Robert Skidelsky has written a well-reviewed biography on Keynes. Here he comments on FDR’s gold-buying program:
The gold-buying policy raised the official gold price from $20.67 an ounce in October 1933 to $35.00 an ounce in January 1934, when the experiment was discontinued. By then, several hundred million dollars had been pumped into the banking system.
The results were disappointing, however. Buying foreign gold did succeed in driving down the dollar’s value in terms of gold. But domestic prices continued falling throughout the three months of the gold-buying spree.
The Fed’s more orthodox efforts at quantitative easing produced equally discouraging results. In John Kenneth Galbraith’s summary: “Either from a shortage of borrowers, an unwillingness to lend, or an overriding desire to be liquid – undoubtedly it was some of all three – the banks accumulated reserves in excess of requirements. Reserves of member banks at Fed were $256 million more than required in 1932; $528 million in 1933, $1.6 billion in 1934, $2.6 billion in 1936.”
What was wrong with the Fed’s policy was the so-called quantity theory of money on which it was based. This theory held that prices depend on the supply of money relative to the quantity of goods and services being sold. But money includes bank deposits, which depend on business confidence. As the saying went, “You can’t push on a string.”
Keynes wrote at the time: “Some people seem to infer…that output and income can be raised by increasing the quantity of money. But this is like trying to get fat by buying a larger belt. In the United States today, the belt is plenty big enough for the belly….It is [not] the quantity of money, [but] the volume of expenditure which is the operative factor.”
I’m afraid that his analysis is both misleading and inaccurate. The US gradually depreciated the dollar between April 1933 and February 1934. During that period unemployment was nearly 25% and T-bill yields were close to zero. Keynes argued that monetary stimulus would not be effective under those circumstances, and Skidelsky seems to accept his interpretation (which was published in the NYT during December 1933.)
[Note that Keynes certainly did believe in the “pushing on a string” theory–I frequently get commenters insisting that Keynes didn’t believe in liquidity traps.]
Unfortunately, Keynes and Skidelsky are wrong. The US Wholesale Price Index rose by more than 20% between March 1933 and March 1934. In the Keynesian model that’s not supposed to happen. The broader “Cost of Living” rose about 10%. Industrial production rose more than 45%.
And the gold-buying program was not an application of the quantity theory of money. George Warren was an opponent of the QT, insisting that the quantity of money was not what mattered, that the price level was determined by the price of gold. His views were much closer to Mundell than Friedman. Keynes’s views on these issues were inconsistent and borderline incoherent. Only a few weeks after Keynes argued that it was foolish to believe that currency depreciation could boost prices, FDR finally stopped depreciating the dollar. How did Keynes react? He congratulated FDR for rejecting the policy advice of the “extreme inflationists.” By early 1934 prices were rising again.
The “disappointing” results that Skidelsky mentions come from cherry-picking a few misleading data points. After the NIRA wage shock of late July, the real economy slumped and commodity prices started falling. The value of the dollar also leveled off for a few months. This led FDR to adopt the gold buying program in late October 1933. Despite the name, the actual “gold buying” was not large enough to be important–rather it was essentially a gold price raising program–a signal of future devaluation intentions. This was well understood by the markets, and commodity prices tended to rise on days when FDR raised the gold price. The broader WPI was relatively stable between September and December, and then started rising briskly again in early 1934.
It’s a mistake to focus on the tiny declines in the WPI during November and December 1933, which partly reflected sharply falling prices in Europe. The key point is that the WPI and industrial production rose strongly during the period of dollar depreciation.
Skidelsky is a big fan of Keynes, but needs to read his hero’s writings with a more critical eye. Other modern Keynesians like Krugman and Eggertsson have argued that FDR’s dollar devaluation program boosted the economy in 1933, and they are right. They would also be horrified to see a Keynesian criticizing QE2:
Now the US, relying on the same flawed theory, is doing it again. Not surprisingly, China accuses it of deliberately aiming to depreciate the dollar. But the resulting increase in US exports at the expense of Chinese, Japanese, and European producers is precisely the purpose.
The euro will become progressively overvalued, just as the gold bloc was in the 1930’s. Since the eurozone is committed to austerity, its only recourse is protectionism. Meanwhile, China’s policy of slowly letting the renminbi rise against the dollar might well go into reverse, provoking US protectionism.
The failure of the G-20’s Seoul meeting to make any progress towards agreement on exchange rates or future reserve arrangements opens the door to a re-run of the 1930’s. Let’s hope that wisdom prevails before the rise of another Hitler.
I can’t see how depreciating the dollar against the euro would cause China to depreciate its currency against the dollar—I would have thought exactly the reverse. What am I missing? (Or was that a typo on Skidelsky’s part?) And it wasn’t protectionism that led to the rise of Hitler, it was deflationary monetary policies in the US, France, and Germany.
PS. Keynes is not my hero, George Warren is. Anyone criticizing Warren in the blogosphere can expect a sharp rebuke from TheMoneyIllusion.
PPS. His statement about the official price of gold being raised after October is also misleading. The par value of gold rose all at once in early 1934. The gold-buying price was already well above $20.67 by October 1933. The focus should be on the market price of gold, which rose gradually over a period of about 10 months.
PPPS. There is one strong similarity to late 1933; the conservative outrage over the gold-buying program forced FDR to stop it long before he reached his objective of reflating the price level to pre-Depression levels. Now there are signs that conservative outrage over QE2 may be making it harder for Bernanke to achieve his inflation objectives, which are to return the inflation rate to pre-recession levels. Plus la change . . .