ONE consequence of the worst economic crisis in 80 years is that dismal scientists everywhere have had to gen up on the Depression in order to contribute to the policy debate. Most have by now picked up the stylised fact that a rigid adherence to the gold standard made a bad slump worse. Countries that cut the link to gold quickly and allowed their currencies to fluctuate endured shallower recessions and recovered more quickly than those that stuck with it. Freed from the need to uphold a gold-price parity, these countries could lower interest rates and so stimulate spending. By devaluing against gold, their money also became cheaper against currencies that kept their gold parity, giving domestic producers a cost advantage over many foreign firms.

A new paper* by Barry Eichengreen of the University of California, Berkeley, and Douglas Irwin of Dartmouth College adds a fresh dimension to this analysis. It examines how the decision to quit gold or to cleave to it affected trade policies. The picture painted by most accounts is of a rush to erect new barriers to trade, as each country tried to shield its businesses and workers from the deepening slump and responded in kind to the protectionism of others. In fact, say the authors, trade barriers were not imposed uniformly. Countries that stuck with gold were more protectionist than those that abandoned it. Tariffs were a poor substitute for policy stimulus, but in an era of balanced budgets they were all that gold-standard countries had.

In order to stand up that claim, the authors first show how the global monetary system broke down. In the decades leading up to the first world war, paper currencies were backed by gold at a fixed parity, in effect linking countries through a system of pegged exchange rates. Once war broke out, the system went into abeyance. When the gold standard was revived in the 1920s, it was a more fragile entity. Despite high inflation in the meantime, many countries restored their pre-war gold parities. With more money in circulation that led to a shortage of bullion. So the two main paper currencies, sterling and the dollar, were used as gold substitutes. Such a ruse relied on credible monetary policy in both Britain and America.

Of the two America is often seen as the main culprit for the spread of protectionism. The infamous Smoot-Hawley act, which was passed in June 1930 and increased nearly 900 American import duties, is usually viewed as central to the collapse in world trade that followed. But Messrs Eichengreen and Irwin argue that it was Britain’s ditching of gold in September 1931 that really started the “avalanche” of protectionism.

The ensuing rush to protect home markets served only to depress commerce further. By 1933 the volume of world trade was down by one-quarter from its 1929 level. Many of Britain’s trading partners responded quickly to sterling’s devaluation by coming off gold too. Two groups of countries held out for longer. The first, including Germany and Austria, was haunted by memories of hyperinflation and fearful of the consequences for financial stability of de-linking from gold. A second group, which included France and Switzerland and is labelled the “gold bloc” by the authors, held fast to gold to preserve their status as financial centres.

Establishing that these countries were more prone to protectionism is tricky. Comprehensive data on 1930s trade barriers are hard to find. One source, a League of Nations estimate of the share of imports covered by import quotas, supports the authors’ thesis: in a small sample of eight countries the gold bloc used more quotas than the others. To test whether that finding holds up in a bigger sample, the authors compared exchange-rate fluctuations of 40 countries between 1928 and 1935 with the increase in import barriers over the same period, using the share of customs revenue in the value of imports as a measure of tariffs. They found barriers rose least where countries had devalued.

The British exception

Though the results look solid, they contain an awkward outlier: Britain. Its devaluation blew a hole in the global monetary system, causing America to raise interest rates in the midst of a slump and forcing others to scrabble for bullion to replace their sterling reserves. The Eichengreen-Irwin theory says Britain, with its cheaper currency, should have been among the freer traders. Yet it raised its import barriers almost immediately. The authors put this down to local politics: the financial crisis brought an avowedly protectionist party, the Conservatives, to power. Mr Eichengreen says the paper has provoked two contrasting responses from colleagues. “Half say we spend far too much time explaining why Britain is a special case. The other half complain that we don’t fully explain why Britain is different.”

The tale underlines the importance of policy co-ordination. It would have been better if all countries had devalued against gold at the same time, allowing a looser global monetary policy much earlier. By 1936 even the gold-bloc countries had abandoned the link, but by then the damage to world trade had been done. There is a similar need today for co-ordination, this time in fiscal policies. If countries feel that others are gaining from their own stimulus packages, they may be tempted to resort to trade barriers.

The broader message is a happier one. The risk of a 1930s-style outbreak of protectionism is much lower because countries are able to use fiscal and monetary policy more flexibly. However, within that big lesson is a smaller one, that devaluations cause trade tensions. In an echo of the 1930s crisis Britain has again benefited from a weaker currency, upsetting its trading partners (notably Ireland). But Mr Eichengreen notes that the euro, by militating against more widespread beggar-thy-neighbour policies, may have helped preserve the European single market.