Currencies Threatened By A Credit Crisis

In this article I draw attention to the similarities between the current economic situation and that of 1929, and the threat to today’s unbacked currencies. There is the coincidence of trade protectionism with the top of the credit cycle, and there are the inflationary events that preceded it. The principal difference today is in modern macroeconomic delusions, which hold that regulating inflation of money and credit is the solution to all ills. I conclude that economic salvation can only come from ditching today’s macroeconomic theories and by returning to monetary stability through credible gold exchange standards.


There is an assumption in economic circles that when the general level of prices changes, it is always due to changes in supply and demand for goods and services. Prices change all the time, but without a change in the public’s preference for or against holding money and with all else being equal, the general level of prices simply cannot change. Changes in the general level of prices are due to changes in the purchasing power of the money, which stems from the public’s preferences for or against it and do not emanate from goods and services.

This may not, at first sight, appear to matter, but it calls into question the widespread assumption that price changes are only due to changes in supply and demand for goods and services. It is a basic error behind modern monetary theory (MMT), whose supporters are busy reviving Georg Knapp’s Chartalist theories of money, the theories that permitted Bismarck’s inflationary pre-war armament financing and the subsequent collapse of the German currency in 1923. Believers in a divine right for the state to issue currency will not let themselves be distracted by inconvenient facts. MMT followers are only one group of neo-Keynesian inflationists, who are generally blind to the blunders of their revisionist economics.

Instead, they assume that the purchasing power of a state-issued currency is objectively fixed, only varied by changes in its quantity. Preferences for or against money are not in their economic lexicon. They ignore the evidence of hyperinflations, where the loss of purchasing power is never a straight-line affair. A myopic approach allows them to believe their feared deflation can be offset simply by regulating the increase in the quantity of money to ensure price stability, when in fact they are advocating what amounts to a hospital pass.

This notwithstanding, it is the apparently innovative solutions of MMT and other whacky ideas to address the evolving global credit crisis that are likely to unite inflationists in their drive to buy off with yet more monetary inflation the consequences of their disruptive actions earlier in the credit cycle. 

This article is the third in a series about a prospective credit crisis, and its likely characteristics. The first (Trade wars – a catalyst for economic crisis) discussed the consequences of American trade protectionism coinciding with the top of the credit cycle. The second (Why monetary easing will fail) gave three reasons why monetary easing would fail to secure intended economic objectives. This article is about the consequences of accelerating inflationary policies for the purchasing-power of state-issued currencies. The comparison upon which our analysis is based is the credit cycle that terminated in the Wall Street crash of 1929 and the slump that followed, for reasons that will become clear. But first, we must remind ourselves of those depressing events.

The 1930s experience

Until 1933, the American dollar was on a gold exchange standard, whereby members of the public could exchange their dollars for gold at the rate of $20.67 to the ounce. By then the great depression was well advanced, and prices of commodities and raw materials had fallen heavily. An index of raw material prices fell approximately 50% between September 1929 and Spring 1933. Semi-manufactured products lost 40% and finished goods 30%. Agricultural prices were especially hard hit, with farm products falling 60% and wholesale food prices declining over 45%.[i] 

It was the fall in prices which led to the dollar’s devaluation to $35 per ounce of gold in January 1934, which by then was no longer available for public exchange. The dollar’s devaluation was an attempt to manage an economic outcome through price manipulation. But the reason for the collapse in prices in the first place was the dollar was tied to gold, and preferences for gold compared with goods had increased.

In effect, it was prices measured in gold through the medium of the dollar that was the issue. As noted above, when the general level of prices shifts, it is always because the purchasing power of the money they are measured in changes. Therefore, measured by an index of raw material prices, gold’s purchasing power doubled between September 1929 and Spring 1933. By the time of the dollar’s devaluation ten months later, the index of raw materials had recovered to a level which indicated a new dollar-gold relationship of $35 to the ounce was roughly right.

Today, there is no such relationship between the dollar and gold. While the US Treasury holds gold reserves, they are not available for monetary exchange. Furthermore, it is the stated objective of monetary policy to maintain a rate of price inflation targeted at two per cent. Therefore, if we face a replay of the slump following the Wall Street Crash then it is the purchasing power of gold that will rise, while that of the dollar will fall. This assumes the general price level can be controlled, which is never the case. And to the extent that other currencies use the dollar as their international yardstick, they will lose purchasing power as well.

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