Are We Fighting the Future?

In 1991, before ascending to the Federal Reserve, then-Princeton University professor Ben Bernanke and Princeton colleague Harold James made the case that “nations’ adherence to the gold standard” caused the Great Depression, and those which quickly dropped the standard and engaged in monetary easing recovered quicker than those that waited.

Contrary to this conventional wisdom, in a recent piece, “Anstalt’s Shadow Looms Over Excessive Credit Today,” I took the view that, during the 1920s it was the credit bubble — and the feeble interwar gold standard that allowed it to come into being — that was the problem.

When the bubble was pushed to its outer limits, and bad loans had resulted in bank failures, the bust followed. Governments rushed in to guarantee the banks against losses, but the watered-down gold exchange standard could not sustain the boom. The world’s monetary system collapsed, and so did the economy.

Now, we will turn to the heart of Bernanke’s argument, which is that after the gold standard was dropped and monetary policy loosened in response to the crisis, supposedly recovery followed. This is important because even if the lax credit standards and easy money were the real culprits of the downturn, that in itself does not advise policymakers as to what the proper course of action afterward to clean up the mess might be.

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