The Background of the 1920s
It is impossible to understand the first New Deal decision for dollar nationalism without setting that choice in the monetary world of the 1920s, from which the New Deal emerged.
Similarly, it is impossible to understand the monetary system of the 1920s without reference
to the pre-World War I monetary order and its break-up during the war, for the world
of the 1920s was an attempt to reconstitute an international monetary order, seemingly
one quite similar to the status quo ante, but actually based on very different principles
and Institutions.
The pre-war monetary order was genuinely, quote, international.
That is, world money rested not on paper tickets issued by one or more governments, but on
a genuine economic commodity, gold, whose supply rested on market supply and demand
principles.
In short, the international gold standard was the monetary equivalent and corollary
of International Free Trade and Commodities.
It was a method of separating money from the state, just as enterprise and foreign trade
had been so separated.
In short, the gold standard was the monetary counterpart of laissez-faire in other economic
areas.
The gold standard in the pre-war era was never, quote, pure.
No more than was laissez-faire in general.
Every major country, except the United States, had central banks which tried their best to
inflate and manipulate the currency.
But the system was such that this intervention could only operate within narrow limits.
If one country inflated its currency, the inflation in that country would cause the
banks to lose gold to other nations, and consequently the banks, private and central, would before
long be brought to heel.
And while England was the world financial center during this period, its predominance
was market rather than political, so it too had to abide by the monetary discipline of
the gold standard.
As H. Parker Willis described it,
Prior to the World War, the distribution of the metallic money of gold standard countries
had been directed and regulated by the central banks of the world, in accordance with the
The generally known and recognized principles of international distribution of the precious
metals.
Free movement of these metals and freedom on the part of the individual to acquire and
hold them were general.
Regulation of foreign exchange existed only sporadically and was so conducted as not to
interfere in any important degree with the disposal of holding of species by individuals
or by Banks.
The advent of the World War disrupted and rendered this economic idol, and it was never
to return.
In the first place, all of the major countries financed the massive war effort through an
equally massive inflation, which meant that every country except the United States, even
including Great Britain, was forced to go off the gold standard since they could no
The International Order not only was sundered by the war, but also split into numerous separate, competing, and warring currencies, whose inflation was no longer subject to the gold restraint.
In addition, the various governments engaged in rigorous exchange control, fixing exchange rates and prohibiting outflows of gold.
Monetary warfare paralleled the broader economic and military conflict.
At the end of the war, the major powers sought to reconstitute some form of international monetary order out of the chaos and warring economic blocks of the war period.
The crucial actor in this drama was Great Britain, which was faced with a series of dilemmas and difficulties.
On the one hand, Britain not only aimed at re-establishing its former eminence, but it meant to use its victorious position and its domination of the League of Nations to work its will upon the other nations, many of them new and small, of post-Versailles Europe.
This meant its monetary as well as its general political and economic dominance.
Furthermore, it no longer felt itself bound by old-fashioned laissez-faire restraints
from exerting frankly political control, nor did it any longer feel bound to observe the
classical gold standard restraints against inflation.
While Britain's appetite was large, its major dilemma was its weakness of resources.
The racking inflation and the withdrawal from the gold standard had left the United States
not Great Britain as the only, quote, hard gold standard country.
If Great Britain were to dominate the post-war monetary picture, it would somehow have to
take the United States into camp as its willing junior partner.
From the classic pre-war pound-dollar par of $4.86 to the pound, the pound had fallen
on the international money markets to $3.50, a substantial 30% drop, a drop that reflected
the greater degree of inflation in Great Britain than in the US.
The British then decided to constitute a new form of international monetary system, the
quote, gold exchange standard, which had finally completed in 1925.
In the classical pre-war gold standard, each country kept its reserves in gold and redeemed
its paper and bank currencies in gold coin upon demand.
The new gold exchange standard was a clever device to permit Britain and the other European
countries to remain inflated and to continue inflating while enlisting the United States
as the ultimate support for all currencies.
Specifically, Great Britain would keep its reserves, not in gold, but in dollars, while
the smaller countries of Europe would keep their reserves, not in gold, but in pounds
sterling.
In this way, Great Britain could pyramid inflated currency and credit on top of dollars, while
Britain's client states could pyramid their currencies, in turn, on top of pounds.
Clearly, this also meant that only the United States would remain on a gold coin standard,
the other countries, quote, redeeming, only in foreign exchange.
The instability of this system, with pseudo gold standard countries pyramiding on top
of an increasingly shaky dollar gold base, was to become evidence in the Great Depression.
But the British task was not simply to induce the United States to be the willing guarantor
of all the shaky and inflated currencies of war-torn Europe, for Great Britain might well
have been able to return to the original form of gold standard at a new, realistic, depreciated
parity of $3.50 to the pound.
But it was not willing to do so, for the British dream was to restore, even more glowingly
Only then before British financial preeminence, and if it depreciated the pound by 30%, it
would thereby acknowledge that the dollar, not the pound, was the world financial center.
This it was fiercely unwilling to do.
For restoration of dominance, for the saving of financial face, it would return at the
good old $4.86 or bust in the attempt.
and bust it almost did.
Or to insist on returning to gold at $4.86, even on the new, vitiated gold exchange basis,
was to mean that the pound would be absurdly expensive in relation to the dollar and other
currencies, and would therefore mean that at current inflated price levels, Britain's
And indeed, Britain suffered a severe depression in her export industries, particularly coal
and textiles, throughout the 1920s.
If she insisted on returning at the overvalued $4.86, there was only one hope for keeping
Between Her Exports Competitive and Price
A Massive Domestic Deflation to Lower Price and Wage Levels
While a severe deflation is difficult at best, Britain now found it impossible, for the new
system of national unemployment insurance and the newfound strength of trade unions
made wage cutting politically unthinkable.
But if Britain would not or could not make her exports competitive by returning to gold
at a Depreciated Par or by deflating at home, there was a third alternative which it could
pursue and which indeed marked the key to the British international economic policies
of the 1920s.
It could induce or force other countries to inflate or themselves to return to gold at
overvalued pars.
In short, if it could not clean up its own economic mess, it could contrive to impose
messes upon everyone else.
If it did not do so, it would see inflating Britain lose gold to the United States, France
and other quote, hard money countries, as indeed happened during the 1920s.
Only by contriving for other countries, especially the US, to inflate also, could it check the
In the short run, the British scheme was brilliantly conceived, and it worked for a time.
But the major problem went unheeded.
If the United States, the base of the pyramid and the sole link of all these countries to
gold and hard money, were to inflate unduly, the dollar too would become shaky.
would lose gold at home and abroad and the dollar would itself eventually collapse, dragging
the entire structure down with it.
And this is essentially what happened in the Great Depression.
In Europe, England was able to use its domination of the powerful financial committee of the
League of Nations to cajole or bludgeon country after country to one, established central
2. Return to gold not in the classical gold coin standard but in the new gold exchange
standard which would permit continued inflation by all the countries, and 3. Return to this
new standard at overvalued pars so that European exports would be hobbled vis-a-vis the exports
of Great Britain.
The Financial Committee of the League of Nations was largely dominated and run by Britain's
major financial figure, Montague Norman, head of the Bank of England, working through such
close Norman associates on the committee as Sir Otto Niemeyer and Sir Henry Strakusch,
leaders in the concept of close central bank collaboration to, quote, stabilize, in practice
to raise, price levels throughout the world.
The distinguished British economist Sir Ralph Autry, Director of Financial Studies at the
British Treasury, was one of the first to advocate this system, as well as to call for
the general European adoption of a gold exchange standard.
In the spring of 1922, Norman induced the League to call the Genoa Conference, which
urged similar measures.
But the British scarcely confined their pressure upon European countries to resolutions and
and Conferences Using the carrot of loans from England and
the United States and the stick of political pressure, Britain induced country after country
to order its monetary affairs to suit the British, that is, to return only to a gold
exchange standard at overvalued pars that would hamper their own exports and stimulate
imports from Great Britain.
Furthermore, the British also use their inflated, cheap credit to lend widely to Europe in order
to stimulate their own flagging export market.
A trenchant critique of British policy was recorded in the diary of Emile Moreau, Governor
of the Bank of France, a country that clung to the gold standard and to a hard-money policy,
and was thereby instrumental in bringing down the pound and British financial domination
in 1931, Moreau wrote, England, having been the first European country to reestablish
a stable and secure money, has used that advantage to establish a basis for putting Europe under
a veritable financial domination.
The Financial Committee of the League of Nations at Geneva has been the instrument of that
policy.
The method consists of forcing every country in monetary difficulty to subject itself to
the committee at Geneva, which the British control.
The remedies prescribed always involve the installation in the central bank of a foreign
supervisor who is British or designated by the Bank of England, and the deposit of a
part of the reserve of the central bank at the Bank of England, which serves both to
To guarantee against possible failure, they are careful to secure the corporation of the Federal Reserve Bank of New York.
Moreover, they pass on to America the task of making some of the foreign loans, if they seem too heavy, always retaining the political advantage of these operations.
England is thus completely or partially entrenched in Austria, Hungary, Belgium, Norway and Italy.
She is in the process of entrenching herself in Greece and Portugal.
She seeks to get a foothold in Yugoslavia and fights as cunningly in Romania.
The currencies will be divided into two classes.
Those of the first class, the dollar and the pound sterling, based on gold, and those of
the second class based on the pound and the dollar, with a part of their gold reserves
being held by the Bank of England and the Federal Reserve Bank of New York.
The latter monies will have lost their independence."
Inducing the United States to support and bolster the pound and the gold exchange system
was vital to Britain's success.
And this cooperation was ensured by the close ties that developed between Montague Norman
and Benjamin Strong, Governor of the Federal Reserve Bank of New York, who had seized effective
and nearly absolute control of Federal Reserve operations from his appointment at the inception
of the Fed in 1914 until his death in 1928.
This control over the Fed was achieved over the opposition of the Federal Reserve Board
Board in Washington, which generally opposed or grumbled at Strong's anglophile policies.
Strong and Norman made annual trips to visit each other, all of which were kept secret
not only from the public but from the Federal Reserve Board itself.
Strong and the Federal Reserve Bank of New York propped up England and the gold exchange
standard in numerous ways.
One was direct lines of credit, which the New York Bank extended, in 1925 and after,
to Britain, Belgium, Poland and Italy, to subsidize their going to a gold exchange standard
at overvalued pars.
More directly significant was a massive monetary inflation and credit expansion, which strong
generated in the United States in 1924 and again in 1927, for the purpose of propping
The idea was that gold flows from Britain to the United States would be checked and reversed by American credit expansion, which would prop up or raise prices of American goods, thereby stimulating imports from Great Britain and also lower interest rates in the US as compared to Britain.
The fall in interest rates would further stimulate flows of gold from the US to Britain and thereby
check the results of British inflation and overvaluation of the pound.
Both times, the inflationary injection worked and prevented Britain from reaping the results
of its own inflationary policies.
But at the high price of inflation in the United States, a dangerous stock market and
real estate boom, and an eventual depression.
At the secret central bank conference of July 1927 in New York, called at the behest of
Norman, Strong agreed to this inflationary credit expansion over the objections of Germany
and France, and Strong gaily told the French representative that he was going to give,
quote, a little coup de whisky to the stock market.
It was a coup for which America and the world would pay dearly.
The Chicago business and financial community, not having Strong's ties with England, protested
vigorously against the 1927 expansion and the Federal Reserve Bank of Chicago held out
as long as it could against the expansion of cheap money and the lowering of interest
rates.
The Chicago Tribune went so far as to call for Strong's resignation and perceptively
strongly charged that discount rates were being lowered in the interest of Great Britain.
Strong, however, sold the policy to the Middle West with the rationale that its purpose was
to help the American farmer by means of cheap credit.
In contrast, the English financial community hailed the work of Norman in securing strong
support and the banker of London lauded Strong as, quote,
One of the best friends England ever had, the banker praised the, quote, energy and skillfulness he, Strong, has given to the service of England, and exalted that, quote, his name should be associated with that of Mr. Walter Hines Page as a friend of England in her greatest need, end quote.
A blatant example of Strong's intervention to help Norman and his policy occurred in
the spring of 1926, when one of Norman's influential colleagues proposed a full gold
coin standard in India.
At Norman's request, Strong and a team of American economists rushed to England to ward
off the plan, testifying that a gold drain to India would check inflation in other countries
and instead they successfully backed the Norman policy of a gold exchange standard and domestic
quote, economizing of gold to permit domestic expansion of credit.
The intimate Norman strong collaboration for joint inflation and the gold exchange standard
was not at all an accident of personality.
It was firmly grounded on the close ties that both of them had with the House of Morgan
and the Morgan interests.
Strong himself was a product of the Morgan Nexus.
He had been the head of the Morgan-oriented Banker's Trust Company before becoming Governor
of the New York Fed, and his closest ties were with Morgan partners Henry P. Davidson
and Dwight Morrow, who induced him to assume his post at the Federal Reserve.
J.P.
Morgan and Company, in turn, was an agent of the British governments and of the Bank
Bank of England and its close financial ties with England, its loans to England and tie-ins
with the American export trade had been highly influential in inducing the United States
to enter World War I on England's side.
As for Montague Norman, his grandfather had been a partner in the London banking firm
of Brown, Shipley & Company and of the affiliated New York firm of Brown Brothers & Company,
A powerful investment banking firm long associated with the House of Morgan.
Norman himself had been a partner of Brown Shipley and had worked for several years in
the offices of Brown Brothers in the United States.
Moreover, J.P. Morgan & Company played a direct collaborative role with the New York Fed,
lending $100 million of its own to Great Britain in 1925 to facilitate its return to gold and
and also collaborating in feudal loans to prop up the shaky European banking system
during the financial crisis of 1931.
It is no wonder that in his study of the Federal Reserve System during the pre-New Deal era,
Dr. Clark concluded that,
The New York Reserve Bank, in collaboration with a private international banking house,
JP Morgan & Company, determined the policy to be followed by the Federal Reserve System
The major theoretical rationale employed by Strong and Norman was the idea of governmental
collaboration to, quote, stabilize the price level.
The laissez-faire policy of the classical pre-war gold standard meant that prices would
be allowed to find their own level in accordance with supply and demand and without interference
by central bank manipulation.
In practice, this meant a secularly falling price level, as the supply of goods rose over
time in accordance with the long-run rise in productivity.
And in practice, price stabilization really meant price raising, either keeping prices
up when they were falling, or quote, reflating prices by raising them through inflationary
action by the central banks.
Price stabilization, therefore, meant the replacement of the classical laissez-faire
gold standard by, quote, managed money, by inflationary credit expansion stimulated by
the central banks.
In England, it was, as we have seen, no accident that the lead in advocating price stabilization
was taken by Sir Ralph Hawtrey and various associates of Montague Norman, including Sir
Sir Josiah Stamp, Chairman of Midland Railways and a Director of the Bank of England and
two other prominent directors, Sir Basil Blackett and Sir Charles Addis.
It long has been a myth of American historiography that bankers and big businessmen are invariably
believers in quote, hard money as against cheap credits or inflation.
This was certainly not the experience of the New Deal or the pre-New Deal era.
While the most articulate leaders of the price stabilizationists were academic economists
led by Professor Irving Fisher of Yale, Fisher was able to enlist in his stable money league
founded in 1921 and its successor, the Stable Money Association, a host of men of wealth,
bankers and businessmen as well as labor and farm leaders.
Among those serving as officers of the League and Association were Henry Agard Wallis, editor
of Wallis's Farmer and Secretary of Agriculture in the New Deal, the wealthy John G. Winant,
later Governor of New Hampshire, George Eastman of the Eastman-Kodak family, Frederick H.
Goff, head of the Cleveland Trust Company, John E. Ravinsky, Executive Vice President
of the Bank of America, Frederick Delano, Uncle of Franklin D. Roosevelt, Samuel Gompers,
John P. Frey, and William Green of the American Federation of Labor, Paul M. Warburg, partner
of Kuhn Lab & Company, Otto H. Kahn, prominent investment banker, James H. Rand Jr., head
of Remington Rand Company, and Owen D. Young of General Electric.
Furthermore, the heads of the following organizations agreed to serve as ex officio honorary vice
presidents, the American Association for Labor Legislation, the American Bar Association,
the American Farm Bureau Federation, the Brotherhood of Railroad Trainmen, the National Association
of Credit Men, the National Association of Owners of Railroad and Public Utility Securities,
The National Retail Dry Goods Association, the United States Building and Loan League,
the American Cotton Growers Exchange, the Chicago Association of Commerce, the Merchants
Association of New York, and the heads of the Bankers Associations of 43 states and
the District of Columbia.
Irving Fisher was unsurprisingly exultant over the supposed achievement of Governor
Fischer was particularly critical of the minority of skeptical economists who warned of over-expansion
in the stock and real estate markets due to cheap money.
And even after the stock market crash, Fisher continued to insist that prosperity, particularly
in the stock market, was just around the corner.
Fisher's partiality towards stock market inflation was perhaps not unrelated to his
own personal role as a millionaire investor in the stock market, a role in which he was
financially dependent on a cheap money policy.
In the general enthusiasm for strong and the new era of monetary and stock market inflation,
the minority of skeptics was led by the Chase National Bank, affiliated with the Rockefeller
interests, particularly A. Barton Hepburn, economic historian and chairman of the board
of the bank, and Chase Nationals chief economist, Dr. Benjamin M. Anderson Jr.
Another highly influential and indefatigable critic was Dr. H. Parker Willis, editor of
the Journal of Commerce, formerly aide to Senator Carter Glass, Democrat from Virginia,
and professor of banking at Columbia University, along with Willis' numerous students, who
included Dr. Ralph W. Robey, later to become economist at the National Association of Manufacturers.
Another critic was Dr. Rufus S. Tucker, economist at General Motors.
On the Federal Reserve Board, the major critic was Dr. Adolph C. Miller, a close friend of
Herbert Hoover, who joined in the criticisms of the strong policy.
On the other hand, Treasury Secretary Andrew W. Mellon, of the powerful Mellon Interests,
enthusiastically backed the inflationist policy.
This split in the nation's leading banking and business circles was to foreshadow the
split over Franklin Roosevelt's monetary departures in 1933.