Golden Fetters: The Gold Standard And The Great...

"In the countries at the center of the system--Britain, France and Germany--the credibility of the official commitment to the gold standard was beyond reproof. Hence market participants relieved central bankers of much of the burden of management. If sterling weakened, funds would flow toward Britain in anticipation of capital gains that would arise once the Bank of England intervened to strengthen the rate. Because the central bank's commitment to the existing parity was beyond question, capital flows responded quickly and in considerable volume. Sterling strengthened of its own accord, usually without any need for government intervention. Speculation had the same stabilizing influence in France, Germany, and other European countries at the center of the gold standard system."

Golden Fetters: The Gold Standard and the Great...

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Britain was the center of world finance. The pound was theprimary currency for international reserves and commerce, and London was theworld's financial center. Negative payments imbalances for the pound wereoften mitigated when payments surplus nations increased the balances left inLondon banks or used their funds to purchase British securities. The elasticityof British bank money also mitigated payments imbalances, but elasticity woulddecline at the top of the business cycle as bank reserves became fullycommitted to loans. Bank of England interest rate and monetary policy tools weregenerally effective in mitigating payments fluctuations. In the U.S. bankingsystem, money was notoriously inelastic, so gold flows were notoriouslysubstantial and consequential. ? Anunderstanding of the gold standard adjustment mechanism as it existed by 1890requires inclusion of a complex of other factors..

"[It included] the combination current- and capital-account adjustments that accommodated balance-of-payments shocks, and in particular - - - the capital flows that were the new and distinctive feature of the late nineteenth-century gold standard. Those capital flows depended on the credibility and cooperation that, by the 1890s, had come to provide the foundation of the international system."

The Bank of England had to deal with periodic financial crises. TheBank's gold reserve was only about 3% of the money supply and sometimes aslittle as 2%. Foreign nations had to hold far more gold to maintain public confidencein their money. The Bank of England could rely on foreign central banks toassist in meeting crisis conditions. ? Eichengreen describes the 1890 Baring Brothers crisis precipitated byrevolution in Argentina and the collapse of Argentine bonds. Gold borrowed fromRussia and France provided the resources to support the banking system,reorganize Baring Brothers, and restore financial confidence to end the panic.Similarly, Bank of France and Reichsbank support was instrumental indealing with the 1906-1907 financial crisis precipitated by financial events inthe United States. Eichengreen provides interesting details. "Rather thanbeing provided by the Bank of England, the lender-of-last resort function wasprovided collectively." ? France was the major repository of monetary gold. Its financial system wasless sophisticated and more heavily reliant on gold and silver but wasalso less vulnerable to panic situations. The Reichsbank was in anintermediate position between the status of the French and British financialsystems. It was correspondingly more heavily impacted by the 1907 crisis thanwas France. ? By 1913, the United States had supplanted France as the majorrepository of monetary gold, with almost 25% of the world total. Monetaryfluctuations in the U.S. were already disturbing the world gold standard system. ?

For many small nations - especially in Latin America - capital flowsunder the gold standard were pro-cyclical. They reinforced political pressuresfor devaluation and inflation on profligate heavily indebted nations. Eichengreen provides details forArgentina and Brazil. Instances of suspension of convertibility were forced anddisastrous, leading to repeated if frequently short-lived efforts to restoregold standard fixed exchange rates. ? British Commonwealth nations were far moresuccessful, demonstrating from 1880 to 1914 that small nations with goodgovernance could prosper under the gold standard.

The rise and fall of the business cycle was naturally a primaryand disturbing feature of the gold standard adjustment process in all goldstandard nations. The gold standard did not prevent the business cycle. Itworked through the business cycle and was in fact dependent on the businesscycle as part of its adjustment process. When working smoothly, however,business cycle contractions could be kept short and shallow. ? The Bank of England provided the lead in discount rate policyand the major central banks cooperated to provide gold reserves as needed tomeet crisis conditions. Confidence in the system caused market speculators tobet in favor of success, thus reinforcing monetary policy. However, the approachof WW-I, Britain's declining status in international commerce and the risinginfluence of an uncooperative United States was straining and perhaps fatallyundermining this system. ?

It is not enough to speculate about the financial feasibility of the goldstandard. Analysis must include the rules essential to make the system work andwhether those rules are a practical possibility. By refusing cooperation, paymentssurplus nations imposed all the adjustment burdens on payments deficit nations.Surplus nations like the U.S. and France "sterilized" payments inflows instead of allowing them tohave the impact on domestic money supply, prices and consumption that would haveboosted the competitiveness of the deficit nations.The author summarizes his main point:

"[Gold] and financial capital were drained by the United States and France from other parts of the world. Superimposed on already weak foreign balances of payments, these events provoked a greatly magnified monetary contraction abroad. In addition they caused a tightening of fiscal policies in parts of Europe and much of Latin America. This shift in policy worldwide, and not merely the relatively modest shift in the United States, provided the contractionary impulse that set the stage for the 1929 downturn. The minor shift in American policy had such dramatic effects because of the foreign reaction it provoked through its interaction with existing imbalances in the pattern of international settlements and with the gold standard constraints."

It was a different world after WW-I in every sphere - military,political, economic, geographic and societal. The rules of the gold standardwere abandoned during the war and never restored. ? Popular support for the war had been maintained by substantial expansionsof the franchise. This heralded the rise of labor parties. Proportionalrepresentation assured old elites they would not be totally displacedpolitically, but this generally resulted in divided governments and coalitionpolitics that could be weak and unstable when political differences becameintense - as was usually the case in Europe during the 1920s. Nonbelligerentnations, including most of the Scandinavian states, faced less serious financial anddistributional issues than the belligerents and so were not as unstable. ? Wage levels andunemployment became grist for the political mill and quickly undermined theindependence of central banks, their ability to cooperate with each other, andthe credibility of their commitment to monetary stability. Inflationistpressures increased ominously. Instead of capitalinflows in anticipation of effective central bank action, capital tended toquickly flee nations experiencing monetary difficulties. Political battles alsointensified over taxation and budget issues.

By the end of the war, the U.S. had displaced Britain as the world'sfinancial and commercial hub. The war altered trade patterns. There waswidespread overcapacity as belligerents shifted back to peacetime production.Agricultural overcapacity was especially serious, especially for the UnitedStates which had tripled wheat exports and increased meat exports ten-foldduring the war.After the war, the sharply declining prices during the 1920-1921 recession forced needed agriculturalcontraction that was often blamed on the gold standard.

Recovery from the 1920-1921 recession was especially rapid, assisted by agricultural exports, somethingthat was no longer possible thereafter. Eichengreen credits the monetaryflexibility abroad that existed before reestablishment of the gold standard, but thisrecovery was also before the 1922 Fordney-McCumber tariff initiated the tradewar. ? By 1923, the decline in agricultural prices and farm income hadended and rapid recovery had begun. Farm income remained well above pre-war levels until 1930, somethingleft wing economists never mention. With vicious efficiency, themarkets had successfully completed a massive rebalancing that no governmentcould have matched. Mechanization and new crop technology was a threat to smallfarmers throughout the 1920s, but the marketitself was healthy and kept expanding until the record wheat crops of 1928.

The vast financial and economic impacts of the Great War wouldhave created imposing obstacles to restoration of the gold standard in anyevent. Successful restoration of the gold standard depended on whether the U.S.would step up to its new responsibilities for international financialleadership.

"More than ever, credibility hinged on international collaboration among governments and central banks--the harmonization of monetary policies in normal periods, the pooling of reserves in times of crisis. During the war, the British, French and U.S. governments had engaged in extensive and regular international financial cooperation. Germany had not been party to these consultations, of course. Now the web of reparations and war debts, by souring international relations, posed a threat to further collaboration. The change in the distribution of financial resources also implied a greatly expanded role for the United States in these arrangements. The restoration and smooth operation of the gold standard system required that policymakers acknowledge the change in circumstances and adapt accordingly." 041b061a72