Whitonomics - Issue 2 July 2014 | Page 13

IN DEPTH P.11   However there are shortcomings of the gold standard. In 1933 the U.S. were showing no signs of exiting the depression. Unemployment was continuing to rise and deflation was mounting. The U.S. were unable to stimulate the economy. The government had to maintain high interest rates in order to deter consumers from cashing in deposits. It was too expensive for consumers and firms to borrow money, limiting growth and spending. By cutting the dollar from gold the government was able to pump money into the economy, and cut interest rates. Liaquat Ahamed, author of the book ‘Lords of Finance’ is quoted as saying ‘Most economists now agree 90% of the reason the U.S. got out of the Great Depression was the break with gold’. Abandoning the gold standard was not as simple as it may sound. It was said that by abandoning the gold standard the dollar would depreciate, causing exports to be relatively cheaper and imports dear- er. Critics argued that this advantage in trade would increase demand for American goods, causing uncontrollable inflation. If the U.S. abandoned the gold standard it would cause Germany and France to swiftly follow in a race for the worse currency, due to the trade benefits it would bring. When Britain had earlier abandoned the gold standard in 1931 the pound’s value depreciated from $5.00 to about $3.60, making it harder for U.S. exporters to sell to the UK and its empire. If more countries followed this lead the consequences could be much more widespread. The price stability afforded by the gold standard would be completely lost, further causing consumers to lose faith in their respective economies, many of which had thrived under the gold standard. It was a controversial and significant decision to drop the gold standard, which had reverberations around the world. Thankfully it yielded significant benefits, with lower interest rates bringing the stimulus the U.S. economy needed. There were complaints initially, an example being from Americans living abroad that had to deal with the unfair exchange rates. However, the aim of arresting deflation was being achieved as the prices of raw materials and common stock started to rise. The feared economic collapse did not transpire. The fundamental problem of deflation had been solved, setting up the chance for economic revival and the end of the Great Depression. The period of the gold standard was highly successful for the world economy. World trade significantly expanded and many countries experienced high growth. It is beyond doubt that in part the gold standard helped to facilitate this success, but abandoning the gold standard was a hugely significant step in economic advancement. Not only did it allow the U.S. government to stimulate the economy and escape the Great Depression but now monetary policy, the basis of Keynesian economics, is much more flexible. This flexibility should act to prevent any depressions of similar magnitude in the future.