Carroll Quigley - Tragedy and Hope - A History of the World in Our Time

The British suspension of gold was by necessity, not by choice. It was regarded as an evil, but it was really a blessing. As a result of this mistake, many of the benefits which could have been derived from it were lost by trying to counterbalance the inflationary results of the suspension by other deflationary actions. The discount rate was raised to 6 percent; valiant efforts to balance the budget continued; a protective tariff was established and a program of fairly stiff taxes installed. As a result, prices did not rise enough to give that spur to production which would have been necessary to increase prosperity and reduce unemployment. No system of exchange control was set up. As a result, the depreciation of sterling in respect to gold-standard currencies could not be prevented, and amounted to 30 percent by December 1931. Such a depreciation was regarded by the authorities as an evil—chiefly because of orthodox economic theories which considered parity of exchanges as an end in itself and partly because of the need to pay the £ 13° million in Franco-American credits—a burden which increased as sterling depreciated in respect to dollars and francs.

As a result of the British abandonment of the gold standard the central core of the world’s financial system was disrupted. This core, which in 1914 was exclusively in London, in 1931 was divided among London, New York, and Paris. London’s share depended on financial skill and old habits; New York’s share depended on her position as the world’s great creditor; Paris’s share depended on a combination of a creditor position with an undervalued currency which attracted gold. From 1927 to 1931, these three had controlled the world’s financial system with payments flowing in to the three, credits flowing out, and stable exchanges between them. The events of September 1931 broke up this triangle. Stable exchanges continued for dollar-franc, leaving dollar-pound and pound-franc to fluctuate. This did not permit an adjustment of the maladjusted exchange rates of 1928-1931. Concretely, the undervaluation of the franc in 1928 and the overvaluation of the pound in 1925 could not be remedied by the events of 1931. A sterling-franc rate which would have eliminated the undervaluation of the franc would have resulted in a sterling-dollar rate which would have over-corrected the overvaluation of sterling. On the other hand, the depreciation of the pound put great pressure on both the dollar and the franc. At the same time, Britain sought to exploit as much as possible her economic relations with her home market, the empire, and that group of other countries known as the “sterling bloc.” The home market was set aside by the establishment of customs duties on imports into the United Kingdom (special customs duties November 1931, and a general tariff in February 1932). The empire was brought into closer economic ties by a group of eleven “Imperial Preference” treaties made at Ottawa in August 1932. The sterling bloc was reinforced and enlarged by a series of bilateral trade agreements with various countries, beginning with Norway, Sweden, Denmark, and Argentina.

Thus the world tended to divide into two financial groups—the sterling bloc organized about Britain and the gold bloc organized about the United States, France, Belgium, the Netherlands, and Switzerland.

The depreciation of sterling in relation to gold made the currencies of the gold bloc overvalued, and relieved Britain of that burdensome status for the first time since 1925. As a result, Britain found it easier to export and more difficult to import, and obtained a favorable balance of trade for the first time in almost seven years. On the other hand, the gold countries found their depressions intensified.

As a third result of the British abandonment of the gold standard Britain freed herself from her financial subjection to France. This subjection had resulted from the vulnerable position of the British gold reserves in contrast to the bulging appearance of the French reserves. After 1931 the financial positions of the two countries were reversed. When Britain was able to add a financial superiority after 1931 to the political superiority she had possessed since 1924, it became possible for Britain to force France to accept the policy of appeasement. Moreover, the financial crisis of 1931 was to bring to power in Britain the national government which was to carry out the policy of appeasement.

As a fourth result, the countries still on gold began to adopt new trade barriers, such as tariffs and quotas, to prevent Britain from using the advantage of depreciated currency to increase her exports to them. The countries already off gold began to see the value in currency depreciation, and the possibility of races in depreciation began to form in the minds of some.

As a fifth result of the abandonment of gold, it became possible to rearm without the resulting unbalancing of the budget leading to financial jeopardy as under a gold standard. Little advantage was taken of this, because pacifism on the Left and appeasement on the Right were regarded as substitutes for arms.

Because of the deflationary policy which accompanied the abandonment of gold in Great Britain, recovery from depression did not result except to a very slight degree. Neither prices nor employment rose until 1933, and, from that year on, the improvement was slow. The depreciation of sterling did result in an improvement in the foreign trade balance, exports rising very slightly and imports falling 12 percent in 1932 in comparison with 1931. This led to a revival of confidence in sterling and a simultaneous decline in confidence in the gold-standard currencies. Foreign funds began to flow to London.

The flow of capital into Britain early in 1932 resulted in an appreciation of sterling in respect to the gold currencies. This was unwelcome to the British government since it would destroy her newly acquired trade advantage. The pound sterling appreciated in respect to the dollar from 3.27 on December 1, 1931, to 3.80 on March 31, 1932. To control this, the government, in May 1932, set up the Exchange Equalization Account with capital of £ 175 million. This fund was to be used to stabilize the exchange rates by buying and selling foreign exchange against the trend of the market. In this way, the old automatic regulation by the market of the internal credit structure through the international flow of funds was broken. Control of the credit structure was left to the Bank of England, while control of the exchanges went to the Exchange Equalization Fund. This made it possible for Britain to adopt a policy of easy and plentiful credit within the country without being deterred by a flight of capital from the country. Since the Exchange Equalization Fund was not a system of exchange control but merely a government management of the regular exchange market, it was not in a position to handle any very considerable emigration of capital. The easy credit policies of Britain (designed to encourage business activity) had thus to be combined with deflationary prices (designed to prevent any powerful flight of capital). The bank rate was dropped to 2 percent by July 1932, and an embargo was placed on new foreign capital issues to keep this easy money at home. The chief exceptions to this embargo arose from loans to be used in the general policy of binding the sterling bloc to Britain, and the proceeds of these had to be used in Britain.

On this basis, although sterling fell to 3.14 by the end of November 1932, a mild economic revival was built up. Cheap credit permitted a shift of economic activity from the old lines (like coal, steel, textiles) to new lines (like chemicals, motors, electrical products). The tariff permitted a rapid growth of cartels and monopolies whose process of creation provided at least a temporary revival of economic activity. The continued low food prices permitted the income from this increase in activity to be diverted to necessities of a different kind, especially dwelling construction. The budget was balanced, and early in 1934 showed a surplus of £ 30 million.