Abandonment of Gold Standard during Inter-War Period
As explained in The Gold Standard during the Inter-War Period, most countries returned to the gold standard after World War I, implying that the countries maintained a stable exchange rate with gold and guaranteed currency convertibility with gold. Countries had three different ways to go back to gold back: reform, stabilization, or restoration. Each of these trajectories came with different costs and benefits with enormous implications for the global monetary system. The experiences of three major European countries during the inter-war period, demonstrate, for example, how the lack of international cooperation, including on global imbalances, eventually led to the abandonment of the Gold Standard by the major European powers and the United States.
Reform, Stabilization or Restoration
In order to understand the abandonment of the Gold Standard during the Inter-War period, one must examine the different paths major players took on their way back to the gold standard. World War I forced countries to go off the gold standard, which meant that European currencies were overvalued compared to the available gold reserves. Germany experienced severe hyperinflation which forced the country to replace their currency, first with the Retenmark which was backed by land and securities, and then in 1924 when the Reichmark was introduced which was backed by gold at the prewar parity level. France and several other countries, such as Belgium, stabilized their currency at the postwar level, which meant they did not have to endure deflation, but their commitment to the gold standard was questioned. Finally, Britain chose to restore and so maintained its prewar exchange rate. It maintained credibility but forced a contraction of the currency supply, and deflation, which led to unemployment. The final important note of the return to the Gold Standard after World War I was the immense amount of economic growth with a relatively small increase in the global gold supply which took place in the 1920's revealing the deflationary bais of the gold standard.
Britain Abandons Gold
After restoration in Britain, as a result of staggered deflation, domestic prices were relatively higher than the price of foreign products, which caused declining exports and increasing imports. The stabilization method pursued by France created the opposite effects, which forced increasing exports and declining imports. Summarizing the above, we see that the Pound was overvalued and the Franc was undervalued which led to gold moving in large quantities away from Britain and towards France. The mounting gold imbalances and the failure of the British and other governments to cooperate and fix the system ultimately led to another collapse. Great Britain abandoned the gold standard in 1931, 23 more countries followed them in 1932, the USA in 1933, and France in 1936.
Many theories have attempted to explain the sudden abandonment of the gold standard. Professor Morrison at Middlebury College has studied this case extensively, and offers the following conclusion conclusion: the British abandonment of the gold standard in 1931 was both surprising and significant: "Great Britain’s abandonment of the gold standard in 1931 was one of the most significant and surprising policy shifts in the history of the international financial system".
Systemic level theorists have attempted to explain the fragility of the gold standard. Charles Kindleberger puts forth an explanation derived from the logic of hegemonic stability theory. In this account, the reason the return to gold failed was because there was no hegemon to provide the impetus and power to run the international monetary system. He points to American unwillingness to act as the hegemon as a key reason for the failure of the system. For example, the US Government had massive gold reserves but was unwillingness to provide the rest of the world with much needed leverage and liquidity. By raising interest rates to cool an overheating stock market, the US prioritized its domestic economy over the international economy and also attracted large volumes of foreign capital. Furthermore, not only did the US halt its lending to Germany, but the stock market crash led to an "orthodox" monetary policy that severely constrained international gold flows, which Kindleberger argued was key to the failure of the new gold standard.
Barry Eichengreen's account focuses on the collapse of international norms after World War I which made international cooperation almost impossible. Before WWI, markets moved with banks, and helped them do their job. After the war, however, markets bet against banks as speculators hoarded or dumped certain currencies, which exacerbated the disequilibria.
Finally, Keynes used the deflationary bias of the gold standard to explain that its time had come. He pointed out that in the 19th century there was plenty of gold to go around, but the 20th century gold shortages and misplaced reliance on this fickle commodity threw the system out of whack. Keynes supported a new global institution that would regulate a new international currency, which would later become the IMF. These are all systemic level explanations which provide a context for the transformation and help explain the underlying causes for the abandonment of the gold standard, but they lack the dexterity to be used in determining proximate causes and the timing of the abandonments.
Polanyi and Morrison
The The 3 I's (ideas, interests, and institutions) provide a more nuances explanation of how domestic politics influences the international monetary system. Karl Polanyi offers an interest group explanation. His argument rests on the idea that the working class in Britain, the group that often bore the brunt of cost of adjustment from price level changes under the Gold Standard, became more politically empowered over the course of the interwar period. Polanyi explains that workers prefer monetary policy autonomy over a fixed exchange rate and with the increased political power they gained after the war, laborers were able to pressure policymakers to change policy and abandon gold.
However, as James Morrison explains, this cannot explain Britain's constant desire to maintain the gold standard, and the credibility for exchange rate stability that went with it, prior to 1931. Morrison attributes a crisis as an opportunity where policymakers are open to new ideas. John Maynard Keynes exploited that opportunity and the Bank of England's ignorance of the causes of the crisis to push forward his exchange rate policy, one not reliant on the gold standard. As Morrison explains, policymakers have two different types of policies to make. That is they will generally pursue policies that ensure the largest economy, but interests ability to influence policymakers will determine the policies that govern the distribution of the economy. As he explains, the exchange rate affects the entire country and thus, policymakers will pursue the exchange rate regime that they believe gives them biggest advantage on the world market. He explains that domestic institutions and interests determine the policies the govern "distribution", but they cannot explain radical shifts in policies like the abandonment of the gold standard in 1931 by Britain. That is left to Keynes's ability to exploit a crisis, and a crisis of knowledge by the leading politicians.
- ↑ Morrison, James, Keynessandra No More: JM Keynes, the 1931 Financial Crisis, and the Death of the Gold Standard in Britain (2010). APSA 2010 Annual Meeting Paper. Available at SSRN: http://ssrn.com/abstract=1641715