Societies are uncertain about which model to strive for and how to repair monetary systems. During the 1930s societies bet on the wrong ideas and many fear that we may be making similar mistakes now. People are worried about the high unemployment rate, deflationary risk, dollar devaluation and status of the US dollar as reserve currency.
By Reuven Brenner
Thursday, November 29, 2012
Then, as today, societies were uncertain about which model of society to strive for and how to repair monetary systems. Societies bet on the wrong ideas; we may be committing similar mistakes now.
Many people draw parallels between today and the 1930s, labeling this the Great Recession. They note the high unemployment rate, referring not to the mismeasured, official statistic, but to the number more than double that rate, which also accounts for those who dropped out from the labor force and are no longer counted as “unemployed.” Others worry about the deflationary risk, the dollar devaluation, and the status of the U.S. dollar as reserve currency. Still others worry that the “vital few” — those with high scientific aptitudes and entrepreneurial drive — no longer come to or stay in the United States, but stay in or go back to the many countries whose Iron Curtains have been punctured since 1989.
Yet the most worrying parallel with the 1930s is one that is not discussed. Then, as today, societies were uncertain about the model of society they should strive for and about how to repair domestic and international monetary systems after wildly varying expansions of credit during and after World War I in the different countries. In addressing these two questions, societies ended up betting on the wrong ideas, which had long-term, disastrous consequences. We may be committing similar mistakes now.
Recall the 1920s and 1930s: Germany, Hungary, Austria, and Italy all destroyed their middle classes and financial markets with hyperinflation — a destruction that has always been a recipe for both political instability and predictable centralization of power. After all, once financial markets are destroyed, even if inadvertently, governments and central banks become financial intermediaries — by default.
It happened in Austria, which — following the large credit expansion during and after WWI, and later the collapse of its largest deposit bank, Credit Anstalt — injected funds, though the problem was not liquidity, but solvency. While this happened, Austria first kept the schilling linked to gold, though investors realized that this could not be for long. As capital flight continued, the government first imposed exchange controls, but eventually delinked the schilling from gold in 1931. Austria’s experiment precipitated the United Kingdom’s own exit from the gold standard in that same year, after it mistakenly relinked the pound to gold at the pre-WWI level in 1925 — in spite of the high inflation the United Kingdom experienced during the war — resulting in predictable deflation and unemployment.
France learned from the United Kingdom’s 1925 mistake. When Raymond Poincaré became French premier in 1926, he commissioned Jacques Rueff to determine the level at which the French franc should be stabilized. Though Poincaré thought initially to return to the prewar gold parity of the currency, as the United Kingdom had done, Charles Rist and Pierre Quesnay, the deputy governors of the Bank of France, persuaded him not to. France relinked to gold by fixing the franc at only one-fifth the pre-WWI parity. Rueff chose this level to be on the safe side and prevent deflation and unemployment, at the risk of pricing the franc low relative to gold. Emile Moreau, the governor of the bank, approved. The franc was stabilized, capital flowed back to France, credit expanded, and the economy boomed without inflation or unemployment, though France’s “competitive devaluation” — France and the United Kingdom were competing powers — quickly destabilized the brief international monetary calm.
Perhaps if Benjamin Strong, chairman of the Federal Reserve at the time, lived a bit longer, he might have managed to sustain order. But he died in 1928, and the short-lived international cooperation he engineered in the inter-war years fell apart. From then on, the mazes of monetary and political errors compounded rapidly around the world, ending in Europe’s devastating political bets that led to WWII.
This is the similarity with the 1930s, and the far bigger danger the world faces today than the aforementioned, superficial, acknowledged ones, which draw on macroeconomics — today’s astrology. Now, as then, the fact that grave monetary mistakes and lack of international collaboration to stabilize exchange rates have drastic political implications appears to be out of most sights and minds. Yet the links are straightforward.
Prosperity is the result of matching talents with capital, holding all parties accountable: the talent, the capital, and the matchmakers. This is easy to say, but hard to realize — building and sustaining the maze of institutions to keep the matchmakers responsible, in particular.
After all, societies have five sources of capital: inheritance/resources; savings; access to financial markets; government; and, last but not least, “crime,” through military power in particular, the use of such power being rationalized by various ideas. During the 1920s and 1930s, the series of monetary blunders and lack of international cooperation decimated people’s savings and the Versailles Treaty kept resources captive. These factors combined caused the weakening or the destruction of capital markets and international trade. Banks failed, markets crashed, unemployment rose, the middle classes lost their anchors, and the 1930s saw a series of devaluations and introduction of tariff policies, Smoot-Hawley being one of them.
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