A large body of research has linked the gold standard to the severity of the Great Depression. This column argues that while economic historians have focused on the role of tightened US monetary policy, not enough attention has been given to the role of France, whose share of world gold reserves soared from 7% in 1926 to 27% in 1932. It suggests that France’s policies directly account for about half of the 30% deflation experienced in 1930 and 1931.France was accumulating and sterilising gold reserves at a much more rapid rate than the US. Partly as a result of the undervaluation of the franc in 1926, the Bank of France began to accumulate gold reserves at a rapid rate. France’s share of world gold reserves soared from 7% in 1926 to 27% in 1932
The redistribution of gold put other countries under enormous deflationary pressure. In 1929, 1930, and 1931, the rest of the world lost the equivalent of about 8% of the world’s gold stock, an enormous proportion – 15% – of the rest of the world’s December 1928 reserve holdings. This massive redistribution of gold would not have been a problem for the world economy if the US and France had been monetising the gold inflows. Then the gold inflows would have led to a monetary expansion in those countries, just as the gold outflows from other countries led to a monetary contraction for them. That would have been playing by the “rules of the game” of the classical gold standard. But during the interwar gold standard, there were no agreed-upon rules of the game, and both France and the US were effectively sterilising the inflows to ensure that they did not have an expansionary effect.Next Irwin asks what were the effect on world prices?
In his 1752 essay “Of Money,” David Hume remarked: “If the coin be locked up in chests, it is the same thing with regard to prices, as if it were annihilated”. So what was the effect of the effective withdrawal of this gold from circulation on the world price level? In recent research (Irwin 2010), I find that a 1% increase in the gold stock increases world prices by 1.5%. Since the US and France effectively withdrew 11% of the world’s gold stock from circulation, this would have led to a fall in world prices of about 16%. From this simple exercise, we can conclude that the Federal Reserve and Bank of France directly account for about half of the 30% deflation experienced in 1930 and 1931 (see Sumner (1991) for a different calculation that is generally consistent with this finding).The conclusion?
Of course, once the deflationary spiral began, other factors began to reinforce it. The most important factor was that growing insolvency (due to debt-deflation problems identified by Irving Fisher) contributed to bank failures, which in turn led to a reduction in the money multiplier as the currency to deposit ratio increased. However, these endogenous responses cannot be considered as independent of the initial deflationary impulse, and therefore US and French policies can be held indirectly responsible for at least some portion of the remaining “unexplained” part of the price decline.
In sum, economic historians have traditionally focused on the tightening of US monetary policy as the origin of the Great Depression. These findings suggest that the French contribution to the worldwide deflationary spiral deserves much greater prominence than it has thus far received.