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NOTE 52. Britain Faces the Postwar World

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1.

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Britain Faces the Post-War World At the end of World War I, only the United

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States dollar remained on the old gold coin standard, at the 1 twentieth of an ounce par.

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The other powers suffered from national fiat currencies.

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Suddenly, their currencies were no longer units of weight of gold but independent names

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such as the pound, franc, mark, etc., their rates depreciating in relation to gold and

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volatile with respect to one another.

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Except for mavericks such as Cambridge's John Maynard Keynes, it was generally agreed

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that this system was intolerable and that a way must be found to reconstruct a world

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monetary order, including restoration of world money and medium of exchange.

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At the heart of the European monetary crisis was Great Britain, which would take the lead

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in trying to solve the problem.

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In the first place, London had been the major pre-war financial center, and second, Britain

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dominated the post-war League of Nations, and in particular, its powerful economic and

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financial committee.

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Furthermore, though inflated and depreciated, the British pound was still in far better

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are shaped than the other major currencies of Europe.

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Thus, while the pound sterling in February 1920 was depreciated by 35% compared to its

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1914 gold par, the French franc was depreciated by 64%, the Belgian franc by 62%, the Italian

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lira by 71% and the German mark in terrible shape by 96%.

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It was clear that Britain was in a position to guide the worldivid to a new, post-war

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monetary order, and it eagerly took up what turned out to be the last remnants of its

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old imperial task.

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The British understandably decided that the fluctuating fiat money system inherited from

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the war was intolerable, and that it was vital to return to a sound international money,

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the gold standard.

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However, at the same time, they also decided that they would have to return to gold at

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the old, pre-war par of $4.86.

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Apparently, few if any economists or statesmen at the time argued for cutting British losses,

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starting with the real world as it existed in the early 1920s, facing reality and going

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Going back to gold at the realistic, depreciated $3.20 or $3.50 per pound sterling.

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In view of the enormous difficulties the decision to go back to gold at $4.86 entailed, it is

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difficult in hindsight to understand why there was so little support for going back at a

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realistic par or why there was so much drive to go back at the old one.

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For going back to a pound 30 to 35% above the market rate meant that English exports

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upon which the country depended to finance its imports were now priced far above their

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competitive price in world markets.

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Coal, cotton textiles, iron and steel, and shipbuilding in particular, the bulk of the

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export industries that had generated pre-war prosperity, became permanently depressed

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in the 1920s, with accompanying heavy unemployment in those industries.

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In order to avoid export depression, Britain would have to have been willing to undergo

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a substantial monetary and price deflation to make its goods once more competitive in

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foreign markets.

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But in contrast to pre-World War I days, British wage rates had been made rigid downward by

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by Powerful Trade Unionism and particularly by a massive and extravagant system of national

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unemployment insurance.

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Rather than accept a rigorous deflationary policy, therefore, to accompany its return

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to gold, Britain insisted on just the opposite, a continuation of monetary inflation and a

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policy of low interest rates and cheap money.

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Thus, Great Britain, in the post-World War I world, committed itself to a monetary policy

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based on three rigidly firm but mutually self-contradictory axioms.

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1.

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A return to gold 2.

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Returning at a sharply overvalued pound of $4.86 3.

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Continuing a policy of inflation and cheap money

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Given a program based on such grave inner self-contradiction, the British maneuvered

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on the world monetary scene with brilliant tactical shrewdness, but it was a policy that

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was doomed to end in disaster.

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Why did the British insist on returning to gold at the old, overvalued par?

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Partly, it was a vain desire to recapture old glories, to bring back the days when

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London was the world's financial center.

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The British did not seem to realize fully that the United States had emerged from the war

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as the great creditor nation and financially the strongest one so that financial predominance

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was inexorably moving to New York or Washington.

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To recapture their financial predominance, the British believed that they would have

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to bring back the old, traditional $4.86.

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Undoubtedly, the British also remembered that after two decades of war against the French

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French Revolution and Napoleon, the pound had quickly recovered from its depreciated

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state, and the British had been able to restore the pound at its pre-fiat money par.

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This restoration was made possible by the fact that the post-Napoleonic war pound returned

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quickly to its pre-war par because of a sharp monetary and price deflation that occurred

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in the inevitable post-war recession.

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The British, after World War I, apparently did not realize that A, the restoration of

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the pre-Napoleonic War par had required a substantial deflation, and B, their newly

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rigidified war structure could not easily afford or adapt to a deflationary policy.

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Instead, the British would insist on having their cake and eating it too, on enjoying

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Another reason for returning at $4.86 was a desire by the powerful city of London, the

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financiers who held much of the public debt swollen during the war, to be repaid in pounds

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that would be worth their old pre-war value in terms of gold and purchasing power.

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Since the British were now attempting to support more than twice as much money on top of approximately

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the same gold base as before the war, and the other European countries were suffering

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from even more inflated currencies, the British and other Europeans complained all during

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the 1920s of a gold quote, shortage, or shortage of quote, liquidity.

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These complaints reflected a failure to realize that, on the market, a quote shortage can

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only be the consequence of an artificially low price of a good.

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The quote gold shortage of the 20s reflected the artificially low quote price of gold.

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That is, the artificially overvalued rate at which pounds, and many other European currencies,

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Return to Gold in the 1920s and therefore the arbitrarily low rate at which gold was

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pegged in terms of those currencies.

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More particularly, since the pound was pegged at an overvalued rate compared to gold, Britain

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would tend to suffer in the 1920s from gold flowing out of the country, or, put another

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way, the swollen and inflated pounds would, in the classic price-specie-flow mechanism,

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tend to drive gold out of Britain to pay for a deficit in the balance of payments, an outflow

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that could put severe contractionary pressure upon the English banking system.

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But how could Britain, in the post-war world, cleave to these contradictory axioms and yet

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avoid a disastrous outflow of gold, followed by a banking collapse and monetary contraction.