Monday, March 12, 2012

393 Gold Standard caused the Great Depression. China peg to $ is similarly blamed today-

Gold Standard caused the Great Depression. China peg to $ is similarly blamed today

The Gold Standard's fixed-exchange rate regime transmitted financial disturbances across countries. One might argue that China's peg to the $ is comparable today.

Countries NOT on the Gold Standard (eg Spain, China) escaped the Great Depression. See item 13.

Thus isolationism, per se, was NOT the cause, despite constant propaganda to the contrary.

(1) Soros: China must fix the global currency crisis
(2) A trade deficit results when the rest of the world (ROW) wishes to net save in the form of dollar assets
(3) Krugman: Taking On China
(4) MICHAEL PETTIS: What happens if the Yuan (RMB) is forced to revalue?
(5) Ambrose: Bernanke to China, let the Yuan rise, or we'll unleash QEII
(6) A currency war has been under way for decades
(7) Current Account imbalances brought down 1930s Gold Standard & postwar Bretton Woods
(8) Ambrose: US could rebuild behind tariffs as Britain did in 1930s under Imperial Preference
(9) Lee Kuan Yew (2005): in 50 years China, Korea and Japan will dominate the world economy
(10) Surplus Countries blamed for Currency Warfare
(11) Martin Wolf: if China stops buying US treasury bonds, $ would fall - but that would be helpful, not damaging
(12) China hollowing out Japan too
(13) Countries not on the Gold Standard escaped the Great Depression; it was NOT caused by Tariffs

(1) Soros: China must fix the global currency crisis

China must fix the global currency crisis

George Soros October 7 2010 19:40 | Last updated: October 7 2010 19:40

I share the growing concern about the misalignment of currencies. Brazil’s finance minister speaks of a latent currency war, and he is not far off the mark. It is in the currency markets where different economic policies and different economic and political systems interact and clash.

The prevailing exchange rate system is lopsided. China has essentially pegged its currency to the dollar while most other currencies fluctuate more or less freely. China has a two-tier system in which the capital account is strictly controlled; most other currencies don’t distinguish between current and capital accounts. This makes the Chinese currency chronically undervalued and assures China of a persistent large trade surplus. ...

Only China is in a position to initiate a process of international cooperation because it can offer the enticement of renminbi appreciation. China has already developed an elaborate mechanism for consensus building at home. Now it must go a step further and engage in consensus building internationally. This would be rewarded by the rest of the world accepting the rise of China.

Whether it realises it or not, China has emerged as a leader of the world. If it fails to live up to the responsibilities of leadership, the global currency system is liable to break down and take the global economy with it. Either way, the Chinese trade surplus is bound to shrink but it would be much better for China if that happened as a result of rising living standards rather than a global economic decline.

(2) A trade deficit results when the rest of the world (ROW) wishes to net save in the form of dollar assets

Central Bank Sterilization

By L. Randall Wray [via CFEPS]


... it is often claimed that the US needs "foreign savings" in order to "finance" its persistent trade deficit ... Such a statement makes no sense ...  a trade deficit results when the rest of the world (ROW) wishes to net save in the form of dollar assets. The ROW exports to the US reflect the "cost" imposed on citizens of the ROW to obtain the "benefit" of accumulating dollar denominated assets.

... a trade deficit mostly shifts ownership of dollar deposits from a domestic account holder to a nonresident account holder.

Comment (Peter M.):

That is, a Trade Deficit sells off the farm and incurs foreign debt.

(3) Krugman: Taking On China

Taking On China


Published: September 30, 2010

Serious people were appalled by Wednesday's vote in the House of Representatives, where a huge bipartisan majority approved legislation, sponsored by Representative Sander Levin, that would potentially pave the way for sanctions against China over its currency policy. As a substantive matter, the bill was very mild; nonetheless, there were dire warnings of trade war and global economic disruption. Better, said respectable opinion, to pursue quiet diplomacy.

But serious people, who have been wrong about so many things since this crisis began — remember how budget deficits were going to lead to skyrocketing interest rates and soaring inflation? — are wrong on this issue, too. Diplomacy on China's currency has gone nowhere, and will continue going nowhere unless backed by the threat of retaliation. The hype about trade war is unjustified — and, anyway, there are worse things than trade conflict. In a time of mass unemployment, made worse by China's predatory currency policy, the possibility of a few new tariffs should be way down on our list of worries.

Let's step back and look at the current state of the world.

Major advanced economies are still reeling from the effects of a burst housing bubble and the financial crisis that followed. Consumer spending is depressed, and firms see no point in expanding when they aren't selling enough to use the capacity they have. The recession may be officially over, but unemployment is extremely high and shows no sign of returning to normal levels.

The situation is quite different, however, in emerging economies. These economies have weathered the economic storm, they are fighting inflation rather than deflation, and they offer abundant investment opportunities. Naturally, capital from wealthier but depressed nations is flowing in their direction. And emerging nations could and should play an important role in helping the world economy as a whole pull out of its slump.

But China, the largest of these emerging economies, isn't allowing this natural process to unfold. Restrictions on foreign investment limit the flow of private funds into China; meanwhile, the Chinese government is keeping the value of its currency, the renminbi, artificially low by buying huge amounts of foreign currency, in effect subsidizing its exports. And these subsidized exports are hurting employment in the rest of the world.

Chinese officials defend this policy with arguments that are both implausible and wildly inconsistent.

They deny that they are deliberately manipulating their exchange rate; I guess the tooth fairy purchased $2.4 trillion in foreign currency and put it on their pillows while they were sleeping. Anyway, say prominent Chinese figures, it doesn't matter; the renminbi has nothing to do with China's trade surplus. Yet this week China's premier cried woe over the prospect of a stronger currency, declaring, "We cannot imagine how many Chinese factories will go bankrupt, how many Chinese workers will lose their jobs." Well, either the renminbi's value matters, or it doesn't — they can't have it both ways.

Meanwhile, about diplomacy: China's government has shown no hint of helpfulness and seems to go out of its way to flaunt its contempt for U.S. negotiators. In June, the Chinese supposedly agreed to allow their currency to move toward a market-determined rate — which, if the example of economies like Brazil is any indication, would have meant a sharp rise in the renminbi's value. But, as of Thursday, China's currency had risen about only 2 percent against the dollar — with most of that rise taking place in just the past few weeks, clearly in anticipation of the vote on the Levin bill.

So what will the bill accomplish? It empowers U.S. officials to impose tariffs against Chinese exports subsidized by the artificially low renminbi, but it doesn't require these officials to take action. And judging from past experience, U.S. officials will not, in fact, take action — they'll continue to make excuses, to tout imaginary diplomatic progress, and, in general, to confirm China's belief that they are paper tigers.

The Levin bill is, then, a signal at best — and it's at least as much a shot across the bow of U.S. officials as it is a signal to the Chinese. But it's a step in the right direction.

For the truth is that U.S. policy makers have been incredibly, infuriatingly passive in the face of China's bad behavior — especially because taking on China is one of the few policy options for tackling unemployment available to the Obama administration, given Republican obstructionism on everything else. The Levin bill probably won't change that passivity. But it will, at least, start to build a fire under policy makers, bringing us closer to the day when, at long last, they are ready to act.

(4) MICHAEL PETTIS: What happens if the Yuan (RMB) is forced to revalue?

What happens if the RMB is forced to revalue?


OCTOBER 6, 2010 8:15 AM

Because of US and European pressure Beijing may allow much faster appreciation of the renminbi than it likes over the next year, but this will almost certainly be accompanied with policies that reduce the adverse employment impact. In my opinion the most likely such policy involves credit. If Beijing expands cheap credit, however, it may exacerbate dangerous imbalances within the economy. ...

So the trade environment will continue to deteriorate and continue to take center stage. By now everyone is probably aware of the remarkable statement last week from Brazil’s finance minister. Here is the Financial Times version :

An “international currency war” has broken out, according to Guido Mantega, Brazil’s finance minister, as governments around the globe compete to lower their exchange rates to boost competitiveness.

Mr Mantega’s comments in São Paulo on Monday follow a series of recent interventions by central banks, in Japan, South Korea and Taiwan in an effort to make their currencies cheaper. China, an export powerhouse, has continued to suppress the value of the renminbi, in spite of pressure from the US to allow it to rise, while officials from countries ranging from Singapore to Colombia have issued warnings over the strength of their currencies. ...

What is remarkable is not that Mr. Mantega has said something that we didn’t know, but rather that someone so senior has said what everyone has avoided saying for so long. The Europeans, too, have entered  the fray more aggressively and are complaining about a rising euro. We are certainly in a global beggar-thy-neighbor process, in which the first round, just like in the 1930s, takes place as currency intervention, and the second round will take place as tariffs. ...

And as everyone by now knows, the US House of Representatives on Wednesday passed a bill to press China to let its currency rise faster. Although this bill does not bind President Obama in any way, and might not even survive a WTO challenge, it is nonetheless pretty clear that the world is tilting inexorably towards more trade conflict.

So the renminbi must rise

After all everyone is already doing it – cheating on trade, that is. The big surplus countries are dragging their feet on enacting the kinds of policies that will increase domestic demand and so reduce the drag on global growth caused by their deficient demand. The big deficit countries are either in collapse (Europe) or are warily eyeing the amount of their domestic demand that leaks abroad to create foreign jobs (the US). In a world of beggar-thy-neighbor policies and anemic global demand growth, countries that do not retaliate will almost certainly see rising unemployment.

So that is why I think pressure on the renminbi is inexorable. The way the numbers work, I see only three options. First, the US can allow its trade deficit to explode. Second, the world can organize a concerted attempt to deal with imbalances. Or third, each country can continue implementing policies aimed at acquiring a larger share of dwindling global demand.

The first two, I think, are unlikely, and so I suspect the renminbi issue will not go away. But excessive focus on currencies and tariffs is likely to make a bad situation worse, and this is what I really want to discuss today. Currencies matter to trade, and it is strange to see the gyrations among many economists who try to deny it.

Most notable, I think, is the complete reversal of official opinion in Japan. Twenty years ago when it was the undervalued yen that was at the center of trade disputes, Japanese officials were adamant that currency intervention has nothing to do with trade imbalances (the problem is “structural” everyone insisted). But after the PBoC started intervening against the yen a few months ago, suddenly Japanese officials have decided that in fact currency intervention matters a great deal to trade.

Perhaps to someone more cynical that I am the reversal in Japanese opinion is not so surprising. As Tokyo seems to have discovered, currencies do indeed matter. The level of the currency has a big impact on the relationship between domestic production and consumption, and of course the difference between the two is the savings rate, which determines the trade surplus (i.e. the excess of savings over investment).

For that reason I am always puzzled by people who say that devaluing the dollar will have no impact on the US trade deficit because the problem is low savings relative to investment. No, that is not the problem. That is simply one of the definitions of a current account deficit. But if the dollar devalues, and consumer prices rise, US consumption is likely to decline. In addition, to the extent that any of the stuff Americans used to import before the devaluation is now produced domestically (not all, but any), then US production must rise. Since savings is equal to production minus consumption, the US savings rate must automatically rise.

But just because the currency matters to trade, it does not mean that it is the only thing that matters, or even the most important thing that matters. Anything that affects the level of production, the level of consumption, or the level of investment, will automatically affect the trade balance. ...

On a related note I want to quote an interesting piece from Douglas Irwin’s “Did France Cause the Great depression?” The non-gated copy is here <>

A large body of economic research has linked the gold standard to the length and severity of the Great Depression of the 1930s. The gold standard’s fixed-exchange rate regime transmitted financial disturbances across countries and prevented the use of monetary policy to address the economic crisis. This conclusion is supported by two compelling observations: countries not on the gold standard managed to avoid the Great Depression almost entirely, while countries on the gold standard did not begin to recover until after they left it.

(5) Ambrose: Bernanke to China, let the Yuan rise, or we'll unleash QEII

Currency wars are necessary if all else fails

The overwhelming fact of the global currency system is that America needs a much weaker dollar to bring its economy back into kilter and avoid slow ruin, yet the rest of the world cannot easily handle the consequences of such a wrenching adjustment. There is not enough demand to go around.

By Ambrose Evans-Pritchard
Published: 8:09PM BST 10 Oct 2010

Asian investment in plant has run ahead of Western ability to consume. The debt-strapped households of Middle America, or Britain and Spain, can no longer hold up the dysfunctional edifice. Asians must take over, or it will come down on their own heads.

The countries actively intervening in exchange markets to suppress their currencies – China, Japan, Korea, Thailand, even Switzerland, to name a few – are all too often the same ones that have the biggest trade surpluses with the US.

They are taking active steps to prevent America extricating itself from the worst unemployment since the Great Depression, now 17.1pc on the latest U6 index and rising again.

Each country is doing so for understandable reasons: Japan to avoid a deflationary crisis, China to hold together a political order that is more fragile than it looks. In both these cases they are trapped because they clung too long to a mercantilist export strategy, failing to wean themselves off American demand when the going was good.

Yet this is an intolerable situation for the US. It should be no surprise that Washington has begun to retaliate in earnest, and not just by passing the Reform for Fair Trade Act in the House (not yet the Senate), clearing the way for punitive tariffs against currency manipulators.

The atomic bomb, of course, is quantitative easing by the Federal Reserve. America has in effect issued an ultimatum to China and G20: either you stop this predatory behaviour and agree to some formula for global rebalancing, or we will deploy QE2 'a l'utrance' to flood your economies with excess liquidity. We will cause you to overheat and drive up your wage costs. We will impose a de facto currency revaluation by more brutal and disruptive means, and there is little you can do to stop it. Pick your poison.

This is what QE2 means, though Fed officials prefer to talk of their "mandate" of supporting employment. It is nothing like QE1, which was emergency action to halt the economic free-fall of late 2008 and early 2009. This time the Fed is using QE as a long-term tool to manage America's chronic ailments.

Uber-dovish Fed comments over recent days have been enough to send the dollar crashing to a 15-year low of 82 against the Japanese yen, to below parity against Swiss franc, and back to the EMU pain barrier of $1.40 against the euro.

There was much tut-tutting about currency warfare at the IMF meeting over the weekend. "If one lets this slide into protectionism, we run the risk of the mistakes of the 1930," said World Bank chief Robert Zoellick.

You have to say this kind of thing if you run a Bretton Woods institution, but in real life wars occur because somebody finds the status quo unacceptable, perhaps justifiably so. As Nobel economist Paul Krugman puts it: "people are looking for innocuous ways to deal with this problem, and there aren't any".

Devaluation was not the mistake of the 1930s: it was the cure, albeit a bad one. The Gold Standard broke down during the inter-war years because the US and France had structurally undervalued exchange rates (like China/Asia today) and ceased recycling their trade surpluses (like China/Asia today). This caused a deflationary downward spiral for everybody.

Escaping from such a deformed system was a path to recovery. The parallel with modern globalization – though not exact – is obvious. So is the 1930s lesson that currency and trade clashes are asymmetric: they are calamitous for surplus countries, but not always for deficit countries. Britain enjoyed a five-year mini-boom after retreating into an Empire trade bloc in 1932.

Fed chair Ben Bernanke knows his history. In a speech as a junior Fed governor he described Roosevelt's 40pc devaluation against gold as "an effective weapon" against deflation and slump, adding "1934 was one of the best years of the century for the stock market". ...

I happen to think that the Fed will need to launch QE2 on a big scale as US fiscal tightening bites, the inventory spike fades, and the housing foreclosure crisis gathers pace. But we are not there yet. Fresh QE cannot be justified at this juncture under any normal understanding of central bank policy. ...

And while the French deny that they are in talks with China over the creation of a new currency regime, I heard French finance minister Christine Lagarde say in person at a meeting in Italy that France would use its G20 presidency to push for an alternative to the dollar. She specifically cited the "Bancor", the idea floated by Keynes in the 1940s for a commodity currency priced off a basket of metals. The US risks gambling away the "exorbitant privilege" it has enjoyed for two thirds of a century as currency hegemon.

Yet the surplus states have most to lose if this brinkmanship tips into commercial war. They must know this, but what we are witnessing may run deeper than a calculus of advantage. Was it naïve to think that Confucian Asia and the old democracies of the Atlantic seaboard can share an open global trading system?

(6) A currency war has been under way for decades

From: John Craig <> To: Ambrose Evans-Prichard ( <> Date: 11.10.2010 08:28 AM

Ambrose Evan-Prichard


Re: 'Currency wars are necessary if all else fails',, 10 Oct 2010

Your article implies that a currency war would be something new, yet such a 'war' has probably been under way for decades. It is just that most observers have been oblivious to what has been happening because a 'war' was not officially declared (see An Invisible Clash of Financial Systems? in Competing Civilizations, from 2001).

Japan was the first  to demonstrate that economic strength could be developed through cultural traditions which were derived from those of ancient China and are profoundly different to those of Western societies (eg in terms of the nature of: knowledge; power; governance; strategy; and economic goals).

Societies whose cultural traditions have historically been heavily influenced by China (and have adopted various forms of the 'Asian' economic model) tend to have quite different economic goals to Western societies. ...

The core of those cultural traditions seems to be an epistemology (ie a way of thinking about knowledge) based on ancient Chinese traditions that is quite different from the concept of 'rationality' that Western societies inherited from classical Greece (ie the concept that abstract ideas usefully model reality - which, as noted above, has been critical to effective problem solving in Western societies). ...

The alternative view may be most simply expressed in terms of the central precept of Daoism which states that 'The Dao (truth / way) that can be named is not the true Dao'. This view (which is related to Shinto and to Zen) is a statement of the limits to rationality ... This epistemology leads to:

  an intuitive (arational) style of problem solving. One observer realistically described this as an "ancient Chinese philosophical outlook that makes little distinction between theory and practice" [1];

  traditional perception of education as the absorption of experience rather than as the absorption of ideas; ...

a view of spirituality in terms of relationships within a community, rather than as (say) a characteristic of individuals; ...

In 2003 a US professor (Richard Nisbett, in The Geography of Thought) argued " that East Asia and the West have had different systems of thought, including perception, assumptions about the nature of the world, and thinking processes, for thousands of years. Ancient Greek philosophers were "analytic" — objects and people are separated from their environment, categorized, and reasoned about using logical rules. Psychological experiments show the same is true of ordinary Westerners today. Ancient Chinese philosophers and ordinary East Asians today share a "holistic" orientation — perceiving and thinking about objects in relation to their environments and reasoning dialectically, trying to find the Middle Way between opposing propositions. Differences in thought stem from differences in social practices, with the West being individualistic and the East collectivistic." ...

An Invisible Clash of Financial Systems?

Financial systems have thus been the most obvious focus for a potential 'clash of civilizations' - though this has received essentially no attention from Western analysts.  ...

{Comment (Peter M.): Some of the Greek philosophers were holistic. Heraclitus, Parmenides, the Pythagoreans, the Cynics}

(7) Current Account imbalances brought down 1930s Gold Standard & postwar Bretton Woods

Robert Skidelsky

Posted: 23 Jun 2010 06:55 AM PDT

This chapter argues that the Keynes Plan of 1941 for dealing with the trade imbalances of his time is highly relevant to the problem of East Asian-US imbalances today. ...

In the 1920s Keynes had come to see deflation as the main cause of British unemployment; and the main source of deflationary pressure as the unbalanced creditor position of the US. In theory, the international gold standard, which was the currency regime of the time provided for automatic and symmetrical adjustment of current account imbalances. Prices would automatically rise in the gold gaining countries and would automatically fall in the gold-losing countries, thus restoring the equilibrium of exports and imports between the two. But Keynes had come to realise, as he put it in 1941, that adjustment was "compulsory for the debtor and voluntary for the creditor". If the creditor does not choose to make, or allow, his share of the adjustment, he suffers no inconvenience: while a country's reserve cannot fall below zero, there is no ceiling which sets an upper limit. The same is true if private capital flows are the means of adjustment. "The debtor must borrow; the creditor is under no…compulsion [to lend]".

During the Great Depression itself, creditor "hoarding" had been aggravated by the flight of capital from deficit to surplus countries. Following the financial crisis of 1931, the gold standard collapsed, the international capital market seized up, and the major countries resorted to tariffs, competitive devaluations, and bilateral trade agreements to balance their accounts. The international payments system created in the 19th century ceased to function.

Keynes' Clearing Union plan of 1941 was designed to avoid a repetition of this disaster. It would retain the advantages (as he saw them) of a fixed exchange rate system while avoiding the asymmetric costs of adjustment. The essential feature of his plan was that creditor countries would not be allowed to sterilise their surpluses, or charge punitive rates of interest for lending them out; rather these surpluses would be automatically available as cheap overdraft facilities to debtors through the mechanism of an international clearing bank whose depositors were the central banks of the union.

All residual international transactions – those giving rise to surpluses and deficits – were to be settled through "clearing accounts" held by member central banks in an International Clearing Bank (ICB). Member banks could buy foreign currencies and sell their own against debits and credits to their accounts at the ICB (denominated in bank money or "bancor") up to an "index quota" equal to half the average value of their country's international trade over the previous five years. Deposits of bank money (credits and debits) would be created by surpluses and deficits and extinguished by their liquidation. Each national currency would have a fixed but adjustable relation to a unit of bank money (bancor) which itself had a fixed relationship to gold. But though bancor could be obtained for gold, it was not convertible into gold. Keynes' long term aim was to de-monetise gold and make bancor the ultimate reserve asset of the system. By increasing or reducing the total of quotas, the Bank's managers would be able to vary the supply of bancor contra-cyclically.

Keynes sought to secure creditor adjustment without renouncing debtor discipline. To this end his scheme aimed to bring a simultaneous pressure on both surplus and deficit countries to "clear" their accounts. Persistent creditor countries would be allowed or required to revalue their currencies, unblock any foreign-owned investments, and be charged rising rates of interest (up to 10 per cent) on credits running above a quarter of their quota. Any credit balances exceeding quotas at the end of a year would be confiscated and transferred to a Reserve Fund. Persistent deficit countries would be allowed or required to depreciate their currencies, to sell the ICB any free gold, and prohibit capital exports. They would also be charged interest on excessive debits. If all countries were in perfect balance at the year's end, the sum of bancor balances would be exactly zero.

The Keynes plan was vetoed by the US, which was not prepared to allow its "hard earned" surpluses to be automatically at the disposal of "profligate" debtor countries. Instead the Bretton Woods Agreement of 1944 set up an International Monetary Fund to provide short-term financial assistance for countries in temporary balance of payments difficulties. The IMF was a fund, not a bank, into which members would pay contributions or quotas made up of gold and domestic currencies. (The total resources of the Fund were set at $8bn, as opposed to $25bn. for Keynes' ICB). The Fund would supply foreign currencies to members up to the limit of their quotas, provided they corrected their domestic policies. Par values of currencies would be fixed in terms of gold, which could be altered only to correct a "fundamental disequilibrium". Both the Keynes Plan and the IMF system relied on capital controls to prevent the destabilising flows of "hot money".

The crucial point was that, while accepting the idea of fixed, but adjustable exchange rates, the Fund provided no mechanism to stop persistent reserve accumulation. ...

That the Bretton Woods fixed exchange rate system, which lasted from 1949 to 1971, did not reproduce the deflationary character of the inter-war system, was due to the general commitment of governments to full employment policies backed by the "dishoarding" policies of the US. America flooded the "free" world with dollars, to such an extent that by the late 1960s it was starting to run a balance of trade deficit itself. The boot was now on the other foot, but the need for the deficit country (now the USA) to deflate was circumvented by the role of the dollar as the world's main reserve asset. As its trade deficit widened, the USA printed an increasing quantity of dollars to cover its unrequited imports. The surplus countries accumulated American dollar liabilities which they invested in US Treasury bonds. The US did not have to restrict domestic credit by raising interest rates since the dollars it printed came back to it. In the absence of what would have been a major deflationary force, the world economy boomed for twenty years.

The flaw in the system, as pointed out by Professor Triffin of Yale University, was that the increase in the liabilities of the key-currency country was bound to raise doubts about its ability to redeem these liabilities in gold. At the end of the 1960s, the French started converting their dollar reserves into gold. This brought about the predicted collapse of the gold-exchange standard in 1971. The dollar became inconvertible. A new supplementary international reserve currency, Special Drawing Rights (SDRs), had been set up, but since there was no mechanism for converting dollar balances into SDRs, the dollar continued to be the world's main reserve asset in a mixed world of floating, fixed, and managed exchange rates.

In theory, floating exchange rates remove the need for any reserves at all, since balance of payments deficits and surpluses would not arise. But the need for reserves unexpectedly survived, mainly to guard against speculative movements of hot money which could drive exchange rates away from their equilibrium values. This happened throughout the 1980s. Starting in the late 1990s, after the East Asian Crisis, East Asian governments unilaterally erected a "Bretton Woods II", linking their currencies to the dollar, and holding their reserves in dollars. This reproduced the expansionary benefits of Bretton Woods I, but at the cost of an increasingly unbalanced reserve position, as the dollar became progressively overvalued against the super-competitive renminbi.

Today's problem of current account imbalances reproduces the problems which brought down both the old gold standard and its successor Bretton Woods system. ...

The absence of a satisfactory adjustment mechanism has resulted in the revival of the asymmetry strongly emphasised by Keynes. Adjustment pressures are concentrated on the deficit countries (unless the deficit country is a reserve-issuer like the US); the countries in surplus can get away without adjustment. A case in point is that of the emerging countries that have discovered the advantages of export-led growth. This strategy has yielded many benefits for these countries but it suffers from a fallacy of composition; the export surpluses must have counterpart deficits elsewhere. In other words, they can generate global imbalances.

The current reserve system is equally unsatisfactory. It is notable that greater capital mobility has increased, not reduced, the demand for owned reserves. Many countries have a rational fear of floating, as well as a rational fear of unstable capital flows; and reserves obtained by short-term borrowing can evaporate in a crisis. The sure-fire way of accumulating owned reserves is to run current account surpluses. East Asian countries were taught the value of owned reserves by the bitter experience of 1997 and the recent crisis has only confirmed this lesson. ...

The argument that current account surpluses are deflationary for the world is only partially correct. Certainly they are deflationary in the first instance for the deficit countries. But the deficit countries are now very likely to be committed to full employment. So their probable and understandable reaction is expansion; large imbalances are the consequential by-product. This is certainly a plausible description of events in the middle of this decade: the "glut" of savings in parts of the world evoked a Keynesian expansionary response in the US, which widened global imbalances. Of course the day of reckoning has to come in the end and has the potential to be strongly deflationary for the world since the burden of adjustment would fall on the deficit countries. ...

We now turn to the reserve system. Keynes presciently wanted to abolish altogether the use of national currencies as international reserves and substitute "bancor" in their stead. Such a change would strike at the root of the self-insurance demand for dollars. And it would do so by enabling countries to acquire fiduciary reserves which they own but do not have to earn since they would be supplied by an international central bank. ...

Of course the appeal of the SDR would be materially enhanced if it were transformed into an asset that can be held by the private sector, not central banks alone. ...

(8) Ambrose: US could rebuild behind tariffs as Britain did in 1930s under Imperial Preference

China has now become the biggest risk to the world economy

By Ambrose Evans-Pritchard

Published: 6:21PM GMT 15 Nov 2009

Far from taking over as the engine of growth from an exhausted West, China is making matters worse. Its "beggar-thy-neighbour" policies continue to play havoc with global trade and risk tipping the world into a second leg of the Great Recession.

"The inherent problems of the international economic system have not been fully addressed," said China's president Hu Jintao. Indeed not. China is still exporting overcapacity to the rest of us on a grand scale, with deflationary consequences.

While some fret about liquidity-driven inflation, Justin Lin, World Bank chief economist, said the greater danger is that record levels of idle plant almost everywhere will feed a downward spiral of job cuts and corporate busts. "I'm more worried about deflation," he said.

By holding the yuan to 6.83 to the dollar to boost exports, Beijing is dumping its unemployment abroad – "stealing American jobs", says Nobel laureate Paul Krugman. As long as China does it, other tigers must do it too.

Western capitalists are complicit, of course. They rent cheap workers and cheap plant in Guangdong, then lobby Capitol Hill to prevent Congress doing anything about it. This is labour arbitrage.

At some point, American workers will rebel. US unemployment is already 17.5pc under the broad "U6" gauge followed by Barack Obama. Realty Track said that 332,000 properties were foreclosed in October alone. More Americans have lost their homes this year than during the entire decade of the Great Depression. A backlog of 7m homes is awaiting likely seizure by lenders. If you are not paying attention to this political time-bomb, perhaps you should.

President Obama said before going to China this week that Asia can no longer live by shipping goods to Americans already in debt to their ears. "We have reached one of those rare inflection points in history where we have the opportunity to take a different path," he said. Failure to take that path will "put enormous strains" on America's ties to China. Is that a threat?

It is fashionable to talk of America as the supplicant. That misreads the strategic balance. Washington can bring China to its knees at any time by shutting markets. There is no symmetry here. Any move by Beijing to liquidate its holdings of US Treasuries could be neutralized – in extremis – by capital controls. Well-armed sovereign states can do whatever they want.

If provoked, the US has the economic depth to retreat into near autarky (with NAFTA) and retool its industries behind tariff walls – as Britain did in the 1930s under Imperial Preference. In such circumstances, China would collapse. Mao statues would be toppled by street riots.

Mr Hu sounded conciliatory last week. China is taking "vigorous" steps to cut reliance on exports, still 39pc of GDP. "We want to increase people's ability to spend," he said.

Beijing is indeed boosting pensions and extending health insurance to the countryside so that people feel less need to save, but cultural revolutions take time. All we have seen so far are "baby steps", says Morgan Stanley's Stephen Roach.

The reality is that much of Beijing's $600bn stimulus has been spent building yet more plant and infrastructure so that China can ship yet more goods, or has leaked into property and stocks.

Credit has exploded. Allocated by Maoist bosses for political purposes, it has become absurd. China is rolling as much steel as the next eight producers combined. It is churning more cement than the rest of the world. Fixed investment is up 53pc this year. Once you know that Hunan authorities have torn down two miles of modern flyway so that they can soak up stimulus by building it again, or that the newly-built city of Ordos is sitting empty in Inner Mongolia, you know what must come next.

Pivot Asset Management said lending has touched 140pc of GDP, "well beyond" levels that have led to crises in the past. With the revolution's 60th birthday out of the way, the central bank has begun to tighten. New yuan loans halved in October. So be careful. Pivot said a hard-landing in China could prove as traumatic for world markets as the US sub-prime crash.

The world economy is still skating on thin ice. The West is sated with debt, the East with plant. The crisis has been contained (or masked) by zero rates and a fiscal blast, trashing sovereign balance sheets. But the core problem remains. The Anglo-sphere and Club Med are tightening belts, yet Asia is not adding enough demand to compensate. It is adding supply.

My view is that markets are still in denial about the structural wreckage of the credit bubble. There are two more boils to lance: China's investment bubble; and Europe's banking cover-up. I fear that only then can we clear the rubble and, very slowly, start a fresh cycle.  

(9) Lee Kuan Yew (2005): in 50 years China, Korea and Japan will dominate the world economy

From: Max <> Date: 08.10.2010 04:27 AM

SPIEGEL Interview with Singapore's Lee Kuan Yew


"It's Stupid to be Afraid"

Singapore's first-ever prime minister, long-time government head and current political mentor Lee Kuan Yew talks about Asia's rise to economic power, China's ambitions and the West's chances of staying competitive.

SPIEGEL: The political and economic center of gravity is moving from the West towards the East. Is Asia becoming the dominant political and economic force in this century?

Mr. Lee: I wouldn't say it's the dominant force. What is gradually happening is the restoration of the world balance to what it was in the early 19th century or late 18th century when China and India together were responsible for more than 40 percent of world GDP. With those two countries becoming part of the globalized trading world, they are going to go back to approximately the level of world GDP that they previously occupied. But that doesn't make them the superpowers of the world.

SPIEGEL: Their leading politicians have publicly discussed the so-called "Asian Century".

Mr. Lee: Yes, economically, there will be a shift to the Pacific from the Atlantic Ocean and you can already see that in the shipping volumes of Chinese ports. Every shipping line is trying to get into association with a Chinese container port. India is slower because their infrastructure is still to be completed. But I think they will join in the race, build roads, bridges, airports, container ports and they'll become a manufacturing hub. Raw materials go in, finished goods go out.

SPIEGEL: You've been the leader of a very successful state for a long time. Returning from your time in China, are you afraid for Singapore's future?

Mr. Lee: I saw it coming from the late 1980s. Deng Xiaoping started this in 1978. He visited Bangkok, Kuala Lumpur and Singapore in November 1978. I think that visit shocked him because he expected three backward cities. Instead he saw three modern cities and he knew that communism -- the politics of the iron rice bowl -- did not work. So, at the end of December, he announced his open door policy. He started free trade zones and from there, they extended it and extended it. Now they have joined the WTO and the whole country is a free trade zone.

SPIEGEL: But has China's success not become dangerous for Singapore?

Mr. Lee: We have watched this transformation and the speed at which it is happening. As many of my people tell me, it's scary. They learn so fast. Our people set up businesses in Shanghai or Suzhou and they employ Chinese at lower wages than Singapore Chinese. After three years, they say: "Look, I can do that work, I want the same pay." So it is a very serious challenge for us to move aside and not collide with them. We have to move to areas where they cannot move.

SPIEGEL: Such as?

Mr. Lee: Such as where the rule of law, intellectual property and security of production systems are required, because for them to establish that, it will take 20 to 30 years. We are concentrating on bio medicine, pharmaceuticals and all products requiring protection of intellectual property rights. No pharmaceutical company is going to go have its precious patents disclosed. So that is why they are here in Singapore and not in China.

SPIEGEL: But the Chinese are moving too. They bought parts of IBM and are trying to take over the American oil company Unocal.

Mr. Lee: They are learning. They have learnt takeovers and mergers from the Americans. They know that if they try to sell their computers with a Chinese brand it will take them decades in America, but if they buy IBM, they can inject their technology and low cost into IBM's brand name, and they will gain access to the market much faster.

SPIEGEL: But how afraid should the West be?

Mr. Lee: It's stupid to be afraid. It's going to happen. I console myself this way. Suppose, China had never gone communist in 1949, suppose the Nationalist government had worked with the Americans -- China would be the great power in Asia -- not Japan, not Korea, not Hong Kong, not Singapore. Because China isolated itself, development took place on the periphery of Asia first.

SPIEGEL: Such a consolation won't be enough for the future.

Mr. Lee: Right. In 50 years I see China, Korea and Japan at the high-tech end of the value chain. Look at the numbers and quality of the engineers and scientists they produce and you know that this is where the R&D will be done. The Chinese have a space programme, they're going to put a man on the Moon and nobody sold them that technology. We have to face that. But you should not be afraid of that. You are leading in many fields which they cannot catch up with for many years, many decades. In pharmaceuticals, I don't see them catching up with the Germans for a long time.

SPIEGEL: That wouldn't feed anybody who works for Opel, would it?

Mr. Lee: A motor car is a commodity -- four wheels, a chassis, a motor. You can have modifications up and down, but it remains a commodity, and the Chinese can do commodities.

SPIEGEL: When you look to Western Europe, do you see a possible collapse of the society because of the overwhelming forces of globalization?

Mr. Lee: No. I see ten bitter years. In the end, the workers, whether they like it or not, will realize, that the cosy European world which they created after the war has come to an end.

SPIEGEL: How so?

Mr. Lee: The social contract that led to workers sitting on the boards of companies and everybody being happy rested on this condition: I work hard, I restore Germany's prosperity, and you, the state, you have to look after me. I'm entitled to go to Baden Baden for spa recuperation one month every year. This old system was gone in the blink of an eye when two to three billion people joined the race -- one billion in China, one billion in India and over half-a-billion in Eastern Europe and the former Soviet Union.

SPIEGEL: The question is: How do you answer that challenge?

Mr. Lee: Chancellor Kohl tried to do it. He did it halfway then he had to pause. Schroeder tried to do it, now he's in a jam and has called an election. Merkel will go in and push, then she will get hammered before she can finish the job, but each time, they will push the restructuring a bit forward.

SPIEGEL: You think it's too slow?

Mr. Lee: It is painful because it is so slow. If your workers were rational they would say, yes, this is going to happen anyway, let's do the necessary things in one go. Instead of one month at the spa, take one week at the spa, work harder and longer for the same pay, compete with the East Europeans, invent in new technology, put more money into your R&D, keep ahead of the Chinese and the Indians.

SPIEGEL: You have seen yourself how hard it is to implement such strategies.

Mr. Lee: I faced this problem myself. Every year, our unions and the Labour Department subsidize trips to China and India. We tell the participants: Don't just look at the Great Wall but go to the factories and ask, "What are you paid?" What hours do you work?" And they come back shell-shocked. The Chinese had perestroika first, then glasnost. That's where the Russians made their mistake.  ...

The interview was conducted by editors Hans Hoyng and Andreas Lorenz.

Translated from the German by Christoper Sultan

(10) Surplus Countries blamed for Currency Warfare

Global currency, trade conflicts dominate IMF meeting

By Barry Grey
8 October 2010

The semi-annual International Monetary Fund and World Bank meeting, being held this weekend in Washington DC, has become the focus of mounting currency and trade conflicts between the major imperialist powers and the so-called emerging economies of Asia and Latin America, and among the great powers themselves.

Warning of the danger of currency wars, IMF Managing Director Dominique Strauss-Kahn told the Financial Times Monday: "There is clearly the idea beginning to circulate that currencies can be used as a policy weapon. Translated into action, such an idea would represent a very serious risk to the global recovery."

The IMF implicitly put the onus for the spread of government intervention into the currency markets on so-called emerging economies, above all, China. Deputy Managing Director John Lipsky in an interview said the Chinese renminbi (also known as the yuan) remained "significantly undervalued."

The growth of anti-Chinese protectionist sentiment in the US and Britain was summed up by Financial Times economics columnist Martin Wolf, who wrote in a column published Wednesday: "Has the time for a currency war with China arrived? The answer looks increasingly to be yes. The politics and economics of an assault on Chinese exchange rate policy are increasingly convincing. The idea is, of course, deeply disturbing. But I no longer believe there is an alternative." ...

A series of events this week have signaled an intensification of what is widely described as a global currency war. On Monday, Brazil doubled a tax it levies on foreign investors who purchase Brazilian bonds. This was done to stem an inflow of speculative capital that has pushed Brazil's currency, the real, 39 percent higher against the dollar since the beginning of 2009.

Brazil is one of a number of emerging economies—including India, Thailand, South Korea and Taiwan—whose currencies have risen sharply as a result of an influx of capital seeking higher returns than are available in the advanced economies, where interest rates are hovering around zero. Many of these countries are intervening repeatedly in the currency markets to hold down the value of their currency.

On Tuesday, the Bank of Japan announced it was lowering its benchmark interest rate to between zero and 0.1 percent and was planning to launch a $60 billion program to purchase Japanese government bonds and other securities. This so-called "quantitative easing" policy amounts to printing yen.

It has been initiated in an attempt to lower the yen's exchange rate, up 12 percent this year against the dollar, so as to cheapen Japan's exports. On September 15, the Japanese government for the first time in six years, acting unilaterally, sold some 2 trillion yen for the same purpose.

Japan acted Tuesday to preempt an expected revival by the US Federal Reserve Board of the quantitative easing policy it ended last March. Over the past week, prominent Fed officials have made public statements urging the resumption of Fed purchases of Treasury bonds and arguing that the US inflation rate is too low. These and similar indications by Fed Chairman Ben Bernanke are intended to encourage a sell-off of the dollar on currency markets and a further fall in the greenback's exchange rate.

Such moves amount to a policy of competitive devaluation and inevitably fuel similar actions by Washington's major trade competitors.

Also on Tuesday, eurozone finance ministers at a European-Asian economic summit in Brussels confronted Chinese Premier Wen Jiabao and called on him to speed up the appreciation of the renminbi in relation to the euro. Wen rejected their demands, leaving the two sides at loggerheads.

Speaking to a business conference in Brussels the following day, the Chinese prime minister warned of the implications of US and European demands that Beijing raise the renminbi at a double-digit pace. "If we increase the yuan by 20 percent or 40 percent, as some people are calling for," Wen said, "many of our factories will shut down and society will be in turmoil."

He continued, "Many of our exporting companies would have to close down, migrant workers would have to return to their villages. If China saw social and economic turbulence, then it would be a disaster for the world."

Later on Wednesday, US Treasury Secretary Geithner delivered a provocative speech calling on the IMF to single out China for censure. Speaking at the Brookings Institution, a Democratic-leaning think tank in Washington, Geithner said, unmistakably referring to China, "When large economies with undervalued exchange rates act to keep the currency from appreciating, that encourages other countries to do the same. This sets off a dangerous dynamic" as nations compete to keep their currencies undervalued.

Maintaining the pose of the aggrieved party, he declared that instead of the "competitive devaluations" of the 1930s, which exacerbated the Depression, the world faces a threat of "competitive non-appreciation." This is a sophistic formula that places the blame for currency warfare entirely on surplus countries like China—and implicitly Germany and Japan—which resist US pressure to allow their currencies to appreciate, and absolves Washington and its cheap dollar policy.

The increasingly protectionist policy of the US was underscored last month when the House of Representatives passed a bill openly directed against China that would enable the Commerce Department to impose punitive damages on countries deemed to be undervaluing their currencies. ...

(11) Martin Wolf: if China stops buying US treasury bonds, $ would fall - but that would be helpful, not damaging

How to fight the currency wars with stubborn China

By Martin Wolf

Published: October 5 2010 20:20 | Last updated: October 5 2010 20:20

Has the time for a currency war with China arrived? The answer looks increasingly to be yes. The politics and economics of an assault on Chinese exchange rate policy are increasingly convincing. The idea is, of course, deeply disturbing. But I no longer believe there is an alternative. ...

Given, in addition, the continued savings surpluses of Germany, Japan and a number of other high-income countries, a return to stable growth in the world economy requires the battered high-income countries, as a group, to move into sizeable current account surplus. ...

Some fear that a cessation of Chinese purchases of US government bonds would lead to a collapse. Nothing is less likely, given the massive financial surpluses of the private sectors of the world and the continuing role of the dollar. If it weakened the dollar, however, that would be helpful, not damaging. ...

Trade deficits started when Reagan used "free trade" to force concessions from labor

How "Free Trade" Led To Currency War

Lyndon Johnson is said to have commented that the press is like birds sitting on a telephone line. When one flies away, they all fly away. This week they are all flying around squawking "currency war!" But the world has been in a currency/trade war for some time, with only one side fighting and the rest losing. Now the world, on the edge of defeat in that war, sees that China is not "trading" they are taking. So, how to fight back, without (further) blowing up the world's economy?

The world can't get to full recovery from this terrible recession without more balanced trade. That is a huge part of the equation. Our trade deficits started with Reagan when "free trade" was used to force concessions from labor by threatening to move the factories to non-democracies, away from the wage and environmental protections We, the People fought so hard to achieve. The wage squeeze resulted in unprecedented concentration of wealth - and loss of buying power for the rest of the population. Under 'W' Bush, Wall Street used China for short-term profits and bonuses and China used the power that brought to buy advantage around the world. So now the rest of us are living with the long-term consequences of race-to-the-bottom policies. Namely, the bottom. ...

If rates adjust to where they should be China might lose some jobs, but Chinese workers will immediately be higher-paid relative to the world than they had been, and Chinese consumers will also be more able to buy things made elsewhere.

(12) China hollowing out Japan too

The US must erect tariffs against China unless they revalue


OCTOBER 5, 2010 10:00 AM

... The data for the US on outbound containers (exports) and inbound containers (imports) points to significant on-going trade deterioration in the US in the months ahead. ...

Worse yet, the deterioration we are now seeing in Japanese exports do not reflect the strength in the yen this year. The lags in trade are long. The threat to Japan from the rising yen is that Japanese corporations are forced by the strong yen to move their production platforms to lower cost economies and thereby hollow out Japan. It takes a long time to make these business investment decisions and act on them. To the extent that "hollowing out" is now hurting Japanese exports, it reflects 95 to 100 yen to the dollar and not 83 yen to the dollar. A further adverse impact on Japanese exports and industrial production from recent yen strength could be huge. Already exports are weak and industrial production is rolling over even though Japanese firms report they can live with 95 yen to the dollar. The majority of Japanese industrial firms say they cannot live with 85 yen to the dollar. The deterioration in Japanese exports and industrial production we are seeing now could be much worse, all other things being equal, if the yen stays above 85 to the dollar.

Worse yet, the new China mega investment boom is on-going. Only the shortest lead time projects are in production, which are now competing with Japan. But, there is a huge surge in new Chinese production ahead which will compete with and substitute for Japanese exports. Exchange rate considerations aside, the secular trend whereby emerging Asia and especially China are competitively advancing on Japan will undermine Japan's exports and industrial production in the near to intermediate future.

There is a curiously perverse but symbiotic relationship that exists between China's mercantilists and America's finance capitalism. It may not be as conspiratorial as Ms O'Donnell suggests, but it's a lot less benign than Fallows suggests. And it's a whole lot worse than what the China apologists are saying (yes, Steve Roach, I'm talking about you). The whole "Bretton Woods II" process contributes to the financialization of our economy, as it continues to hollow out our manufacturing base. ...

And what does this mean for Japan, which is the canary in the coal mine? With this kind of investment going on in China, the Japanese firms haven't a chance to compete with the yen prevailing at this level. And China knows this so it continues to buy Japanese yen bonds, which keeps the currency high and basically destroys its main Asian competitor. It represents the ultimate revenge for Manchukuo and the Rape of Nanking. And this is a development that could move very fast because the excesses of investment in China are currently so great. ...

Ed wrote in response:

So, you're a protectionist, then? Are you throwing your hat in the ring with Krugman?

Here's what I say to this question:

I'm totally with Krugman on this. I want a full employment policy, not a "free trade" policy per se. It's impossible to speak about "free trade" when it doesn't apply both ways. Free trade is another one of these neo-liberal myths, largely predicated on the notion that we need China to "fund" our deficits. That's nonsense. We continually read that nations with current account deficits (CAD) are living beyond their means and are being bailed out by foreign savings.

A CAD can only occur if the foreign sector desires to accumulate financial (or other) assets denominated in the currency of issue of the country with the CAD. China makes that choice. I would rather go for higher tariffs than a forced revaluation of the RMB, as I don't think that the promotion of exports per se is a good policy for the US. We seem to be fixated on this idea of reducing domestic wages, often through fiscal and monetary austerity measures that keep unemployment high. The best way to stabilise the exchange rate is to build sustainable growth through high employment with stable prices and appropriate productivity improvements, which is what I want to do. A low wage, export-led growth strategy sacrifices domestic policy independence to the exchange rate – a policy stance that at best favours a small segment of the population. ...

(13) Countries not on the Gold Standard escaped the Great Depression; it was NOT caused by Tariffs

Spain and China are examples (see footnote 2).

The gold standard's fixed-exchange rate regime transmitted financial disturbances across countries. One might argue that China's peg to the $ is comparable today.

The following paper is in pdf format; excerpts are included here. Charts and References are omitted, and only a few Footnotes are included.

A Central Bank "sterilizes" by selling Government Bonds to the private sector (banks, pension funds etc), thereby withdrawing money from the economy.

Did France Cause the Great Depression?

Douglas A. Irwin

Dartmouth College & NBER

This Draft: September 2, 2010


The gold standard was a key factor behind the Great Depression, but why did it produce such an intense worldwide deflation and associated economic contraction? While the tightening of U.S. monetary policy in 1928 is often blamed for having initiated the downturn, France increased its share of world gold reserves from 7 percent to 27 percent between 1927 and 1932 and effectively sterilized most of this accumulation. This "gold hoarding" created an artificial shortage of reserves and put other countries under enormous deflationary pressure. Counterfactual simulations indicate that world prices would have increased slightly between 1929 and 1933, instead of declining calamitously, if the historical relationship between world gold reserves and world prices had continued. The results indicate that France was somewhat more to blame than the United States for the worldwide deflation of 1929-33. The deflation could have been avoided if central banks had simply maintained their 1928 cover ratios.

Acknowledgements: I thank Barry Eichengreen, James Feyrer, Nancy Marion, Allan Meltzer, Michael Mussa, Marjorie Rose, Scott Sumner, and Peter Temin for helpful comments and conversations.

{p. 1} Did France Cause the Great Depression?


A large body of economic research has linked the gold standard to the length and severity of the Great Depression of the 1930s.1 The gold standard's fixed-exchange rate regime transmitted financial disturbances across countries and prevented the use of monetary policy to address the economic crisis. This conclusion is supported by two compelling observations: countries not on the gold standard managed to avoid the Great Depression almost entirely, while countries on the gold standard did not begin to recover until after they left it.2

While the link between the gold standard and the Great Depression is widely accepted, it begs the question of how the international monetary system produced such a monumental economic catastrophe. Structural flaws in the post-World War I gold standard and the fragility of international financial stability are often blamed for the problems of the period. However, it is not clear why such factors should have necessarily led to the massive price deflation experienced between 1929 and 1933 and the enormous economic difficulties that followed. In particular, there was no apparent shortage of gold in the 1920s and 1930s - worldwide gold reserves continued to expand - so it is not obvious why the system self-destructed and produced such a cataclysm.

1 See Choudhri and Kochin (1982), Eichengreen and Sachs (1985), Temin (1989), Eichengreen (1992), and Bernanke (1995), among many other works.

2 In terms of countries that were not on the gold standard, Spain and China stand out as examples. Because countries on the gold standard chose to leave it at different times – the United Kingdom in 1931, the United States in 1933, and France in 1936 – there is sufficient variation in country experiences to identify this relationship.

{p. 2} by central banks. The standard explanation for the onset of the Great Depression is the tightening of U.S. monetary policy in early 1928 (Friedman and Schwartz 1963, Hamilton 1987). The increase in U.S. interest rates attracted gold from the rest of the world, but the gold inflows were sterilized by the Federal Reserve so that they did not affect the monetary base. This forced other countries to tighten their monetary policies as well, without the benefit of a monetary expansion in the United States. From this initial deflationary impulse came currency crises and banking panics that merely reinforced the downward spiral of prices. The United States deserves blame for starting the vicious cycle in the view of many economists. Friedman and Schwartz (1963, 360) argue that "the United States was in the van of the movement and not a follower."3 Similarly, Eichengreen (1992, 222) states that "events in America were directly responsible for the slowdown in other parts of the world."

However, what often frequently overlooked - or mentioned only in passing - is the fact that France was doing almost exactly the same thing. In fact, France was accumulating and sterilizing gold reserves at a much more rapid rate than the United States. Contemporary observers then and scholars of the Great Depression today have been aware of this fact, but it still remains a relatively neglected factor whose importance has not been fully appreciated.

Some scholars of French monetary history have even concluded that France deserves more blame than the United States for the world's increasing monetary stringency in the late

3 "The international effects were severe and the transmission rapid, not only because the gold-exchange standard had rendered the international financial system more vulnerable to disturbances, but also because the United States did not follow gold-standard rules," Friedman and Schwartz (1963, 361) note. "We did not permit the inflow of gold to expand the U.S. money stock. We not only sterilized it, we went much further. Our money stock moved perversely, going down as the gold stock went up. . . . The result was that other countries not only had to bear the whole burden of adjustment but also were faced with continued additional disturbances in the same direction, to which they had to adjust."

{p. 3} 1920s and early 1930s. Johnson (1997, 147) contends that "while the United States did little to hinder the decline in world prices, especially after 1928, French policy can be charged with directly causing it."4 "That French gold policy aggravated the international monetary contraction from 1928 to 1932 is beyond dispute," Mouré (2002, 180) maintains. "The magnitude and timing of French gold absorption from mid-1928 to 1930 imposed a greater constraint on systemic monetary expansion than the gold accumulation in the United States during the same period." Even Milton Friedman later revised his view on the origins of the Great Depression and wrote that France also deserved some responsibility for its occurrence.5 ...

4 As Johnson notes, "Beginning in 1929, the price declines were triggered by the rapid concentration of gold in a small number of central banks, where it was partly or entirely sterilized (that is, the increase in reserves was not permitted correspondingly to increase the amount of currency or deposits). The Federal Reserve drew large amounts of gold from abroad starting in early 1929 and continuing through the summer of 1931, which contributed to the deflationary process; but this movement was exceeded by a larger amount flowing concurrently to the Bank of France. In addition, the gold inflow to France began earlier and persisted after the flow to the United States was reversed."

5 After re-reading the memoirs of the Emile Moreau, the governor of the Bank of France, Friedman (1991, xii-xiii) said that he "would have assessed responsibility for the international character of the Great Depression somewhat differently" than he did originally in his Monetary History with Anna Schwartz, namely by laying blame on France as well. Both the Federal Reserve and the Bank of France "were determined to prevent inflation and accordingly both sterilized the gold inflows, preventing them from providing the required increase in the quantity of money. ... France's contribution to this process was, I now realize, much greater than we treated it as being in our [Monetary] History."

{p. 4} central banks were concerned to retain some proportion between their reserves and domestic liabilities," Eichengreen concludes, "this redistribution of reserves would have provided considerable scope for an expansion of money supplies." Sumner (1991) uses a decomposition, rather than the estimated relationships and counterfactual analysis employed here, to find that central bank demand for monetary gold had a major impact of the world price level between 1926 and 1932. Although he does not focus on France in particular, his conclusions are consistent with this paper's findings and will be discussed below. Bernanke and Mihov (2000) also decompose national price movements due to changes in the money supply to components such as changes in the money multiplier, cover ratios, reserve to gold ratios, and the stock of gold. They conclude that the maldistribution of gold across countries and the sterilization of gold were broadly responsible for the early stages of the deflationary epoch, but they do not focus on the broader international consequences of France's policies.

This paper revisits the origins of the Great Depression to highlight the key role played by France. After examining France's monetary policy in the late 1920s, particularly its gold accumulation and sterilization policy, the paper estimates a simple model of the relationship between world prices and the world stock of monetary gold between 1875 and 1924. An out-of-sample forecast of the price level between 1925 and 1933 based on the actual changes in gold reserves suggests that, had the historical relationship between gold and prices continued, world prices would be expected to rise somewhat instead of declining 42 percent.

The paper then calculates how much gold would have been freed up if the United States and France had kept only enough to cover their actual liabilities at their 1928 cover ratios. By this measure, both countries held excess gold equivalent to 6 percent of the world gold stock in 1929 and 12 percent in 1930-32. While the United States and France contributed equally to the

{p. 5} effective reduction in the world gold stock in 1929 and 1930, France was almost entirely responsible for the effective reduction in 1931 and 1932. The fact that the two countries kept such a large proportion of the world's gold stock inert and withdrawn from world circulation in 1929 and 1930 directly explains half of the massive worldwide deflation in 1930 and 1931 and is indirectly responsible for part of the remainder. Finally, an appendix surveys the views of a number of economists – Gustav Cassel, Allyn Young, and John Maynard Keynes – who anticipated many of these problems and warned of the dangers that would arise if central banks (France's in particular) began accumulating gold reserves without monetizing them.

These results support the view that France played a key role in bringing about the Great Depression. While France's role is sometimes acknowledged (usually briefly, if at all, however), economic historians have traditionally focused on the United States. Because of the country's smaller size, the impact of French policies is often believed to have been much smaller than the United States.6 Yet these findings suggest that the French role deserves much greater prominence than it has thus far received for having transmitted a tightening of monetary policy to other countries and thus beginning the worldwide deflationary spiral.

The Controversy about France's Monetary Policy, 1928-1932

Many of the international monetary difficulties of the late 1920s can be traced to the decisions made to resume the gold standard in the mid-1920s after World War I. The Genoa conference of 1922 established guidelines (unenforceable ones, however) for the reconstructed gold standard. One concern at the time was that there would be insufficient new gold production to keep up with the growing demand for gold, and thereby result in deflation. Sweden's Gustav

{p. 6} Cassel was the leading economist who warned of an impending shortage of gold and the possibility of worldwide price deflation. Based on historical experience, he concluded that the world stock of monetary gold had to increase by about three percent a year to keep up with commercial activity and the growing demand for gold and thereby maintain the existing level of world prices. If the monetary gold stock grew more than 3 percent, world prices would increase; if the monetary gold stock grew less than 3 percent, world prices would fall.7

Cassel and others believed that world gold production was slowing and that this was a cause for concern because of the problems associated with deflation. He also thought that there would be higher demand for gold after the war because central banks had to support a larger base of liabilities due to the inflation that occurred during the war when the gold standard was suspended. The wartime inflation meant that nominal liabilities could not be covered by the existing monetary base of gold, so countries would either have to reset their exchange rate parities or accumulate more gold reserves. Fearful of the deflationary consequences of many central banks seeking to acquire more gold reserves at the same time, Cassel advocated a "gold-exchange" standard in which foreign exchange holdings could also be used as central bank reserves to augment gold and thereby ensure stable prices.8

The Genoa conference endorsed the view that central banks should economize on the use of gold by using foreign exchange as part of their reserve base. Resolution No. 9 of the Conference recommended that central banks "centralise and coordinate the demand for gold, and so avoid those wide fluctuations in the purchasing power of gold which might otherwise result

7 Because the nominal price of gold was fixed in terms of national currencies, an increase in the supply of gold would manifest itself not in a lower price of gold, but in a higher price of all other commodities. Similarly, an increase in the demand for gold would manifest itself in a lower price of all other commodities, not in a higher price of gold itself.

{p. 7} from the simultaneous and competitive efforts of a number of countries to secure metallic reserves." However, the Genoa resolutions were simply guidelines that could not be enforced. There was no agreement at all on the "rules" of gold standard game, particularly the idea that countries with increasing gold reserves should inflate their money supplies. In addition, many countries, France foremost among them, were skeptical of using foreign exchange reserves (such as British pounds) as part of its reserve base, fearing that such a policy would be inflationary.

The reconstructed gold standard started off on the wrong foot in 1925 when Britain rejoined it at an exchange rate that overvalued the pound (Moggridge 1969). This not only harmed the competitive position of export industries, but meant that the British balance of payments would remain in a fragile state until the country left gold in 1931. The balance of payments weakness required the Bank of England to maintain a tight monetary policy to sustain the pound at its high level, keeping interest rates high and thereby diminishing domestic investment. This kept economic growth in check and made it difficult for Britain to reduce its already high level of unemployment.

These problems were compounded in 1926 when France, after enduring a traumatic bout of inflation in 1924-26, stabilized the franc at an undervalued rate (Sicsic 1992). France also made two other key policy decisions: it rejected the British idea of a gold-exchange standard and chose to hold gold alone as part of its central bank reserves, and it decided to prevent any return of inflation by sterilizing gold inflows to prevent them from increasing domestic prices.9 France codified this set of policies with the Monetary Law of June 1928. This law officially restored

9 As Mouré (2002, 188-89) notes: "The attitude of the Bank of France exemplified the asymmetry and the deflationary bias of the gold standard. The bank rejected the gold exchange standard as a dilution of the gold standard that promoted an over-expansion of credit . . . The Bank of France set itself resolutely against measures to increase domestic monetary circulation and prices."

{p. 8} convertibility of the franc in terms of gold at the undervalued rate, prevented the Bank from accumulating foreign exchange reserves, and required the Bank of France to maintain gold reserves equal to cover 35 percent of liabilities (notes in circulation and demand deposits).10

One of the main worries expressed by Cassel and acknowledged at the Genoa conference was that there would be a shortage of gold and deflation if new production of gold was insufficient to meet the growing demand for it. As it happened, the forecasts of declining gold production were off the mark. As Figure 1 shows, the supply of gold reserves continued to grow through the late 1920s and into the 1930s. In fact, world gold reserves increased 19 percent between 1928 and 1933.

What changed, however, was the international distribution of those reserves. Partly as a result of the undervaluation of the franc, the Bank of France began accumulate gold reserves at a rapid rate. As Figure 2 shows, France's share of world gold reserves soared from 7 percent in 1926 to 27 percent in 1932. By 1932, France held nearly as much gold as the United States, though its economy was only about a fourth of the size of the United States. Together, the United States and France held more than sixty percent of the world's monetary gold stock in 1932. ...

{p. 11} Meanwhile, the pressure on Britain due to the overvalued pound is also evident as its share of reserves gradually declined after 1925, and especially in 1931 when it faced large gold losses and was forced off the gold standard.

France's stabilization in 1926 and America's tightening of monetary policy in 1928 combined to attract gold to these two countries at the expense of the rest of the world. Table 1 provides another look at the change in gold reserves during this period. ...

The deflationary pressure that this redistribution of gold put on other countries is remarkable. In 1929, 1930, and 1931, the rest of the world lost the equivalent of about 8 percent of the world's gold stock, an enormous proportion – 15 percent – of the rest of the world's December 1928 reserve holdings.

The cumulative effect is astounding. In December 1932, world gold reserves were 24 percent larger than they had been in December 1927. However, France absorbed almost every ounce of the additional gold, leaving the rest of the world with no net increase.12 The United

12 John Maynard Keynes (1932, 83) could not resist this biting remark: "And, when the last gold bar in the world has been safely lodged in the Bank of France, that will be the appropriate moment for the German Government to announce that one of their chemists has just perfected the technique for making the stuff at 6d. an ounce."

{p. 12} States seems to have been less of a problem because it was not systematically accumulating gold throughout the period. ...

This massive redistribution of gold would not have been a problem for the world economy if the United States and France had been monetizing 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 elsewhere. That would have been playing by

{p. 13} the "rules of the game" of the classical gold standard. However, there were no agreed-upon rules of the game in the interwar gold standard. And both France and the United States were effectively sterilizing the inflows to ensure that they did not have an expansionary effect.13

The sterilization is implicit in the cover ratios presented in Figure 3. The cover ratio is the ratio of central bank gold reserves to its domestic liabilities (notes in circulation and demand deposits). Once again, the change in France is astonishing in comparison to the other countries. ...

{p. 20} France's refusal to make any concessions infuriated many in Britain. ...

{p. 32} From this simple exercise, we can conclude that the Federal Reserve and Bank of France directly account for about half of the 30 percent deflation experienced in 1930 and 1931. 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 (Boughton and Wicker 1979). However, these endogenous responses cannot be considered as independent of the initial deflationary impulse, and therefore U.S. and French policies can be held indirectly responsible for at least some portion of the remaining "unexplained" part of the price decline. ...

{p. 33} Conclusion

The standard account of the onset of the Great Depression usually begins with the Federal Reserve's tightening of monetary policy in 1928. However, the rapid accumulation and effective sterilization of gold reserves by the Bank of France deserves equal – if not greater – billing in the narrative. The impact of the monetary policies of the two countries was equally significant in producing deflationary pressure in 1929 and 1930, while France became the dominant deflationary force in 1931 and 1932.

This paper provides a very simple explanation for the sudden onset of deflation in terms of changes in U.S. and French monetary policy around 1928. Of course, declining prices do not necessarily imply declining output, yet recent research has shown that the Great Depression of the 1930s is somewhat unique in linking the two (Atkeson and Kehoe 2004, Bordo, Lane, and Redish 2004). Hence, simply avoiding deflation during this period would likely have changed the course of world history. One shudders to think of the historical ramifications of the policies pursued at this time. As Robert Mundell (2000, 331) has speculated: "Had the price of gold been raised in the late 1920's, or, alternatively, had the major central banks pursued policies of

{p. 34} price stability instead of adhering to the gold standard, there would have been no Great Depression, no Nazi revolution, and no World War II."

{p. 35} Appendix: Contemporary Analysis of the French Gold Situation

{p. 36} ... That same month (January 1929), John Maynard Keynes acknowledged that he had been wrong not to take Cassel's pronouncements more seriously. Keynes (1929) warned that "a difficult, and even a dangerous, situation is developing" because "there may not be enough gold in the world to allow all the central banks to feel comfortable at the same time. In this event they will compete to get what gold there is – which means that each will force his neighbor to tighten credit in self-protection, and that a protracted deflation will restrict the world's economic activity, until, at long last, the working classes of every country have been driven down against their impassioned resistance to a lower money wage." ...

{p. 37} British officials at the League of Nations also tried to raise the issue, but it was so controversial that the multilateral body was unable to address it head on (Clavin and Wessels 2004). The Gold Delegation issued an interim report in September 1930 that largely sidestepped the main policy issues. However, it did conclude that "the problem of the distribution of gold is thus one of great importance . . . if the distribution of gold is the result of excessive or abnormal competition by a few countries, or if it has the effect of sterilizing important amounts of monetary stocks, serious consequences will arise affecting the general level of prices" (League of Nations 1930, 17). It noted that the amount of gold cover against notes and sight liabilities is determined by many factors, but that minimum reserves were usually established by national legislation. While no one country could act to reduce its cover ratio, the Delegation suggested that international agreement to reduce cover ratios could alleviate the problem of demand for monetary gold. ...

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