VoxEU Column Economic history Global crisis International trade

Fetters of gold and paper

The world economy is experiencing tensions arising from inflexible exchange rates – particularly the dollar-renminbi peg and the Eurozone. Drawing on lessons from the gold standard, this column points out that an international monetary system is a system – nations’ policies have spillovers. Now, as in the 1930s, surplus nations’ refusals to increase spending force deficit countries to contract. Keynes drew this lesson from the Great Depression, which is why he wanted measures to deal with chronic surplus countries. Sixty-plus years later, we seem to have forgotten his point.


The lessons-of-the-1930s marketplace has become highly competitive in recent years (see for example Mason and Mitchener 2010, Fishback 2010, and Helbling 2009). Our own entry focuses on the role of pegged exchange rates in propagating the financial crisis and on the lessons of experience under the gold standard.

That the gold standard played an important role in the global crisis of the 1930s is an idea in which we both have a stake (Temin 1989, Eichengreen 1992). The gold standard was characterised by the free flow of gold between countries, fixed values of national currencies in terms of gold, and the absence of an international coordinating organisation.

These arrangements implied that there was an asymmetry between countries with balance-of-payments deficits and surpluses. There was a penalty for running out of reserves and being unable to maintain the fixed value of the currency, but no penalty (aside from foregone interest) for accumulating gold. The adjustment mechanism for deficit countries, under normal circumstances, was deflation rather than devaluation.

The result was that the surplus countries, the US and France, sucked gold and foreign reserves out of the deficit countries, Germany and the UK, all through the 1920s. While there was no pressure for the former to reflate, there was increasingly intense pressure for the latter to deflate.

The gold standard is ideology

But the gold standard was not just a monetary arrangement. It was also an ideology. Depression-era choices were made according to a worldview in which maintenance of the gold standard was the primary prerequisite for prosperity. Policies were therefore formulated to preserve the gold standard, not to stabilise output and employment. Central bankers thought that maintaining the gold standard would restore employment, while attempts to increase employment directly would fail. The collapse of output and prices and the loss of savings as banks closed in the early 1930s were precisely what the gold standard promised to prevent.

Reconciling outcomes with expectations consequently required interpreting these exceptional events in unexceptional terms. Where the crisis was most severe, blame was laid on the authorities' failure to embrace the gold-standard mentalité. The Federal Reserve and the Bank of England, it was alleged, succumbed to the lure of managed money. Having refused to obey the rules of gold standard, they committed abuses of credit, sterilised international gold flows, and prevented them from exerting their normal stabilising influence on credit conditions. This in turn prevented prices and costs from adjusting.

In the deflationary circumstances of the time, this was precisely the wrong way of thinking about the problem.

The 21st century analogues – the euro and the dollar-renminbi peg – are not identical, but the parallels are there.

Eurozone commitment: Harder than gold

Adopting the euro is, if anything, an even harder commitment than gold. Countries could leave the gold standard during crises without enraging investors, but countries cannot temporarily abandon the euro in times of crisis (Eichengreen 2007, Blejer and Levy-Yeyatia 2010), proposals for Greece to take a euro-holiday notwithstanding (Feldstein 2010).

But the Eurozone did not simply follow the gold standard; it also followed Bretton Woods. The importance of this lays not so much in the Bretton Woods system itself as the negotiations leading up to it. Keynes, one of the key negotiators, had come to realise the pernicious influence of the gold standard as it operated in the interwar years. He acknowledged that deflating in response to a loss of reserves, under already deflationary circumstances, was harmful not only for the initiating country but also its neighbours.

His plan for avoiding this outcome in the post-war world was that surplus countries would be obliged to curtail their imbalances just as deficit countries were obliged to curtail theirs. Keynes’s plan did not come to fruition because of a disagreement between the US and Britain. But that the question was unresolved is no excuse for forgetting it now.

Dollar-renminbi peg as ideology

The other important exchange rate, the dollar-renminbi peg, is best thought of in terms of the ideology of Chinese development policy. The role of the peg is three-fold:

  • to facilitate the export of manufactures,
  • to ease the decisions of foreign companies contemplating investment in China,
  • and to enlarge the earnings of Chinese enterprises that are the main source of savings for infrastructure investment.

As in the 1920s, there is some awareness that policies in the countries linked together by this regime have implications for the other participants, but there is also little willingness to act on that awareness. In 2006 the IMF arranged a Multilateral Consultation with the goal of encouraging them to take those cross-border implications into account. The US and China meet annually in a bilateral Strategic and Economic Dialogue. The IMF conducts regular multilateral surveillance exercises. But few consequential policy adjustments are evident.

The point of this discussion is not to let deficit countries – Germany in the context of the gold standard, Greece in the context of the euro, the US in the case of global imbalances – off the hook. All three were reluctant to acknowledge that they faced budget constraints. All three lived beyond their means, running budget and current-account deficits and financing them by borrowing abroad.

But there is another side of this coin – the policies of the surplus countries. In the 1920s and early 1930s, the difficulties of Germany and other Central European countries were greatly aggravated by policies of gold sterilisation by the US and France. With these countries in balance-of-payments surplus, someone else had to be in deficit. With their refusal to expand, someone else had to contract. With their refusal to extend emergency financial assistance, the extent of the contraction to which the deficit countries were subject intensified. The political consequences proved disastrous.

A similar process is currently underway. Greece trades with Germany, which has a strong surplus. With Germany reluctant to raise spending, a cash-strapped Greece has no alternative but to deflate. Whether it can cut spending by 10 % of GDP in short order remains to be seen. Greece’s problem now, like Germany’s in the early 1930s, is that cutting costs only makes the burden of indebtedness heavier.

1931 German debt moratorium: Greek debt restructuring 2010?

This is why even US President Hoover was ultimately forced to recognise the need for a German debt moratorium. And it is why internal devaluation, the only form of devaluation available to Greece, will require restructuring its debts. Just as the Hoover Moratorium required a change in policy by the US, a Greek restructuring will require a change of heart by the EU and IMF.

Similarly, in the absence of China and other countries boosting their spending and allowing their currencies to rise faster against the dollar, the only way for the US to grow employment is by making its exports more competitive. President Obama’s goal of doubling US exports within five years is designed to map this route to full employment. But absent an adjustment in the real exchange rate, delivered by more spending and either nominal currency appreciation or inflation in Asia, this will have to be done by cutting costs or miraculously raising productivity. The failure of efforts to do so would open the door to a protectionist backlash.


The point is that an international monetary system is to be a system in which countries on both sides of the exchange rate contribute to its smooth operation. Actions by surplus countries, and not just their deficit counterparts, have systemic implications. They cannot realistically assign all responsibility for adjustment to their deficit counterparts.

Keynes drew this lesson from the Great Depression. It was why he wanted measures to deal with chronic surplus countries in the international monetary plan he developed during World War II. Sixty-plus years later, we seem to have forgotten his point.


Blejer, Mario I and Eduardo Levy-Yeyati (2010), “Leaving the euro: What’s in the box?”, VoxEU.org, 21 July.

Eichengreen, Barry (1992), Golden Fetters: The Gold Standard and the Great Depression, 1919-1939, Oxford University Press.

Eichengreen, Barry (2007), “The euro: love it or leave it?”, VoxEU.org, 17 November.

Fishback, Price (2010), “US monetary and fiscal policy in the 1930s – and now”, VoxEU.org, 30 April.

Feldstein, Martin (2010), “Let Greece Take a Euro-Holiday,” Financial Times, 16 February, www.ft.com.

Helbling, Thomas (2009), “How similar is the current crisis to the Great Depression?”, VoxEU.org, 29 April.

Mason, Joseph and Kris James Mitchener (2010), “Exit strategies for central banks: Lessons from the 1930s”, VoxEU.org, 15 June.

Temin, Peter (1989), Lessons from the Great Depression, MIT Press.


4,409 Reads