WEBVTT NOTE 58. Depression and the End of the Gold-Sterling-Exchange Standard: 1929-1931 1 00:00:00.000 --> 00:00:09.280 Depression and the end of the gold sterling exchange standard, 1929 to 1931. 2 00:00:09.280 --> 00:00:14.560 The depression, or what nowadays would be called the, quote, recession, that struck 3 00:00:14.560 --> 00:00:21.120 the world economy in 1929, could have been met in the same way the U.S., Britain and 4 00:00:21.120 --> 00:00:26.960 other countries had faced the previous severe contraction of 1920 to 21, and the way in 5 00:00:26.960 --> 00:00:31.800 and which all countries met recessions under the classical gold standard. 6 00:00:31.800 --> 00:00:37.880 In short, they could have recognized the folly of the preceding inflationary boom and accepted 7 00:00:37.880 --> 00:00:43.880 the recession mechanism needed to return to an efficient free market economy. 8 00:00:43.880 --> 00:00:48.560 In other words, they could have accepted the liquidation of unsound investments and the 9 00:00:48.560 --> 00:00:54.480 liquidation of egregiously unsound banks and have accepted the contractionary deflation 10 00:00:54.480 --> 00:00:58.080 of Money, Credits and Prices. 11 00:00:58.080 --> 00:01:03.200 If they had done so, they would, as in the previous cases, have encountered a recession 12 00:01:03.200 --> 00:01:09.660 adjustment period that would have been sharp, severe, but mercifully short. 13 00:01:09.660 --> 00:01:14.080 Recessions unhampered by government almost invariably worked themselves into recovery 14 00:01:14.080 --> 00:01:17.220 within a year or 18 months. 15 00:01:17.220 --> 00:01:21.680 But the United States, Britain and the rest of the world had been permanently seduced 16 00:01:21.680 --> 00:01:24.720 by the Siren Song of Cheap Money. 17 00:01:24.720 --> 00:01:30.080 If inflationary bank credit expansion had gotten the world into this mess, then more, 18 00:01:30.080 --> 00:01:33.200 more of the same would be the only way out. 19 00:01:33.200 --> 00:01:39.120 Pursuit of this inflationist, quote, proto-Keynesian folly, along with other massive government 20 00:01:39.120 --> 00:01:44.080 interventions to prevent price deflation, managed to convert what would have been a 21 00:01:44.080 --> 00:01:51.320 short, sharp recession into a chronic, permanent stagnation with an unprecedented high unemployment 22 00:01:51.320 --> 00:01:54.440 that only ended with World War II. 23 00:01:54.440 --> 00:01:59.600 Great Britain tried to inflate its way out of the recession, as did the United States, 24 00:01:59.600 --> 00:02:04.320 despite the monetarist myth that the Federal Reserve deliberately contracted the money 25 00:02:04.320 --> 00:02:08.480 supply from 1929 to 1933. 26 00:02:08.480 --> 00:02:13.400 The Fed inflated, partly to help Britain and partly for its own sake. 27 00:02:13.400 --> 00:02:19.080 During the week of the Great Stock Market Crash, the final week of October 1929, the 28 00:02:19.080 --> 00:02:29.080 The Federal Reserve, specifically George Harrison, doubled its holdings of government securities and discounted $200 million for member banks. 29 00:02:29.080 --> 00:02:46.080 During that one week, the Fed added $300 million to bank reserves, the expansion being generated to prevent stock market liquidation and to permit the New York City banks to take over broker's loans being liquidated by non-bank lenders. 30 00:02:46.080 --> 00:02:51.320 Over the objections of Roy Young of the Federal Reserve Board, Harrison told the New York 31 00:02:51.320 --> 00:02:56.700 Stock Exchange that, quote, I am ready to provide all the reserve funds that may be 32 00:02:56.700 --> 00:02:58.960 needed, end quote. 33 00:02:58.960 --> 00:03:04.080 By December, Secretary Mellon issued one of his traditionally optimistic pronouncements 34 00:03:04.080 --> 00:03:10.020 that there was, quote, plenty of credit available, and President Hoover, addressing a business 35 00:03:10.020 --> 00:03:15.840 conference on December 5th, hailed the nation's good fortune in possessing the splendid Federal 36 00:03:15.840 --> 00:03:25.840 The Federal Reserve system, which had succeeded in saving shaky banks, had restored confidence and had made capital more abundant by reducing interest rates. 37 00:03:26.840 --> 00:03:39.840 In early 1930, the Fed launched a massive cheap money program, lowering re-discount rates during the year from 4.5% to 2%, with acceptance rates and call loan rates falling similarly. 38 00:03:39.840 --> 00:03:47.320 The Fed purchased $218 million in government securities, increasing total member bank reserves 39 00:03:47.320 --> 00:03:50.240 by over $100 million. 40 00:03:50.240 --> 00:03:55.360 The money supply, however, remained stable and did not increase due to the bank failures 41 00:03:55.360 --> 00:03:57.600 of late 1930. 42 00:03:57.600 --> 00:04:00.840 The inflationists were not satisfied, however. 43 00:04:00.840 --> 00:04:07.000 Businessweek then, as now, a voice for quote, enlightened business opinion, thundering in 44 00:04:07.000 --> 00:04:12.560 In late October that the, quote, deflationists were, quote, in the saddle. 45 00:04:12.560 --> 00:04:18.560 In contrast, H. Parker Willis, in an editorial in the New York Journal of Commerce, trenchantly 46 00:04:18.560 --> 00:04:23.280 pointed out that the easy money policy of the Fed was actually bringing about the bank 47 00:04:23.280 --> 00:04:28.640 failures because of the banks', quote, inability to liquidate. 48 00:04:28.640 --> 00:04:33.320 Willis noted that the country was suffering from frozen and wasteful malinvestments in 49 00:04:33.320 --> 00:04:51.240 In 1930, Montague Norman got part of his wish to achieve a formal inter-central bank collaboration. 50 00:04:51.240 --> 00:04:56.780 Norman was able to push through a new quote, central bankers bank, the bank for international 51 00:04:56.780 --> 00:05:08.780 to meet regularly at Basel, to provide clearing facilities for German reparations payments, and to provide regular facilities for meeting and cooperation. 52 00:05:08.780 --> 00:05:17.780 While Congress forbade the Fed from formally joining the BIS, the New York Fed and the Morgan Interests worked closely with the new bank. 53 00:05:17.780 --> 00:05:24.780 The BIS, indeed, treated the New York Fed as if it were the central bank of the United States. 54 00:05:24.780 --> 00:05:34.780 Gates W. McGarra resigned his post as chairman of the board of the New York Fed in February 1930 to assume the position of president of the BIS. 55 00:05:34.780 --> 00:05:42.780 And Jackson E. Reynolds, a director of the New York Fed, was chairman of the BIS's first organizing committee. 56 00:05:42.780 --> 00:05:47.780 J.P. Morgan and company unsurprisingly supplied much of the capital for the BIS. 57 00:05:47.780 --> 00:05:53.660 And even though there was no legislative sanction for US participation in the bank, New York 58 00:05:53.660 --> 00:05:59.300 Fed Governor George Harrison made a, quote, regular business trip abroad in the fall to 59 00:05:59.300 --> 00:06:01.820 confer with the other central bankers. 60 00:06:01.820 --> 00:06:07.180 And the New York Fed extended loans to the BIS during 1931. 61 00:06:07.180 --> 00:06:15.300 During 1931, many of the European banks, swollen by unsound credit expansion, met their comeuppance. 62 00:06:15.300 --> 00:06:24.060 In October 1929, the important Austrian bank, the Boden Kreditanstalt, was headed for liquidation. 63 00:06:24.060 --> 00:06:30.300 Instead of allowing the bank to fold and liquidate, international finance, headed by the Rothschilds 64 00:06:30.300 --> 00:06:33.380 and the Morgans, bailed the bank out. 65 00:06:33.380 --> 00:06:39.540 The Boden Bank was merged into the older and stronger Oster-Eikische Kreditanstalt, now 66 00:06:39.540 --> 00:06:44.980 by far the largest commercial bank in Austria, capital being provided by an international 67 00:06:44.980 --> 00:06:50.380 Financial Syndicate, including JP Morgan and Rothschild of Vienna. 68 00:06:50.380 --> 00:06:56.020 Moreover, the Austrian government guaranteed some of the Bowdoin Bank's assets. 69 00:06:56.020 --> 00:07:03.780 But the now huge Creditanstalt was weakened by the merger and, in May 1931, a run developed 70 00:07:03.780 --> 00:07:09.420 on the bank, led by French bankers angered by the announced customs union between Germany 71 00:07:09.420 --> 00:07:11.100 and Austria. 72 00:07:11.100 --> 00:07:16.580 Despite aid to the Creditanstalt by the Bank of England, Rothschild of Vienna, and the 73 00:07:16.580 --> 00:07:24.020 BIS, aided by the New York Fed and other central banks, to a total of over $31 million, and 74 00:07:24.020 --> 00:07:31.380 the Austrian government's guarantee of Creditanstalt liabilities up to $150 million, bank runs 75 00:07:31.380 --> 00:07:37.880 once launched are irresistible, and so Austria went off the gold standard, in effect declaring 76 00:07:37.880 --> 00:07:42.080 National Bankruptcy in June 1931. 77 00:07:42.080 --> 00:07:47.420 At that point, a fierce run began on the German banks, the Bank for International Settlements 78 00:07:47.420 --> 00:07:54.080 again trying to shore up Germany by arranging a $100 million loan to the Reichsbank, a credit 79 00:07:54.080 --> 00:07:59.240 joined in by the Bank of England, the Bank of France, the New York Fed and several other 80 00:07:59.240 --> 00:08:01.320 central banks. 81 00:08:01.320 --> 00:08:05.980 But the run on the German banks, both from the German people as well as from foreign 82 00:08:05.980 --> 00:08:09.020 and Creditors proved devastating. 83 00:08:09.020 --> 00:08:14.660 By mid-July, the German banking system collapsed from internal runs and Germany went off the 84 00:08:14.660 --> 00:08:16.460 gold standard. 85 00:08:16.460 --> 00:08:21.660 Since the German public feared runaway inflation above all else and identified the cause of 86 00:08:21.660 --> 00:08:27.300 the inflation as exchange rate devaluation, the German government felt it had to maintain 87 00:08:27.300 --> 00:08:32.780 the par value of the mark, now highly overvalued relative to gold. 88 00:08:32.780 --> 00:08:37.940 To do so, while at the same time resuming inflationary credit expansion, the German 89 00:08:37.940 --> 00:08:45.140 government had to quote, protect the mark by severe and thorough going exchange controls. 90 00:08:45.140 --> 00:08:49.780 With the successful runs on Austria and Germany, it was clear that England would be the next 91 00:08:49.780 --> 00:08:56.060 to suffer a worldwide lack of confidence in its currency, including runs on gold. 92 00:08:56.060 --> 00:09:01.680 Sure enough, in mid-July, sterling redemption in gold became severe, and the Bank of England 93 00:09:01.680 --> 00:09:07.760 and lost $125 million in gold in nine days in late July. 94 00:09:07.760 --> 00:09:13.660 The remedy to such a situation under the classical gold standard was very clear, a sharp rise 95 00:09:13.660 --> 00:09:19.480 in bank rate to tighten English money and to attract gold and foreign capital to stay 96 00:09:19.480 --> 00:09:22.080 or flow back into England. 97 00:09:22.080 --> 00:09:28.120 In classical gold standard crises, the bank had raised its bank rate to 9 or 10 percent 98 00:09:28.120 --> 00:09:34.240 until the crisis passed, and yet so wedded was England to cheap money that it entered 99 00:09:34.240 --> 00:09:41.280 the crisis in mid-July at the absurdly low bank rate of 2.5% and grudgingly raised the 100 00:09:41.280 --> 00:09:47.760 rate only to 4.5% by the end of July, keeping the rate at this low level until it finally 101 00:09:47.760 --> 00:09:53.400 threw in the towel and, on the black Sunday of September 20th, went off the very gold 102 00:09:53.400 --> 00:09:58.400 and the gold exchange standard that it recently had foisted upon the rest of the world. 103 00:09:58.400 --> 00:10:05.400 Indeed, instead of tightening money, the Bank of England made the pound shakier still by inflating credit further. 104 00:10:05.400 --> 00:10:14.400 Thus, in the last two weeks of July, the Bank of England purchased nearly $115 million in government securities. 105 00:10:14.400 --> 00:10:22.400 England disgracefully threw in the towel, even as foreign central banks tried to prop the Bank of England up and save the gold exchange standard. 106 00:10:22.400 --> 00:10:27.880 Answering Norman's pleas, the Bank of France and the New York Fed each loaned the Bank 107 00:10:27.880 --> 00:10:36.640 of England $125 million on August 1, and then, later in August, another $400 million provided 108 00:10:36.640 --> 00:10:40.480 by a consortium of French and American bankers. 109 00:10:40.480 --> 00:10:46.880 All this aid was allowed to go down the drain on the altar of inflationism and a 4.5% bank 110 00:10:46.880 --> 00:10:48.220 rate. 111 00:10:48.220 --> 00:10:56.420 As Dr. Anderson concluded, England went off the gold standard with bank rate at 4.5%. 112 00:10:56.420 --> 00:11:00.980 To a British banker in 1913, this would have been an incredible thing. 113 00:11:00.980 --> 00:11:05.660 The collapse of the gold standard in England was absolutely unnecessary. 114 00:11:05.660 --> 00:11:12.220 It was the product of prolonged violation of gold standard rules and, even at the end, 115 00:11:12.220 --> 00:11:18.660 It could have been averted by the return to orthodox gold standard methods." 116 00:11:18.660 --> 00:11:23.380 England betrayed not only the countries that aided the pound, but also the countries it 117 00:11:23.380 --> 00:11:28.480 had cajoled into adopting the gold exchange standard in the 1920s. 118 00:11:28.480 --> 00:11:33.600 It also specifically betrayed those banks it had persuaded to keep huge sterling balances 119 00:11:33.600 --> 00:11:39.100 in London, specifically the Netherlands Bank and the Bank of France. 120 00:11:39.100 --> 00:11:46.140 Indeed, on Friday, September 18th, Dr. G. Wissering, head of the Netherlands Bank, phoned 121 00:11:46.140 --> 00:11:49.980 Monty Norman and asked him about the crisis of sterling. 122 00:11:49.980 --> 00:11:55.740 Wissering, who was poised to withdraw massive sterling balances from London, was assured 123 00:11:55.740 --> 00:12:02.140 without qualification by his old friend Norman that England would, at all costs, remain on 124 00:12:02.140 --> 00:12:03.980 the gold standard. 125 00:12:03.980 --> 00:12:07.100 Two days later, England betrayed its word. 126 00:12:07.100 --> 00:12:10.220 The Netherlands Bank suffered severe losses. 127 00:12:10.220 --> 00:12:14.740 The Netherlands Bank was strongly criticized by the Dutch government for keeping its balances 128 00:12:14.740 --> 00:12:18.060 in sterling until it was too late. 129 00:12:18.060 --> 00:12:22.820 In its own defense, the bank quoted repeated assurances from the Bank of England about 130 00:12:22.820 --> 00:12:26.000 the safety of foreign funds in London. 131 00:12:26.000 --> 00:12:31.140 The bank made it clear that it was betrayed and deceived by the Bank of England. 132 00:12:31.140 --> 00:12:38.660 The Bank of France also suffered severely from the British betrayal, losing about $95 million. 133 00:12:38.660 --> 00:12:44.180 Despite its misgivings, it had loyally supported the English gold standard system by allowing 134 00:12:44.180 --> 00:12:47.020 sterling balances to pile up. 135 00:12:47.020 --> 00:12:52.220 The Bank of France sold no sterling until after England went off gold. 136 00:12:52.220 --> 00:12:59.980 By September 1931, it had amassed a sterling portfolio of $300 million, one-fifth of France's 137 00:12:59.980 --> 00:13:02.380 as Monetary Reserves. 138 00:13:02.380 --> 00:13:08.900 In fact, during the period of 1928-31, the sterling portfolio of the Bank of France was 139 00:13:08.900 --> 00:13:14.940 at times equal to two-thirds of the entire gold reserve of the Bank of England. 140 00:13:14.940 --> 00:13:19.500 Despite Montague Norman, who began to blame the French government for his own egregious 141 00:13:19.500 --> 00:13:26.020 failure, it was not the French authorities who put pressure on sterling in 1931. 142 00:13:26.020 --> 00:13:31.580 On the contrary, it was the shrewd private French investors and commercial banks who, 143 00:13:31.580 --> 00:13:36.300 correctly sensing the weakness of sterling and the British refusal to employ orthodox 144 00:13:36.300 --> 00:13:42.540 measures in its support, decided to make a run on the pound in exchange for gold. 145 00:13:42.540 --> 00:13:47.780 The run was aggravated by the glaring fact that Britain had a chronic import deficit 146 00:13:47.780 --> 00:13:52.700 and also was scarcely in a position to save the gold standard through tight money when 147 00:13:52.700 --> 00:14:00.100 and the British government, at the end of July, projected a massive fiscal 1932-33 deficit 148 00:14:00.100 --> 00:14:07.400 of £120 million, the largest since 1920. Attempts in September to cut the budget were 149 00:14:07.400 --> 00:14:12.620 overridden by union strikes and even by a short-lived sit-down strike by British naval 150 00:14:12.620 --> 00:14:17.080 personnel which convinced foreigners that Britain would not take sufficient measures 151 00:14:17.080 --> 00:14:19.180 to defend the pound. 152 00:14:19.180 --> 00:14:24.740 In his memoirs, the economist Moritz J. Bonne neatly summed up the significance of England's 153 00:14:24.740 --> 00:14:27.540 action in September 1931. 154 00:14:27.540 --> 00:14:33.860 Quote, September 20, 1931 was the end of an age. 155 00:14:33.860 --> 00:14:38.820 It was the last day of the age of economic liberalism, in which Great Britain had been 156 00:14:38.820 --> 00:14:40.820 the leader of the world. 157 00:14:40.820 --> 00:14:43.460 Now the whole edifice had crashed. 158 00:14:43.460 --> 00:14:48.720 The slogan, Safe as the Bank of England, no longer had any meaning. 159 00:14:48.720 --> 00:14:51.760 The Bank of England had gone into default. 160 00:14:51.760 --> 00:14:57.860 For the first time in history, a great creditor country had devalued its currency and by so 161 00:14:57.860 --> 00:15:04.400 doing had inflicted heavy losses on all those who had trusted it. 162 00:15:04.400 --> 00:15:09.880 As soon as England went off the gold standard, the pound fell by 30%. 163 00:15:09.880 --> 00:15:15.400 It is ironic that, after all the travail Britain had put the world through, the pound fell 164 00:15:15.400 --> 00:15:22.340 fell to a level, $3.40, that might have been viable if she had originally returned to gold 165 00:15:22.340 --> 00:15:24.040 at that rate. 166 00:15:24.040 --> 00:15:31.300 25 countries followed Britain off gold and onto floating and devaluating exchange rates. 167 00:15:31.300 --> 00:15:34.540 The era of the gold exchange standard was over.