Episode 253: Gold Standard, R.I.P. : Planet Money On today's Planet Money: The gold standard and the Great Depression. It's the latest in our gold series.

Episode 253: Gold Standard, R.I.P.

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Hey, PLANET MONEY listeners. It's David. Every so often we like to actually buy something in order to better understand it. In 2010, we bought a toxic asset - you all named it Toxie. Toxie eventually died. Next week we are going to buy something new. And to set the stage, we are re-airing a couple stories we did in 2011 when we bought a gold coin.

In the last episode, we met a charming guy who made an argument for going back to the gold standard. Today we tell you what actually happened when the world was on a gold standard and why most economists think it's best we just put the whole thing behind us. Here it is.


BRIGHT EYES: (Singing) If I could change my mind, change the paradigm...


Hello, and welcome to PLANET MONEY. I'm Jacob Goldstein.

KESTENBAUM: And I'm David Kestenbaum.

GOLDSTEIN: Today on the podcast, the story of a coded message that one of the world's most powerful bankers totally does not understand.

KESTENBAUM: Also, the story of how Franklin Delano Roosevelt ignored the advice of America's big-name economists and listened instead to a guy who helped him take care of his trees.


KESTENBAUM: Almost everyone we talked to about the gold standard told us that it is not just a bad idea, it's actually a dangerous one.

GOLDSTEIN: Take, for example, the economist Randy Parker from East Carolina University. He seemed like a very easy going guy, but when we asked him about the gold standard, he got all serious on us.


RANDALL PARKER: I think that it is a pernicious anachronism that should be kept in the history books. And to think that modern people today want to speak about its resurrection should absolutely horrify and terrify anyone who understands economics even a little bit.

KESTENBAUM: He actually said it should die the death of a thousand stings.

GOLDSTEIN: Yeah, he's not kidding around when it comes to the gold standard. And the reason he thinks this and - I don't know, say 99 percent of his colleagues think this and hate the gold standard so much is they say it caused the modern world's worst financial disaster. They say it caused the Great Depression.

KESTENBAUM: And just to set the stage, back then, all the key economic powers in the world - England, France, Germany, the United States, even Japan, they are all on the gold standard. Austria, Canada, Czechoslovakia, Denmark, Estonia, Finland, Latvia, Poland, Norway, New Zealand and even Australia - they are all on the gold standard.

GOLDSTEIN: I think you were doing circular breathing there, Kestenbaum. That was very impressive. So now remember, this - in a way it's not that surprising because gold and money have basically been synonymous forever. You've got gold coins going back to 2000 B.C. And in England, they've been on some form of the gold standard since the 1700s when Isaac Newton - yes, that Isaac Newton - ran the Mint.

KESTENBAUM: So that's the way things had been up until 1931, which is where we pick up the story. In 1931, there's a man with a pointy beard who is running England's central bank. His name is Montagu Norman. So England is the most powerful economic force on earth at the time. So he is the most important central banker on the planet. And by all accounts, he's a very wise man, a very smart man, and somewhat eccentric. We talked about Montagu Norman with Liaquat Ahamed, who wrote a book about this era called "Lords Of Finance."


LIAQUAT AHAMED: In contrast to most bankers of the time who dressed in, you know, top hat and frock coat, and had long whiskers, he was a very unusual looking man. He had this big, black floppy hat, a cape, an Emerald tie pin, a sort of Van Dyke beard. The New York Times described him as looking like the chief conspirator out of an Italian opera.

KESTENBAUM: Reporters loved Montagu Norman and Montagu Norman loved to hide from reporters. Ahamed writes that he once jumped over the side of a ship in high seas to avoid the press - basically got into a dinghy and slipped away before the ship got to port where the reporters had gathered.

GOLDSTEIN: Now unfortunately for Montagu Norman, in 1931, reporters had a lot of questions for him. The world was falling apart, stock markets were way down, unemployment was way up, banks were collapsing.

KESTENBAUM: And the gold standard was becoming a big problem. So just to review, the way the gold standard worked was that every major currency in the world was backed by gold. In the U.S., you could take $20.67 and the government had to give you an ounce of gold. In England, it was four pounds 86 pence for an ounce of gold. That was fixed. And in normal times, people didn't even really think about trading in their money for gold. They were perfectly happy with their paper dollars and their paper pounds.

GOLDSTEIN: But of course 1931 was not normal times. People were saying, you know what? I don't trust my paper pounds. I'm freaked out. I want gold. The stock market crashed in the U.S. Banks are going under. I'm worried the whole financial system might crash. So everybody started trading in their cash and demanding gold. And this was a big problem for Montagu Norman and the Bank of England.

KESTENBAUM: Because at some point, the Bank of England is going to run out of gold. So Montagu Norman has to stop this. And the only way to stop the rush of people converting their pounds for gold is to raise interest rates. Why raise interest rates? Well, if you raise interest rates, that's an incentive for people to hold on to their paper currency. People will say, OK, I won't trade it in for gold. If I keep it in the bank in England, I can earn all this interest.

GOLDSTEIN: And this is why economists today look back and say the gold standard was such a disaster. In times of crisis, you want to be doing the exact opposite of this. You want to be lowering interest rates to make it easier for business to borrow money and hire people to get the economy going. This is what we do now when we hit recessions.

KESTENBAUM: Again, Liaquat Ahamed.

AHAMED: So you have this perverse system whereby in the middle of the Great Depression with 15 percent unemployment, countries were raising interest rates. And that is essentially what converted what was a terrible depression into the Great Depression.

KESTENBAUM: This is Montagu Norman's dilemma - he has to raise interest rates to keep gold in his country, but by raising interest rates, he's causing the Great Depression.

GOLDSTEIN: Of course Montagu Norman does have another option, right? He could just say we're off the gold standard. You can no longer trade in 4 pounds and 86 pence for an ounce of gold. This would solve his problem. He wouldn't have to worry about the Bank of England running out of gold, so he wouldn't have to keep raising interest rates. But for Montagu Norman, the idea of going off the gold standard was insane. England was the world's biggest economic power, and in his mind, Britain's economy rested on the gold standard.

KESTENBAUM: So what does Montagu Norman do faced with this choice between two impossible paths - go off the gold standard or choke the economy by raising interest rates? What does he do? He collapses.

AHAMED: The sort of pressures of the job got to him and he collapsed one day.

KESTENBAUM: Like loses consciousness, or...

AHAMED: Yeah. I mean, he would - he just couldn't get out of bed. And I don't quite know what all of the symptoms are of a nervous breakdown, but he basically couldn't function and would have terrible headaches. And so his doctor told him that you're going to have to leave the country and go on a rest cure.

KESTENBAUM: This is the most important central banker on the planet at the time.

AHAMED: Yeah. During the worst financial crisis.

GOLDSTEIN: It's basically like Ben Bernanke taking a vacation the day after Lehman Brothers goes bankrupt.

AHAMED: Yeah, or the week before actually. So, you know - and Ben Bernanke's doctors telling him, God, you know, you're not functioning. I'm afraid you're going to have to just leave the country and go off somewhere.

KESTENBAUM: I suppose he was worried that if he did the wrong thing, he was going to bring the entirety of civilization to a halt.

AHAMED: Well, that's exactly - you know, he thought that the entire - the future of Western civilization was in his hands.

GOLDSTEIN: So with the future of Western civilization in his hands, Montagu Norman gets on a ship and takes a trip to Canada. He writes in his diary, quote, "feeling queer." And then while he's gone - actually while he's on the ship on his way back home to England, the people he's left in charge - they decide, you know, we said we weren't going to do this but we have to do it. We have to abandon the gold standard because if we don't, we, the Bank of England, we're going to run out of gold.

KESTENBAUM: And they have to notify the boss, Montagu Norman. So they send Montagu Norman this cable in code - remember, he's on the ship coming home. And the cable reads, sorry we have to go off tomorrow and cannot wait to see you before doing so.

GOLDSTEIN: And Montagu Norman, he actually thinks this just means, oh my friend's going to be out of the office when I get back. But, of course, what the cable means is we're off the gold standard. They're not leaving work early. They're taking one of the most radical steps in the history of finance. And not only is England catapulting itself into this crazy new world where money is just paper, they're also setting up what will be a chain reaction around the world.

KESTENBAUM: So to understand this, imagine two people in London the day before England goes off the gold standard. Both have 20 pounds in cash money. One of them goes to the bank that day and trades in his pounds for gold. He gets about five ounces of gold, just like it's always been. The other guy, he holds onto his paper money. All right, next day Montagu Norman's colleagues at the Bank of England drop the bomb - boom - England's off the gold standard. What that means in practice is that when England cuts those strings tying the pound to the gold standard, the pound drops in value.

GOLDSTEIN: So this guy who traded in his pounds for gold, he made a smart move, he did great. His five ounces of gold are now worth more than 20 pounds. He just made money by getting rid of his pounds before England went off the gold standard. The other guy, the guy who kept his pounds, he's the sucker. And obviously nobody wants to be a sucker.

KESTENBAUM: So people all over the world see England go off the gold standard - England, the mightiest economy in the world. And they worry. Will my government do the same thing? Am I going to be the next sucker? So as their economies get worse, they start turning in their paper money for gold - including people here in the United States.


FRANKLIN D. ROOSEVELT: Because of undermined confidence on the part of the public, there was a general rush by a large portion of our population to turn bank deposits into currency or gold.

KESTENBAUM: This is FDR's first fireside chat on March 12, 1933. The U.S. has just had the mother of all bank runs. People are afraid that banks are going to fail, so they're yanking their dollars out. And they're also worried that the U.S. will follow England and abandon the gold standard. So a lot of people are trading in their dollars for gold. People are hoarding cash and gold. And FDR is really upset about that.


ROOSEVELT: Let me make it clear to you that the banks will take care of all needs, except, of course, the hysterical demands of hoarders. And it is my belief that hoarding during the past week has become an exceedingly unfashionable pastime in every part of our nation.

GOLDSTEIN: But FDR is actually about to make a move that will take all those unfashionable gold hoarders and turn them into winners. Everybody who's not hoarding gold - FDR's about to turn them into suckers.

KESTENBAUM: Here's Barry Eichengreen. He's an economist at the University of California, Berkeley, and one of the world experts on the Great Depression and the gold standard.

BARRY EICHENGREEN: He's preparing to take the U.S. off the gold standard. He's preparing to say we will no longer pay out gold at a price of $20 an ounce.

KESTENBAUM: You know what's amazing to me? He doesn't say, look, I know a lot of people are really attached to the gold standard. It sounds like it makes sense, but it doesn't make sense, and I'm taking you off it.

GOLDSTEIN: He doesn't say that at all. It's sort of in code.

EICHENGREEN: Yeah he is kind of tiptoeing around the issue. And that's for two reasons. I think number one, to say the gold standard was a disaster, and we are abandoning it for something better, stay tuned for what that is wouldn't have been confidence inspiring. But the other part of the answer is that Roosevelt was kind of still grappling toward a full response to the crisis.

GOLDSTEIN: In fact, FDR's top economic advisers are saying to him, do not go off the gold standard. They basically felt the same way as Montagu Norman. Gold is the rock. It's holding everything together.

KESTENBAUM: But the U.S. is in the same bind that England was. If you stay on the gold standard, you got to keep raising interest rates, which is strangling the economy.

GOLDSTEIN: There is one guy advising FDR to leave the gold standard; a guy Liaquat Ahamed says was definitely not part of the economics establishment; a guy named George Warren.

AHAMED: FDR has been talking to this one crank, George Warren, who was his - who was a professor at Cornell who he had met because George Warren had helped him deal with some of his trees on his estate at Hyde Park.


GOLDSTEIN: What - his trees?

AHAMED: Yeah. He had a problem with some of his trees, you know, that they were - I don't know - suffering from some disease.

GOLDSTEIN: You don't imagine calling an economist in when you have that problem.

AHAMED: Well, he was an agricultural economist. And Cornell had a very famous school of agricultural economics.

KESTENBAUM: You write that he's known as an expert on cows and chickens.

AHAMED: Exactly.

KESTENBAUM: So this expert on cows and chickens had actually published a huge monograph on how the gold standard affected commodity prices in the economy. And he said you've got to leave the gold standard. It's the only way.

GOLDSTEIN: And FDR took his advice.

AHAMED: FDR comes into the room in the White House, and all his advisors had gathered around. And he announces - by the way, we're off the gold standard. He had introduced the decision to go off gold as an amendment, a sort of minor clause into, I think it was the Agricultural Adjustment Act.

GOLDSTEIN: He snuck it in.

AHAMED: He snuck it in.

KESTENBAUM: And he sits there in this room with all his advisors and says, I know you think I can't do this, but here it is. We pass this thing.

AHAMED: And they all exploded, and Dean Acheson resigned over it. He was the assistant secretary of the treasury. And one guy, one of Roosevelt's advisors, told him that, you know, this is going to be the end of western civilization.

KESTENBAUM: And Roosevelt is just kind of winging it here. He has this idea from the guy who helped him with his trees that now that he's off the gold standard, his hands are freed, and he can fix this thing he thinks is a key problem - falling prices.

GOLDSTEIN: This is what economists called deflation. And we've talked about this a lot on the podcast. Deflation means prices are dropping. And this can lead you into this thing called the deflationary spiral where prices start falling so businesses, they have to cut people's wages. People are getting lower wages so they don't spend as much money. So that means prices have to fall some more. And this just keeps going on and on, back and forth in this downward spiral.

KESTENBAUM: And imagine a business. Say I'm thinking of opening a shoe factory. I need to borrow money to get started, but borrowing money seems scary because it's going to be really hard to pay that money back if the price of shoes keeps dropping; if I'm going to have to charge less and less each year for shoes. So I don't borrow the money. I don't build the factory, and I don't hire anyone.

GOLDSTEIN: So FDR looks at this, and he thinks, I've got to stop prices from falling. I've got to push prices up. And the price of gold, it's linked to the price of everything else. So FDR starts raising the price of gold. He has the government start buying more and more gold so that the price of gold goes up and up and up. And Liaquat Ahamed says Roosevelt does this over breakfast.

AHAMED: You know, he would have his whatever - boiled eggs and toast - and he'd be lying in bed. And these guys would come in, and he'd say so how much should we raise the price of gold today? And one day he said, let's do it by 21 cents. And the other said, why 21 cents? He said, well, seven times three and, you know, that sounds like a good number.


KESTENBAUM: It's my lucky number.

GOLDSTEIN: It's lucky.

AHAMED: Yeah, I mean, it's completely absurd. (Laughter) There was no economic rationale, although, he sort of conveyed the image that this was a very well-thought-out sort of well-conceived plan.


KESTENBAUM: So this works.

AHAMED: It did work. And the U.S. got out of the Great Depression. Almost, you know, most economists now agree, 90 percent of the reason why the U.S. got out of the Great Depression was the break with gold.


ROOSEVELT: After all, there is an element in the readjustment of our financial system more important than currency, more important than gold. And that is the confidence of the people themselves.

KESTENBAUM: The Great Depression lasted for a long time after 1933, but 1933 - the year we went off the gold standard, that was the year things stopped getting worse and started getting better.

GOLDSTEIN: And as the economist Randall Parker points out, this was true all over the world.

PARKER: It's incredible and remarkable. The British left the gold standard in September of '31, and they instantly began to recover. We left the gold standard in March or April of 1933, we began to recover. The Spanish were never on the gold standard at all. They missed the great depression altogether.

GOLDSTEIN: You'd think Randall Parker is done, but he's not.

PARKER: President Takahashi at the Bank of Japan in 1931 saw trouble with the gold standard, took the Japanese off the gold standard in 1931. They recovered. The Belgians, the Pols and the French stayed on until 1936, long after we and England had left. And they continued to fall into the Great Depression until they left in 1936. So you look at the timing of this, when you recovered and when you left the gold standard are pretty much one to one.

KESTENBAUM: The great depression mortally wounded the gold standard, but it lived on in this strange sort of coma for decades.

GOLDSTEIN: After World War II, the world's big economic powers agreed to what became known as the Bretton Woods system. You can think of this as basically the world coming together and saying, yeah, OK, we know the gold standard blew up in our face, but we're actually too freaked out to get rid of gold altogether so we're going to make it work like this. The big currencies around the world, you can convert them into U.S. dollars at a fixed rate. And foreign governments, if they really want to, they can go to the U.S. government and trade their U.S. dollars for a fixed amount of gold.

KESTENBAUM: So that was there on paper as part of the agreement, but no one really did it in any sort of meaningful way, until the late 1960s when the economy started getting rocky again and people were worrying about inflation. Governments started making noises about trading in their dollars for gold. And just like in the 1930s, the president of the United States, this time Richard Nixon, says you know that thing about gold...


RICHARD NIXON: I directed Secretary Connelly to suspend temporarily the convertibility of the dollar into gold or other reserve assets.

GOLDSTEIN: Even though Nixon says here this is temporary, it's not. On August 15, 1971, Nixon ends up pulling the plug on the gold standard once and for all.

KESTENBAUM: So here's a history of money in one sentence from the beginning of time to 1971. We started out with gold coins, we moved to paper bills where we said trust us, we've got gold in a vault, to now where we just say trust us.

GOLDSTEIN: And in particular, we say trust a bunch of guys in a room. Trust the economists at the Federal Reserve and their counterparts at central banks all over the world because now it's their job to decide what money should be worth.

KESTENBAUM: The gold standard, economists say, that was crazy. A bunch of guys in a room, OK, also crazy, but less crazy.


BRIGHT EYES: (Singing) It's a shell game. It's a shell game.

GOLDSTEIN: To listen to all of the stories in our series on gold, visit the PLANET MONEY blog. That's at npr.org/money.

KESTENBAUM: And we really recommend the new NPR show Invisibilia. The latest episode is the story of a woman who has no fear. This is from some of the people who created This American Life and Radiolab - Lulu Miller and Alix Spiegel. You can get Invisibilia on iTunes or Stitcher or wherever you get your podcasts.

GOLDSTEIN: As always, email us at planetmoney@npr.org or visit us on Facebook to let us know what you think. I'm Jacob Goldstein.

KESTENBAUM: And I'm David Kestenbaum. Thank you for listening.


BRIGHT EYES: (Singing) We're never going to move it alone. Here it come, that heavy love, playing as the cylinder rolls. Here it come, that heavy love.

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