Brilliant analogy and educational article from Robert J.Samuelson; A MUST READ.
After World War I, countries sought to restore the gold standard, which had been widely suspended during the fighting. Because the reliance on gold had delivered prosperity, this was understandable. But there were daunting problems: Prices had exploded during the war; gold was relatively scarce; exchange rates had shifted; countries were saddled with large debts. As a result, the restored gold standard was unstable. Skewed exchange rates meant that two countries, the United States and France, ran large trade surpluses and accumulated disproportionately large gold stocks. By 1930, they owned nearly 60 percent of the world’s gold.
The resulting gold scarcity—for most countries—created a fatal interdependence. If one country raised interest rates, it might drain gold from others. Depositors and investors, foreign and domestic, would withdraw their money or sell their bonds, convert the receipts into gold, and transfer the gold to the country with higher interest rates. There, the process would be reversed: Gold would be converted into local currency and invested at the higher rates. The gold standard created a potential domino effect of tighter credit that would make the Depression feed on itself. While credit was plentiful, the danger was theoretical. Once economies turned downward, the scramble for gold intensified the slump.
Casting the welfare state in this role will strike many as outrageous. After all, the welfare state—what Americans blandly call “social spending”—didn’t cause the 2007–09 financial crisis. This dubious distinction belongs to the huge credit bubble that formed in the United States and elsewhere, symbolized by inflated real estate prices and large losses on mortgage-related securities. But neither did the gold standard directly cause the 1929 stock market crash. Wall Street’s collapse stemmed, most simply, from speculative excesses. Stock prices were too high for an economy that was already (we now know) entering recession. But once the slump started, the gold standard spread and perpetuated it. Today, the weakened welfare state is perpetuating and spreading the slump. What has brought the welfare state to grief is not an excess of compassion, but an excess of debt.
After World War I, countries sought to restore the gold standard, which had been widely suspended during the fighting. Because the reliance on gold had delivered prosperity, this was understandable. But there were daunting problems: Prices had exploded during the war; gold was relatively scarce; exchange rates had shifted; countries were saddled with large debts. As a result, the restored gold standard was unstable. Skewed exchange rates meant that two countries, the United States and France, ran large trade surpluses and accumulated disproportionately large gold stocks. By 1930, they owned nearly 60 percent of the world’s gold.
The resulting gold scarcity—for most countries—created a fatal interdependence. If one country raised interest rates, it might drain gold from others. Depositors and investors, foreign and domestic, would withdraw their money or sell their bonds, convert the receipts into gold, and transfer the gold to the country with higher interest rates. There, the process would be reversed: Gold would be converted into local currency and invested at the higher rates. The gold standard created a potential domino effect of tighter credit that would make the Depression feed on itself. While credit was plentiful, the danger was theoretical. Once economies turned downward, the scramble for gold intensified the slump.
Casting the welfare state in this role will strike many as outrageous. After all, the welfare state—what Americans blandly call “social spending”—didn’t cause the 2007–09 financial crisis. This dubious distinction belongs to the huge credit bubble that formed in the United States and elsewhere, symbolized by inflated real estate prices and large losses on mortgage-related securities. But neither did the gold standard directly cause the 1929 stock market crash. Wall Street’s collapse stemmed, most simply, from speculative excesses. Stock prices were too high for an economy that was already (we now know) entering recession. But once the slump started, the gold standard spread and perpetuated it. Today, the weakened welfare state is perpetuating and spreading the slump. What has brought the welfare state to grief is not an excess of compassion, but an excess of debt.
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