The Great Depression’s Patsy
[This article originally appeared in the January 4 edition of Lewrockwell.com.]
The culprit responsible for the Wall Street crash of 1929 and the Great Depression can be easily identified—the government.
To protect fractional reserve banking and generate a buyer for its debt, the US government created the Federal Reserve System in 1913 and put it in charge of the money supply. From July 1921 to July 1929, the Federal Reserve inflated the money supply by 62 percent, resulting in the crash in late October. The US government, following an aggressive “do something” program for the first time in American history, intervened in numerous ways throughout the 1930s—first under Herbert Hoover, then more heavily under Franklin D. Roosevelt. The result was not an easing of pain or an acceleration of recovery but a deepening of the Great Depression, as Robert Higgs explains in detail.
The preceding is not, of course, the generally accepted explanation. In conventional discourse, one of the main culprits behind the Depression—or at least responsible for exacerbating it—was the international community’s adherence to a gold standard. Economist Barry Eichengreen popularized this view. The Wikipedia entry for Eichengreen includes Ben Bernanke’s summary of Eichengreen’s thesis:
The proximate cause of the world depression was a structurally flawed and poorly managed international gold standard. . . . For a variety of reasons, including among others a desire of the Federal Reserve to curb the US stock market boom, monetary policy in several major countries turned contractionary in the late 1920’s—a contraction that was transmitted worldwide by the gold standard.
Why would a contractionary monetary policy be harmful? Because fractional reserve banking is a house of cards, and such policy risked toppling it. When inflation is exposed and the gold is not there, bankers do the Jimmy Stewart scramble. In Bernanke’s words, “what was initially a mild deflationary process began to snowball when the banking and currency crises of 1931 instigated an international ‘scramble for gold.’”
The State’s Classical Gold Standard
The classical gold standard that operated throughout the West from the 1870s to 1914 was in fact a fiat gold standard—meaning it operated at the pleasure of the state. When the state was not pleased with the gold standard’s operation, gold convertibility was suspended to allow banks to break their promise to redeem paper currency and deposits in gold coins on demand.
But even under the auspices of the state, the classical gold standard kept a lid on inflation. Gold was money, and national currencies were named after certain weights of gold; a dollar was the name for one-twentieth of an ounce of gold for example. A do
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