SSU Summer Lesson #2:
Mundell on Gold

Jude Wanniski
June 19/20, 2005


To: Ben.S.Bernanke@***.gov
Subject: SSU Summer Lesson #2: Mundell on Gold
Bcc: Bob Mundell, Bill Mundell, Poly, Eichengreen, Dick Gilder, David Howe
From: Jude Wanniski
10:02 am, 6/20/2005


You're exactly right. Mundell's take on the Crash and the Great Depression was more or less along your lines when I met him in May 1974, believing there was a "shortage of gold specie" after WWI ended and that there should have been  a dollar/gold devaluation so the world gold stock would go further. But he was the fellow who taught me what I know now about monetary theory -- although I tacked on insights by reading Marx and Von Mises and others. It was Mundell's teachings that led me on a search for what REALLY caused the Crash of 1929.  My aim at that time was to rescue Say's Law of Markets. I remember calling Bob from my desk at the WSJ a few days after I made the discovery in March 77 and he was so excited he urged that I drop work on "The Way the World Works" and do a separate book on 1929. (Which I couldn't do). In subsequent years, though, he downplayed my discovery to what I thought was the degree necessary to make it compatible with the ideas he held earlier.

I had the same experience with Alan Reynolds, who was a protege of Milton Friedman's when I met him in 1977 (working as chief economist for the National Review).  Alan subsequently became Poly's chief economist and I turned him into a supply-sider, for which Milton never forgave me or Alan. Nevertheless, while Alan came to thoroughly accept my thesis on the Crash, he still held to the monetarist view that he had learned at Milton's feet, i.e., that the contraction of the money supply in the early 1930s contributed to the intensity of the Great Depression. I always saw that the money supply had to contract when the exchange economy had no need for the liquidity in supply when there would be so many fewer transactions as a result of the contraction (not deflation). Otherwise we would have had a Great Stagflation.

When you say we returned to gold at the wrong parity, what do you mean by that? $20.67 oz?? The dollar never really floated during WWI, which means it remained constant as the unit of account. Prices of goods climbed because the government was running big deficits to finance purchases for war, but there was no "price inflation" in the monetary sense. Non-war goods, real estate, etc., did not climb, and when the war ended and the government cancelled contracts, those producers who had geared up for more war sales were stuck with excess inventories. Prices had to fall back to pre-war levels at the gold parity of $20.67.  The only true deflation was in Britain where sterling had floated above its longtime parity with gold and Churchill brought it back in 1925.

In other words, I cannot find any evidence that Mundell's early belief on the scarcity of specie was the cause of the economic distress. When FDR devalued in stages in 1933-34 to $35, there was no relief in aggregate, only an inflation that was coupled with progressive tax rates to produce an early example of bracket creep.... deepening the Depression.

The biggest change in Bob's thinking since 1997 when he gave the lecture has been in his acceptance that raising or lowering the funds rate is not the way to manage monetary policy. He originally taught me that only by the Fed's buying or selling bonds from its portfolio would cause the dollar to become more or less scarce relative to gold. I think he believed moving the funds rate would accomplish that objective in a roundabout way, but it clearly has not.  But I hate to be putting words in his mouth. You really should make contact with him. I think he would be extremely pleased to see that you took the trouble of reading his 97 lecture.


-----Original Message-----
From: Ben.S.Bernanke@* * * * *.gov
Sent: Sunday, June 19, 2005 9:40 AM
To: Supply-Side University
Subject: SSU Summer Lesson #2: Mundell on Gold


I can't help but note that Mundell's view of the Depression is close to the Eichengreen-Bernanke view --- that returning to gold at the wrong parity (and, I would add, with unstable institutional and political underpinnings) led to a falling price level and had a major contractionary effect in the late 1920s and early 1930s.  Of course, one can blame a mismanaged gold standard for bad outcomes in the 1930s while still believing (as Mundell clearly does) that a properly structured gold-based system would work well.