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Tuesday, December 2, 2008

The Great Depression: Part I

Archduke Ferdinand and Family

Some have been asking me to embark on a historical tour of the economic history of the Great Depression via my blog.

That's a good here is Part I of what will be an extensive and multi-entry posting. I hope you enjoy the ride, we have a ways to go.

Let's start at the start...reason number one for the Great Depression can be placed at the feet of World War I. It is somewhat disturbing to read original historical documents from this era as they only refer to "The War". Of course they did not know about the wars to follow as this was to be the war to end all wars. The carnage is ghastly and ghoulish to reflect upon. In a major battle such as the Battle of Verdun, over one million casualties occurred as the weapons of modern warfare had advanced but the tactics of battle had not. It was a machine gun war with Civil War tactics.

Anyway, the social, political, financial and economic upheaval that resulted from WWI was never to be replaced after the war was over. The world had changed drastically but all the world's leaders wanted to do was go back to the pre-1914 days where all believed it was a better world. The only trouble was there was no piecing it back together. The mechanisms in the pre-WWI world that promoted stability, such as flexible wages and prices and cooperation and coordination amoung countries on the gold standard were nowhere to be found after 1918. So the leaders around the globe went reaching for what they knew and set the world up for the next calamity. Most all countries set about restoring the gold standard after it had been suspended during WWI, and the seeds for the coming Depression had been sown.

Here is a nice summary of this very topic in an exchange I had with Peter Temin in my second book:

Randall Parker: If I could try to sum up, if you’ll indulge me, we can break it down later if you want. One of the major un-doings was the shock from World War I and the Depression should be viewed in the context of the overall second Thirty Years War trying to re-establish the status quo ante in a changed world leading to contraction and a sustained downturn. World War I was the shock and the propagating mechanism was the gold standard. The resumption of the gold standard announced the continuation of the policy regime that existed before the War. But more than this, it was the fundamental adherence to the gold standard mentality, that it was a prerequisite for prosperity, that actions outside of it were not in the realm of discussion and were not taken seriously and that deflation was the prescription and the only way to cope with falling demand. This mentality and the universal commitment to this system, and thus the difficulty for any one country to take independent action, determined the depth and severity of the Depression and drove the world economy into the ground. Does this about sum it up?

Peter Temin: Yes. I think that’s quite a good summary.

The re-establishment of the gold standard brought about the recession of 1920-1921 and that recession was reason number two for the Great Depression. We shall have more to say in this regard in my next Great Depression posting.

For anyone with an interest in a deeper analysis, Peter Temin's Lessons from the Great Depression and Barry Eichengreen's Golden Fetters are two books that are not to be missed.

And anyone who wants to read a debate I got into with CNBC's Donald Luskin about re-establishing the gold standard (I took the "no" side) can follow that debate here:

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