Hall and Ferguson reveal their uneasiness with and lack of insight into the operation of the money supply process under a genuine gold standard with the following example
Suppose a fad had swept the nation in 1927 because Calvin Coolidge appeared in public wearing one gold earring. Then every teenager in America wanted to wear a gold earring «just like silent Cal». money supply to decline. While it is true that the commercial demand for gold does play a role in determining the supply and value of money under a gold standard, it is hardly cause for alarm.
Rather, it highlights the important fact that the gold standard evolved on the market from a useful commodity with a preexisting supply and demand and was not the product of a set of arbitrary rules promulgated by governments. Now, Hall and Ferguson conclude that by breaking the rules of the game and persisting in sterilizing the gold inflows from 1929 to 1933, the Fed caused a monetary deflation in Great Britain and throughout Europe. The nations losing gold were forced to contract their money supplies and this contributed to a financial collapse and a precipitous decline in real economic activity that marked the onset of the Great Depression. Thus while the authors blame the initiation of the Great Depression on Fed sterilization policies, they attribute its length and severity to the gold standard.
According to the authors, as long as European countries remained on the gold standard and US sterilization continued, there could be no end of the Depression in sight. The US gold stock would become a huge pile of sterilized and useless gold. Starting with the British in 1931, our trading partners began to recognize this fact, and one by one they left the gold standard. The Germans and ironically the United States were among the last to leave gold and so were hurt the worst, experiencing the longest and deepest forms of the Depression.
The monetary system that sowed the seeds of the Great Depression in the 1920s was a central-bank-manipulated and inflationary pseudogold standard. Finally you will read that from 1929 to 1932, the Fed continued to exercise a highly inflationary impact on the money supply, as it feverishly pumped new reserves into the banking system in a vain attempt to ward off the cyclical downturn entailed by its own earlier inflation of the money supply. The Fed was defeated in this endeavor to pump up the money supply and «reflate» prices in the early 1930s by domestic and foreign depositors who reclaimed their rightful property from an inherently bankrupt US banking system. They had suddenly lost confidence in the Fed-controlled monetary system masquerading as a gold standard, when they perceived at last the dwindling prospect of ever redeeming the rapidly expanding mountain of inflated paper claims for their gold dollars.
Source: Joseph T. Salerno | Mises Institute