The Gold Standard during the Inter-War Period
The Gold Standard had two formal rules: currency convertibility and exchange rate stability vis-à-vis gold and other currencies on the Gold Standard. During World War I convertibility was suspended and exchange rate stability was abandoned. As a result, European currencies were overvalued after the war. Currency increases had surpassed gold reserves and the market values of currencies were far below their official values. European nations wanted to return to the Gold Standard to restore their currencies’ credibility, and to avoid hyperinflation, the perils of which could be seen in countries like Hungary and Austria where the exchange value of the currency actually fell below the intrinsic value of the money itself (e.g. the paper). States tried to return to the Gold Standard using three methods:
Currency reform: a country could reform its currency by replacing it entirely. For example, Germany transitioned to a new currency, the Reichsmark, in 1924. The Reichsmark was backed by gold at its prewar parity.
Stabilization: Stabilization allowed a currency to remain at its new market value. This would be a devaluation from the pre-war parity, but saved the government and central bank from needing to deflate the economy. The advantage was that countries were able to maintain a relatively high employment rate, but the disadvantage was that the government undermined the credibility of their commitment to the Gold Standard.
Restoration: Restoration was a return to the pre-war parity. Britain attempted this method of reinstating to the Gold Standard. This caused enormous, painful deflation because Britain had experienced inflation during the war. The government continually balanced the budget and the central bank raised interest rates to deflate the economy, but in 1931 Britain ultimately abandoned the Gold Standard altogether.