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Book reviews


Barry Eichengreen, Golden Fetters: The Gold Standard and the Great
Depression (Oxford University Press, New York, 1992) pp. xix + 448, $39.95.
This important book in the NBER series on Long-Term Factors in
Economic Development follows in the tradition of W.A. Lewis, Economic
Survey (1939) and W.A. Brown, The International Gold Standard ReInterpreted, 1914-1934 (1940). The book synthesizes many of the author's
earlier articles on the pre-1914 classical gold standard and the interwar
period and skillfully, with minimal jargon, uses recent theoretical approaches
in macroeconomics, political economy and international finance to give a
novel interpretation to the global Great Depression of the 1930s. The book
will be of great interest to economic historians, international economists,
policy-makers and the educated public at large.
The basic thesis of the book is that the interwar gold standard was a pale
shadow of its pre World War I self and unlike the original did not stabilize
the international monetary system. Instead, Eichengreen views the interwar
gold standard both as an important cause of the worldwide collapse of
output and prices and, following a long tradition going back to Fisher
(Bulletin of the International Statistical Institute, 1935), Friedman and
Schwartz (A Monetary History of the United States, 1963) and Temin
(Lessons from the Great Depression, 1989), an obstacle to recovery. His view
is in contrast to an earlier one [Kindleberger (The World in Depression,
1973)] that attributes the world depression to financial chaos brought about
by the gold standard's collapse.
In a nutshell, the prewar classical gold standard provided price level, real
output and exchange rate stability to the world but, according to the author,
not because it was well managed by the Bank of England, but because of its
multipolar nature. The credible commitment of the core countries - Britain,
France and Germany - led market agents to believe that the monetary
authorities would take whatever actions were required to preserve gold
convertibility. This commitment - made possible by central bank independence from fiscal authorities, by limited political influence of those groups
who would gain from inconvertibility and depreciation, and by the lack of
understanding by policy-makers of the connection between adherence to
convertibility and internal stability - encouraged stabilizing private capital
flows which in turn facilitated the maintenance of convertibility.
The credible commitment was buttressed by international cooperation. In
normal times the Bank of England setting its bank rate acted as leader and
the other European central banks followed its lead. In periods of crisis - in
the Baring crisis of 1890 and in 1907 - because of its limited gold reserves,
the Bank of England was helped by loans from the Banque de France and
other central banks. Cooperation was possible because of the absence of
serious differences between the core countries, because they shared a


Book reviews

common conceptual framework and strong domestic opposition to it was
absent. The peripheral countries, when included the United States - because
of their less sophisticated financial systems, their dependence on primary
commodity exports, and the power of domestic interest groups - lacked a
credible commitment. However, in normal periods, fearing loss of access to
London's deep capital markets, even they adhered to the gold standard rule.
This rosy picture died with World War I. The exigencies of war finance
ended convertibility. The attempt to restore the gold standard was difficult in
the face of a new world order which attached great importance to internal
stability and to redistribution of income to newly enfranchised groups.
Countries with low inflation were able to restore their prewar parities with
less difficulty; those with high inflation rates, such as France and Germany,
had to resolve a fiscal war of attrition between the left and the right over
who would bear the burden of restoring fiscal orthodoxy. In a brilliant
analysis of the stabilization by these and other high inflation countries, the
author argues that returning to gold, but at an undervalued parity, was a
key part of the armistice in the war of attrition.
The restored gold standard lacked the credible commitment of the prewar
system because it became apparent to market agents that monetary authorities could no longer be counted upon to subsume internal stability to
external goals. Hence according to Eichengreen, international cooperation
was essential for the system to work. Systematic cooperation, however, was
not possible in a world divided over the issues of reparations and war debts,
although on at least two occasions, 1924 and 1927, concerted international
efforts were taken by the United States, Britain and France to aid sterling.
This system began to unravel in 1928 when the Federal Reserve raised
interest rates to stem the Wall Street stock market boom. Tight U.S.
monetary policy drastically reduced foreign lending which in turn put serious
pressure on the balance of payments of debtor countries - many already hurt
by a decline in their terms of trade. To maintain debt service these countries
followed tight monetary policies. The consequent decline in economic activity
in 1929, by reducing U.S. exports, reinforced its downturn.
The gold standard (a fixed exchange rate system) was crucial in the onset
of the downturn because it transmitted shocks between countries and
because monetary authorities were unwilling to follow expansionary policies
fearing that the consequent gold outflows would threaten convertibility. The
gold standard was also crucial in converting a serious recession into the
Great Depression because of its connection with banking instability.
Monetary authorities, according to Eichengreen, were unable to act as
leaders of last resort to banking systems weakened by deflation because
expansionary policies would be viewed by foreign depositors as a threat to
convertibility. They in turn would withdraw their deposits and stage a
speculative attack on the currency. The 'Golden Fetters' of the gold standard

Book reviews


prevented expansionary policy. Even the United States, holding the lion's
share of world gold reserves, was subject to 'Golden Fetters'. According to
Eichengreen, the Fed did not act as lender of last resort during the second
banking crisis of 1931 because it felt constrained by a shortage of 'free gold'.
The downward spiral could have been halted by an internationally
coordinated reflation policy, but attempts to do so were stymied by limited
understanding of the causes of the depression and conflicting domestic
interests. Thus the only solution was to break the golden fetters and devalue.
Here Eichengreen, following Fisher and Choudhri and Kochin (JMCB,
1980), documents the link between devaluation and subsequent recovery, but
goes further and argues that successful recovery also required expansionary
monetary policy, a step countries were at first unwilling to take because of a
fear of igniting inflation. Those countries remaining on gold continued to
suffer. In an excellent discussion of the Gold Bloc, the author argues that
fear of a return to the chaos of the 1920s inflation and war of attrition tied
France, Belgium and the other members of the Bloc to gold for close to five
years after Britain left gold in 1931.
In conclusion, the author argues that the lesson to be learned from the
interwar experience is the need for international cooperation. The more
successful experiences of the pre World War I gold standard and the post
World War II Bretton Woods System he attributes in large part to fewer
impediments to cooperative actions.
The book tells a fascinating story which gives the impression of being a
complete explanation for the world depression. Yet a close reading reveals
some chinks in the foundation.
First is the treatment of the classical gold standard. That the core
countries were committed to gold convertibility is certain, but the rule they
followed was the contingent rule of adherence that pertained, except in welldefined emergencies such as major wars and financial crises. In the latter
contingency, a temporary departure from gold would not be regarded as a
breach of the rule sufficient to precipitate capital flight. The presence of this
safety valve suggests that the success of the classical gold standard may not
have depended on international cooperation.
Second, the importance of cooperation in the interwar period is overplayed. Given that the gold exchange standard had all the fatal flaws of
Bretton Woods, coupled with gold maldistribution and perverse sterilization
policies by France and the United States, how likely is it that this flawed
system would have been preserved by international cooperation. It is far
more likely that it lasted the few years that it did because of a favorable set
of circumstances.
Third, according to 'Golden Fetters' the threat of capital flight prevented
the monetary authorities in virtually every country from acting as lender of
last resort to the banking system. For Thornton and Bagehot, the prescrip-


Book reviews

tion for a central bank when facing both an internal and external drain was
to lend freely but at a penalty rate. The circumstances in which lender of last
resort action was to be taken was a scramble for high powered money. The
action to stem panic takes place in a very short period of time - a matter of
hours or days. In such circumstances the monetary authority should provide
liquidity to the money market by whatever means necessary. In other words
it must temporarily expand the money supply. Under a gold standard,
market agents would understand that this was a temporary event, not the
same thing at all as, for example, a permanent increase in monetary growth
to finance a budget deficit - a circumstance that would prejudice maintenance of convertiblity. To lump the speculative attack on the Austrian
schilling, which was in response to a bailout of the Credit Anstalt financed
by a permanent increase in money growth [Schubert, The Credit Anstalt
Crisis of 1931 (1992)], with the failure of the Federal Reserve to increase high
powered money in the second half of 1931 that could have averted the
second banking crisis, is simply unjustifiable.
Most importantly, the argument in Chapter 10 that the Federal Reserve
would not have been able to expand the money supply in the 1931 episode
because it would have violated the free gold constraint, and forced the
United States off the gold standard, is incorrect. First, the author argues that
since M1 fell by two billion dollars between August 1931 and January 1932,
a two billion dollar open market operation would have been required to
offset the decline and would have forced the United States off the gold
standard with only $400 million in free gold. This argument ignores the
arithmetic of money supply relationships. The ratio of M1 to high powered
money fell between August 1931 and January 1932 from 3.2 to 2.8 - the
average money multiplier over the period was approximately 3. Thus an
open market operation to increase the monetary base by $600-650 million
was all that would have been needed if no other forces were at work.
According to Friedman and Schwartz, other forces were present so that a
one billion dollar purchase would have been needed. But would the one
billion dollar purchase have exhausted free gold? It would have if the open
market purchase, as Eichengreen assumes, had been absorbed by a dollarfor-dollar increase in currency, which has to be backed 40 percent by gold
and 60 percent eligible paper. But if the purchase had increased bank
reserves by one billion, which would have had the effect of calming
depositors' fears about bank safety, then free gold would not have been
Second, given that the United States had the largest monetary gold stock
in the world and that at its lowest point in 1932 the Fed's gold reserve ratio
was 56 percent, there was no reason before March 1933 why the threat of the
United States being forced off the gold standard should have been a binding
constraint. Were free gold a real problem, the Federal Reserve could have

Book reviews


asked the Congress to alter the eligibility requirement before it enacted such
legislation in February 1932. According to Friedman and Schwartz, free gold
was largely an ex post justification for (Fed) policies followed, not on ex
ante reason for them' (p. 406).
Finally, Eichengreen's claim that international cooperation could have
averted the Great Depression seems quite heroic given the record of
cooperation in the preceding decade.
In sum, Golden Fetters is an important contribution to the literatures on
the gold standard and the Great Depression. It presents a coherent,
overarching view of the interwar period. However, in the attempt to present
a complete story it leaves unsettled some important issues that need to be
resolved by future research.
Michael D. Bordo
Rutgers University
Stephen V. Marks and Keith E. Maskus, eds., The Economics and Politics of
World Sugar Policies (University of Michigan Press, Ann Arbor, 1993) pp.
176 + viii.
Aficionados of U.S. international trade policies regard American policies
toward sugar as one of the worst, if not the worst, abominations of U.S.
protectionism. There are altogether no more than 10,000 sugar farmers. The
U.S. price of sugar is more than double the world price; the average payment
per sugar farm by virtue of U.S. sugar policy is in excess of $100,000. Under
high domestic sugar prices, sugar cane production has expanded in Florida,
contributing to the despoilation of the Everglades, Louisiana and Texas,
while contracting in traditional growing areas such as Hawaii and Puerto
Rico, despite high domestic prices.
Although the United States administers country-specific quotas permitting
specified amounts of exports from trading partners at U.S. domestic prices,
the induced substitution of high fructose corn syrup (HFCS) for sugar has
reduced sugar's share of total caloric sweetner consumption (from over 80
percent to less than 50 percent) so much that American imports in total have
declined from over 5 million tons annually to around 1 million tons,
representing a drop in world imports of about 20 percent. There are now
very few countries whose higher price received on their strictly limited sugar
exports under quote to the United States compensates for the lower world
price (resulting from the downward shift in demand from the United States,
among other factors) received for the rest of their crop.
In other countries as well sugar is a politicized commodity. The EC
subsidizes sugar exports under a complicated scheme, although unlike the
United States it has limited domestic production (and banned the substitution of HFCS).