A History of Money and Banking in the United States: The Colonial Era to World War II (56 page)

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 48When the gold-exchange standard broke down in 1931, the economist H. Parker Willis noted that “the ease with which the gold-exchange standard can be instituted, especially with borrowed money, has led a good many nations during the past decade to ‘stabilize’ . . . at too high a rate.” H. Parker Willis, “The Breakdown of the Gold Exchange Standard and its Financial Imperialism,”
The Annalist
(October 16, 1931): 626 ff.

The Gold-Exchange Standard in the Interwar Years
387

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 49Palyi,
Twilight of Gold
, pp. 73–74. See also p. 185.

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A History of Money and Banking in the United States:
The Colonial Era to World War II

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 50Robert Skidelsky,
John Maynard Keynes,
vol. 1,
1883–1920
(New York: Viking Press, 1986), p. 275. See also ibid., pp 272–74; and Palyi,
Twilight of
Gold,
pp. 155–57. While Keynes’s book was largely an apologia for the existing system in India, he also gently chided the British government for not going far enough in managed inflation by failing to establish a central bank. Skidelsky,
Keynes
, pp. 276–77.

The Gold-Exchange Standard in the Interwar Years
389

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 51Skidelsky,
Keynes
, pp. 374–83. Meanwhile, in the United States, the government, investment bankers, and economists such as Charles A.

Conant, Jeremiah W. Jenks, and Jacob Hollander, collaborated in imposing or attempting to impose gold-exchange standards and central banks in Latin America and Asia, beginning with the U.S. acquisition of a colonial empire after the Spanish-American War. During the 1920s, Edwin W.

Kemmerer, the “money doctor,” a student of Jenks and disciple of Conant, continued this task throughout the Third World. See Edward T. Silva and Sheila Slaughter,
Serving Power: The Making of the Academic Social Science
Expert
(Westport, Conn.: Greenwood Press, 1984), pp. 103–38; Emily S.

Rosenberg, “Foundations of United States International Financial Power: Gold Standard Diplomacy, 1900–1905,”
Business History Review
59

(Summer 1985): 172–98; and Robert N. Seidel, “American Reformers Abroad: The Kemmerer Missions in South America, 1923–1931,”
Journal
of Economic History
32 (June 1972): 520–45.

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A History of Money and Banking in the United States:
The Colonial Era to World War II

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.

52Eric G. Davis, “R.G. Hawtrey, 1879–1975,” in
Pioneers of Modern
Economics in Britain,
D.P. O’Brien and J.R. Presley, eds. (Totowa, N.J.: Barnes and Noble, 1981), p. 219. Hawtrey’s speech was published as “The Gold Standard,”
Economic Journal
29 (1919): 428–42. Fisher’s proposal was in Irving Fisher,
The Purchasing Power of Money
(New York: Macmillan, 1911), pp. 332–46.

The Gold-Exchange Standard in the Interwar Years
391

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 53Rothbard,
America’s Great Depression
, p. 161. See also Paul Einzig,
Montagu Norman
(London: Kegan Paul, 1932), pp. 67, 78; Clay,
Lord
Norman,
p. 138; and Anne Orde,
British Policy and European Reconstruction
After the First World War
(Cambridge: Cambridge University Press, 1990), pp. 105–18.

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A History of Money and Banking in the United States:
The Colonial Era to World War II

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 inter-governmental 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 54Davis, “R.G. Hawtrey,” pp. 219–20, 232; Carole Fink,
The Genoa
Conference: European Diplomacy, 1921–1922
(Chapel Hill: University of North Carolina Press, 1984), pp. 158, 232; and Dan P. Silverman,
Reconstructing Europe After the Great War
(Cambridge, Mass.: Harvard University Press, 1982), pp. 282ff.

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