International Political Economy #10

The Pre-WWII Monetary System

W. K. Wineco | IPE #10: The Pre-WWII Monetary System

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William Kindred Wineco
Indiana University at Bloomington

October 3, 2013

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The Exam

Not great: mean and median of about 21/30 = 70%.

W. K. Wineco | IPE #10: The Pre-WWII Monetary System

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The Gold Standard

Local currencies (e.g. British , U.S. $) were valued in gold weight.

Pros: price stability across countries reduced uncertainty and facilitated trade. Cons: governments had no exibility to adjust to economic booms and bust via monetary policy. (More next week.)

W. K. Wineco | IPE #10: The Pre-WWII Monetary System

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The Gold Standard

The idea is to guarantee political and economic stability at the same time:

Restrain governments (many of which werent constitutional democracies). Restrain speculators (esp bankers). Facilitate trade by reducing information gaps.
All of these could be achieved, it was thought, with a gold standard. It worked for awhile.

W. K. Wineco | IPE #10: The Pre-WWII Monetary System

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The Problem

A good government doesnt need a gold standard; a bad government wont maintain it. Political change put pressure on the gold standard.

Once one country defects it is good for others to defect.

If investors think a government will devalue, it will try to take gold out of the country.

W. K. Wineco | IPE #10: The Pre-WWII Monetary System

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The Monetary Dilemma

Country 1

Stay on Gold Defect

W. K. Wineco | IPE #10: The Pre-WWII Monetary System

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Country 2 Stay on Gold Defect 2 0 3 1 2 3 0 1
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The Reason

Capitalist economies periodically overheat, then slow down.

Economic networks sometimes need to become rearranged. This is a very messy process.

If government is authoritarian, it can ride it out by suppressing its citizens. If government is democratic, voters will demand help.

W. K. Wineco | IPE #10: The Pre-WWII Monetary System

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The Output Formula

GDP = C + I + G + (X M ).

GDP is Gross Domestic Product, the sum of a countrys

yearly output. C is private Consumption. I is Investment. G is Government consumption. X is eXports; M is iMports.

Thus, the trade balance is linked to output.

W. K. Wineco | IPE #10: The Pre-WWII Monetary System

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Thinking About Recessions

GDP = C + I + G + (X M ).

A recession means GDP drops.

If GDP goes down, what else must happen?

W. K. Wineco | IPE #10: The Pre-WWII Monetary System

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9/17

Thinking About Recessions

GDP = C + I + G + (X M ).

A recession means GDP drops.

At least one of:

If GDP goes down, what else must happen?

C could go down, via lower wages. I could go down, if folks are scared of the future. G could go down, if the government keeps a balanced budget. (X M ) could go down.

W. K. Wineco | IPE #10: The Pre-WWII Monetary System

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The Problem

Recessions imply a need for adjustment. Some way to bring the economy back into balance. Specically, some kind of devaluation.

Internal: drop in domestic prices, including wages.

External: drop in the domestic price level.

Can boost employment by boosting X .

W. K. Wineco | IPE #10: The Pre-WWII Monetary System

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If wages are sticky (and they are) this could end up as unemployment.
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Beggar Thy Neighbor

The problem is that devaluation is zero-sum: one country gains in competitiveness, the other loses. During a global recession this can just make things worse. On a gold standard it is supposed to be out of bounds.

William Jennings Bryan (1896): you shall not crucify mankind on a cross of gold. Barry Eichengreen: Golden Fetters.

Faced with a recession, the gold standard is unsustainable in a democratic political system.

W. K. Wineco | IPE #10: The Pre-WWII Monetary System

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The Depression: Devaluations

W. K. Wineco | IPE #10: The Pre-WWII Monetary System

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The Great Crash

There was no governance structure for exchange rates. There was no way to achieve cooperation.

Kindleberger: The international economic system [was] rendered unstable by British inability and U.S. unwillingness to assume responsibility for stabilizing it.
The political question is: who adjusts? Politicians have incentives to try to force adjustment onto others.

W. K. Wineco | IPE #10: The Pre-WWII Monetary System

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The Monetary Dilemma

Country 1

Stay on Gold Defect

W. K. Wineco | IPE #10: The Pre-WWII Monetary System

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Country 2 Stay on Gold Defect 2 0 3 1 2 3 0 1
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Gold and Industrial Production

W. K. Wineco | IPE #10: The Pre-WWII Monetary System

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Gold and GDP

W. K. Wineco | IPE #10: The Pre-WWII Monetary System

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The Need for a Process

National governments were constrained by the gold standard.

They needed policymaking exibility to appease domestic citizens. Abandoning the gold standard helped...

... but then how are we to a stable trade and monetary system?

W. K. Wineco | IPE #10: The Pre-WWII Monetary System

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