Part 4 THE GOLD-EXCHANGE STANDARD IN THE INTERWAR YEARS THE GOLD-EXCHANGE STANDARD IN THE INTERWAR YEARS

Great Britain emerged victorious from its travail in World War I, but its economy, and particularly its currency, lay in shambles. All the warring countries had financed their massive four-year war effort by monetizing their deficits, most of them doubling, tripling, or quadrupling their money supply, with equivalent impacts upon their prices.¹ The massive influx of government paper money forced these warring governments to go rapidly off the gold standard. The currencies depreciated in terms of gold, but the depreciation was masked by a network of exchange controls that marked the collectivized economies during World War I. Only the United States, which entered the war two and a half years after the other countries and hence inflated its currency less, managed to remain de jure on its prewar gold standard. De facto, however, the U.S. barred export of gold during the war, and so was effectively off gold during that period. In March 1919, when foreign exchange markets became free once more, the bad news became evident: while the dollar, again de facto as well as de jure on gold, remained at its prewar par (approximately one-twentieth of a gold ounce), European fiat paper currencies were sadly depreciated. The once-mighty pound sterling, traditionally at approximately $4.86, now sold at approximately $3.50 and at one point, in February 1920, was down to $3.20.² Here was a 30- to 35-percent depreciation from its prewar par.

Thus, wartime and postwar Europe was thrown into a cauldron of inflation, depreciation, exchange-rate volatility, and the menace of warring currency blocs. For the first time since the Napoleonic Wars, the world lacked an international money, a medium of exchange that could be used throughout the world, and lacked the international harmony, the monetary stability and calculability, that a world money could generate. Europe, and the world, were plunged into the chaos of an international moneyless, or barter, system. All the countries therefore looked back with understandable nostalgia at the relative Eden that had existed before the Great War.

THE CLASSICAL GOLD STANDARD

The nineteenth-century monetary system has been referred to as the “classical” gold standard. It has become fashionable among economists to denigrate that system as only existent in the last decades of the nineteenth century, and as simply a form of pound sterling standard, since London was the great financial center during this period. This disparagement of gold, however, is faulty and misleading. It is true that London was the major financial center in that period, but the world was scarcely on a pound standard. Active competition from other financial centers—Berlin, Paris, Amsterdam, Brussels, New York—ensured that gold was truly the only standard money throughout the world.³ Furthermore, to stress only the few decades before 1914 as the age of the gold standard ignores the fact that gold and silver have been the world’s two monetary metals from time immemorial. Countries shifted to and from freely fluctuating parallel gold and silver standards, in attempts, self-defeating in the long run, to fix the rate of exchange between the two metals (“bimetallism”). The fact that countries stampeded from silver and toward gold monometallism in the late nineteenth century should not obscure the fact that gold and silver, for centuries, were the world’s moneys, and that previous paper money experiments (the longest during the Napoleonic Wars) were considered to be both ephemeral and disastrously inflationary. Specie standards, whether gold or silver, have been virtually coextensive with the history of civilization.⁴ Apart from a few calamitous experiments, such as John Law’s Mississippi Bubble and the South Sea Bubble in the 1710s, and apart from the generation-long experience in Britain during the Napoleonic War, until the twentieth century specie rather than paper had always been the standard money.

In the classical gold standard, every nation’s currency was defined as a unit of weight of gold, and therefore the paper currency was redeemable by its issuer (the government or its central bank) in the defined weight of gold coin. While gold bullion, in the form of large bars, was used for international payment, gold coin was used in everyday transactions by the general public. For obvious reasons, it is the inherent tendency of every money-issuer to create as much money as it can get away with, but governments or central banks were, on the gold standard, restricted in their issue of paper or bank deposits by the iron necessity of immediate redemption in gold, and particularly in gold coin on demand. As in the familiar Hume-Cantillon international price-specie flow mechanism, an increase of bank notes or deposits in a country beyond its gold stock increases the supply of money, say francs in France. The increase of the supply of francs and incomes in francs leads to (a) an increase in both domestic and foreign spending, hence raising imports; and (b) a rise in domestic French prices, in turn making domestic goods less competitive abroad and lowering exports, and making foreign goods more attractive and raising imports. The result is an inexorable deficit in the balance of payments, putting pressure upon French banks to supply gold to English, American, or Dutch exporters. In short, since in fractional reserve banking, paper and bank notes pyramid as a multiple of gold reserves, this expansion of the already engorged top of the inverted pyramid, must inexorably be followed by a loss in the bottom supporting the swollen liabilities. In addition, clients who are holders of French bank notes or deposits, are apt to become increasingly concerned, lose confidence in the viability of the French banks, and hence call on those banks to redeem in gold—putting those banks at risk for a devastating bank run. The result will be an often panicky and sudden contraction of bank notes, generating a recession to replace the previous inflationary boom, and leading to a contraction in notes and deposits, a drop in the French money supply, and a consequent fall in domestic French prices. The balance-of-payments deficit is reversed, and gold flows back into French coffers.

In short, the classical gold standard put a severe limit upon the inherent tendency of monopoly money-issuers to issue money without check. As Ludwig von Mises pointed out, this international specie-flow mechanism also described a correct, if primitive, model of the business cycle. While central banking and fractional reserve banking allowed play for a boom-bust cycle, the inflationary boom, and its compensating bust, was kept in strict bounds.⁵ While scarcely perfect or lacking problems, the classical gold standard worked well enough for the world after World War I to look back upon it with understandable nostalgia.⁶

BRITAIN FACES THE POSTWAR WORLD

At the end of World War I, only the United States dollar remained on the old gold-coin standard, at the one-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 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 a 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 prewar financial center; and second, Britain dominated the postwar 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 shape than the other major currencies of Europe. Thus, while the pound sterling in February 1920 was depreciated by 35 percent compared to its 1914 gold par, the French franc was depreciated by 64 percent, the Belgian franc by 62 percent, the Italian lira by 71 percent, and the German mark in terrible shape by 96 percent.⁷ It was clear that Britain was in a position to guide the world to a new postwar 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 prewar 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 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.⁸ For going back to a pound 30 to 35 percent above the market rate, meant that English exports upon which the country depended to finance its exports, 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 prewar 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 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; and (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 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 prewar par, because of a sharp monetary and price deflation that occurred in the inevitable postwar recession.⁹ 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 the benefits of gold at a highly overvalued pound while still continuing to inflate and luxuriate in cheap money.

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 prewar 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 “shortage,” or shortage of “liquidity.” These complaints reflected a failure to realize that, on the market, a “shortage” can only be the consequence of an artificially low price of a good. The “gold shortage” of the ‘20s reflected the artificially low “price” of gold, that is, the artificially overvalued rate at which pounds—and many other European currencies—returned 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 postwar world, cleave to these contradictory axioms and yet avoid a disastrous outflow of gold followed by a banking collapse and monetary contraction?

RETURN TO GOLD AT $4.86: THE CUNLIFFE COMMITTEE AND AFTER

Britain’s postwar course had already been set during the war. In January 1918, the British Treasury and the Ministry of Reconstruction established the Cunliffe Committee, the Committee on Currency and Foreign Exchanges After the War, headed by the venerable Walter Lord Cunliffe, retiring governor of the Bank of England. As early as its first interim report in the summer of 1918, and confirmed by its final report the following year, the Cunliffe Committee called in no uncertain terms for return to the gold standard at the prewar par. No alternatives were considered.¹⁰ This course was confirmed by the Vassar-Smith Committee on Financial Facilities in 1918, which was composed largely of representatives of industry and commerce, and which endorsed the Cunliffe recommendations. A minority of bankers, including Sir Brien Cockayne and incoming Bank of England Governor Montagu Norman, argued for an immediate return to gold at the old par, but they were overruled by the majority, led by their economic adviser, the distinguished Cambridge economist and chosen successor to Alfred Marshall’s professorial chair, Arthur Cecil Pigou. Pigou argued for postponement of the return, hoping to ease the transition by loans from abroad and, particularly, by inflation in the United States. The hope for U.S. inflation became a continuing theme during the 1920s, since inflated and depreciated Britain was in danger of losing gold to the United States, a loss which could be staved off, and the new 1920s system sustained, by inflation in the United States. After exchange controls and most other wartime controls were lifted at the end of 1919, Britain, not knowing precisely when to return to gold, passed the Gold and Silver Export Embargo Act in 1920 for a five-year period, in effect continuing a fiat paper standard until the end of 1925, with an announced intention of returning to gold at that time. Britain was committed to doing something about gold in 1925.¹¹

The United States and Great Britain both experienced a traditional immediate postwar boom, continuing the wartime inflation, in 1919 and 1920, followed by a severe corrective recession and deflation in 1921. The English deflation did not suffice to correct the overvaluation of the pound, since the United States, now the strongest country on gold, had deflated as well. The fact that sterling began to appreciate to the old par during 1924 misled the British into thinking that the pound would not be overvalued at $4.86; actually, the appreciation was the result of speculators betting on a nearly sure thing: the return to gold during 1925 of the pound at the old $4.86 par.

A crucial point: while prices and wage rates rose together in England during the wartime and postwar inflationary boom, they scarcely fell together. When commodity prices fell sharply in England in 1920 and 1921, wages fell much less, remaining high above prewar levels. This rise in real wage rates, bringing about high and chronic unemployment, reflected the severe downward wage rigidity in Britain after the war, caused by the spread of trade unionism and particularly by the massive new unemployment insurance program.¹²

The condition of the English economy, in particular the high rate of unemployment and depression of the export industries during the 1922–1924 recovery from the postwar recession, should have given the British pause. From 1851 to 1914, the unemployment rate in Great Britain had hovered consistently around 3 percent; during the boom of 1919–1920, it was 2.4 percent. Yet, during the postwar “recovery,” British unemployment ranged between 9 and 15 percent. It should have been clear that something was very wrong.

It is no accident that the high unemployment was concentrated in the British export industries. Compared to the prewar year of 1913, most of the domestic economy in Britain was in fairly good shape in 1924. Setting 1913 as equal to 100, real gross domestic product was 92 in 1924, consumer expenditure was 100, construction was 114, and gross fixed investment was a robust 132. But while real imports were 100 in 1924, real exports were in sickly shape, at only 72. Or, in monetary terms, British imports were 111 in 1924, whereas British exports were only 80. In contrast, world exports were 107 as compared to 1913.

The sickness of British exports may be seen in the fate of the traditional, major export industries during the 1920s. Compared to 1913, iron and steel exports in 1924 were 77.5; cotton textile exports were 65; coal exports were 80; and shipbuilding exports a disastrous 35. Consequently, Britain was now in debt to such strong countries as the United States, while a creditor to such financially weak countries as France, Russia, and Italy.¹³

It should be clear that the export industries suffered particularly from depression because of the impact of the overvalued pound; and that furthermore the depression took the form of permanently high unemployment even in the midst of a general recovery because wage rates were kept rigidly downward by trade unions, and especially by the massive system of unemployment insurance.¹⁴

There were several anomalies and paradoxes in the conflicts and discussions over the Cunliffe Committee recommendations from 1918 until the actual return to gold in 1925. The critics of the committee were generally discredited for being ardent inflationists as well as opponents of the old par. These forces included J.M. Keynes; the Federation of British Industries, the powerful trade association; and Sir Reginald McKenna, a wartime chancellor of the Exchequer and after the war head of the huge Midland Bank. And yet, most of these inflationists and antideflationists (with the exception of Keynes and of W. Peter Rylands, Federation of British Industries president in 1921) were willing to go along with return at the prewar par. This put the critics of deflation and proponents of cheap money in the curiously anomalous position of being willing to accept return to an overvalued pound, while combating the logic of that pound—namely, deflation in order to attain English exports competitive in world markets. Thus McKenna, who positively desired a policy of domestic inflation and cheap money and cared little for exchange-rate stability or gold, was willing to go along with the return to gold at $4.86. The Federation of British Industries, which recognized the increasing rigidity of wage costs, was fearful of deflation, and its 1921 President Peter Rylands argued forcefully that stability of exchange “is of far greater importance than the re-establishment of any prewar ratio,” and went so far as to advocate a return at the far more sensible rate of $4.00 to the pound:

We have got accustomed to a relationship... of about four dollars to the pound, and I feel that the interests of the manufacturers would be best served if it could by some means be fixed at four dollars to the pound and remain there for all time.¹⁵

But apart from Rylands, the other antideflationists were willing to go along with the prewar par. Why?

The influential journal, the Round Table, one of their number, noted the anomaly:

[W]hile there is a very large body of opinion which wants to see the pound sterling again at par with gold, there are very few so far as we know, who publicly advocate in order to secure such a result an actively deflationary policy at this particular moment, leading to a further fall in prices.¹⁶

There are several solutions to this puzzle, all centering around the view that deflationary adjustments from a return to the prewar par would be insignificant. In the first place, there was a confident expectation, echoing the original view of Pigou, that price inflation in the United States would set things right and validate the $4.86 pound. This was the argument used on behalf of $4.86 by the Round Table, by McKenna, and by his fellow dissident banker, F.C. Goodenough, chairman of Barclays Bank.

A second reason we have already alluded to: the inevitable rise in sterling to par as the return date approached misled many people into believing that the market action was justifying the choice of rate. But a third reason for optimism particularly needs exploring: that the British were subtly but crucially changing the rules of the game, and returning to a very different and far weaker “gold standard” than had existed before the war.

When the British government made its final decision to return to gold at $4.86 in the spring of 1925, Colonel F.V. Willey, head of the Federation of British Industries, was one of the few to register a perceptive warning note:

The announcement made today... will rapidly bring the pound to parity with the dollar and will... increase the present difficulties of our export trade, which is already suffering from a greater rise in the value of the pound than is justified by the relative level of sterling and gold prices.¹⁷

The way was paved for the final decision to return to gold by the Committee on Currency and Bank of England Note Issues, appointed by Chancellor of the Exchequer Philip Snowden on May 5, 1924, at the suggestion of influential British Treasury official Sir Otto Niemeyer. The committee, known as the Chamberlain-Bradbury Committee, was co-chaired by former Chancellor Sir Austen Chamberlain and by Sir John Bradbury, a former member of the old Cunliffe Committee. Also on the new committee were Niemeyer and Professor Pigou of the Cunliffe group. We have a full account of the testimony before the Chamberlain-Bradbury Committee, and of the arguments used to induce Chancellor of the Exchequer Churchill to go back to gold the following year. It is clear from those accounts that the dominant theme was that deflation and export depression could be avoided because of expected rising prices in the United States, which would restore the British export position and avoid an outflow of gold from Britain to the United States. Thus, Sir Charles Addis, a member of the old Cunliffe Committee, a director of the Bank of England, and the director upon whom bank Governor Montagu Norman relied most for advice, called for a return to gold during 1925. Addis welcomed any deflation as a necessary sacrifice in order to restore London as the world’s financial center, but he expected a rise in prices in the United States. After listening to a great deal of testimony, the committee leaned toward recommending not a return to gold but waiting until 1925 so as to allow American prices to rise. Bradbury wrote to Gaspard Farrer, a director of Barclays and a member of the Cunliffe Committee, that waiting a bit would be preferred: “Odds are that within the comparatively near future America will allow gold to depreciate to the value of sterling.”¹⁸ In early September 1924, Pigou stepped in again, reworking an early draft by the committee secretary to make his economist’s report. Pigou once more asserted that an increase in U.S. prices was likely, thereby easing the path toward restoration of gold at $4.86 with little needed deflation. Acting on Pigou’s recommendation, the Chamberlain-Bradbury Committee in its draft report in October urged a return to $4.86 at the end of 1925, expecting that the alleged gap of 10 to 12 percent in American and British price levels would be made up in the interim by a rise in American prices.¹⁹

Even influential Treasury official Ralph Hawtrey—a friend and fellow Cambridge apostle of Keynes, an equally ardent inflationist and critic of gold, and chief architect of the European gold-exchange standard of the 1920s—favored a return to gold at $4.86 in 1925. He differed in this conclusion from Keynes because he confidently expected a rise in American prices to bear the brunt of the adjustment.²⁰

The British Labor government fell in early October 1924, and the general election in late October swept a conservative government into power. After carefully listening to Keynes, McKenna, and other critics, and after holding a now-famous dinner party of the major advocates on March 17, the new chancellor of the Exchequer, Winston Churchill, made the final decision to go back to gold on March 20, announcing and passing a gold standard act, returning to gold at $4.86 on April 28, and putting the new gold standard into effect immediately.²¹

It cannot be stressed too strongly that the British decision to return to gold at $4.86 was not made in ignorance of deflationary problems or export depression, but rather in the strong and confident expectation of imminent American inflation. This dominant expectation was clear from the assurances of Sir John Bradbury to Churchill; from the anticipation of even such cautious men as Sir Otto Niemeyer and Montagu Norman; from the optimism of Ralph Hawtrey; and above all in the official Treasury memorandum attached to the Gold Standard Act of 1925.^{22, 23}

AMERICAN SUPPORT FOR THE RETURN TO GOLD AT $4.86: THE MORGAN CONNECTION

Why were the British so confident that American prices would rise sufficiently to support their return to gold at the overinflated $4.86? Because of the power of the new United States central bank, the Federal Reserve System, installed in 1914, and because of the close and friendly relationship between the British government, its Bank of England, and the Federal Reserve. The Fed, they were sure, would do what was necessary to help Britain reconstruct the world monetary order.

To understand these expectations, we must explore the Federal Reserve–Bank of England connection, and particularly the crucial tie that bound them together: their mutual relationship with the House of Morgan. The powerful J.P. Morgan and Company took the lead in planning, drafting the legislation, and mobilizing the agitation for the Federal Reserve System that brought the dubious benefits of central banking to the United States in 1914. The purpose of the Federal Reserve was to cartelize the nation’s banking system, and to enable the banks to inflate together, centralizing and economizing reserves, with the Federal Reserve as “lender of last resort.” The Federal Reserve’s new monopoly of note issue took the de facto place of gold as the nation’s currency. Not only were the majority of Federal Reserve Board directors in the Morgan orbit, but the man who was able to become the virtually absolute ruler of the Fed from its inception to his death in 1928, Benjamin Strong, was a man who had spent his entire working life as a leading Morgan banker.²⁴

Benjamin Strong was a protégé of the most powerful of the partners of the House of Morgan after Morgan himself, Henry “Harry” Pomeroy Davison. Strong was also a neighbor and close friend of Davison and of two other top Morgan partners in the then-wealthy New York suburb of Englewood, New Jersey, Dwight Morrow and Thomas W. Lamont. In 1904, Davison offered Strong the post of secretary of the new Morgan-created Bankers Trust Company, designed to compete in the burgeoning trust business. So close were Davison and Strong that, when Strong’s wife committed suicide after childbirth, Davison took the three surviving Strong children into his home. Strong later married the daughter of the president of Bankers Trust, and rose quickly to the posts of vice president and finally president. So highly trusted was Strong in the Morgan circle that he was brought in to be J. Pierpont Morgan’s personal auditor during the panic of 1907. When Strong was offered the crucial post of governor of the New York Fed in the new Federal Reserve System, Strong, at first reluctant, was convinced by Davison that he could run the Fed as “a real central bank... run from New York.”²⁵

The House of Morgan had always enjoyed strong connections with England. The original Morgan banker, J. Pierpont Morgan’s father Junius, had been a banker in England; and the Morgan’s London branch, Morgan, Grenfell and Company, was headed by the powerful Edward C. “Teddy” Grenfell (later Lord St. Just). Grenfell’s father and grandfather had both been directors of the Bank of England as well as members of Parliament, and Grenfell himself had become a director of the Bank of England in 1904. Assisting Grenfell as leading partner at Morgan, Grenfell was Teddy’s cousin, Vivian Hugh Smith, later Lord Bicester, a personal friend of J.P. Morgan, Jr.’s. Not only was Smith’s father a governor of the Bank of England, but he came from the so-called “City Smiths,” the most prolific banking family in English history, originating in seventeenth-century banking. Due to the good offices of Grenfell and Smith, J.P. Morgan and Company, before the war, had been named a fiscal agent of the English Treasury and of the Bank of England. In addition, the House of Morgan had long been closely associated with British and French wars, its London branch having helped England finance the Boer, and its French bank the Franco-Prussian War of 1870–1871.²⁶

As soon as war in Europe began, Harry Davison rushed to England and got the House of Morgan a magnificent deal: Morgan was made the monopoly purchaser of all goods and supplies for the British and French in the United States for the duration of the war. In this coup, Davison was aided and abetted by the British ambassador to Washington, Sir Cecil Arthur Spring-Rice, a personal friend of J.P. Morgan, Jr. These war-based purchases eventually amounted to an astronomical $3 billion, out of which the House of Morgan was able to earn a direct commission of $30 million. In addition, the House of Morgan was able to steer profitable British and French war contracts to those firms which it dominated, such as General Electric, DuPont, Bethlehem Steel, and United States Steel, or to those firms with which it was closely allied, such as DuPont Company and the Guggenheims’ huge copper companies, Kennecott and American Smelting and Refining.

To pay for these massive purchases, Britain and France were obliged to float huge bond issues in the United States, and they made the Morgans virtually the sole underwriter for these bonds. Thus, the Morgans benefited heavily once more: from the bond issues, as well as from the fees and contracts from war purchases by the Allies.

In this way, the House of Morgan, which had been suffering financially before the outbreak of war, profited greatly from and was deeply committed to, the British and French cause. It is no wonder that the Morgans did their powerful best to maneuver the United States into World War I on the side of the English and French.

After the United States entered the war in the spring of 1917, Benjamin Strong, as head of the Fed, obligingly doubled the money supply to finance the war effort, and the U.S. government took over the task of financing the Allies.²⁷ Strong was able to take power in the Fed with the help of and close cooperation from Secretary of the Treasury William Gibbs McAdoo after U.S. entry into the war. McAdoo, for the first time, made the Fed the sole fiscal agent for the Treasury, abandoning the Independent Treasury System that had required it to deposit and disburse funds only from its own subtreasury vaults. The New York Fed sold nearly half of all Treasury securities offered during the war; it handled most of the Treasury’s foreign exchange business, and acted as a central depository of funds from other Federal Reserve banks. Because of this Treasury support, Strong and the New York Fed emerged from the U.S. experience in World War I as the dominant force in American finance. McAdoo himself came to Washington as secretary of the Treasury after having been befriended and bailed out of his business losses by J.P. Morgan, Jr., personally, and by Morgan’s closest associates.²⁸

Scarcely had Benjamin Strong been appointed when he began to move strongly toward “international central bank cooperation,” a euphemism for coordinated, or cartelized, inflation, since the classical gold standard had no need for such cooperation. In February 1916, Strong sailed to England and worked out an agreement of close collaboration between the New York Fed and the Bank of England, with both central banks maintaining an account with each other, and the Bank of England regularly purchasing sterling bills on account for the New York bank. In his usual high-handed manner, Strong bluntly told the Federal Reserve Board in Washington that he would go ahead with such an agreement with or without board approval; the cowed Federal Reserve Board then finally decided to endorse the scheme. A similar agreement was made with the Bank of France.²⁹

Strong made his agreement with the governor of the Bank of England, Lord Cunliffe, but his most fateful meeting was with the man who was then the bank’s deputy governor, Montagu Norman. This meeting proved to be the beginning of the momentous Strong-Norman close friendship and collaboration that was a dominant feature of the international financial world in 1920. Norman became governor of the Bank of England in 1920 and the two men continued their momentous collaboration until Strong’s death in 1928.

Montagu Collet Norman was born to banking on both sides of his family. His father was a banker and related to the great banking family of Barings, while his uncle was a partner of Baring Brothers. Norman’s mother was the daughter of Mark W. Collet, a partner in the London banking firm of Brown, Shipley and Company, the London branch of the great Wall Street banking firm of Brown Brothers. Collet’s father had been governor of the Bank of England in the 1880s. As a young man, Montagu Norman began working at his father’s bank, and then at Brown, Shipley; in the late 1890s, Norman worked for three years at the New York office of Brown Brothers, making many Wall Street banking connections, and then he returned to London to become a partner of Brown, Shipley.

Intensely secretive, Montagu Norman habitually gave the appearance, in the words of an admiring biographer, “of being engaged in a perpetual conspiracy.” A lifelong bachelor, he declared that “the Bank of England is my sole mistress, I think only of her, and I’ve dedicated my life to her.”³⁰ Two of Norman’s oldest and closest friends were the two main directors of Morgan, Grenfell: Teddy Grenfell and particularly Vivian Hugh Smith. Smith had buoyed Norman’s confidence when the latter had been reluctant to become a director of the Bank of England in 1907; more particularly, one of Norman’s best friends was the vivacious and high-spirited wife of Vivian, Lady Sybil. Norman would disappear for long, platonic weekends with Lady Sybil, who inducted him into the mysteries of theosophy and the occult, and Norman became a godfather to the numerous Smith children.

Strong, who had been divorced by his second wife, and Norman, formed a close friendship that lasted until Strong’s death. They would engage in long vacations together, registering under assumed names, sometimes at Bar Harbor or Saratoga but more often in southern France. The pair would, in addition, visit each other at length, and also write a steady stream of correspondence, personal as well as financial.

While the close personal relations between Strong and Norman were of course highly important for the collaboration that formed the international monetary world of the 1920s, it should not be overlooked that both were intimately bound to the House of Morgan. “Monty Norman,” writes a historian of the Morgans, “was a natural denizen of the secretive Morgan world.” He continues:

The House of Morgan formed an indispensable part of Norman’s strategy for reordering European economies.... Imperial to the core, he [Norman] wanted to preserve London as a financial center and the bank [of England] as arbiter of the world monetary system. Aided by the House of Morgan, he would manage to exercise a power in the 1920s that far outstripped the meager capital at his disposal.

As for Benjamin Strong, he

was solidly in the Morgan mold.... Hobbled by a regulation that he couldn’t lend directly to foreign governments, Strong needed a private bank as his funding vehicle. He turned to the House of Morgan, which benefited incalculably from his patronage. In fact, the Morgan-Strong friendship would mock any notion of the new Federal Reserve System as a curb on private banking power.³¹

Let us now turn specifically to the aid that Benjamin Strong delivered to Great Britain to permit its return to gold at $4.86 in 1925. A key as we have seen, to permit Britain to inflate rather than declare, was to induce the United States to inflate dollars so as to keep it from losing gold to the U.S. Before the return to gold, the United States was supposed to inflate so as to persuade the exchange markets that $4.86 would be viable and thereby lift the pound from its postwar depreciated state to the $4.86 figure.

Benjamin Strong and the Fed began their postwar inflationary policy from November 1921 until June 1922, when the Fed tripled its holdings of U.S. government securities and happily discovered the expansion of reserves and inflation of the money supply. Fed authorities hailed the inflation as helping to get the nation out of the 1920–21 recession, and Montagu Norman lauded the easy credit in the U.S. and urged upon Strong a further inflationary fall in interest rates.³²

During 1922 and 1923, Norman continued to pepper Strong with pleas to inflate the dollar further, but Strong resisted these blandishments for a time. Instead of rising further toward $4.86, the pound began to fall in the foreign exchange markets in response to Britain’s inflationary policies, the pound slipping to $4.44 and reaching $4.34 by mid-1924. Since Strong was ill through much of 1923, the Federal Reserve Board was able to take command during his absence, and to sell off most of the Fed’s holdings of government securities. Strong returned to his desk in November, however, and by January his rescue of Norman and of British inflationary policy was under way. During 1924 the Fed purchased nearly $500 million in government securities, driving up the U.S. money supply by 8.3 percent during that year.³³

Benjamin Strong outlined the reasoning for his inflationary policy in the spring of 1924 to other high U.S. officials. To New York Fed official Pierre Jay, he explained that it was in the U.S. interest to facilitate Britain’s earliest possible return to the gold standard, and that in order to do so, the U.S. had to inflate, so that its prices were a bit higher than England’s, and its interest rates a bit lower. At the proper moment, credit inflation, “secret at first,” would only be made public, “when the pound is fairly close to par.” To Secretary of the Treasury Andrew Mellon, Strong explained that in order to enable Britain to return to gold, the U.S. would have to bring about a “gradual readjustment” of price levels so as to raise U.S. prices relative to Britain. The higher U.S. prices, added Strong, “can be facilitated by cooperation between the Bank of England and the Federal Reserve System in the maintaining of lower interest rates in this country and higher interest rates in England.” Strong declared that “the burden of this readjustment must fall more largely upon us than upon them.” Why? Because

it will be difficult politically and socially for the British government and the Bank of England to force a price liquidation in England beyond what they have already experienced in face of the fact that their trade is poor and they have a million unemployed people receiving government aid.³⁴

Or, to put it in blunter terms, the American people would have to pay the penalties of inflation in order to enable the British to pursue a self-contradictory policy of returning to gold at an overvalued pound, while continuing an inflationary policy, so that they would not have to confront the consequences of their own actions, including the system of massive unemployment insurance.

Moreover, to ease the British return to gold, the New York Fed extended a line of credit for gold of $200 million to the Bank of England in early January 1925, bolstered by a similar $100 million line of credit by J.P. Morgan and Company to the British government, a credit instigated by Strong and guaranteed by the Federal Reserve. It must be added that these large $300 million credits were warmly approved by Secretary Mellon and unanimously approved by the Federal Reserve Board.³⁵

American monetary inflation, backed by the heavy line of credit to Britain, temporarily accomplished its goal. American interest rates were down by 1.5 percent by the autumn of 1924, and these interest rates were now below those in Britain. The inflow of gold from Britain was temporarily checked. As Lionel Robbins explained in mid-1924:

Matters took a decisive turn. American prices began to rise.... In the foreign exchange markets a return to gold at the old parity was anticipated. The sterling-dollar exchange appreciated from $4.34 to $4.78. In the spring of 1925, therefore, it was thought that the adjustment between sterling and gold prices was sufficiently close to warrant a resumption of gold payments at the old parity.³⁶

Just as Montagu Norman was the master manipulator in England, he himself was being manipulated by the Morgans, in what has been called “their holy cause” of returning England to gold. Teddy Grenfell was the Morgan manipulator in London, writing Morgan that “as I have explained to you before, our dear friend Monty works in his own peculiar way. He is masterful and very secretive.” In late 1924, when Norman got worried about the coming return to gold, he sailed to New York to have his confidence bolstered by Strong and J.P. Morgan, Jr. “Jack” Morgan gave Norman a pep talk, saying that if Britain faltered on returning to gold, “centuries of goodwill and moral authority would have been squandered.”³⁷

It should not be thought that Benjamin Strong was the only natural ally of the Morgans in the administrations of the 1920s. Andrew Mellon, the powerful tycoon and head of the Mellon interests, whose empire spread from the Mellon National Bank of Pittsburgh to encompass Gulf Oil, Koppers Company, and ALCOA, was generally allied to the Morgan interests. Mellon was secretary of the Treasury for the entire decade. Although there were various groups around President Warren Harding, as an Ohio Republican, he was closest to the Rockefellers, and his secretary of state, Charles Evans Hughes, was a leading Standard Oil attorney and a trustee of the Rockefeller Foundation.³⁸ Harding’s sudden death in August 1923, however, elevated Vice President Calvin Coolidge to the presidency.

Coolidge has been misleadingly described as a colorless small-town Massachusetts attorney. Actually, the new president was a member of a prominent Boston financial family, who were board members of leading Boston banks, and one, T. Jefferson Coolidge, became prominent in the Morgan-affiliated United Fruit Company of Boston. Throughout his political career, furthermore, Coolidge had two important mentors, neglected by historians. One was Massachusetts Republican chairman W. Murray Crane, who served as a director of three powerful Morgan-dominated institutions: the New Haven and Hartford Railroad, AT&T, and the Guaranty Trust Company of New York. He was also a member of the executive committee of the board of AT&T. The other was Amherst classmate and Morgan partner Dwight Morrow. Morrow began to agitate for Coolidge for president in 1919, and at the Chicago Republican convention of 1920, Dwight Morrow and fellow Morgan partner Thomas Cochran lobbied strenuously, though discreetly behind the scenes, for Coolidge, allowing fellow Amherst graduate and Boston merchant Frank W. Stearns to take the foreground.³⁹

Furthermore, when Secretary of State Charles Evans Hughes returned to private law practice in the spring of 1925, Coolidge offered his post to then-veteran Wall Street attorney and former Secretary of State and of War Elihu Root, who might be called the veteran leader of the “Morgan bar.” Root was at one critical time in Morgan affairs, J.P. Morgan, Sr.’s, personal attorney. After Root refused the secretary of state position, Coolidge was forced to settle for a lesser Morgan light, Minnesota attorney Frank B. Kellogg.⁴⁰ Undersecretary of state to Kellogg was Joseph C. Grew, who had family connections with the Morgans (J.P. Morgan, Jr., had married a Grew), while, in 1927, two highly placed Morgan men were asked to take over relations with troubled Mexico and Nicaragua.⁴¹

The year 1924 saw the Morgans at the pinnacle of their political power in the United States. President Calvin Coolidge, friend and protégé of Morgan partner Dwight Morrow, was deeply admired by Jack Morgan, who saw the president as a rare blend of deep thinker and moralist. Morgan wrote a friend: “I have never seen any President who gives me just the feeling of confidence in the Country and its institutions, and the working out of our problems, that Mr. Coolidge does.”

On the other hand, the Democratic presidential candidate that year was none other than John W. Davis, senior partner of the Wall Street law firm of Davis Polk and Wardwell, and the chief attorney for J.P. Morgan and Company. Davis, a protégé of the legendary Harry Davison, was also a personal friend and backgammon and cribbage partner of Jack Morgan’s. Whoever won the 1924 election, the Morgans couldn’t lose.⁴²

THE ESTABLISHMENT OF THE NEW GOLD STANDARD OF THE 1920S

BULLION, NOT COIN

One of the reasons the British were optimistic that they could succeed in their basic maneuver in the 1920s is that they were not really going back to the gold standard at all. They were attempting to clothe themselves in the prestige of gold while trying to avoid its anti-inflationary discipline. They went back, not to the classical gold standard, but to a bowdlerized and essentially sham version of that venerable standard.

In the first place, under the old gold standard, the nominal currency, whether issued by government or bank, was redeemable in gold coin at the defined weight. The fact that people were able to redeem in and use gold for their daily transactions kept a strict check on the overissue of paper. But in the new gold standard, British pounds would not be redeemable in gold coin at all: only in “bullion” in the form of bars worth many thousands of pounds. Such a gold standard meant that gold could not be redeemed domestically at all; bars could hardly circulate for daily transactions, so that they could only be used by wealthy international traders.

The decision of the British Cabinet on March 20, 1925, to go back to gold was explicitly predicated on three conditions. First was the attainment of a $300 million credit line from the United States. Second was that the bank rate would not increase upon announcement of the decision, so that there would be no contractionary or anti-inflationary pressure exercised by the Bank of England. And third and perhaps most important was that the new standard would be gold bullion and not gold coin. The chancellor of the Exchequer would persuade the large “clearing banks” to “use every effort... to discourage the use of gold for internal circulation in this country.” The bankers were warned that if they could not provide satisfactory assurances that they would not redeem in gold coin, “it would be necessary to introduce legislation on this point.” The Treasury, in short, wanted to avoid “psychologically unfortunate and controversial legislation” barring gold redemption within the country, but at the same time wanted to guard against the risk of “internal drain” (that is, redemption in the property to which they were entitled) from foreign agents, the irresponsible public, or “sound currency fanatics.”⁴³ The bankers, headed by Reginald McKenna, were of course delighted not to have to redeem in gold, but wanted legislation to formalize this desired condition.

Finally, the government and the bankers agreed happily on the following: the bankers would not hold gold, or acquire gold coins or bullion for themselves, or for any customers residing in the United Kingdom. The Treasury, for its part, redrafted its banking report to allow for legislation to prevent any internal redemption if necessary, and “enforce” such a ban on the all-too-willing bankers.

Under the Gold Standard Act of 1925, then, pounds were convertible into gold, not in coin, but in bars of no less than 400 gold ounces, that is $1,947. The new gold standard was not even a full gold bullion standard, since there was to be no redemption at all in gold to British residents; gold bullion was only due to pound-holders outside Great Britain. Britain was now only on an “international gold bullion standard.”⁴⁴

The purpose of redemption in gold bullion only, and only to foreigners, was to take control of the money supply away from the public, and place it in the hands of the governments and central bankers, permitting them to pyramid monetary inflation upon gold centralized into their hands. Thus, Norman, when asked by the governor of the Bank of Norway for his advice about returning to gold, urged Norway to return only in gold bars, and only for international payments. Norman’s reasoning is revealing:

[I]n Norway the convenience of paper currency is appreciated, and confidence in the value of money does not depend upon the existence of gold coin.... Demand is rendered more inelastic wherever the principle of gold circulation, for currency or for hoarding, is accepted, and any inelasticity may be dangerous.... I do not believe that gold in circulation can safely be regarded as a reserve that can be made available in case of need, and I think that even in times of abundance hoarding is bad, because it weakens the command of the Central Bank over the monetary circulation and hence over the purchasing power of the monetary unit.

For these reasons, I suggest that your best course would be to establish convertibility of notes into gold bars only and in amounts which will ensure that the use of monetary gold can be limited, in case of need, to the settlement of international balances.^{45, 46}

Norway, and indeed all the countries returning to gold, heeded Norman’s advice. The way was paved for this development by the fact that, during World War I, the European countries had systematically taken gold coins out of circulation and replaced them with paper notes and deposits. During the 1920s, virtually the only country still on the classical gold-coin standard was the United States.

Despite this tradition, it was still necessary for Monty Norman and the Bank of England to exert considerable pressure to force many European nations to return to gold bullion rather than gold coin. Thus, Dr. William Adams Brown, Jr., writes:

In some countries the reluctance to adopt the gold bullion standard was so great that some outside pressure was needed to overcome it... [that is] strong representations on the part of the Bank of England that such action would be a contribution to the general success of the stabilization effort as a whole. Without the informal pressure... several efforts to return in one step to the full gold standard would undoubtedly have been made.⁴⁷

THE GOLD-EXCHANGE STANDARD, NOT GOLD

The major twist, the major deformation of a genuine gold standard perpetrated by the British in the 1920s, was not the gold bullion standard, unfortunate though that was. The major inflationary camouflage was to return, not to a gold standard at all, but to a “gold-exchange” standard. In a gold-exchange standard, only one country, in this case Great Britain, is on a gold standard in the sense that its currency is actually redeemable in gold, albeit only gold bullion for foreigners. All other European countries, even though nominally on a gold standard, were actually on a pound-sterling standard. In short, a typical European country, say, “Ruritania,” would hold as reserves for its currency, not gold but British pounds sterling, in practice, bills or deposits payable in sterling at London. Anyone who demanded redemption for Ruritanian “rurs,” then, would receive British pounds rather than gold.

The gold-exchange standard, then, cunningly broke the classical gold standard’s stringent limits on monetary and credit expansion, not only for the other European countries, but also for the base or key currency country, Great Britain itself. Under the genuine gold standard, inflating the number of pounds in circulation would cause pounds to flow into the hands of other countries, which would demand gold in redemption. Thereby gold would move out of British bank and currency reserves, and pressure would be put on Britain to end its inflation and to contract credit. But, under the gold-exchange standard, the process was very different. If Britain inflated the number of pounds in circulation, the result, again, was a deficit in the balance of trade and sterling balances piling up in the accounts of other nations. But now that these nations have been induced to use pounds as their reserves rather than gold, these nations, instead of redeeming the pounds in gold, would inflate, and pyramid a multiple of their currency on top of their increased stock of pounds. Thus, instead of checking inflation, a gold-exchange standard encourages all countries to inflate on top of their increased supply of pounds. Britain, too, is now able to “export” her inflation to other nations without paying a price. Thus, in the name of sound money and a check against inflation, a pseudo gold standard was instituted, designed to induce a double-inverted pyramid of inflation, all on top of British pounds, the whole process supported by a gold stock that does not dwindle.

Since all other countries were sucked into the inflationary gold-exchange trap, it seemed that the only nation Britain had to worry about was the United States, the only country to continue on a genuine gold standard. That was the reason it became so vitally important for Britain to get the United States, through the Morgan connection, to go along with this system and to inflate, so that Britain would not lose gold to the United States.

For the other nations of Europe, it became an object of British pressure and maneuvering to induce these countries themselves to return to a gold standard, with several vital provisions: (a) that their currencies too be overvalued, so that British exports would not suffer, and British imports would not be overstimulated—in other words, so that they join Britain in overvaluing their currencies; (b) that each of these countries adopt their own central bank, with the help of Britain, which would inflate their currencies in collaboration with the Bank of England; and (c) that they return, not to a genuine gold standard, but to a gold-exchange standard, keeping their balances in London and refraining from exercising their legal right to redeem those sterling balances in gold.

In this way, for a few years Britain could have its cake and eat it too. It could enjoy the prestige of going back to gold, going back at a highly overvalued pound, and yet continue to pursue an inflationary, cheap-money policy instead of the opposite. It could inflate pounds and see other countries keep their sterling balances and inflate on top of them; it could induce other countries to go back to gold at overvalued currencies and to inflate their money supplies;⁴⁸ and it could also try to prop up its flagging exports by using cheap credit to lend money to European nations so that they could purchase British goods.

Not that every country was supposed to return to gold at the overvalued, prewar par. The rule of thumb imposed in the 1920s was that (a) currencies, such as that of Britain herself, that had depreciated up to 60 percent from prewar (for example, the Netherlands and the Scandinavian countries) would return at the prewar par; (b) currencies that had depreciated from 60 to 90 percent were to return to gold within that zone, but at a rate substantially above their lowest rate (for example, Belgium, Italy, Czechoslovakia, and France). The French franc, which had depreciated to 240 to the pound due to massive inflation, returned to gold at the doubled rate of 124 to the pound. And (c) only those currencies that had been wiped out by devastating hyperinflation, like Austria, Bulgaria, and especially Germany, were allowed to return to gold at a realistic rate, and even they were stabilized at a little bit above their lowest point. As a result, virtually every European currency suffered from the requirement to raise the value of its currency artificially above its depreciated level.⁴⁹

The gold-exchange standard was not created de novo by Great Britain in the interwar period. It is true that a number of European central banks before 1914 had held foreign exchange reserves in addition to gold, but these were strictly limited, and they were held as earning assets—these after all were privately owned central banks in need of earnings—not as instruments of monetary manipulation. But in a few cases, particularly where the pyramiding countries were from the Third World, they did function as a gold-exchange standard: that is, the Third World currency pyramided its currency on top of a key country’s reserves (pounds or dollars) instead of on gold. This system began in India, after the late 1870s, as a historical accident. The plan of the British imperial center was to shift India which, like many Third World countries, had been on a silver standard, onto a seemingly sounder gold, following the imperial nations. India’s reserves in pound sterling balances in London were supposed to be only a temporary transition to gold. But, as in so many cases of seeming transition, the Indian gold-exchange standard lingered on, and received great praise for its modern inflationary potential from John Maynard Keynes, then in his first economic post at the India Office. It was Keynes, after leaving the India Office and going to Cambridge, who trumpeted the new form of monetary system as a “limping” or imperfect gold standard but as a “more scientific and economic system,” which he dubbed the gold-exchange standard. As Keynes wrote in February 1910, “it is cheaper to maintain a credit at one of the great financial centres of the world, which can be converted with great readiness to gold when it is required.” In a paper delivered the following year to the Royal Economic Society, Keynes proclaimed that out of this new system would evolve “the ideal currency of the future.”

Elaborating his views into his first book, Indian Currency and Finance (London, 1913), Keynes emphasized that the gold-exchange standard was a notable advance because it “economized” on gold internally and internationally, thus allowing greater “elasticity” of money (a longtime code word for ability to inflate credit) in response to business needs. Looking beyond India, Keynes prophetically foresaw the traditional gold standard as giving way to a more “scientific” system based on one or two key reserve centers. “A preference for a tangible reserve currency,” Keynes declared blithely, “is... a relic of a time when governments were less trustworthy in these matters than they are now.”⁵⁰ He also believed that Britain was the natural center of the new reformed monetary order. While his book was still in proofs, Keynes was appointed a member of the Royal Commission on Indian Finance and Currency, to study and make recommendations for the basic institutions of the Indian monetary system. Keynes dominated the commission proceedings, and while he got his way on maintaining the gold-exchange standard, he was not able to convince the commission to adopt a central bank. However, he managed to bully it into including his annex favoring the state bank in its report, completed in early 1914. In addition, in his work on the commission, Keynes managed to enchant his doting mentor, Alfred Marshall, the unquestioned ruler of academic economists in Britain.⁵¹

While Montagu Norman was the field marshal of the gold-exchange standard of the 1920s, its major theoretician was longtime Treasury official Ralph Hawtrey. When Hawtrey rose to the position of director of Financial Enquiries at the Treasury in 1919, he delivered a speech before the British Association on “The Gold Standard.” The speech presaged the gold-exchange standard of the 1920s. Hawtrey sought not only a system of stable exchange rates as before the war, but also a monetary system that would stabilize the world purchasing power of gold, or world price levels. Hawtrey recommended international cooperation to stabilize price levels, and urged the use of an index number of world prices, a proposal reminiscent of Yale Professor Irving Fisher’s suggestion for a “tabular” gold-exchange standard made in 1911. In practice, such calls for price-level stabilization, which were pursued by Benjamin Strong in the 1920s, were really calls for price inflation, to combat the dominant secular trend in a progressing free-market economy of falling prices.

In the post–World War I world, this attempt at dual stabilization meant that the governments would have to salvage the high postwar price levels from the threat of deflation, and in particular to alleviate the “shortage” of gold compared to the swollen totals of paper currencies existing in Europe. As Professor Eric Davis writes:

There had been concern in official circles that a return to the Gold Standard would be inhibited by a shortage of gold. Prices were much higher than before the war, and thus if there was a general return to the old parities there might be insufficient gold.... Hawtrey picked up on the idea that the Gold Exchange Standard could be widely introduced to economise on the use of gold for monetary purposes. Since countries would hold foreign exchange, much presumably in sterling balances as a substitute for gold, there was a special advantage for Britain: the demand for the pound would be increased at the same time the demand for gold lessened.⁵²

The central instrument for imposing the new gold-exchange standard on Europe was the international financial conference called by the League of Nations at Genoa in the spring of 1922. At a previous international financial conference at Brussels in September 1920, the league had established a powerful financial and economic committee, which from the very beginning was dominated by Montagu Norman through his allies on the committee. Head of the committee was British Treasury official Sir Basil Blackett, and also dominant on the committee were two of Norman’s closest associates, Sir Otto Niemeyer and Sir Henry Strakosch. All of these men were ardent price-level stabilizationists. Moreover, Norman’s chief adviser in international monetary affairs, Sir Charles S. Addis, was also a dedicated stabilizationist.⁵³

Prodded by Norman, British Prime Minister Lloyd George successfully urged the British Cabinet, in mid-December 1921, to call for a broad economic conference on the postwar reconstruction of Europe, to include discussions of German reparations, Soviet Russian reconstruction, the public debt, and the monetary system. At a meeting of the Allied Supreme Council at Cannes in early January 1922, Lloyd George got the delegates to propose an all-European economic and financial conference for the reconstruction of Central and Eastern Europe. Promptly the British set up an interdepartmental committee on economics and finance to prepare for the conference. Head of the committee was the permanent secretary of the Board of Trade, Sir Sidney Chapman. The aim of the Chapman Committee was to return to a gold standard, restore international credit, and establish cooperation between the various central banks. On March 7, 1922, the Chapman Committee issued its report for a draft agreement, which included currency stabilization, central bank cooperation, and adoption of a gold-exchange rather than a straight gold standard, with each country deciding on the rate at which it would return to gold.

The European economic conference occurred at Genoa from April 10 to May 19, 1922. The conference divided itself into several commissions, including economic and transportation commissions. The relevant commission for our concerns was the Financial Commission, headed by British Chancellor of the Exchequer Sir Robert Horne. The Financial Commission divided itself into three subcommissions, on credits, exchanges, and currency. Credit resolutions dealt with intergovernmental loans, and exchanges was an attempt to eliminate exchange controls. Currency was the subcommission dealing with the international monetary system. The crucial committee, however, was a large Committee of Experts covering all three subcommissions, and which actually drew up the resolutions finally passed by the conference. The Committee of Experts was appointed solely by Sir Robert Horne, and it met in London during the early stages of the Genoa Conference. This large committee, consisting of government officials and financial authorities, was headed by the ubiquitous Sir Basil Blackett.

Ralph Hawtrey drew up the Treasury plans for international money, after having “extended discussions” with Montagu Norman, and presented them to the Committee of Experts. After a temporary setback, the Hawtrey plan was reintroduced and substantially passed, in the form of 12 currency resolutions, by the Financial Commission and then ratified by the plenary of the Genoa Conference.⁵⁴ Having gotten his plan approved by the nations of Europe, Hawtrey became the leading fugleman and interpreter of the Genoa resolutions.⁵⁵

The currency resolutions of the Genoa Conference, which formed the European monetary system of the 1920s, called for a stable currency value in each country, and for the establishment of central banks everywhere: “in countries where there is no central bank of issue, one should be established.” These central banks, not only in Europe but elsewhere (particularly the United States) should practice “continuous cooperation” in order to bring about and maintain “currency reform.” The conference suggested an early formal meeting of central banks and an international convention to launch this coordination. The currencies of Europe should be on a common standard, which at present would have to be gold. After expressing a desire for balanced budgets in each nation, the conference declared that some countries would need foreign loans to attain stabilization. Fixing the value of the currency unit in gold was left, by the conference, to each country, and the resolutions were vague on the criteria to be used.

Resolution 9 looked specifically to a new form of gold standard, which would

centralize and coordinate the demand for gold, and so... avoid those wide fluctuations in the purchasing power of gold which might otherwise result from the simultaneous and competitive efforts of a number of countries to secure metallic reserves.

In other words, to fix and raise price levels above the free market, and in particular to try to avoid redemption in gold and subsequent contraction of overexpanded paper currencies. Resolution 9 then became specific: the point was to economize “the use of gold by maintaining reserves in the form of foreign balances, such, for example, as the gold-exchange standard or an international clearing system.” Resolution 11 spelled out the gold-exchange system in detail, and also declares that credit will be regulated not only to keep the various currencies at par, “but also with a view of preventing undue fluctuations in the purchasing power of gold,” that is, the stabilizationist program of fixing (and raising) prices higher than free-market levels.

In particular, in Resolution 11, “the maintenance of the currency at its gold value must be assured by the provision of an adequate reserve of approved assets, not necessarily gold.” In more detail:

A participating country, in addition to any gold reserve held at home, may maintain in any other participating country reserves of approved assets in the form of bank balances, bills, short-term securities, or other suitable liquid resources.

And:

The ordinary practice of a participating country will be to buy and sell exchange on other participating countries within a prescribed fraction of parity of exchange for its own currency on demand.

The gold aspect of this scheme is covered in the clause: “When progress permits, certain of the participating countries (i.e., Great Britain, and the U.S., if it participates) will establish a free market in gold and thus become gold centers.” The upshot, the currency resolution concludes, is that “the convention will thus be based on a gold exchange standard.”⁵⁶

Ralph Hawtrey’s essay on behalf of the Genoa system is instructive in many ways. Most of it is devoted to defending the idea of coordinated central bank action, that is, essentially monetary expansion, to stabilize the price level. Hawtrey asks the crucial question:

It may be asked, why is any international agreement on the subject of the gold standard necessary at all? When we have once got a currency based on commodity like gold, why should we not rely on free market conditions, as we did before the war?⁵⁷

Why indeed? Why can’t the new pseudo gold standard be like the old? Hawtrey makes it clear that his reason is a phobia about deflation. The paper money stock had multiplied since 1914, and therefore there “has been a great fall in the commodity value of gold.” Even in late 1922, after the price fall of the 1921 recession, the value of the gold dollar was “only two-thirds of what it was before the war.” Hence, the “danger” of a scramble to secure gold, and a contraction of money and prices. But what is so terrible about deflation? Here, Hawtrey avoids even mentioning the wage rigidity and the unemployment insurance system that had changed the economic face of Britain. He simply points to the “notorious... chronic state of depression which prevailed during the spread of the gold standard in the period 1873–1896.” This is really his only horrible example.

But, in the first place, Hawtrey is wrong in attributing falling prices during the late nineteenth century to a shift from silver to gold. The falling prices were due to the industrial revolution, and the phenomenal advance of productivity, and hence a drop in price levels, during this period. But a more important error is that Hawtrey has made the all-too-common modern error of identifying falling prices with “depression.” In reality, production and living standards were progressing, in Britain and the United States, during this period, costs were falling and therefore there was no squeeze on profits. The era of falling prices was not a “depression” at all, and was only experienced as such decades later by historians who fail to understand the social benefits of falling prices.⁵⁸

Second, in his exegesis Hawtrey lets the cat out of the bag. He virtually concedes that his ideal is to abandon gold altogether, and remain with only managed fiat money. Thus, in discussing the key currency countries, Hawtrey states wistfully, “At the gold centres some gold reserves must be maintained.” But if the gold standard becomes worldwide, “if all the gold standard countries adhere to it, gold will nowhere be needed as a means of remittance, and gold will only be withdrawn from the reserves for use as a raw material of industry.”⁵⁹ In short, Hawtrey looked forward to dispensing with gold as a monetary metal altogether, and to have the world solely on a fiat paper standard.

Hawtrey concludes his essay by conceding that there was only one defect in the Genoa resolutions: that there was no mention of how long it would take to return to gold. Even the strongest countries, he emphasized, would have to wait until their currencies rose on the exchange market to equal their designated rates. To induce a rise in pound sterling to meet the high fixed rate, Britain would either have to deflate, or else foreign countries, especially the United States, would have to inflate to correct the international discrepancy. “Further deflation,” declaimed Hawtrey, “is out of the question.” Therefore the only hope was to “stabilize our currency at its existing purchasing power,” and wait for the increased gold supply in the United States to lead to a substantial inflation in the United States.⁶⁰ Like the other British leaders, Hawtrey was pinning his faith on Uncle Sam’s inflating enough to “help Britain.”⁶¹

Many historians have written off the Genoa Conference as a “failure” and dismissed its influence on the international money of the twentieth century. It is true that the formal institutions of central bank cooperation called for at Genoa were not established, largely because of the reluctance of the United States. But the critical point is that Genoa triumphed anyway, since Benjamin Strong was willing to perform the same tasks in informal but highly effective central bank cooperation to establish and prop up Britain’s pseudo gold standard. Strong’s reluctance stemmed from two sources: an understandable fear that isolationist and antibank sentiment would raise a firestorm against any formal collaboration with European central banks—especially in an America that had reacted against the formal foreign interventionism of the League of Nations. And second, Strong actually preferred the full gold standard, and was queasy about the inflationary unsoundness of a gold-exchange standard. But his reluctance did not prevent him from collaborating closely in support of his friend Montagu Norman and of their common Morgan connection. Their collaboration constituted, in the words of Michael Hogan, an “informal entente.”⁶² Actually, what Strong preferred was close “key currency” collaboration between, say, the central banks of the United States, England, and France, rather than to be outvoted at formal international conventions.⁶³

In fact, after international commodity prices began to decline in 1926, Norman became more frantic in pursuing formal meetings of central bankers, and more insistent on continuing and intensifying the inflationary thrust of the gold-exchange standard. Finally, with the establishment of the Bank for International Settlements at Geneva in 1930, Norman at least succeeded in having regular monthly meetings of central bankers.⁶⁴

Far from Genoa being merely a flash in the pan, the 1922 conference placed its decisive stamp upon the postwar monetary world. In the words of Professor Davis, “the widespread adoption of the Gold Exchange Standard can be seen as the legacy of Genoa.”⁶⁵

Following the Genoa model, Great Britain, as we have seen, set up the gold-exchange system by returning to its new version of gold in 1925; the other European countries, as well as other nations, followed, each at its own pace. By early 1926, some form of gold standard was established, at least de facto, in 39 countries. By 1928, 43 nations were de jure on the gold standard. Of these, even the few allegedly on the gold bullion standard such as France, kept most of their reserves in sterling balances in London, and the same is true of officially gold-coin nations such as the Netherlands. Apart from the United States, the only officially gold-coin countries were minor nations on the world periphery, such as Mexico, Colombia, Cuba, and the Union of South Africa.⁶⁶ It should be noted that Norway and Denmark, who insisted in following the Genoa path of struggling back to gold at a highly overvalued currency, suffered, like Britain, from an export depression throughout the 1920s; whereas Finland, acting on better advice, went back at a realistically devalued rate, and avoided chronic depression during this period.⁶⁷

Throughout Europe, Great Britain, wielding its control of the Finance Committee of the League of Nations, engineered the stabilization of currencies on a gold-exchange, that is, a sterling-exchange standard: in Germany, Austria, Hungary, Estonia, Bulgaria, Greece, Belgium, Poland, and Latvia. New central banks were established in the nations of Eastern Europe, basing themselves on reserves in sterling, with British supervisors and directors installed in those banks.⁶⁸

Emile Moreau, the shrewd governor of the Bank of France, recorded his analysis of this British monetary power play in his diary:

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 support the pound and to fortify British influence. To guarantee against possible failure they are careful to secure the cooperation 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 advantages of these operations.⁶⁹

THE GOLD-EXCHANGE STANDARD IN OPERATION: 1926–1929

By the end of 1925, Montagu Norman and the British Establishment were seemingly monarch of all they surveyed. Backed by Strong and the Morgans, the British had had everything their way: they had saddled the world with a new form of pseudo gold standard, with other nations pyramiding money and credit on top of British sterling, while the United States, though still on a gold-coin standard, was ready to help Britain avoid suffering the consequences of abandoning the discipline of the classical gold standard.

But it took little time for things to go very wrong. The crucial British export industries, chronically whipsawed between an overvalued pound and rigidly high wage rates kept up by strong, militant unions and widespread unemployment insurance, kept slumping during an era when worldwide trade and exports were prospering. Unemployment remained chronically high. The unemployment rate had hovered around 3 percent from 1851 to 1914. From 1921 through 1926 it had averaged 12 percent; and unemployment did little better after the return to gold. In April 1925, when Britain returned to gold, the unemployment rate stood at 10.9 percent. After the return, it fluctuated sharply, but always at historically very high levels. Thus, in the year after return, unemployment climbed above 12 percent, fell back to 9 percent, and jumped to over 14 percent during most of 1926. Unemployment fell back to 9 percent by the summer of 1927, but hovered around 10 to 11 percent for the next two years. In other words, unemployment in Britain, during the entire 1920s, lingered around severe recession levels.⁷⁰

The unemployment was concentrated in the older, previously dominant, and heavily unionized industries in the north of England. The pattern of the slump in British exports may be seen by some comparative data. If 1924 is set equal to 100, world exports had risen to 132 by 1929, while Western European exports had similarly risen to 134. United States exports had also risen to 130. Yet, amid this worldwide prosperity, Great Britain lagged far behind, exports rising only to 109. On the other hand, British imports rose to 113 in the same period. After the 1929 crash until 1931, all exports fell considerably, world exports to 113, Western European to 107, and the United States, which had taken the brunt of the 1929 crash, to 91; and yet, while British imports rose slightly from 1929 to 1931 to 114, its exports drastically fell to 68. In this way, the overvalued pound combined with rigid downward wage rates to work their dire effects in both boom and recession. Overall, whereas, in 1931, Western European and world exports were considerably higher than in 1924, British exports were very sharply lower.

Within categories of British exports, there was a sharp and illuminating separation between two sets of industries: the old, unionized export staples in the north of England, and the newer, relatively nonunion, lower-wage industries in the south. These newer industries were able to flourish and provide plentiful employment because they were permitted to hire workers at a lower hourly wage than the industries of the north.⁷¹ Some of these industries, such as public utilities, flourished because they were not dependent on exports. But even the exports from these new, relatively nonunionized industries did very well during this period. Thus from 1924 to 1928–29, the volume of automobile exports rose by 95 percent, exports of chemical and machinery manufactures rose by 24 percent, and of electrical goods by 23 percent. During the 1929–31 recession, exports of these new industries did relatively better than the old: machinery and electrical exports falling to 28 percent and 22 percent respectively below the 1924 level, while chemical exports fell only to 5 percent below and automobile exports remained comfortably in 1931 at fully 26 percent above 1924.

On the other hand, the older, staple export industries, the traditional mainstays of British prosperity, fared very badly in both these periods of boom and recession. The nonferrous metal industry rose only slightly by 14 percent by 1928–29 and then fell to 55 percent of 1924 in the next two years. In even worse shape were the once-mighty cotton and woolen textile industries, the bellwethers of the Industrial Revolution in England. From 1924 to 1929, cotton exports fell by 10 percent, and woolens by 20 percent, and then, in the two years to 1931, they plummeted phenomenally, cottons to 50 percent of 1924 and woolens to 46 percent. Remarkably, cotton and woolen exports were at this point their lowest in volume since the 1870s.

Perhaps the worst problem was in the traditionally prominent export, coal. Coal exports had declined to 69 percent of 1924 volume in 1931; but perhaps more ominously, they had fallen to 88 percent in 1928–29, slumping, like textiles, in the midst of worldwide prosperity.

So high were British price levels compared to other countries, in both of these periods, that Britain’s imports, remarkably, rose in every category during boom and recession. Thus, imports of manufactured goods into Britain rose by 32.5 percent from 1924 to 1928–29, and then rose another 5 percent until 1931. So costly, too, was the once-proud British iron and steel industry that, after 1925, the British, for the first time in their history, became net importers of iron and steel.

The relative rigidity of wage costs in Britain may be seen by comparing their unit wage costs with the U.S., setting 1925 in each country equal to 100. In the United States, as prices fell about 10 percent in response to increased productivity and output, wage rates also declined, falling to 93 in 1928, and to 90 in 1929. Swedish wages were even more flexible in those years, enabling Sweden to surmount without export depression and return to gold at the prewar par. Swedish wage rates fell to 88 in 1928, 80 in 1929, and 70 in 1931. In Great Britain, on the other hand, wage rates remained stubbornly high, in the face of falling prices, being 97 in 1928, 95 the following year, and down to only 90 in 1931.⁷² In contrast, wholesale prices in England fell by 8 percent in 1926 and 1927, and more sharply still thereafter.

The blindness of British officialdom to the downward rigidity of wage rates was quite remarkable. Thus, the powerful deputy controller of finance for the Treasury, Frederick W. Leith-Ross, the major architect of what became known as the “Treasury view,” wrote in bewilderment to Hawtrey in early August 1928, wondering at Keynes’s claim that wage rates had remained stable since 1925. In view of the substantial decline in prices in those years, wrote Leith-Ross, “I should have thought that the average wage rate showed a substantial decline during the past four years.” Leith-Ross could only support his view by challenging the wage index as inaccurate, citing his own figures that aggregate payrolls had declined. Leith-Ross doesn’t seem to have realized that this was precisely the problem: that keeping wage rates up in the face of declining money may indeed lower payrolls, but by creating unemployment and the lowering of hours worked. Finally, by the spring of 1929, Leith-Ross was forced to face reality, and conceded the point. At last, Leith-Ross admitted that the problem was rigidity of labor costs:

If our workmen were prepared to accept a reduction of 10 percent in their wages or increase their efficiency by 10 percent, a large proportion of our present unemployment could be overcome. But in fact organized labor is so attached to the maintenance of the present standard of wages and hours of labor that they would prefer that a million workers should remain in idleness and be maintained permanently out of the Employment Fund, than accept any sacrifice. The result is to throw on to the capital and managerial side of industry a far larger reorganization than would be necessary: and until labor is prepared to contribute in larger measure to the process of reconstruction, there will inevitably be unemployment.⁷³

Leith-Ross might have added that the “preference” for unemployment was made not by the unemployed themselves but by the union leadership on their alleged behalf, a leadership which itself did not have to face the unemployment dole. Moreover, the willingness of the workers to accept this deal might have been very different if there were no generous Employment Fund for them to tap.

It was in fact the highly militant coal miners’ union, led by the prominent leftist Aneurin “Nye” Bevan, that was the first to stir up grave doubt about the glory of the British return to gold. Not only was coal a highly unionized export industry located in the north, but already overinflated coal-mining wages had been given an extra boost during the first Labor government of Ramsay MacDonald, in 1924. In addition to the high wage rates, the miners’ union insisted on numerous cost-raising restrictive, featherbedding practices, some of them resurrected from the defunct postmedieval guilds. These obstructionist tactics helped rigidify the British economy, preventing changes and adaptations of occupation and location, and hampering rationalizing and innovative managerial practices. As Professor Benham trenchantly pointed out:

Employers who wished to make changes had to face the powerful opposition of organized labor. The introduction of new methods, such as the “more looms to a weaver” system, was resisted. Strict lines of demarcation between occupations were maintained in engineering and elsewhere. A plumber could repair a pipe conveying cold water; if it conveyed hot water, he had to call in a hot water engineer. Entry into certain occupations was rendered difficult. A man can become an efficient building operative in a few months; an apprenticeship of four years was required. British railways could not have their labour force as they chose. A host of restrictions, insisted upon by the Trade Unions, made this impossible.⁷⁴

By 1925, the year of the return to gold, British coal was already facing competition of rehabilitated, newly modernized, low-cost coal mines in France, Belgium, and Germany. British coal was no longer competitive, and its exports were slumping badly. The Baldwin government appointed a royal commission, headed by Sir Herbert Samuel, to study the vexed coal question. The Samuel Commission reported in March 1926, urging that miners accept a moderate cut in wages, and an increase in working hours at current pay, and suggesting that a substantial number of miners move to other areas, such as the south, where employment opportunities were greater. But this was not the sort of rational solution that would appeal to the spoiled, militant unions, who rejected those proposals and went on strike, thereby generating the traumatic and abortive general strike of 1926.

The strike was broken, and coal-mining wages fell slightly, but the victory for rationality was all too pyrrhic. Keynes was able to convince the inflationist press magnate, Lord Beaverbrook, that the miners were victims of a Norman–Churchill–international banker conspiracy to profit at the expense of the British working class. But instead of identifying the problem as inflationism, cheap money, and the gold bullion–gold-exchange standard in the face of an overvalued pound, Beaverbrook and British public opinion pointed to “hard money” as the villain responsible for recession and unemployment. Instead of tightening the money supply and interest rates in order to preserve its own created gold standard, the British Establishment was moved to follow its own inclinations still further: to step up its disastrous commitment to inflation and cheap money.⁷⁵

During the general strike, Britain was forced to import coal from Europe instead of exporting it. In olden times, the large fall in export income would have brought about a severe liquidation of credit, contracting the money supply and lowering prices and wage rates. But the British banks, caught up as they were in the ideology of inflationism, instead expanded credit on a lavish scale, and sterling balances piled up on the continent of Europe. “Instead of a readjustment of prices and costs in England and a breaking up of the rigidities, England by credit expansion held the fort and continued the rigidities.”⁷⁶

The massive monetary inflation in Britain during 1926 caused gold to flow out of the country, especially to the United States, and sterling balances to accumulate in foreign countries, especially in France. In the true gold-standard days, Britain would have taken all this as a furious signal to contract and tighten up; instead it persisted in continuing inflationism and cheap money, lowering its crucial “bank rate” (Bank of England discount rate) from 5 percent to 4.5 percent in April 1927. This action further weakened the pound sterling, and Britain lost $11 million in gold during the next two months.

France’s important role during the gold-exchange era has served as a convenient whipping boy for the British and for the Establishment ever since. The legend has it that France was the spoiler, by returning to gold at an undervalued franc (pegging the franc first in 1926, and then officially returning to gold two years later), consequently piling up sterling balances, and then breaking the gold-exchange system by insisting that Britain pay in gold. The reality was very different. France, during and after World War I, suffered severe hyperinflation, fueled by massive government deficits. As a result, the French franc, classically set at 19.3¢ under the old gold standard, had plunged down to 5¢ in May 1925, and accelerated its decline to 1.94¢ in late July 1926. By June 1926, Parisian mobs protesting the runaway inflation and depreciation surrounded the Chamber of Deputies, threatening violence if former Premier Raymond Poincaré, known as a staunch monetary and fiscal conservative, was not returned to his post. Poincaré was returned to office July 2, pledging to cut expenses, balance the budget, and save the franc.

Armed with a popular mandate, Poincaré was prepared to drive through any necessary monetary and fiscal reforms. Poincaré’s every instinct urged him to return to gold at the prewar par, a course that would have been disastrous for France, being not only highly deflationary but also saddling French taxpayers with a massive public debt. Furthermore, returning to gold at the prewar par would have left the Bank of France with a very low (8.6-percent) gold reserve to bank notes in circulation. Returning at par, of course, would have gladdened the hearts of French bondholders as well as of Montagu Norman and the British Establishment. Poincaré was talked out of this path, however, by the knowledgeable and highly perceptive Emile Moreau, governor of the Bank of France, and by Moreau’s deputy governor, distinguished economist Charles Rist. Moreau and Rist were well aware of the chronic export depression and unemployment that the British were suffering because of their stubborn insistence on the prewar par. Finally, Poincaré reluctantly was persuaded by Moreau and Rist to go back to gold at a realistic par.

When Poincaré presented his balanced budget and his monetary and financial reform package to Parliament on August 2, 1926, and drove them through quickly, confidence in the franc dramatically rallied, pessimistic expectations in the franc were changed to optimistic ones, and French capital, which had understandably fled massively into foreign currencies, returned to France, quickly doubling its value on the foreign exchange market to almost 4¢ by December. To avoid any further rise, the French government quickly stabilized the franc de facto at 3.92¢ on December 26, and then returned de jure to gold at the same rate on June 25, 1928.⁷⁷

At the end of 1926, while the franc was now pegged, France was not yet on a genuine gold standard. Officially, and de jure, the franc was still set at the prewar par, when one gold ounce had been set at approximately 100 francs. But now, at the new pegged value, the gold ounce, in foreign exchange, was worth 500 francs. Obviously, no one would now deposit gold at a French bank in return for 100 paper francs, thereby wiping out 80 percent of his assets. Also, the Bank of France (which was a privately owned firm) could not buy gold at the current expensive rate, for fear that the French government might decide, after all, to go back to gold de jure at a higher rate, thereby inflicting a severe loss on its gold holdings. The government, however, did agree to indemnify the bank for any losses it might incur in foreign exchange transactions; in that way, Bank of France stabilization operations could only take place in the foreign exchange market.

The French government and the Bank of France were now committed to pegging the franc at 3.92¢. At that rate, francs were purchased in a mighty torrent on the foreign exchange market, forcing the Bank of France to keep the franc at 3.92¢ by selling massive quantities of newly issued francs for foreign exchange. In that way, foreign exchange holdings of the Bank of France skyrocketed rapidly, rising from a minuscule sum in the summer of 1926 to no less than $1 billion in October of the following year. Most of these balances were in the form of sterling (in bank deposits and short-term bills), which had piled up on the continent during the massive British monetary inflation of 1926 and now moved into French hands with the advent of upward speculation in the franc, and with continued inflation of the pound. Willy-nilly, and against their will, therefore, the French found themselves in the same boat as the rest of Europe: on the gold-exchange or gold-sterling standard.⁷⁸

If France had gone onto a genuine gold standard at the end of 1926, gold would have flowed out of England to France, forcing contraction in England and forcing the British to raise interest rates. The inflow of gold into France and the increased issue of francs for gold by the Bank of France would also have temporarily lowered interest rates there. As it was, French interest rates were sharply lowered in response to the massive issue of francs, but no contraction or tightening was experienced in England; quite the contrary.⁷⁹

Moreau, Rist, and the other Bank of France officials were alert to the dangers of their situation, and they tried to act in lieu of the gold standard by reducing their sterling balances, partly by demanding gold in London, and partly by exchanging sterling for dollars in New York.

This situation put considerable pressure upon the pound, and caused a drain of gold out of England. In the classical gold-standard era, London would have responded by raising the bank rate and tightening credit, stemming or even reversing the gold outflow. But England was committed to an unsound, inflationist policy, in stark contrast to the old gold system. And so, Norman tried his best to use muscle to prevent France from exercising its own property rights and redeeming sterling in gold, and absurdly urged that sterling was beneficial for France, and that they could not have too much sterling. On the other hand, he threatened to go off gold altogether if France persisted—a threat he was to make good four years later. He also invoked the spectre of France’s World War I debts to Britain.⁸⁰ He tried to get various European central banks to put pressure on the Bank of France not to take gold from London. The Bank of France found that it could sell up to £3 million a day without attracting the angry attention of the Bank of England; but any more sales than that would call forth immediate protest. As one official of the Bank of France said bitterly in 1927, “London is a free gold market, and that means that anybody is free to buy gold in London except the Bank of France.”⁸¹

Why did France pile up foreign exchange balances? The anti-French myth of the Establishment charges that the franc was undervalued at the new rate of 3.92¢, and that therefore the ensuing export surplus brought foreign exchange balances into France. The facts of the case were precisely the reverse. Before World War I, France traditionally had a deficit in its balance of trade. During the post–World War I inflation, as usually occurs with fiat money, the foreign exchange rate rose more rapidly than domestic prices, since the highly liquid foreign exchange market is particularly quick to anticipate and discount the future. Therefore, during the French hyperinflation, exports were consistently greater than imports.⁸² Then, when France pegged the franc to gold at the end of 1926, the balance of trade reversed itself again to the original pattern. Thus, in 1928, French exports were only 96.1 percent of imports. On the simplistic-trade, or relative-purchasing-power criterion, then, we would have to say that the post-1926 franc was over- rather than undervalued. Why didn’t gold or foreign exchange flow out of France? For the same reason as before World War I; the chronic trade deficits were covered by perennial “invisible” net revenues into France, in particular the flourishing tourist trade.

What then accounted for the amassing of sterling by France? The inflow of capital into France. During the French hyperinflation, capital had left France in droves to escape the depreciating franc, much of it finding a haven in London. When Poincaré put his monetary and budget reforms into effect in 1926, capital happily reversed its flow, and left London for France, anticipating a rising or at least a stable franc.

In fact, rather than being obstreperous, the French, succumbing to the blandishments and threats of Montagu Norman, were overly cooperative, much against their better judgment. Thus, Norman warned Moreau in December 1927 that if he persisted in trying to redeem sterling in gold, Norman would devalue the pound. In fact, Poincaré prophetically warned Moreau in May 1927 that sterling’s position had weakened and that England might all too readily give up on its own gold standard. And when France stabilized the franc de jure at the end of June 1928, foreign exchange constituted 55 percent of the total reserves of the Bank of France (with gold at 45 percent), an extraordinarily high proportion of that in sterling. Furthermore, much of the funds deposited by the Bank of France in London and New York were used for stock market loans and fueled stock speculation; worse, much of the sterling balances were recycled to repurchase French francs, which continued the accumulation of sterling balances in France. It is no wonder that Dr. Palyi concludes that

[i]t was at Norman’s urgent request that the French central bank carried a weak sterling on its back well beyond the limit of what a central bank could reasonably afford to do under the circumstances. No other major central bank took anything like a similar risk (percentage-wise).^{83, 84}

Monty Norman could neutralize the French, at least temporarily. But what of the United States? The British, we remember, were counting heavily on America’s continuing price inflation, to keep British gold out of American shores. But instead, American prices were falling slowly but steadily during 1925 and 1926, in response to the great outpouring of American products. The gold-exchange standard was being endangered by one of its crucial players before it had scarcely begun!

So, Norman decided to fall back on his trump card, the old magic of the Norman-Strong connection. Benjamin Strong must, once more, rush to the rescue of Great Britain! After Norman turned for help to his old friend Strong, the latter invited the world’s four leading central bankers to a top-secret conference in New York in July 1927. In addition to Norman and Strong, the conference was attended by Deputy Governor Rist of the Bank of France and Dr. Hjalmar Schacht, governor of the German Reichsbank. Strong ran the American side with an iron hand, keeping the Federal Reserve Board in Washington in the dark, and even refusing to let Gates McGarrah, chairman of the board of the Federal Reserve Bank of New York, attend the meeting. Strong and Norman tried their best to have the four nations embark on a coordinated policy of monetary inflation and cheap money. Rist demurred, although he agreed to help England by buying gold from New York instead of London, (that is, drawing down dollar balances instead of sterling). Strong, in turn, agreed to supply France with gold at a subsidized rate: as cheap as the cost of buying it from England, despite the far higher transportation costs.⁸⁵

Schacht was even more adamant, expressing his alarm at the extent to which bank credit expansion had already gone in England and the United States. The previous year, Schacht had acted on his concerns by reducing his sterling holdings to a minimum and increasing the holdings of gold in the Reichsbank. He told Strong and Norman: “Don’t give me a low [interest] rate. Give me a true rate. Give me a true rate, and then I shall know how to keep my house in order.”⁸⁶ Thereupon, Schacht and Rist sailed for home, leaving Strong and Norman to plan the next round of coordinated inflation themselves. In particular, Strong agreed to embark on a mighty inflationary push in the United States, lowering interest rates and expanding credit—an agreement which Rist, in his memoirs, maintains had already been privately concluded before the four-power conference began. Indeed, Strong gaily told Rist during their meeting that he was going to give “a little coup de whiskey to the stock market.”⁸⁷ Strong also agreed to buy $60 million more of sterling from England to prop up the pound.

Pursuant to the agreement with Norman, the Federal Reserve promptly launched its greatest burst of inflation and cheap credit in the second half of 1927. This period saw the largest rate of increase of bank reserves during the 1920s, mainly due to massive Fed purchases of U.S. government securities and of bankers’ acceptances, totaling $445 million in the latter half of 1927. Rediscount rates were also lowered, inducing an increase in bills discounted by the Fed. Benjamin Strong decided to sucker the suspicious regional Federal Reserve banks by using Kansas City Fed Governor W.J. Bailey as the stalking horse for the rate-cut policy. Instead of the New York Fed initiating the rediscount rate cut from 4 percent to 3.5 percent, Strong talked the trusting Bailey into taking the lead on July 29, with New York and the other regional Feds following a week or two later. Strong told Bailey that the purpose of the rate cuts was to help the farmers, a theme likely to appeal to Bailey’s agricultural region. He made sure not to tell Bailey that the major purpose was to help England pursue its inflationary gold-exchange policy.

The Chicago Fed, however, balked at lowering its rates, and Strong got the Federal Reserve Board in Washington to force it to do so in September. The isolationist Chicago Tribune angrily called for Strong’s resignation, charging correctly that discount rates were being lowered in the interests of Great Britain.⁸⁸

After generating the burst of inflation in 1927, the New York Fed continued, over the next two years, to do its best: buying heavily in prime commercial bills of foreign countries, bills endorsed by foreign central banks. The purpose was to bolster foreign currencies, and to prevent an inflow of gold into the U.S. The New York Fed also bought large amounts of sterling bills in 1927 and 1929. It frankly described its policy as follows:

We sought to support exchange by our purchases and thereby not only prevent the withdrawal of further amounts of gold from Europe but also, by improving the position of the foreign exchanges, to enhance or stabilize Europe’s power to buy our exports.⁸⁹

If Strong was the point man for the monetary inflation of the late 1920s, the Coolidge administration was not far behind. Pittsburgh multimillionaire Andrew W. Mellon, secretary of the Treasury throughout the Republican era of the 1920s, was long closely allied with the Morgan interests. As early as March 1927, Mellon assured everyone that “an abundant supply of easy money” would continue to be available, and he and President Coolidge repeatedly acted as the “capeadores of Wall Street,” giving numerous newspaper interviews urging stock prices upward whenever prices seemed to flag. And in January 1928, the Treasury announced that it would refund a 4.5-percent Liberty Bond issue, falling due in September, in 3.5-percent notes. Within the administration, Mellon was consistently Strong’s staunchest supporter. The only sharp critic of Strong’s inflationism within the administration was Secretary of Commerce Herbert C. Hoover, only to be met by Mellon’s denouncing Hoover’s “alarmism” and interference.⁹⁰

The motivation for Benjamin Strong’s expansionary policy of the late 1920s was neatly summed up in a letter by one of his top aides to one of Montagu Norman’s top henchmen, Sir Arthur Salter, then director of Economic and Financial Organization for the League of Nations. The aide noted that Strong, in the spring of 1928, “said that very few people indeed realized that we were now paying the penalty for the decision which was reached early in 1924 to help the rest of the world back to a sound financial and monetary basis.”⁹¹ Similarly, a prominent banker admitted to H. Parker Willis in the autumn of 1926 that bad consequences would follow America’s cheap-money policy, but that “that cannot be helped. It is the price we must pay for helping Europe.” Of course, the price paid by Strong and his allies was not so “onerous,” at least in the short run, when we note, as Dr. Clark pointed out, that the cheap credit aided especially those speculative, financial, and investment banking interests with whom Strong was allied—notably, of course, the Norman complex.⁹² The British, as early as mid-1926, knew enough to be appreciative. Thus, the influential London journal, The Banker, wrote of Strong that “no better friend of England” existed. The Banker praised the “energy and skillfulness that he has given to the service of England,” and exulted that “his name should be associated with that of Mr. [Walter Hines] Page as a friend of England in her greatest need.”⁹³

On the other hand, Morgan partner Russell C. Leffingwell was not nearly as sanguine about the Strong-Norman policy of joint credit expansion. When, in the spring of 1929, Leffingwell heard reports that Monty was getting “panicky” about the speculative boom in Wall Street, he impatiently told fellow Morgan partner Thomas W. Lamont, “Monty and Ben sowed the wind. I expect we shall all have to reap the whirlwind.... I think we are going to have a world credit crisis.”⁹⁴

Unfortunately, Benjamin Strong was not destined personally to reap the whirlwind. A sickly man, Strong in effect was not running the Fed throughout 1928, finally dying on October 16 of that year. He was succeeded by his handpicked choice, George L. Harrison, also a Morgan man but lacking the personal and political clout of Benjamin Strong.

At first, as in 1924, Strong’s monetary inflation was temporarily successful in accomplishing Britain’s goals. Sterling was strengthened, and the American gold inflow from Britain was sharply reversed, gold flowing outward. Farm produce prices, which had risen from an index of 100 in 1924 to 110 the following year, and had then slumped back to 100 in 1926 and 99 in 1927, now jumped up to 106 the following year. Farm and food exports spurted upward, and foreign loans in the United States were stimulated to new heights, reaching a peak in mid-1928. But, once again, the stimulus was only temporary. By the summer of 1928, the pound sterling was sagging again. American farm prices fell slightly in 1929, and agricultural exports fell in the same year. Foreign lending slumped badly, as both domestic and foreign funds poured into the booming American stock market.

The stock market had already been booming by the time of the fatal injection of credit expansion in the latter half of 1927. The Standard and Poor’s industrial common stock index, which had been 44.4 at the beginning of the 1920s boom in June 1921, had more than doubled to 103.4 by June 1927. Standard and Poor’s rail stocks had risen from 156.0 in June 1921 to 316.2 in 1927, and public utilities from 66.6 to 135.1 in the same period. Dow Jones industrials had doubled from 95.1 in November 1922 to 195.4 in November 1927. But now, the massive Fed credit expansion in late 1927 ignited the stock market fire. In particular, throughout the 1920s, the Fed deliberately and unwisely stimulated the stock market by keeping the “call rate,” that is, the interest rate on bank call loans to the stock market, artificially low. Before the establishment of the Federal Reserve System, the call rate frequently had risen far above 100 percent, when a stock market boom became severe; yet in the historic and virtually runaway stock market boom of 1928–29, the call rate never went above 10 percent. The call rates were controlled at these low levels by the New York Fed, in close collaboration with, and at the advice of, the Money Committee of the New York Stock Exchange.⁹⁵ The stock market, during 1928 and 1929, went into overdrive, virtually doubling these two years. The Dow went up to 376.2 on August 29, 1929, and Standard and Poor’s industrials rose to 195.2, rails to 446.0, and public utilities to 375.1 in September. Credit expansion always concentrates its booms in titles to capital, in particular stocks and real estate, and in the late 1920s, bank credit propelled a massive real estate boom in New York City, in Florida, and throughout the country. These included excessive mortgage loans and construction from farms to Manhattan office buildings.⁹⁶

The Federal Reserve authorities, now concerned about the stock market boom, tried feebly to tighten the money supply during 1928, but they failed badly. The Fed’s sales of government securities were offset by two factors: (a) the banks shifting their depositors from demand deposits to “time” deposits, which required a much lower rate of reserves, and which were really savings deposits redeemable de facto on demand, rather than genuine time loans, and (b) more important, the fruit of the disastrous Fed policy of virtually creating a market in bankers’ acceptances, a market which had existed in Europe but not in the United States. The Fed’s policy throughout the 1920s was to subsidize and in effect create an acceptance market by standing ready to buy any and all acceptances sold by certain favored acceptance houses at an artificially cheap rate. Hence, when bank reserves tightened as the Fed sold securities in 1928, the banks simply shifted to the acceptance market, expanding their reserves by selling acceptances to the Fed. Thus, the Fed’s selling of $390 million of securities was partially offset, during latter 1928, by its purchase of nearly $330 million of acceptances.⁹⁷ The Fed’s sticking to this inflationary policy in 1928 was now made easier by adopting the fallacious “qualitativist” view, held as we have seen also by Herbert Hoover, that the Fed could dampen down the boom by restricting loans to the stock market while merrily continuing to inflate in the acceptance market.

In addition to pouring in funds through acceptances, the Fed did nothing to tighten its rediscount market. The Fed discounted $450 million of bank bills during the first half of 1928; it finally tightened a bit by raising its rediscount rates from 3.5 percent at the beginning of the year to 5 percent in July. After that, it stubbornly refused to raise the rediscount rate any further, keeping it there until the end of the boom. As a result, Fed discounts to banks rose slightly until the end of the boom instead of declining. Furthermore, the Fed failed to sell any more of its hoard of $200 million of government securities after July 1928; instead, it bought some securities on balance during the rest of the year.

Why was Fed policy so supine in late 1928 and in 1929? A crucial reason was that Europe, and particularly England, having lost the benefit of the inflationary impetus by mid-1928, was clamoring against any tighter money in the U.S. The easing in late 1928 prevented gold inflows from the U.S. from getting very large. Britain was again losing gold; sterling was again weak; and the United States once again bowed to its wish to see Europe avoid the consequences of its own inflationary policies.

Leading the inflationary drive within the administration were President Coolidge and Treasury Secretary Mellon, eagerly playing their roles as the capeadores of the bull market on Wall Street. Thus, when the stock market boom began to flag, as early as January 1927, Mellon urged it onward. Another relaxing of stock prices in March spurred Mellon to call for and predict lower interest rates; again, a weakening of stock prices in late March induced Mellon to make his statement assuring “an abundant supply of easy money which should take care of any contingencies that might arise.” Later in the year, President Coolidge made optimistic statements every time the rising stock market fell slightly. Repeatedly, both Coolidge and Mellon announced that the country was in a “new era” of permanent prosperity and permanently rising stock prices. On November 16, the New York Times declared that the administration in Washington was the source of most of the bullish news and noted the growing “impression that Washington may be depended upon to furnish a fresh impetus for the stock market.” The administration continued these bullish statements for the next two years. A few days before leaving office in March 1929, Coolidge called American prosperity “absolutely sound” and assured everyone that stocks were “cheap at current prices.”^{98, 99}

The clamor from England against any tighter money in the U.S. was driven by England’s loss of gold and the pressure on sterling. France, having unwillingly piled up $450 million in sterling by the end of June 1928, was anxious to redeem sterling for gold, and indeed sold $150 million of sterling by mid-1929. In deference to Norman’s threats and pleas, however, the Bank of France sold that sterling for dollars rather than for gold in London. Indeed, so cowed were the French that (a) French sales of sterling in 1929–31 were offset by sterling purchases by a number of minor countries, and (b) Norman managed to persuade the Bank of France to sell no more sterling until after the disastrous day in September 1931 when Britain abandoned its own gold-exchange standard and went on to a fiat pound standard.¹⁰⁰

Meanwhile, despite the great inflation of money and credit in the U.S., the massive increase in the supply of goods in the U.S. continued to lower prices gradually, wholesale prices falling from 104.5 (1926=100) in November 1925 to 100 in 1926, and then to 95.2 in June 1929. Consumer price indices in the U.S. also fell gradually in the late 1920s. Thus, despite Strong’s loose money policies, Norman could not count on price inflation in the U.S. to bail out his gold-exchange system. Montagu Norman, in addition to pleading with the U.S. to keep inflating, resorted to dubious short-run devices to try to keep gold from flowing out to the U.S. Thus, in 1928 and 1929, he would sell gold for sterling to raise the sterling rate a bit, in sales timed to coincide with the departure of fast boats from London to New York, thus inducing gold holders to keep the precious metal in London. Such short-run tricks were hardly adequate substitutes for tight money or for raising bank rate in England, and weakened long-run confidence in the pound sterling.¹⁰¹

In March 1929, Herbert Clark Hoover, who had been a powerful secretary of commerce during the Republican administrations of the 1920s, became president of the United States. While not as intimately connected as Calvin Coolidge, Hoover long had been close to the Morgan interests. Mellon continued as secretary of the Treasury, with the post of secretary of state going to the longtime top Wall Street lawyer in the Morgan ambit, Henry L. Stimson, disciple and partner of J.P. Morgan’s personal attorney, Elihu Root.¹⁰² Perhaps most important, Hoover’s closest, but unofficial adviser, whom he regularly consulted three times a week, was Morgan partner Dwight Morrow.¹⁰³

Hoover’s method of dealing with the inflationary boom was to try not to tighten the money supply, but to keep bank loans out of the stock market by a jawbone method then called “moral suasion.” This too was the preferred policy of the new governor of the Federal Reserve Board in Washington, Roy A. Young. The fallacy was to try to restrict credit to the stock market while keeping it abundant to “legitimate” commerce and industry. Using methods of intimidation of business honed when he was secretary of commerce, Hoover attempted to restrain stock loans by New York banks, tried to induce the president of the New York Stock Exchange to curb speculation, and warned leading editors and publishers about the dangers of high stock prices. None of these superficial methods could be effective.

Professor Beckhart added another reason for the adoption of the ineffective policy of moral suasion: that the administration had been persuaded to try this tack by the old manipulator, Montagu Norman. Finally, by June 1929, the moral suasion was at last abandoned, but discount rates were still not raised, so that the stock market boom continued to rage, even as the economy in general was quietly but inexorably turning downward. Secretary Mellon once again trumpeted our “unbroken and unbreakable prosperity.” In August, the Federal Reserve Board finally agreed to raise the rediscount rate to 6 percent, but any tightening effect was more than offset by the Fed’s simultaneously lowering its acceptance rate, thereby once again giving an inflationary fillip to the acceptance market. One reason for this resumption of acceptance inflation, after it had been previously reversed in March, was, yet again, “another visit of Governor Norman.”¹⁰⁴ Thus, once more, the cloven hoof of Montagu Norman was able to give its final impetus to the boom of the 1920s. Great Britain was also entering upon a depression, and yet its inflationary policies resulted in a serious outflow of gold in June and July. Norman was able to get a line of credit of $250 million from a New York banking consortium, but the outflow continued through September, much of it to the United States. Continuing to help England, the New York Fed bought heavily in sterling bills from August through October. The new subsidization of the acceptance market, mostly foreign acceptances, permitted further aid to Britain through the purchase of sterling bills.

A perceptive epitaph on the qualitative-credit politics of 1928–29 was pronounced by A. Wilfred May:

Once the credit system had become infected with cheap money, it was impossible to cut down particular outlets of this credit without cutting down all credit, because it is impossible to keep different kinds of money separated in water-tight compartments. It was impossible to make money scarce for stock-market purposes, while simultaneously keeping it cheap for commercial use.... When Reserve credit was created, there was no possible way that its employment could be directed into specific uses, once it had flowed through the commercial banks into the general credit stream.¹⁰⁵

DEPRESSION AND THE END OF THE GOLD-STERLING-EXCHANGE STANDARD: 1929–1931

The depression, or what nowadays would be called the “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 1920–21, and the way in 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, credit, 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 work 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, “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 Federal Reserve, specifically George Harrison, doubled its holding 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 brokers’ loans being liquidated by nonbank lenders. Over the objections of Roy Young of the Federal Reserve Board, Harrison told the New York Stock Exchange that “I am ready to provide all the reserve funds that may be needed.”¹⁰⁶ By December, Secretary Mellon issued one of his traditionally optimistic pronouncements that there was “plenty of credit available,” and President Hoover, addressing a business conference on December 5, hailed the nation’s good fortune in possessing the splendid 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 rediscount rates during the year from 4.5 percent to 2 percent, 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, Business Week (then as now a voice for “enlightened” business opinion) thundering in late October that the “deflationists” were “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’ “inability to liquidate.” Willis noted that the country was suffering from frozen and wasteful malinvestments in plants, buildings, and other capital, and that the depression could only be cured when these unsound credit positions were allowed to liquidate.¹⁰⁷

In 1930, Montagu Norman got part of his wish to achieve a formal intercentral bank collaboration. Norman was able to push through a new “central bankers’ bank,” the Bank for International Settlements (BIS), to meet regularly at Basle, 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. McGarrah 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 U.S. participation in the bank, New York Fed Governor George Harrison made a “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-Kredit-Anstalt, 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 Österreichische-Kredit-Anstalt, now by far the largest commercial bank in Austria, capital being provided by an international financial syndicate including J.P. Morgan and Rothschild of Vienna. Moreover, the Austrian government guaranteed some of the Boden bank’s assets.

But the now-huge Kredit-Anstalt 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 Kredit-Anstalt 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 Kredit-Anstalt 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 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 “protect” the mark by severe and thoroughgoing 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 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 crises 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 percent, and grudgingly raised the rate only to 4.5 percent 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 20, went off the very 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-percent bank rate. As Dr. Anderson concluded,

England went off the gold standard with Bank Rate at 4.5 percent. 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.¹⁰⁸

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 18, Dr. G. Vissering, head of the Netherlands Bank, phoned Monty Norman and asked him about the crisis of sterling. Vissering, 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.¹⁰⁹ 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.¹¹⁰

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 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 Montagu 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.¹¹¹ 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 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. Bonn neatly summed up the significance of England’s action in September 1931:

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.¹¹²

As soon as England went off the gold standard, the pound fell by 30 percent. It is ironic that, after all the travail Britain had put the world through, the pound fell to a level, $3.40, that might have been viable if she had originally returned to gold at that rate. Twenty-five countries followed Britain off gold and onto floating, and devaluating, exchange rates. The era of the gold-exchange standard was over.

EPILOGUE

The world was now plunged into a monetary chaos of fiat money, competing devaluation, exchange controls, and warring monetary and trade blocs, accompanied by a network of protectionist restrictions. These warring blocs played an important though neglected part in paving the way for World War II. This trend toward monetary and other economic nationalism was accentuated when the United States, the last bastion of the gold-coin standard, devalued the dollar and went off that standard in 1933. The Franklin Roosevelt branch of the family had always been close to its neighbors the Astors and Harrimans, and American politics, since the turn of the twentieth century, had been marked by an often bitter financial and political rivalry between the House of Morgan on the one hand, and an alliance of the Harrimans, the Rockefellers, and Kuhn, Loeb on the other. Accordingly, the early years of the Roosevelt New Deal were marked by a comprehensive and successful assault on the House of Morgan, that is, in the Glass-Steagall Act, outlawing Morgan-type integration of commercial and investment banking. In contrast to the Morgan dominance during the Republican era of the 1920s, the early New Deal was dominated by an alliance of the Harrimans, Rockefellers, and various retailers, farm groups, the silver bloc, and industries producing for retail sales (for example, automobiles and typewriters), all of whom were now backing an inflationist and economic nationalist program. When the British, backed by the Morgans, convened a World Economic Conference in London in June 1933, to try to restabilize exchange rates, the plan was scuttled at the last minute by President Roosevelt, under the influence of the inflationist-economic nationalist bloc. The Morgans were taking a shellacking at home and abroad.

It was only in 1936, by the good offices of leading Morgan banker Norman Davis, a longtime friend of Roosevelt’s, and of Democrat Morgan partner Russell Leffingwell, that the Morgans would begin to recoup their political losses. The beginning of the return of the Morgans was symbolized by the September 1936 Tripartite Monetary Agreement, partially stabilizing the exchange rates of the currencies of Britain, France, and the U.S., a collaboration that was soon extended to Belgium, Holland, and Switzerland. These agreements, in addition to the dollar’s still remaining on an international (but not domestic) gold bullion standard at $35 an ounce, set the stage for the Morgan drive organized by Norman Davis, head of Morgan’s Council of Foreign Relations, to bring a new world gold-exchange standard out of the cauldron of World War II. The difference is that this inflationary “Bretton Woods” system would be a dollar, not a sterling, gold-exchange standard. Moreover, this inflationary system under the cloak of the prestige of gold, was destined to last a great deal longer than the British venture, finally collapsing at the end of the 1960s.¹¹³