The Gold Standard and the Great Depression

There are various factors that led to the Great Depression, but when America's economy was already weak and vulnerable, the gold standard simply led to more destruction.

The gold standard before 1931 was used to allow currencies to place a value on their currency relative to a set standard. This allowed people to know the worth of their money no mater what currency they possessed. However, for many countries who were low on gold, the pressure to keep up with the gold standard was building up. Some suggest that abandoning the gold standard made nations one step closer to recovering from the depression. These countries would have to tighten their credit in fear that if they didn't they would have to default on the exchange rate. If a country didn't cut back on their spending, people holding their notes would exchange their notes for gold worrying that inflation would devalue the notes. However, if people panicked, which many did, and started turning in their dollars for gold, the gold reserves would be exhausted. If the reserve levels were low, the nations couldn't issue as much currency. For many countries, it was a lot easier to abandon the gold standard and to set the value of the currency based on their own system. In September of 1931, Britain defaulted on its gold payments to foreigners and abandoned the gold standard. This followed up with a chain reaction from 24 other countries.

Because Britain pulled out of the gold standard, the world economy became still. America at this time had already been raising high tariffs and enacting protective policies which further clogged the flow of money. This feeling of fear from central Europe and Britain was quickly reaching the United States. When the government's budget was running low because of all the services it was providing, banks, depositors, and investors were quick to trade in their cash for gold. With their gold, they would simply hoard it and hold on to it without making new investments or purchases. Just like we discussed in class when the 2% of the population that were in control of 26% of the wealth stopped purchasing and circulating their money, no one else was there to make up the gap. Much like the 2% that sold their stocks during a time of panic, the wealthy investors and depositors were quick to exchange their paper money for gold to hold on to what they were left with.

It's interesting to see how a weak economy can be so easily and instantly affected by a sudden trigger. When one person starts to panic and sell their stock or exchange their money for gold, it simply becomes a chain reaction that just goes downhill. Britain's departure of gold led to 24 other countries abandoning the gold standard. In a time of depression, people went from having a nice house, car, and a full stomach one day to absolutely nothing the next day. This is all a result of how quickly fear is able to take over people's minds and how easily one trigger can spark an entire disaster.


Sources:
http://www.nber.org/chapters/c11482.pdf
Freedom from Fear, David Kennedy
http://www.bloombergview.com/articles/2011-12-12/the-gold-standard-and-the-great-depression-echoes