Irving Fisher and George Warren

I am currently a bit over half way through an excellent book entitled “American Default“, by Sebastian Edwards. The primary focus of the book is the abrogation of the gold clause in debt contracts, which (I believe) is the only time the US federal government actually defaulted on its debt. But the book also provides a fascinating narrative of FDR’s decision to devalue the dollar in 1933-34.  I highly recommend this book, which I also discuss in a new Econlog post. Later I’ll do a post on the famous 1935 Court case on the gold clause.

Edwards has an interesting discussion of the difference between Irving Fisher and George Warren.  While both favored a monetary regime where gold prices would be adjusted to stabilize the price level, they envisioned somewhat different mechanisms.  Warren focused on the gold market, similar to my approach in my Great Depression book.  Changes in the supply and demand for gold would influence its value.  Raising the dollar price of gold was equivalent to raising the nominal value of the gold stock.  Money played little or no role in Warren’s thinking.

Fisher took a more conventional “quantity theoretic” approach, where changes in the gold price would influence the money supply, and ultimately the price level.  Edwards seems more sympathetic to Fisher’s approach, which he calls a “general equilibrium perspective”.  Fisher emphasized that devaluation would only be effective if the Federal Reserve cooperated by boosting the money supply.

I agree that Warren’s views were a bit too simplistic, and that Fisher was the far more sophisticated economist.  Nonetheless, I do think that Warren is underrated by most economists.

To some extent, the dispute reflects the differences between the closed economy perspective championed by Friedman and Schwartz (1963), and the open economy perspective advocated by people like Deirdre McCloskey and Richard Zecher in the 1980s.  Is the domestic price level determined by the domestic money supply?  Or by the way the global supply and demand for gold shape the global price level, which then influences domestic prices via PPP?  In my view, Fisher is somewhere in between these two figures, whereas Warren is close to McCloskey/Zecher.  I’m somewhere between Fisher and Warren, but a bit closer to Warren (and McCloskey/Zecher).

There’s a fundamental tension in Fisher’s monetary theory, which combines the quantity of money approach with the price of money approach.  Why does Fisher favor adjusting the price of gold to stabilize the price level (a highly controversial move), as opposed to simply adjusting the money supply (a less controversial move)?  Presumably because he understands that under a gold standard it might not be possible to stabilize the price level merely through changes in the domestic quantity of money.  If prices are determined globally (via PPP), then an expansionary monetary policy will lead to an outflow of gold, and might fail to boost the price level.  Thus Fisher’s preference for a “Compensated Dollar Plan” rather than money supply targeting is a tacit admission that Warren’s approach is in some sense more fundamental than Friedman and Schwartz’s approach.

Warren’s approach also links up with certain trends in modern monetary theory, particularly the role of expectations.  During the 1933-34 period of currency depreciation, both wholesale prices and industrial production soared much higher, despite almost no change in the monetary base.  Even the increase in M1 and M2 was quite modest; nothing that would be expected to lead to the dramatic surge in nominal spending.  That’s consistent with Warren’s gold mechanism being more important that Fisher’s quantity of money mechanism.  In fairness, the money supply did rise with a lag, but that’s also consistent with the Warren approach, which sees gold policy as the key policy lever and the money supply as being largely endogenous.  You might argue that the policy of dollar devaluation eventually forced the Fed to expand the money supply, via the mechanism of PPP.

A modern defender of Warren (like me) would point to models by people like Krugman and Woodford, where it’s the expected future path of policy that determines the current level of aggregate demand.  Dollar devaluation was a powerful way of impacting the expected future path of the money supply, even if the current money supply was held constant.

This isn’t to say that Warren’s approach cannot be criticized. The US was such a big country that changes in the money supply had global implications.  When viewed from a gold market perspective, you could think of monetary injections (OMPs) as reducing the demand for gold (lowering the gold/currency ratio), which would reduce the value of gold, i.e. raise the price level.  A big country doing this can raise the global price level.  So Warren was too dismissive of the role of money.  Nonetheless, Warren’s approach may well have been more fruitful than a domestically focused quantity theory of money approach.

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PS.  Because currency and gold were dual “media of account”, it’s not clear to me that the gold approach is less of a general equilibrium approach, at least under a gold standard.  When the price of gold is not fixed, then you could argue that currency is the only true medium of account, and hence is more fundamental.  During 1933-34, policy was all about shaping expectations of where gold would again be pegged in 1934 (it ended up being devalued from $20.67/oz. to $35/oz.)

PPS.  There is a related post (with bonus coverage of Trump!) over at Econlog.



8 Responses to “Irving Fisher and George Warren”

  1. Gravatar of El roam El roam
    7. June 2018 at 12:14

    Interesting post , but one should not forget , that gold as an asset , is actually perceived as a sort of ” apocalyptic safe haven ” during financial and economic crisis . This is notwithstanding the denomination by dollars or otherwise , but per se so . Like let’s say , real estate asset in the center of city , providing so more secure and solid investment during crisis . In the subprime crisis for example , the gold has reached the price of 1823 USD ( in 2011 ) typically thanks to the crisis . As the crisis has faded out , in accordance the price lowered more and more of course ( today 1297 ) .


  2. Gravatar of El roam El roam
    7. June 2018 at 12:47

    Just link to the chart of gold . One may observe , since the crisis ( 2009 ) up to 2011 huge rise , here :


  3. Gravatar of Harry Harry
    7. June 2018 at 15:17

    There was a technical default in 1979.

  4. Gravatar of Benjamin Cole Benjamin Cole
    7. June 2018 at 16:30

    In his Econlog post Scott Sumner refers to crackpots.

    Crackpots are often crackpots. But after decades of government and financial reporting, I can tell you that it is often the crackpots and the gadflies who first challenge (incorrect) conventional thinking.

    Odd observation: for 35-40 years conventional economists have been predicting higher inflation and interest rates coming in the United States. Instead the long run trend has been towards lower inflation and interest-rates.

    Be careful of conventional thinking.

  5. Gravatar of Christian List Christian List
    7. June 2018 at 17:40

    I like both reviews a lot. They are written in a very informative, open minded, amusing, yet humble style. The FDR/Trump comparison is very bold but funny, it’s always good to get another angle. It’s also important to put things into historical perspective. How would somebody like FDR be perceived today? Your review on econlog reminds me of a good piece by Ezra Klein, in which he is putting Trump into a historical perspective as well.

    One little quibble though: The reviews seem to omit the elephant in the room, which is the default. How bad (or good) was it? I thought hell would break lose if the US federal government (and “crazy” Trump) actually defaulted on the debt, and that this never happened before, and so on. Now we learn that FDR actually defaulted on (parts of) the debt – and even more suprising you don’t seem to be that mad about it. Why not?

    I think commenter Benjamin Cole (?) likes to talk about “defaulting” as well, for example when he talks about Japan and the balance sheet of the BoJ. The new Italian government seems to have similar ideas regarding the ECB. Or the infamous Trump who thought about default as well as a way of making the US debt free. And you found this extremely funny. –> Maybe not so crazy ideas anymore? What would actually happen? My first guess is that hell would NOT break lose.

  6. Gravatar of Benjamin Cole Benjamin Cole
    7. June 2018 at 18:55

    Christian List:

    I do not think I ever said Japan would default on its national debt, now somewhere around 250% of GDP, by some measures.

    In fact, there is the confounding situation of exactly the opposite happening.

    The Bank of Japan now owns about 45% of JGBs. This means the government of Japan owes the government of Japan a lot of money.

    The private bondholders have been taken out, through QE. They have digital cash in the bank now, or as often the case in Japan, paper cash in drawers.

    I call this “Mobius Strip” economics. It is a topic loathed by orthodox economists.

    Adair Turner says the BoJ will never sell its hoard of JGBs. I sense Turner is right.

    Presently, Japan is slipping back towards deflation, though the BoJ has managed to get the CPI up to about 1% in recent years.

    When the Fed started QE, the Fed branch in St Louis released studies that QE would have to be four times as large to have much impact. That would have just about eliminated the national debt, btw.

    For now, it appears central banks can buy a lot of national debt, without much result. Thus, it appears national debts can be paid off, or much reduced, through QE.

    That is macroeconomic heresy, but it happens. Cover your eyes!

    Another interesting story is that the Swiss National Bank has bought $90,000 of global bonds for every Swiss resident, in an attempt to prevent the Swiss franc from appreciating.

    Yet under the koo-koo accounting systems in place, the Swiss citizenry is exposed to risk. They must cough up taxes to make up for any loss on the Swiss National Bank portfolio, should global bonds prices fall and the Swiss National Bank sell the bonds.

    None of the above makes any sense, but all of the above is true.

  7. Gravatar of Morgan Warstler Morgan Warstler
    8. June 2018 at 10:37

    Oabama sucked and Trump rocks

  8. Gravatar of Jim Glass Jim Glass
    8. June 2018 at 17:49

    The primary focus of the book is the abrogation of the gold clause in debt contracts…

    A fascinating story of power politics versus the Constitution. We can all learn from it. For those who don’t want to pay for/read a whole book the tale is told well here…

    “The Gold Clause Cases and Constitutional Necessity”

    FDR expected the Supreme Court to rule his action to be an unconstitutional default and prepared a speech (which still exists) announcing to the public that he was steamrolling it, effectively turning it into the Supreme Court of Argentina.

    Five Justices wrote opinions calling FDR’s act “default”. Louis Brandeis told Felix Frankfurter that “the action on the gold clause is terrifying in its implications”. Harlan Fiske Stone vowed that he would never buy another federal bond. Benjamin Cardozo told a friend “there is room for a lot of immorality within the confines of the Constitution.” And these Justices were FDR’s allies.

    Chief Justice Hughes, a very experienced politician (former governor of NY, Secretary of State, and presidential candidate) saved the Court’s chestnuts by keeping those opinions separate and writing a deciding one that’s been described as “one of the most baffling ever issued” in which he resorted to the dodge ‘the plaintiffs have a right but no remedy’ in an immensely wordy fudge. As a result the Court survived until another day, when it ruled FDR’s NRA unconstitutional.

    … which (I believe) is the only time the US federal government actually defaulted on its debt

    The USA also refused to pay off bonds in gold after the Civil War, another interesting story.

    During the War Lincoln ordered Secretary of the Treasury Chase to issue greenbacks to pay war expenses. Chase objected, entirely correctly by the understanding of the day, that such unbacked paper money was unconstitutional. Lincoln told Chase “I have the Constitution in my desk drawer”, ordered him to do it, and so it was done.

    After the War owners of pre-War bonds denominated in gold money found them being paid off with greenbacks, and objected. The case went to the Supreme Court where the Chief Justice now happened to be Chase. The Court ruled for the bond owners. On *the same day* that the decision was announced President Grant appointed two new Justices to the Court who promptly voted to reconsider and then became the swing voters in reversing.

    Grant succeeded in “packing the court” as FDR only dreamt of — and thusly our fiat money became constitutional.

    Though to the end of his life Grant insisted that his making those two appointments was pure coincidence.

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