I think this article about Australia and the Great Depression might open up another chapter on that economic tragedy. It reveals that contrary to the standard view Australia in fact suffered a near monetary collapse and it was this massive deflation that sent the Australian economy into depression. It is a known fact that manufacturing led the recovery. What is revealed here is that though real wages (nominal wages divided by the price level) remained stable during the depression the real factory wage in terms of output fell by 43 per cent! It comes to the remarkable conclusion that Australia recovered not because of the Premiers’ Plan but because the Plan did so little while allowing prices to do their work.
A short time ago the Institute of Public Affairs published an article by Sinclair Davidson and Julie Novak on the same subject and how the Australian economy recovered from the Great Depression. The Davidson-Novak argument is that government spending cuts combined with leaving the gold standard in 1931, even though Australia was not on a gold standard at the time, generated the recovery. For this they praise the Premiers Plan. Gerry Jackson’s article refutes this view, pointing out that Sinclair Davidson and Julie Novak omitted any references to the role of money, prices and wage rates. Once these factors are included the pictures changes dramatically.
Australia and the Great Depression: What you don’t know but should
What makes the Australian experience particularly interesting is not just the fact that its massive economic contraction was not preceded by a boom1 but that its recovery was comparatively swift and reasonably balanced when compared with the rest of the world. On the other hand, the Roosevelt ‘recovery’ was largely “illusory” and heavily imbalanced2. It is invariably noted that the striking difference between the two economies is that while the Hoover and Roosevelt administrations increased spending substantially and ran deficits the Australian government cut spending and kept the budget in surplus.
Because the Australian recovery followed the cuts in government spending and a massive devaluation our free market commentariat drew the erroneous conclusion that these events must be the primary reason for recovery. There is no doubt in my mind that the cuts did indeed aid recovery but the idea that they played a prominent role in driving down the appalling unemployment rate and expanding production is grossly misleading. Since this idea has taken root it is necessary to examine it in greater detail. Let us begin with Sinclair Davidson3 who expressed what has become the orthodox view on our right:
Two things happened in 1931: Australia went off the gold standard and the Premiers’ Plan was adopted. Contra Rudd, the economic consequences of these events did not result in an economic rout, appalling unemployment, or negligible growth. Rather the economy made a massive recovery and unemployment began falling. (Five and a half big things Kevin Rudd doesn’t understand about the Australian economy and Rudd, Depressions and the lessons of history.)
Alas, if only it were that simple. Let us begin with Australia’s abandonment of the gold standard. Having looked at the facts I am inclined to agree with the Professor Schedvin that “it is doubtful if Australia was on the gold standard in anything more than name.4” However, she was definitely on a sterling-exchange standard — which basically amounted to gold-exchange standard5 — and had been even before WWI, a curious fact that few seem to have noticed.
When both countries ‘returned to gold’ on 30 April 1925 Australia did so at par. Unfortunately, Britain did not return to the classical gold standard but to a gold-bullion standard6 at the pre-war par of $4.86. (There had been considerable debate as to the appropriate exchange rate. Sadly, the wrong rate was chosen7.) Given that war-time inflation had driven the pound down against the US dollar it would have taken a significant deflation to successfully restore the exchange rate to its market-clearing pre-war level, an impossible task given the political situation. Australia was now pegged to an overvalued sterling.
From 1925 to 1929 the country’s wholesale prices fell by about 2 per cent while British wholesale prices fell by 15 per cent. Faced by rising domestic costs and prices out of kilter with world prices Australian manufacturing underwent a profits squeeze, investment fell and unemployment rose. It had become clear by 1927-28 that the country was in recession. The stark difference between British prices and Australian prices began to be reflected in the exchange rate with a premium on the British pound emerging in July of 1929. By March 1930 the premium was officially at 6.5 per cent while the market was quoting 8 per cent. The banking community fully understood that the situation was unsustainable and that the Australian currency would have to fall further, by how much was the only question.
By December 1930 Alfred Davidson, general manager of the Bank of New South Wales, was urging a rate of at least 113 be set by January 1931. Come 6 January he had the ‘Wales’ set the rate at 115: the other banks quickly did likewise. Seven days later he raised it to 118. The banking conference that was convened on 16 January passed a motion that on 17th the rate should be raised to 125. Under further pressure from Davidson the Associated Banks agreed that on 29th they would raise the rate to 130, in doing so they aroused considerable opposition from some Melbourne bankers. Nevertheless, on 29 January 1931 the exchange rate was set at 1308. (It was a clear case of better late than never.) Because of the 1931 devaluation (later fixed by the Commonwealth Bank at 125) some people have evidently concluded it also marked the year in which Australia left the gold standard. But as Professor Frederic Benham stated:
In December 1929 the free export of gold from Australia was forbidden by statute, which meant that Australia officially went “off” the gold standard9.
Benham was not alone in pinpointing December 1929 as the time that Australia abandoned gold. Given the historical evidence it is truly baffling as to how any informed person could conclude that the gold standard had been terminated in 1931. In addition, taking into account the manner in which the country’s so-called gold-standard was administered it is perfectly legitimate to argue that the 1929 statute was merely evidence that Schedvin is right and that Australia had not in fact been on a genuine gold standard.
Moreover, we can scarcely assert that the 1931 devaluation led, or at least contributed, to a sudden and “massive recovery” (by severely raising the price of imports) when unemployment in the third quarter of 1932 was over 29 per cent against an unemployment rate in the first quarter of 1931 of nearly 26 per cent. It should not take any significant devaluation some 18 months to make a substantial cut in unemployment. We also have to take note of the fact that a dramatic drop in imports actually preceded the 1931 devaluation. Therefore, to give credit to the devaluation for a recovery that did not begin until 15 months after the event is to stretch the bow beyond breaking point. None of this is to imply that the necessary exchange rate adjustment did not play a role in the recovery only that a great deal is missing from what has recently become the received wisdom.
Let us begin with the emergence of the depression. The total value of exports (excluding specie) for 1928-29 stood at £141,615,00010. Despite the 1929 premium on the British pound and the 1931devaluation the value of exports — in terms of sterling — had plunged by the year 1931-32 to 60 per cent of the 1928 value while the value of imports for the same period plummeted by an astonishing 69 per cent10. Virtually the whole of the massive drop in imports was due not to any devaluation but to the severe contraction in the national income which “in terms of sterling fell nearly 50 per cent by 1931-3211”. This fact is confirmed by the following table that shows unemployment rising as imports fell.
As we can see, the sudden and dramatic fall in imports and domestic incomes is accompanied by a massive rise in unemployment. This strongly suggests that Australia was suffering a severe deflation. One particular view of the depression holds the steep fall in commodity prices as the principal reason why national income plunged by about 30 per cent. Another has it that the cessation of long-term overseas borrowing was the real culprit. The finger of guilt is also frequently pointed at the London funds as the real villain of the piece. And it is at this point that our story begins to take another turn and becomes even more interesting.
The London funds (Australia’s foreign reserves) formed a mechanism which allowed the trading banks to keep enough funds in London to maintain the sterling-exchange rate. This means that the funds also governed the Australian banks’ domestic credit policy. In other words, they directed monetary policy. Hence, a continuing rise in imports would cause the London funds to fall forcing the banks to tighten domestic credit. The reverse would happen if exports continued to rise in excess of imports. The severest blow to the economy struck when the London funds fell from £52.912 million in March 1929 to £18.8 million in March 193013. This 64 per cent drop amounted to a monetary contraction the severity of which has yet to be appreciated.
However, Schedvin states (p. 207) that “Australia did not share with the United States a near monetary collapse.” Although this has become the orthodox view it is in fact not what the monetary aggregates actually show. From 1929 to 1933 America’s M1 (currency plus demand deposits) contracted by 27 per cent. Now Schedvin gives a figure of 10.5 per cent for Australia14. Yet from March 1929 to September 1930 Australia’s M1 contracted by 25 per cent. There was a slight expansion followed by a further contraction in the third quarter of 1931.
Therefore, from March 1929 to September 1931 M1 contracted by 28 per cent. Another monetary fact that is never raised is that from March 1929 to September 1932 demand deposits fell by 31 per cent. A contraction of this magnitude should be reflected in prices —and this is exactly what we find. Using 1928 as a base wholesale prices had fallen by nearly 26 per cent by March 1933 and retail prices by nearly 30 per cent. These figures clearly show that Australia’s deflation closely mirrored the scale of the American deflation15 and thereby refute Schedvin’s conclusion (p. 210) that there is no
significant relationship between contraction of the money stock and the fall in income and employment.
While M1 is used to define the money supply when discussing the American deflation Schedvin used the total money stock (M1 plus time deposits and savings deposits [p. 386]) to define the Australian money supply. This is akin to adding apples to oranges. One must always use the same definitions to avoid confusion. But this raises a question: which of these two definitions is the correct one? This is an old problem to which, I believe, Walter Boyd gave the definitive answer. In an open letter to Prime Minister Pitt in 1801 Boyd defined money in the following terms:
By the words ‘Means of Circulation’, ‘Circulating Medium’, and ‘Currency’, which are used almost as synonymous terms in this letter, I understand always ready money, whether consisting of Bank Notes or specie, in contradistinction to Bills of Exchange, Navy Bills, Exchequer Bills, or any other negotiable paper, which form no part of the circulating medium, as I have always understood that term. The latter is the Circulator; the former are merely objects of circulation16.
Boyd also defined demand deposits as money (p. 11).
Therefore credit instruments are not money because, as Colonel Torrens put it, they do not possess “the power of effecting final payments17”: they are merely a means of temporarily transferring purchasing power and that is why they cannot increase the money supply. Let us take as an example a couple that puts the wife’s wages in a savings deposit account and then live on the husband’s wage. The bank will in turn loan out those dollars. In principle, this would be no different from the wife making the loan herself. This is why the money stock remains unchanged. If the couple decide to withdraw their savings the bank must pay them out of its reserve or sell assets. The same reasoning applies to time deposits, certificates of deposit, bills of exchange18 and mutual funds19.
This leads us to consider a rather serious charge against Australian bankers. According to Schedvin (p. 204) the banks defined money as currency, meaning there could be no deflation if the amount of notes did not contract. If Schedvin is correct, then the banks were clinging to the old currency school fallacy that demand deposits were not part of the money supply. In fact, few people seem to realise that the currency school was divided on this issue with Colonel Torrens, James Pennington, George Arbuthnot and William Clay arguing that demand deposits are money. Unfortunately the opinions of David Ricardo and Samuel Jones-Loyd were the ones that carried the day. Their success in this matter had severe detrimental consequences for trade cycle theory.
Chart 1 reveals the true scale of the deflation. In March of 1928 M1 was 158.8. It then dropped to 151.5 from which point it rose to 158.6 in March 192820. It then went into a tailspin, reaching rock bottom at 114.7 in September 1931. This was a 27.7 per cent contraction. It was September 1933 before M1 began a steady expansion20.
The consequences were devastating: employment in manufacturing fell by 25 per cent while the value of manufacturing output shrank by 35 per cent. Another twist to the story now appears. Our free market commentariat focus heavily on the Premiers’ Plan which was implemented in 1931 and in which spending cuts played a key role. For these people the Premiers’ Plan is the principle cause of the recovery, except when it is the devaluation and the abandonment of the gold standard. However, the contention of this article is that the success of the Premiers’ Plan really lay in the fact that it did very little considering the political circumstances.
The heart of the plan consisted of a proposed 20 per cent cut in Commonwealth spending which included a 10 per cent cut in government salaries and wages. For the year ending on 30 June 1931 Commonwealth spending peaked at £68,585,546. The 1932 period saw spending fall to £61,004,576, an 11 per cent drop. Unemployment peaked in June 1932 at 30 per cent and then started to fall. From these figures one could deduce that the 11 per cent reduction in spending initiated the continuing fall in unemployment, except for the fact that total government spending also peaked in 1931 and then fell from £192,640,998 to £185,867,658, a mere 3 per cent drop.
Call me a pessimist if you will but I hardly think a modest 3.5 per cent fall in total government spending is going to initiate a rapid recovery in an economy that just suffered a massive monetary shock, even though the total cut in spending had expanded to 11 per cent by 1934. I am not denying that the reduced spending contributed to the recovery only that it did not generate it let alone sustain it. As the chart 2 shows, commonwealth expenditures rapidly increased from about mid-1933 and total spending started accelerating in 1934 even though state spending did not begin to rise again until 1935. This weakens the case of those who argue that reduced government spending spurred the recovery.
However, it is vitally important to stress that the Australian experience completely cuts the legs out from beneath the Keynesians. Compounding their embarrassment is the additional fact that the Commonwealth ran surpluses from the year 1931-32 until WWII. According to Keynesians deficit spending is an absolute necessity for economic recovery. Without it an economy would remain mired in depression. Chart 3 exposes this Keynesian recipe as totally bogus. Now the budget surplus for the year 1931-32 was £3,546,608. Yet the recovery began in early 1932 and continued at an accelerating pace until 1938 when there was a slight downturn. During this whole period the budget remained in surplus. This fact alone utterly refutes Keynesian dogma
What is curious about those who stress spending cuts as the deus ex machine that saved the economy is that the role of money, wages and prices is completely absent from their argument. One expects this omission from Keynesians but not free market economists. To understand why wages are the real key to the recovery we need to focus on manufacturing. Forty-three per cent of the unemployment rate was due to the loss of manufacturing jobs but it was manufacturing that also led the recovery with metals and machinery in the lead. It is important to understand that in the Commonwealth Year Books manufacturing means factories and a factory was defined as any “workshop or mill where four or more persons are employed or power is used.” It is clear that the sector covered a wide area of the economy. We shall now explain why it was the change in the real manufacturing wage relative to the value of manufacturing output that initiated the recovery and not government spending cuts.
When a country suffers a deflation (monetary contraction) prices fall. This means that if money wages remain unchanged persistent widespread unemployment will appear21. Now when an employer considers renting the services of more labour he does not think in terms of real wages, real prices or price levels. He deals only with the money prices of those services and whether they will pay for themselves. In short, he looks at the ratio of the money wage to the money value of those services. It follows that if the money value of those services falls below the money wage unemployment and idle capacity will emerge. This is precisely what you get with a deflation. The depression period is what the Austrian school of economics calls the adjustment process. (There is no denying how painful this process can be). Prices and costs must adjust to the new monetary conditions if full employment (a situation where anyone able and willing to work can find a job) is to be restored.
Chart 4 tells the true story. Instead of using the real wage (the money wage over the price level) which largely remained unchanged during the 1930s I took the ratio of the factory money wage to the total money value of factory output to produce what I called the real factory wage. I then set the index at 100 for the year 1928-29. As we can see, the monetary contraction caused the value of factory output to drop by nearly 35 per cent. Even though the factory money wage fell the real factory wage for the year 1930-31 rose to 130, a 30 per cent increase over 1928-29, and factory unemployment dived by 25 per cent. Once the real factory wage began to decline from its peak the fall in factory unemployment immediately flattened out. When the decline reached 125 a rise in the demand for additional labour appeared. From that point on we find a clear inverse correlation of -1 between the rise in factory employment and the decline in the real factory wage so that by the beginning of the year 1938-39 factory employment was 25 per cent above its 1928-29 level22.
It needs to be stressed, and was commented on at the time, that the recovery made its appearance in early 1932 and that it began in manufacturing and then steadily increased its pace. This is an important fact because it puts to rest the belief of many that the recovery started in 1933 and that the spending cuts were deflationary and caused a contraction. But if there had been a contraction then manufacturing would not have enjoyed an uninterrupted expansion. As the chart shows, unemployment peaked in 1932 after which it steadily fell. Note that the rise in the value of output, the demand for labour and the increase in the money supply23 tended to occur at the same time.
Chart 5 reveals the curious fact that from March 1932 to September 1933 M1 contracted by 10.2 per cent while the recovery continued without a pause. (This contraction is not distinct in chart 4 because the figures are annual). The contraction consisted entirely of deposits. As there was no change in interest rates a deliberate tightening of credit seems to be out of the question. However, a fall in the banks’ cash reserves of 23 per cent during the same period would account for the contraction.
Evan as the money supply shrank capital formation in money terms continued to increase unabated while interest rates on treasury bills, trading bank deposits, savings bank deposits, along with yields on long term bonds, continued an uninterrupted decline. So why didn’t the contraction abort or at least slowdown the recovery? The facts suggest that manufacturing remained unaffected because it was funding virtually the whole of its expansion from internal sources, making it unnecessary to borrow significant amounts from the banks or any other source. I would argue that the relatively fast fall in the real factory wage combined with the severe drop in input prices that preceded it are the only factors that could make this situation possible, which brings us to wages and prices. One of the great lessons of the Depression that is rarely mentioned is that wage rates matter. As for those so-called economists who argue that supply and demand do not apply to the services of labour, they would be better to put aside their hatred of capitalism and focus on the facts and then apply sound economic theory to them.
Like the much misunderstood classical school the Austrian school of economics stresses that for the recovery to succeed prices and costs must make the necessary adjustments to the new monetary conditions. What we therefore see is a pattern that always marked every recovery from a monetary contraction. When the bottom of the depression has been reached interest rates will have fallen, debts and malinvestments liquidated, the prices of raw material inputs will have dropped, wages will have adjusted, and stocks will need to be replenished. As the situation stabilises business confidence begins to return, output starts to rise and money supply once again expands. The success of this recovery process lies in not keeping wage rates above their market clearing levels. It also relies on politicians not sabotaging the adjustment process as happened in the US under Hoover and Roosevelt.
The January 1931 devaluation and the sharp fall in the prices of raw materials used in manufacturing are rightly cited as playing a significant role in the recovery. It is true that by bringing about an exchange rate that more closely reflected the country’s purchasing power parity the devaluation created an opportunity for manufacturing to significantly expand production. And it is self-evident that the 35 per cent fall in raw material prices would lower manufacturing costs just as it is self-evident that lower interest rates would encourage business activity.
What these arguments overlook, however, is that the only reason why beneficial effects flowed from these developments is because the necessary adjustments in the real factory wage were not frustrated by political interference as happened in the United States. Without those adjustments those benefits would not have materialised. A the late William Hutt would have put it: the wage adjustments released withheld capacity which in turn expanded output and, in accordance with Say’s law of markets, therefore expanded real demand24. The conclusion is inescapable: the Keynesian argument that Australia suffered a massive case of demand deficiency and that the spending cuts and surpluses were contractionary is a complete myth.
A critic could argue that it was the rise in the value of the output combined with an increase in productivity that raised the demand for labour and that any fall in wages no matter how defined is irrelevant. Any direct fall in the prices of inputs would indeed have the effect of reducing the real wage relative to the value of the worker’s output, as would an increase in productivity, and therefore raise the demand for labour services. In other words, the demand for labour would rise because the price of its services relative to the value of its output had fallen. This is a process the classical economists fully understood and can be found in the works of Henry Thornton25 and Robert Torrens26.
Without realising the Australian government had implemented the classical remedy (albeit significantly modified) for a depression. It is this fact that explains why Australia recovered faster and earlier than the UK and the US even though the Commonwealth cut spending and ran surpluses. Schedvin basically admitted this when he said:
The central point that emerges…is that the deliberate policy measures were comparatively unimportant in influencing the nature of the contraction or the speed of recovery. (p. 372).
One outstanding feature of the Australian depression is that it is not part of the trade cycle framework. It was not preceded by a boom accompanied by frenzied speculation culminating in a market crash. Instead, “the economy stagnated” from 1925 until depression struck. The final irony is that though it was basically that “ol’ time religion” that got the Australia out of depression, by the late thirties the country’s leading economists had embraced Keynes’ mercantilist snake oil, the true antidote to which would have been a sound knowledge of classical economic thinking.
Australia should be eternally grateful that these discerning economists did not fully adopt Keynesian-like thinking in the 1920s otherwise Australia would have taken the disastrous Hoover-Roosevelt route and experience the same high levels of unemployment that America was forced to endure until ‘rescued’ by Emperor Hirohito and Adolf Hitler. This has not stopped critics from pointing out that from 1937 to 1940 “ Australia’s unemployment rate never got below 8%” What is not mentioned is that for the same period American unemployment averaged 16 per percent. So much for Roosevelt’s brilliant New Deal economics.
Keynesians always ignore the fundamental economic fact that if you price the services of labour above its market clearing price and keep it there you will get a permanent pool of unemployed workers.
1The Austrian theory of the trade cycle deals with a specific phenomenon and not general economic fluctuations. Now the Australian experience obviously does not fall into the boom bust category. However, Austrianism is much better at dealing with this kind of problem than mainstream economics because it understands the vital importance of prices and money.
2It was pointed out at the time that the Roosevelt ‘recovery’ was “illusory” and that there were dangerous imbalances in the economy. Shortly afterwards America experienced 1937-38 crash. (C. A. Phillips, T. F. McManus and R. W. Nelson, Banking and the Business Cycle, Macmillan and Company 1937). This “depression within a depression” was triggered by a massive wage push. Nevertheless, it exposed the terrible weaknesses in the economy. Unlike America where large chunks of manufacturing suffered unemployment and idle capacity while the consumer industries expanded, Australian manufacturing became fully employed.
3Sinclair Davidson is Professor of Institutional Economics in the School of Economics, Finance and Marketing at RMIT University and a senior fellow at the Institute of Public Affairs.
4C. B. Schedvin, Australia and the Great Depression, Sydney University Press, 1988, pp. 76-77. This passage raises an interesting point because it is not generally recognised that the nineteenth century classical gold standard was not a true gold standard but a de facto quasi-gold standard. It was this situation that gave rise to the trade cycle phenomenon. The majority of classical economists understood booms and busts as originating with the banking system. When the banks deviated from the gold standard by expanding notes or credit beyond the amount of real savings in their deposits they would generate a boom that would have to be terminated once a gold drain was set in motion.
5A gold-exchange standard a system by which a country that is not directly on the gold standard keeps its currency on par with a country that is supposed to be on the gold standard by holding that country’s currency as a reserve along with liquid securities. This was the case with the London funds.
6With a gold bullion standard no gold coins circulate and notes exchange against bullion. When Britain adopted this system in May 1925. The Bank of England was required to sell gold at £3 17s. 101/2d per ounce for a minimum amount 400 fine ounces.
7The British government had faced similar dilemma after the Napoleonic Wars. England went off gold in 1797 in favour of an inconvertible currency. The eventual result was inflation and a greatly depreciated pound. The full return to the gold standard in 1821 required the note issue to contract by over 40 per cent causing prices to dive by more than 30 per cent. David Ricardo, who supported the resumption of cash payments, had greatly underestimated the magnitude of the necessary monetary adjustment. This chastening experience had him write a friend:
I perceive that you rather misconceive my opinions on this question — I never should advise a Government to restore a currency which was depreciated 30 percent to par; I should recommend, as you propose, but not in the same manner, that the currency should be fixed at the depreciated value by lowering the standard, and that no further deviations should take place. It was without any legislation that the currency from 1813 to 1819 became of an increased value, and within 5 percent of the value of gold — it was in this state of things and not with the currency depreciated 30 percent, that I advised a recurrence to the old standard (Letters of Ricardo to Hutches Trower and others 1811-1823, Edited by James Bonar and J. H. Hollander, p. 159).
If the British government and the commentariat had known their economic history it’s possible the the return to the gold would have been done at post-war par.
8This was not a beggar-your-neighbour policy. Such policies are deliberate attempts to force down the value of the currency in an attempt to obtain a competitive advantage. Australia’s currency was clearly overvalued and required and exchange rate adjustment that reflected the country’s purchasing power parity.
9Frederic Benham, The Prosperity of Australia: An Economic Analysis,P.S. King & Son, Limited, 1930, p. 247.
10Official Year Book of the Commonwealth of Australia1939, p.500.
11Lyndhurst F. Giblin, The growth of a central bank: the development of the Commonwealth Bank of Australia 1924–1945, Melbourne University Press, p. 80.
12Report of the Royal Commission on Money and Banking, 1937, p. 334.
13According to Schedvin (p. 78) £30 million was the minimum amount that the funds should hold. Anything below this figure meant “it was high time to apply the [monetary] breaks and reduce lending.
14In a footnote Schedvin noted that if we calculate from March 1928 to June 1931 the deflation amounts to 13.6 per cent, p, 207. Using M1 put this figure out by 100 per cent.
15Unlike Australia’s experience the American deflation was caused by a runs on the banking system.
16Walter Boyd, A Letter to the Right Honourable William Pitt on the Influence of the Stoppage of Issues in Specie at the Bank of England, on the Prices of Provisions, and other Commodities, 2nd edition, T. Gillet, London, 1801, p. 2. TMS
I realise that some people will argue that this definition is too narrow and that thrifts should be included. Now James Stewart’s character in It’s a Wonderful Life nearly lost his thrift because of a run. But note: the cash had actually been loaned out directly. No credit money had been created. Hence there had been no effect on the money supply. The same goes for companies like Avco.
17Robert Torrens, The principles and practical operation of Peel’s Act of 1844 Explained and Defended, London: Longman, Brown, Green, Longmans, and Roberts, 1857, p.20.
18Bills of exchange are merely credit instruments. The rapid expansion of bills of expansion during booms was generated by monetary expansion. Once this ceased the market for bills collapsed.
19I need to point out that not everybody in the Austrian school would agree with this.
20These monetary aggregates are from Schedvin, pages 386-87.
21Many blame the 1937-38 crash on a monetary contraction. From December 1936 to December 1937 M1 contracted by 9 per cent. If you refer to chart 5 you will see that in Australia from March 1932 to September 1932 M1 contracted by 9.4 per cent — and yet the recovery did not even burp. The difference between the two is that America suffered a massive wage push in manufacturing and Australia did not. I shall discuss this in more detail when I write about about Roosevelt’s depression.
22Manufacturing in the US did not recover until war-time spending kicked in whereas in Australia the recovery was purely domestic driven and did not involve any military spending.
23The reader might wonder how in the nineteenth century you could get sudden monetary contractions followed by a monetary expansion if the country was on gold. The problem is that the classical gold standard was not a true gold standard but a quasi-gold standard because a genuine gold standard is incompatible with fractional reserve banking. This situation is bound to result in a low gold ratio.
According to Sir George Paish, before 1913 the gold reserves of the Bank of England never exceeded $50,000,000 [about £10,000,000], (The Credit of Nations and The Trade Balance of the United States, Washington: Government Printing Office, 1910, p. 210). Jacob Viner noted that the British banking system rested on an extremely low ratio of gold to liabilities. He estimated that the ratio “fell at times to as low as 2 per cent and never between 1850 and 1890 exceeded 4 per cent” and that “[f]rom the late I820s on to the end of the century a continuous succession of writers called attention to the inadequacy of the gold reserves, but without any visible results.” (Jacob Viner, Studies in the Theory of International Trade, Harper & Brothers, 1937, p. 264).
24See Willam H. Hutt’s The Keynesian Episode: A Reassessment, LibertyPress, 1979.
25Thornton noted how raising prices without any change in nominal wages lowers the cost of labour. He also drew attention to the consequences of sticky wages during a deflation. (Henry Thornton, An Enquiry into the Nature and Effects of the Paper Credit of Great Britain, (1802), Augustus M. Kelley, New York 1965, pp. 118, 189-90)
26Not only did Robert Torrens explain the effect of rising prices on the demand for labour services, he also pointed out the consequences for capital accumulation (forced saving) and “the distribution of wealth”.
[A] fall in the value of money, instead of diminishing, would, for some time, increase the demand for labour. As long as this fall raised the price of goods, without effecting an equivalent rise in the rate of money wages, the profits of stock would be increased; and thus the master’s capital would accumulate more rapidly, while he would have a stronger motive to employ upon productive labour… (Robert Torrens, An Essay on the Production of Wealth, Longman, Hurst, Rees, Orme, and Brown, Paternoster Row, 1821, pp. 326-27).