and pounds sterling as reserves. As a result, investors couldn’t be sure every country on the new gold standard really could stay on the standard. If they started losing gold reserves, they might just abandon gold convertibility, and then the value of the currency would drop. Many countries lacked credibility, in other words.

The other problem with the gold-exchange standard was enhanced network effects. If Britain went off the gold standard, then the pound sterling would lose much of its value, and so would everyone’s pound sterling reserves. So the countries holding pounds sterling would also have to go off the gold standard, unless they wanted to buy up massive amounts of gold on international markets, which would be costly both for the central bank and for the market (because it would significantly drive down money supply).

When the U.S. contracted the dollar supply, gold flowed to the U.S. as the value of the dollar rose. Foreign holders of gold wanted to invest in the U.S. dollar. But there’s a limited amount of gold in the world. As the U.S. Federal Reserve attracted gold, other central banks lost it. But you can’t keep losing gold and stay on the gold standard. So the other central banks had to reduce their money supplies as well, to attract gold back. With every central bank scrambling for gold by contracting the money supply, they drove all their economies into recession.

Why did monetary contraction lead to recession? The best story for the Great Depression years seems to be sticky wages. Monetary contraction reduced the price level (deflation), which caused real wages to rise, making workers unaffordable. So employers laid off workers, creating persistent unemployment. Figure 3 from Eichengreen shows what happened to prices in some major economies as the global recession deepened.

Between 1929 and 1932, prices collapsed by more than 30% in the U.S.! That’s the inevitable result of far less money chasing about the same amount of goods. Note that France saw massive deflation all the way through 1935. France stayed on the gold standard until 1936.

Now look at what happened to wages as the Great Depression set in (Figure 4).

Wages adjusted for deflation rose in all these economies in the first two years of the recession. That’s the last thing you want to happen to wages in a recession. You want wages to fall in a recession so that employers will start wanting to hire again. Check out what happens in the U.S. The U.S. sees real wages rise 20% from 1929 to 1937! No wonder the U.S. had the worst depression of all the major economies: workers couldn’t get jobs at these elevated wages.

Because fewer people were working, industrial production fell (Figure 5). The U.S. had the sharpest decline of these five economies and the second-slowest recovery (after France). Note that Japan left the gold standard early and immediately inflated (depreciated) its currency, and it didn’t even have a significant recession. Britain and Germany went off the gold standard in 1931, depreciated their currencies, and immediately started to recover. The U.S. didn’t go off the gold standard until 1933, and that greatly delayed its recovery.

Countries that got off the gold standard earlier recovered more quickly (Table 2). Countries that allowed their currencies to float freely in international markets, where their exchange rates were set by supply and demand, did better than exchange-control countries that tightly regulated people’s ability to convert their money.

Getting off the gold standard allowed central banks to increase the money supply, causing inflation, reducing real wages, and encouraging hiring (Figure 8). U.S. money supply collapsed between 1929 and early 1933, then started rising again after FDR took the U.S. off the gold standard. By 1937, the U.S. had had the most rapid increase in the money supply of these four economies.

Part of the reason the U.S. had such a huge collapse in money supply in 1931 and 1932 was that the Federal Reserve allowed many banks to fail when they suffered runs. Most of us have seen the movie “It’s a Wonderful Life” in which Jimmy Stewart’s character persuades bank customers to take a small share of their deposited money at once and come back for more later. The bank was profitable, but it didn’t have on hand most of the deposited funds, because it had loaned them out.

Well, prior to the Federal Reserve, banks had done something similar. It was called “suspension of payments,” and it allowed solvent banks to deter runs. The Federal Reserve banned the practice and then allowed solvent banks to fail simply due to illiquidity (not having the required funds on hand). When a bank failed, all the deposits in it disappeared. The money supply fell.

Now, if going off the gold standard helped Japan, Britain, and Germany so much, and staying on the gold standard until 1936 hurt France so much, why was the U.S. recovery from 1933 to 1937 so weak? Let’s think back to that chart showing U.S. real wages climbing year after year during the Depression. There’s a good reason for that. FDR’s New Deal programs were explicitly intended to keep wages high. Back then, they thought this would “stimulate” the economy. How wrong they were. The National Industrial Recovery Act (invalidated by the Supreme Court in 1935) and the National Labor Relations Act that was enacted in 1935 forced large companies to keep prices and wages high. That ended up being a fundamentally wrongheaded policy choice, and it kept the U.S. economy in the doldrums even as other economies made their recovery. By 1938, the Federal Reserve was foolishly tightening monetary policy again, and the U.S. experienced the second-worst year of the Great Depression. The U.S. economy didn’t really emerge from depression until 1946.

So what caused the Great Depression? Bad U.S. monetary policy and a badly designed international gold standard that spread recession from country to country.

Postscript: Here’s the full version of Milton and Rose Friedman’s Free to Choose TV program on the Great Depression:

Great Depression

The Great Depression was the longest and most severe economic depression ever experienced by the global economy. It took place during the 1930s, began with the U.S. stock market crash of 1929 and ended after World War II.

Gold Standard and Great Depression

Some economists argue that the rigidities of the gold standard caused or at least contributed to the Great Depression. However, according to the Austrian school , the crisis was caused by excessively expansionary monetary policy conducted by the Fed during the 1920s, which created an unsustainable boom. The Depression was then prolonged by many failed interventions of the Hoover and Roosevelt administrations. These interventions curbed the economy’s ability to quickly adjust after a shock. The global policy of heavy taxation and tariffs didn’t help either, of course.

Great Depression and Gold Price

Since the price of gold was fixed at that time, we cannot analyze its performance during the Great Depression. However, the shares of Homestake Mining, the largest gold miner in the U.S. at the time, surged in the 1930s. If we assume that HM’s performance was representative of the entire gold market, then it means that periods of recessions are positive for the shiny metal as the ultimate safe-haven .

It is also worth pointing out that the Great Depression was a turning point which reduced the faith in the free market and stable money, paving the way for Keynesian economics and fiat money , and the intense demand for gold as insurance against the breakdown of a monetary system based on fiat currencies. The trauma associated with the crisis was also responsible for the central banks’ overreaction to the threat of unemployment in the 1960s, which ultimately led to the stagflation in the 1970s and the resulting gold bull market .

We encourage you to learn more about the gold market – not only about how the Great Depression affected it, but also how to successfully use gold as an investment and how to profitably trade it. A great way to start is to sign up for our gold newsletter today. It's free and if you don't like it, you can easily unsubscribe.

Related terms:

Austrian School

The Austrian School is one of the schools of economic thought. Due to its methodological individualism, it is situated in opposition to the mainstream economics, which is based on large aggregates and mathematical models. The Austrian school was founded in 1871 with the publication of Carl Menger’s Principles of Economics, developing the marginalist revolution in economic analysis. Since it early representatives lived in Vienna, the term ‘Austrian School’ was coined, but its influence spreads across the world.

Bull market

A bull market is characterized by optimism, investor confidence and expectations that prices will tend to go up. During a bull market in stocks prices are expected to rise even after severe declines. In the precious metals market, however, the situation is quite different. Bear markets can last for a long time and there is no confidence that serious slumps will be followed by periods of recovery. In case of precious metals, the secular gold bull market started in 1999. Some say that it ended in 2011, but this doesn't seem to be the case in our opinion as the fundamental drivers remain in place and the key Fibonacci retracement (61.8%) wasn't broken.

The Federal Reserve System, or sometimes referred to as “the Fed” is the central bank of the United States. The agency was created through the House Resolution 7883 by Rep. Carter Glass and it came into effect on December 23, 1913 after President Woodrow Wilson signed the Federal Reserve Act. The Fed is entrusted with the responsibility of ensuring that the country will have a safer, more stable, and flexible financial and monetary system.

Fiat Money

Fiat money is a currency that a government has declared to be legal tender, but is not backed by a physical commodity. The term derives from the Latin fiat (“it shall be” or “let it be done”) as fiat money did not spontaneously emerge in the free market, but it was established by government regulation or law. Contrary to commodity money, which is money that is at the same time a commercial commodity, fiat money is a legal claim, which derives all its properties from the law. It is neither a commercial commodity, nor a title to any such commodity, so it is irredeemable paper money without any intrinsic value.

Gold as an Investment

Gold had served as money for thousands of years until 1971 when the gold standard was abandoned for a fiat currency system. Since that time, gold has been used as an investment. Gold is often classified as a commodity however, it behaves more like a currency. The yellow metal is very weakly correlated with other commodities and is less used in the industry. Unlike national currencies, the yellow metal is not tied to any particular country. Gold is a global monetary asset and its price reflects the global sentiment, however, it is mostly influenced by the U.S. macroeconomic conditions.

Gold Standard

Gold standard is a monetary system wherein the value of domestic currencies is fixed to a certain amount of gold. National money including bank deposits and bank notes is convertible to gold at a fixed price. Gold is used as the standard because of its durability, rarity, and universal acceptance. When it is used as part of the hard-money system, it reduces the volatility of currencies.

Safe Haven

A safe-haven asset is an asset that is uncorrelated (weak safe-haven) or negatively correlated (strong safe haven) with another asset or portfolio in times of market stress or turmoil. So, a safe-haven asset protects investors during crises, but not necessarily during normal times. Hence, a safe-haven asset is expected to retain its value or even increase in value during times of market turbulence when most asset prices decline.

How Did the Gold Standard Contribute to the Great Depression? - HISTORY

Note: 1925, rejoined gold standard at pre-war parity. Left gold standard in 1931 and suffered sharp devaluation.

This shows the real interest rates necessary to keep the UK in the gold standard. It was only after 1931 that real interest rates fell.

The Gold Standard led to problems for the UK manufacturing sector:

  • Firstly, exports were uncompetitive leading to lower aggregate demand
  • Secondly, high real interest rates led to further deflationary pressure and lower economic growth
  • See also: UK Economy in the 1920s
  • However, to guard against the inflationary potential of floating exchange rates and Central Banks with the power to print money, the Bretton Woods system was set up.
  • This was a fixed exchange rate system where countries pegged their currency to the dollar and the US fixed the price of gold at $35.
  • Bretton woods broke down in the 1970s.

Disadvantages of Gold Standard

  • However, the gold standard has many drawbacks because of its ability to create deflationary pressures e.g. which harmed the UK economy in the 1920s
  • Inflation or deflation could be created by variations in production of gold.
  • In recessions, monetary policy becomes ineffective because governments cannot increase the money supply.
  • Fixed exchange rates can encourage speculative attacks on the currency. (e.g. it was argued the US was forced to raise interest rates in Great depression to protect value of currency)


(1) Is there any way of setting up a Gold Standard which would avoid the past disadvantages you outline?

(2) Given that logical deduction (as per the Austrian economists) must use some, albeit basic, empirical data - after all, "for every debit there is a credit" - can there ever be a rapprochment between this camp and the econometricians?

Under the gold standard, as described, a country is only as financially stable as it has a sufficient
reserve of gold to back its currency. This means, those countries that are developing have little, if
any opportunity to grow if they do not have a gold reserve backing their currency. Moreover,
there is the reluctance, if not the impossibility of borrowing because by definition, the borrower is
acquiring a portion of wealth that is not backed by anything other than his credit and that is not
gold. Indeed, the ability to lend under the gold standard carries with it the same objections as
printing money because the lender is in effect extending value that is not backed up by gold
causing the same inflationary conditions as if money had been printed.

So why is it that under certain conditions, non gold standard economies are able to maintain a
stable, non-inflationary status? The reason lies in the maintaining the standard of value for the
currency by allowing the free market as part of the equation to regulate the currency’s supply and
demand. On the other hand, where government engages in passing programs that cannot be paid
for by current revenues, which represent the level of national productivity, the supply of money
increases without being backed by productivity, the equivalent of gold, and the trend is
inflationary. As the increase in productivity of labor justifies increased wages without increasing
the costs of the product, so the increase in productivity results in increased revenues that allow for
financing government programs. Moreover, where the gold standard inhibits lending because of
the relative scarcity of the metal to finance programs, the system of a central monetary banking
system that monitors and regulates bank reserves and economic conditions can provide for
substantial lending programs, which increase the money supply but where the potential productive
return on the investment increasing the supply of goods and/or serves as an offset to the economic
affect caused by the increase in the money supply. Both systems are susceptible to abuse. The
gold standard by government manipulation of the value of gold relative to its currency and the
monetary fiat system that allows government to print money to finance programs otherwise
unsupported by existing revenues.

Nice essay. Something missing though…like a very MAJOR thing missing. Currency notes arose as receipts for gold, which is why they were based on gold in the first place. You hand in your gold, you get a receipt, which you can then use to trade instead of carrying your gold around. At any time, you can redeem your receipt for the gold, because it is a receipt, it is NOT MONEY. Whoever decided to allow these receipts to be unexchangeable for the gold they represent to the full amount is a thief. When currency became zero backed by gold the robbery became complete. A piece of paper in exchange for gold WAS NOT THE AGREEMENT. The agreement was to take a piece of paper as a RECEIPT for the gold STILL OWNED by the bearer of the gold. Not allowing the bearer to redeem his gold, means the bearer has been robbed, and given paper while the bank keeps the gold. It would be interesting to know the original legislation that allowed this to happen. In the UK that piece of legislation may be legal but it is unlawful, because it legalises stealing. HM government does not have the power to break Common Law as each Bill must be presented for ratification to the Monarch, who has sworn an oath to uphold the law of the land, which is COMMON LAW. (commit no harm or loss to others, and no fraud in business dealings.).

The Gold Standard and the Great Depression

Most certainly not, though that is often given—and usually rather flippantly—as a plausible explanation.

There are several sources I would like to suggest you consider consulting for further detail, including a pamphlet I've written myself on this very subject. It also mentions the depressions prior to 1929, though very briefly in each case. The additional sources are:

1. America's Great Depression—by Murray N. Rothbard

2. Economics and the Public Welfare—by Benjamin M. Anderson

3. The Case for Gold—by Ron Paul

Blaming the gold standard for the Great Depression ignores the substantial monetary manipulations of the Federal Reserve System in the 1920s and 1930s—manipulations that would have been utterly impossible if the country had not already abandoned major elements of the gold standard and bestowed wide discretionary powers upon government monetary authorities. As Rothbard and many others have documented, the money and credit supply was substantially increased between 1924 and 1929 by the Federal Reserve, which then presided over just the opposite: a contraction of the money supply by one-third between 1929 and 1933. This was not the normal operations of an unfettered gold standard or of a free market at work rather, it was the result of monetary mischief at the hands of government.

Other factors, all government-imposed, assured that the recession that was underway in early 1930 would actually deepen into a decade-long depression: the Smoot-Hawley tariff in June 1930, the doubling of the income tax in 1932, the costly and counterproductive interventions of the early New Deal in 1934, and the Wagner Act of 1935. All these and more are discussed in the pamphlet we will be providing you.

Each time I hear the tired, old refrain about "the gold standard caused the depression," I wonder if the speaker is even aware of the vast literature to the contrary, or if he is simply ignoring it because it doesn't fit into some larger ideological agenda. In any event, it's nonsense, and your professor needs to climb out of the economic dark ages and get past the bumper stickers to examine what the record really shows.

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How did the gold standard affect the Great Depression?

A level student here looking to pursue an economics degree in university. I want to ask about how the gold standard prevented countries from increasing their money supply and why deflation led the public to hoard gold. Any information answering the question would be a great help! :)

Gold standard limited the ability for central banks to issue new currency which prevented them from avoiding the liquidity freeze which ended up defaulting most american banks. Economic uncertainty as a result of the recession meant there was a flight to quality for most investors which decreased the amount of gold in circulation. A freeze in global trade also reduced gold coming into the US. Laws were later passed by the federal government which limited gold hoarding and put limits on capital leaving the country. Deflation had the effect of lowering consumption as consumers could expect lower prices in the future which became a self fulfilling prophecy.

I'm not an expert so take anything I say with a grain of salt. This is a complex topic and much has been written on it and usually broad statements like the ones given above do not do the topic justice.

Advantages and disadvantages

The advantages of the gold standard are that (1) it limits the power of governments or banks to cause price inflation by excessive issue of paper currency, although there is evidence that even before World War I monetary authorities did not contract the supply of money when the country incurred a gold outflow, and (2) it creates certainty in international trade by providing a fixed pattern of exchange rates.

The disadvantages are that (1) it may not provide sufficient flexibility in the supply of money, because the supply of newly mined gold is not closely related to the growing needs of the world economy for a commensurate supply of money, (2) a country may not be able to isolate its economy from depression or inflation in the rest of the world, and (3) the process of adjustment for a country with a payments deficit can be long and painful whenever an increase in unemployment or a decline in the rate of economic expansion occurs.

The Editors of Encyclopaedia Britannica This article was most recently revised and updated by Brian Duignan, Senior Editor.