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The crisis spread abroad but was also exacerbated by pre-existing conditions in Europe. In 1930, Germany encountered extremely large unemployment numbers, and unemployment insurance was funded by a government deficit (Rothermund 1996). Political reorganization under an increasingly nationalistic policy led to foreign withdrawal of funds the same year. Banks went into distress as deposits declined, and economic strain mounted.

The return of Italian banks in 1926 to the quota novanta led to a sharp appreciation of the lira and stressed the banking system (Rothermund 1996). Government intervention took place through the Bank of Italy. France faced bank failures as commodity and security prices fell, leading to non-performing loans.

Austria’s economic troubles after World War I faced no abatement. Austria’s largest bank, the Creditanstalt, was forced to declare bankruptcy in 1931. It took almost two years to settle accounts with foreign creditors of the bank and begin financial reconstruction. The failure of Creditanstalt led to panic that flowed over Austria’s borders into neighboring nations and abroad (Schubert 1991).

Monetary currents grew stronger in the lead-up to the Great Depression. Both the United States and the United Kingdom wished to restore the gold standard. The Federal Reserve Governor Benjamin Strong lowered interest rates starting in 1924 to help Britain gain necessary reserves for its return to gold (Eichengreen 2014). The interest rate differential between the US and Britain channeled funds to London.

However, after the Great Depression unraveled, claims upon Britain’s pound sterling mounted in 1931 as European economic pressures climbed (Eichengreen et al. 1996). Withdrawals of gold thereby increased and became intolerable. Britain was forced to abandon the gold standard at year end and the pound devalued subsequently. Twenty-five countries followed Britain off gold, and it was only a matter of time before countries still on the gold standard began to place gold withdrawal requests on the US. Monetary authorities increased the discount rate, but devaluation in countries off gold further pushed the downward spiral of prices.

The financial crisis spread through declines in the value of securities, contractions in spending and trade, and monetary shocks that broadcast deflation (Kindleberger 1986). Panic was also a factor. The gold standard and war reparations played the largest incipient role in the transmission of financial shocks from the US to Europe. Developing countries were hardest hit through slowdowns in their exports to developed countries. In Table 2.1, Triantis (1967) shows the percentage decline in exports at the beginning of the crisis within 49 exporting countries.

The gold standard was revived after World War I under different

Table 2.1 49 primary-exporting countries classified by percentage of

decline in exports, 1928-29 to 1932-33

Percentage decline in exports







Bolivia, Cuba, Malaya, Peru, Salvador


Argentina, Canada, Ceylon, Netherlands Indies, Estonia, Guatemala, India, Irish Free State, Latvia, Mexico, Siam, Spain


Brazil, Dominican Republic, Egypt, Greece, Haiti, Hungary, Netherlands, Nicaragua, Nigeria, Poland, Yugoslavia


Denmark, Ecuador, Honduras, New Zealand


Australia, Bulgaria, Colombia, Costa Rica, Finland, Panama, Paraguay


Norway, Persia, Portugal, Romania


Lithuania, Philippines, Turkey, Venezuela

Source: Triantis (1967).

circumstances. Claims upon gold against foreign currencies posed a danger, particularly to the British, but also to the French, who held both spot and forward contracts against the British pound sterling (Kindleberger 1986). The gold standard was increasingly a point of contention.

Bernanke (1995) elaborates on the mechanism by which the contraction was channeled abroad through the widely continued use of the gold standard. The tendency to transmit financial contagion through a common monetary standard had earlier been shown in Fisher (1934), and was echoed in later work by Temin (1989) and Eichengreen and Sachs (1985). The gold standard fixed a unit of national currency to a given weight of gold. The ratio of national currency to gold was contracted by the Fed to reign in the mounting stock market speculation beginning in 1928, and monetary contraction spread to the rest of the world beginning in 1931.

The mechanism by which the gold standard created deflation is spelled out in Bernanke (1995). A country’s domestic money supply was comprised of a multiple of the money supply to monetary base ratio, the monetary base to international reserve ratio, the international reserves to gold reserve ratio, the price of gold, and the quantity of gold. This is illustrated in the following equation:


The first variable, the money supply to monetary base ratio, is the money multiplier, which fell as lending transactions declined. Flight away from foreign exchange reserves to gold produced a decline in the international reserve to gold ratio. In many countries, the flight to gold also produced declines in the monetary base to international reserve ratio. Therefore, the money supply within countries on the gold standard dropped, producing deflation.

Deflation had real effects, operating through several channels, including the Fisherian debt-deflation spiral, in which debt contracts become harder to service, leading to a “fire sale” of assets and further price declines. Countries that abandoned the gold standard were able to reflate their economies and begin real economic recovery. The United Kingdom (UK), upon abandoning the gold standard, was able to recover its terms of trade and living standards (Eichengreen 1992). Sweden, which left the gold standard with the UK, was equally successful in recovering stable prices, incomes, and employment. As prices rose more quickly than nominal wages in countries leaving gold, real wages fell, allowing employment to sharply increase (Bernanke 1995).

In addition, post-World War I reparations were repaid by Germany at the expense of its own economic growth and stability. The reparations repayment schedule was interrupted by the Great Depression, since foreign loans from New York that financed reparations repayment were withdrawn, and this led to near financial collapse in Germany (Eichengreen 1992). New York loans to Europe had already declined at the height of the boom as investors redirected their funds into the stock market (Kindleberger 1986). As contagion spread, Austria experienced capital flight5 from German investors and a loss of reserves, and Hungary also saw short-term capital flow reversals. Importantly, US President Hoover put forth a one-year moratorium on German reparations in 1931 as Germany faced increasing financial difficulties.

Transmission of the contraction was exacerbated by worldwide overproduction in agriculture, which led to steeply declining farm prices. Although in developed countries the business cycle was separated from agricultural harvests beginning in the middle of the nineteenth century, the interaction between agricultural price declines, a sharp reduction in foreign loans, and tariffs exacerbated farm debt and the living circumstances of farmers around the world (Temin 1976). Countries that were still largely agricultural, however, faced hardship in advance of the rest of the world. Global leadership was not strong enough to raise agricultural prices while enforcing the prosecution of violators.

Tariffs were implemented globally after the US passed the Smoot- Hawley Tariff Act in 1930, which placed tariffs on a range of goods in response to growing excess capacity in US factories (Beaudreau 2005). The Smoot-Hawley Tariff attempted to encourage consumption of American-made goods, mainly agricultural products. Although foreign trade was a small part of the American economy constituting only 4.2 percent of gross domestic product (GDP), the agriculture sector was greatly affected by imports. Farming income declined even after enacting the tariffs because the overall economy was worsening and consumers were unable to purchase products across all sectors despite the tariffs. Exports declined as other countries retaliated in response to the Smoot-Hawley Tariff. The tariffs were seen as an effective tax on goods and intensified worldwide deflation.

In time, the pound sterling began to rapidly depreciate and in 1931, Britain moved off the gold standard (Kindleberger 1986). Twenty-five countries then went off gold, including the US somewhat belatedly, in 1933. The cancellation of reparations in 1932 and shift away from the gold standard over the same period put Europe on the road to recovery, even as the shocks of the depression were still spreading to export-oriented developing countries through declining international demand.

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