Gold, The Commodity Money Jude Wanniski January 15, 2005

Memo To:  SSU Students
From:  Jude Wanniski
Re:  Gold, the Commodity Money

In last week’s lesson on the Crash of 1929, I made the case that it was a “fiscal” shock to the U.S. economy -- the putative passage of the Smoot-Hawley Tariff Act of 1930 -- that caused the first wave of what became the Great Depression. In other words, the financial market had in the last week of October 1929 anticipated the enactment of the law and its signing by President Hoover in June 1930. Nobody before had made that connection. When I made the finding in the spring of 1977, at the Morristown, N.J. library’s microfilm station, in an instant I knew I had stumbled upon one of the most important discoveries of the 20th century. If I was right, classical economic theory built on Jean Baptiste Say’s “law of markets” had not been invalidated. The Crash was not simply a “bubble bursting” because of the irrational behavior of the broad market, but rather a validation of Say’s insight in the Napoleonic era that “supply creates its own demand.”

The year of my birth, 1936, was also the depth of the Great Depression and the year of the publication of The General Theory of Employment, Interest and Money,by the British economist John Maynard Keynes expressly set out to smash classical theory by arguing that if Say’s Law ever did work, it no longer did, as evidenced by the persistence of the Global Depression. In Chapter VI, he wrote:

From the time of Say and Ricardo the classical economists have taught that supply creates its own demand; meaning by this in some significant, but not clearly defined, sense that the whole of the costs of production must necessarily be spent in the aggregate, directly or indirectly, on purchasing the product. In J. S. Mill’s Principles of Political Economy the doctrine is expressly set forth: “What constitutes the means of payment for commodities is simply commodities. Each person’s means of paying for the productions of other people consist of those which he himself possesses. All sellers are inevitably, and by the meaning of the word, buyers. Could we suddenly double the productive powers of the country, we should double the supply of commodities in every market; but we should, by the same stroke, double the purchasing power. Everybody would bring a double demand as well as supply; everybody would be able to buy twice as much, because every one would have twice as much to offer in exchange.”[Principles of Political Economy, Book III, Chap. xiv.]</blockquote> Boiled down to essentials, Keynes was simply observing that Say had argued that people would not go to the trouble to supply their goods and services to the market if they did not anticipate they would be bought by other people coming to the market with the proceeds of the sale of their own goods and services. Say did not argue there could not be downturns in the economy, for of course the evidence of history showed otherwise. But as the global depression deepened in the 1930s, neither the public nor the political class had the patience to wait for things to work themselves out, or for Wanniski to figure out what happened in 1929, and what Keynes was arguing made some sense. The capitalist class brought all these goods and services to the world market and instead of being snapped up, they simply piled up as unsold inventory. Hoover’s Treasury Secretary Andrew Mellon in 1931 recommended a cure: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” To this day, modern economic historians and Keynesian economists like Princeton’s Paul Krugman and Berkeley’s Barry Eichengreen condemn Mellon for what appear to them to be a heartless and cruel statement, but the advice was correct. If labor and business inventories of stocks and farm goods and real property were all “frozen” in price, they could not resolve the condition that had brought on business inaction and massive unemployment. If these factors would all become “liquid” in price, the exchange economy would quickly run down what was at that point a simple “inventory” or “V-shaped” economic weakness.

In retrospect, what the Keynesians now say in retrospect echoes Keynes’ argument that in this new, modern, industrial economy there had come about a disparity in the incomes of the upper classes and the underclass’s. Capitalists had brought their goods to market thinking they would be bought up, but the upper classes had the greatest potential to spend from their incomes to buy up those goods, but preferred instead to save. The lower income classes eagerly wished to buy those goods, having a “higher propensity to spend,” but they did not have the income. Given the fact this was not happening, Keynes and his followers correctly opined that the government itself should step in and buy the surplus that had piled up, either by borrowing spending power from the upper classes or taxing it away from them, and distributing the goods to those who could not afford to buy, not simply as handouts, but in exchange for their work on public goods.

It was a brilliant scheme and as New Deal historian Arthur Schlesinger Jr. has argued over the years, President Franklin Roosevelt’s policies of using the government as an intermediary rather than as an owner of the means of production may have save the U.S. from the kinds of socialist, fascist and communist reactions to the Depression. Milton Friedman was not yet a force in economics in the Depression years, but there were monetarist predecessors who saw that huge pile of surplus goods and opined that if only there was more “money” in circulation, the population would buy it up, and there would be no need for deficit spending, borrowing or taxing. In late 1933, these ideas helped persuade FDR to devalue the dollar against gold, because the Federal Reserve could not put more money in circulation if the market preferred holding gold to holding paper dollars. To make sure people would actually use the extra dollars put into circulation with gold at  $35 per ounce than the previous $20.67 per ounce, FDR also signed legislation making it illegal for Americans to own monetary gold.

Here we come to the point of this last lesson in this semester’s concentration on monetary policy, why the academic profession resists the classical approach to defining money in terms of a commodity money, so it would have a basis in reality. The devaluation of gold by FDR and the ban on owning gold bullion did not work. The Depression deepened. This has led the Keynesian and monetarist academics to argue the devaluation was too little and too late. The current defense of the failure of heightened spending and deficits by the New Deal to alleviate the unemployment is to blame the gold standard as it existed in 1930-33 for the widespread bank failures. The gigantic federal budget deficits of recent years have not had the effects supposed by the early Keynesians, which has led to the appearance of the “neo-Keynesians,” who argue that economic weakness is caused by too much spending and too little saving. Keynes is turned on his head.

The Krugmans and the Eichengreens in academia have also joined forces with the demand-side monetarists in arguing that the Great Depression could have been cured by printing more money, but that the gold standard prevented that cure. Eichengreen’s 1994 book, Golden Fetters, is an explication of that view as you can easily tell by the title. It is a valuable addition to the debate because it is chock full of facts and figures in support of the argument, but Eichengreen never mentions Smoot-Hawley or the Hoover tax increase of 1932 or the foreign retaliation to Smoot-Hawley that prevented that pile of goods from being liquidated, as Mellon had recommended. His thesis is that injections of money in 1931 would have been sufficient to run down the surplus that Keynes thought could be run down by taxing, borrowing and spending.

Another economist who has played tag-team with Eichengreen, spending time at Berkeley before settling at Millsaps College in Jackson, Miss; is Robert S. McElvaine, who not only devoted a book to The Great Depression: America 1929-1941, first published in 1984, but did me the honor in his opening pages of challenging my Smoot-Hawley thesis. I say that in all seriousness, because while my 1977 discovery of the cause of the Crash was surely one of the most important of the century, it has been studiously ignored by academics. Two or three (at most) have assigned graduate students to write doctoral dissertations that have dismissed my thesis on the grounds that something that happened in 1930 could not have caused a 1929 Crash.

To be fair to McElvaine, he is not an economist, but a historian, and the several pages he devotes to debunking my thesis would be recognized my serious economists of most schools of thought as sophomoric. Aside from his early shots at me for defending classical economics, the social and political accounts of how the 1930s unfolded are not bad at all and worth reading in any basket of books on the era. He even says Smoot-Hawley may have had a small part to play, “But it cannot let classical economics off the hook.” I’ve not read a sentence in the last 25 years that summed up the opposition to my discovery more than McElvaine’s. He and 99% of his colleagues were educated at the best universities in American to believe classical economics was to blame. How can they be let off the hook?

In 1979 or 1980, I think, while supply-siders were coalescing behind Ronald Reagan’s run for the White House, I bumped into the Gipper’s chief economic advisor in the campaign, Marty Anderson, and we talked about gold and Smoot-Hawley. Marty was a fan of gold, or he could never have gotten that close to Reagan, and he carried a $20 gold piece in his pocket to demonstrate his fealty. I can’t forget Marty telling me that the academics know that I got the Crash of ’29 right, but that I should not get credit for the discovery until long after I’ve passed on. “We are still trying to explain how Adam Smith could have written ‘The Wealth of Nations’ without any formal education in economics.”

When I made the discovery that morning in 1977 at the Morristown, N.J., library, knowing I had found the Grail to rescue classical economics, I left the microfilm and went to a pay phone in the lobby and called my mother, who worried that so many people were ridiculing my ideas. I told her: “Mom, don’t worry, they will never be able to laugh at me again. I figured it out.”

Well, to be honest, Marty Anderson was right. They don’t stop laughing because it’s all they have left in protecting their “school of thought.” I remember reading that Max Planck, the German physicist who discovered quantum theory a hundred years ago and won the Nobel Prize in 1918, once observed in those early years that new ideas do not come to acceptance until the people who advanced the old ideas passed away. If I’m not mistaken, Planck was not boosting himself at the time, but urging his foot-dragging colleagues to take young Albert Einstein’s theory of relativity seriously.

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The spring semester, devoted to fiscal policy and public finance, will begin in 2 weeks.