The Great War put an end to the supremacy of the British pound (GBP) and with it the structures of gold standard were also shaken. The United Stated lent to the Great Britain 5 bil. USD for the warfare (total war debt – 43 bil. USD when converted to modern values) and 4 bil. USD to France (30 bil. USD). Germany on the other hand were 47 bil. USD in debt. The common debt of European countries was 200 bil. USD. Because of financing the warfare and borrowing money from the United States, the Great Britain stopped being the largest creditor of the US, which became free from the dictate of the Bank of England.
USA fiercely insisted on being paid all of the dues, repeating that “The United States are not an ally but only a co-worker and war debts of European allies are commerce loans”. On the other hand Germany was not eager to immediately regulate war reparations, which counted against victorious European countries in terms of paying their debts to the United States.
Facing the danger of losing the gold reserves during the war, the reserves being an indicator of spending value of the currency, the European countries decided to keep them in the United States. Geographical conditions and numerous actions of the allies made the American dollar gain an enormous spending value and the trust of international markets, posing a threat to the British Empire and the influence of pound.
During the war gold reserves of European countries estimated at 20 bil. USD got to the United States, which gold reserves were estimated at 2 bil. USD. Next the United Stated bought gold so as to enlarge its reserves to 4,5 bil. USD. It made the American dollar five times stronger than the British pound (gold reserves of the Great Britain were estimated at about 800 mil. USD).
The fundaments of the model of functioning of the gold standard in banking were created by the Bank of England, which made use of the hegemony of the United Kingdom. The government bonds served as a provision for the issue of the currency. Because of enlarging the debt which the issue of the bonds was, the government had to issue currency which led to even larger transfer of the capital and deepened the debt. The “problem” of that system is that the accumulation of the capital in the gold standard is quite slow so as not to cause inflation. Inflation in the gold standard is highly undesired as it consumes the interest of the loan (which is the income of the bank).
Gold and short term notes are crucial assets for the functioning of the gold standard. Because gold is characterised with high liquidity (exchangeability) and an international recognition as a currency, the prices of goods, interest rates (and following them loans) and the balance of trade can regulate themselves. National currencies follow the trend of gold in such system which in real life causes the currency fluctuations to be minor.
To keep the status of a hegemon and a world financial centre, after the Great War the Great Britain had to take action to regain the trust for pound – to do something so as to return to the value of pound from before the war. The problem was inflation caused by excessive amounts of currency issued compared to owned gold reserve. It resulted in the United States, which had an absolute dominance in terms of owning gold reserves, having enough power to undermine British financial system. It provided the US with a suitable position for setting the currency standards in international clearings and price privileges (thanks to colonial system they could impose prices of the natural resources and were a huge outlet).
One should remember that the United Kingdom was in possession of substantial equities in the crucial sectors of American economy and that the fleet of the British Empire was the biggest in the world, controlling all major sea routes. Thanks to its reign over the seas and oceans the United Kingdom had its share in 2/3 of all business deals. Because of that it had complete control over the exchange of bank loan notes in the settlings of accounts in the international cash (British pound that is) trade. Pound was both fast and intrusive, which made it the world accounting currency. The United States and its trade was unable to compete with highly developed network of the British Empire which at the same time was also world’s largest lender due to the guarantee of solvency which was thanks to the long term accumulation of the industrial capital.
The competitiveness of the British industry at the end of the 19th century was getting steadily smaller due to the dynamic progress of the economy of Germany and the United States. It made the percentage of British share in the export on the international markets lessen.
Additional printing of the currency for financing of short term warfare with keeping relatively constant amount of gold at the same time led to overliquidity in the international financial system. Pax Britannica had been severely compromised and the international trade system controlled by the British was shaken and put to a hard test.
BRITISH PEOPLE DEFEND POUND. RETURN TO THE GOLD STANDARD
Between 10th of April and 19th of May 1922 the Genoa Conference took place. The matters discussed were that of creating a new economic order, independent central banks as the highest financial instance of a country, cooperation of the central banks and bringing back the gold standard. Also the representatives of the Soviet Union and Germany had been invited which put an end to their international isolation. The Soviets wanted also Turkey to take part in the conference, however eventually it wasn’t invited.
The president of the Bank of England – Montagu Norman – aimed by all means at the restitution of the gold standard and proving that pound can be exchanged for gold at any time. For the first time in history the term of foreign-exchange reserves was created and its functioning determined as a system of partial reserves which use gold and foreign currency (hard currency exchangeable for gold) deposed in strongholds of banks as hedge. It would also serve as foundations to monetary policy (issue of money and creating loans). Keynes on the other hand was a supporter of the idea to shake off the chains of the gold standard because it imposed limitations for the development potential of the British Empire. The City also wanted the abolition of all trade barriers created through the war by all the countries.
Most of the countries partaking in the conference were sceptical about this new idea. The crucial move, however, was made by Hjalmar Schacht (the President of the Reichsbank) who reached an agreement with Norman as for Germany to possess foreign-exchange reserves in British pound which would bond the largest economy to date in Europe and its currency (Deutsche mark) with the British sterling. By bringing back the gold standard the British were also bringing back trust for their currency in the eyes of the international opinion.
During the Genoa Conference the Soviet Union and Germany signed the Rapollo Treaty, which obliged both countries to mutual amortisation of all war reparations, rebuilding relationships on the intergovernmental level and secret cooperation, both military and economic. It was thanks to this cooperation (above all German technologies of industrial production) that the amazing industrialisation of the Soviet Union was possible.
Trusting the matter of regulating country’s bank system to the Central Bank was supposed to prevent depressions faster through harmonious cooperation and consultation of those banks. However, as it turned out in the future, by serving the role of the loaner of the last instance the Central Bank encouraged commercial banks to taking even greater risk in their loan expansion policy, which caused the prolonging of the period of inflation production instead of shortening it, which was the aim of the Central Bank. Private banks supported the creation of the Central Banks because they were getting rid of the responsibility for their obligations. The chosen system of the partial reserve together with strong political pressure on the Central Banks was bound to experience depressions much bigger than the system of Currency School, which had functioned before.
The central banks had among their reserves: gold, national currencies with certificates of clearance in gold and were made to enlarge their hard currencies. Hard currencies, because American dollar and British pound were the reserve currencies and by enlarging the hard currencies Central Banks were also enlarging the supply of dollar and pound. For that reason the problem of double-spending appeared, which caused lowering the standards of crediting and an ever bigger speculative bubble was emerging.
On 13th of May 1925 Winston Churchill’s government outvoted the Gold Standard Act so as to protect the dominant position and power of pound sterling. The consequence of this action was stiffening of the rate of sterling. Export and competitiveness of British industry were getting steadily lower. Economy entered recession, rate of unemployment was rising (to 18%), social discontent was manifesting itself with strikes. Also the costs of keeping British domination over seas were getting higher.
In 1928, while a financial reform in Great Britain the Currency and Bank Notes Act was outvoted. It broke off the 1844 so called Peel Act (Bank Charter Act 1844). The act from 1844 prohibited issuing new bank notes by the commercial banks within the United Kingdom and gave the monopoly of issuing new bank notes to the Bank of England only when they would be 100% based on gold. By this a government deficit of 14 million pounds was created through issuing of bonds.
The act was to reduce the influx of new bank notes to the workflow and at the same it excluded the safety deposits from the legal requirement of keeping 100% reserve based on gold. Currency and Bank Notes Act enabled the Bank of England to print additional money without boundaries after the permission of the parliament and the ministry of finances. Before that the Federal Reserve had such possibility.
The Federal Reserve was created in 1913. Regulation of bank rate (a percent indicator for calculating the discount – percentage of the sum of a loan note taken away when it’s bought before the term of payment) by the FED was supposed to by the main tool of influencing the credit environment. By rising the bank rates FED was blocking the credit expansion of private banks and the other way round.
The boost of technological innovations at the beginning of 20th century caused a huge surge of productivity in the United States which led to the US being the greatest economy in the world, deposing the United Kingdom (similar to current situation between China and the US). Huge sums of gold coming to the American banks caused the commercial ones to not see a reason for taking loans from the Federal Reserve as they themselves possessed the hedge of gold for conducting their own credit expansion. If the supply of money wasn’t enlarged in the form of loans, the prices of goods and services would come down and the real income of the Americans would rise. Credit expansion caused inflation and the prices were at roughly the same level. It was a fundament for a boom and then the Great Depression in 1929.
FED used the actions of the open market by selling the assets in the form of government bonds (lessening the supply of money) and buying the government bonds (enlarging the supply of money). In the gold standard system it was gold that was supposed to be the largest part of reserve assets, and the rest of them (securities and bonds) were to support the system. Gold is the key since it determines legally how much of the ore should be in the currency issued by a given Central Bank. The rule of equality must be followed without exception to ensure the stability of the bank balance. Putting gold in one line with the bank assets is a guarantee of stability, but the income from the interest is a minor one.
Replacing gold with bonds (loans) results in a break of the core of the currency because the terms of the deal may not be kept. In this process there is a risk for which precautions needed to be taken. The hedge and a guarantee of government’s solvency are future income from its citizens’ taxes. And so bankers, by using bonds as a part of bank assets, were broadening the possibilities for credit expansion and enabling obtainment of higher interest. By this it caused a situation in which the more money there in the market the larger the public debt was which as a result led to inflation.
In Europe because of the ware the possibilities of industrial and agricultural production were getting smaller and so the need for American products was high. The financial capital was moved to warfare and the shortage of trading loans resulted in moving of discounting of loan notes in dollars on the American market. Americans funded Europeans’ actions by issuing inter alia liberty bond. Fluctuations of pound and stability of dollar caused the Europeans to settle up directly with dollar. The American Congress allowed its banks (those with a capital above 1 mil USD) to open branch offices abroad. However, they had to support American trade. All those factors caused the American trade loan note market (additionally hedged with a bank guarantee of a trade acceptance) to be twice the size of the British one in 1924. Thus dollar became a crucial international currency.
Enactment of the dollar standard required countries to start creating demand for dollar. Because of that Americans pragmatically demanded the payment of Europe’s obligations. Having not received them and seeing the British hegemon fade, they demanded binding their debtors to be bound with American dollar, at the same time undermining the system created by the British. European countries were waiting for the payment of reparations by Germany and money they would get was to end up in the treasury of the United States. Germany, however, first wanted to get a hold of its economy and only then pay the reparations. The second option was the export of European commodity surplus to the United States. The United States at the beginning of 20’s came back to the policy of isolationism and started to rise the taxation on its own citizens and also import duty to protects its young industry by securing itself against the commodities from Europe. Europe was forced to enlarge its debt in dollars to pay short term obligations (debt rollover).
In such situation Americans saw their chance. During London 1924 conference Dawes’ Plan was put to action. It was about spreading German reparations in time and giving a loan of 200 mil USD. The US deprived pound of German currency reserve monopolisation. The loan was to be paid at an initial amount of 200n mil USD/year and rising to 600 mil USD in subsequent years. The term of payment was 40 years. By this the influx of American investments to Germany was started off and they were taking for nothing crucial sectors of German economy. Next the Young Plan was used for Germany. Currency reform of post-war Germany was also consulted with the Americans which bound this country with dollar as a reserve currency. Germany used the incoming dollars to rebuild its own economy and then to pay its reparations to European countries and the US. The strategy of the United States was to dollarise Europe.
Using the weak state of pound, restitution of the gold standard as the system of partial reserves and a great dominance of the US in gold, the countries were deciding to enlarge their hard currency in currency reserves betting on the American dollar. The consequence of those actions was building a foundation for future hegemony of American currency in the new international system.
DOLLAR vs. POUND: CURRENCY RIVALRY FOR GLOBAL DOMINANCE
In the inter-war period, while the United States kept on lending money, global prosperity could develop. The Wall Street craze on granting leveraged loans in 1929 inflated the speculative bubble to 300% of US GDP. A sudden leap in interest rates issued by the FED caused a massive outflow of gold from the United Kingdom, who had to take a similar step as FED in order to stop the outflow, thus increasing the recession in the country.
The Great Depression of 1929 “spilled” on Europe in 1931 when the collapse of the largest Austrian bank Creditanstalt (founded by the Rothschilds) caused a number of serious problems and bankruptcies in Germany, Switzerland, Hungary, Poland, France and British Empire countries. People started withdrawing money from banks and buying gold on a massive scale. The French, being distrustful of the British, demanded the withdrawal of their part of the gold deposit from the Bank of England. The British firmly refused, saying that they do not have gold in the vault and announced their break with the gold standard in May 1931.
After the Great Depression, the debt to the US was partly cancelled, which in turn resulted in the dollar’s shrinking reach and its diminishing influence on other countries. By abandoning the gold standard the British pound managed to revive the economy and use the vast territory of the British Empire, which continued to control the sea trade routes and had a huge resource base and outlet markets.
In 1932, during the Conference in Ottawa, the “Imperial Benefits System” was introduced, which lowered the tax rates (or entirely freed from them) for pound-using countries. Higher import duties were applied to countries outside the so-called “sterling block“. The strong devaluation of the pound, getting rid of the link with gold (and the dollar) allowed for a strategic trade war with the United States, which fell into the economic recession.
An independent pound surrounded the dollar, which was on the defensive.
In 1929 the United States for the first time used the Quantitive Easing mechanism (QE), which we know due to its use during the financial crisis of 2007. Then the FED used this strategy again in 1932, breaking with the rule that the issue of 100 USD must be covered in 40% with gold and in 60% with short-term debt securities. While pursuing a policy of cheap money through an open market operation, the Fed, in fact, started to control Congress.
On March 4, 1933, Franklin Delano Roosevelt became the president and he immediately closed all US banks for 10 days. At that time 13 million Americans were unemployed. Prices of goods and services were falling. Investments decreased, while citizens’ debts towards banks increased. Lack of working people means that you can no longer give loans. For this reason, in order to give the impetus to the development of the US economy, the president launched a great New Deal program, creating numerous workplaces for citizens.
Roosevelt saw the falling prices as the source of the crisis. George F. Warren returned to politics in the early 1920s, telling Roosevelt that holding large amounts of gold causes a fall in prices, but it is also an opportunity to pursue a policy of credit expansion (inflation policy), which will encourage people to buy goods and not to saving. So the president decided to force citizens, through Executive Order 6102 (from April 5, 1933), to hand over all the gold they owned (exceptions: a small amount of gold coins and gold certificates) to the Federal Reserve at a rate of USD 20.67 / oz. Then in 1934 Roosevelt overturned the ordinance and lowered the price of gold to 35 USD / oz. It was a blatant plundering of the US citizens’ savings.
Then, in 1933, another quantitative easing policy was launched, which proved to be effective and provided a four-year economic recovery, only to re-enter the recession tracks in 1937. In 1934, the Foreign Securities Act (the so-called Johnson Act), came into effect, which said that countries that had not paid off the war debts to the US could not count on its financial support in the future. The US Neutrality Act of 1935, 1936 and 1939 (Neutrality Acts) prohibited the US from providing arms to countries in conflict or selling war material and giving loans to parties involved in the conflict.
The American neutrality in World War II was officially abandoned after the Japanese attack on Pearl Harbor. However, unofficially it was sparked off by the bankers’ desire of profits and the dream of the US domination in the world. The GDP of the Axis countries totalled 50% of the US GDP. By entering the war and creating Lend-Lease act, the Americans wanted to acquire British colonial territories as a repayment of the debt from the First World War and the possibility of financing the activities of the United Kingdom during the Second World War. In the book by Charles Merlin Umpenhour Freedom and Fading Illusion, the action of Roosevelt adviser Armand Hammer was described. He advised Roosvelt to, in exchange for repayment of debt, obtain British naval bases, lease the territories of British colonies for the period of 99 years and claim their 50 destroyers. The agreement is known as Destroyers for Bases Agreement and was signed on September 2, 1940. Thus, the Americans received from the British the territories through which they could control the sea trade routes.
The British, protecting the sterling block, forced their colonies to pay in pounds for the goods imported from other countries using the colonial preference system, and to buy weapons for American dollars. During the war, the United Kingdom also froze the exchange of pounds for any other currency. After the war, on June 15, 1946, the Americans opened credit lines for Canada and the United Kingdom (Anglo-American loan). The agreement was based on one key condition – the unfreezing of foreign currency reserves by the British Empire until July 15, 1947. This was tantamount to the opening of the gate for the collection of foreign exchange reserves in the US dollar. At this point, the hegemony of the pound ended, while the Cold War era and the struggle of classic geopolitical concepts ushered in.
This article was translated by Studenckie Biuro Tłumaczeń Uniwersytetu Jagiellońskiego.