An Assessment of the Causes of the Abandonment of the Gold Standard by the U.S. in 1933.

• Author: Hallwood, Paul

Paul Hallwood [*]

Ronald MacDonald [+]

Ian W. Marsh [++]

In this paper we present an investigation of the pressures on the United States to devalue the dollar against the franc and gold in the early 1930s. We calculate monthly time-series of realignment expectations and find that these are well explained by a set of fundamental economic variables. The implication is drawn that macroeconomic events were at least in part responsible for jolting the U.S. off the gold standard and that the Federal Reserve was constrained in its response to the Depression by the United States' commitment to gold.

1. Introduction

   The indictment that the Fed played a causal role in the Great Depression in the United States is still of interest because it challenges the credibility of the Fed as an institution (Friedman and Schwartz 1963). Indeed, this matter has remained controversial, witness a recent conference where papers on material relevant to the issue by Temin (1998) and Sims (1998) attracted often contrary discussion. Moreover, whether the Great Depression in the United States was home-grown or was caused at least in part by the international economic contraction has been the subject of many earlier investigations including Eichengreen (1992), Kindleberger (1986), Temin (1989), and Wigmore (1987).

   In this paper we investigate the role of the Fed in the Great Depression using ideas drawn from the recently developed theory of target zones (Krugman 1991) in combination with a reduced-form version of the monetary approach to the balance of payments. As money is endogenous in the monetary approach, any success of our modeling would indicate that the Fed was not a free agent in determining the American money base and interest rates. We in fact do find that the Fed managed money in a manner consistent with the United States' commitment to maintain the gold standard--a commitment that was widespread across the American political scene in the early 1930s (Eichengreen and Temin 1997).

   We proceed to investigate the independence or otherwise of American monetary policy under the interwar gold standard in the following way. As we view the United States as being a part of an international system, section 2 describes relevant concurrent macroeconomic events in France--the other major country still on the gold standard after speculative pressures in foreign exchange markets had ejected the United Kingdom from it in 1931:09. Section 3 describes a method for calculating franc-dollar realignment expectations, using the theory of uncovered interest parity, for the period spanning the United States' and France's simultaneous adherence to the gold standard in the interwar period, 1926:12 to 1933:02. Empirical realignment expectations are then described. Section 4 shows how the macroeconomic determinants of realignment expectations may be modelled, and section 5 discusses our empirical evidence on the determination of expectations. Section 6 offers conclusions suggesting that the Fed was not an actor autonomous of the international gold standard.

2. France

   The United States cannot be characterized as a colossus bestriding a rump of disconnected small open economies still on the gold standard after the United Kingdom's ejection. The population of the four countries that were later to form the gold bloc after the United States suspended gold in 1933:03--Belgium, France, Netherlands, and Switzerland--had a combined population that was almost exactly one-half that of the U.S. (League of Nations 1931/2, table 2). And, although their per capita incomes were lower than the United States', we know that this bloc was large enough to absorb copious quantities of American monetary gold.

   In this study French macroeconomic data effectively proxy for that of the other gold bloc countries. This is justified as, outside the United States, the French economy was the largest still on gold. Secondly, for key macroeconomic variables--money, prices, and production--French monthly data are highly correlated with that of the other three countries. Thus, in the respective correlation matrixes for the four gold bloc countries over the period 1928:06 to 1933:02 most correlations are well over 0.90.

   French monetary policy after the Great Crash in 1929:10 was more helpful to the Bank of England in its struggle to 1931:09 to stay on gold than it was after this date to the Federal Reserve in the run up to the American suspension of gold in 1933:03. Thus, the French nominal money base increased from F88bn in 1929:10 to F104bn in 1931:09--an 18% increase. [1] But in the crucial period for the Federal Reserve following the pound's departure from gold, 1931:10 to 1933:02, the French nominal money base contracted by 9%--from Fl15bn to Fl05bn. At the same time the U.S. money base increased by 16%--from $7.57bn to $8.8bn. This contraction of the French nominal money base was not due to falling French gold reserves because in these 17 months there were 15 straight months of bullion and specie inflows to France. The two odd months of outflows being the last two, possibly because increasing speculative pressure on the dollar eventually brought the franc under suspicion--Switzerland and the Netherlands receiving net bullion and specie inflows in these months.

   This absolute and relative (to the United States) tightening of the French nominal money base was more unhelpful to the Federal Reserve than these figures indicate. This is because the demand for money and French interest rates were being supported by a smaller contraction in French industrial production compared to that in United States. Thus, French and U.S. industrial production fell by, respectively, 27% and 47% 1929:10 to 1933:02; and in the critical 17 months after the U.K. left gold by, respectively, 12% and 15% (i.e., 1931:10 to 1933:02).

   U.S. short-term interest rates (90-day prime bankers' acceptances) during these 17 critical months fell sharply from 2.25% to 0.44%; while French short-rates (private discount rate) fell only from 1.8% to 1.75%. (But they had been only 0.91% in 1932:12 before almost doubling by 1933:02, presumably due to the disturbances on foreign exchange markets.)

3. Calculating Realignment Expectations

   Countries on the gold standard defined a price of gold at which domestic currency was convertible. In turn these commitments set the mint par parity between a pair of currencies. Owing to the cost of arbitraging gold between countries, the gold import and export points implicitly defined the edges of an exchange rate fluctuation band or target zone. If financial markets thought that national commitments to convertibility at unchanged prices were credible, the expectation for mint par parity would be for no change and...