Another extract from my book-in-progress, Economic Consequences of the Pandemic
The 20-year armistice from 1919 to 1939 was a period of economic stagnation in Europe, punctuated by crises which had disastrous economic and political effects. And while the US boomed in the 1920s, the Great Depression that began in 1929 caused massive unemployment and suffering which lasted through the 1930s. What lessons can we learn for the present?
The most important is the danger of ‘austerity’ policies based on the perceived need for governments to balance budgets and ‘tighten their belts’. Keynes’ second great polemic, The Economic Consequences of Mr Churchill was a critique of the austerity policies of Winston Churchill, then Chancellor of the Exchequer (equivalent to Treasury Secretary) in the Conservative government of Stanley Baldwin.
Churchill’s critical mistake was made in 1925 when he announced that Britain’s return to the gold standard. Before the outbreak of the Great War, both the British pound and the US dollar had been convertible to gold at fixed rates, such that one pound sterling was worth $4.86. By imposing exchange controls when war broke out, Britain effectively ended convertibility and left the gold standard.
Churchill’s decision restored the pre-war exchange rate, even though the price level in Britain had risen substantially faster than in the US. This implied the need for a sharp deflation, driven by budget cuts and credit restrictions. The inevitable outcome was an increase in unemployment rates. Churchill’s decision was the culmination of a long period of austerity policies aimed at driving down price levels, which had already pushed the rate of unemployment towards 10 per cent. Unemployment remained at or above this level until the return to war in 1939, at which point it vanished almost instantly.
Churchill’s policies were disastrous, but the damage was mostly limited to Britain. Far worse in its consequences was the austerity policy adopted by Heinrich Bruning, the Chancellor of Germany from 1930 to 1932 in response to the Great Depression. The resulting upsurge in unemployment produced massive social discontent. Bruning was forced from office and replaced, after a brief interval, by Adolf Hitler. Repudiating Bruning’s austerity policies, Hitler adopted a policy of large scale spending on public works and military expansion which greatly reduced unemployment. This success increased his popularity and allowed him to crush his opponents without significant resistance.
These examples are the rule rather than the exception. Austerity policies have almost invariably failed as a response to depression and unemployment. Further examples ….
Despite its disastrous consequences, Bruning’s austerity policies have been forgotten almost entirely. The same can’t be said of the German hyperinflation of 1923 (discussed in detail later). The Imperial German government had relied heavily on inflation and debt to finance the war, relying on the spoils it expected to seize to resolve its problems. Instead, its democratic successor inherited high levels of debt and continuing inflation, along with the reparations imposed under Versailles. When the government tried to support striking workers in the French-occupied Ruhr valley and acquire gold to pay reparations at the same time, it had no tax revenue to cover the costs. Instead it relied on printing money which depreciated rapidly.
The hyperinflation caused less suffering than the Great Depression. Nevertheless, it wiped out the savings of millions of people and contributed both to radicalisation and to the embrace of austerity policies in Germany, not only in the 1930s, but right down to the present day.
There’s no serious prospect of inflation now, and there won’t be for years to come. But that doesn’t mean that it’s safe to rely on money creation rather than taxation to finance large new public spending programs. It took ten years for the German mark to go from gold-backed hard currency to worthless paper. The process could have been stopped earlier. But, as we learned in the 1970s and 1980s, squeezing inflation out of a system is a painful process.
To sum up, we can draw two lessons from the economic failures of the 20-year armistice.
First and most importantly, market economies do not automatically tend towards full employment . Governments must be willing to fill the gap when private consumption and investment expenditure is inadequate. Conversely, in the rarer case when private demand is excessive, governments and central banks must act to constrain demand to a level consistent with the productive capacity of the economy.
Second, the ordinary operations of government require resources that must, in the end, be supplied by taxation. Attempting to deliver substantially increased public expenditure while leaving private expenditure untouched will run up against the constraints imposed by the productive capacity of the economy. These constraints will initially be reflected in shortages, queues and reduced quality and ultimately inflation.
John Quiggin 
Very good and precise account of that economic and social roller-coaster ride from the end of WWI to the very beginning of WWII. You are right about the failure to see that market economies do not self correct back to full employment once an external shock has disturbed that period of stability. John Maynard Keynes warned about this when he wrote that full employment equilibrium was precious and unique.
The role of Winston Churchill does bear some responsibility for the BOOM – BUST experiences of the this twenty year inter war period. As Zachary D. Carter pointed out in his book THE PRICE OF PEACE (pages 160-163) In the 1924 British parliamentary election Winston Churchill shamelessly switched parties to land the post as Chancellor of the Exchequer. The City of London was pressurizing the new Prime Minister Stanley Baldwin to “return Great Britain to the gold standard”.
There were more than one million unemployed persons in Britain at that time. This was the first time Britain had experienced double digit unemployment since 1887. British exports were still 25 percent BELOW pre war levels. John Maynard Keynes in his book A Tract on Monetary Reform, called on the Bank of England to stabilize the price level to promote “predictable commerce and social stability”. But the Bank of England chose to continue to deflate the pound (Between 1920 and 1925 by almost 30 percent). Their aim was to restore the exchange rates that had prevailed in 1913.
Classical economists in the 1920s, like the Austrian Ludwig von Mises, insisted that’
“unemployment is a problem of wages, not of work”.
John Maynard Keynes lampooned this “orthodox” explanation when he wrote:
“Blame it on the working man for working too little and getting paid too much.”.
In the Evening Standard article he wrote:
“Deflation does not reduce wages ‘automatically’. It reduces them by causing unemployment.”
Yet when the Wall Street crash sent businesses broke in 1929, the Bank of England advice to business owners was just three words:
“RETRENCH! RETRENCH! RETRENCH!”
In July 25, 1924 John Maynard Keynes wrote to Charles Addis:
“Are you quite sure that the rigid linking up of the London and New York money markets is all honey?
It means that we should become, without any power of helping ourselves, the victim of every inflationary boom that America may indulge in.”
All this is very chilling given that it happened AFTER a pandemic and in an era of large sovereign debts.
John, are you able to consult the German language literature on this topics given the robust debates between schools that occurred pre and post WWII here. I would be wary of relying on English languages accounts.
I find Adam Tooze very useful here as he move easily between the languages.
American readers will expect some discussion of the New De
.. Deal’s inconsi
… inconsist
“Nevertheless, it [hyperinflation] wiped out the savings of millions of people and contributed both to radicalisation and to the embrace of austerity policies in Germany, not only in the 1930s, but right down to the present day.”
JQ, the last part of the above quote isn’t well supported by data, except to the extent that the term ‘austerity’ refers to ‘frugal’ or not wasteful or careless rather than the predominant macro-economic meaning in the anglo-saxon literature.
Germany (West until 1990) had budget deficits during the period 1969 to 2014 and again now. As a result of unfunded government spending to finance the unification of the East and West (infrastructure and social welfare payments) Germany breached the Stability and Growth Pact of the EU in 2000. A special unification tax (Solidarity Penny) was introduced and levied on all but the lowest of income earners with some progressiveness in the tax rates. It is still in place for the top income earners. In response to the global financial crisis, Germany followed a Keynesian approach with increases in public debt. In 2009, the constitution was amended to prevent unbounded growth in government debt by limiting “structural deficit” to .35% of GDP (Schuldenbremse meaning debt brake). Schäuble’s 2014 budget was the first since 1969 with a zero budget deficit (this became known as “die schwarze Null” (the black zero). The pursuit of the black zero has been called a fetish or a obsession. This pursuit has been thrown out the window in 2020 with the Finance Minister, Scholz, announcing a ‘bazooka’ of financial assistance in response to the coronavirus pandemic and he openly declared that the policy response is Keynesian. Moreover, he claimed it worked in response to the GFC.
To the best of my knowledge, it is the case that, relative to say the USA population, the German population, including the medium sized private companies, are not fond of debt, particularly consumer debt and governments that are careful in financial matters are preferred.
Memo to self: stop trying to comment from a phone. Memo to John: comments editing please!.And you can delete the dud comments. Trying again.
American readers will expect a mention of the New Deal, rather half-hearted on the macroeconomic front. The UK was roughly parallel, with Neville Chamberlain’s cautious and unavowed Keynesianism. IIRC France was in the austerity camp apart from the brief Popular Font government of Blum: France escaped fascism, but it was a bigger threat than in the UK or USA. Interestingly, after 1940 Vichy France had some quite progressive social polices: creation of child allowances and an occupational health service. Subject to correction, I don’t think it rolled back the Popular Front’s main social achievements like the 40-hour week.
As you all recall, the Popular Font government tried to impose Comic Sans as a universal standard. This was fortunately unsuccessful, like the inconsistent Nazi support of “Aryan” blackletter typefaces. Fraktur was first lauded, then banned.
https://www.wired.com/2017/05/how-fonts-are-fueling-the-culture-wars/
JQ- “The most important is the danger of ‘austerity’ policies ”
Cory Doctrow nailing it
” American Lysenkoism kills”!
“How Republicans froze Texas solid
“The GOP ideology holds that businesses are “efficient” because every penny they squeeze out of their costs is converted to profit. There’s a kernel of truth to this – indeed, the most prominent early theorist of this was Karl Marx!
…” Stalin insisted on applying Lysenkoism to wheat cultivation, to prove that his ideology would work. The result was the famine of 1932-3, which killed tens of millions of people. So many people that there weren’t enough survivors to count the dead.
“The Republican insistence that selfishness is optimal, that companies should only care about maximizing shareholder returns, that deregulation produces efficiencies, that states cannot perform – this is American Lysenkoism.
“American Lysenkoism is why Red States like Texas refused to lock down and have told each county to design its own vaccination and public health program. It’s also why those states refuse climate science.
“American Lysenkoism kills. It’s why the pandemic has killed 500k Americans. It’s why so many Texans are in danger of freezing to death now. It’s also why Republicans – the “party of life” – are performatively refusing to care about these deaths. “…
https://pluralistic.net/2021/02/19/texas-lysenko/#mess-with-texas
JQ, when reading your post again it struck me that the fundamental problem of the 20 year armistice is not macro-economic in nature but it is the horrific wastage of resources of imperial wars or more generally all wars that are not purely defensive.
In no way is the above comment to diminish the crucial difference between the 19th and early 20th century belief in the self-regulatory laissez-faire system of resource allocation and Keynes’ writings, including the important sentence to the effect that ‘the wrong people have the money’. Indeed, the fact that imperial powers and imperial wars happened means that those who promoted the idea of laissez-faire economics did not believe in it or failed to recognise the contradiction; IMHO.
In the meantime we learned to distinguish between local and general stability of an economic system. A disturbance such as China no longer buying barley from Australia is an example of an external disturbance when viewed from the perspective of Australian growers. However, it is local in so far as it did not upset the entire Australian economy and I hear barley growers have already found new markets – a small scale example of local stability of the system. Military conflicts, such as WWI and WWII, Vietnam, …., I should think destabilise any economic system.
As to inflation, it seems to me the cause for government deficits and ‘printing money’ is crucial. As you wrote not long ago, deficits to finance investments have a different impact on ‘the economy’, including inflation, from deficit to finance current expenditure. I would argue deficits and ‘printing money’ to finance destructive activities such as wars have a different impact to those used to finance the survival of people and businesses such as during the current pandemic. Destructive activities result in a severe shortage of resources and therefore ‘inflation’ (as measured in macro-models) – the devaluation of savings held in currency units for future consumption – will follow.
Where does this leave the global financial crisis? It was destructive, more so in some regions of the global economy than in others. The crisis was curtailed by government deficits and printing money (quantitative easing). Asset price inflation followed and wealth inequality increased. The wrong people have the money (that was printed to prevent further damages to what is sometimes called ‘the real economy’.)
Wars and financial crises are human made. A pandemic is, to the best of my knowledge, a natural phenomenon.
The monetary system is human made. Wouldn’t it be sweet if one could nicely separate deficits and money printing due to destructive human actions (wars and financial crises) from deficits and money printing due to saving resources (people and businesses) that are at risk due to a natural phenomenon such as a pandemic. To the best of my knowledge the balance sheet model of money does not allow such a separation.
KT2: Can you cite any historian of the Holodomor who blames Lysenko (a dangerous charlatan to be sure) rather than Stalin? IIRC the method of the genocide was not compulsion to plant the wrong crops, but forced cellectivisation and infeasible requisitions of Ukrainian harvests, including the seeds needed for the next one.
Ernestine for Treasurer.
” Wouldn’t it be sweet if one could nicely separate deficits and money printing due to destructive human actions (wars and financial crises) from deficits and money printing due to saving resources (people and businesses) that are at risk due to a natural phenomenon such as a pandemic. ”
James, IIRC, I’ll reply in the next sandpit.