Depression and the end of the gold sterling exchange standard, 1929 to 1931.
The depression, or what nowadays would be called the, quote, recession, that struck
the world economy in 1929, could have been met in the same way the U.S., Britain and
other countries had faced the previous severe contraction of 1920 to 21, and the way in
and which all countries met recessions under the classical gold standard.
In short, they could have recognized the folly of the preceding inflationary boom and accepted
the recession mechanism needed to return to an efficient free market economy.
In other words, they could have accepted the liquidation of unsound investments and the
liquidation of egregiously unsound banks and have accepted the contractionary deflation
of Money, Credits and Prices.
If they had done so, they would, as in the previous cases, have encountered a recession
adjustment period that would have been sharp, severe, but mercifully short.
Recessions unhampered by government almost invariably worked themselves into recovery
within a year or 18 months.
But the United States, Britain and the rest of the world had been permanently seduced
by the Siren Song of Cheap Money.
If inflationary bank credit expansion had gotten the world into this mess, then more,
more of the same would be the only way out.
Pursuit of this inflationist, quote, proto-Keynesian folly, along with other massive government
interventions to prevent price deflation, managed to convert what would have been a
short, sharp recession into a chronic, permanent stagnation with an unprecedented high unemployment
that only ended with World War II.
Great Britain tried to inflate its way out of the recession, as did the United States,
despite the monetarist myth that the Federal Reserve deliberately contracted the money
supply from 1929 to 1933.
The Fed inflated, partly to help Britain and partly for its own sake.
During the week of the Great Stock Market Crash, the final week of October 1929, the
The Federal Reserve, specifically George Harrison, doubled its holdings of government securities and discounted $200 million for member banks.
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.
Over the objections of Roy Young of the Federal Reserve Board, Harrison told the New York
Stock Exchange that, quote, I am ready to provide all the reserve funds that may be
needed, end quote.
By December, Secretary Mellon issued one of his traditionally optimistic pronouncements
that there was, quote, plenty of credit available, and President Hoover, addressing a business
conference on December 5th, hailed the nation's good fortune in possessing the splendid Federal
The Federal Reserve system, which had succeeded in saving shaky banks, had restored confidence and had made capital more abundant by reducing interest rates.
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.
The Fed purchased $218 million in government securities, increasing total member bank reserves
by over $100 million.
The money supply, however, remained stable and did not increase due to the bank failures
of late 1930.
The inflationists were not satisfied, however.
Businessweek then, as now, a voice for quote, enlightened business opinion, thundering in
In late October that the, quote, deflationists were, quote, in the saddle.
In contrast, H. Parker Willis, in an editorial in the New York Journal of Commerce, trenchantly
pointed out that the easy money policy of the Fed was actually bringing about the bank
failures because of the banks', quote, inability to liquidate.
Willis noted that the country was suffering from frozen and wasteful malinvestments in
In 1930, Montague Norman got part of his wish to achieve a formal inter-central bank collaboration.
Norman was able to push through a new quote, central bankers bank, the bank for international
to meet regularly at Basel, to provide clearing facilities for German reparations payments, and to provide regular facilities for meeting and cooperation.
While Congress forbade the Fed from formally joining the BIS, the New York Fed and the Morgan Interests worked closely with the new bank.
The BIS, indeed, treated the New York Fed as if it were the central bank of the United States.
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.
And Jackson E. Reynolds, a director of the New York Fed, was chairman of the BIS's first organizing committee.
J.P. Morgan and company unsurprisingly supplied much of the capital for the BIS.
And even though there was no legislative sanction for US participation in the bank, New York
Fed Governor George Harrison made a, quote, regular business trip abroad in the fall to
confer with the other central bankers.
And the New York Fed extended loans to the BIS during 1931.
During 1931, many of the European banks, swollen by unsound credit expansion, met their comeuppance.
In October 1929, the important Austrian bank, the Boden Kreditanstalt, was headed for liquidation.
Instead of allowing the bank to fold and liquidate, international finance, headed by the Rothschilds
and the Morgans, bailed the bank out.
The Boden Bank was merged into the older and stronger Oster-Eikische Kreditanstalt, now
by far the largest commercial bank in Austria, capital being provided by an international
Financial Syndicate, including JP Morgan and Rothschild of Vienna.
Moreover, the Austrian government guaranteed some of the Bowdoin Bank's assets.
But the now huge Creditanstalt was weakened by the merger and, in May 1931, a run developed
on the bank, led by French bankers angered by the announced customs union between Germany
and Austria.
Despite aid to the Creditanstalt by the Bank of England, Rothschild of Vienna, and the
BIS, aided by the New York Fed and other central banks, to a total of over $31 million, and
the Austrian government's guarantee of Creditanstalt liabilities up to $150 million, bank runs
once launched are irresistible, and so Austria went off the gold standard, in effect declaring
National Bankruptcy in June 1931.
At that point, a fierce run began on the German banks, the Bank for International Settlements
again trying to shore up Germany by arranging a $100 million loan to the Reichsbank, a credit
joined in by the Bank of England, the Bank of France, the New York Fed and several other
central banks.
But the run on the German banks, both from the German people as well as from foreign
and Creditors proved devastating.
By mid-July, the German banking system collapsed from internal runs and Germany went off the
gold standard.
Since the German public feared runaway inflation above all else and identified the cause of
the inflation as exchange rate devaluation, the German government felt it had to maintain
the par value of the mark, now highly overvalued relative to gold.
To do so, while at the same time resuming inflationary credit expansion, the German
government had to quote, protect the mark by severe and thorough going exchange controls.
With the successful runs on Austria and Germany, it was clear that England would be the next
to suffer a worldwide lack of confidence in its currency, including runs on gold.
Sure enough, in mid-July, sterling redemption in gold became severe, and the Bank of England
and lost $125 million in gold in nine days in late July.
The remedy to such a situation under the classical gold standard was very clear, a sharp rise
in bank rate to tighten English money and to attract gold and foreign capital to stay
or flow back into England.
In classical gold standard crises, the bank had raised its bank rate to 9 or 10 percent
until the crisis passed, and yet so wedded was England to cheap money that it entered
the crisis in mid-July at the absurdly low bank rate of 2.5% and grudgingly raised the
rate only to 4.5% by the end of July, keeping the rate at this low level until it finally
threw in the towel and, on the black Sunday of September 20th, went off the very gold
and the gold exchange standard that it recently had foisted upon the rest of the world.
Indeed, instead of tightening money, the Bank of England made the pound shakier still by inflating credit further.
Thus, in the last two weeks of July, the Bank of England purchased nearly $115 million in government securities.
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.
Answering Norman's pleas, the Bank of France and the New York Fed each loaned the Bank
of England $125 million on August 1, and then, later in August, another $400 million provided
by a consortium of French and American bankers.
All this aid was allowed to go down the drain on the altar of inflationism and a 4.5% bank
rate.
As Dr. Anderson concluded, England went off the gold standard with bank rate at 4.5%.
To a British banker in 1913, this would have been an incredible thing.
The collapse of the gold standard in England was absolutely unnecessary.
It was the product of prolonged violation of gold standard rules and, even at the end,
It could have been averted by the return to orthodox gold standard methods."
England betrayed not only the countries that aided the pound, but also the countries it
had cajoled into adopting the gold exchange standard in the 1920s.
It also specifically betrayed those banks it had persuaded to keep huge sterling balances
in London, specifically the Netherlands Bank and the Bank of France.
Indeed, on Friday, September 18th, Dr. G. Wissering, head of the Netherlands Bank, phoned
Monty Norman and asked him about the crisis of sterling.
Wissering, who was poised to withdraw massive sterling balances from London, was assured
without qualification by his old friend Norman that England would, at all costs, remain on
the gold standard.
Two days later, England betrayed its word.
The Netherlands Bank suffered severe losses.
The Netherlands Bank was strongly criticized by the Dutch government for keeping its balances
in sterling until it was too late.
In its own defense, the bank quoted repeated assurances from the Bank of England about
the safety of foreign funds in London.
The bank made it clear that it was betrayed and deceived by the Bank of England.
The Bank of France also suffered severely from the British betrayal, losing about $95 million.
Despite its misgivings, it had loyally supported the English gold standard system by allowing
sterling balances to pile up.
The Bank of France sold no sterling until after England went off gold.
By September 1931, it had amassed a sterling portfolio of $300 million, one-fifth of France's
as Monetary Reserves.
In fact, during the period of 1928-31, the sterling portfolio of the Bank of France was
at times equal to two-thirds of the entire gold reserve of the Bank of England.
Despite Montague Norman, who began to blame the French government for his own egregious
failure, it was not the French authorities who put pressure on sterling in 1931.
On the contrary, it was the shrewd private French investors and commercial banks who,
correctly sensing the weakness of sterling and the British refusal to employ orthodox
measures in its support, decided to make a run on the pound in exchange for gold.
The run was aggravated by the glaring fact that Britain had a chronic import deficit
and also was scarcely in a position to save the gold standard through tight money when
and the British government, at the end of July, projected a massive fiscal 1932-33 deficit
of £120 million, the largest since 1920. Attempts in September to cut the budget were
overridden by union strikes and even by a short-lived sit-down strike by British naval
personnel which convinced foreigners that Britain would not take sufficient measures
to defend the pound.
In his memoirs, the economist Moritz J. Bonne neatly summed up the significance of England's
action in September 1931.
Quote, September 20, 1931 was the end of an age.
It was the last day of the age of economic liberalism, in which Great Britain had been
the leader of the world.
Now the whole edifice had crashed.
The slogan, Safe as the Bank of England, no longer had any meaning.
The Bank of England had gone into default.
For the first time in history, a great creditor country had devalued its currency and by so
doing had inflicted heavy losses on all those who had trusted it.
As soon as England went off the gold standard, the pound fell by 30%.
It is ironic that, after all the travail Britain had put the world through, the pound fell
fell to a level, $3.40, that might have been viable if she had originally returned to gold
at that rate.
25 countries followed Britain off gold and onto floating and devaluating exchange rates.
The era of the gold exchange standard was over.