The international monetary system that operated immediately prior to the 1914–18 war was termed the ‘gold standard’. Then, countries accepted two major assets – gold and sterling – in settlement of international debt. So the term ‘gold/sterling standard’ might be more appropriate.
Most major countries operated the gold standard system. A unit of a country’s currency was defined as a certain weight – a part of an ounce – of gold. It also
16 Chapter 2. The international monetary system
provided that gold could be obtained from the treasuries of these countries in exchange for money and coin of the country concerned.
The pound sterling could be converted into 113.0015 grains of fine gold, and the US dollar into 23.22 grains. The pound was effectively defined as 113.0015/23.22 times as much gold as the dollar – or 4.8665 times as much gold. Through gold equivalents, the pound was worth $4.8665. This amount of dollars was termed the ‘par value’ of the pound.
A country is said to be on the gold standard when its central bank is obliged to give gold in exchange for its currency when presented to it. When the United Kingdom was on the gold standard before 1914, anyone could go to the Bank of England and demand gold in exchange for bank notes. The United Kingdom came off the gold standard in 1914, but in 1925 it returned to a modified version termed the ‘gold bullion standard’. Individual bank notes were no longer convertible into gold, but gold bars of 400 ounces were sold and bought by the Bank of England. Other coun- tries adopted either this system or the gold exchange standard, under which their central banks would exchange home currency for the currency of some other coun- try on the gold standard rather than for gold itself. The United Kingdom was forced to abandon the gold standard in 1931.
The gold standard was a keystone in the classical economic theory of equilibrium in international trade. The currency of countries on the gold standard was freely con- vertible into gold at a fixed exchange rate and enabled all international debt settle- ment to be in gold. A balance of payments surplus caused an inflow of gold into the central bank. This enabled it to expand its domestic money supply without fear of having insufficient gold to meet its liabilities. The increase in the quantity of money tended to raise prices, resulting in a fall in the demand for exports and therefore a reduction in the balance of payments surplus. In the event of a deficit in the balance of payments, the reverse was expected to happen. The outflow of gold would be accompanied by a relative money supply contraction, resulting in exports becoming more competitive and the deficit automatically becoming corrected.
The adoption of the gold standard began in the United Kingdom early in the nine- teenth century. An attempt was made in the 1860s by a number of European coun- tries to establish the Latin Monetary Union, involving bimetallism for gold and silver. The intention was that both gold and silver should be used for international debt settlement. But the establishment of the gold standard in Germany in 1871, together with less demand for silver in other areas, led to a diminished use of silver as international money. The United States was forced to abandon redemption of paper money in metal during the Civil War, but the redemption of paper money for gold began in 1879.
Key dates for the adoption of the gold standard in selected countries are summar- ized in Table 2.1.
The First World War had a serious effect on the international monetary system. The United Kingdom was forced to abandon the gold standard because of the wartime deficit on its balance of payments, and its reluctance at that time to provide gold to settle international differences. This was, perhaps, the beginning of a reduc- tion in confidence in sterling as an international reserve asset.
Many other countries abandoned the gold standard temporarily, but none had the same significance as the action of the United Kingdom because sterling had financed 90 per cent of world payments. The UK government, recognizing the importance of sterling and of UK institutions in international finance, wished to return to the gold standard as soon as possible. Delay occurred because of the recession in the United States in 1920 and 1921, coupled with the post-First World War inflation, which reversed itself as rapidly as it had occurred. Recovery came in the United States, and a degree of recovery also occurred in the United Kingdom. After its disastrous hyperinflation, ending with the value of the mark at 4 trillion to the dollar, Germany also experienced stabilization and returned to the gold standard in 1924.
The gold standard to which major countries returned in the mid-1920s was dif- ferent from that which had existed before the First World War. The major difference was that instead of two international reserve assets – gold and sterling – there were several. Both the United States and France had become much more important in international finance, and dollar and franc deposits were used for much financing. However, generally speaking, countries other than the United Kingdom had only small amounts of gold. When some countries, including France, accumulated sterling balances, they sometimes attempted to convert these into gold, drawing upon the United Kingdom’s gold reserves. When sterling had been the only international cur- rency apart from gold, operating the international monetary system had not been difficult, but when there were a number of countries whose bank deposits constituted international money, and when confidence in different currencies varied, the system became more difficult to operate.
A second important difference was that flexibility in costs and prices no longer existed as it had before the First World War. This was especially important in the United Kingdom which had returned to the gold standard based on pre-war par values. But only with a decline in relative costs and prices could the former par value
Table 2.1 Dates for the adoption of the gold standard
United Kingdom 1816
Germany 1871
Sweden, Norway and Denmark 1873 France, Belgium, Switzerland, Italy and Greece 1874
Holland 1875 Uruguay 1876 United States 1879 Austria 1892 Chile 1895 Japan 1897 Russia 1898 Dominican Republic 1901 Panama 1904 Mexico 1905 Source: Chandler (1948).
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of the pound have been maintained in the long run. Given that flexibility in costs and prices was lacking, confidence in sterling deteriorated, culminating in the United Kingdom abandoning the gold standard in 1931. Most other countries followed the UK example in quitting the gold standard.
But there were other forces impinging on the United Kingdom in the early 1930s which also had a significant effect on its decision to discard the gold standard. Two of these were the Great Depression of the late 1920s and early 1930s and the inter- national financial crisis of 1931; each of these topics is now summarized with a focus upon their impact on the international monetary system.