Depression Remedy – what we can learn from old newspaper articles

I strongly believe that we can learn a lot about the present crisis from studying economic and monetary history. Particularly the study of the Great Depression should be of interest to anybody who is interested in the causes of the present crisis and how to get us out of the crisis.

Scott Sumner would hence tell you that he has read most of what was printed in the financial section of the New York Times in early 1930s. I think Scott is right when he is telling us that we should read old newspaper articles. My favourite source for Great Depression newspaper articles is the National Library of Australia’s newspaper database Trove.

The Trove newspaper database makes it possible to follow the discussion about economic and financial matters for example during the 1930s.  It is amazing how many interesting articles one will find there. The latest piece I have found is a very good article about Irving Fisher’s Compensated dollar plan. Below I have reproduced parts of the article. You can read it all on Trove. The article appeared in The Mercury on May 18 1933. I have added my own comments.

Depression Remedy: Professor Irving Fisher’s Plan for a Compensated Currency

In “Booms and Depressions” Professor Irving Fisher of Yale University (U.S.A.). has… set out to discover the causes of depressions and their cures. He is best known internationally as the originator of a plan whose object is to keep prices stable by varying as may be required the gold content of legal tender money. In his preface he indicates that the main conclusion of his book is that depressions are for the most part preventable, and that their prevention requires a definite policy, in which the central banking system of each country must play an important role. Such knowledge as he has obtained on the subject, he declares, he has only recently acquired.

That over-production is the cause of depressions he will not have. There is no over-production, nor is there anything wrong with the mechanical means of the distribution of production, nor with the roads, the bridges, or the transport systems by land or sea. But he asks as to the other distributive mechanism – the money mechanism – is there any more reason why the money mechanism should be proof against getting out of order than a railroad or a ship canal. Profits are measured in money, and if money should become deranged, is it not at least probable that the derangement would affect all profits in one way at one time? This is what he sets out to prove.

LC: Hence, you here see that Fisher’s view is that recessions are caused by a monetary disequilibrium. This of course is exactly what Market Monetarists argue today. The problem is not some inherent instability of the market system,  but rather instability created by monetary policy failure.

Disaster of over-indebtedness

Debts are a necessary part of the establishment of business. For business to be carried out in volume as we know it today debts must be incurred. Debts may lead to over-indebtedness, which he defines as that degree of in-debtedness which multiplies unduly the chances of becoming insolvent. Pressure caused by over-indebtedness leads to distress selling, which prevents the operations of the law of supply and demand, and when a whole community is involved in distress selling the effect is to lower the general price level. It does this because the stampede liquidation involved there by actually shrinks the volume of currency, that is, deposit currency.

Three of the main factors causing depressions are in this manner shortly stated-debts, currency volume, price level. The al- teration of tho price level causes an alteration of the real measures of money-dollar in tho United States, pound in Great Britain and Australia. When the price level falls in the manner stated it reacts on the debt situation, which first caused the alteration.

“When a whole community is in a state of over-indebtedness” Professor Fisher states, “the dollar reacts in such a way that the very act of liquidation may sometimes enlarge the real debts, instead of reducing them. Nominally every liquidation must reduce debts, but really by swelling the worth of every dollar in the country it may swell the unpaid balance of every debt in the country, because the dollar which has to be paid may increase in size faster than the number of dollars in the debt decreases, and when this process starts It must go on, much after the fashion of a vicious spiral . . . downward into the trough of depression.”

So he concludes that when the expanding dollar (that is when the value of the dollar increases) grows faster than the reduction of the number of dollars of debt, liquidation docs not really liquidate, so that the depression goes right on, until there are sufficient bankruptcies to wipe out the activating cause the debts.

LC: Fisher’s comments about indebtedness seem highly relevant today. What Fisher is arguing is that deleveraging is a necessary evil if we have become over-indebted, but if the price level is allowed to contract at during the deleveraging process (the “liquidation”) then the desirable process of “liquidation” will become depressionary. This of course is the argument that Market Monetarists make today when we argue that the euro crisis is not a debt crisis, but a monetary crisis. Yes, it is necessary to reduce debt levels in parts of the euro zone but this process is unlikely to end well if monetary policy remains too tight.

Similarly Fischer’s discussion shows that the debate between one the one hand Keynesian fiscalists and the ‘Austerians’ on the other hand is a phony debate. The Austerians are of course right when they argue that if you have become overly indebted you have to reduce debts, but the Keynesians are equally right that the collapse in aggregate demand is the main cause of the present crisis. Where both sides are wrong is their common focus on fiscal policy. Irving Fisher would have told them to focus on monetary policy instead. Yes, we should reduce debt levels (if we are overly indebted), but the central bank needs to ensure nominal stability so this process does not become deflationary.

Correcting the Price Level

But Why, he asks, suffer from this dollar disease, this variation in the value of the dollar? Should gold coin become copious in the nick of time the gold inflation might counteract the credit deflation. The same result might come from paper inflation for instance, by way of financing a war. That inflation would be a matter ot exercising control of the currency. It should be equally clear, Professor Irving Fisher considers, that deflation or dollar bulging is not an “act of God.” We need not wait for a happy accident to neutralise deflation; we may frustrate, it by design. Man has, or should have, control of his own currency. If we must suffer from the debt disease, why also catch the dollar disease?

LC: Deflation is not a necessary outcome of the “bust”. Deflation is a result of overly tight monetary policy. Irving Fischer knew this very well. Friedman learned that from studying Fisher and Market Monetarists know that today.

The remedy, Professor Fisher declares is first a correction of the price-level by reflation and then henceforward its safe-guarding. He admits that the problem of “what price-level?” is difficult, because the matter what year may be chosen as the year whose level should be restored, it will do injustice. He proposes, therefore, as between the years from 1929 to 1932 to put the price-level part of the way back, so that the injustice would be shared by a great part of two groups, the debtors and the creditors.

…Reflation is the duty of Central Banks, he considers, through expanding thc currency and credit, and when sufficient reflation has been obtained to serve the purpose sought, the currency and credit should be so managed that the general price index after it has been raised to the height required should be maintained at that height.

LC: While Fisher focused on the price level Market Monetarists today focus on the level of nominal GDP,  but the policy message is basically the same – a monetary contraction caused the crisis so monetary policy needs to be eased to “undo” the damage done by monetary tightening. The question then is how much? What level of prices/NGDP should be targeted? This was a challenge to Fisher and that is a challenge to Market Monetarists today.

The Other Means

If, in spite of all other efforts to regulate the price level, the purchasing power of gold over goods should fall, the weight of the gold dollar or sovereign should be increased; or if the purchasing power of gold should rise, the weight of the dollar or sovereign would be correspondingly reduced. Under this plan the actual coinage of gold would be abandoned, and instead of gold I coins, gold bars would be used to redeem the gold certificates. Only gold certificates would circulate, and the price of the bars in terms of these certificates I would be varied from time to time. One advantage of the compensated gold coin plan would be that any nation could operate it alone. The inconvenience of each alteration in the gold coin’s weight causing a corresponding alteration in the foreign exchange would be, he considers, a small matter.

LC: Hence, Irving Fisher was suggesting to revalue or devalue the dollar against the price of gold to ensure a stable price level. Hence, if the price level dropped below the targeted level then the dollar would be devalued against gold, while if prices rose above the targeted level then the dollar would be revalued. The Market Monetarist proposal that central banks should use an NGDP future to conduct monetary policy is very much in the spirit of Fisher’s compensated dollar plan. Both are rule based policies that ensures nominal stability and at the same time strongly limits the central bank’s discretionary powers.

We can learn a lot from history so I encourage everybody interested in monetary history to have a look at the Trove database and similar newspaper archives and please let me know if you find something interesting that can teach us more about how to get out of the present crisis.

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  1. PS Thanks for the Trove link. Am already exploring!

  2. Hi Lars!

    Benny Carlsson has now published the longer version of his paper on the Swedish press debate in the 1930s (unfortunately only in Swedish):

    Click to access kwc-pp-2013-1.pdf

    A public debate dominated by Cassel, Heckscher, and Ohlin. It is very different than today, and not in a good way.

    Here is Heckscher, the monetarist, in 1931:
    “I samma nummer av DN tog en herre som inte var känd för sitt skämtlynne, Eli Heckscher, upp frågan om importpriser och prisnivå. Han ville göra upp med ett domine- rande resonemang i debatten, nämligen detta: Om man lämnar guldmyntfoten och de ut- ländska växelkurserna stiger får importörerna betala mer för sina varor i svenska kronor räknat och då stiger de inhemska priserna på importvaror och på andra varor i vilka im- porten ingår. Därmed är pappersmyntfot liktydig med inflation. Heckscher kontrade med följande resonemang: Importvarornas priser kommer förvisso att stiga. Men om den monetära köpkraften hålls oförändrad kommer priserna på importvaror att stiga relativt övriga priser och det leder till att importen minskas. Importvarorna kommer att spela mindre roll än tidigare och det behövs bara en obetydlig sänkning av priserna på inom landet tillverkade varor för att prisnivån som helhet ska bli oförändrad. Föreställningen om en allmän prisstegring skulle antagligen få skenbart stöd i statistiken, genom en ökning av partiprisindex och livsmedelsindex, som båda dominerades av importvarornas priser, men den stegringen behövde inte betyda inflation eftersom den kompenserades av en nedgång i mängden importerade varor. Förutsättningen om oförändrad monetär köp- kraft var pudelns kärna:

    ‘Alltsammans beror av den penningpolitik som föres, den kreditvolym som ställes till förfogande, den penningmängd som cirkulerar. Under förutsättning av tillräck- ligt restriktiv penningpolitik kan en stegring i de inhemska priserna, som helhet betraktade, så gott som alltid hindras och alldeles särskilt när det, som i förelig- gande fall, icke är fråga om någon varuknapphet.’

    Att Heckscher tilldelar penningmängden en avgörande betydelse har sitt intresse mot bakgrund av att en hittillsvarande uppfattning varit att nationalekonomerna på 1930-talet såg diskontot som penningpolitikens självklara verktyg och inte tilldelade ”monetära aggregat” någon större betydelse”


  3. Petar Sisko

     /  April 28, 2013

    Wow, amazing post, and as Marcus said, thnx for the Trove info!
    I find Fisher’s argument about distressed selling very interesting since that is, how I see it, one of the reasons ECB totally missed out on nominal stability. A variation of distressed selling caused problems in bank funding which was reflected on the interbank market. As ECB often names its minimum bid rate – the “stance” of monetary policy, they were so focused on the money market and the banks, while they missed the true reason of the fire sales, which was lack of nominal stability in broader economy and falling incomes. Now they have prolonged the recession, no nominal stability and the banking system is so damaged by the falling NGDP that ECB is basically saving banks. Since NGDP fell and debt ratios exploded – monetary crisis today is called the debt crisis. yields are diverging which further distorts interest rate channel which they tried to save. That prompted them to fire at selected markets which is allocative and not neutral. Whole thing ended up totally counterproductive and causing a lot of suffering….

    I guess one lesson we can learn from history is that people never learn from history.


  4. James in London

     /  April 28, 2013

    Where are the Spanish Market Monetarists? Where even is the populist anti-EU movement. At least Italy has the Five Star movement to be anti-EU and it is a broad liberal grouping, so it’s not so bad. Is there anyone amongst Beppe Grillo’s advisors interested in Market Monetarism? Hello, hello? Please, come here!

  5. jamesxinxlondon

     /  April 29, 2013

    Ok. I see Ilusion Monetaria on the blog roll. Will forward the link to my Spanish friends. Is there an Italian one?


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