Sound Money

An insightful account of the social, economic and political trends of the 1920’s, 30’s and 40’s, centred on the monetary economics leading to the great depression. As someone with a passion for monetary economics, there were times when I was looking for a little more opinion, defence of good ideas and criticism of weak. But Ahmed does well to note the various opinions in a reasonably objective way, allowing the reader to assess them and delve a little deeper themselves. I enjoyed the thread through the lives of the major central bankers – interesting characters. The digressions got tedious but it’s a difficult balancing act between potentially boring historical facts, entertaining but unnecessary anecdotes and insightful but opinionated interpretation of the facts.

My 6 take away’s:

1. Historical experience has a strong impact on principles in the subsequent period. The bigger the crisis, the stronger the impact and the longer it lasts.

French inflation north of 20% post-WW1 stoked a particularly conservative characteristic in French bankers leading into the Great Depression, making them a dominant force of the time. France had the world’s second highest gold reserves, low levels of inflation, a strong currency and a reasonably strong economy in the late 1920’s, which is in stark contrast to the more profligate approach of current French politicians. The scars from the 1920’s experience have worn off by now.

Germany also experienced high levels of inflation directly after WW1. With the assistance of reparations fears, the country went into hyperinflation in the late 1920’s. The scars from this catastrophe remain engrained in German monetary policy. The Bundesbank is far and away the most conservative central bank in Europe. I’m inclined to think the historical experience is more important than inherently German characteristics, as others might argue.

This relationship between historical experience and subsequent principles, biases and actions in the following period could be applied to more recent historical events. Some might argue that the 2008 financial crisis, for example, made investors ultra-scared of potential crises and perhaps now they aren’t taking enough risk? The flip-side is that subsequent unprecedented central bank support may have lulled investors into thinking that monetary support will consistently stand as a back-stop against future crisis, breeding complacency?

2. Dogmatic implementation of principles, even if they are good ideas, creates negative outcomes and can turn people against the good principles.

The pre-WW1 gold standard imposed a degree of budgetary prudence, monetary conservatism and it avoided competitive cross-border FX devaluations. These are good principles that probably aided pre-war prosperity. However, dogmatic implementation of the gold standard post the war was damaging.

The UK, in particular, tried to assert the gold standard at pre-war levels because to maintain the prestige of being the world’s banker and convince investors that that debts wouldn’t be inflated away. Inflation during the war years made the GBP/troy oz. relation unrealistic though. Pre-war, 15% of UK money supply was backed by gold, which fell to 7% post war. Substantial monetary deflation was required to make a credible commitment to the pre-war peg. Without sharp economic liberalisation required to adjust prices quickly, this deflation caused economic depression and unemployment.

In hindsight it’s clear that the monetary inflation during the war was the original sin. If the UK wanted to return to the gold standard it had to own up to this monetisation of it’s debts and devalue the GBP vs. gold. Dogmatic implementation of the gold standard at pre-war levels and the subsequent relief when the UK finally broke the peg public in 1931, made the gold standard the scape goat for the economic difficulties. In reality it was the monetary inflation of the war and the dogmatic implementation of the standard post the war that were at fault, not the underlying principles.

3. Keynes wasn’t a Keynesian.

John Maynard Keynes was a vehement critic of GBP/gold convertibility at pre-war levels but he was actually an advocate of the gold standard on many occasions. He was vindicated in his opposition to pre-war convertibility levels but this doesn’t imply that he was opposed to sound money. When WW2 broke out Keynes became an unpaid economic advisor to the Chancellor and the principal wartime economic strategist. He was determined not to repeat the mistakes of WW1, which he identified as Britain’s decision to finance the war through the printing press and inflation. He designed a framework of paying for WW2 with far lower rates of inflation. I’m not enough of a Keynes expert to understand all the nuances of his theories but this sounds a far cry from the Paul Krugman, who is the archetypal modern day Keynesian. I bet Keynes wouldn’t support the rampant monetary and fiscal inflation implemented by western governments during each economic crisis for the last 20 years.

4. Norms, use of terminology and trends change drastically over time.

UK Prime Minister Ramsay McDonald was a fervent and committed socialist but was also committed to balance the budget, even though the UK was in a depression. Very few socialist leaders would entertain the idea of a balanced budget today. While the economic norm may have changed to greater acceptance of deficits, the economic principles haven’t changed. Society is paying for massive government debts through weaker economic growth, less economic mobility and higher tax rates. I wonder when the trend away from fiscal conservatism will reverse again. Probably only when the negative consequences deepen and become even clearer. For now, we’re dealing with increasingly profligate leaders on the left and right.

5. Wars changed the landscape of history, often allowing greater state centralisation

Wars were used throughout history to centralise control of the monetary mechanism. Historically, banks were independent entities that naturally formed as society developed. States used to ask for funding during wars in order to pursue their economic and political interests and would have to repay the debt with the spoils. Over time governments realised that they were dependent on banks, leading to increased control and centralisation where possible.

In 1694 after bankrupting itself during war, the British govt granted monopoly rights to a group of merchants to become the exclusive bank of the state. The BoE operated like a private bank in between financing state wars. During WW1 the BoE tried to reassert its independence but was put firmly in its place and told to finance the war through inflation and war bonds. In France, Napoleon Bonaparte created the Banque de France. It was founded independently in order to encourage merchant investors to allocate their capital but centralised during war as Napoleon demanded finance and inflation for his European expansion. The US Fed was created independent of war but centralised and became an organ for state financing during WW1. Its public profile also grew as government pushed society to purchase war bonds.

6. The Great Depression is exactly what central bankers are trying to avoid today

The Fed, BoE, ECB, BoJ and PBoC certainly have a similar club of bankers having secret conversations behind the scenes today. The scars from the Great Depression imply that Governors have become increasingly trigger happy as each crisis has rolled around the corner. The public applauds these figures as hero’s for their ability to avert crises but global coordination is becoming increasingly difficult and repeated monetary expansion has unintended consequences. Just as forests are protected for catastrophe when isolated forest fires clear out the dead wood, economies benefit by liquidating weak companies. What has monetary hypervigilance meant for the quality of economic/social/politic activity today? And what consequences could it have during the next global downturn?