I am currently about one half way through an excellent book entitled “American Default“, by Sebastian Edwards. The primary focus of the book is the abrogation of the gold clause in debt contracts, which (I believe) is the only time the US federal government actually defaulted on its debt. But the book also provides a fascinating narrative of FDR’s decision to devalue the dollar in 1933-34.
Here’s what I noticed about FDR:
1. His decision to devalue the dollar went against the advice of most experts, although initially there was also substantial support.
2. Over the course of time, FDR became more and more extreme in his views on gold, mostly under the influence of George Warren. Warren was a heterodox economist who was then (and still is) viewed as something of a crackpot. In my view, this reputation is unwarranted.
3. FDR could be a bit mischievous. He seemed to delight in provoking and shocking conventional opinion. At the June 1933 World Monetary Conference in London, FDR’s advisors worked out a series of tentative agreements with the major European powers to re-establish exchange rate stability. Each time, FDR would reject the agreement suggested by his own advisors, and ask for more. A new agreement would be negotiated which seemed to address FDR’s concerns, and he would then proceed to reject even that agreement. Eventually he made it clear that he would not accept any plausible compromise, and the conference fell apart.
4. FDR put a lot of weight on the reaction of asset prices, especially stocks and commodities, to his policy initiatives.
I don’t know about you, but this sort of reminds me of President Trump. Think of Peter Navarro as Trump’s George Warren. Navarro favors the sort of protectionism that is anathema to most conventional economists. Trump uses the stock market as an index of how he’s doing. Trump can be mischievous, delighting in shocking conventional opinion. Trump can change his views suddenly—seeming to back an agreement and then suddenly walking away, asking for more. Or completely losing interest in making an agreement (on something like DACA.)
Of course I believe that George Warren was a brilliant economist whereas I think Peter Navarro is deeply misguided. But my subjective opinion is not very important. On the other hand I do see one important objective difference between these two cases. While Warren was viewed as a crackpot by respectable opinion, the stock and commodity markets actually supported his policy of depreciating the dollar. (When I say they “supported” the policy, I mean that asset prices rose on unexpected news of further devaluation, presumably markets don’t literally think.)
On the other hand, markets seem opposed to protectionist policies, falling on news that makes protectionism more likely. If Peter Navarro were fired tomorrow, and replaced with Gary Cohn, stocks would probably rise sharply. And this makes the Trump case slightly different, in an interesting way. Trump presumably notices the adverse reaction of Wall Street to protectionist policies. That doesn’t stop these policies entirely, but may put a sort of brake on how far he goes.
This is the familiar “circularity problem” with monetary policy. What if the markets watch the Fed, and the Fed watches the markets for signs that policy is too easy or too tight? Then in the case of an excessively tight policy, the markets must take account of not just the likely effect of the policy on the economy, but also the likely effect of any resulting market crash on Fed policy. Thus the market response may understate the true impact of the policy, if carried through unmodified. Markets are already looking ahead to the policymaker repairing the damage.
In a perfect world, I would not want policy being made in response to the stock market. But if the policymaker’s instincts are misguided, it’s probably better that they do pay some attention to how markets are reacting to their initiatives.
I’ll have more to say about Edwards’ book in future posts–I encourage people interested in economic history, gold, and the Great Depression to take a look—it’s much more readable than my Depression book.
PS. The book is also of interest to people who follow the law, as the last part of the book focuses on a key Supreme Court case on the abrogation of the gold clause in contracts. Spoiler alert!! The outcome was quite similar to the Obamacare case, where one conservative justice swung to the liberal side for pragmatic reasons, to prevent a controversial rejection of an important public policy initiative.
PPS. There is a related post over at TheMoneyIllusion.
READER COMMENTS
Andrew_FL
Jun 7 2018 at 1:55pm
Warren’s own charts in this book indicate that by ca 1935 or so, prices had fallen far below the level one would expect based on the historical relationship between gold and prices
Philo
Jun 7 2018 at 2:10pm
I doubt that thinking about a perfect world has any pragmatic value. In a perfect world we would all behave optimally without the need for governmental “policy”–indeed, without any need for government at all.
I think you mean that in a world very similar to what we actually have but with a different policy-making process the best such process would include little or no reliance on following the stock market. But I do not see why you want to shun this source of information. I note that you do propose relying (for some purposes) on an NGDP futures market.
Scott Sumner
Jun 7 2018 at 4:00pm
Andrew, That’s right, and reflects a big increase in the demand for gold. But you could also argue that despite this big miss, the monetarist and Keynesian models did even worse.
Philo, Perhaps I should have said it’s often better than nothing, but you’d generally prefer to rely on other metrics—such as NGDP futures prices in the case of monetary policy.
Lorenzo from Oz
Jun 7 2018 at 8:30pm
Do we know what Warren thought of NIRA?
Conscience of a Citizen
Jun 7 2018 at 11:12pm
Why is it surprising or particularly gratifying that nominal asset prices rise after a currency devaluation? It’s almost tautological! (See http://www.latimes.com/world/mexico-americas/la-fg-venezuela-inflation-0531-snap-htmlstory.html).
The Roosevelt devaluation punished cash holders and fixed-income savers and rewarded net borrowers and leaseholders by transferring wealth from the former to the latter. The uncompensated abrogation of private gold clauses was clearly unconstitutional. It didn’t relieve the Depression, and may well have prolonged it.
Of course, the Roosevelt devaluation was more of an acknowledgement than an action– the dollar had already been debased but no one had told the public that many dollars had been printed without gold backing. The Fed wanted Roosevelt to devalue as a way for the government and cronies to welsh on their debts.
E. Harding
Jun 8 2018 at 1:02am
Surprisingly solid post.
“In a perfect world, I would not want policy being made in response to the stock market.”
Why’s this? Externalities?
“it’s much more readable than my Depression book.”
Your Depression book’s great; don’t knock it.
E. Harding
Jun 8 2018 at 1:06am
“It didn’t relieve the Depression, and may well have prolonged it.”
It was among the only things FDR did that relieved the Depression. Any theory of FDR’s impact on the economy has to reckon with the fact he was both elected and re-elected in giant landslides.
Robert EV
Jun 8 2018 at 10:34am
Not too surprising given that Trump, FDR, (and LBJ) share the same basic personality type.
The last, and possibly only, president with my basic personality type was Coolidge.
Some kinds of people are just more electable than others.
Scott Sumner
Jun 8 2018 at 5:59pm
Lorenzo, Not certain, but I’d guess he opposed it.
Harding, There are certain policies, say stronger environment controls, or shifting the tax burden from corporations to small businesses, or making income more equal, that might be beneficial despite hurting the stock market. But I do accept the argument that the two are often correlated, at least I think it’s more likely to be true than if you asked a left wing progressive the same question.
Robert, Good point. Obama is the recent president most like me in personality, albeit not in economic philosophy. I like both aspects of Coolidge.
Gary Anderson
Jun 9 2018 at 1:43pm
Trump is very consistently crazy. He has always viewed our allies as sponges. He has always viewed strong leaders like we see in China and Russia as men to be admired. He has always wanted to be king.
Whether he acts on those views is another matter. But it has to be disturbing that he has these views.
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