The European Crisis: Lessons from the 1920s, the Gold Standard, and Historical Trilemmas

Yves here. This post by Michael Bordo and Howard James finds significant parallels between the 1920s and the economic and policy conflicts facing the Eurozone, which does not speak well for them being resolved tidily. The post is dense at points but it is very much worth your attention.

By Michael Bordo, professor of Economics at Rutgers University and Harold James, professor of History at Princeton University. Cross posted from VoxEU

The Eurozone’s tangle of conflicting goals – a series of ‘trilemmas’ – is not without precedent. This column argues that it is reminiscent of the interwar situation. The interwar slump was so intractable not just due to financial issues, but also a crisis of democracy, of social stability, and of the international political system. The big difference in the EZ is that nations cannot go off the euro as they went off the gold standard. That is why the initial EZ crisis may not have been so acute as some of the gold standard sudden stops, but the recovery or bounce back is painfully slow and protracted.

The European financial crisis has often produced comparisons with the historical problems of the classical gold standard. Many of the key political figures who drove forward European monetary integration admired the discipline and certainty of the gold standard. Both Valéry Giscard d’Estaing and Helmut Schmidt shared this view. But recently, the comparison is more usually a negative or hostile one. The intent is to demonstrate the unrealise-ability or absurdity of the constraints that rigid monetary systems impose (Krugman 2013), or the problems of an asymmetric adjustment process (Eichengreen and Temin 2010).

Adherence to the gold standard, and to the euro, involved an acceptance of:

• Monetary orthodoxy

In the gold standard, the constraint is the convertibility of claims into a metallic equivalent. In the modern monetary union, it is imposed by a central bank with a price stability target.

• Fiscal orthodoxy

Both regimes depend on the avoidance of fiscal deficits that would place the monetary objective in danger. In the gold standard era, most states had little room (little technical capacity or political consent) to raise large amounts in taxation. Before the First World War, despite a costly arms race, economic growth meant that for most countries the share of government debt of GDP was falling. The modern European monetary union – the Eurozone – occurred in the context of much higher spending levels and higher levels of government debt in all industrial countries, as well as of continual social and political pressure to expand government spending.

The benefits of the gold standard were seen in the nineteenth century as lying in:

• Ease of a common monetary standard
• Access to capital markets (overcoming “original sin” that made financially immature economies unable to borrow abroad except in foreign-denominated currency)
• Reduction of borrowing costs
• The gold standard as a contingent rule

In the event of an emergency – such as a war – the gold peg could be temporarily suspended, but with an expectation of an eventual return to convertibility at the original peg. The contingent rule gave a safety valve for fiscal policy in dealing with exceptional circumstances (Bordo and Kydland 1995).

But there were also substantial risks. Large-scale emerging market borrowers ran a substantial risk of entering into an unstable dynamic with a destabilizing fiscal policy that might threaten the maintenance of the rules of the game. The gold standard experience is filled with sudden stops of capital inflows in which advanced country creditors either hit by domestic shocks or fearful of events in the borrowing countries turn off the lending spigot (Bordo 2006).

The flows of capital almost always produced an expansion of the banking system in the importing country. That expansion could turn into a source of instability if banks became unable to repay credits, either because of a liquidity or a solvency problem. When countries credibly adopted the gold standard, they often experienced surges of capital inflows. These were almost always mediated through the financial system. Sudden stops, were sometimes caused by banking sector weakness, and sometimes lead to bank collapses. They did not inevitably end the exchange rate commitment. There was thus a close association between capital flows and banking crises.

A strong and effective state could underpin a banking system, and thus allow greater volumes of borrowing to continue for longer and with greater sustainability. In Russia, for instance, the State Bank was widely regarded as a reinsurance mechanism that would bail out problematical private debtors: it was often referred to as “the Red Cross of the bourse”. Thus Russia had large inflows, and a sudden stop in the early twentieth century, but no suspension of convertibility.

International diplomatic commitment enhanced the market perception of state effectiveness. The story of how diplomatic commitments enhance credibility is especially evident in the well-known case of Russia. The beginning of the diplomatic rapprochement of Russia with France in 1891 was accompanied by a French bond issue, which the supporters of the new diplomacy celebrated as a “financial plebiscite” on the Franco-Russian alliance.

Popular political discontent eventually limited the possibility of adjustment policy. The Tsarist Empire was an effective and capacious borrower, it never seemed to violate the gold standard rule in peacetime, but it was brought down by massive social discontent that was in large part driven by the widespread perception that its policy had been sold out to foreigners. A major part of Lenin’s analysis, for instance, was devoted to the demonstration that Russia had become a quasi-colony as a result of the large scale capital imports, and that the foreign creditors in effect controlled Russia’s foreign policy.

The linkages of these issues can be summarized as a series of impossible trinities or trilemmas.

1. The macroeconomic classic – fixed exchange rates, capital flows, autonomous monetary policy
2. The financial sector – fixed exchange rates, capital flows, financial stability
3. The international relations setting – fixed exchange rates, capital flows, national policy independence
4. The political economy – fixed exchange rates, capital flows, democratization

The Interwar Experience

All four of these trilemmas became impossible after World War I.

First, the asymmetry of the adjustment problem in the gold exchange standard of the 1920s and sterilization of gold inflows by the surplus countries ( US and France) put deflationary pressure on the deficit countries ( UK, Central Europe and Latin America) when capital flows dried up ( Eichengreen 1992).

Second, in the financial sector, high inflation destroyed the capital base of many financial institutions in the defeated countries of Central Europe making them vulnerable to sudden stops. Correspondent banking networks between these countries and neutral countries exposed them to contagion.

Third, taking on international commitments by debtor countries enhanced their credibility for the lenders (US) which ultimately increased the borrowers exposure to sudden stops.

Fourth, taking on international commitments became a focus for domestic political disorder when the great Contraction after 1929 required adjustment by deflation.

The Eurozone Story

The move in Europe to monetary union for weaker countries was a credibility enhancing mechanism that would lower borrowing costs. For countries that had strong creditor positions, the attractions of monetary union lay in the depoliticizing of the adjustment process (James 2012). The Eurozone worked quite well as a disciplining mechanism before it entered into effect, but much less well afterwards.

The trilemmas became an increasing constraint in the years after the euro:

Banking expanded after the establishment of the euro (Shin 2012). No adequate provision on a European basis existed for banking supervision and regulation, which like fiscal policy, was left to rather diverse national authorities. An explosion of banking activity occurred simultaneously with the transition to monetary union and may well have been stimulated by the new single money. A “banking glut” led to a new challenge to monetary policymaking.

The bank expansion could go on longer because of implicit government backstop. It was reversed when government debt management no longer looked credible – in the Greek case after the elections of October 2009.

The implicit national government backstop was really only credible because of the international commitment to the European integration project. It was that commitment that led markets to believe that – in spite of the no bailout provisions of the Maastricht Treaty – there were almost no limits to the amount to which debt levels could accumulate both in the private and the public sector. When governments turned round, in particular after the Deauville meeting of Chancellor Merkel and President Sarkozy in October 2010 and demanded a haircut for Greek creditors (or Private Sector Involvement, PSI), the yields immediately diverged. Deauville undid the framework of solidarity that the EU treaties seemed to have created.

When the democratic/popular backlash occurs, it takes the form of rejection of international/cross-border political commitment mechanism. Voters are surprisingly discerning. Opinion poll data shows a major increase in hostility to the EU in peripheral countries, but with no corresponding unpopularity of the common currency. Hostility to the EU is also evident in parliamentary elections results in Greece and Italy.

The trilemmas are worse in the recent context because of the absence of an escape clause. In the absence of an exchange-rate option, there is a need for greater debt reduction, but that raises a politically awkward question of the distribution of losses between the private and the public sector.

The result is reminiscent of the interwar political debate about whether (mostly American) private creditors or (mostly European) official reparations creditors should have priority in the payment of German debts. What made the interwar slump so intractable was that it was not just a financial issue, but also a crisis of democracy, of social stability, and of the international political system. In the interwar period, increased social tension as a consequence of increased unemployment and of widespread bankruptcy made normal democratic politics impossible. Domestic political pressure also became a source of heightened international tension.

That is true in today’s Europe. Democracy has become a central target of complaints by the European elite. Luxembourg Prime Minister Jean-Claude Juncker and former euro group chair stated that it wasn’t that European leaders didn’t know what the right policies were; but that they didn’t know how to be re-elected after they had implemented them. The 2013 Cyprus crisis and its resolution exposed two new dimensions to the clashes over Europe’s debt and bank crisis. The discussion of a levy on bank deposits, and whether small customers should be exempted, puts class conflict at centre stage. The question of foreign, and especially Russian, depositors – along with the proximity to Syria – makes the incident into an international relations problem.

Supranational commitments however do not change the problems posed by the adjustment requirement, and the asymmetric character of crisis adjustment is more apparent in the modern era (and in the interwar experience) than it was under the classic gold standard. A design that intentionally excluded a contingent clause made the system at first apparently more robust, but aggravated the eventual adjustment issue. That is why the initial crisis may not have been so acute as some of the gold standard sudden stops, but the recovery or bounce back is painfully slow and protracted. The instability is increased by the heightened complexity and length of credit chains, and by the fact of the mediation of credits through small country banking centres.

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  1. mansoor h. khan

    Our current crises is much harder to solve than the great depression crises.

    The great depression was a crises of falling demand due to deflation but there were no true resource constraints (like labor or raw materials availability).

    The resolution to the great depression was simple: Get currency (money) in the hands of the consumer and get demand going. This was done via FED printed currency to pay for the War effort. The war effort created immense number of jobs.

    Today, Capitalism has finally arrived at true resource constraints (note the price of crude oil).

    Usury (affectionately called Fractional Reserve Banking) must be abandoned at this point. There is no other solution. Abandon Fractional Reserve Banking or Lose our Civilization. It is that simple:

    We need an alternate money distribution method:

    We now must solve this distribution problem and we must keep in mind the dwindling fossil fuel supplies which has powered our material production/modernity so far.

    I suggest the following:

    A) we should start a social credit/social dividend/guaranteed income program and give every U.S. citizen $500 per month regardless of income or regardless of any public assistance they currently receive.

    B) Increase taxation to keep inflation in check. Increased taxation should include stiff consumption tax to discourage too much consumption by the rich and upper middle classes.

    C) Start stringent energy conservation and run a low-grade industrial civilization with less yearly fossil fuel consumption.

    D) This will buy us time to develop another cheap energy source and possibly resume growth or if we don’t find another another cheap energy source we will have time to learn how to live without machines, fertilizers and pesticides.


    1. Banger

      Your comment was more interesting than the article.

      On balance your approach makes sense but there is a critical flaw–in the U.S. there is no chance at all of anything like that being implemented. Increased taxation is completely impossible because the public does not believe the government can do anything right–whether they are right or wrong that is the general sense among us.

      I am struck, btw, with the brilliance of possible solutions to our major and minor problems that people have come up with. We live at at a time when we can ideed create some kind of earthly paradise–it is there at the tip of our fingers yet something holds us back. Whenever I read about reasonable solutions I am sad because I know that because they make sense they cannot be implemented in our system. All sane solutions are automatically discarded why? Fear of what a gentle, peaceful and prosperous humanity might be like? Maybe we like the idea of a world that has a few winners many losers and the majority sort of scratches by in a state of fear.

      1. Mansoor H. Khan


        The general global mis-understanding/confusion about econonmics is not an accident but intentionally encouraged/promoted by the ruling classes of the world in order to intellectually enslave humanity.

        The intellectual slavery imposed by the current global elite is very similar to the intellectual slavery imposed by the Church in the middle ages (i.e., no salvation outside the church!).

        The knowledge (light) spread via the printing press destroyed the church I pray and hope that (inshallah) the knowledge (light) spread via the internet (printing press version II) destroys the lies about economics, banking and the monetary system spread/maintained by the current global elite.

        Mansoor H. Khan

        1. susan the other

          Very good points Mansoor and Banger. Before my eyes glazed over with these canned descriptions I did read the 4 trilemmas and it occurred to me that they represent only one trilemma which is easily solved by sovereign money. And then there are only 3 trilemmas becauise 3 and 4 are the same – more similar than the other two. A healthy domestic, sovereign, economy is the holy grail of economics. It is grassroots. Why do we vilify “nationalist” movements like they were Hitler all over again? Nationalism shouldn’t be discarded just as it is evolving into the best political solution. In fact, the most humane. IMO.

      2. Generalfeldmarschall von Hindenburg

        Banger, Buckminster Fuller essentially posited the same question over and over, showing how ease and prosperity for all are, on some level there for the taking. But humanity seems intent on proving the gnostic assertion that we live in an iron prison of suffering created by an insane God.
        We have a sociopathic and dysfunctional elite that everywhere sells some version of the “sweat of thy brow” swindle, where 99.9% must toil for the rulers appointed by (YHVH, The Market) if we can overcome this ontological crisis, a lot of the rest becomes much easier. Economy is just math and were good at that.

          1. Banger

            The West misses many of the virtues of Islam and misses the historical fact that Islamic societies have tended to be more peaceful than Christian ones and the current turmoil in the Islamic world is largely due to a combination of Western Imrialism particularly in the ME after the fall of the Ottoman Empire as well as the West’s support of Islamic fundamentalism to oppose both nationalism and socialism in the ME (Nasserism and the Baath movement).

            Having said that I have to oppose any religion that claims supremacy even if it is my own (Christianity). We can learn from each other if we keep an open heart. I follow the ideas of Aldous Huxley as articulated in his book The Perennial Philosophy.

      3. James Levy

        Banger, I’ve been reading Corey Robin’s book The Reactionary Mind, and I think that I agree with him that reactionaries fear abundance and hate the idea of the “mediocrity” that they associate with it. They love powered and striving and strife. Teddy Roosevelt was obsessed to the point of the Freudian with the word and idea of “virility” (go back and look at his speeches). Part of Hitler’s appeal was struggle and force, which holds a strange sway over the Western (male) mind. In its most banal form, it’s why football (with all its time outs and huddles and running down of the clock) is considered wonderful and exciting while baseball is falling away. Contests of skill are no longer compelling–we love contests of speed, strength, and aggression. And the more we are told we can’t beat up our wives, children, and “undesirables” the more that insanity is channeled into economics and politics. That’s why, I think, that a better way is unimaginable and frightening to our alpha male elites. It would rob them of the psychic rewards of power, domination, and victory.

        1. Banger

          Excellent points–and there are remedies for this disease. They involve two interrelated areas: 1) expanding consciousness; and 2) expanding relationships and community. When we feel connected we are less likely to be aggressive and destructive.

    2. R Foreman

      Implant a chip in everybody’s arm that keeps track of credit. There’s your money distribution solution. People could use it to get paid, pay their taxes, and buy things at the store.

      If they refuse the implant then they can’t hold a job or buy things in the public marketplaces.

      1. taunger

        After a generation or two, the chip-less entrepreneurs that survivided by foraging and organic argiculture will form a stong society and leave behind the post-industrial syndico-fascists toward an era of individual realization and lasting peace.

        1. R Foreman

          Did you just say two generations of foraging off the land like a herd animal? I just wanted to be clear on that, because it sounds like so much fun. :)

        2. Mansoor H. Khan


          So you do not think it is possible for humanity to use material abundance at its disposal with justice and mercy. You may be right.

          Islam predicts that humanity will (someday) have extreme material abundance (much, much more than the last 100 years). And yes it also predicts that it will be bad news for humanity because satisfaction with life will be almost non-existent.

          Mansoor H. Khan

          1. taunger


            It is even worse than you interpret. I believe that as a whole, humanity can’t live with justice and mercy for any meaningful period of time, whether necessities are abundant or not.

            But, I’ll keep on trying to prove myself wrong, mainly because I don’t seem to have anything better to do.

            1. Mansoor H. Khan


              Keep trying. I suggest you read a novel by Herman Hesse named Siddharta to learn how to think in the spiritual dimension which most wersterner’s have forgotton how to do since the abandonment of Christianity.

              Yes. Defnitely keep trying. Islam says when you search for the Truth (God?) and take one step toward finding him he will take ten steps toward you!

              Mansoor H. Khan

              1. taunger

                Yes, Siddharta is good, but I suspect you would enjoy (have enjoyed?) Idreas Shah “The Wisdom of the Idiots” more. But books are just words, it is action that gives meaning anyway. I won’t give up; like I said, there’s nothing better to do anyway.

                1. Mansoor H. KHan


                  Remember, each action must have a theory (reason) behind it.

                  As it is said:

                  Action without understanding (Theory) is Blind and Theory without Action is Empty. So you need both! And you need Theory first BEFORE you act.

                  Mansoor H. Khan

    3. MRW


      We haven’t used Fractional Reserve Banking since we were on the gold standard. That was 80 years ago. It is not applicable today. Loans create deposits, not the other way around.

      Fossil fuel reserves are not dwindling. We’re awash in the stuff. Commodity manipulation by ‘banks’ accounts for the high price, not supply.

      Increased taxes and a consumption tax when our economy is in the tank is not the way to create full employment. We need full employment first before we worry about inflation, which right now is running below projections at 1.5%.

      1. Thisson

        Indeed, Steve Keen’s treatment of this topic is excellent. I highly recommend his article The Roaming Cavaliers of Credit. I don’t have time to give critical treatment of Mansoor’s proposed solutions (e.g. Social Credit) and to debunk the ideas that printing money solves things or that deflation is bad. Perhaps tomorrow ;-)

    4. Bapy

      Got it,

      So it’s money we need, not the goods and services you “think” you will get with the additional money. Truth? You won’t get none, instead, what you will get is what you folks call “inflation”. Keep your eye on the token instead of the real stuff Mansoor, that will get you very far… no it wont.

      The article has some reasons as to why gold was a constraint on nations, I invite every one of you lefties to re-read the reasons. Do they not sound like excuses to let the government spend like drunken sailors.

      And than you have the guts to blame it on capitalism. What a bunch of hypocrites.

  2. Ellen Anderson

    I look forward to reading comments that will surely follow. Does anyone think that A-D would be politically acceptable to either the Dems or the Repubs?

  3. allcoppedout

    The article isn’t interesting. We can clearly live in material abundance today without breaking backs and could have a transparent money system to organise what work needs doing. We keep treating economics as a solution rather than part of the problem. I’ve accepted what Banger says for more than 30 years, the problems being largely about how we can organise after deciding this should be our aim. The ‘Islamic prediction’ has largely come to pass in terms of not being able to find decent meaning in what we have to do to survive in bullshit jobs and not end up in the same position as the world’s poor.

    I’m studying something called the Duggan Inquest for work purposes. The details are weird and obscure, but what is entirely obvious is that a court of extremely well-paid, upper class white men are making lots of money. This seems to sum up much “economic argument” – missing what stares us in the face. We are forever starting in the wrong place with complex scholastic assumptions that push the truth of what we are really doing under the carpet. When you’ve got sod all, are you bothered whether it is backed with gold you can’t eat?

  4. allcoppedout

    The questions for me are how we get to the ‘Banger consensus’ and what we would have to do after that. With a world of relatively free individuals (at least from poverty), how do we get necessary stuff done, including such moral knots as population control and the prevention of banditry.

    I don’t want much other than to be able to walk my dog, keep the roof over our heads, a few friends – whatever the list it doesn’t seem to meet with the paid work needed to maintain it. I don’t want processed food or to wear sweat shop clothes – or work less than my taxi driver or surgeon. I don’t want the bullying relations of the work place …

    The ‘I’ in all this needs to turn ‘we’ before we start economic theorising – what we have now is a history of mistakes caught up in ancient ideologies. We could already be talking to each other, but in fact the Internet is being perverted away from this as surely as other media.

    The form of economic comment as in this post reminds me of virtue ethics – a complex formula for an individual no one can achieve, yet almost everyone can pretend with a few manners. There is no admission of the opportunity costs of following “economics” to date, instead of sensible, peaceful practices.

  5. CagewasBrahms

    allcoppedout says
    “We keep treating economics as a solution rather than part of the problem.” 

    And likely the large majority of the readers of this forum agree with this. But the ‘treating’ comes mostly as a result of language and speech. Aristotle’s man as political animal by way of the gift of speech neglects that humans code speech. To be treated as a speaking subject requires a cultural and political decision over which speech will be qualified as speech. Jacques Ranciere shows quite clearly that politics is not a conflict between two or more equal parties of speech, but is rather a matter of claiming participation.
    Campbell Jones in his tight little book, Can the Market Speak makes several crucial observations. “When something  appears to be speech, what is most vital is the condition of the coding of this speech as speech and the politics of this operation….to this recognition of speech and consciousness must be added that capitalism involves a twin process of…seeking to capture or harvest useful speech for its own purposes and …to reduce those not useful to it to senseless mutterers…Capitalism contains a logic whereby economic imperatives come to talk over and to speak for other possible ways of deliberating on collective purposes.” The locus of his book argues that the displacement of intentionality away from the capitalist (and toward the ‘hand of the market’) is only possible in the context of the imagination that there is an external agency (at this moment God) that takes care of intentions. The capitalist is thus freed by ‘the Market’ of certain otherwise troubling questions regarding the morality of the motivation of particular forms of action.

    I greatly appreciate this forum and it’s participants. Analysis of the daily details in the sense of who is doing what amd how is clearly necessary and is the “claiming of participation” but it keeps us discussing variations of the same recipe. I keep coming back to NC because of the strength and depth of analysis here and because I sense a possibility of and desire for real change.

    I would like to see strongly, effectively and publicly “outing” language such as the mythical Market and introduction of such concepts as the abolition of human rental (i.e. jobs) because of its moral and ethical direct equivalence with slavery, and the reversal of Capitalism to something that might be called 
    Laborism where labor hires capital rather than vice versa. Ideas which I came across reading the work of David Ellerman “Intellectual Trespassing” is a good way to start. 

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