From the Gold Standard to Bretton Woods

1. From the Gold Standard to Bretton Woods Cornel Ban

2. The gilded age upstairs

3. The gilded age downstairs

4. Pre WW I according to

5. Got a problem with war?

6. ww1 • Gold was used to fund the war • Its export was prohibited • As governments issued fiat money (unbacked by gold) to finance deficits, exchange rates began to float and capital controls were introduced, leading to currency depreciations • Only the dollar was backed by gold

7. Versailles, Versailles

8. Ouch!

9. Post-WW1 • Britain loses prominence • A key creditor, Germany becomes a debtor • Democracy, unions and left parties made the fiscal and monetary bases of the Gold Standard unsustainable and demanded flexible exchange rates to accommodate shocks

10. Gold Standard versus democracy

11. Reintroducing gold convertibility • Hyperinflation countries (Austria, Germany, Hungary) move first • Austerity and loans from the League of Nations boost gold reserves to back the GS • Central bank independence is strengthened

12. Why did GS 2.0 last only 5 years? • The Great Depression triggered a deflationary spiral leading commodity exporters to cut reserve levels and then the money supply • This led to demand to relax GS rules (inflationary gold bans that ruined the par values of currencies to gold)

13. Why did GS 2.0 last only 5 years? • Banking crises in Austria and Germany depreciate gold and forex reserves • Convertibility is suspended and exchange controls are introduced • Where countries stay on gold, central banks sold off reserves and increased interest rates aggravating unemployment and adding to pressures for devaluation>currency war ensues in mid 30s • Speculation on currencies remained

14. Germany’s Gold • Run high inflation to cut war debt to the French->hyperinflation->new currency tied to real estate assets->another currency ends the crisis, supported by US capital inflows • 1929: US inflows end->higher interest rates are useless following Fed’s higher interest rates->collapse of foreign reserves->austerity

15. The Great Depression

16. Lets get this straight • Recession: When your neighbor loses his or her job • Depression: When you lose your job.

17. Now seriously… • Gross Domestic Product (GDP): Comprehensive measure of the nation’s output of final goods and services. • Real GDP: GDP measured at a fixed price level (i.e., inflation adjusted). • Recession: Sustained decline in real GDP (approximately two quarters). • Depression: Very severe recession

18. How Great was the Great Depression? • Real output (GDP) fell 29% from 1929 to 1933. • Unemployment increased to 25% of labor force. • Consumer prices fell 25%; wholesale prices 32%.

19. Stock Market Boom and Bust S&P Composite Index

20. Commercial Bank Failures, 1920-2004

21. Percent Real Nominal Nominal and Real Interest Rates, 1922-33

22. Great Depression • Bank runs plus contractionary monetary policy to defend the ratio between gold reserves and the money supplycurrencyrunsdepletedreservesexchange rate controlsoff gold

23. Neoclassicals • If people save, the higher level of savings leads to lower interest rates • Lower interest rates should lead to increased investment spending and demand stabilization • Say’s law: a rational business will never hoard money but spend it • Booms and busts are inevitable

24. Keynesians • Demand-driven • Financial bust followed by underconsumption and underinvestment • As prices dropped, a liquidity trap followed: even if the interest rate falls, investment dos not increase because investors’ expectations of profit are lowered by expectations that the fall in consumption is long term • Secular stagnation theory • Only government spending can improve expectations

25. Monetarists • Money driven • An ordinary recession is met with the shrinking of the money supply, causing people to hoard money and consume less, leading to a large fall in output and emplyment • the recession to morph into a depression

26. Austrians • Easy money during the 1920s led to malinvestment

27. Marxists • Inherent instability • Classism

28. The Collapse of World Trade $ value imports of 75 countries

29. Why Did It Happen? Some Suggested Causes • The stock market crash – end of the party • Collapse of world trade – globalization in reverse • Monetary collapse

30. Bank Failures • 7000 banks failed -- many during “panics” • Number of banks fell from 25,000 in 1929 to 15,000 by 1934 • Possible Channels: • Loss of deposits  decline in expenditures • Customer relationships broken harder to borrow • Money supply contraction

31. The chart shows that 99% of the population received a 9% increase in their income, while the top 1% saw their income rise by 75%. 1,230,000 Americans 121,770,000 Americans

32. US credits and the Great Depression • US becomes main creditor to European sovereigns and corporates • To cool the speculative boom the Fed increases interest rates in 1928; money flows back in the US and interest rates go up in Europe • The sudden stop in capital inflows compresses demand in Europe, forcing deflation there

33. The periphery seizes up • Austria bails out the biggest bank while trying to stay on gold-depleted gold reservesmarkets fear devaluationcapitalflightexchange controls end the GS • Hungary • Germany: defended the GS reserves by limiting credit until it triggered a banking crisis

34. Managed floating 30s • Currencies values varies but governments can intervene on forex • Monetary reflation: Central banks cut the discount rate recovery led by interest rate sensitive sectors • Devaluations were done in an orderly fashion • Coordinated reflation impossible because of different interpretation of monetary reflation • Propelled protectionist measures

35. Bretton Woods • Exchange rate stability • Trade boom

36. Bretton Woods’ monetary system • Pegged but adjustable exchange rates • Capital controls • IMF • …but not Keynes’ Clearing Union

37. BW’s extra levees • Interest rate caps • Development banks • Assets in which banks could invest were restricted • Financial markets were made to invest in domestic strategic sectors • Licensing for importers to control trade imbalances • Governments with full employment mandates

38. BW’s first cracks • 1959: convertibility of currencies weakens exchange controls • Needed by US interest to guarantee its exporters a level playing field • Key for a multilateral trade regime • But high interest rates needed to maintain credibility were limited by the postwar compromise: full employment and welfare state. The solution: exchange controls and devaluations

39. BW in the convertible 60s • How to finance trade imbalances? • Weak currency countries: more generous IMF assistance to increase their reserves to counter the speculative flows brought by the relaxation of controls • Strong currency guys: you live beyond your means!

40. Triffin’s bank run • The system had a tendency to meet excess demands for reserves through the growth of the demand for dollars • once foreign dollar reserves looked large relative to US gold reserves made the system unstable, • especially as the US foreign monetary liabilities exceeded its gold reserves • If foreigners saw this and tried to cash in their US liabilities for dollars before the US was forced to devalue, the gold: dollar parity would be questioned