GOLD BUGGERY:

Our Depression Obsession: a review of Liaquat Ahamed's Lords of Finance (Robert J. Samuelson, April 20, 2009, Washington Post)

[A]hamed excels in evoking the political and personal forces that led to disaster. His title refers to four men deeply implicated in the era's perverse policies: Montagu Norman, governor of the Bank of England; Benjamin Strong, head of the New York Federal Reserve Bank; Émile Moreau, head of the Banque de France; and Hjalmar Schacht, head of Germany's Reichsbank. Their determination to reinstate the gold standard -- seen as necessary for global prosperity -- brought ruin.

Under the gold standard, paper money was backed by gold reserves. If gold flowed into a country (normally from a trade surplus or a foreign loan), its money and credit supply were supposed to expand. If gold flowed out, money and credit were supposed to contract. During World War I, Europe's governments suspended the gold standard. They financed the war with paper money and loans from America. The appeal of restoring the gold standard was that it would instill confidence by making paper money trustworthy.

Unfortunately, the war damaged the system beyond repair. Britain, the key country, was left with only 7.5 percent of the world's gold reserves in 1925. Together, the United States and France held more than half the world's gold. The war had expanded U.S. reserves, and when France returned to gold, it did so with an undervalued exchange rate that boosted exports and gold reserves. Meanwhile, German reparations to Britain and France were massive, while those countries owed huge amounts to the United States. The global financial system was so debt-laden that it "cracked at the first pressure," writes Ahamed.

That came after a rise in American interest rates in 1928 forced other countries to follow (no one wanted to lose gold by having investors shift funds elsewhere) and ultimately led to the 1929 stock market crash. [...]

[S]triking differences separate now from then. The biggest is that governments -- unencumbered by the gold standard -- have eased credit, propped up financial institutions and increased spending to arrest an economic free fall.

The Fed biffed badly by hiking interest rates into the teeth of global deflation--again--because it was confused by the dysfunctional oil markets. But they've corrected the mistake, even if a tad late.

Posted by Orrin Judd at April 26, 2009 6:57 AM