“The Bacon Standard” (the PIG PEG) would have saved Denmark from the Great Depression

Even though I am a Danish economist I am certainly no expert on the Danish economy and I have certainly not spend much time blogging about the Danish economy and I have no plans to change that in the future. However, for some reason I today came to think about what would have been the impact on the Danish economy if the Danish krone had been pegged to the price of bacon rather than to gold at the onset of the Great Depression in 1929. Lets call it the Bacon Standard – or a the PIG PEG (thanks to Mikael Bonde Nielsen for that suggestion).

Today less than 10% of Danish export revenues comes from bacon export – back during in the 1920s it was much more sizable and agricultural products dominated export revenues and Denmark’s main trading partner was Great Britain. Since bacon prices and other agricultural product were highly correlated (and still are) the bacon price probably would have been a very good proxy for Danish export prices. Hence, a the PIG PEG would basically have been similar to Jeff Frankel’s Peg the Export Price (PEP) proposal (see my earlier posts on this idea here and here).

When the global crisis hit in 1929 it put significant downward pressure on global agricultural prices and in two years most agricultural prices had been halved. As a consequence of the massive drop in agricultural prices – including bacon prices – the crisis put a serious negative pressures on the Danish krone peg against gold. Denmark had relatively successfully reintroduced the gold standard in 1927, but when the crisis hit things changed dramatically.

Initially the Danish central bank (Danmarks Nationalbank) defended the gold standard and as a result the Danish economy was hit by a sharp monetary contraction. As I argued in my post on Russian monetary policy a negative shock to export prices is not a supply shock, but rather a negative demand shock under a fixed exchange rate regime – like the gold standard. Said in another way the Danish AD curve shifted sharply to the left.

The shock had serious consequences. Hence, Danish economic activity collapsed as most places in the world, unemployment spiked dramatically and strong deflationary pressures hit the economy.

Things got even worse when the British government in 1931 decided to give up the gold standard and eventually the Danish government decided to follow the lead from the British government and also give up the gold standard. However, unlike Sweden the Danish authorities felt very uncomfortable to go it’s own ways (like today…) and it was announced that the krone would be re-pegged against sterling. That strongly limited the expansionary impact of the decision to give up the gold standard. Therefore, it is certainly no coincidence that Swedish economy performed much better than the Danish economy during the 1930s.

The Danish economy, however, started to recovery in 1933. Two events spurred the recovery. First, FDR’s decision to give the gold standard helped the US economy to begin pulling out of the recovery and that helped global commodity prices which certainly helped Danish agricultural exports. Second, the so-called  Kanslergade Agreementa political agreement named after the home address of then Prime Minister Thorvald Stauning in the street Kanslergade in Copenhagen – lead to a devaluation of the Danish krone. Both events effectively were monetary easing.

What would the Bacon standard have done for the Danish economy?

While monetary easing eventually started to pull Denmark out of the Great Depression it didn’t happen before four year into the crisis and the recovery never became as impressive as the development in Sweden. Had Denmark instead had a Bacon Standard then things would likely have played out in a significantly more positive way. Hence, had the Danish krone been pegged to the price of bacon then it would have been “automatically” devalued already in 1929 and the gradual devaluation would have continued until 1933 after, which rising commodity prices (and bacon prices) gradually would have lead to a tightening of monetary conditions.

In my view had Denmark had the PIG PEG in 1929 the crisis would been much more short-lived and the economy would fast have recovered from the crisis. Unfortunately that was not the case and four years was wasted defending an insanely tight monetary policy.

Monetary disequilibrium leads to interventionism   

The Danish authorities’ decision to maintain the gold standard and then to re-peg to sterling had significant economic and social consequences. As a consequence the public support for interventionist policies grew dramatically and effectively lay the foundation for what came to be known as the danish “Welfare State”. Hence, the Kanslergade Agreement not only lead to a devaluation of the krone, but also to a significant expansion of the role of government in the Danish economy. In that sense the Kanslergade Agreement has parallels to FDR’s policies during the Great Depression – monetary easing, but also more interventionist policies.

Hence, the Danish experience is an example of Milton Friedman’s argument that monetary disequilibrium caused by a fixed exchange rate policy is likely to increase interventionist tendencies.

Bon appetite – or as we say in Danish velbekomme…

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15 Comments

  1. Ha – great point about the deflationary policies back then laying the foundation for the welfare state. But as you note Sweden was (and still is) much smarter in terms of monetary policy, and yet they too seems to have developed a relatively big welfare state, no?

    It is nice that you throw in a post on the Danish economy once in a while. For a young and naive guy like me it is still mindboggling to see how clueless Danish pundits and political elites are about basic macroeconomics – and monetary policy in particular. And I can’t help thinking about what the right thing would be for Denmark. A free-floating XR with discretionary NGDP level targeting? Obviously not a perfect solution and it would require us to employ people who actually know something about monetary theory (I’m looking at you Bernstein!). The export price peg is another very interesting suggestion although i wonder how big the difference would be in practice compared to the current euro-peg given the structure of our exports.

    Anyway – always a pleasure to read your posts Lars!

    Reply
    • Thank you Jakob. I do agree that Denmark and Sweden developed much the same Welfare State (from around 1965). My point was just that a number of interventionist policies were introduced in early 1930 with the only purpose of defending the monetary regime of the day.

      Reply
    • I can’t see any strong argument for why Denmark could not manage a floating currency. I actually checked yesterday, and M2 is still falling. Not to mention NGDP is nearly dead in the water, as is employment. EU treaties are such a joke now, what is stoping Denmark from devaluing? Even if the CB didn’t want to answer for policy thereafter, a 15% devaluation, and then peg to the SEK would be a huge improvement.

      Reply
  2. Lars
    An enjoyable and fun to read post. On the serious side and taking the hint from Scott´s latest post, these “economic managers” should be liable for making life hell for most folks!

    Reply
    • Thanks Marcus, I do not really blame the Danish authorities for not introducing the Bacon Standard, but in general I do agree that there is a tendency that decision makers who make decisions on monetary policy are not held accountable for them. As I have stressed before – there is a risk that “independent” becomes “unaccountable”.

      Reply
  3. david stinson

     /  April 23, 2012

    Hi Lars.

    Interesting series of posts.

    As I understand from your previous posts, your argument is that, under a fixed exchange rate, changes in export prices are demand shocks because they affect the money supply. But changes in import prices would also affect the money supply under a fixed regime. An increase in import prices would cause the money supply to fall as the central bank engages in domestic currency purchases to support the exchange rate. In that case, a fixed exchange rate would add a negative demand shock to a negative supply shock. Is that the basis for targeting only export prices?

    In the case of Switzerland’s recent peg, I have been interpreting that as the central bank basically accommodating the increased external demand to hold the franc for safe haven investment purposes. I wonder if one might characterize the franc as the “export” against which the central bank is pegging, except in their case an increase in the value of the “export” would represent a negative demand shock absent pegging?

    Reply
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