The current crisis may not have shattered the ossified shell of economic theory, but it has unleashed a cascade of arguments within the policy-making elite.footnote1 The Bank for International Settlements and the imf are at odds. The Bundesbank is pitted against virtually every other major central bank in its dogged adherence to deflation. Larry Summers, Clinton’s Treasury Secretary and once a cheerleader of market liberalization, has announced that what we have been living through since the 1980s is a steady slide into secular stagnation disguised by a series of credit-fuelled bubbles. The unlikely success of Piketty’s Capital has provoked a half-hearted debate about inequality in the financial press. Barry Eichengreen’s latest book, Hall of Mirrors, is most interesting when read as a voice from within this establishment turmoil.

Eichengreen belongs to the last generation of so-called ‘saltwater’ macroeconomists trained by Yale, mit and Harvard in the 1970s and early 80s. His interest in the historical development of international finance was sparked by the influential lectures given at mit by Charles Kindleberger, a veteran of the Marshall Plan, which Eichengreen attended along with Peter Temin, Larry Summers, Paul Krugman and Ben Bernanke. Also in the crowd were Christina Romer, first chair of Obama’s Council of Economic Advisers, and Brad DeLong, who did time in the Clinton Treasury under Summers and is now an influential blogger, based like Eichengreen and Romer in the Berkeley economics department. For this generation, there was one central problem. As Ben Bernanke put it, ‘to understand the Great Depression is the holy grail of macroeconomics.’ As they rose through the ranks, their professional self-confidence derived from the sense that they were getting closer to grasping that grail.

The starting point for their quest was the monetarist interpretation of the Great Depression offered by Milton Friedman and Anna Schwartz in their 1962 Monetary History of the United States. By the same logic through which they attributed inflation to the expansion of the money supply, Friedman and Schwartz blamed the disastrous deflation after 1929 on the failure of the Federal Reserve to prop up the American banking system. It was the implosion of the private credit system that collapsed the money supply, driving prices down, upsetting the balance sheets of indebted businesses and farmers and triggering a wave of bankruptcies. Keynesians responded that expenditure flows—such as savings and investment or government consumption—were more important than monetary aggregates. But by the mid-1970s a commitment to aggregative macroeconomic argument, whether Keynesian or monetarist, for or against Friedman and Schwartz, put all of the saltwater group at odds with the so-called freshwater, supply-side economics that was bubbling up through the research departments of the Midwestern Federal Reserve banks. The freshwater approach, as Krugman would cruelly remark, reduced the Great Depression to the ‘Great Vacation’—a voluntary adjustment of labour supply, triggered by over-generous welfare systems and labour-market distortions, misdescribed in official statistics as a surge in involuntary joblessness. For dogmatic believers in market equilibrium, only distorting interventions could wrench demand and supply out of balance. By contrast with this freshwater school, the differences on the East Coast between monetarists, who emphasized central banking as the driver of the Great Depression, and Keynesians, who emphasized the fall in private investment, were small indeed.

The version of the monetarist interpretation that Eichengreen laid out in his field-defining Golden Fetters: The Gold Standard and the Great Depression (1990) was distinctive for the fact that he moved beyond the personalized, parochial focus on the leadership of the us Federal Reserve, insisted on by Friedman and Schwartz, to emphasize the structural and institutional constraints of the international gold standard. What prevented the Fed from counteracting the implosion in the money supply after 1929 was not a lack of economic understanding or initiative, but the risk that gold would flee the country; these same ‘golden fetters’ propagated deflation and the downturn across the world economy. But this begged the question: between the 1870s and 1914, the gold standard had provided a durable framework for the first wave of globalization, so why did it no longer function after World War I? The most obvious, and perhaps still the best answer, is that the War created vast new imbalances and therefore new problems of international regulation. One could blame the French for their one-sided hoarding of gold; Charles Kindleberger highlighted the lack of American leadership in the 1920s. Eichengreen and his generation were shaped by the collapse of Bretton Woods in the early 70s. They had learned, they believed, that American hegemony was neither necessary nor even functional for the working of the world economy. What was required was cooperation and the unquestioned credibility of conservative monetary institutions. That was what had been lost in the early twentieth century—the erosion was in train even before the disaster of 1914. For Eichengreen, the vulnerability of the gold standard was best grasped in terms suggested by Karl Polanyi in The Great Transformation: a mounting conflict had developed between the rigid institutions of the world economy, inherited from the mid-nineteenth-century ‘golden age’ of liberalism, and the imperatives of mass democracy. Workers and debtors resisted free trade, mass immigration and the rigid imperative for deflation demanded by the gold standard. William Jennings Bryan’s populist crusade in the 1890s against the ‘Cross of Gold’ was a harbinger of the future. This anti-market resistance—even if it could be defeated, as Bryan was in 1896—undermined the confidence required to make the gold standard a stable and self-equilibrating system. As the Great Depression was to prove, upholding the gold standard in the face of sceptical bond markets was a recipe for disastrously lopsided deflation.

Golden Fetters provided inspiration for an entire generation of economic historians, offering an open-ended framework into which the fortunes of territories as far apart as Latin America, Japan and Bulgaria have been integrated. Apart from its historical persuasiveness, Eichengreen’s narrative harmonized with the policy consensus of the 1990s and 2000s. Golden Fetters rejected any nostalgia for the apparent monetary stability of the gold-standard era—or of Bretton Woods. This was the basic lesson of the 1930s. The countries that left the gold standard earliest, like Japan and Britain in September 1931, recovered most rapidly from the Depression. Given the unquestioned imperative of free capital movement, fixed exchange-rate systems were fetters upon modern politics. As the period since the 1970s had confirmed, nations were best served by setting their own monetary and fiscal policies, whilst allowing free-floating exchange rates to adjust away any discrepancies in competitiveness.