Gold Standard and the Great Depression - Essay Example

Gold Standard and the Great Depression Name; AL-MARRI, Salem Ali College; Keele University Course; ECO-10025 Tutor; Date; The economic depression of the 1930s phenomenon that was felt in all countries around the world. Countries as far as Japan, Germany as well as United States were some of the many countries that experienced some kind of economic depression. Kindleberger(1973) acknowledges the depression of 1930 and lays the basis for the cause of the world depression. The causes as well as the spread of depression from country to another has been attributed to gold standard and which exchange rates was pegged on and which remained fixed. Fixed exchange rates theory presumption that it helped send shockwaves across world economies has long remained fertile ground for economists. Sala-i-Martin &Sachs (1991) actually based their study on how depression shocks crossed boundaries on the presumption of fixed exchange rates. The United States usually fixed exchange rates against a common currency. Prior to 1930s, the fixed exchange rate between countries was the gold standard hence the whole genesis of the great depression is attributed to exchange rate of the gold during that period and how it influenced and transmitted the economic downturn of the world. The gold standard therefore formed the benchmark for all exchange taking place in the world market. The gold standard was actually defined by unrestricted exchange of gold between countries and individuals with no supervision from any world financial authority in terms of provision of rules and regulations to streamline the industry. Currencies held by respective countries were pegged against the quantity of gold in their possession. In essence, the value of the country’s currency was directly proportional to the amount of gold the country had. Transactions across boundaries was not always resulting in balance of payments. Some countries remained with deficits and others, which were well endowed with resources, remained with surpluses being the difference between the exports and imports. A country with surplus received gold imports while a country experiencing shortages had to export gold. The deficit persistence of some countries meant that risked running out of foreign reserves (gold) which actually meant that the concerned country’s currency could not be fixed against gold hence the value of her currencies could not be fixed against gold. Since this was an informal agreement among countries, the situation meant that countries in perpetual deficit was not able to access loans from foreign countries. The situation could get worse with the setting in of runaway inflation, which could snowball, into hyperinflation. On the other hand, a country with surpluses little risks. The surpluses translated into little interest for gold held as well as the potential for inflation if more currency is circulated since there was enough backing of surplus gold. Countries facing deficit improvised ways of reducing the gap by coming up with mechanism of that aimed at reducing inflation therefore resulting deflation. They did this without devaluing their currencies. The irony was that countries lowered the prices of goods and services without improving the quantity and value of exports to address the deficit. The countries in deficit therefore did not address the real issue of exchange rate of her currency compared with other countries currency. Hume(1952) give a brief outline of price specific conditions adopted by most countries. By adopting deflation over devaluation by countries running on deficits, they particularly choose the path to the great depression of 1930 which had was replicated in almost all economies with varied intensity. Robbins(1934) in his argument of flexible wage rate that could drastically lower unemployment along with other raft of measures led to deflation rather than devaluation. Churchill(1948) in actually acknowledged the first world being the major contributor to the great depression. The war actually redefined the trading areas as well as patterns while also destabilizing the already established networks of international cooperation that was in place before (Eichengreen, 1992). The downward spiral that turned out to be the infamous great depression became real towards the end of 1920s when Gemany and United States adopted tight policies. Hamilton (1987) shows that the US government for example initiated contractionary policy by selling her securities in the open market in 1928. Temin (1989) suggest that federal reserve policy change was reactionary measure aimed at reducing the outflow of U.S gold to France since the country had undervalued her currency. Hamilton(1987) further suggests that not only gold motivated the U.S federal reserve to adopt contractionary policy but the performance of the U.S stock market .The U.S federal reserve also had motive of curtailing the stock market boom by hiking interest rates. The measures adopted by U.S federal reserve was not strictly aimed at adhering to the gold standard but most countries followed suit and this resulted in the great depression. From the outset therefore the gold standard phenomenon in the world economy was a notion that initiated the great depression and strive to achieve external balance of payment was the ultimate goal and any boom in the local stock market like in the U.S case was a sign of danger. The ultimate effect of gold standard was in its real sense was wholesale psychology not in existence in real situations. The economies depressed initially due to contractionary policies which aimed at remedying situations that did not really exist, resulted in them reducing imports hence throwing other countries into the mix. The antidote for depressing economies was to abandon the gold standard as suggested by Eicheengreen & Sachs (1985).Abandoning the relationship between gold and the countries currency means that a countries balance of payment does not relate to prices of goods and services. Economies could expand production or lower interest rates without affecting the value of her currency. Deliberate change in inflation rate by different countries rather than interfering with prices of goods and services is a sure way of avoiding deflation. It is imperative to not that unilateral devaluation could put countries under some kind of pressure but universal devaluation certainly devolves gains to the all economies. The U.S economy though endowed with vast resources in terms of resources could not pull alone but was forced to abandon the gold standard. A classic example of country that avoided depression by never adopting the gold standard was Spain. Studies shows that countries that stuck longer on the gold standard suffered depression longer. Temin (1989) actually summarized that the gold standard brought the whole world economy on her heels. The great depression continued through 1931 and 1932 and its effects were felt across several countries. Substantial difference in depression were recorded in several countries. United States suffered the most during the depression. The world economy is more than ever very interconnected unlike the 1920s.Any poor or myopic policy decision has an immediate effect in the world economy. The great depression of 1930s could have been avoided if countries could have adopted joint efforts rather than trying protectionism policies, which were counterproductive in the long run. Fixed exchange rates and gold standard policy commitment has been associated with transmission of depression of gold standard. European currency crisis of 1992 served to explain the reason why countries has turned to flexibility rather sticking around the old notion of gold standard shortage that resulted in the great depression. A currency that can withstand economic shock remains elusive to countries. Countries should discard rigidity and instead adopt policies that are progressive rather than sticking in ideas that are no longer working. It is imperative to note that some countries remain stuck in the old notion while some have opted for new path aimed at dealing with economic downturn. This involves developing macro-economic shocks. To this, far countries have not come to ways of avoiding financial crisis. Since the last depression of 1930 countries have been experiencing varied bouts of recession which have a potential threat of assuming full scale financial crisis like the1930 economic depression. The explanation for this sporadic financial crisis is no longer the issue of the gold standard as several countries have abandoned the same. Countries should endeavor to come up with macro-economic policies that aim at stabilizing currencies while instilling confidence among the public. The confidence can then be reflected in the economic sentiments in the market. References 1. Eichengreen, Barry, Elusive Stability essays in the History of International finance, 1919-1939. Cambridge': Cambridge University Press. 1990. 2. Hamilton, James D., Monetary Factors in the Great Depression," Journal of Monetary Economics, March 1987, 9, 145-69. 3. Kindleberger, Charles P., The World in Depression,1929-39, First Fdition. 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