The Gold Standard Didn’t Create the Great Depression, the Federal Reserve Did

Today, conventional discourse leads us to believe that the Great Depression was created by a failure of laissez-faire economics—by a failure of the free market and an unregulated economy. This is the narrative that has been constructed and is now perpetuated in all classes of political science and history taught to students.

The Great Depression

Many intellectuals and economists have furthered this narrative by asserting that the gold standard was the real cause of the market failure, thus government intervention was consequently legitimate to rescue the economy. This is a myth that must be debunked before it polarizes forthcoming generations. As Dr. Murray Rothbard, who was a strong proponent of laissez-faire economics, once famously said of the Great Depression:

What was the trouble? Economic theory demonstrates that only governmental inflation can generate a boom-and-bust cycle and that the depression will be prolonged and aggravated by inflationist and other interventionary measures. In contrast to the myth of laissez-faire, we have shown in this book how government intervention generated the unsound boom of the 1920s, and how Hoover’s new departure aggravated the Great Depression by massive measures of interference.

The guilt for the Great Depression must, at long last, be lifted from the shoulders of the free-market economy and placed where it properly belongs: at the doors of politicians, bureaucrats, and the mass of enlightened economists. And in any other depression, past or future, the story will be the same.

The Gold Standard 

The gold standard did not generate the crash of the stock market of 1929, but the Federal Reserve did. By definition, the gold standard is a monetary system in which the value of money is determined by a physical commodity—mainly gold because gold has been the most precious and trusted metal to convey trades. In 1861, Treasury Secretary Salmon Chase signed the US Paper Certificate, which enabled individuals to exchange paper money for a set amount of gold. In 1900, the Gold Standard Act was enacted to make gold the legal tender that would determine the value of the dollar.

So, the value of gold was set at $20.67 an ounce; therefore, one dollar was equal to one-twentieth of an ounce of gold. The pure and classical gold standard was effective from 1870 to 1914. Individuals used gold as commodity money because it guaranteed that the government would redeem any amount of paper money for its value in gold. Furthermore, the gold standard was mainly trusted as backed-commodity money because it kept inflation relatively low and sustainable. In 1913, the Federal Reserve was created by Congress to be used as a lender of last resort due to bank panics. It established that the Federal Reserve’s main objective was to maintain the value of gold during the period of bank panics.

The leaders of the Federal Reserve committed an irreparable mistake that unfortunately led to the Great Depression.

In 1914, the United States was engaged in World War I and could not subsidize its military expenditures by solely relying on the gold standard. President Woodrow Wilson took the United States economy off the gold standard and used the Federal Reserve to print more money so the United States government could supply its military arsenal during the war. The early 1920s saw the rise of the Federal Reserve as the central authority as it became the regulator of the value of gold during the Pre-World War II era.

Though they thought they were doing the right thing, the leaders of the Federal Reserve committed an irreparable mistake that unfortunately led to the Great Depression. They imposed a policy that allowed the Federal Reserve to control the loans and credits it would offer to commercial banks. This is how the Real Bills Doctrine was implemented.

According to a study conducted by Professor Richard H. Timberlake, who has extensively researched the Real Bills Doctrine and monetary policy, the theory of the Real Bills Doctrine states that the unrestricted issuing of money in exchange for real bills will not cause excessive inflation from undue increases in the money supply and that doing so will not cause bank failure from illiquidity.

The Real Bills Doctrine

So, the Federal Reserve supplied an excess of money to commercial banks during times of economic expansion. According to another study conducted by Professor Lawrence H. White and published by the Cato Institute, the Real Bills Doctrine

wrongly takes the nominal quantity demanded of a particular type of credit as a reliable guide to the nominal quantity of money the public wants to hold.

Moreover, Professor White argues that the Real Bills Doctrine incorrectly made the redeemability of bank liabilities an unimportant aspect in the process that determined the quantity of money. In effectuating the Real Bills Doctrine during the 1920s, leaders of the Federal Reserve did not include an alternative response to counter bank panics during times of economic recession.

The accumulation of the excess of money supplied to commercial banks by the Federal Reserve generated a substantial deflation. Prices of goods and services significantly shrank below zero percent of the inflation rate, and this deflation subsequently created the crash of the stock market in 1929.

Don’t Blame the Gold Standard

When Franklin Delano Roosevelt became president, one of his major acts as the most powerful man in America was to increase the value of gold by enacting the Gold Reserve Act. The value of gold increased from $20.67 an ounce to $35 an ounce. Enacted in 1934, the Gold Reserve Act asserted that gold could no longer be privately owned. The law required that gold certificates held by the Federal Reserve through private ownership be surrendered and vested in the Department of the Treasury.

The federal government did not need to take full control of the money supply to restore the economy.

Only licensed jewelers were allowed to have gold for sales purposes. The Gold Reserve Act was the primary policy that, in fact, took the United States off the gold standard before it was utterly dissolved by President Nixon in 1971. The Gold Reserve Act entrenched the nationalization of money and epitomized a clear, unjustified encroachment of the central government on the economy. The federal government did not need to take full control of the money supply to restore the economy.

The Federal Reserve could have changed its monetary policy while leaving commercial banks with the power to freely establish their own exchange rates without government interference. Based on this history, it is clear that the gold standard did not create the Great Depression—but the Federal Reserve did.