The Golden Millstone

Robert Zoellick, the president of the World Bank, recently suggested that leading economies consider adopting a diluted gold standard (under which currencies are pegged to the price of gold) to help moderate international currency fluctuations. The gold standard is not beloved by mainstream economists, and a study by economists Barry Eichengreen of the University of California, Berkeley, and Douglas A. Irwin of Dartmouth should give Zoellick further pause. Countries that stuck to the gold standard throughout the Great Depression enacted harsh protectionist policies that caused a sharp contraction in international trade; even after economies began to recover, trade lagged.

The Depression is often remembered as a time when every country imposed strict trade barriers in an effort to protect its own. But nations that abandoned the gold standard tightened their trade restrictions “only marginally.” As their currencies devalued, these countries benefited from an influx of gold, as people sought their cheaper goods. To prevent their gold from going overseas, those still on the gold standard were forced to enact tariffs, duties, and other protectionist measures against imported goods.

The first big step toward a restrictive trade era was the enactment in the United States of the Smoot-Hawley Tariff Act of 1930, which raised tariffs by 20 percent. But the wave of protectionist policies did not begin in earnest until 1931. That September, following a financial crisis in Austria, Britain abandoned the gold standard, a move that “sent shock waves through the world economy.” Other countries with close financial ties to Britain followed suit within days, including Denmark, Finland, Norway, and Sweden. Japan did so two months later. In general, these countries recovered from the Depression earlier than those that stayed on the gold standard.

France, which stuck with gold until 1936, reacted to the fall in the value of the British pound (which made British goods cheaper overseas) by imposing a 15 percent surcharge on British goods. The Netherlands, also tied to gold, raised its duties by 25 percent. Between the third quarters of 1931 and 1932, world trade decreased 16 percent.

Once countries ditched the gold standard, they began relaxing their trade restrictions. In 1934, one year after the United States left gold behind, Congress passed the Reciprocal Trade Agreements Act, authorizing the president to reduce tariffs. Within four years, the Smoot-Hawley increases were virtually gone.

Ideally, countries should have coordinated a simultaneous devaluation against gold, Eichengreen and Irwin argue. Instead, devaluation occurred willy-nilly between 1931 and 1936. For the countries married to the gold standard during that time, those were five very long years.

* * *

The Source: "The Slide to Protectionism in the Great Depression: Who Succumbed and Why?" by Barry Eichengreen and Douglas A. Irwin, in The Journal of Economic History, December 2010. 

Photo courtesy of Flickr/Bullion Vault