In the 1920’s, it was the interruption of the distribution of gold flows via sterilizations and the creation and maintenance of foreign “reserves” and influencing the nascent wholesale markets of the age that served to maintain a high degree of leverage throughout the economy. That it did not show up in consumer prices is only due to the nature of monetary distribution, with excessive liquidity flowing directly to call money and stock market prices.
The Fed in July 1928 actually agreed with the first part of that interpretation:
The loss from the country’s monetary stock of gold in a little over a year of $580,000,000, including net loss through exports and through earmarkings, indicates the extent to which gold accumulated in this country during the period of monetary disorganization of the world has been redistributed, largely in connection with the adoption of monetary reforms by different foreign countries. Of the more than $500,000,000 of net gold exports between the middle of May 1927, and the end of June 1928, covering transactions with all countries except Canada, the larger part went to the following eight countries: France, $257,000,000; Argentina, $131,000,000; Brazil $55,000,000; England, $33,000,000; Germany, $27,000,000; Italy, $20,000,000; Uruguay, $11,000,000; and Poland, $8,000,000.
What the “market” for global money was trying to do was further redistribute gold across the globe based on market conditions rather than central bank targets. And that was really the point – in the US the Fed targeted money growth and interest rates, and thus hoped to steady consumer prices (against deflation as much as inflation) by allowing new artificial imbalances that had to pour out somewhere.
All of this should be very familiar to anyone paying attention during the past few decades. This was even true of the 1960’s, where once again the rise of foreign “reserves” would unbalance both the domestic and global system. In that particularly case it did not end in deflationary catastrophe, instead in the disaster of the Great Inflation (and it was far worse outside the US) as gold was removed entirely. It wasn’t gold that was the problem, but rather central banks and national governments taking priority over true markets for money.
Liquidity systems were built as a consequence of the Federal Reserve only paying attention to the narrow view of consumer inflation. This time the target is an interest rate and results have been obviously similar – an immense buildup of “liquidity” driving asset prices on the way up that eventually served as a devastating bottleneck on the way down.
The gold movements during the decade of the 1920’s were delayed responses trying to alleviate the imbalanced distribution left over from the floating currency mess, the “monetary disorganization” as the contemporary Fed called it. But in this new age of monetary “enlightenment” central banks were trying to alleviate gold, and by doing so disrupted the vital self-correction mechanisms that maintained order. Working around this market-based self-correction meant “money” growth would not be restrained at precisely the time it needed exactly that. The over-indebtedness, to borrow Fisher’s observation, which prevailed upon the disaster was nurtured by the fact that gold flows were being manipulated rather than freely allowed to do the dirty work of keeping money in check so that imbalances never grew far enough as to be existentially dangerous.
Monetary authority in the US and elsewhere was intent on defeating the business cycle, especially in the late 1920’s with the recession of 1927 and the coincident “deflationary” flow of gold adjustment. It would have meant deflation and likely even depression, but that was not to be allowed (encouraged no less by an election year and political pressure) as there was no shortage of hubris in thinking it could all be overcome and the economy safely transported to a better, more lasting place.
Instead, the flow of gold, had it been allowed to proceed, would likely have kept the money system from reaching such dangerous proportions. That includes especially call money and stock prices, as you can imagine how much less danger there might have been had the market began its decline in early 1928 (maybe even the middle of 1927 if stock investors truly act freely as discounting agents) rather than late 1929. We can never know for sure, but the US and global economy was far less imbalanced at that point, particularly foreign reserves and interbank conditions, than the unbelievable extremes right before the crash.
Despite all of that, the idea of a central control over the economy, even banishing the business cycle, lived on for decades. It should have died in the late 1920’s with the crash and collapse, and largely did as the Fed took a backseat to the Treasury in terms of policy direction after its further intrusive mistakes in 1935 and 1936 (leading to the redepression of 1937). However, the monetarist version of the Great Depression, with square aim on instead the gold standard and the introduction of the 1930-Fed mistakes as primary culprits, rebirthed the monetarist dream of going beyond the money market. Greenspan’s quest to fulfill that dream in the 1980’s and 1990’s was due entirely to that – the refashioning of history of the 1920’s into an overly simplified “golden age.”
If you ignore the vast majority of the events in the 1920’s, the idea of central bank control and management can be preserved and provide a seemingly empirical foundation for the current incarnation. There really is not much difference, as though the systems have evolved and gained complexity, the root and general mannerisms are all the same. That is why there are so many similarities on both the upside and in the current downturn – the mechanism for monetarism is the intentional disabling of market-based self-correction. Central banks are determined to prove one more time that they can’t do anything more than make it worse. All that is left is to fashion some kind of alternate explanation.
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