Originally posted Thursday, November 08, 2012
“Throughout the 19th century, Britain presided over a tenfold rise in global trade under the classical Gold Standard.”
In the Winter 2011-12 issue of Finest Hour, a journal of Churchill studies, there also is a learned overview of the problems confronting Churchill as Chancellor of the Exchequer … and especially of the big presenting problem of resumption of the gold standard, a problem, which, in Churchill’s own retrospective view, as well as in the view of historians, he badly misjudged. From The Burden of Statesmanship, Churchill as Exchequer, by Ryan Brown, pp. 12 – 14:
Check from Churchill to the Duke of Marlborough, courtesy of the Library of Congress
Many, however, fail to trace a consistent path between Churchill’s hawkish stances in both world wars through his 1924-29 tenure as Chancellor of the Exchequer. His conduct of this office attracts heavy criticism for his decision to return Britain to the Gold Standard in 1925. Though the immediate consequences of this policy were bad, a just evaluation must avoid the error of isolating it from historical context, imposing pure economic philosophy onto consequences determined by political forces. In the end, the return to gold shows Churchill shouldering the burden of statesmanship—using every tool at his disposal to forge a lasting peace in a world intent upon repeating the fatal mistakes of the past.
Throughout the 19th century, Britain presided over a tenfold rise in global trade under the classical Gold Standard. Often misunderstood, the Standard arose naturally from the bartering system in which commodities were exchanged directly. Over time, gold proved to be the most universally desired commodity, and we began to measure the value of goods against it.
As a commodity, gold became the measuring stick of value for goods and eventually developed into the accepted medium of exchange. For ease of trade, banks began to hold gold reserves, and would issue the depositor a paper receipt that could be exchanged as gold in the marketplace. Over time, central banks gained a monopoly on issuing these receipts, and produced paper currencies that were “IOUs” for “a specified weight of gold” held by the national banking system.
The amount of currency in circulation was, therefore, limited by the amount of bullion in the national gold reserve. If a central bank pursued an unwise inflationary policy—say by issuing paper currency not represented by gold reserves—the citizenry could protect their savings and “vote” against this action by exchanging their paper bills for gold at national banks. This would contract the gold reserves in the central bank and force them to reverse their policy to stem the gold drain.
Since units of currency were worth a set amount of gold, they could be directly translated into foreign currencies at fixed exchange rates based upon their relationship to gold. These constant exchange rates, founded on gold, tied world markets together with a single standard and created a uniform set of global prices. If a central bank did not preserve the value of a currency, and inflated the money supply, the rise in domestic prices would decrease exports and cause people to spend money abroad, where goods were cheaper.
As a nation received gold, it would issue paper currency to represent this monetary inflow. This increase in money would eventually cause domestic prices to rise and make foreign goods more affordable. In response, the flow of trade would reverse, as gold found its way to cheaper goods abroad and synchronized trade with market forces. In this way, domestic monetary policy was directly linked to a nation’s exchange rate. This process held international gold reserves in proportion to each other based upon how much wealth individual nations produced. This self-regulating international system depended on central banks to follow these “rules of the game” and to maintain confidence in their national monetary structures by following the impulses of the Gold Standard mechanism as they set policy. Under this system, money was an impartial standard of value through which market forces could direct capital and allocate resources in proportion to needs of society. Central banks could not abuse monetary policy by artificially lowering interest rates to overextend credit, issuing bonds to finance budget deficits, or manipulating the money supply to boost exports—since excessive borrowing and lending would deplete the national gold reserve.
As a result, countries could not manipulate their currency to run long-term budget deficits or trade imbalances without risking financial collapse: distortions in the market were forced back to equilibrium by the Gold Standard.
Before the war, London was the investment capital of the world. Of the 31.5% of British national income derived from trade,9 8% came from overseas investments. But Britain emerged from the war with exports at half their prewar levels and gold reserves dwindling. In response, Parliament suspended the export of bullion until 1925, when the country expected to resume a functioning Gold Standard. Restoring trade was imperative to reviving the British economy, but this first required realigning domestic and international price levels. The only historical guide for Britain’s domestic quandaries was the return to the Gold Standard in 1821. Rather than devalue sterling following the Napoleonic Wars, the Bank of England had chosen to reverse wartime inflation by deflating the currency to its prewar value over six painful years. Britain emerged a colossus, and experienced a century of unprecedented progress.
a Good Idea at the Time
Now, a century later, after a far more devastating war, Bank of England Governor Montagu Norman sought to apply the same methods to bring sterling back to its prewar worth of $4.86. To this end, he set out to stabilize the global monetary system and return to gold through the international cooperation of central banks. At the Genoa Conference in 1922, Norman helped engineer a new monetary order around the gold-exchange standard. Under this system, currencies of primary countries, such as the United States and Great Britain, were backed by gold and could essentially function as gold in most international transactions. Rather than send bullion to pay for imports, a nation could make payments in gold-backed bills.
Secondary countries not directly tied to gold could use these bills, instead of gold reserves, to issue more paper currency. Since the world’s money supply was not strictly limited to gold, this gold-exchange standard disabled the old Gold Standard’s anti-inflationary mechanism and increased the amount of credit flowing through the international markets.
By 1924, the pound was within 10% of its prewar parity against the dollar. Norman had gained approval to resume the Gold Standard from Philip Snowden, Chancellor of the Exchequer in the first Labour government (January-November 1924). When that government fell, the final decision was left for the incoming Conservative ministry.
Winston Churchill was glowing as he donned the robes his father had worn as Chancellor of the Exchequer and assumed the same high office. His return to the Conservative Party and appointment by the Prime Minister were as big a surprise to him as they were to England. But no shortage of problems awaited him.
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