The Return of Depression Economics

A WHIFF OF THE 1930S

In the spring of 1931 Austria's largest bank, the Credit Anstalt, was on the verge of collapse. The Austrian government could not simply stand by and let it fail, but when it came to the bank's rescue with large sums of freshly printed domestic currency, the resulting capital flight rapidly depleted Austria's gold and foreign exchange reserves. The obvious answer would have been to abandon the gold standard and let the currency float. But this solution was unacceptable -- not just because a drop in the schilling's value would magnify the burden of foreign-currency-denominated debt, but because a currency devaluation would deal a devastating blow to the confidence of a country whose memories of post-World War I hyperinflation were still fresh. Austria pleaded for help from its neighbors and the then-new Bank for International Settlements, but the offered assistance was too little, too late. In the end, the desperate government resorted to capital controls.

It is a familiar story to economic historians. It is also astonishingly modern-sounding: if the plot does not exactly fit any one of today's crisis-ridden economies around the world, it does sound very much like a pastiche of recent events in Indonesia, Malaysia, and Brazil. The main difference now is that financial rescue attempts from the international community have become routine. When a country gets in trouble today a swat team from the International Monetary Fund and the U.S. Treasury quickly arrives on the scene. Suppose, however, that the IMF could use a time machine to send its best money doctors back to that Vienna spring of 1931, but without the ability to offer a huge, no-questions-asked credit line on the spot. What would today's experts say? What could they tell the Austrians that they did not already know?1