Bloomberg TV interview with Michael Darda

Here is a nice little interview with Michael Darda. Michael is 100% market monetarist and I find it hard to disagree with anything he is saying.

Denmark and Norway were the PIIGS of the Scandinavian Currency Union

As the euro crisis continues speculation of an eventual break-up of the euro also continues. There are numerous examples in monetary history of currency unions breaking up. One is the breakup of the Scandinavian Currency Union in 1924.

I have found an interesting paper on this important event in Scandinavian monetary history. In his 2004-paper “The Decline and Fall of the Scandinavian Currency Union 1914 – 1924: Events in the Aftermath of World War I” Krim Talia discusses the reason for the collapse of the Scandinavian Currency Union.

Here is the abstract:

In 1873, Denmark, Norway and Sweden formed the Scandinavian Currency Union (SCU) and adopted the gold standard. The Union worked fairly smoothly during the next thirty years and was partly extended until 1914. The outbreak of World War I triggered a series of events that eventually would lead to the formal cancellation of the union in 1924. The suspension of convertibility and the export prohibition on gold in 1914, opened exchange rate tensions within the union, and acted as a first nail in the SCU’s coffin. Although the countries de facto had their currencies valued at different rates externally, the treaty of 1873 made them tradable at par within the union. This conflict, between de facto situation and de jure regulation, opened arbitrage opportunities for the public; but also resulted in opportunistic behaviour in the relation between the Scandinavian Central Banks. This study of the break-up of the SCU finds that the gold standard functioned as a unifying straitjacket on monetary policy and was an important prerequisite for a monetary union without a common central bank. It also challenges earlier work on the break-up of the SCU, by suggesting that the most important factor behind the centrifugal tensions within the Currency Union was the improved Swedish balance of trade following the outbreak of Word War I. The fact that wartime trade performance differed between the three countries made the currency area face an asymmetric external shock that required an exchange-rate adjustment – causing the fall of the union.

What is the implication for the euro zone? Well, I am not sure, but it might be interesting to have a closer look at the internal trade imbalance in the Scandinavian currency union and compare that to the imbalances that we have seen build in the euro zone during the boom-year prior to 2008. Both Denmark and Norway saw booms (and bubbles) during the first World War years and the early 1920s. In that sense Denmark and Norway looked like today’s PIIGS, while Sweden with it’s increasing trade surplus was the Germany of the Scandinavian currency union. In my previous post I described how insane monetary tightening in Norway and Denmark after 1924 lead to depression, while Sweden avoided depression.

Danish and Norwegian monetary policy failure in 1920s – lessons for today

History is fully of examples of massive monetary policy failure and today’s policy makers can learn a lot from studying these events and no one is better to learn from than Swedish monetary guru Gustav Cassel. In the 1920s Cassel tried – unfortunately without luck – to advise Danish and Norwegian policy makers from making a massive monetary policy mistake.

After the First World War policy makers across Europe wanted to return to the gold standard and in many countries it became official policy to return to the pre-war gold parity despite massive inflation during the war. This was also the case in Denmark and Norway where policy makers decided to return the Norwegian and the Danish krone to the pre-war parity.

The decision to bring back the currencies to the pre-war gold-parity brought massive economic and social hardship to Denmark and Norway in the 1920s and probably also killed of the traditionally strong support for laissez faire capitalism in the two countries. Paradoxically one can say that government failure opened the door for a massive expansion of the role of government in both countries’ economies. No one understood the political dangers of monetary policy failure better than Gustav Cassel.

Here you see the impact of the Price Level (Index 1924=100) of the deflation policies in Denmark and Norway. Sweden did not go back to pre-war gold-parity.

While most of the world was enjoying relatively high growth in the second half of the 1920s the Danish and the Norwegian authorities brought hardship to their nations through a deliberate policy of deflation. As a result both nations saw a sharp rise in unemployment and a steep decline in economic activity. So when anybody tells you about how a country can go through “internal devaluation” please remind them of the Denmark and Norway in the 1920s. The polices were hardly successful, but despite the clear negative consequences policy makers and many economists in the Denmark and Norway insisted that it was the right policy to return to the pre-war gold-parity.

Here is what happened to unemployment (%).

Nobody listened to Cassel. As a result both the Danish and the Norwegian economies went into depression in the second half of the 1920s and unemployment skyrocketed. At the same time Finland and Sweden – which did not return to the pre-war gold-partiy – enjoyed strong post-war growth and low unemployment.

Gustav Cassel strongly warned against this policy as he today would have warned against the calls for “internal devaluation” in the euro zone. In 1924 Cassel at a speech in the Student Union in Copenhagen strongly advocated a devaluation of the Danish krone. The Danish central bank was not exactly pleased with Cassel’s message. However, the Danish central bank really had little to fear. Cassel’s message was overshadowed by the popular demand for what was called “Our old, honest krone”.

To force the policy of revaluation and return to the old gold-parity the Danish central bank tightened monetary policy dramatically and the bank’s discount rate was hiked to 7% (this is more or less today’s level for Spanish bond yields). From 1924 to 1924 to 1927 both the Norwegian and the Danish krone were basically doubled in value against gold by deliberate actions of the two Scandinavian nation’s central bank.

The gold-insanity was as widespread in Norway as in Denmark and also here Cassel was a lone voice of sanity. In a speech in Christiania (today’s Oslo) Cassel in November 1923 warned against the foolish idea of returning the Norwegian krone to the pre-war parity. The speech deeply upset Norwegian central bank governor Nicolai Rygg who was present at Cassel’s speech.

After Cassel’s speech Rygg rose and told the audience that the Norwegian krone had been brought back to parity a 100 years before and that it could and should be done again. He said: “We must and we will go back and we will not give up”. Next day the Norwegian Prime Minister Abraham Berge in an public interview gave his full support to Rygg’s statement. It was clear the Norwegian central bank and the Norwegian government were determined to return to the pre-war gold-parity.

This is the impact on the real GDP level of the gold-insanity in Denmark and Norway. Sweden did not suffer from gold-insanity and grew nicely in the 1920s.

The lack of reason among Danish and Norwegian central bankers in the 1920s is a reminder what happens once the “project” – whether the euro or the gold standard – becomes more important than economic reason and it shows that countries will suffer dire economic, social and political consequences when they are forced through “internal devaluation”. In both Denmark and Norway the deflation of the 1920s strengthened the Socialists parties and both the Norwegian and the Danish economies as a consequence moved away from the otherwise successful  laissez faire model. That should be a reminder to any free market oriented commentators, policy makers and economists that a deliberate attempt of forcing countries through internal devaluation is likely to bring more socialism and less free markets. Gustav Cassel knew that – as do the Market Monetarists today.

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My account of these events is based on Richard Lester’s paper “Gold-Parity Depression in Denmark and Norway, 1925-1928” (Journal of Political Economy, August 1937)

Update: Here is an example that not all German policy makers have studied economic and monetary history.

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