Gold Standard the Federal Reserve's 'Cross Thesis

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Gold Standard

The Federal Reserve's 'Cross of Gold': The Great Depression and the existence of the gold standard

The causes of the Great Depression are still hotly debated amongst economists, even today. Usually cited causes include the over-speculation by investors in the stock market. This resulted in a series of small crashes, and one, catastrophic plunge on October 20, 1929 that is today known as The Great Crash (Kelly 2009). By the end of 1929, investors had lost more than $40 billion dollars, a great sum even by today's estimation, and almost inconceivably large by early 20th century standards. The Dust Bowl conditions in the Midwest that preceded the Depression further exacerbated the decline of living standards in the United States. Unemployment climbed to 25%, because of these double-barreled losses in both the financial and farming sectors of America. Bank failures caused Americans to lose their lifesavings, as their deposits were uninsured. Consumer goods began to pile up in factories. Inventories even before the crash were high, given that the nation's prosperity during the Roaring 20s was extremely lopsided -- poorer Americans did not have the money to buy the goods manufactured by greedy producers. These high inventories caused Congress to pass a misguided protectionist tariff known as the Smoot-Hawley Tariff of 1930, which worsened economic relations between the U.S. And Europe and intensified a growing trade war (Kelley 2009).Download full Download Microsoft Word File
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TOPIC: Thesis on Gold Standard the Federal Reserve's 'Cross of Assignment

However, beyond the usual suspects of causes of the Great Depression, there is also the question of the nation's monetary policy at this time. Current Federal Reserve Bank Chairman Ben Bernanke believes that monetary policy has a far greater role in creating the conditions that gave rise and exacerbated the Great Depression than is often assumed by economic historians. Far from a passive or merely exacerbating force, Bernanke believes that monetary policy was a core, constituent cause that lead to the nation going economically awry. At the time, America deployed the gold standard in managing its national money policy. The gold standard "was a commitment by participating countries to fix the prices of their domestic currencies in terms of a specified amount of gold. National money and other forms of money (bank deposits and notes) were freely converted into gold at the fixed price" (Bordo 2008).

The gold standard, which was formally ended in 1971, actually had a relatively brief lifespan in its classical incarnation in the United States. Until 1834, the United States was formally on a bimetallic (gold and silver) standard. In 1900 when Congress passed the Gold Standard Act, the gold standard became official. "The period from 1880 to 1914 is known as the classical gold standard" (Bordo 2008). "The gold standard broke down during World War I" as the major European powers were forced to run massive deficits to finance their wartime expenditures (Bordo 2008). After 1925, a modified gold standard, known as the Gold Exchange Standard was implemented from 1925 to 1931. "Under this standard, countries could hold gold or dollars or pounds as reserves, except for the United States and the United Kingdom, which held reserves only in gold" (Bordo 2008).

The Gold Exchange Standard, according to Bernanke, combined with mismanagement of monetary policy by the Federal Reserve Bank, became one of the reasons the U.S. failed to pull itself out of the economic downturn after the 1929 crash, and recession spiraled into depression. The Fed's first great error was its "the deliberate tightening of monetary policy that began in the spring of 1928 and continued until the stock market crash of October 1929" (Bernanke 2002). However, the tighter money practices occurred during what was obviously a trough in the business cycle, when more liberalized monetary policies are usually recommended, as infusing money into the economy stimulates borrowing, buying, and production. In fact, two full months before the October crash, production, wholesale prices, and personal income had fallen at annual rates of 20 per cent, 7-1/2 per cent, and 5 per cent, respectively" (Bernanke 2002). The discount rate, the rate at which banks are charged to borrow money from the central federal bank, "had been raised in New York to 5 per cent, the highest since 1921," and encouraged the nation's banks as a whole to engage in tighter lending practices (Bernanke 2002). But more than a pure upholding of the gold standard was a concern. The Fed was extremely worried about speculation on Wall Street. "The Federal Reserve had long made the distinction between 'productive' and 'speculative' uses of credit, and the rising stock market and the associated increases in bank loans to brokers were thus a major concern" hence the rise in the discount rate (Bernanke 2002). Concerned about the outflow of gold, "the system's holdings of government securities had been reduced to a level of over $600 million at the end of 1927 to $210 million by August 1928" (Bernanke 2002).

Then, "a wave of speculative attacks on the pound forced Great Britain to leave the gold standard," making the United States the only nation which 'purely' adhered to the Gold Exchange Standard. Anticipating that the United States might be the next to abandon the standard, a massive outflow of capital ensued: "Central banks and private investors converted a substantial quantity of dollar assets to gold in September and October of 1931" (Bernanke 2002). The external drain of gold reserves and internal drain of revenue as foreigners liquidated dollar deposits and domestic depositors withdrew cash in anticipation of additional bank failures, demanded a swift reaction by the Fed. However, "The Federal Reserve System reacted vigorously and promptly [only] to the external drain. . . . On October 9 [1931], the Reserve Bank of New York raised its rediscount rate to 2-1/2 per cent, and on October 16, to 3-1/2 per cent -- the sharpest rise within so brief a period in the whole history of the System, before or since" (Bernanke 2002). In short, the Fed responded with alacrity only to the reduction in gold reserves, not to the overall loss of cash that was sure to further cause the economy to engage in a downward spiral. While the Fed's action reduced the outflow of gold overall, it also precipitated a serious of even more bank failures and bank runs, "with 522 commercial banks closing their doors in October alone. The policy tightening and the ongoing collapse of the banking system caused the money supply to fall precipitously, and the declines in output and prices became even more virulent. Again, the logic is that a monetary policy change related to objectives other than the domestic economy -- in this case, defense of the dollar against external attack -- were followed by changes in domestic output and prices in the predicted direction" downward (Bernanke 2002). A contracting supply of dollars once again made for a disastrous prescription.

What is often forgotten is that in April 1932, "the Congress began to exert considerable pressure on the Fed to ease monetary policy, in particular, to conduct large-scale open-market purchases of securities. The Board was quite reluctant; but between April and June 1932, it did authorize substantial purchases. This infusion of liquidity appreciably slowed the decline in the stock of money and significantly brought down yields on government bonds, corporate bonds, and commercial paper… [t]he tapering off of the decline in the stock of money and the beginning of the purchase program were followed shortly by an equally notable change in the general economic indicator…Wholesale prices started rising in July, production in August. Personal income continued to fall but at a much reduced rate. Factory employment, railroad ton-miles, and numerous other indicators of physical activity tell a similar story" (Bernanke 2002).

Bernanke believes that had the Fed 'stayed the course,' even at this late date, the economic decline could have been reversed. However, financial orthodoxy… [END OF PREVIEW] . . . READ MORE

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