My review of Hayek’s work, which with today’s post now thoroughly,
though not completely, spans from late 1920s to 1930s, has revealed to me a
consistent weakness throughout his writing. Aside from short inklings into his
future work on spontaneous social orders, his work from this period is backward
looking and his attempts to bridge theory and policy produce awkward, and probably
unworkable, suggestions. It is this tension between Hayek the theorist and Hayek
the policy wonk that I hope relay in reviewing his analysis of the international
gold standard. I must first present the monetary difficulties that the world
faced due to a managed gold standard and the distaste for gold that his bred.
A great strength of Hayek’s analysis of the gold standard is
that he differentiates the gold standard in practice from the gold standard in
the abstract. The Great Depression was a consequence of the former, a managed
gold standard. He writes at the end of Price
and Production:
I am not even
convinced that a good deal of the harm which is just now generally ascribed to
the gold standard will not by a future and better informed generation of
economists be recognized as a result of the different attempts of recent years
to make the mechanism of the gold standard inoperative.
To some extent, he was correct in this prediction, though it
seems that few economists have actually spelled this out specifically so as to place
the failure of the gold standard entirely on the shoulders of bad management. (I
am unsure if the phrase good management is not a paradox within this context.)
Richard
Timberlake states this most clearly:
They [presumably Barry Eichengreen and Peter Temin] seem
unaware that if central bankers are managing a ‘gold standard’ in order to
control monetary policy, whatever it is they are managing is not really a gold standard.
The problem is not due
to
gold. If central banks managed any
other commodity standard with fixed exchange rates, the same problem would
likely occur. The problem was management. Historical observation and counter-historical
modeling from
Christina
Romer and Chang-Tai Hsieh support a similar conclusion:
Our
evidence from the one time that the Federal Reserve undertook monetary
expansion in the early 1930s is that the Federal Reserve actually had
substantial room to maneuver. For this reason, we are inclined to agree with
Friedman and Schwartz that the Federal Reserve’s failure to act was a policy
mistake of monumental proportions, not the inevitable result of the U.S.
adherence to the gold standard.
Despite evidence that ought
to rectify an excessively harsh view toward the gold standard
qua gold standard (see also
here
and
here),
the general sentiment toward it remains closer to the “golden fetters” perspective
than to any other. In short, the dominant sentiment has not changed considerably
since the Great Depression, this is likely due to the difficulty of separating
policy from theory, especially among intellectuals (in the Hayekian sense).
Hayek sums the monetary problem
clearly at the start of Monetary
Nationalism and International Stability.
It [monetary
nationalism] will certainly continue to gain influence for some time to come,
and it will probably indefinitely postpone the restoration of a truly international
currency system. Even if it does not
prevent the restoration of an international gold standard, it will almost
inevitably bring about its renewed breakdown soon after it has been
re-established.
The gold standard, as it historically
operated under a system of independent central banks, is, in the long run, not
a functional solution. The policies of central banks will likely not promote the
health of the system as they are not constrained by market incentives. This system was especially fragile. As I argue
in
my
recent paper, “the resumption
of gold redemption by European central banks [after WWI] would lead to
financial disaster even if only several attempted to maintain prewar exchange
rates or attract gold by other means.” In particular, the Federal Reserve had
to arbitrarily inhibit demand for gold as Great Britain returned to the gold standard
at an overvalued parity. They and other central banks unsuccessfully engaged
the prisoner’s dilemma. Hayek certainly takes this into account in
Monetary Nationalism and International
Stability:
It seems to me impossible to doubt that there is indeed a
very considerable difference between the case where a country, whose
inhabitants are induced to decrease their share in the world’s stock of money
by ten percent, does so by actually giving up this ten percent in gold, and the case where, in order to preserve
the accustomed reserve proportions, it pays out only one percent in gold and
contracts the credit superstructure in proportion to the reduction of reserves.
It is as if all balances of international payments had to be squeezed through a
narrow bottleneck as special pressure to be brought on people who would
otherwise not have been affected by the change to give up money which they
would have invested productively.
Hayek
must have in mind the deflation that followed tight central bank policies in
1928 and 1929.
It is
not unsurprising that some readers might be confused by such a view from Hayek.
Throughout the 1920s, Hayek was concerned about inflationary central bank
policy. Even in Prices and Production, a lecture that were given in the midst of a deflationary crisis, Hayek busied
himself by explaining the policies that might lead to depression and only touches
on policies necessary to avert the deepening of a depression:
Hence the only practical maxim for monetary policy to be
derived from our considerations is probably the negative one that the simple
fact of an increase of production and trade forms no justification for an
expansion of credit, and that – save in
an acute crisis – bankers need not be afraid to harm production by
overcaution.
It is only natural that the attention of academics is swayed
by present circumstances. If one is interested in providing policy suggestions
to officials, he or she must pay attention to the crisis at hand, not the
problems of yesterday. Given the circumstances of the Great Depression, Hayek
made himself irrelevant.
Hayek continued this trend
throughout the decade.
As
noted by David Glasner, Hayek defended France’s policy of an undervalued
Franc. In 1932 he wrote:
The accusation that France systematically hoarded gold seems
at first sight to be more likely to be correct [than the charge that the US
Federal Reserve had been hoarding gold, an accusation dismissed in the previous
paragraph]. France did pursue an extremely cautious foreign policy after the
franc stabilized at a level which considerably undervalued it with respect to
its domestic purchasing power, and prevented an expansion of credit
proportional to the amount of gold coming in. Nevertheless, France did not prevent her monetary circulation from
increasing by the very same amount as that of the gold inflow – and this alone
is necessary for the gold standard to function.
Glasner comments:
So Hayek’s observation that France did not prevent her monetary
circulation from increasing by the very same amount as that of the gold inflow
means only that the Bank of France refused to increase the French money supply
at all (or even attempted to decrease it), forcing the French to increase their
holdings of cash by acquiring gold through an export surplus.
It is bad enough that
Hayek suggests backward looking solutions in arguing against the price level
stabilizers. He surely discredited himself among contemporaries in 1932 as he
sanctioned the policy that was steering the world economy off course and
destroying the gold standard. To his opponents were it was very clear that the
interwar gold standard and its effect on the price of gold was the source of
the trouble. In 1928, Cassel noted the problem and suggested a solution:
But if the gold-economizing
policy does not succeed, or if it at a future time is found no longer possible
to carry through, the unavoidable consequence must be that the gold standard
will have to be abolished, and that the world's economy will have to be based
on paper standards regulated with the single purpose of keeping the general
level of prices constant.
In retrospect it is not
difficult to see why Hayek lost this battle. For about a decade he fought against price stabilization without fully acknowledging the danger of gold price volatility and without offering a realistic alternative. The earliest concession from Hayek concerning
the gold standard and central bank driven price distortion from Hayek that I can find is in Monetary Nationalism and International Stability, and which I have
mentioned in a previous post:
Now the present abundance of gold offers an exceptional
opportunity for such a reform. But to achieve the desired result not only the
absolute supply of gold but also its distribution is of importance. In this
respect it must appear unfortunate that those countries which command already
abundant gold reserves and would therefore be in a position to work the gold
standard on these lines, should use that position to keep the price artificially
high. The policy on the part of those countries which are already in a strong
gold position, if it aims at the restoration of an international gold standard,
should have been, while maintaining constant rates of exchange with all
countries in a similar position, to reduce the price of gold in order to direct
the stream of gold to those countries which are not yet in a position to resume
gold payments. Only when the price of gold had fallen sufficiently to enable
those countries to acquire sufficient reserves should a general simultaneous
return to a free gold standard be attempted.
This appears to be the
moment that Hayek’s analysis in some ways catches up with the profession. But
it would be about another about another decade before his research into
spontaneous order merged with his monetary interest (see last post) and still
more time before this would allow him to create work that was far ahead of his
field.
There is still much more to
appreciate from
Monetary Nationalism and
International Instability. Next time I plan to compare Hayek’s analysis
with Friedman’s article
“Real
and Pseudo Gold Standards.”