We will not have any more crashes in our time.
—John Maynard Keynes, 1927
You can lay every bit of the blame on John Maynard Keynes
Following the Depression of 1920–21, the one that no one ever heard about because it was quickly over, the post-war world decided it was time to get back on a gold standard to put an end to all the economic disruptions. (Nations would typically go off the gold standard during and after wartime to help inflate away their debt.) And so was held the Genoa Conference (1922).
Now, a gold standard is not ideal. Inflation is built in whenever there is a significant gold or silver strike (rapid expansion of the money supply), and deflation is built in whenever production keeps increasing despite no gold or silver strikes of import. And so, John Maynard Keynes, head of the British delegation, was successful at getting the convention to adopt a new scheme–a gold-exchange standard by promising the hybrid would make for a better, more-manageable balance.
Two frauds and a blunder from J. M. Keynes
And well it might have except that he got away with two utter frauds of great magnitude. For reasons of British pride, the Pound sterling was to be restored to its pre-War value of $5.00 from the $3.50 it had been battered down to. Also, it was, along with the American dollar, to become a reserve currency, that is, a Gold certificate, a currency redeemable for gold as almost all currencies formerly had been–all other currencies would “float” against them. This despite the fact that Britain’s gold reserves were negligible, having been traded to the US for war materiel. To mask these deceits, the pound would be used only for government-to-government gold redemption, not ordinary consumer banking as would be the case in the US.
In addition, Keynes did not factor in that being the world’s primary reserve currency would make the dollar overly strong.
The Great Depression is a misnomer. It was a recession followed by three depressions. The Genoa Conference plan was implemented started in 1926 and Keynes’s duplicity on the value of the pound and the strengthening dollar started roiling markets soon after. By 1929, the US was in recession, which President Hoover helped none too much because as a progressive, he leaned toward the new Keynes school of economics. He immediately shored up wages, which had the effect of hampering the production cycle by limiting the capital stock available to finance it.
Keynes’ ugly chickens come home to roost one by one
All nations wanted the world’s most secure currency, and this meant that it was cheap for Americans to buy goods produced overseas but expensive for them and everyone else to buy American goods. The recession exacerbated the problem, and the US responded in the summer of 1930 with the Smoot–Hawley Tariff Act, and immediately threw itself into a depression.
A year later, France, tired of British foot-dragging on payments, presented its reserve of 4 billion in pounds (=$20B then or $347B now) for redemption. Because of the Keynes fraud, Britain had no choice but to renege and renounce its reserve status, which event caused the whole world to join the US in the now Great Depression.
Franklin D. Roosevelt talked a good fight, and on his assumption of office in 1933, the unemployment that had shot up from 5 to 9% with the Wall Street Crash of 1929 before settling down to 6+%, stood at its peak at a whopping 28%. From 6%, with passage of Smoot-Hawley it had skyrocketed to 14% in little more than a month and then on up to 17% by the time the British reneged on redeeming French-held pounds. Within a year, it peaked at 27.5% before diving sharply to 23 and then spiking to 28 coinciding with Roosevelt taking office.
Note: Unemployment for the Depression years was calculated similar to our U6 rate now rather than our reporting standard of U3 — Table A-15. Alternative measures of labor underutilization except that there were no disability or educational programs then into which the unemployed could be steered so that they did not count against unemployment. Our unemployment figures today in 2015, calculated on the same basis, remain comparable to the Great Depression figures.
Because of Roosevelt’s show of activity on taking office, unemployment steadily dropped to 20% in a year and then started to climb again. It had returned to 24% in the late summer of ’34 when a Republican undersecretary of Agriculture caught FDR’s ear and turned the Depression around [this event not noted in the chart]. He pointed out that the US, as the world’s reserve currency, had had to print sufficient dollars to meet the demand of foreign governments for dollars with which to conduct trade–enough dollars that the overseas reserve alone exceeded the amount of gold in Fort Knox. Should our enemies conspire against us, not only could we be facing steep inflation with all those overseas dollars returning home, our gold reserves could be wiped out making the dollars already home worthless.
Over the strenuous objections of Bernard Baruch and his other advisors (early progressives were often “gold bugs”), FDR repegged the dollar to gold. Throughout US history to that point a dollar bought 1.5 grams of gold. Per FDR, it would now purchase 0.85 grams. Everyone who held dollars had just received a 43-percent haircut, but honesty had been restored to the system and the dollar was instantly no longer strong. The resulting inflow of gold because of the higher price (from $20.67 to $35.00 per troy ounce) increased the money supply, and for the next three years unemployment zigged and zagged its way back down to 14%, where it had been in the wake of passage of Smoot-Hawley seven years earlier.
Add to all that a book from J. M. Keynes
Unfortunately, in 1936 Keynes forwarded Roosevelt a gift copy of his new book, The General Theory of Employment, Interest and Money, which extended his economic thinking into even more seriously bogus realms. “General theory” because he wanted to imply that all of liberal economics (Smith, Say, Ricardo, etc.) was really only a special theory, applicable in times of low unemployment. His general theory would work all the time and would be good for preventing or arresting recessions. He expressed this infamously as “money doesn’t matter,” that is, increasing the capital stock available to industrialists to get production going again was no longer the way to go. Better was for politicians to take charge and use fiscal (rather than monetary) methods–tax increases, wage protections and so on in order to increase demand for goods rather than the supply of goods.
Despite the expansion of the money supply caused by the monetization of gold, the Federal Reserve System misread interest-rate signals and steadily increased banking reserve requirements, soaking up much of the money supply. When Roosevelt in ’36 pushed a Keynesian-style corporate undistributed profits tax, it caused great uncertainty about the future in the business world, and we were swiftly in the Recession of 1937–38, also known as the “Roosevelt recession,” the third of the depressions of the Great Depression. We were also back up over 20% unemployment and stayed at high levels until our participation in World War II started.
Lesson: The depression of ’20-21 had larger starting metrics than the one that came along in 1930. It was over quickly because the US dollar was not then strong–it took a beating and adjusted–and because Harding and Coolidge were not fans of Mr Keynes and so dealt with it with supply-side approaches.