The Irrepressible 1930’s

By Robert Skidelsky


The just concluded G-20 meeting in Seoul broke up without agreement on either currencies or trade. China and the United States accused each other of deliberately manipulating their currencies to get a trade advantage. The Doha Round of global trade talks remain stalled. And, amid talk of the “risks” of new currency and trade wars, such wars have already begun.

Thus, despite global leaders’ vows to the contrary, it seems that the dreadful protectionist precedent of the 1930’s is about to be revived. That decade’s trade war was started by the US with the Smoot-Hawley tariff of 1930. The British retaliated with the Import Duties Act of 1932, followed by Imperial Preference. Soon, the world economy was a thicket of trade barriers.

Britain fired the first shot in the 1930’s currency war, leaving the gold standard in September 1931. The US retaliated by leaving the gold standard in April 1933. The pound fell against the dollar, then the dollar against the pound.

While the two main currencies of the day were slugging it out, France headed a European “gold bloc” of countries whose currencies became increasingly overvalued against both, until the bloc collapsed in 1936. A world economic conference, convened in London in 1933 to end the currency war, adjourned without reaching any decision.

Substitute China for Britain and today’s eurozone for the gold bloc and the trend of events today has the same ominous feel.

The US Federal Reserve now proposes to stimulate the American economy by printing more money – a second round of (quantitative easing, or QE2), to the tune of $600 billion. Almost no one remembers that President Franklin Roosevelt tried the same thing in 1933. Prices had started falling in September of that year, following a brief commodity boom. George F. Warren, a professor of farm management at Cornell University, told FDR that the way to raise prices was by reducing the gold value of the dollar.

Under the gold standard, the dollar was convertible into gold at a fixed price of $20.67 an ounce. To stabilize the price level, the economist Irving Fisher had produced a plan for a “compensated dollar,” which would vary the dollar’s gold value to offset rising or falling prices, in effect allowing the Fed to issue more or fewer dollars as dictated by business conditions.

In response to deflationary pressure, Fisher’s plan would have enabled banks to draw down their reserves and thus, supposedly, increase their lending (or create deposits). The extra spending would cause prices to rise, which would stimulate business activity. Fisher provided a new rationale for an old practice of debasing the coinage called seignorage.

The variant proposed by Warren, and followed by FDR in 1933, was to raise the price at which the government bought gold from the mint. Since a higher price meant that each dollar cost less in terms of gold, the result would be the same as in the Fisher plan. Domestic prices would rise, helping farmers, and the external value of the dollar would fall, helping exporters.

Starting on 25 October 1933, Roosevelt, Henry Morgenthau, his acting Secretary of the Treasury, and Jesse Jones, head of the Reconstruction Finance Corporation, met every morning in Roosevelt’s bedroom to set the price of gold. One day, they increased it by $0.21, since 21 seemed like a lucky number. At first, they bought only newly minted gold in the US. Later they bought up gold supplies from abroad.

The gold-buying policy raised the official gold price from $20.67 an ounce in October 1933 to $35.00 an ounce in January 1934, when the experiment was discontinued. By then, several hundred million dollars had been pumped into the banking system.

The results were disappointing, however. Buying foreign gold did succeed in driving down the dollar’s value in terms of gold. But domestic prices continued falling throughout the three months of the gold-buying spree.

The Fed’s more orthodox efforts at quantitative easing produced equally discouraging results. In John Kenneth Galbraith’s summary: “Either from a shortage of borrowers, an unwillingness to lend, or an overriding desire to be liquid – undoubtedly it was some of all three – the banks accumulated reserves in excess of requirements. Reserves of member banks at Fed were $256 million more than required in 1932; $528 million in 1933, $1.6 billion in 1934, $2.6 billion in 1936.”

What was wrong with the Fed’s policy was the so-called quantity theory of money on which it was based. This theory held that prices depend on the supply of money relative to the quantity of goods and services being sold. But money includes bank deposits, which depend on business confidence. As the saying went, “You can’t push on a string.”

Keynes wrote at the time: “Some people seem to infer…that output and income can be raised by increasing the quantity of money. But this is like trying to get fat by buying a larger belt. In the United States today, the belt is plenty big enough for the belly….It is [not] the quantity of money, [but] the volume of expenditure which is the operative factor.”

Now the US, relying on the same flawed theory, is doing it again. Not surprisingly, China accuses it of deliberately aiming to depreciate the dollar. But the resulting increase in US exports at the expense of Chinese, Japanese, and European producers is precisely the purpose.

The euro will become progressively overvalued, just as the gold bloc was in the 1930’s. Since the eurozone is committed to austerity, its only recourse is protectionism. Meanwhile, China’s policy of slowly letting the renminbi rise against the dollar might well go into reverse, provoking US protectionism.

The failure of the G-20’s Seoul meeting to make any progress towards agreement on exchange rates or future reserve arrangements opens the door to a re-run of the 1930’s. Let’s hope that wisdom prevails before the rise of another Hitler.


Copyright Project Syndicate