56. The Gold-Exchange Standard, Not Gold

0:00The 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 quote, 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.

0:46In 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 rurers then would receive British pounds rather than gold. The gold exchange standard then cunningly broke the classical gold standard stringent limits on monetary and credit expansion, not only for the other European countries but 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.

1:34Thereby, 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.

2:28Britain too is now able to quote, 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.

3:20For 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. c. That they return, not to a genuine gold gold standard, but to a gold exchange standard, keeping their balances in London and refraining from exercising their legal rights to redeem those sterling balances in gold.

4:11In this way, for a few years, Britain could have its kick 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. 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 pre-war par.

4:59The rule of thumb imposed in the 1920s was that A. Currencies, such as that of Britain herself, that had depreciated up to 60% from pre-war, for example, the Netherlands and the Scandinavian countries, would return at the pre-war par. B. Currencies that had depreciated from 60 to 90% were to return to gold within that 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 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.

6:00As a result, virtually every European currency suffered from the requirement to raise the value of its currency artificially above its depreciated level. 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.

6:45That 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 and 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.

7:36It was Keynes, after leaving the India office and going to Cambridge, who trumpeted the new form of monetary system as a quote, limping or imperfect gold standard, but as a quote, more scientific and economic system, end quote, which he dubbed the gold exchange standard. As Keynes wrote in February 1910, quote, It is cheaper to maintain a credit at one of of the Great Financial Centers 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, quote, the ideal currency of the future.

8:23Elaborating 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 long-time 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, quote, scientific system based on one or two key reserve centers, quote, a preference for a tangible reserve currency, end quote, Keynes declared blithely, quote, is a relic of a time when governments were less trustworthy in these matters than they are now, end quote. He also believed that Britain was the natural center of the new reformed monetary order.

9:22While 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. Written While Montague Norman was the field marshal of the gold exchange standard of the 1920s, its major theoretician was long-time Treasury official Ralph Autry.

10:18When Autry rose to the position of Director of Financial Enquiries at the Treasury in 1919, he delivered a speech before the British Association on, quote, the gold standard, the speech presage, the gold exchange standard of the 1920s. Autry 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. Autry recommended international cooperation to stabilize price levels and urged the use of an indexed number of world prices, a proposal reminiscent of Yale professor Irving Fisher's suggestion for a, quote, tabular gold exchange standard made in 1911.

11:04In 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 post-war price levels from the threat of deflation, and in In particular to alleviate the, quote, shortage of gold compared to the swollen totals of paper currencies existing in Europe. As Professor Eric Davis writes, quote, There had been concern in official circles that a return to the gold standard would be inhibited by a shortage of gold.

11:52Prices were much higher than before the war, and thus if there was a general return to the old parodies there might be insufficient gold. Autry picked up on the idea that the gold exchange standard could be widely introduced to economize 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. 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.

12:37At 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 Montague 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 Strakusch. All of these men were ardent price-level stabilizationists. Moreover, Norman's chief advisor in international monetary affairs, Sir Charles S. Addis, was also a dedicated stabilizationist. Frauded 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 post-war reconstruction of Europe to include discussions of German reparations, Soviet-Russian reconstruction, the public debt and the monetary system.

13:42At a meeting of the Allied Supreme Council at Cannes in early January 1922, Lloyd George The research 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 credits, 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.

14:41The European Economic Conference occurred at Genoa from April 10th to May 19th, 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 Horn. 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 sub-commission dealing with the international monetary system. The crucial committee, however, was a large committee of experts covering all three sub-commissions and which actually drew up the resolutions finally passed by the conference.

15:32The committee of experts was appointed solely by Sir Robert Horne and it met in London during in 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 Autry drew up the Treasury plans for international money after having quote, extended discussions with Montague Norman and presented them to the Committee of Experts. After a temporary setback, the Autry 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. Having gotten his plan approved by the nations of Europe, Autry became the leading Fugelman and interpreter of the Genoa Resolutions.

16:23The 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, quote, In countries where there is no central bank of issue, one should be established, end quote. These central banks, not only in Europe, but elsewhere, particularly the United States, should practice, quote, continuous cooperation in order to bring about and maintain, quote, 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.

17:12After 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. Section 9 looked specifically to a new form of gold standard which would, quote, 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, end quote. 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 over-expanded paper currencies.

18:09Resolution 9 then became specific. The point was to economize, quote, the use of gold by maintaining reserves in the form of foreign balances, such, for example, as the gold exchange standard or an international 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.

19:07In 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 of Bank Balances, Bills, Short-Term Securities, or other Suitable Liquid Resources. 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.

20:03The upshot the currency resolution concludes is that the convention will thus be based on a gold exchange standard. Ralph Autry'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. Autry asks the crucial question, quote, 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?

20:50Why indeed? Why can't the new pseudo-gold standard be like the old? Autry makes it clear that his reason is a phobia about deflation. The paper money stock had multiplied since 1914, and therefore their, quote, has been and 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 program that had changed the economic face of Britain.

21:43He simply points to the quote, notorious chronic state of depression which prevailed during the spread of the gold standard in the period 1873 to 1896, end quote. This is really his only horrible example. But in the first place, Autry is wrong in attributing falling prices during the late 19th 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 Autry has made the all-too-common modern error of identifying falling prices with, quote, depression.

22:28In 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 quote, depression at all and was only experienced as such decades later by historians who failed to understand the social benefits of falling prices. Second, in his exegesis, Autry 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, Autry states wistfully, quote, At the gold centers some gold reserves must be maintained, end quote.

23:17But if the gold standard becomes worldwide, quote, If all the gold standard countries adhere to it, gold will nowhere be needed as a means In short, Autry looked forward to dispensing with gold as a monetary metal altogether and to have the world solely on a fiat paper standard. Autry 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.

24:04To 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 Harvey, 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. Like the other British leaders, Autry was pinning his faith on Uncle Sam's inflating Many historians have written off the Genoa Conference as a, quote, failure and dismissed its influence on the international money of the 20th century.

24:59It 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 anti-bank 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.

25:45And 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, a quote, informal entente. Actually, what Strong preferred was close, quote, key currency collaboration between, say, the central banks of the United States, England and France, rather than to be outvoted at Formal International Conventions. 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.

26:55Far from Genoa being merely a flash in the pan, the 1922 conference placed its decisive stamp upon the post-war monetary world. In the words of Professor Davis, quote, the widespread adoption of the gold exchange standard can be seen as the legacy of Genoa, end quote. 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.

27:41By 1928, 43 nations were du jour 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 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 in the 1920s.

28:36During This Period 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. 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 re-establish a stable and secure money, has used that advantage to establish a basis for putting Europe under a veritable financial domination.

29:36The 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.