Monday, December 19, 2011

A different perspective on the Great Depression

I just reviewed two articles by economist David Glasner, Keynes v. Hayek: Enough Already and Deutsche Bank Gets It, Why Can't Mrs. Merkel?, and they have gotten me thinking about a prior posting, Why Intervention is Necessary, where I explained the Great Depression in terms of the bursting of an asset-price bubble and the hangover of excessive debt.  Frankly, I don't think a retraction is in order.  There still seems to be a very strong argument to the effect that it was a chief contributor to the Great Depression, but there is a monetary component that I did not really bring to bear.

Basically, Professor Glasner's position is that the Great Depression was brought about by rising demand for gold, which, under the Gold Standard, means that the value of money has to rise relative to other goods and services.  When the price of gold and the value of money are not locked together in such a system, then rising relative prices of gold do not imply deflation, but currency that is tied to gold entails exactly that.  Gold values rose, the currency had to go with it, meaning that deflation was the only way out.  The following are charts from the Deutsche Bank report that Professor Glasner cited in his second article:

The first graph shows how a series of currencies gradually abandoned the Gold Standard.  The next graph shows how the economies recovered relative to 1929.  About this, Deutsche Bank says:

"The UK and Sweden, which left the Gold Standard earliest (September 1931) in this sample, saw a ‘relatively’ mild negative growth shock compared to the other four. In contrast, France which stuck to Gold until late 1936 saw growth notably under-perform until they left the standard. Interestingly as discussed above, France later saw a dramatic 3 year 70% devaluation to Gold which helped restore nominal GDP close to that of the UK and Sweden by the end of the 1930s. However, in real terms they were still the laggard at this point. The worst slump of all was that seen in the US between 1929 and 1932 where they lost nearly half the value of their economy in nominal terms and nearly 30% in real terms. However, the bottom pretty much corresponded to the end of the Dollar’s gold convertibility and subsequent devaluation. From this point on, the recovery was fairly dramatic until the 1937 recession we’ll discuss below. Overall, Figure 13 does indicate some fairly strong evidence that growth did seem to respond to currency debasement and that countries which left this later ended up with weaker economies for longer and also, in France’s case, a more dramatic end devaluation." (emphasis his)

This may not have much relevance to the U.S. economy, but we can imagine that there might be something like this occurring within the European Union.  Several of the EU countries would be doing much better if they could devalue their currency relative to the Euro, except that they are constrained from doing so since they do not have their own currency.

One thing to consider about this is that deflation is very difficult.  It takes a lot of dislocation and unemployment to get to the place where a significant deflation will occur. I'm not sure it's worth the price you have to pay, so maybe a relative deflation would be better for the Euro, holding inflation low in the periphery which the core countries, particularly Germany, let inflation rip.  Can anyone say, "Not gonna happen"?

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