The Anatomy of Crisis
87
buy and sell gold freely at the official price, but they committed
themselves to keep the exchange rate fixed at the level determined
by the two official prices of gold by buying
and selling dollars on
demand at that exchange rate. Under such a system, if United
States residents, or others who had dollars, spent (or lent or gave)
abroad more dollars than the recipients of those dollars wanted
to spend (or lend or give) in the United States, the recipients
would demand gold for the difference. Gold would go from the
United States to foreign countries.
If the balance was in the
opposite direction, so that holders of foreign currencies wanted
to spend (or lend or give) more dollars in the United States than
holders of dollars wanted to convert into foreign currencies to
spend (or lend or give) abroad, they would get the extra dollars
by buying them from their central banks at the official exchange
rates. The central banks, in turn, would get the extra dollars by
sending gold to the United States. (In
practice, of course, most
of these transfers did not involve the literal shipping of gold
across the oceans. Much of the gold owned by foreign central
banks was stored in the vaults of the New York Federal Reserve
Bank, "earmarked" for the country that owned it. The transfer
was made by changing the labels on the containers holding the
gold bars in the deep basements under the bank building at 33
Liberty Street in the Wall Street area.)
If the depression had originated abroad while the U.S. economy
continued, for a time, to boom, the
deteriorating economic con-
ditions abroad would have reduced U.S. exports and, by lowering
the cost of foreign goods, encouraged U.S. imports. The result
would have been an attempt to spend (or lend or give) more
dollars abroad than recipients wanted to use in the United States
and an outflow of gold from the United States. The outflow of
gold would have reduced the Federal Reserve System's gold
reserves. And that would, in turn, have induced the System to
reduce the quantity of money. That
is how a system of fixed ex-
change rates transmits deflationary (or inflationary) pressure
from one country to another. If this had been the course of events,
the Federal Reserve could correctly have claimed that its actions
were
a
response to pressures coming from abroad.
Conversely, if the depression originated in the United States,
88
FREE TO CHOOSE: A Personal Statement
an early effect would be a decline in the number of U.S. dollars
that their holders wanted to use abroad and an increase in the
number of dollars that others wanted to use in the United States.
That would have produced an inflow of gold into the United
States. That, in turn, would bring pressure
on foreign countries
to reduce their quantity of money and would be the way the U.S.
deflation would be transmitted to them.
The facts are clear. The U.S. gold stock
rose from August 1929
to August 1931, the first two years of the contraction—clinching
evidence that the United States was in the van of the movement.
Had the Federal Reserve System followed the rules of the gold
standard, it should have reacted to the inflow of gold by in-
creasing the quantity of money. Instead, it actually let the quan-
tity of money decline.
Once the depression was under way and had been transmitted
to other countries, there was, of course,
a reflex influence on the
United States—another example of the feedback that is so ubiqui-
tous in any complex economy. The country in the vanguard of
an international movement need not stay there. France had ac-
cumulated a large stock of gold as a result of returning to the
gold standard in 1928 at an exchange rate that undervalued
the franc. It therefore had much leeway and could have resisted
the deflationary pressure coming from the United States. Instead,
France followed even more deflationary policies than the United
States and not only began to add to its large gold stock but also,
after late 1931, to drain gold from the United States. Its dubious
reward
for such leadership was that, although the U.S. economy
hit bottom when it suspended gold payments in March 1933, the
French economy did not hit bottom until April 1935.
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