III. Depression and devaluation
We examined the difference between a depression and a recession, arguing that the former is a real contraction of economic activity, and the latter merely a contraction of monetary activity. We also examined the connection between the two forms of economic contraction, and discovered both historical and material links between them. Now, we will examine how recession emerges as a distinct and separate form of economic contraction by focusing on the relation between depression and currency devaluation.
The fact that the end of the Great Depression in 1933 and the beginning of the recovery is linked by economic studies to the end of the gold standard and devaluation — not just in the United States, but in all industrialized countries — should raise a question in your mind.
What magical quality does devaluation possess to rejuvenate an economy?
The answer to that question is, “None”.
If you consider a closed economy, devaluation cannot have any effect on the economy unless you, at the same time, covertly smuggle in an implicit assumption of something outside the economy which has greater purchasing power as a result of the devaluation. In an open economy, devaluation can help one nation if it reduces the prices of its output against the prices of another nation. The fall in the purchasing power of one nation’s currency is, at the same time, a rise in the purchasing power of the currencies of all other nations. This leads to increased exports for the devaluing nation and imports for the non-devaluing nations.
But, this was not the case for the Great Depression. Remember, according to the wiki, “Every major currency left the gold standard during the Great Depression.” While the timing of this devaluation varied by country, the world economy is a closed system. Thus, the net economic impact of such devaluations should have been zero. The timing of a country’s currency devaluation may partly explain why some countries recovered sooner than others, but it cannot explain why the world economy as a whole recovered.
If we control for the timing of such concerted devaluations, the other factor which can vary is the extent of the devaluation. One nation may devalue ten percent, while another devalues five percent, and a third devalues only three percent. Again, this may explain the impact on international trade, and the recovery of one nation versus another, but it does not provide for a global recovery. A country may devalue less than its peers, and so absorb the exports of those peers, but it suffers an offsetting fall in its own exports. Another country may devalue more than its peers, and so export more than its peers, but its peers will suffer an offsetting collective fall in their exports.
Devaluation is pretty much a zero sum game. Even if some country is prepared to step forward and become the designated importer for the global economy, devaluation cannot result in a global recovery — in this case a global recovery must result in an offsetting net loss of employment, output and trade for the designated importer country.
Yes, once again, we conclude economists are simpletons, who think the world is as silly and simple as they are. Try as they might, there is no possible explanation for why devaluation helped the world economy recover from the Great Depression. The change in the purchasing power of the various national currencies against each other offers us no solution to this paradox.
A clue is provided by Christina Romer, former economic adviser to the Messiah. In the words of the wiki:
According to Christina Romer, the money supply growth caused by huge international gold inflows was a crucial source of the recovery of the United States economy, and that the economy showed little sign of self-correction. The gold inflows were partly due to devaluation of the U.S. dollar and partly due to deterioration of the political situation in Europe.
If, you were the owner of gold, the purchasing power of your gold rose by 70 percent the moment President Roosevelt signed Executive Order 6102. Similar devaluations by other nations of their currencies would have had similar effects on the purchasing power of gold in those currencies. With the competitive devaluation waves sweeping the planet the owners of gold saw the purchasing power of their holdings increasing everywhere. At the bottom of the depression the devaluation of the national currency dumped a windfall into the laps of the owners of gold, who, already enjoyed the deflationary impact of the depression, now found a further drop of 70 percent in dollar prices provided gratis by Washington.
The price of everything fell in a global fire sale of currency devaluation. The owners of gold had their pick of a delightful platter of currencies from around the world, and unprecedentedly low wages. The existing stock of gold now sat, ready to be lent out, at the very point in the industrial cycle when assets, output and labor power already cheap because of deflation, could be had for a fraction of their actual value owing to the further appreciation of gold purchasing power resulting from currency devaluations in one country after another. The result was just about the largest single transfer of social wealth in human history into the coffers of the owners of gold hoards that had been safely moved to Switzerland in anticipation of just such an event.
In a fashion not unlike the American states, who distort their tax codes to attract investment by lavishing tax breaks on corporations, since the Great Depression every national government now engages in propping up the rate of profit by forcibly driving the price of labor power well below its real value through continuous currency depreciation against gold. It was not devaluation of currency that produced the recovery of the world economy from the Great Depression, it was the ruthless devaluation of wages — the price of labor power — that made recovery possible.
This devaluation is subject to certain conditions to which we must now turn our attention.