DeLong Smackdown Watch: James Wimberly Enters the List, Armed Cap-a-Pie...
Which Romney Is Romney?

David Glasner: Hawtrey, Cassel, Hayek and the Great Depression

David Glasner:

Keynes v. Hayek: Enough Already: Ralph Hawtrey and Gustav Cassel had explained what was happening ten years before the downturn started in the summer of 1929. Both… understood that restoring the gold standard after the demonetization of gold that took place during World War I would have hugely deflationary implications if, when the gold standard was reinstated, the world’s monetary demand for gold would increase back to the pre-World War I level…. That is why both… called for measures to limit the world’s monetary demand for gold (measures agreed upon in the international monetary conference in Genoa in 1922 of which Hawtrey was the guiding spirit). The measures agreed upon at the Genoa Conference prevented the monetary demand for gold from increasing faster than the stock of gold was increasing so that the world price level in terms of gold was roughly stable from about 1922 through 1928.

But in 1928, French demand for gold started to increase rapidly just as the Federal Reserve started to tighten monetary policy in a tragically misguided effort to squelch a supposed stock-price bubble on Wall Street, causing an inflow of gold into the US while the French embarked on a frenzied drive to add to their gold holdings and other countries rejoining the gold standard were increasing their gold holdings as well, though with a less fanatical determination than the French. The Great Depression was therefore entirely the product of monetary causes, a world-wide increase in gold demand causing its value to increase, an increase manifesting itself, under the gold standard, in deflation.

Hayek, along with his mentor Ludwig von Mises, could claim to have predicted the 1929 downturn as well, having criticized the Fed in 1927 for reducing interest rates to 3.5%, by historical standards far from a dangerously expansionary rate…. But it has never been even remotely plausible that a 3.5% discount rate at the Fed for a little over a year was the trigger for the worst economic catastrophe since the Black Death of the 14th century. Nor could Keynes offer a persuasive explanation for why the world suddenly went into a catastrophic downward spiral in late 1929. References to animal spirits and the inherent instability of entrepreneurial expectations are all well and good, but they provide not so much an explanation of the downturn as a way of talking about it or describing it. Beyond that, the Hawtrey-Cassel account of the Great Depression also accounts for the relative severity of the Depression and for the sequence of recovery in different countries, there being an almost exact correlation between the severity of the Depression in a country and the existence and duration of the gold standard in the country. In no country did recovery start until after the gold standard was abandoned, and in no country was there a substantial lag between leaving the gold standard and the start of the recovery.

So not only did Hawtrey and Cassel predict the Great Depression, specifying in advance the conditions that would, and did, bring it about, they identified the unerring prescription – something provided by no other explanation — for a country to start recovering from the Great Depression.

Hayek, on the other hand, along with von Mises, not only advocated precisely the wrong policy, namely, tightening money, in effect increasing the monetary demand for gold, he accepted, if not welcomed, deflation as the necessary price for maintaining the gold standard…. Faced with a conflict between maintaining the gold standard and following his own criterion for neutral money, Hayek along with his friend and colleague Lionel Robbins, in his patently Austrian book The Great Depression, both opted for maintaining the gold standard.)

Not only did Hayek make the wrong call about the gold standard, he actually defended the insane French policy of gold accumulation in his lament for the gold standard after Britain wisely disregarded his advice and left the gold standard in 1931. In his paper “The Fate of the Gold Standard” (originally Das Schicksal der Goldwahrung) reprinted in The Collected Works of F. A. Hayek: Good Money, Part 1, Hayek offered a lament for impending demise of the gold standard after Britain tardily did the right thing. The tone of Hayek’s lament is struck in his opening paragraph (p. 153).

There has been much talk about the breakdown of the gold standard, particularly in Britain where, to the astonishment of every foreign observer, the abandonment of the gold standard was very widely welcomed as a release from an irksome constraint. However, it can scarcely be doubted that the renewed monetary problems of almost the whole world have nothing to do with the tendencies inherent in the gold standard, but on the contrary stem from the persistent and continuous attempts from many sides over a number of years to prevent the gold standard from functioning whenever it began to reveal tendencies which were not desired by the country in question. Hence it was by no means the economically strong countries such as America and France whose measures rendered the gold standard inoperative, as is frequently assumed, but the countries in a relatively weak position, at the head of which was Britain, who eventually paid for their transgression of the “rules of the game” by the breakdown of their gold standard…

I have only three relatively minor quibbles with what Glasner has to say:

  1. He seems to want to have it both ways. He says both (a) the decision to return to the gold standard with an inadequate gold cover caused the Depression, and (b) French and American refusals to actually use their (gold) reserves for their proper purpose (shades of the ECB today) caused the Depression. It's hard to make both arguments at once. If the Bank of France and the Federal Reserve acting in a non-insane way could have prevented the Great Depression, you can't say that the gold cover was inadequate. If you say the gold cover was inadequate, then it is hard to see how Bank of France and Federal Reserve spending their gold could have rescued the situation.

  2. The experience of the past four years leads me to think that perhaps Glasner should rethink elements of his position. The Federal Reserve and the ECB and the Bank of England have flooded the North Atlantic economy with liquidity over the past four years. Yet it has not been enough to produce a healthy recovery. Cassel and Hawtrey took it for granted that enough monetary ease--buying enough short-term bonds for gold or other forms of rock-solid cash--would do the job. But today it looks as though balance-sheet depressions are more stubborn beasts, that simple liquidity-provision by the government is not enough, and that proper handling may require banking and fiscal policy to provide the market with duration and safety as well.

  3. Related to (2), I think that Cassel and Hawtrey are not enough. I think that their exclusive focus on monetary liquidity misses large aspects of the picture. You need to think along Bagehot-Minsky-Kindleberger lines about safety and risk and along Wicksellian lines about the savings-investment balance as well. And, historically, the traditional road from the quantity theory of money to those concerns has been the Keynes-Hicks-Tobin road.