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Gold in the Interwar Period

Gold in the Interwar Period. Lecture 13 – Thursday, 26 October 2011 J A Morrison. Winston Churchill. Hjalmar Schacht. JM Keynes. 1. Decline and Fall of the Gold Standard. The Return to Gold (1919-1925) The “New Gold Standard” (1925-1931) Gold in the Great Depression and War

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Gold in the Interwar Period

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  1. Gold in the Interwar Period Lecture 13 – Thursday, 26 October 2011J A Morrison Winston Churchill Hjalmar Schacht JM Keynes 1

  2. Decline and Fall of the Gold Standard • The Return to Gold (1919-1925) • The “New Gold Standard” (1925-1931) • Gold in the Great Depression and War • A Case: the Puzzle of Great Britain 2

  3. Decline and Fall of the Gold Standard • The Return to Gold (1919-1925) • The “New Gold Standard” (1925-1931) • Gold in the Great Depression and War • A Case: the Puzzle of Great Britain 2

  4. I. The Return to Gold • The Legacy of WWI • The Paths Back to Gold 3

  5. The gold standard was always more of an ideal than the reality...And the First World War took the reality even further from the ideal. 4

  6. WWI & Gold • WWI prompted policymakers to abandon “rules of gold standard game” • Convertibility: Suspended • Outright restrictions on gold export • “Backed” currencies no longer redeemable in gold • ER Stability: Abandoned • States issue fiat currency in excess of gold reserves and stock of goods & services • Inflation of domestic prices (including gold) follows 5

  7. After the War: Overvaluation • European currencies were overvalued • Currency increases outstripped gold reserves • Market value of currency < official value • Immediate Response • Capital restrictions were removed, allowing foreign exchange • BUT convertibility was still suspended: to protect reserves, currencies were not redeemable • Practical effect: currencies continued to float in the market • Only the US retained gold convertibility 6

  8. I. The Return to Gold • The Legacy of WWI • The Paths Back to Gold 7

  9. States eventually returned to the international monetary system in three different ways: currency reform, stabilization, and restoration. 8

  10. In some countries, the issuance of fiat currency had been abused. These states—Austria, Hungary, Germany, and Poland—suffered… 9

  11. Hyperinflation. Here, the exchange value plummeted below the intrinsic value of the paper itself. 10

  12. Most of these countries turned to currency reform. 11

  13. (1) Currency Reform • Currencies replaced entirely • Retenmark: backed by land & industrial securities • Reichsmark (1924): backed by gold at prewar parity • $1 US: 4.2 RM • Other countries with hyperinflation followed suit • Austria 1923; Poland 1924; Hungary 1925 Hjalmar Schacht 12

  14. In other countries, the inflation had been moderate. There the currency was either stabilized or restored. 13

  15. (2) Currency Stabilization • Currency is stabilized at the new market value • Devalued from pre-war parity • Gold parity established at inflated rate • Countries: Belgium 1925; France 1926; Italy 1927 • Advantage: saves from unemployment-producing deflation • Disadvantage: undermines credibility of commitment to gold standard 14

  16. Who argued that latter point (about credibility)? John Locke Montague Norman 15

  17. One notable country decided to return to gold and demonstrate a most serious commitment to the standard… Britain elected to restoreits currency to the prewar standard.(Sweden did as well, but it had much less trouble doing so.) 16

  18. (3) Restoration • Currency is returned to pre-war parity • Bank of England promises to exchange pounds at old price (£1 = $4.86) • Currency supply must be contracted to preserve reserves at old parity • Classic debate • Keynes: stabilize at new price level • Treasury (including Norman): restore!!! • Advantage: strong signal of commitment to gold • Disadvantage: deflation  unemployment! 17

  19. So, countries returned to gold in three different ways. What was the experience of these countries on “the new gold standard”? 18

  20. This question is crucial since understandings of the experience on gold in the 1920s shaped the plans made after the Second World War to rebuild the international monetary system. 19

  21. Attempts to Revive Gold • The Return to Gold (1919-1925) • The “New Gold Standard” (1925-1931) • Gold in the Great Depression and War • A Case: the Puzzle of Great Britain 20

  22. The Experience Back on Gold was Determined by: • Exchange Rate Values • Exogenously Determined Shifts in International Economic Flows • Nature of the Gold Standard Itself  We’ll take each in turn. 21

  23. II. The “New Gold Standard” • Exchange Rate Values • Exogenous Changes in Int’l Econ Flows • Workings of the Gold Standard Itself 22

  24. The first factor was the countries’ exchange rate values.Part of this followed from the paths they took back to gold. And part followed from their monetary policy after the return. 23

  25. The cases of Britain and France will illuminate this. 24

  26. The Pound in the Late 1920s • Path back to gold: restoration of prewar parity • Revaluation: raise pound vis-à-vis gold • But there were too many pounds in circulation! • Monetary policy: reduce supply of pounds • April 1925 Return to Gold • Price of gold is artificially lowered • But other prices don’t fall immediately •  Foreign purchases cost less (by moving through gold) than do domestic • Result: exports decline; imports rise 25

  27. The Economic Crisis of 1925-1926 • Return prompts 10% deflation • Exacerbated challenges of post-war adjustment • National unemployment rate passes 20% • Much higher in certain industries  1926 General Strike: Coal miners bring Britain to brink of “revolution” 26

  28. The Franc in the Late 1920s • Path back to gold: stabilize at new level • Devaluation: lower franc vis-à-vis gold • Monetary Policy: maintain supply of francs • Price of gold is maintained/raised • But other prices don’t rise immediately • Domestic purchases cost less than do foreign (given the cost of converting into gold) • Result: imports decrease; exports increase 27

  29. So, the British ER encouraged imports and discouraged exports.And the French ER encouraged exports and discouraged imports.You can imagine the implications of this for these countries’ balances of payments… 28

  30. Balances of Payments After the Return • Britain • 1927, 1929-1931: Deficit • 1928: Small surplus • France • 1927-1931: Surplus • United States • Surplus most years in 1920s 29

  31. But shouldn’t the price-specie-flow mechanism have moderated this? Shouldn’t the franc have appreciated and the pound depreciated, mitigating this trend? 30

  32. In theory, yes. But, as a practical matter, the price-specie-flow model broke down—largely as a result of French intervention. 31

  33. Price-Specie-Flow Fails • The Overvalued Pound • Domestic prices were downwardly sticky • Britons traded pounds for exchange reserves • The Undervalued Franc • French enjoyed competitive advantage in foreign markets • 1926-1931: French repeatedly intervene to stop appreciation of the franc  Gold travels from Britain to France • 1926-1931: French reserves quadruple 32

  34. So, the paths back to gold had some influence on states’ experiences back on gold. (And French attempts to maintain the undervalued currency did not help.) 33

  35. II. The “New Gold Standard” • Studying the Balance of Payments • Exogenous Changes in Int’l Econ Flows • Workings of the Gold Standard Itself 34

  36. Throughout this period, there were structural changes (exogenously determined) in the patterns of trade and capital flows. 35

  37. Change in Trade Patterns • During WWI, the US took over export markets traditionally dominated by the Europeans 36

  38. Foreign demand for US goods and services created upward pressure on the dollar.In theory, price-specie-flow should have appreciated the dollar, eliminated the current account surplus, and eventually redistributed gold back to Europe. 37

  39. But that didn’t happen.What happened instead? 38

  40. The US loaned the money back to Europe, specifically Germany. 39

  41. Reparations and Loans • The Allies repeatedly pressed Germany for reparations • Plans • Dawes (1924): 1bn/year for 5 years; then 2.5bn annually • Young (1929): Germany pays $475m for 59 years • Reality • 1924-1929: Allies receive $2bn from Germany • 1926-1931: US loans $1bn to Germany 40

  42. The implication: the US amassed gold reserves, limited the production of dollars, and maintained an “undervalued” currency. 42

  43.  There is a contemporary parallel here with China and the US today! 43

  44. II. The “New Gold Standard” • Studying the Balance of Payments • The Balance of Payments • Workings of the Gold Standard Itself 44

  45. Gold Shortage • 1924-1929: considerable economic growth but limited growth of gold supply • Worldwide Ratio of Reserves to Notes Issued • 1913: 48% • 1927: 40% •  Implication: deflationary bias in the new gold standard; all countries struggled to secure gold. 45

  46. “Never in history was there a method devised of such efficacy for setting each country's advantage at variance with its neighbours' as the international gold...standard. For it made domestic prosperity directly dependent on a competitive pursuit of markets and a competitive appetite for the precious metals.”-- JM Keynes, General Theory, 349 46

  47. This explains why some states—France & the US—hoarded gold. 47

  48. What was the cumulative result of these events? 48

  49. 49 Source: Eichengreen, Globalizing Capital, 65.

  50. Source: Eichengreen, Globalizing Capital, 65. (Note that the United States is omitted here.) 50

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