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Gustav Cassel foresaw the Great Depression

I might be a complete monetary nerd, but I truly happy when I receive a new working paper in the mail from Douglas Irwin on Gustav Cassel. That happened tonight. I have been waiting for the final version of the paper for a couple weeks. Doug was so nice to send me a “preview” a couple a weeks ago. However, now the paper has been published on Dartmouth College’s website.

Lets just say it at once – it is a great paper about the views and influences of the great Swedish economist and monetary expert Gustav Cassel.

Here is the abstract:

“The intellectual response to the Great Depression is often portrayed as a battle between the ideas of Friedrich Hayek and John Maynard Keynes. Yet both the Austrian and the Keynesian interpretations of the Depression were incomplete. Austrians could explain how a country might get into a depression (bust following an investment boom) but not how to get out of one (liquidation). Keynesians could explain how a country might get out of a depression (government spending on public works) but not how it got into one (animal spirits). By contrast, the monetary approach of economists such as Gustav Cassel has been ignored. As early as 1920, Cassel warned that mismanagement of the gold standard could lead to a severe depression. Cassel not only explained how this could occur, but his explanation anticipates the way that scholars today describe how the Great Depression actually occurred. Unlike Keynes or Hayek, Cassel explained both how a country could get into a depression (deflation due to tight monetary policies) and how it could get out of one (monetary expansion).”

Douglas Irwin has written a great paper on Cassel and for those who do not already know Cassel’s important contributions not only to the monetary discussions in 1920s and 1930s, but to monetary theory should read Doug’s paper.

Cassel fully understood the monetary origins of the Great Depression contrary to the other main players in the discussion of the day – Hayek and Keynes. From the perspective of today it is striking how we are repeating all the discussions from the 1930s. To me there is no doubt Gustav Cassel would have been as outspoken a critique of both Keynesians and Austrians as he was in 1930s and I am pretty sure that he would have been a proud Market Monetarist. In fact – had it not been for the fantastic name of our school (ok, I got a ego problem…) then I might be tempted to say that we are really all New Casselian economists.

Cassel clearly explained how gold hoarding by especially the French and the US central banks was the key cause for the tightening of global monetary conditions that pushed the global economy into depression – exactly in the same way as “passive” monetary tightening due to a sharp rise in money demand generated deflationary pressures that push the global economy and particularly the US and the European economies into the Great Recession. I my mind Cassel would have been completely clear in his analysis of the causes of the Great Recession had he been alive today.

In fact even though I think Market Monetarists tell a convincing and correct story of the causes for the Great Recession and I also sure that Gustav Cassel would have helped Market Monetarists in seeing the international dimensions of the crisis – particular European demand for dollars – better.

Douglas Irwin has written an excellent paper and it should be read by anyone who is interested monetary theory and monetary history.

Thank you Doug – you did it again!

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See a couple of previous comments on Doug’s work and on Cassel:

Hawtrey, Cassel and Glasner

“Our Monetary ills Laid to Puritanism”

“Calvinist economics – the sin of our times”

“Gustav Cassel on recessions”

“France caused the Great Depression – who caused the Great Recession?”

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“Our Monetary ills Laid to Puritanism”

Douglas Irwin has been so nice to send me an article from the New York Times from November 1 1931. It is a rather interesting article about the Swedish monetary guru Gustav Cassel’s view of monetary policy and especially how he saw puritanism among monetary policy makers as the great ill. I had not read the article when I wrote my comment on Calvinist economics, but I guess my thinking is rather Casselian.

The New York Times article is based on an article from the Swedish conservative Daily Svenska Dagbladet (the newspaper still exists).

Professor Cassel claims that overly tight US monetary policy in the early 1930s is due to two “main ills”: “deflation mania” and “liquidation fever”.

NYT quote Cassel: “The deeper psychological explanation of this whole movement..can without doubt be found in American Puritanism. This force assembled all its significant resources in what was considered a great moral attack on the diabolism of speculation. Each warning against deflation has stranded on fear on the part of Puritanism that a more liberal monetary policy might infuse new vigor in the spirit speculation.”

It isn’t it scary how much this reminds you about how today’s policy makers are scared of bubbles and inflation? I wonder what Gustav Cassel would tell the ECB to do today?

Maybe here would just say: “That the deflation has meant the ruin of one business after another and forced many banks to suspend payments is a matter that little concerns the stern Puritan”…”on the contrary, it is highly approves proper punishment of speculation and thorough cleaning out of questionable business projects. It totals disregards the fact that deflation in itself by degrees adversely affects the finances of any enterprise and forces even sound business to ruin”. 

Wouldn’t it be a blessing if Cassel was around today to advise central bankers? And that they actually would listen…but of course if you are a puritan or what I termed a believer on Calvinist economics then you don’t have to listen because all you want it just doom and pain to punish all the evil speculators.

 

 

 

Calvinist economics – the sin of our times

A couple a days ago I had a discussion with a colleague of mine about the situation in Greece. My view is that it is pretty clear to everybody in the market that Greece is insolvent and therefore sooner or later we would have to see Greece default in some way or another and that it therefore is insane to continue to demand even more austerity measures from the Greek government, while at the same time asking the already insolvent Greek government to take on even more debt. My colleague on the other hand insisted that the Greeks “should pay back what they owe” and said “we can’t let countries default on their debt then everybody will do it”. It was a moral and not an economic argument he was making.

I am certainly not a Keynesian and I do not think that fiscal tightening necessarily is a bad thing for Greece, but I do, however, object strongly to what I would call Calvinist economic thinking, which increasingly is taking hold of our profession.

At the core of Calvinist economics is that Greece and other countries have committed a sin and therefore now have to repent and pay for these sins. It is obvious that the Greek government failed to tighten fiscal policy in time and even lied about the numbers, but its highly problematic that economic thinking should be based on some kind of quasi-religious morals. If a country is insolvent then that means that it will never be able to pay back its debt. It is therefore in the interest for both the country and its creditors that a deal on debt restructuring is reached. That’s textbook economics. There is no “right” or “wrong” about it – it is simple math. If you can’t be pay back your debts then you can’t pay. It’s pretty simple.

In another area very Calvinist economic thinking is widespread is in the conduct of monetary policy. Around the world central bankers resist easing monetary policy despite clear disinflationary or even deflationary tendencies and the main reason for this is not economic analysis of the economic situation, but rather the view that a loosening of monetary policy would be immoral. The Calvinists are screaming out “We will have another bubble if you ease monetary policy! Don’t let the speculators of the hook!”

The problem is that the Calvinists are confusing an easing of monetary policy or the default of insolvent nations with moral hazard.

If a central bank for example has a inflation target of 2% and inflation is running at below 1% and the central bank then decides to loosen monetary policy – then that might well be positive for “speculators” – such as property owners, banks or equity investors. The Calvinists see this as evil. As immoral, but the fact is that that is exactly what a central bank that is undershooting its inflation target should. Monetary policy is not about making judgements of what is “fair” or not, but rather about securing a nominal anchor in which investors, labour, companies and consumers can conduct there business in the market place.

The Calvinists are saying “It will be Japan”, “the global economy will not grow for a decade” and blah, blah…it nearly seems as if they want this to happen. We have sinned and now we need to repent. The interesting thing is that these Calvinists where not Calvinists back in 2005-6 and when some of us warned about excesses in the global economy they where all cheerleaders of the boom. They are like born-again Christian ex-alcoholics.

And finally just to get it completely clear. I am not in favour of bailing out anybody, or against fiscal austerity and I despise inflation. But my economics is back on economic reasoning and not on quasi-religious dogma.

PS anybody that studies history will note that Calvinist economics dominated economic thinking in countries which held on to the gold standard for too long. This is what Peter Temin has called the “Gold Standard mentality”. The in countries like France and Austria the gold standard mentality were widespread in the 1930s. We today know the consequences of that – Austria had major banking crisis in 1931, the country defaulted in 1938 and the same it ceased to existed as an independent nation. Good luck with your Calvinist economics. It spells ruins for nations around the world.

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UPDATE: Douglas Irwin has kindly reminded me that my post remind him of Gustav Cassel. Cassel used the term “puritans” about what I call Calvinist economics. Maybe Market Monetarists are New Casselians?

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