1. The Great Depression … of 1921 & the Gold Standard
ECO 473 – Money & Banking
Dr. D. Foster

2. The Great Depression of 1920-1921
Was it necessary?
Yes – the inevitable cost of wartime inflation:
Fed accommodates Treasury & buys bonds.
Consumer prices:  11% in 1916
 17% in 1917
 18.6% in 1918
on a pace to  14% in 1919
Yes – the cost of transitioning back to peace:
Federal budget: $2 billion in 1917
$18 billion in 1919
$5 billion in 1920
$3 billion in 1921

3. The Great Depression of 1920-1921
How did it unfold?
Fed policy (individual Reserve Banks):
Nov. 1919, NYF raises i (discount) to 4.75%
Jan. 1920, NYF raises i to 6%
June 1920, NYF raises i to 7%
May 1921, Fed banks lower i to 6.5%, 6%
It was a depression:
Real output fell an est. 9%
Unemployment rose to an est. 19%
Industrial production down 31%
Corporate profits down 92%
Prices down an est. 20%

4. The Great Depression of 1920-1921
What did government do?
Presidents ignored the depression
Wilson – stroke; League of Nations
Harding – not the government’s place
Congress  spending & balanced budget
Grant: “The last …”
The real recovery of 1922:
Industrial production rose +26%
Mfg. employment rose from 8.2 mill. to 9 mill
Increased income, profits, confidence

5. 2008
1981
1920

6. The 1920s: Aftermath of the Great Depression
What happened in the 1920s?
Increased auto ownership.
The country became increasingly electrified.
Increased income.
Stock market boom.

7. The 1920s: Aftermath of the Great Depression
What happened in the 1920s?
Increased auto ownership.
The country became increasingly electrified.
Increased income.
Stock market boom.
Lessons learned?
No! Consider …
Hoover and his belief in stopping  wages.
Fisher & Keynes promote price stability, not gold standard.

8. How the Gold Standard works
A gold standard implies that we have “fixed” exchange rates between currencies.
$20.67 = 1 oz.
1 oz. = £4.25
1 oz. = £4.25
$50 mill.
$4.86 = £1
£10.29 mill.
American firms export goods to England … tractors. Value = $50 m.
British firms export goods to U.S. … fish & chips. Value = £10.29 m.
At exchange rate of $4.86 = £1, the £ earned by U.S. firms will just trade for the $ earned by the British firms.
Suppose that British exports fall by 23% and that only £8 mill. of F&C is exported, selling for $38.88 mill. in the U.S..

9. How the Gold Standard works
$20.67 = 1 oz.
1 oz. = £4.25
1 oz. = £4.25
$50 mill.
$4.86 = £1
£8 mill.
Now, American exporters can’t exchange all of their £10.29 mill. for $.
They can only exchange £8 mill. at the going exchange rate, receiving $38,880,000. But, they aren’t going to lose here…
They would cash the rest out in gold: £2.29 mill. = 538,823 oz.
They would redeem in U.S. for dollars: 538,823 oz. = $11,120,000
Total value received = $50,000,000

10. How the Gold Standard works
$20.67 = 1 oz.
1 oz. = £4.25
1 oz. = £4.25
$50 mill.
$4.86 = £1
£8 mill.
538,823 ounces
The flow of gold from England to U.S. won’t persist over time.
M•V=P•Y
 gold =  MS
 MS =  P
deflation
 gold =  MS
 MS =  P
inflation
U.S. exports fall and British exports rise until trade flows balance.

11. Confounding the Gold Standard
In England, the outflow of gold will lead to price deflation and probably a recession (or a depression).
So, the Bank of England raises interest rates. This attracts foreign investment (capital inflows) which ends outflow of gold.
In the U.S., expanding the money supply means inflation and falling exports.
The Fed can buy this gold by selling Treasury securities, so not allowing the money supply to increase. But, this will also raise U.S. interest rates which works against British policy and encourages more gold inflows!

12. Stress on the Gold Standard
WWI - Combatant countries go off gold standard to spending.
Gold rushes into the U.S. as countries buy war material.
Post-WWI, gold stocks insufficient for existing price levels.
Worldwide deflation (i.e., depression) is required.
Victors can ease burden by acquiring gold stocks.
Burden on losers is unsustainable.
Eventually, U.S. lends gold to Germany.

13. Stress on the Gold Standard
The Gold Exchange Standard:
U.S. & U.K. hold gold
Other countries hold gold, $, £
U.K. recession restores gold value by 1925.
France devalues currency; gold inflows.
France redeems pounds; more gold inflows.
Fed lowers i; gold flows from U.S.; burden on U.K. lessened.
% of world’s gold; %; %
Gold inflows sterilized and MS in France was constant.

14. Stress on the Gold Standard
U.S. monetary policy is erratic:
lowers i (3.5%) and gold flows out.
raises i to stop gold outflows.
By Sept. 1929, i up to 6%; gold inflows 1929/1930.
After crash, i lowered; down to 1.5% in April 1931.
Gold outflows 1931; raised i to 3.5%.
March 1932 Fed begins OMO which stops deflation.
OMO stop in July 1932.
Devaluation concerns drive gold outflow Jan-Mar 1933.

15. Why did the depression last until 1932?
Herbert Hoover
Commerce Secretary in the 1920s.
Rallied business leaders in 1922.
Believed solution was to maintain wages & prices.
How a Depression becomes “Great”
Smoot-Hawley tariffs kick off trade war (1930).
Congress increases taxes to cover deficits (1932).
Hoover’s policy erodes business profits and raises unemployment.
Banks fail en masse in
Why didn’t it end?

16. The Great Depression … of 1921 & the Gold Standard
ECO 473 – Money & Banking
Dr. D. Foster

17. DJIA inflation-adjusted, 1915-1933
Macrotrends.net