Notes – 4. The Inter War Gold Standard
About this topic
Why did the gold standard worked well before 1914 but failed miserably in the inter-war period?
Did it really word well before 1914 or was its success a consequence of other factors?
Were there features of the inter-war period that were particularly damaging to the system?
Focus: Great Britain, France and the U.S.
Return to Gold? What price? When?
Many believed that a return to gold = stability, and the best policy = return to pre-war rate of exchange.
Relative prices had changed dramatically, so this could only be achieved through deflating.
Different rates & different times
UK, D, N, S, CH, NH returned at pre-war rate mostly in or before 1925
F, I, B returned later, and at devalued rates;
G, A, H, P experienced hyperinflation and underwent currency reform.
Did the rate at which countries returned to gold have any impact on domestic economic activity?
Yes – associated, but is it causal?
Form, Liquidity, Adjustment, Cooperation
How/to what degree the inter-war gold standard differed from its pre-war predecessor
In the inter-war period, it’s more common for countries to hold foreign reserves, and larger amount.
Two reserve currencies: US dollars and pounds.
Why does it matter?
Countries accumulate foreign currency accumulate claims on reserve currency country’s gold.
Increased vulnerability constrained policy options.
E.g. France held lots of pounds; Britain has fear of gold shortage thus has to stop such steps
raise interest rates, slowing domestic economic activity.
General anxiety that gold production had dropped; supply of gold available grew less rapidly, creating
liquidity problem. Money in circulation tied to gold slow growth in gold limits the increase in MS
negative impact on aggregate output, employment, etc.
But this anxiety is NOT justified.
Foreign exchange also serves as reserves
Withdrew gold coins in circulation;
Evidence: (Eichengreen & Flandreau): gold production > demand + the use of foreign reserves no
Problem with the distribution of gold
By 1929, >50% of the gold reserves was held by France and the U.S; amount greater than their
money in circulation. For other countries who are short of gold, foreign exchange accumulation.
No later than 1924, US dollar had become the major reserve currency; but dominant currency can
change, as later on in the 1930s the Pound is in the lead again.
Adjustment Pre-war gold standard did not work automatically. Countries were unwilling to allow domestic
economic activity to be subjected to the ebb and flow of international trade.
Countries (UK, G, US) developed techniques for intervening in domestic money markets to break
the connection between gold flows and the domestic money supply (open market operations) – made
very easy to sterilize inflows of gold.
Exporters brought gold to the Fed in exchange for dollars Fed sells bonds to the public
absorb liquidity and “bury” the excess dollars
Problem: trade surplus accumulating gold MS & price go up (remember how the gold
standard worked); self-correcting forces.
But it didn’t happen, so adjustment falls on U.S.’s trading partners to eliminate deficit, by buying
bonds, pumping liquidity into the system, offsetting the gold outflows. But since the statutory
link between the money supply and gold, doing so would only hasten the outflow of gold and
eventually force them off of the gold standard. In the Trilemma, can’t pursue independent
monetary policy if you have fixed exchange rate + capital mobility.
Restrictive monetary policy also came with high costs in terms of growth and employment due to
the more militant unions and thus less flexible wages.
Spirit of cooperation died after WWI.