Our Depression Obsession

The Great Depression of the 1930s was the most momentous economic event of the 20th century. It was a proximate cause of World War II, having fed the Nazis' rise in Germany. It inspired a new American welfare system as a response to mass misery. Everywhere, it discredited unsupervised capitalism. Given today's economic crisis, our renewed fascination with the Depression is natural. But we ought to be cautious in stretching the parallels too far.

It's worth recalling how exceptional the Depression was. As Liaquat Ahamed writes in his engrossing "Lords of Finance":

"During a three-year period, real GDP [gross domestic product] in the major economies fell by over 25 percent, a quarter of the adult male population was thrown out of work … The economic turmoil created hardships in every corner of the globe, from the prairies of Canada to the teeming cities of Asia."

In this well-researched and elegantly written book, Ahamed—a professional money manager—attributes the Depression to two central causes: the misguided restoration of the gold standard in the 1920s and the massive intergovernmental debts, including German reparations, resulting from World War I.

Up to a point, his narrative builds upon the previous scholarship of economists Milton Friedman, Anna Schwartz, Charles Kindleberger, Barry Eichengreen and Peter Temin. But where Ahamed excels is in evoking the political, social and personal forces that led to disastrous economic decisions. His title refers to the four men who heavily engineered the era's perverse policies: Montagu Norman, governor of the Bank of England; Benjamin Strong, head of the New York Federal Reserve Bank; Émile Moreau, head of the Banque de France; and Hjalmar Schacht, head of Germany's Reichsbank.

Determined to reinstate the gold standard—seen as a precondition of global prosperity—they cooperated and quarreled. But "all the thought and work and good intentions," as Norman wrote years later, "achieved absolutely nothing." Just the opposite: they set the world on the path to ruin.

The gold standard required that paper money be backed by gold reserves. If gold flowed into a country (normally from a trade surplus or a foreign loan), the country's money and credit supply were supposed to expand. If gold flowed out, money and credit were supposed to contract. During World War I, Europe's governments had suspended the gold standard. They financed the war with paper money and loans from America. The devotion to the gold standard presumed that it alone could make paper money trustworthy and, thereby, instill economic confidence.