The Gold Standard and the Crisis
(Correction.—In the first of these articles, published in the November issue, it was stated, in the middle of the second column on page 45, that a difference in price levels in two countries on the gold standard would mean that “the value of gold is lower in A than in B.” This should have read : “the purchasing power of gold is lower in A than in B.” The temporary fluctuations in prices do not indicate a change in the relative values of gold and commodities.)
In a previous article (see November SOCIALIST STANDARD), the writer gave “no” as the answer to two questions he then postulated. The answer to the first, “Was the crisis caused by the failure of the gold standard?” has now to be justified.
In order to clear the ground, it is worth while considering for a moment what those who prate of “the failure of the gold standard” have in mind when they use the phrase. In fact its use is indicative of a belief that in the main the ills from which the world is now suffering are due to monetary causes and would be cured if defects in the monetary machine could be removed. The belief is based on the fact that at a period when other countries have either had great difficulties in maintaining their gold reserves or in some instances (Brazil is an example) have even lost the whole of them, one-half of the world’s stock of monetary gold had become piled up in America and a further quarter accumulated in France. From these undeniable facts in the world gold situation, two lines of reasoning have been developed. By some it has been argued that there is an absolute shortage of gold, that the supply is insufficient to satisfy the normal expansion in the monetary requirements of the world, so that, as a consequence, trade is stagnating because there is not enough gold available for business to be carried on. But when the world stock of monetary gold is about £2,000,000,000 and output from the mines is steadily increasing (output in the Transvaal increased by 2.9 per cent. in 1930 as compared with the previous year, and in the first 11 months of 1931 by a further 1.5 per cent, as compared with 1930), there is no need to waste time disproving such an assertion. Attention can be confined to examining how much truth, if any, lies in the second argument, which is, that the maldistribution of gold between the various gold standard countries has been responsible for the crisis. Before the value of this contention can be judged, it is necessary to examine the case in more detail. The argument of those who hold this view runs something on the following lines.
HOW THE OTHER SIDE ARGUE
America and France have, since the War, become the leading creditor nations. The causes of this are many and various, and need not be discussed here. It is sufficient for the argument that these two countries have been in the position of having large claims on the rest of the world.
So far as America is concerned, her high tariff walls hindered debtors liquidating these claims in goods and services, with the consequence that they had to have recourse to payment in gold. Now, one of the rules of the gold standard is that a movement of gold should, by causing an expansion of credit, raise prices in the gold importing country, and by a converse sequence, lower them in the gold exporting country. The gold that flowed into America after the War, however, was not utilised, at any rate during the last five or six years, as the basis for an expansion of credit. Far from the American price level rising, there was a continuous downward movement. From 1925 the fall was relatively small and gradual until 1929. After that date, however, it became very pronounced. The failure of banking authorities in America to produce a higher price level by expanding credit as gold flowed into the country, which is usually referred to as their policy of “gold sterilization,” meant that the normal machinery for reducing international gold movements to a minimum was not working. Consequently, the gold reserves of other gold standard countries were subject to continuous pressure. Further, as all price levels were linked to gold and the purchasing power of gold is determined by that of the dollar (owing to the enormous gold reserves in America), the course of prices in Great Britain, for instance, was dependent upon the movement of prices in America. In other words, producers everywhere had to contend with falling prices. This (so runs the argument) was particularly disastrous for Great Britain, as, owing to the rigidity of wages and other fixed charges on industry, producers were not in a position to reduce their costs of production proportionately to the fall in prices. Consequently their competitive power was reduced, foreign goods invaded the home market in increasing quantities, and foreign competition drove them out of the export markets. This, in turn, meant an increase in the adverse visible trade balance and a reduction in the amount available for lending abroad, so that debtor countries could no longer rely, as they had done in the past, on being able to borrow for their needs in Great Britain.
The position as regards France was somewhat different. As a result of a large excess of exports during a period of years, France accumulated large funds abroad. French capitalists, prior to 1914, had invested large sums in Russian, Serbian, and other foreign bonds, which the War had rendered valueless. The French investor, in consequence, had become very shy of long-term foreign loans. Funds accumulated abroad, therefore, were not invested at long term, but were in the main left on deposit with banks or invested in short-term securities such as three-months British Treasury Bills. By keeping her foreign balances liquid, France was in a position to demand their repayment at any time. In 1928 she did, in fact, begin to ask for repayment at a steadily increasing rate. From 1929 onwards, her foreign balances were being reduced very rapidly and repatriated in the form of gold.
Although most of the gold which flowed into France during this period came, in fact, out of the reserves of such countries as Spain, Argentine, Brazil and Australia, the repatriation of French balances put great pressure on the London money market and on the sterling exchange. The position that had been arrived at, therefore, was that France and America were drawing to themselves the bulk of the world’s gold supply. They were not lending their surplus balances to the debtor countries as the rules of the gold standard required that they should. England was no longer in a position to make loans abroad, and the restrictive credit policy of America was forcing prices downwards. The debtor countries, being unable to obtain foreign loans, on which they relied, were faced with an impossible position, and those of them that were producers of primary products at once began to unload those products in order to obtain funds to meet their obligations. This intensified the downward tendency of prices, which, once it had started on any scale, soon came to involve all producers in all countries.
The above summarises their argument.
While this is an admittedly incomplete account of the causes leading to the crisis, as they appeared to those whose views we are now considering, it is sufficiently accurate and fair to serve our present purpose. From this analysis of the causes, those who advance these views proceed to argue that if America had not “sterilized” its gold, but had allowed prices to rise and thereby brought about a wider and better distribution of the world’s gold stocks, if France had invested her export surplus abroad in the form of long-term loans instead of converting them into gold which was then buried in the vaults in the Bank of France, everything would have been different; world depression would have been avoided, and this country would not have been forced off the gold standard. Is there any justification for this view?
WHAT THE BANK DID
The question of the abandonment of the gold standard by this country on September 21st can be dealt with apart from the general question of the world depression. Before proceeding further, however, it should perhaps, be pointed out that, so far as we are concerned, we offer no opinion either for or against that abandonment. We neither consider the departure from the gold standard as the greatest of evils nor as the most blessed of boons. For the moment we are only concerned to consider the event from the viewpoint of those who believe that the destinies of the world are involved.
In their Report, published in June of last year, the Macmillan Committee made it quite clear that they, at any rate, thought the suspension of the gold standard would be a tragedy. They wrote : —
“If we need emergency measures to relieve the immediate strain, we should seek them in some other direction (i.e., than departure from an international monetary standard). … If this country were to cut adrift from the international system with the object of setting up a local standard . . . we should be abandoning the larger problem—the solution of which is certainly necessary to a satisfactory solution of the purely domestic problem—just at the moment maybe, when, if we were able to look a little farther forward, the beginnings of general progress would be becoming visible.”—(Pages 108, 109.)
Further, the fact that the Treasury and the Bank of England obtained credits abroad considered the gold standard something it was vital to preserve. Yet, when the Bank of England suspended payment on September 21st with £130,000,000 of gold in its vaults, it was perhaps natural to expect that it should be declared—as it was declared—that the suspension was the best thing that ever happened and had been forced on the Bank by events outside its control. The Bank claimed that it had fought the good fight, but that the stupidity and faults of others had rendered its efforts useless.
When all the facts are examined, however, there can be no doubt that it was not the unsound banking policy of the Bank of France and the Federal Reserve Board of America that forced this country off the gold standard. In fact, it was not a question of being forced off, but of falling off. The Bank of England failed in its principal function as a central bank because it had consistently pursued an unsound banking policy and had acted in complete defiance of the rules proved by time to be essential for the proper working of the gold standard. The failure of the Bank may have proceeded from ignorance of these elementary rules or from weakness. It is not important to decide the reason. We are content to point out that in their failure the Bank Directors provided another example of the inefficiency of capitalist enterprise and the weakness of that directive ability which is supposed to be the exclusive possession of only a small portion of the community.
One of the first principles of central banking where a central bank is entrusted, as was the Bank of England, with the maintenance of the currency standard of the country, is that if there is pressure on the exchanges and gold is leaving the country in disquieting amounts, the Bank Rate should be raised. It should continue to be raised until the pressure on the exchanges is eased and the drain of gold ceases. The theory is that as the Bank Rate rises, say, in London, other interest rates in the London money market will also rise. This will make the investment of funds in London relatively more profitable than in other financial centres. Consequently there will be a tendency for balances already in London not to be withdrawn, and finally for gold to flow in from abroad as foreigners send their liquid capital to London to obtain the benefit of higher interest rates prevailing there. The first step the Bank of England might have been expected to take to defend the gold standard in this country was to raise the Bank Rate. This is just what it failed to do. At the beginning of 1930 the Bank Rate was 5 per cent. The crash in Wall Street in October, 1929, the economic disturbances that had already occurred in such countries as Brazil, Argentina and Australia towards the end of 1929, and the large scale movements of gold to France and America—all indicated early in 1930, even if no other warnings had been given, that a period of difficulty was ahead. Yet, despite these warning signs, the Bank Rate was reduced by successive stages until by May 13th, 1931, it was down to 2½ per cent. No increase took place until July 22nd: then the rate was raised to 3½ per cent., and again on July 29th to 4½ per cent. On August 1st the Bank of England raised a foreign credit for £50,000,000. Although this was soon exhausted in supporting sterling and a new credit for £80 million had to be raised by the Treasury on August 28th, no further rise in the Bank Rate took place until after the gold standard had been abandoned.
Looking without prejudice at the manner in which the Bank of England handled the situation, it is impossible to acquit it of amateurish bungling. If it was seeking, as it appeared to be, to maintain the gold standard, why did it not utilise its gold reserve and raise its rate to 8, 9, 10 per cent., or even higher, earlier in the year, instead of raising credits abroad and acting in the half-hearted manner in which it did act? As Prof. Gustav Cassel said (see The Times September 23rd) :—
“If the raising of the discount rate to 6 per cent. is useful now after the abandonment of the gold standard, it would have been much more effective a month ago. The Bank might have done better to use its gold reserves down to the last ounce rather than stop payment.”
Dr. Anderson, the economist of the Chase National Bank, expressed the same view when he wrote (Times, November 19th) :—
“The collapse of the gold standard in England was absolutely unnecessary. It was the product of a prolonged violation of gold standard rules. Even at the end it could have been averted by a return to orthodox gold standard measures. Great Britain undertook to carry through, in recent years, a cheap money policy, not justified by her gold position or by the liquidity of her general assets.”
In extenuation of the supine handling of the situation by the Bank, its defenders allege that the Bank Rate had ceased to be an effective weapon for the protection of the goid reserve. They endeavour to shift the blame on to the shoulders of the wicked workers, who refused to accept wage reductions, or the foolish foreigners, who lost their heads and insisted on having gold. Unfortunately, Mr. Montagu Norman, the Governor of the Bank of England, has knocked the bottom out of this argument. In cross-examination before the Macmillan Committee on November 19th, 1930, a date, it will be noticed, before the storm had broken, but when it was apparent to anyone following the situation that a storm was brewing, Mr. Montagu Norman was asked whether “the power which resides in the Bank of England for raising or lowering the Bank Rate was an effective instrument if used for the purpose oi preserving the stock of gold?” Mr. Norman’s reply was : “It is effective.” (Minutes of Evidence, November 19th.) The other argument, that foreigners were so determined to withdraw their balances that there was no height to which the Bank Rate could be raised that would have deterred them, is equally useless as a defence of the Bank. If fears of foreigners regarding sterling were incapable of being allayed, then there was no point in raising the £130,100,000 credit abroad. The obvious policy under those circumstances would have been either to have paid out gold until the reserve was exhausted, or to have abandoned the gold standard two months earlier. By all the rules of the game, the Bank of England failed miserably. Ricardo wrote of the Court of Directors of the Bank of England of his day that “they were ignorant of the principles of currency and did not know how, at such an important moment, to manage the difficult machine which had been entrusted to them . . . they are indeed a very ignorant set.” There has apparently been no improvement in the mental equipment of the Court, despite the passage of a century, for Ricardo’s remarks of 1821 can be applied equally well in 1931. And yet capitalism has endured through the century. The incompetence of capitalists, even when it goes so far as to aggravate a crisis, does not destroy capitalism. Capitalism survived the blunderings of its fools of the nineteenth century, just as it will survive those of their twentieth century prototypes.
In a further article the real causes of the world depression will be examined.
B. S.