The Gold Standard and the Depression

I have been teaching on this topic this week. One of the accepted views on the Depression is that countries that depreciated earlier recovered faster from the crisis. The classic paper by Eichengreen and Sachs sort of established the result.* The notion is the traditional one. Depreciation leads to lower prices in foreign currency, increased competitiveness and higher exports. Graph below shows the correlation between depreciation (since the exchange rate is measured as the foreign price of domestic currency, lower rate means depreciation).

The indexes show the difference between the exchange rate and export volumes in 1929 (100) and 1935. So in 1935 France had not left the Gold Standard and the exchange rate remained at 100, while the exports were close to 50% of their 1929 level. There seems to be a clear negative relation between the exchange rate depreciation and export performance. However, note that in the United Kingdom a depreciation of about 40% implied exports at around 75% or so of the 1929 level. Only Norway and Finland seem to have higher exports in 1935 than in 1929. This was not an external demand led recovery.

This suggests that if depreciation had a role it was more likely related to the space that breaking with the Gold Standard rules provided for domestic authorities to pursue expansionary policies at home. Note that in this context, the depreciation, as much as higher tariffs and other trade related policies, are less relevant for their role in stimulating external demand, than by their role in protecting domestic production.

In the US the group of economists that were in favor of the depreciation of the dollar (see the letter by Harvard economists J. Raymond Walsh, Lauchlin Currie, John B. Crane, John M. Cassels, Robert Keen Lamb and Alan R. Sweezy in support of FDR's depreciation policy in 1934; and yes that includes Currie, later advisor to Eccles, and Paul's brother Alan, a Keynesian, not a Marxist), were also in favor of domestic fiscal expansion, which was at the end of the day Keynes point too. You can see Keynes arguing why the abandonment of the Gold Standard would be a good thing here, at the beginning of John Kenneth Galbraith's documentary.

This is still an important point, since there are significant lessons, at least it seems to me, for the European periphery story, in particular Greece. Depreciation alone cannot do the job. But a combination of import substituting policies, to reduce external constraint problems, with expansionary demand policies might work.

* There are also issues related to the role of the Gold Standard in causing the Depression, since the crisis was international, and many authors think that this suggests that it must have international causes. Hence, the Monetarist contraction story, or the Keynesian consumption collapse story (including the more radical version in which income distribution plays a role) would be incomplete. In this view, the relatively high rate of interest, related to the not credible inter-war Gold Standard, would be the cause of the depression. This view, as I noted before, seems closer to Keynes' Treatise on Money than his GT.

Sachs is wrong on Krugman and the recovery

Washed out, has-been pop icon and Bono

Jeffrey Sachs, Columbia professor and the foremost advocate for development aid to save development countries, attacks again. Back in the 1980s he was a neoliberal advisor to the governments of Bolivia (on stabilization), and Poland (on transition to a market economy, favoring the so-called 'shock therapy') among others. He was also the director of the Harvard Institute for International Development (HIID), which was basically a consultancy oriented institution, at the time of the Harvard-Russia Aid Scandal.*

Now in a recent op-ed he criticizes Krugman (and essentially anybody that believes that the current recovery in the US is not that good) on his predictions about the recovery. The argument is basically that, in spite all fears of lack of fiscal expansion, the economy has done pretty well. In his words:

For several years, and often several times a month, the Nobel laureate economist and New York Times columnist and blogger Paul Krugman has delivered one main message to his loyal readers: deficit-cutting “austerians” (as he calls advocates of fiscal austerity) are deluded. Fiscal retrenchment amid weak private demand would lead to chronically high unemployment... Yet, rather than a new recession, or an ongoing depression, the US unemployment rate has fallen from 8.6% in November 2011 to 5.8% in November 2014. Real economic growth in 2011 stood at 1.6%, and the IMF expects it to be 2.2% for 2014 as a whole. GDP in the third quarter of 2014 grew at a vigorous 5% annual rate, suggesting that aggregate growth for all of 2015 will be above 3%. So much for Krugman’s predictions.

This is not very different than the message the White House has been pushing on, he only forgot to say that the Dow Jones has hit new records. And yes GDP is recovering (and the fiscal package of 2009 was important, as well as fiscal transfers to states, which reduce the contractionary stance of local and state governments), but when you look the figure below (real GDP growth) it is clear that this recovery does not compare well with the Clinton or even Bush-II boom, which were not particularly good recoveries historically.

And that's not all. Not only the recovery is slow, but also the benefits are not evenly distributed, with employment recovering little (the unemployment rate is not the best measure in this case), as can be seen below with the employment to population ratio.

Not surprisingly real wages have not recovered much. So labor markets are weaker than what the numbers presented by Sachs suggest. Finally, note that the recovery has been so weak that many mainstream Keynesians, like Larry Summers, now are talking about secular stagnation. The ghost of Alvin Hansen is haunting mainstream economics.

* USAID gave the HIID a huge grant to advise the Russian government on privatization. The head of the team, Andrei Shleifer (and his hedge-fund wife), attempted to steal from better-qualified competitors Russia’s license to sell mutual funds, and was later sued and found guilty by the courts of conspiring to defraud the US government. Shleifer had to pay back millions and was stripped of his Whipple V.N. Jones Professor of Economic chair due to ethics violations, but it has been argued that he managed to preserve his position at the university due to cronyism, i.e. basically his close relation to Larry Summers, who was by then Harvard's President. David Warsh has told the details of the story.

Reasonable liberals and conservatives, unreasonable economics

The ambiguously liberal/conservative duo, Joe Scarborough and Jeff Sachs, self-denominated reasonable (what Krugman refers to as 'serious' people), suggest that we need austerity in their WAPO op-ed. Forget for a second the inconsistencies of Scarborough, the conservative in the duo. What I find incredible is that Sachs continues to push the fiction that he is a liberal in the American sense of the word, meaning progressive or lefty, rather than a right wing neoliberal.

Let's not forget that Jeff Sachs is Dr. Shock Therapy,* a doctrine that suggested that budget deficits should be cut to control inflation, and that deregulated markets would promote growth and development, and that he applied in Bolivia, Poland and Russia, among other countries. The collapse and failure in these countries foreshadowed the failures of the so-called Washington Consensus. Forget also the institutional problems Sachs had regarding his advice in Russia [note that he did not have the same legal problems that led his collegue "Andrei Shleifer, whose misbehavior cost Harvard something like $25 million in damages, plus another $10 million or $15 million in legal fees," according to David Warsh].

The really incredible thing is that they try to argue, on the basis, of their reasonable principles, that we need austerity. They put Dick Cheney's and the right wing supply-siders that sometimes say that deficits do not matter, in their view because the supply side effects of higher productivity (entrepreneurship) brought by lower taxes would produce growth and higher revenue, together with Krugman and other Keynesians that suggest with full support of the evidence that spending does have positive effects on the level of activity. Note that in the second case Keynesians, and even further Functional Finance people (following Abba Lerner) would not suggest that deficits do not matter. What they suggest is that the way you spend and tax matters. So deficits could be bad or good, depending on what causes them. Higher deficits caused by tax cuts for the wealthy and to support wars of choice abroad, are not the same that deficits to reconstruct infrastructure and promote full employment.

But the incredible thing is that they (Scarborough and Sachs) try to claim that Keynes would have been against fiscal expansion now. Yes, Keynes was indeed for some fiscal restraint, but that was during the war, when deficits were above 20%, and not in the middle of the recovery.

For more on Sachs long and strange career read the following article by Doug Henwood at the Left Business Observer.

* He actually gave the Tanner Lecture at the University of Utah on Poland's shock therapy. I was not there in 1994, I should add. By the way, at that time he actually still thought that shock therapy was a success story. Oh well.