Lords of Finance, by Liaquat Ahamed, is a book about the world (well, France, Britain, Germany and the US) financial collapse in the 1930s. The book starts earlier and mostly focuses on the central banking directors of each country—asserting that they played a huge role in the crisis.
It’s an interesting read so far, but I’m afraid my rudimentary understanding of economics and finance is limiting my understanding and appreciation of the book. I thought I’d use this thread to post some questions and try to find answers for them. My hope is that others who have more knowledge of economics and finance will help me out.
Hmm, I’m not really sure where to start, but I guess I would start with the questions involving the gold standard (GS), which most of the major economies operated under in the early 20th Century. From what I understand, gold would back the paper currency. Now let’s stop there. By “back the paper currency,” I assume this means that people didn’t fully trust paper currency, so if the value of currency plummeted for some reason, a country would have the gold—the value of which was more stable and unquestioned—to give to people instead of paper currency. Would others agree with this?
Now, the GS had another feature—namely, every country had rules about how much they could borrow in relation the amount of gold they had. This would limit the amount of borrowing (or printing money?) that a country could do—unless the country could secure more gold, of course, which would allow them to borrow more. So this kept a country from living outside of its means or inflating their currency (printing too money which lessened the value of money?). I’m not sure if this correct, but hopefully more knowledgeable people can correct me if not.
Now, here’s one part that confuses me. Britain (and maybe some other countries) also used Sterling (silver?) to suppor their currency. How does this work, within the GS system?
Also, I wondered about whether the value of gold fluctuated in this system as it does now. Does the value of gold only fluctuate now because we’re not on the GS. In other words, under the GS, there wasn’t a paper money value attached to gold, as it was sort of at a set value. I assume that means the value of a country’s currency was relative gold.
At the same time, a country’s currency was also relative to currencies from other countries, right? How does that work?
Urg . . . just thinking about economics makes my head ache. Here’s a fairly straightforward explanation of the gold standard that might help with some of the basics.
Urg . . . just thinking about economics makes my head ache.
Oh shoot. You too, huh? I was hoping I’d find people who could help. Wasn’t Robert work as an investor?
Thanks for the link. Hopefully, it’s clearer than some of the others I’ve read online.
I’ll do my best.
Most of what you say is accurate enough to the point that you do get the general gist of the importance of the gold standard. In answer to your specific question
“Does the value of gold only fluctuate now because we’re not on the GS?”
No. Say we had one world currency, only one. Call it gold. It would still fluctuate in terms of “buying power”, that is to say the amount of gold available would have to stand to represent the total number of goods and services available and thus your ability to buy those goods or services with whatever portion of the currency known as gold that you have. Thus, if you inject more goods or services, you lessen the purchasing power of gold.
Expand beyond one currency into multiple, and you have various currencies’ purchasing power in relationship to each other, and thus fluctuating values of currency. Even if you simplified the world by making one currency, there’s still barter and trade and so on. Values fluctuate as a principle of economics, though I think the method I have of explaining this is incomplete and maybe even raise the hairs of some economists.
The point is, though, “In other words, under the GS, there wasn’t a paper money value attached to gold, as it was sort of at a set value.” —> There’s no “set value” of economics as a general rule, though you are correct that “the value of a country’s currency was relative gold.” NOW it’s relative to the consumer power of the country that supports it; the dollar is valuable because Americans have the largest economy in the world (until China takes over), and so as part of the largest economy in the world, everyone else values the dollar.
As for the sterling silver, it operates in much the same way as gold and silver can also be valued in terms of its relation to gold.
Off-hand political niggling, anybody who is telling you right now to buy gold is either somebody who has gold to sell, or someone convinced by the people who have gold to sell. Had to inject that in there.
Thus, if you inject more goods or services, you lessen the purchasing power of gold.
But if you inject more goods and services to the point of surplus, wouldn’t that lower the price of those goods and services, thereby increasing the purchasing power of gold?
Does the value of gold only fluctuate now because we’re not on the GS?
You said, No. But if you go back to when the world used the GS, the value of gold didn’t fluctuate did it? It was the value of the paper currencies that fluctuated, right? Or is that wrong?
I assume now the price of gold fluctuates because the value is based on paper currency (so the roles of paper currency and gold are flip-flopped).
NOW it’s relative to the consumer power of the country that supports it; the dollar is valuable because Americans have the largest economy in the world (until China takes over)
But wasn’t the British pound worth more than the dollar?
? How much was sterling silver worth in relative to gold? Doesn’t that have to be answered? I’m confused about this.
OK, I have some questions based on that link Matt posted:
The gold standard was a commitment by participating countries to fix the prices of their domestic currencies in terms of a specified amount of gold.
So if a country has 100 tons of gold, the country would have then calculate the value of the gold in terms of the currency? For example, the U.S. might decide that one ounce of gold would be worth $20.00.
I also want to ask a question of overvaluing a currency. In the 20’s Britain overvalued its currency by 10%. What does this mean exactly?
I wouldn’t call myself that level of an economics expert but I have taken a few economics courses so I’ll answer what I can.
The reason folks like Ron Paul want money tied to the gold standard is that there exists a school of economics called monetarism which tries to manipulate the economy by controlling the supply of money. People from the Austrian school of economics, such as Paul, believe that such manipulation can’t have any more than short term effects and will cause a devaluation of money in the long term.
People who want you to buy gold have a poor understanding of the Austrian school of economics.
What I want to know is how would a country determine the value of its currency based on the amount of gold it had? And what would it mean to overvalue, undervalue or get the paper currency just right? Do you have any ideas?
So if you had a 100 tons of gold, how would you divide this into units of paper currency? (I’m not sure if I’m even framing the question correctly.)
It hasn’t always even been gold. The whole origin of paper notes were deeds to iron stores. Gold was just a very precious metal that was conveniently stored in a huge heavily secure fort.
The issue isn’t whether to tie money to gold, the issue is whether the government should be printing money that doesn’t represent ownership of any tangible good. What we essentially have right now is Tinkerbell money. If people stop believing in it, it dies. Fancy pieces of paper that are only valuable because other people value them. Money as an icon of faith.
The value of gold? That depends on how much people value gold products relative to other products. It’s assumed gold will always be valued for it’s use in producing luxury items. People value it because it can be used for something: People value paper dollars because they know other people value them and for no other reason. From that perspective, having a gold standard, or a standard of some measurable material, is more stable.
You might want to look at this too, Jazz, as it’s talking about the same issue as your book.
" how would a country determine the value of its currency based on the amount of gold it had?"
I’m not sure what you’re asking. In 1834, the United States fixed the price of gold at $20.67 per ounce and it stayed that way until 1933. Do you mean how was it decided that x amount of gold = 1 dollar?
“The reason folks like Ron Paul want money tied to the gold standard is that there exists a school of economics called monetarism which tries to manipulate the economy by controlling the supply of money. People from the Austrian school of economics, such as Paul, believe that such manipulation can’t have any more than short term effects and will cause a devaluation of money in the long term.”
Yeah, but the whole reason everyone abandoned the gold standard in the first place is that during the Depression hordes of speculators demanded gold in exchange for their currency, threatening the very solvency of the various national monetary systems.
Do you mean how was it decided that x amount of gold = 1 dollar?
Yes! Is the value based on some fraction of the total weight of gold that the country has?
Just to be clear, I’m not asking the questions I am because I’m considering GS as a viable replacement for the current financial structure. I’m actually just trying understand the concept in general—as well as other concepts related to finances and money.
Matt said, Yeah, but the whole reason everyone abandoned the gold standard in the first place is that during the Depression hordes of speculators demanded gold in exchange for their currency, threatening the very solvency of the various national monetary systems.
The other drawback is that if the currency is tied to gold, then this limits a country’s ability to borrow or print more money based on the amount of gold they have. For people who don’t like the idea of debt and don’t trust the government to be fiscally responsible, this is an appealing idea, but this restriction can have some serious and painful consequences (e.g., people losing jobs, etc.). At least, that’s my understanding of the concept so far.
The thing about Libertarian ideas regarding economic policy is that while there may be some sense to it, in practical terms, it often requires large numbers of people to go through some seriously painful situations. For example, with the recent financial collapse, without government bailouts, the government wouldn’t have accrued large debts, and maybe in a few years the economy would have bounced back in a healthy way. But in those few years, a lot of people would have suffered dramatically, more than likely—and we’re not just talking about banks and Wall Street types. Not sure if the government would have remained intact in such a circumstance either (look at the riots in Greece). Anyway, based on my limited knowledge, this is the sense I get.
“Yes! Is the value based on some fraction of the total weight of gold that the country has?”
Jazz, gold is not valued in terms of dollars and dollars are not valued in terms of gold. Both are valued only by how much people value them, those values created via different means, as explained above.
“Is the value based on some fraction of the total weight of gold that the country has?”
It’s sort of convoluted. In most cases the value of a given national currency is ultimately tied to that of another country. Back in the very early days of the US, we starting minted silver dollar coins, and these coins circuited alongside Spanish dollars According to the Coinage Act of 1792, the value of the dollar was therefore linked to the value of the peso and Spanish dollar at 1 dollar=1 peso/Spanish dollar or between 371 grains of silver (the weight of of the the average Spanish dollar in circulation in the US at the time.
But, yeah, theoretically on a strict gold standard, the value of gold a nation is holding in reserve should be equal to the total value of all the the paper money that government has issued.
See, but how did they come up with the 371 number?
This may be totally wrong and stupid, but here’s my guess: the government decides or determines how much currency is circulating in their economy and divide that by the weight of the gold they possess.
But I’m still confused about how you can overvalue your currency in this set-up. That’s what really put Britain in a bind in the 1920s. Apparently, their currency was 10% too high, and they had to deflate their currency, which would cause jobs losses and a recession, or something really damaging like that. (My memory is fuzzy now.) But I don’t quite understand how the British government overvalued the currency or how the currency came to be that way.
“how did they come up with the 371 number”
I was the weight of the Spanish silver coins in circulation at the time.
“I’m still confused about how you can overvalue your currency in this set-up.”
My guess would be it was due to aftereffects of WWI.
But did they determine the weight of the coin based on the amount of gold or silver they had, plus the amount of currency they wanted? And in the case of a paper currency, would they do the same thing except the paper bill would represent a certain weight of gold?
I’m looking at a more general explanation based on a principles or theory. See what I mean? (My understanding is very, very minimal about this subject—if that’s not already obvious. :)
So, if we studied the WWI’s aftereffects on the overvaluing of currency, how would we explain that? (Btw, I’m going to have to check the books, but I think the government set the rate of the currency in relation to gold, and I believe that’s where the mistake occurred. Of course, that mistake might have stemmed from aftereffects of the war.)
I’m not championing the gold standard, and I’m surely not an expert enough to say for sure which is better than the other.
But, a staunch libertarian would argue that allowing people to go through pain in the short term will prevent them going through a lot more pain in the long term.
I don’t know which is correct, but I’m pretty sure reckless borrowing and just printing money that doesn’t represent anything tangible is awfully reckless. Yeah, I could make things a lot easier for myself in the short term by charging up my credit card. That doesn’t make it a good plan.
My brother is 26 and lives at home, and is kinda-sorta looking for a job but not really. He got a new computer for Christmas and bought an XBox despite having no income, and he pays no rent or utilities. He’d go through a painful situation if our mother kicked him out on his butt, but a year later he’d be much better off. He’d have a job.
And I’m pretty sure, if money was required to represent some existing tangible good, as opposed to nothing, the market wouldn’t react so violently to every economic event that happens anywhere in the world.
The key depends on what we mean by “short” and “pain.” Suppose “short” means 2-5 years. That’s relatively short in relation to an entire country. But for individuals, that’s not so short—especially if by “pain” we mean unemployment, losing one’s home/becoming homelss, etc. Now, suppose we’re talking tens or hundreds of thousands of individuals, if not more? That’s a whole heck of a lot of hurt. Pain can also mean crime, lawlessness and political unrest to the point where government itself is threatened. That last point isn’t so far-fetched if the government took a do-nothing approach, just waiting to the economy to right itself. Indeed, even if the Libertarian view might be good in the long run, the “short” term cost might be politically impossible. (The approach is really a tough sell, isn’t it? Thousands of people losing their jobs, and the government’s response, “Doing anything would be worse. We’ve just got to wait and be patient.” I don’t think that would fly.)
I don’t advocate reckless borrowing or printing of money, either—but given the circumstances, I don’t think the government’s deficit spending was reckless—just the opposite in fact. Now, when the economy gets back on its feet, employment gets better, if the government doesn’t do something about the deficit and debt, then we can talk about recklessness.
(We’re getting off subject here, though.)
I have a friend who’s a really dogmatic libertarian, and when I brought up these same arguments, he told me “If we don’t let the economy bottom out now, it will crash even worse later.”
I don’t know if that’s true, but he certainly didn’t pull it out of his ass, it’s what the Austrian school of economics predicted, and that also predicted the current recession. If that is true, it means the decision is between 2-5 million jobs lost now and then a stronger recovery, or 20-50 million jobs lost later on, and America being in fifty years where Greece is now.
I repeat, I don’t know if that is the case, but if it were the case, wouldn’t it be worth it?
If that is true, it means the decision is between 2-5 million jobs lost now and then a stronger recovery, or 20-50 million jobs lost later on…
I guess if you could show a) we have a high chance of losing 20-50 million jobs in the future because of government stimulus; b) that doing nothing would only result in 2-5 million jobs and would have a high chance of saving 20-50 million jobs, then I would consider this position more seriously. I don’t get the sense that short term government deficit spending—even excessive amounts—will lead to irrevocable and catastrophic damage to the economy in the future.
Well I mean, the whole “Too Big to Fail” argument dictated supplying untold amounts of dollars we don’t have to protect the jobs of few (not just the CEOs, mind, but people who worked for those companies too), resulting in an economic recession which lost the jobs of many. Would we be better off now if we had let those big companies fail? I would like to think so.
But dogmatic libertarians are wanting things to fail that are designed for the specific purpose of making sure that when things fail, the entire society does not. The phoenix myth of regrowth from ruins is compelling, and especially attracts the political nihilists in us, but then again, so does the movie Fight Club. Jerry Johnson, I think, posted on a separate thread that we can easily match our deficit if we cut defense, health care, and pensions in half (apologies to Jerry if I am misattributing the argument). I crunched the numbers and found that to be the case, though I cannot make an argument for how to cut those things that much (ironically, I set about crunching the numbers to disprove the statement and was surprised to discover the math held out). I have some ideas (tort reform, police fraudulent insurance claims, return military R&D to bidding with required due dates for results, as well as do what we are in fact doing with retraction from Iraq and Afghanistan), but I cannot claim it’ll fix the whole problem. A similar issue is that of carbon emissions. A sustainable global emissions is 350ppm, we are currently at 392 and counting as the result of developing countries adding to the weight and first world countries not reducing enough. Again, small fixes (wind power, policing poachers, microagricultures, more efficient food preservation and delivery) but no big solution. Many dogmatic environmentalists envision solutions that basically get rid of the comforts of modern life altogether, an overly romantic notion of a pure nature that simply doesn’t change the fact that people are here to stay and consume things. A 350ppm global goal is perfectly possible, even if I do not know exactly how. Solutions to the problem exist without nixing out the entire structure that involves the problem in the first place. It is excessive to smash pottery because chips have appeared on the lids, even if the chips show signs of becoming cracks that will cause the whole thing to fall apart.
That’s the social implications. Your example of your brother is a good example of the ways in which people these days do overconsume/overspend (speaking both environmentally and economically) without producing anything substantial or reducing waste. However, one subject I’m somewhat interested in right now is the idea of the post-scarcity world, basically the simple fact that your brother’s lifestyle is possible at all. Now don’t get me wrong: the description you give is of a lazy, unethical person who needs a swift kick. However, part of the problem of our economy is that we’re still trying to “grow” it well past the point of human needs and even comfort. “We’re the 99%” doesn’t change the fact that we’re the 1% as far as much of the rest of the world is concerned. Even our poor can afford an occasional pizza (that’s killing them due to their lack of health care). We’re sort of in a weird place, is what I’m saying. We shouldn’t be telling women, as some social conservatives still do, to stay at home to do the cooking, but we may very well be heading to a world where it becomes socially acceptable for people to stay home and never work — as long as they do the cooking, otherwise they get a swift kick.
And yes Jazz, we’re getting off topic but that’s sort of okay here I think.
“Suppose “short” means 2-5 years.”
The fact is that we shouldn’t expect for this recession to let up for another decade, if we’re lucky. It might let up sooner and, back to that libertarian philosophy, it may be bad simply because it teaches us that everything will just naturally rebound, even if the root issues of the problem (overconsumption, greed, waste, debt) are not fixed. It looks to be going in that direction right now, unfortunately. Newspapers are reporting with hope-filled words increased spending on…. luxury goods. I.e., in many economic perspectives and most Western social values, all that glitters IS an underlying sign of gold.
OK, but I do want to get back to some issues from the book. (Part of the reason I’m reading this book and trying to understand the economic concepts is so that I can better understand what’s going on now.)
Would we be better off now if we had let those big companies fail? I would like to think so.
My sense is that most reasonable economists would disagree. I don’t really want to go into my thoughts on the matter as that would really spiral this thread way off course. Plus, it’s a highly complicated subject, and I’m completely out of my depth.
“And I’m pretty sure, if money was required to represent some existing tangible good, as opposed to nothing, the market wouldn’t react so violently to every economic event that happens anywhere in the world.”
How would you explain the Great Depression, then?
“how would we explain that?”
Basically, stable values depend on the relative free flow of gold, etc., between countries. The war disrupted this, and also countries printed additional currency because they had to cover their war debts and didn’t necessarily have access to additional gold stores to cover it.
“I think the government set the rate of the currency in relation to gold, and I believe that’s where the mistake occurred. "
Right, essentially currencies including the pound had lost purchasing power during the war (due to inflation, drain of currency and the suspension of the gold standard). The US however, immediately came out in 1918 and announced they would maintain the dollar price of gold at its prewar level. This put the British in a position where they felt they had to match the US rate—even though the pound was not worth as much as the dollar—or risk undermining international confidence in the pound. So that’s how it ended up being “overvalued” in terms of the economic theory of the day.
I think a lot of economists today would argue why not simple go off the gold standard at this point rather than reattach to it at a point at which the established price of gold was no longer an accurate reflection of what the currency was actually worth in the UK?
I think a lot of economists today would argue why not simple go off the gold standard at this point rather than reattach to it at a point at which the established price of gold was no longer an accurate reflection of what the currency was actually worth in the UK (ultimately causing high prices and high unemployment).
In this sample of leading economists, 100% of disagreed with the claim that returning to a gold standard would improve price-stability or employment outcomes. Nobody even answered uncertain, because this question really isn’t up for debate anymore.
Interesting article. I wish it was more in-depth, going especially into greater detail about why the economists agree and how they go about formulating their arguments/thinking of these issues. The first section especially is the most controversial issue and the articles flat summary can come off as offensive to people who are arguing these values in more depth. Nevertheless, I think the strength of the article is its concept of certainty (scientific certainty, which unfortunately soft sciences like economics are a little less objective) is reflected by the no-nonsense connotation of its word usage.
Thanks for the link, DiB. I have about a 100 pages to go.
Sorry for the lack of participation and response. Formulating my thoughts has been a bit too time consuming, so I haven’t been able to participate as much as I would have wanted to. Maybe later when I finish the book.
I just finished the book, and I have a zillion questions—but I’m having trouble articulating them, and I don’t know where to start.
Some general thoughts about what I learned:
>Economic activity, especially on large scale (national and international economic activity), seem very psychology. Indeed, the actions taken by policymakers and bankers are means to an end—the end being dispeling fears, restoring confidence in the system and hope for the future. As long as a lot of people have this positive outlook, the economy will or can be OK. At the same time, the converse is also true.
This is interesting because the economy sometimes is based more on psychology than economic principles or theories (not that the latter isn’t important), and it has some important implications. For one thing, world leaders, like the Potus, and bankers can almost never be entirely candid if the economic situation is awlful. Doing so could potentially lead to negative attitudes and perceptions that could lead to a downward spiral of the economy. So they almost always have to put a positive spin on things—not doing so would be irresponsible. This is important, because some might criticize or blame world leaders for not telling the truth. But this is one situation where not telling the complete truth is probably the more responsible action.
>In the case of a large-scale financial crisis, governments and central banks have to act quickly before things spiral out of control. Momentum is really important—preventing negative momentum and spurring a positive one. That really seems to be the key. (Or am I missing something?) When I say “act quickly,” what kind of acts am I thinking of specifically? I’m not sure, to be honest—but my sense is that the actions involve injecting a lot of money into the system or helping countries or banks by suspending debt payments. (I’m struggling here, so if anyone can help me out, that would be nice. :)
>The author concludes several factors that were preventable lead to the world financial crisis in the 30s. First, placing large debts on nations—Germany from F and GB and the U.S. to European countries—after WWI. I believe this not only drained economic resources for each country, leaving them vulnerable, but it also didn’t foster good relations between countries; second, world bankers going back to the gold standard. My understanding is that one of the reasons this was bad was that it limited options for governments. (There are other reasons, but I don’t understand them well.); finally, the author sites quick decisive action from central banks (maybe governments as well)—that many central bankers took too long to act or did not have the flexibility to act.
>Events in the 1920s and 30s seem to echo our time now. For example, the mistrust central bankers and institutions like the Fed. The book doesn’t really discuss whether the central bankers acted in good faith or if they were acting mainly for their own interests and those of the financial sector, but I get the sense that they did act in good faith—or saving the financial sector was basically tantamount to saving the larger economy.
But I’m wondering if there are variety of ways of helping the economy recover—some better than others—and that maybe the bankers don’t choose the best route because the best route doesn’t necessarily help them. Just a thought.
>I still don’t have a good grasp of the basic principles involving the relationship between interest rates, employment, the value of the currency and the value of goods. :(