In AP US we have recently been studying the Great Depression and one factor that we haven’t discussed much which is underplayed in most documented histories, is the role of the gold standard. I have previously discussed the gold standard as an intermediate in the creation of money with no intrinsic value. NPR’s Planet Money did an interesting report on the vital role the gold standard played in starting the Greatest Depression we have ever faced.
Prior to the 1930s, nearly every economics power in the world and even the small-scale trade nations was on the gold standard. The story of the turnaround begins in 1931 with Montagu Norman who was central banker at the Bank of England and in effect was one of if not the most powerful economic figures in the world. As stock markets crashed, banks collapsed and the world slipped into depression much of the public withdrew their money and many sought to exchange it for gold. England like most other countries didn’t have nearly enough gold for everyone to reclaim their notes and so to deter these citizens, Norman had to resort to raising interest rates. In doing so, people had an incentive to keep their money in their accounts rather than have gold sit idly in their homes. But this ran wholly counter to depression policy; raising interest rates meant that now less money would be circulated preventing consumer spending, and lending became more expensive which prevented inhibited new entrepreneurs and existing businesses. Just look at today’s world; when recession hit, we regularly heard of the Fed lowering interest rates, not raising them.
And so the depression worsened. In fact you could say that though economies were suffering from a visible downturn, these interest rate hikes caused the actual start of depression. And all thanks to the gold standard. So obviously, why don’t we just end it? To Norman, the gold standard was the foundation of the British economy and he simply felt that removing it would cause complete fiscal collapse and chaos. So Norman who now finds himself between a rock and a hard place with the fate of England and, to some degree, the whole world in his hands, cracks. He began having nervous breakdowns, severe headaches and was essentially breaking down. And so on recommendation from his doctor, England’s Central Banker goes on vacation to Canada right as the world economies begin collapsing. As Norman is on the ship returning to England, his advisors who are in charge without him, decide to leave the gold standard. They send a cable to Montagu saying they “were going off tomorrow” and of course he thinks they mean they’re taking a day of vacation… He does not object and bam England is off the gold standard. The pound immediately loses value and fear sweeps the world as people everywhere begin turning their money to gold. Roosevelt, who must react quickly, acts against his advisors, doesn’t tell the public and sneaks this amendment onto the Agricultural Adjustment Act which is unsuspectingly passed. And so the cabinet, treasury and public get a pleasant surprise when they find out that Roosevelt had conveniently removed the gold standard.
Now FDR is free to act as is necessary and so he begins taking counter measures to the deflationary spiral. He did so by raising the price of gold by having the government buy out gold. Slowly the United States began climbing out of depression and countries around the world parted with the gold standard. Soon money was back in circulation and confidence returned to money for what it was; paper.
And so we only transitioned into the final stage of creating money over the Great Depression. And this final step was absolutely vital to progress. To this day, economists consider the gold standard as one of the most dangerous and counterproductive means of conferring currency its value.
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