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

by Murray N. Rothbard

  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 the leading fugleman and interpreter of the Genoa resolutions.55

  The 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: “in countries where there is no central bank of issue, one should be established.” These central banks, not only in Europe but elsewhere (particularly the United States) should practice “continuous cooperation” in order to bring about and maintain “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. After 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.

  Resolution 9 looked specifically to a new form of gold standard, which would

  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.

  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 overexpanded paper currencies. Resolution 9 then became specific: the point was to economize “the use of gold by maintaining reserves in the form of foreign balances, such, for example, as the gold-exchange standard or an international clearing system.” 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.” In 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 bank balances, bills, short-term securities, or other suitable liquid resources.

  And:

  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.” The upshot, the currency resolution concludes, is that “the convention will thus be based on a gold exchange standard.”56

  Ralph Hawtrey’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. Hawtrey asks the crucial question:

  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?57

  Why indeed? Why can’t the new pseudo gold standard be like the old? Hawtrey makes it clear that his reason is a phobia about deflation. The paper money stock had multiplied since 1914, and therefore there “has been 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 system that had changed the economic face of Britain. He simply points to the “notorious... chronic state of depression which prevailed during the spread of the gold standard in the period 1873–1896.” This is really his only horrible example.

  But, in the first place, Hawtrey is wrong in attributing falling prices during the late nineteenth 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 Hawtrey has made the all-too-common modern error of identifying falling prices with “depression.” In 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 “depression” at all, and was only experienced as such decades later by historians who fail to understand the social benefits of falling prices.58

  Second, in his exegesis Hawtrey 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, Hawtrey states wistfully, “At the gold centres some gold reserves must be maintained.” But if the gold standard becomes worldwide, “if all the gold standard countries adhere to it, gold will nowhere be needed as a means of remittance, and gold will only be withdrawn from the reserves for use as a raw material of industry.”59 In short, Hawtrey looked forward to dispensing with gold as a monetary metal altogether, and to have the world solely on a fiat paper standard.

  Hawtrey 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. To 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 Hawtrey, “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.60 Like the other British leaders, Hawtrey was pinning his faith on Uncle Sam’s inflating enough to “help Britain.”61

  Many historians have written off the Genoa Conference as a “failure” and dismissed its influence on the international money of the twentieth century. It 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 antibank 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. And 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, an “informal entente.”62 Actually, what Strong preferred was close “key currency” collaboration between, say, the central banks of the United States, England, and France, rather than to be outvoted at formal international conventions.63

  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.64

  Far from Genoa being merely a flash in the pan, the 1922 conference placed its decisive stamp upon the postwar monetary world. In the words of Professor Davis, “the widespread adoption of the Gold Exchange Standard can be seen as the legacy of Genoa.”65

  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. By 1928, 43 nations were de jure 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 the world periphery, such as Mexico, Colombia, Cuba, and the Union of South Africa.66 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 during this period.67

  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.68

  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 reestablish a stable and secure money has used that advantage to establish a basis for putting Europe under a veritable financial domination. The 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.69

  THE GOLD-EXCHANGE STANDARD IN OPERATION: 1926–1929

  By the end of 1925, Montagu Norman and the British Establishment were seemingly monarch of all they surveyed. Backed by Strong and the Morgans, the British had had everything their way: they had saddled the world with a new form of pseudo gold standard, with other nations pyramiding money and credit on top of British sterling, while the United States, though still on a gold-coin standard, was ready to help Britain avoid suffering the consequences of abandoning the discipline of the classical gold standard.

  But it took little time for things to go very wrong. The crucial British export industries, chronically whipsawed between an overvalued pound and rigidly high wage rates kept up by strong, militant unions and widespread unemployment insurance, kept slumping during an era when worldwide trade and exports were prospering. Unemployment remained chronically high. The unemployment rate had hovered around 3 percent from 1851 to 1914. From 1921 through 1926 it had averaged 12 percent; and unemployment did little better after the return to gold. In April 1925, when Britain returned to gold, the unemployment rate stood at 10.9 percent. After the return, it fluctuated sharply, but always at historically very high levels. Thus, in the year after return, unemployment climbed above 12 percent, fell back to 9 percent, and jumped to over 14 percent during most of 1926. Unemployment fell back to 9 percent by the summer of 1927, but hovered around 10 to 11 percent for the next two years. In other words, unemployment in Britain, during the entire 1920s, lingered around severe recession levels.70

  The unemployment was concentrated in the older, previously dominant, and heavily unionized industries in the north of England. The pattern of the slump in British exports may be seen by some comparative data. If 1924 is set equal to 100, world exports had risen to 132 by 1929, while Western European exports had similarly risen to 134. United States exports had also risen to 130. Yet, amid this worldwide prosperity, Great Britain lagged far behind, exports rising only to 109. On the other hand, British imports rose to 113 in the same period. After the 1929 crash until 1931, all exports fell considerably, world exports to 113, Western European to 107, and the United States, which had taken the brunt of the 1929 crash, to 91; and yet, while British imports rose slightly from 1929 to 1931 to 114, its exports drastically fell to 68. In this way, the overvalued pound combined with rigid downward wage rates to work their dire effects in both boom and recession. Overall, whereas, in 1931, Western European and world exports were considerably higher than in 1924, British exports were very sharply lower.

  Within categories of British exports, there was a sharp and illuminating separation between two sets of industries: the old, unionized export staples in the north of England, and the newer, relatively nonunion, lower-wage industries in the south. These newer industries were able to flourish and provide plentiful employment because they were permitted to hire workers at a lower hourly wage than the industries of the north.71 Some of these industries, such as public utilities, flourished because they were not dependent on exports. But even the exports from these new, relatively nonunionized industries did very well during this period. Thus from 1924 to 1928–29, the volume of automobile exports rose by 95 percent, exports of chemical and machinery manufactures rose by 24 percent, and of electrical goods by 23 percent. During the 1929–31 recession, exports of these new industries did relatively better than the old: machinery and electrical exports falling to 28 percent and 22 percent respectively below the 1924 level, while chemical exports fell only to 5 percent below and automobile exports remained comfortably in 1931 at fully 26 percent above 1924.

  On the other hand, the older, staple export industries, the traditional mainstays of British prosperity, fared very badly in both these periods of boom and recession. The nonferrous metal industry rose only slightly by 14 percent by 1928–29 and then fell to 55 percent of 1924 in the next two years. In even worse shape were the once-mighty cotton and woolen textile industries, the bellwethers of the Industrial Revolution in England. From 1924 to 1929, cotton exports fell by 10 percent, and woolens by 20 percent, and then, in the two years to 1931, they plummeted phenomenally, cottons to 50 percent of 1924 and woolens to 46 percent. Remarkably, cotton and woolen exports were at this point their lowest in volume since the 1870s.

  Perhaps the worst problem was in the traditionally prominent export, coal. Coal exports had declined to 69 percent of 1924 volume in 1931; but perhaps more ominously, they had fallen to 88 percent in 1928–29, slumping, like textiles, in the midst of worldwide prosperity.

  So high were British price levels compare
d to other countries, in both of these periods, that Britain’s imports, remarkably, rose in every category during boom and recession. Thus, imports of manufactured goods into Britain rose by 32.5 percent from 1924 to 1928–29, and then rose another 5 percent until 1931. So costly, too, was the once-proud British iron and steel industry that, after 1925, the British, for the first time in their history, became net importers of iron and steel.

  The relative rigidity of wage costs in Britain may be seen by comparing their unit wage costs with the U.S., setting 1925 in each country equal to 100. In the United States, as prices fell about 10 percent in response to increased productivity and output, wage rates also declined, falling to 93 in 1928, and to 90 in 1929. Swedish wages were even more flexible in those years, enabling Sweden to surmount without export depression and return to gold at the prewar par. Swedish wage rates fell to 88 in 1928, 80 in 1929, and 70 in 1931. In Great Britain, on the other hand, wage rates remained stubbornly high, in the face of falling prices, being 97 in 1928, 95 the following year, and down to only 90 in 1931.72 In contrast, wholesale prices in England fell by 8 percent in 1926 and 1927, and more sharply still thereafter.

  The blindness of British officialdom to the downward rigidity of wage rates was quite remarkable. Thus, the powerful deputy controller of finance for the Treasury, Frederick W. Leith-Ross, the major architect of what became known as the “Treasury view,” wrote in bewilderment to Hawtrey in early August 1928, wondering at Keynes’s claim that wage rates had remained stable since 1925. In view of the substantial decline in prices in those years, wrote Leith-Ross, “I should have thought that the average wage rate showed a substantial decline during the past four years.” Leith-Ross could only support his view by challenging the wage index as inaccurate, citing his own figures that aggregate payrolls had declined. Leith-Ross doesn’t seem to have realized that this was precisely the problem: that keeping wage rates up in the face of declining money may indeed lower payrolls, but by creating unemployment and the lowering of hours worked. Finally, by the spring of 1929, Leith-Ross was forced to face reality, and conceded the point. At last, Leith-Ross admitted that the problem was rigidity of labor costs: