1.
Britain Faces the Post-War World At the end of World War I, only the United
States dollar remained on the old gold coin standard, at the 1 twentieth of an ounce par.
The other powers suffered from national fiat currencies.
Suddenly, their currencies were no longer units of weight of gold but independent names
such as the pound, franc, mark, etc., their rates depreciating in relation to gold and
volatile with respect to one another.
Except for mavericks such as Cambridge's John Maynard Keynes, it was generally agreed
that this system was intolerable and that a way must be found to reconstruct a world
monetary order, including restoration of world money and medium of exchange.
At the heart of the European monetary crisis was Great Britain, which would take the lead
in trying to solve the problem.
In the first place, London had been the major pre-war financial center, and second, Britain
dominated the post-war League of Nations, and in particular, its powerful economic and
financial committee.
Furthermore, though inflated and depreciated, the British pound was still in far better
are shaped than the other major currencies of Europe.
Thus, while the pound sterling in February 1920 was depreciated by 35% compared to its
1914 gold par, the French franc was depreciated by 64%, the Belgian franc by 62%, the Italian
lira by 71% and the German mark in terrible shape by 96%.
It was clear that Britain was in a position to guide the worldivid to a new, post-war
monetary order, and it eagerly took up what turned out to be the last remnants of its
old imperial task.
The British understandably decided that the fluctuating fiat money system inherited from
the war was intolerable, and that it was vital to return to a sound international money,
the gold standard.
However, at the same time, they also decided that they would have to return to gold at
the old, pre-war par of $4.86.
Apparently, few if any economists or statesmen at the time argued for cutting British losses,
starting with the real world as it existed in the early 1920s, facing reality and going
Going back to gold at the realistic, depreciated $3.20 or $3.50 per pound sterling.
In view of the enormous difficulties the decision to go back to gold at $4.86 entailed, it is
difficult in hindsight to understand why there was so little support for going back at a
realistic par or why there was so much drive to go back at the old one.
For going back to a pound 30 to 35% above the market rate meant that English exports
upon which the country depended to finance its imports were now priced far above their
competitive price in world markets.
Coal, cotton textiles, iron and steel, and shipbuilding in particular, the bulk of the
export industries that had generated pre-war prosperity, became permanently depressed
in the 1920s, with accompanying heavy unemployment in those industries.
In order to avoid export depression, Britain would have to have been willing to undergo
a substantial monetary and price deflation to make its goods once more competitive in
foreign markets.
But in contrast to pre-World War I days, British wage rates had been made rigid downward by
by Powerful Trade Unionism and particularly by a massive and extravagant system of national
unemployment insurance.
Rather than accept a rigorous deflationary policy, therefore, to accompany its return
to gold, Britain insisted on just the opposite, a continuation of monetary inflation and a
policy of low interest rates and cheap money.
Thus, Great Britain, in the post-World War I world, committed itself to a monetary policy
based on three rigidly firm but mutually self-contradictory axioms.
1.
A return to gold 2.
Returning at a sharply overvalued pound of $4.86 3.
Continuing a policy of inflation and cheap money
Given a program based on such grave inner self-contradiction, the British maneuvered
on the world monetary scene with brilliant tactical shrewdness, but it was a policy that
was doomed to end in disaster.
Why did the British insist on returning to gold at the old, overvalued par?
Partly, it was a vain desire to recapture old glories, to bring back the days when
London was the world's financial center.
The British did not seem to realize fully that the United States had emerged from the war
as the great creditor nation and financially the strongest one so that financial predominance
was inexorably moving to New York or Washington.
To recapture their financial predominance, the British believed that they would have
to bring back the old, traditional $4.86.
Undoubtedly, the British also remembered that after two decades of war against the French
French Revolution and Napoleon, the pound had quickly recovered from its depreciated
state, and the British had been able to restore the pound at its pre-fiat money par.
This restoration was made possible by the fact that the post-Napoleonic war pound returned
quickly to its pre-war par because of a sharp monetary and price deflation that occurred
in the inevitable post-war recession.
The British, after World War I, apparently did not realize that A, the restoration of
the pre-Napoleonic War par had required a substantial deflation, and B, their newly
rigidified war structure could not easily afford or adapt to a deflationary policy.
Instead, the British would insist on having their cake and eating it too, on enjoying
Another reason for returning at $4.86 was a desire by the powerful city of London, the
financiers who held much of the public debt swollen during the war, to be repaid in pounds
that would be worth their old pre-war value in terms of gold and purchasing power.
Since the British were now attempting to support more than twice as much money on top of approximately
the same gold base as before the war, and the other European countries were suffering
from even more inflated currencies, the British and other Europeans complained all during
the 1920s of a gold quote, shortage, or shortage of quote, liquidity.
These complaints reflected a failure to realize that, on the market, a quote shortage can
only be the consequence of an artificially low price of a good.
The quote gold shortage of the 20s reflected the artificially low quote price of gold.
That is, the artificially overvalued rate at which pounds, and many other European currencies,
Return to Gold in the 1920s and therefore the arbitrarily low rate at which gold was
pegged in terms of those currencies.
More particularly, since the pound was pegged at an overvalued rate compared to gold, Britain
would tend to suffer in the 1920s from gold flowing out of the country, or, put another
way, the swollen and inflated pounds would, in the classic price-specie-flow mechanism,
tend to drive gold out of Britain to pay for a deficit in the balance of payments, an outflow
that could put severe contractionary pressure upon the English banking system.
But how could Britain, in the post-war world, cleave to these contradictory axioms and yet
avoid a disastrous outflow of gold, followed by a banking collapse and monetary contraction.