Wednesday, November 30, 2011

The Great Depression in a nutshell

This was based on a comment I made here.

In the late 1920s, most developed economies were on the gold standard. The Bank of France and the Fed took gold out of (pdf) the monetary system, driving up the price of gold inside the monetary system, which drove up the price of money (since gold set the price of money) which drove down the price of everything else, and so people’s incomes. A significantly leveraged economy suffering an income crash (for debt, nominal income is what counts) leads to bankruptcies and bank failures in a disastrous downward spiral in economic activity.

The quicker countries left the gold standard, which the Bank of France and the Fed had turned into a doomsday machine, the quicker they recovered from the Great Depression. (If they were not on the gold standard, they did not suffer it at all.) There does not seem to be much mystery to all this.

R. G. Hawtrey (pdf) and Gustav Cassell (pdf) accurately predicted the danger in the early 1920s and explained what was going on at the time. Alas, Hayek was a brilliant economist who brilliantly expounded the Austrian (the real one, not the internet one) theory of the business cycle at precisely the wrong moment. Alas, Keynes was a brilliant economist who decided to revamp macroeconomics in quite unnecessary ways, when a Swedish economist and a British Treasury official had already got it right. But a Swede and a bureaucrat were not nearly as well placed as Keynes-the-public-intellectual and brilliant (if not always entirely honest) rhetorician to capture the debate.

It is strange, how much people seem to want complicated or new, or complicated and new, explanations for grand disasters in preference to a simple one already available.


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