Did France cause the Great Depression?

There is an intriguing paper by Douglas Irvin on the topic. Voxeu has a nice summary (one of the best things to have happened on web for economics students- voxeu. Most economists use it to summarise key papers/thoughts/ideas etc)).

He says:

A large body of research has linked the gold standard to the severity of the Great Depression. This column argues that while economic historians have focused on the role of tightened US monetary policy, not enough attention has been given to the role of France, whose share of world gold reserves soared from 7% in 1926 to 27% in 1932. It suggests that France’s policies directly account for about half of the 30% deflation experienced in 1930 and 1931.

A large body of economic research has linked the gold standard to the length and severity of the Great Depression of the 1930s, primarily because fixed exchange rates precluded the use of monetary policy to address the crisis (see for example Temin 1989, Eichengreen 1992, and Bernanke 1995)

But it has never been entirely clear why the gold standard produced the massive worldwide price deflation experienced between 1929 and 1933 and the enormous economic difficulties that followed. In particular, worldwide gold reserves expanded continuously through the 1920s and 1930s, so it is not obvious why the system self-destructed and produced such a cataclysm.

How did this work? Under gold standard countries maintained their currencies at a fixed level and were backed by gold. So central bank bought and sold gold to maintain the currency levels (need to study this in detail though). In times of great depression, Fed raised rates. This led to gold flows in US. In order to maintain the value if USD, Fed sterilised the gold flows. So there was no increase in monetary base.

Now this is pretty well-known. What is not known is just like US, France was also doing the same thing:

Yet what is often overlooked is the fact that France was doing almost exactly the same thing. In fact, France was accumulating and sterilising gold reserves at a much more rapid rate than the US (see Johnson 1997 and Mouré 2002). Partly as a result of the undervaluation of the franc in 1926, the Bank of France began to accumulate gold reserves at a rapid rate. As Figure 1 shows, France’s share of world gold reserves soared from 7% in 1926 to 27% in 1932.

The redistribution of gold put other countries under enormous deflationary pressure. In 1929, 1930, and 1931, the rest of the world lost the equivalent of about 8% of the world’s gold stock, an enormous proportion – 15% – of the rest of the world’s December 1928 reserve holdings. This massive redistribution of gold would not have been a problem for the world economy if the US and France had been monetising the gold inflows. Then the gold inflows would have led to a monetary expansion in those countries, just as the gold outflows from other countries led to a monetary contraction for them. That would have been playing by the “rules of the game” of the classical gold standard. But during the interwar gold standard, there were no agreed-upon rules of the game, and both France and the US were effectively sterilising the inflows to ensure that they did not have an expansionary effect.

In 1930, when the US and France held about 60% of the world’s gold stock, they were sitting on (non-monetising) about 11% of the world’s gold stock relative to 1928. Overall, US and France exerted roughly equal deflationary pressure on the rest of the world in 1929 and 1930 and France exerted a much more deflationary impact in 1931 and 1932. Over the entire period from 1928 to 1932, France had a greater deflationary impact than the US. France could have released 13.7% of the world’s gold stock, while the US could have released 11.7%, and still have maintained their 1928 cover ratios.

He offers a more precise explanation:

So what was the effect of the effective withdrawal of this gold from circulation on the world price level? In recent research (Irwin 2010), I find that a 1% increase in the gold stock increases world prices by 1.5%. Since the US and France effectively withdrew 11% of the world’s gold stock from circulation, this would have led to a fall in world prices of about 16%. From this simple exercise, we can conclude that the Federal Reserve and Bank of France directly account for about half of the 30% deflation experienced in 1930 and 1931 (see Sumner (1991) for a different calculation that is generally consistent with this finding).

Of course, once the deflationary spiral began, other factors began to reinforce it. The most important factor was that growing insolvency (due to debt-deflation problems identified by Irving Fisher) contributed to bank failures, which in turn led to a reduction in the money multiplier as the currency to deposit ratio increased. However, these endogenous responses cannot be considered as independent of the initial deflationary impulse, and therefore US and French policies can be held indirectly responsible for at least some portion of the remaining “unexplained” part of the price decline.

Simply Fascinating to read all this. So nearly after 81 years since great depression started we are still looking at reasons behind the great event. It is still such an active area of research. Come 2100 we will still be talking about this 2007 crisis and be still comparing it with great depression. May be there are a couple of other major crisis chipped in till then as well.

Economics history is so so interesting.


One Response to “Did France cause the Great Depression?”

  1. The Destructionist Says:

    If you haven’t already watched the documentary, Capitalism: A Love Story, then I highly suggest you do.

    At first, the trailers made it sound like it was a joke. I thought it was going to be another one of those propaganda films pitting “Bleeding-heart Liberals” against “Right-wing Neocons” (you know the kind), but it wasn’t like that at all. Instead, the film was serious and focused primarily on corporations and their zeal to maximize their profits at all costs and with total disregard to the people or to the countries they might ultimately affect.

    A part of the film that I found especially intriguing was the presentation of a document written by Citigroup that was sent to the wealthiest of its investors; essentially stating that America was no longer a Democracy, but a Plutonomy (an economy run and powered – not by people like you and me – but by corporations and the wealthiest 1%). To be honest, I thought the document was made up bullshit and I’d never be able to find it online. ((After all, who’d be so brazen (or so stupid) as to compile such information and then let it get out into the public?)) But I was wrong, and it is real:

    Equity Strategy
    Plutonomy: Buying Luxury, Explaining Global Imbalances

    As I read, page-after-page, I could feel my eyes growing wider and wider in utter disbelief (My God…I mean, it was like reading a manual on how to successfully turn our world into George Orwell’s, “1984”)!

    I have to say that I’m rather embarrassed that I didn’t know about this document (or the documentary) before today. But now that I do, it only confirms what I’ve written about in times past: the powerful corporate élite are actually designing plans to take over the world’s economies and fashion its various countries into collectively owned corporate blocs, whereby people are no longer consumers, but hive-like workers.

    Now I know what you’re saying, and I totally agree with you…(It sounds like, “crazy talk,” right?) But there will come a day – however absurd it sounds – where national allegiances will be replaced with “corporate allegiances.” It might not happen tomorrow – or even a year from now – but trust me… Someday, it will happen…

    (CHECK OUT THIS LINK) http://www.youtube.com/v/IhydyxRjujU?fs=1&hl=en_US&rel=0

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