The gold standard and the euro-area†
Summary of paper submitted to
“The euro: (Greek) tragedy or Europe‟s destiny?
Economic, historical and legal perspectives on the common currency”
Scott Andrew Urban*
†
JEL codes N24, F33, F34
* D.Phil. candidate, St Antony‟s College, Oxford. scott.urban@gmail.com
The gold standard and the euro-area
The euro is only the most recent European effort at monetary union. The closest recent
parallel is the interwar gold standard. In both cases, membership is hard-won and
ostensibly irrevocable -- i.e. without provision for exit. In both cases, the exchange rate as
a means of adjustment is gone. In both cases, the sovereign borrows in a currency over
which it has no control. Among other things, this entails a serious constraint on the lender-
of-last-resort role of the monetary authority. Such LOLR is unimportant in times of
growth. Here the parallel between the euro-area story and the interwar gold standard is
ominous. Capital inflows supported the balance of payments of the continental WWI
belligerents in the 1920s; EMU saw a surge in capital flows to the periphery in the 2000s.1
What happens in the event of a „sudden stop‟? In both cases, upholding the monetary
order is deemed paramount. Opinions in the interwar period equated maintenance of the
gold standard with the survival of civilization; EU politicians equate euro-area integrity
with the fortunes of the „European project‟. Both of these contentions preclude an
adjustment strategy which has a role for money creation and exchange-rate adjustment.
Instead, the response in both cases is a concerted attempt to draw economic adjustment out
of wages and prices, while seeking initially to protect the status of creditors. In the
language of the monetary „trilemma‟, preservation of the monetary order and open
financial borders trumps policy independence.2
As is clear from history, such efforts were not sustainable in the interwar period.
Moreover, when departure from the fixed-rate monetary order finally arrived, it usually
turned a country‟s fortunes. This made the ex-ante predictions of financial catastrophe
look foolish. If anything, such predictions merely prolonged the pain of internally based
adjustment and put off the day when the economy could start growing again. The
prevailing view today is that austerity in the name of the gold standard turned a bad
recession into the Great Depression.3
This paper traces the evolution of today‟s parallels with events circa 1931, while outlining
some very crucial differences. It conjectures what might be in store if further 1931-type
dynamics are to play out. Among the pressing questions are the outlook for open trade, the
financial linkages by which „unconnected‟ economies are affected, and the role played by
the world‟s large external-surplus economies. The paper asks how the policy consensus
forms around a path with limited empirical foundations, and, lastly, draws out implications
for a preferable policy in the current context.
1
European monetary unions include the pre-WW1 gold standard and the Latin Monetary Union. See Redish,
A., „The Latin Monetary Union and the emergence of the international gold standard' in M. Bordo and F.
Cappie, Monetary Regimes in Transition (Cambridge, 1993). On USA lending to Europe, see Lary, H.B.,
The United States in the World Economy, 1919-1939 (Washington DC, 1943).
2
An example of interwar policy urgency to uphold the gold standard is UK Cabinet Papers 219(31):
„Memoranda distributed by the Prime Minister to the cabinet: Sterling and the Gold Standard‟. Fears of
hyperinflation were much sharper then, but still colour conventional wisdom in Frankfurt today. For an
interwar viewpoint, see "The End of an Epoch", Economist (September 26, 1931), 547. On the trilemma, see
Obstfeld, M., et al., „The trilemma in history: tradeoffs among exchange rates, monetary policies, and capital
mobility‟, Review of Economics and Statistics 87:3 (August 2005), 423-438.
3
Eichengreen, B., Golden Fetters: The Gold Standard and the Great Depression, 1919-1939 (Oxford,
1992). Whether Berlin could have reflated without illiberalism is debated. See Ritschl, A., „Reparation
transfers, the Borchardt hypothesis and the Great Depression in Germany, 1929–32: A guided tour for hard-
headed Keynesians‟, European Review of Economic History 2 (1998), 49-72.