Well that didn’t take long. I have to admit that when I made this prediction eight days ago I didn’t really expect it to happen so fast:
The great irony of the Depression period is that by 1936 things had gotten so bad that even the French had to devalue. The French had helped cause the Depression by their obsessive hoarding of gold, and their refusal to help out the weaker countries. In other words, in monetary terms France was the Germany of the 1930s. When you see doubts raised about countries like Finland and Austria, you really have to wonder if even the German debt is truly safe.
I still think the policy elite are slightly less pigheaded than in the 1930s, so I doubt things will go that far. But it would be a lot simpler if they recognized reality right now, instead of dragging out the pain.
First a bit of background. In the late 1920s and the early 1930s the Bank of France hoarded vast quantities of gold. This raised the value of gold, which meant deflation (once the US and Britain stopped offsetting the French hoarding after October 1929.) An international financial crisis ensued, with one country after another leaving the gold standard. Britain in 1931, the US in 1933, etc. At first France got off lightly, as their currency had been undervalued on the eve of the Depression. But by 1936 the deflation in France was so bad that even they had to devalue. In each case countries didn’t begin recovering until they had left the gold standard.
In the modern world things seem to move much faster than during the long agonizing 1931-36 collapse of the gold standard. Today German bonds were hit hard:
The debt crisis that began more than two years ago now risks engulfing Germany. The Markit iTraxx SovX Western Europe Index of credit-default swaps on 15 governments rose to an all- time high as Germany failed to find buyers for 35 percent of the bonds offered at an auction.
Germany is of course the France of the 21st century.
It’s now quite possible that the Fed may have to move toward NGDP targeting before they would have liked. The Fed cannot allow another collapse of NGDP like we saw in 2009. The cost in terms of banking distress, worsening public finances, international discord and mass unemployment is simply too great to contemplate. I have no doubt that Ben Bernanke of all people understands this.
Perhaps the Europeans will come together and do something dramatic in the next few days. But if not, the Fed must be prepared to hold an emergency meeting and do whatever it takes. To quote David Beckworth:
Also, if a nominal GDP level target is explicit and widely understood it would actually serve to mitigate the effects of financial shocks. If the public understood the Fed would always close return nominal GDP to its trend path, public expectations would be better anchored and thus be less susceptible to wide swings. That means velocity (i.e. real money demand) would be more stable. For these reasons, it is reasonable to conclude that had the Fed been targeting nominal GDP during the 2008-2009 financial crisis, the outcome would have been far milder. And for the same reasons, the Fed should be targeting nominal GDP now given the looming financial threat coming from the Eurozone crisis.
It’s Bernanke’s moment of truth.