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. The article on the gold standard explains the three different ways that countries went back to the gold standard: reform, stabilization, and restoration. However, the article fails to explain the implications that followed from these three different ways. Looking at the three major European countries during the inter-war period, we can see the problems that arose due to the lack of international cooperation.  Global imbalances, among other factors which will be discussed below, eventually led to the abandonment of the Gold Standard by the major European countries and the United States.

In order to understand the abandonment of the Gold Standard during the Inter-War period, one must examine the paths of the major players in the international system 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 maintained its prewar level exchange rate. It maintained credibility but forced a contraction of the currency supply, and deflation, which led to unemployment.  As a result of the staggered deflation, domestic prices were relatively higher than the price of foreign products by going through gold 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 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.

The result was that 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 of our very own Middlebury College (and this class) has studied this case study extensively leading him to the conclusion that 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".  However, before getting to his explanation, first we will examine the systemic level theories that many have used to explain the fragility of the gold standard.  Kindleberger's theory on hegemonic stability theory focuses on the United States' hoarding of the gold reserves and their desire to not provide the rest of the world with necessary leverage and liquidity.  By raising interest rates to cool an overheating stock market, the US prioritized its domestic economy over the international economy and had an effect of attracting foreign capital. Furthermore, not only did the US halt its lending to Germany, but the stock market crash led to an "orthodox" monetary policy, and a lack of gold distribution internationally, which Kindleberger argued was key to the fall of the new gold standard. Eichengreen's theory 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.

To this we look at The 3 I's (ideas, interests, and institutions) to provide domestic context to the international system.  The scholar who preceded Professor Morrison as the most devoted to analyzing the abandonment in this vein was Karl Polanyi.  Polanyi's argument rests on the empowerment of the working class which finally was able to exert political pressure in order to have their interests carried out.  Polanyi explains that workers prefer monetary policy autonomy over a fixed exchange rate and with more political power gained after the war were able to pressure policymakers to change the policy.  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 2 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.

See also

Gold Standard