Inside America's Worst Financial Crisis: Gold, the Real Bills Doctrine, and the Fed

real bills doctrine, the fed, gold, timberlake, humphries, cato, milton friedman

Gold standard, real bills doctrine, Great Depression, Monetary History, Milton Friedman, Economic historyThe Cato Institute's newest book, Gold, the Real Bills Doctrine, and the Fed: Sources of Monetary Disorder, 1922–1938 is out now—and it's already getting rave reviews for challenging conventional wisdom on the Great Depression.

In Gold, the Real Bills Doctrine, and the Fed, preeminent monetary historians Thomas M. Humphrey and Richard H. Timberlake deliver a compelling critique of the U.S. central bank’s once-central theory on monetary policy: the Real Bills Doctrine. Theirs is the first full-length treatise on the doctrine and its formative role in the Great Depression and other monetary disorders of the early 20th century.

Even today, the gold standard remains one of the most popular scapegoats for "the Great Contraction"—the unprecedented collapse of the U.S. money supply, which began after the 1929 stock market crash and led to the Great Depression. Skeptical of this hypothesis, Gold, the Real Bills Doctrine, and the Fed traces the Contraction and the Depression—along with similar monetary crises like the German hyperinflation—to their true source: the Real Bills Doctrine. By drawing a false dichotomy between “productive activity” and “speculative activity,” Humphrey and Timberlake argue, the Doctrine wrongfully impugned speculation as the source of asset price bubbles and financial panic. Such flawed premises made the Fed unduly reluctant to make full use of the United States' ample gold reserves.

Gold, the Real Bills Doctrine, and the Fed refutes these erroneous beliefs and vindicates the true gold standard. It also provides a stirring defense for what was once the United States’ decentralized network of competing monetary regimes.

Among the book’s many compelling contributions are:

  • Its thesis that a centrally-managed “gold standard” is a contradiction in terms: a true gold standard requires no discretionary management whatsoever.
  • Its discussion of the difference between a money stock based on real production—which can be price-stabilizing—and a money stock based only on the nominal dollar value of real production, which can never stabilize prices. Humphrey and Timberlake illustrate this distinction by comparing the New York Federal Reserve Bank’s monetary regime, which stabilized prices by adhering to the “quantity theory” of money, with the dysfunctional Real Bills-driven monetary regime that the Washington Fed Board imposed, and struggled under, at the same time.
  • The authors’ revolutionary new economic model, which presents the Real Bills Doctrine as a “metastatic equilibrium concept”: one whose ability to support a stable economy is exogenous to the Doctrine itself. On its own, the authors’ formal model shows, the Real Bills Doctrine can neither stabilize nor destabilize the economy. It can only reflect the preexisting level of political or economic stability within the price level and money supply.
  • A chapter on the history of the quantity theory of money, explaining its relative success compared to the Real Bills Doctrine.
  • The authors’ full-fledged refutation of the Real Bills Doctrine’s erroneous beliefs about production and speculation: Humphrey and Timberlake show that all productive activity is driven by expectations of future outcomes, and is therefore partly speculative. Likewise, all speculative activity is capable of producing real value, and can therefore be productive.

Former president and CEO of the Federal Reserve Bank of Richmond Jeffrey Lacker writes that the book "persuasively document[s] the baneful effects of a well-intentioned but hopelessly flawed economic idea—the Real Bills Doctrine." And long before the book's publication, 1976 Nobel Prize recipient Milton Friedman praised Humphrey and Timberlake's scholarship on the Real Bills Doctrine, writing:

It certainly was not adherence to any kind of gold standard that caused the [Great Depression]. If anything, it was the lack of adherence that did. Had either we or France adhered to the gold standard, the money supply in the United States, France, and other countries on the gold standard would have increased substantially… . [Tom Humphrey and Dick Timberlake’s] emphasis of the Real Bills Doctrine complements in an important way Anna [Schwartz] and my analysis of why Fed policy was so "inept." We stressed and discussed at great length the shift of power in the System. We did not emphasize, as in hindsight … we should have, the widespread belief in the Real Bills Doctrine on the part of those to whom the power shifted.”

Finally, Phil Gramm, economist and former chairman of the Senate Banking Committee, calls this

the most important book written on the Great Depression since Friedman and Schwartz published their Monetary History of the United States. In originality and significance, I know of no other book that comes close in … explaining why U.S. monetary policy during the Depression allowed a financial panic, not significantly different from the Panic of 1907, to cripple the banking system, destroy a third of the money supply, and cause the most traumatic economic downturn in our history. . . .I strongly recommend this book to anyone who seeks to understand the economic history of America.

Gold, the Real Bills Doctrine, and the Fed is the only book in the economic literature devoted to the Real Bills Doctrine, its logic, history, strengths, weaknesses, and role in policy debates. It is also the first and only book to suggest that the Real Bills Doctrine was a key causal factor of the Great Depression and other monetary disorders of the 20th century. Anyone interested in understanding the causes of Great Depression, the role that prevailing economic theories played in it, and its implications for monetary policy and alternative currencies today, should regard Gold, the Real Bills Doctrine, and the Fed: Sources of Monetary Disorder, 1922­–1938 as an absolutely essential work. You can order it here today!