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Discussions of international monetary regimes since 1920 invite comparisons with the pre–World War I gold standard, which was viewed by contemporary bankers and officials as an automatically self-equilibrating system. It is difficult to understand later events without realizing that the minds of officials in the 1920s and even there-after were cluttered with images of the prewar system, which many saw as an ideal to which the world should return.

TABLE 4.1 International Monetary Policy: Issues for U.S. Government, 1920–72

1920 23 25 28 30 33 35 38 40 43 45 48 50 53 55 58 60 63 65 68 70 72

Gold^a x x x x x x x x x x x x x

Balance of payments^a x x x x x x x x X

Foreign exchange X x x x x X

Stabilization (of exchange): U.S.

Treasury

x x x x x x x x x X

International monetary cooperation

x x x

IMF x x x x x x x x x x X

OECD (monetary issues and Working Party Three)

x x x X

aBetween 1953 and 1965, “gold” and “balance of payments” appear in a single heading, “balance of payments and gold movements,” or “balance of payments and gold and dollar movements.”

Note: The table indicates the key phrases that appeared in headings or subheadings of at least three U.S. Treasury Annual Reports, for the first, fourth, sixth, and ninth years of each decade (counting 1920 as the first year of its decade). For the years surveyed, over three-fourths of the head-ings in Treasury Annual Reports that were considered to refer to international monetary policy contained these phrases. All of the headhead-ings with-out these phrases could easily be classified into sets, relating closely to phrases 1–3 (unilateral U.S. actions and general developments); 4 (bilateral agreements); or 5–7 (multilateral actions).

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The classic interpretation of how the gold standard operated was presented by the Cunliffe Committee, established by the British government toward the end of World War I. This committee argued that the Bank of England reinforced the effects of gold movements by raising the discount rate when a gold drain reduced its ratio of reserves to liabilities, thus restricting credit and reducing prices, economic activity, and employment. It commented:

There was therefore an automatic machinery by which the volume of purchas-ing power in this country was continuously adjusted to world prices of commodities in general. Domestic prices were automatically regulated so as to prevent excessive imports; and the creation of banking credit was so controlled that banking could be safely permitted a freedom from State interference which would not have been possible under a less rigid currency system.⁴

In the official view, this self-equilibrating system was an excellent device. Little concern was expressed that under this interpretation the burden of adjusting to change—especially through unemployment—was borne by the working class, in particular its most marginal members.

More recent analysis has thrown considerable doubt on this interpretation of the gold standard system. Arthur Bloomfield has shown that central banks were more active than the Cunliffe report allowed, and that they used a greater variety of techniques:

Unquestionably, convertibility was the dominant objective; and central banks invariably acted decisively in one way or another when the standard was threatened. But this did not imply unawareness of, or indifference to, the effects of central bank action upon the level of domestic business activity and confidence, or neglect of considerations of central bank earnings and other subsidiary aims, or sole reliance upon movements of the reserve ratio in deciding upon policy. . . . Far from responding invariably in a mechanical way, and in accord with simple or unique rule, to movements in gold and other external reserves, central banks were constantly called upon to exercise, and did exercise, discretion and judgment in a wide variety of ways. Clearly, the pre-1914 gold standard system was a managed and not a quasi-automatic one, from the viewpoint of the leading individual countries.⁵

Although the Cunliffe Committee had emphasized domestic effects of Bank of England policy, by 1931 dominant opinion about the prewar gold standard increas-ingly stressed the effects of British discount rates on international flows of capital. As the Macmillan Report indicated in that year:

The automatic operation of the gold standard . . . was more or less limited to the sphere of the Bank of England and was satisfactory in its results only because London was then by far the most powerful financial centre in the world . . . and could thus by the operation of her bank rate almost immediately adjust her reserve position. Other countries had therefore in the main to adjust their conditions to her.⁶

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London was not the only major financial center—Berlin and Paris were also important—but it was certainly the most important. Increases in British rates, or reductions in the flow of new loans to peripheral areas, greatly affected short- and long-term capital flows, and thus balances of payments, not only of Britain but of states dependent on her. These effects occurred even if several central banks all raised their rates proportionately to the rise in British interest rates, because tighter monetary conditions stimulated shifts toward liquid assets, which meant increased balances of key currency countries at the expense of minor centers.⁷Control was thus asymmetrical, as Britain shifted the burden of adjusting to change to peripheral countries such as Argentina, which depended heavily on British trade. The second-ary key currency centers, Berlin and Paris, acted similarly: the hierarchical system allowed them to draw funds from lesser centers, as Britain was drawing funds from them. Thus the system was remarkably stable, though it was not nearly as thor-oughly dominated by Britain, and by sterling, as earlier writers had thought:

The extra control of the Bank of England over the sterling-mark exchange might conceivably have placed excessive strain on German reserves as money grew tighter in London. The financial structure was such, however, as to give the Reichsbank a similar advantage in moving the exchange rates on smaller neighboring countries in favor of Germany. This hierarchy of short-run financial influence, through which funds moved from lesser to greater financial centers as interest rates rose everywhere, helped to minimize monetary friction among major centers by passing the short-run financial adjustment burden along to the peripheral countries. It provides a striking contrast to the tendency of New York and London to compete for the same mobile funds in later years without either center’s having decisive drawing power over funds from Continental countries in payments surplus.⁸

The impressive degree of British control is illustrated by the small amounts of gold that the Bank of England and the British Treasury were required to hold.

Confidence in sterling was so great that in 1913 the Bank of England held only about $165 million worth of gold, or less than 4 percent of the total official gold reserves of thirty-five major countries at that time. Britain’s holdings of gold were less than 15 percent of those of the United States and less than 25 percent of those of either Russia or France; they were also exceeded by the official gold holdings of Germany, Italy, Austria-Hungary, and Argentina.⁹The need to hold so little nonin-terest-bearing gold was a mark of strength, not weakness:

London could economize on her gold holdings, like any good banker, because of the quality of her other quick international assets, her institutional structure, and because, such was the power of Bank rate and the London Market rate of discount, gold would always flow in the last resort from other monetary centres.¹⁰

The stability of this system rested on its hierarchical structure and on financiers’

confidence in the continued convertibility of sterling, and other major currencies, into gold at par value. Liquidity was increased not merely by new gold discoveries and

by diverting monetary gold stocks into official reserves, but also by increasing holdings of foreign exchange. Whereas world official gold reserves approximately doubled between 1900 and 1913, official holdings of foreign exchange increased more than fourfold; by 1913 foreign exchange accounted for 16 to 19 percent of total reserves.¹¹ Financial hierarchy was reinforced by political hierarchy. Britain was not mili-tarily dominant over either Germany or France, but she had access to much more extensive and prosperous areas overseas. This advantage was reflected in other countries’ holdings of the foreign exchange of the three key states: Britain, France, and Germany. Only about 18 percent of European holdings of these three currencies in 1913 were in sterling, whereas over 85 percent of non-European holdings of those currencies were held in sterling.¹²

Peripheral countries generally allowed their money supplies to be influenced strongly by actions of central banks in the center countries. Even for advanced small states with well-developed banking systems, the movement of short-term funds “was undoubtedly much more responsive to changes in the discount rates of the Bank of England and other large central banks than to changes in their own.”¹³Argentina, which depended heavily on Britain, allowed its gold flow to determine its money supply; it had no effective central bank to control the process. Thus Argentina

“could not nullify the negative effects of changes in British interest rates on its own economy.” It is not at all clear, indeed, that the peripheral states’ governments understood the processes that were going on or the disadvantageous position that they occupied. The absence of balance of payments statistics, and the lack of knowl-edge of the extent to which the system was managed by key central banks, rather than being “natural,” probably helped to maintain the system’s stability by making the inequality and its causes less visible. In addition, local oligarchies in the periph-eries benefited from the system.¹⁴

Although often viewed as a very long period extending into the murky past, the international gold standard’s life span was actually less than half a century. Some authorities date its beginning from the 1870s, when France, Holland, the Scandinavian countries, and the United States discontinued the use of silver coins and tied their currencies to gold; others date it from 1880 or even 1900, reflecting the adherence of Austria-Hungary, Russia, and Japan to the system during the 1890s.¹⁵ Moreover, the international gold standard did not operate as smoothly as has sometimes been supposed. The central banks were not particularly sensitive to the international effects of their actions. They did not cooperate to manage the interna-tional gold standard in the general interest (although the central banks of England and France did cooperate somewhat). Yet by the end of the period, the need for such cooperation was increasingly apparent as a result of the growth and volatility of short-term capital. After 1907, “there was a growing sentiment in certain quarters in favor of some kind of systematic international monetary cooperation, the absence of which was a conspicuous feature of the pre-1914 arrangements, in order to minimize undue shocks to the payments system from these and other sources.”¹⁶

Thus the prewar gold standard was by no means immutable. Foreign exchange was being used increasingly in reserves; capital movements were becoming more disturb-ing; and the need for cooperation was increasingly evident. More fundamental political

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changes were also taking place. As the working class gained political power it would be able to fight adjustment policies that caused unemployment and wage cuts, as the British strikes of 1926 later indicated. As peripheral countries became somewhat more autonomous, their policies would become less passive. And perhaps most important, the United States was becoming more prominent in the international economy. Even without the stimulus of World War I, it would eventually have begun to compete with London for funds, and the hierarchy would have been broken.¹⁷

The end of the international gold standard in its well-functioning phase came with the beginning of World War I. But the trends we have just enumerated, which were intensified by the war, were by no means created by it. One can therefore assume that eventually the international gold standard would have collapsed or have been transformed, even without the war; however, the conditions under which that would have taken place, the form it would have taken, and its effects can never be known.

In practice, therefore, the prewar gold standard was short-lived, managed (although with national orientations rather than an international one), and highly subject to change. It rested on political domination—the domination of the wealthy classes in Britain over less prosperous groups, and of Britain, France, and Germany over peripheral countries. Thus the reality diverged substantially from the myth of an eternal, automatic, stable, and fair system, which could only be damaged if tampered with by politicians. Yet in later years, the myth was in many ways more powerful, in its effects on behavior, than the reality itself. The rules of the old regime were no longer being followed—indeed, they had never been followed as perfectly as people imagined—but they remained the standard of behavior for statesmen and bankers, particularly in central countries such as Britain.