09 May 2010

Counter to Ben Bernanke's The World on a Cross of Gold

Extract from Gold Standards and the Real Bills Doctrine in U.S. Monetary Policy by Richard Timberlake. The references to "Bernanke 1993" are to Ben Bernanke's 1993 article "The World on a Cross of Gold" in the Journal of Monetary Economics.

Ben Bernanke, in a laudatory review of Golden Fetters, agrees with its main thesis. “Eichengreen,” Bernanke states, “has made the case that the international gold standard, as reconstituted following World War I, played a central role in the initiation and propagation of the worldwide slump” (Bernanke 1993, 252). “In this masterful new book,” he notes approvingly, “Barry Eichengreen has gone well beyond his previous work to marshal a powerful indictment of the interwar gold standard, and of the political leaders and economic policy-makers who allowed themselves to be bound by golden fetters while the world economy collapsed.” The United States, especially, absorbed and sterilized gold, “largely reflecting conscious Federal Reserve policy. . . . Monetary policy became tight in the U.S. in 1928. . . . High returns on both bonds and stocks attracted gold into the U.S., but the Fed, intent on its domestic policy goals, sterilized the inflows” (Bernanke 1993, 253-258).

Bernanke’s words, much like Temin’s and Eichengreen’s, contradict his argument. If central banks could absorb and sterilize gold, “reflecting conscious Federal Reserve policy,” the central bank, not the gold standard, was running the show.


Bernanke finally poses a very apt question that he leaves unanswered. “Why was there such a sharp contrast between the stability of the gold standard regime of the classical, pre-World War I period and the extreme instability associated with the interwar gold standard?” (Bernanke 1993, 261).

Here are two commentaries that may help answer his question. The first is from Lionel D. Edie, a prominent economist of the time. At a conference of economists in early 1932, he stated,
The Federal Reserve Act cut the tie which binds the gold reserve directly to the credit [money] volume, and by so doing automatically cut off the basic function of the gold standard . . . in an essential respect we abandoned [the automatic money supply function] some time ago. . . . We are not now on the gold standard . . . and we have not been for some time . . . it is time to recognize that the Federal Reserve mechanism does not constitute an automatic self-corrective device for perpetuating a gold standard. (Edie1932, 119-128)

And Leland Yeager in 1966 described the “gold standard” of the 1920s in these words:
The gold standard of the late 1920s was hardly more than a fa├žade. It involved extreme measures to economize on gold. . . . It involved the neutralization or offsetting of international influences on domestic money supplies, incomes, and prices. Gold standard methods of balance of payments equilibrium were largely destroyed and were not replaced by any alternative. . . . With both the price and income and the exchange-rate mechanisms of balance of payments adjustment out of operation, disequilibriums were accumulated or merely palliated, not continuously corrected. (Yeager 1966, 290)

These commentaries provide the answer to Bernanke: “The” interwar gold standard was not a gold standard. It was an entirely different system than the pre-1914 gold standard that had existed for 100 years.

Also quoted in the article is the following from Joseph Schumpeter's 1954 History of Economic Analysis:

An ‘automatic’ gold currency is part and parcel of a laissezfaire and free-trade economy. It links every nation’s money rates and price levels with the money-rates and price levels of all the other nations that are ‘on gold.’ It is extremely sensitive to government expenditure and even to attitudes or policies that do not involve expenditure directly, for example, to foreign policy, to certain policies of taxation, and, in general, to precisely all those policies that violate the principles of [classical] liberalism. This is the reason why gold is so unpopular now [1950] and also why it was so popular in a bourgeois era. It imposes restrictions upon governments or bureaucracies that are much more powerful than is parliamentary criticism. It is both the badge and the guarantee of bourgeois freedom—of freedom not simply of the bourgeois interest, but of freedom in the bourgeois sense. From this standpoint a man may quite rationally fight for it, even if fully convinced of the validity of all that has ever been urged against it on economic grounds. From the standpoint of etatisme and planning, a man may not less rationally condemn it, even if fully convinced of the validity of all that has ever been urged for it on economic grounds.

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