We Are Not Alone

What happens in one nation can affect economic activity in other nations. One can sometimes forget this in a nation that is as large and self-sufficient in many items as the United States. To help you remember that the rest of the world matters, this site has woven discussion of international issues into many topics.

The ways in which economic disturbances can be transmitted to other countries, and whether they can be transmitted at all, depend on the way a nation sets up its international monetary arrangements. If it lets its exchange rate float, its monetary policy is enhanced and its fiscal policy is weakened relative to what happens with fixed exchange rates (without exchange rate controls).

German hyperinflation did not spill over into France or England and the residents of these countries were little affected by what was happening in Germany. Germany had a floating exchange rate, so as its domestic prices went up, the value of its currency in terms of the French franc and the British pound fell. This fall offset for the French and the British the price rise inside Germany. The British buyer of German wine saw little or no change in the price he had to pay.

In contrast, the United States was on the gold standard until 1933. As its price level dropped, its goods became cheaper relative to goods in foreign nations that were also on the gold standard. Since the price of the dollar could not rise, this deflation set into effect flows of gold across boundaries, and the logic of the system forced a deflation throughout the nations that were also on the gold standard. All countries that had fixed the value of their currencies in terms of gold experienced the depression at roughly the same time. For those not on gold, the effects were less severe and in some cases very minor. For countries that had fixed the value of their currencies in terms of silver, the depression began when the United States began to buy silver at a price above the market price, leading to an outflow of silver from these countries and a reduction of their price levels.

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Copyright Robert Schenk