As Trump’s “Secretary of War” Pete Hegseth demands a fifty-percent increase to the war budget—topping an eye watering $1.5 trillion—it may be instructive to remember that war spending has always and everywhere been the primary enemy of sound money. Some advocates of the warfare state like to lay the blame on social spending, but it has historically been wars that end up ruining currencies and blowing the top off the public fisc. While social spending can indeed be crippling, and certainly empowers the ruling class, it is the fiscal demands of war that cause enormous surges in public spending to levels that would have never been politically unjustifiable for mere pension programs. Rather, it is during wars that government budgets will triple or quadruple, or, —in the case of Britain during the Great War—increase by a factor of twelve. Moreover, it’s important to note that in cases like these, tax revenues rarely keep up. During the war in Britain, for example:
Part of the military spending was paid for with cuts to other spending; civil spending fell from 10% of GDP to 5%. Still, even together with tax increases, this could not match the growth in war-related spending. While tax revenues quadrupled during the war years, expenses increased by a factor of twelve. So, only 25% of spending was met by taxes in the five fiscal years starting April 1, 1914.
More “moderate” increases were also enormous. In France total government spending, fueled by war spending, increased from 10.5 billion francs in 1914 to 46.9 billion francs in 1918. The German state’s spending rose 17 fold during the war, rising from 3 billion marks in 1914 to 52 billion marks in 1918.
In France, as in Britain, the United States, Germany, and the other belligerents of the war, massive war debts made up for enormous gaps between tax revenue and total government spending. The European governments generally chose to monetize much of this debt, rather than raise taxes enough to cover war costs. France, the UK, and Germany, “relied much more heavily on debt and inflation than on taxation to fund government spending.” Consequently, monetary inflation was significant:
German debt ... became monetized and the volume of new currency exploded. German currency in circulation rose 599 percent over the course of the war ... Great Britain and France saw an increase of money in circulation of 91 and 386 percent respectively.
These enormous surges in deficits and spending over such a short period are rarely, if ever, seen in conneciton to social spending. Rather, runaway government spending, to the point of increasing total spending by five or ten fold, is justified on the back of a complex of nationalism, fear, and propaganda claiming that “winning” the war—what constitutes victory is defined by the elites, of course— is worth any expense.
It is well known today that Germany experienced hyperinflation after the War as a result of its crushing debts, made worse by reparations imposed by the Treaty of Versailles. But it is important to note that the “winners” in the war enduring debilitating levels of debt, spending, and inflation. The consequence was rapid inflation for all parties, and “From 1914 to 1918 the money supply [in the UK] doubled. Naturally, this had consequences for the level of prices in the UK, which doubled as well.” By 1919, prices in Belgium, Britain, France, the Netherlands, and Italty all had “debt-to-GDP ratios in excess of 100% and saw their price level double from 1913.”1
This led directly to the revolution in monetary politics that followed the First World War. This came about through two international conferences on monetary policy. The first was the Brussels International Financial Conference of 1920, and the second was the Genoa Conference of 1922. Through these, the stage was set for the new world of central banking and the final destruction of the gold standard.
The Brussels International Financial Conference of 1920
To deal with mounting war debt, and to allow for the easy monetization of that debt, the governments of Europe suspended the gold standard during the war. As explained by a Federal Reserve publication in 1989:
The First World War nearly demolished the international gold standard. ... To be on the gold standard a country needed to maintain the convertibility between notes and gold and to allow gold to flow freely across its borders. In the early days of the war, Austria-Hungary, France, Germany, and Russia all went off the gold standard as they suspended specie payments and instituted legal or de facto embargoes on the export of gold by private citizens. Like the British Treasury, the governments of these warring countries exported gold and borrowed heavily to finance the war, but these tactics raised only a fraction of the large sums of money that the war required. Because new taxes did not and could not make up the difference, the continental belligerents financed a large share of the war by printing money, which caused prices to soar and complicated the return of these countries to the gold standard after the war.
The UK did not formally suspend the gold standard, but imposed a number of regulations that effectively suspended the specie-payment system that existed under the gold standard that had existed up to 1914. Similarly, the United States imposed its own regulations under which specie payments to private parties remained nominally legal, but under which “the redemption of notes for gold became difficult until the end of the war.”
In Europe, however, the states’ debts had become so enormous, and devaluation of national currencies so dramatic, that a return to the gold standard was increasingly tenuous.
This was something new. The gold standard had been suspended in the UK and in much of Europe before—perhaps most notably during the Napoleonic wars—but “peace had always brought restoration.” It is likely that the European states assumed this would be the case as they suspended specie-payments in the early years of the war.
But, which the classical gold standard in tatters—thanks to government intervention, of course—the “victorious” governments of the war looked to reconstruct what had previously been an incredibly efficient international monetary system.
One of the first steps in this attempt to piece together a new monetary system was the Brussels International Financial Conference of 1920.
The classical gold standard had fostered immense economic growth and gains in the standard of living during the nineteenth century. But in 1920 it was unclear how the states of Europe could rebuild the institutional framework—a framework built by the economic liberals who had favored the classical gold standard—that had existed before the war. In 1920, 86 delegates from 39 states—most of whom were bankers or treasury officials—met in Brussels to discuss ways to recapture the benefits of the nineteenth century’s economic system which had been characterized by relatively free trade, fiscal discipline, and the gold standard.
In contrast, the war years had been something else entirely:
The European situation during the war years, then, was characterized by a lack of productivity, by monetary inflation, by heavy taxation, and by a great internal, as well as external, indebtedness. After the Armistice the vestiges of pre-war industrialism in Europe were scarcely discernible in the omnipresent economic and financial chaos and material ruin.
The meeting at Brussels had been called to fix the situation, as “Without the depressed economic context of the after-war there would have probably been no reason to discuss the creation of international cooperation bodies.”
Ideologically, the conference was unremarkable for the time in the sense that the delegates expressed approval of liberal economic policies. For instance, amonmg the resolutions unanimously adopted by the delegates was the statement that “It is highly desirable that the countries which have lapsed from an effective gold standard should return thereto.” The delegates also embraced free trade stating that “Another urgent need is the freest possible international exchange of commodities.”
The delegates were well aware of the monetary realities of the time, however, and also noted that “It is useless to attempt to fix the ratio of existing fiduciary currencies to their nominal gold value…” This was not an embrace of “easy money,” but simply a recognition of the fact that the national currencies had been so debased in terms of gold that it was scarcely practical to attempt to return to pre-war nominal values.
Notably, the participants at the conference understood the basics of the problem of increasing the money supply, stating:
It is of the utmost importance that the growth of inflation should be stopped, and this, although no doubt very difficult to do immediately in some countries, could quickly be accomplished by (i) abstaining from increasing the currency (in its broadest sense as defined above), and (2) by increasing the real wealth upon which such currency is based.
(The “difficulty,” of course, is not a technical problem, but a political problem. Politically, it is difficult for policymakers to simply refuse to monetize any more debt or promote easy money through policy.)
But when it came to discussions on monetary institutions and the perceived need for an international monetary framework, the Brussels conference paved the way for future political innovations which would lead to the new world of central banks and fiat currency. In many ways, according to the conference delegates, any return to the gold standard had to be coordinated through the central banks of the world.
This was not to be a return to a monetary system coordinated by the marketplace. Rather, it became clear in Brussels that central banks were to be the central monetary institutions of the future.
Meanwhile, we also find at Brussels much talk of maintaining “independence” for central banks. That is, the Brussels delegates were innovators in the rather naive idea that central banks could—somehow—be made independent of central banks and be guided only by scientific economics. (This myth of the possibility of central-bank independence continues to this day.)
Moreover, the conference called for more central banks and for the creation of an international monetary system that was to be dominated by central banks. Among the conference’s adopted resolutions we find this: “In countries where there is no central Bank of Issue, one should be established, and if the assistance of foreign capital were required for the promotion of such a Bank, some form of international control might be required.”
This was highly influential in Latin America where a number of states had not yet established central banks. The Brussels conference set Latin America on the path of central banking:
Organised by the League of Nations, the Brussels International Financial Conference, in 1920, played a decisive role in the creation of central banks in Latin America. In that meeting, countries that did not yet have their own central banks advised to constitute one. The central bank would be both the basis upon which the monetary systems of the post-war would rise and the trustful mechanism that would facilitate countries’ financial relationship. Central bank autonomy from direct influence of national governments was considered a key factor to oppose budgetary deficit tendencies and, consequently, a guarantee against inflation surges.
Nor surprisingly, the Brussels conference is sometimes credited as setting the stage for the International Monetary fund which would be formally established in 1944.
The Genoa Economic and Financial Conference of 1922
What came next was the Genoa Conference. Brussels made it clear that the future of the gold standard was to be a future in which the world’s monetary systems were managed by “independent” central banks. With the politicians of the world now in agreement that central banks ought to manage the global monetary situation, the Genoa Conference took things further by introducing the ersatz gold standard known as the “gold-exchange standard.”
The delegates at Genoa were still confronting the same problem facing those at the Brussels conference: the nations’ drastic devaluation of their national currencies relative to gold. John Phelan explains:
After the war most countries wished to return to the gold standard but faced a problem: there was now much more currency relative to their gold reserves. The parity prices of gold were far below the market prices, which would lead to massive outflows of gold once convertibility was re-established.
To solve this problem, among others, the statesmen gathered [in Genoa] in April and May 1922. Their solution was the gold exchange standard.
The gold exchange standard would solve the imbalance between currency and gold reserves by increasing reserves. But the gold stock could not be expanded beyond new discoveries so the gold exchange standard allowed central banks to add to their gold reserves the assets of countries whose currency was convertible into gold. In practice these were sterling and dollars. By 1927, foreign exchange [i.e., foreign currencies presumed to be convertible into gold, but not actual gold] accounted for 42% of the total reserves (gold and foreign exchange) of twenty-four European central banks, up from 27% in 1924 and 12% in 1913.
In other words, the central bankers and politicians at Genoa hatched a new way to return to a “gold standard,” but this would be a gold standard quite unlike what had come before.
In his book, Gold and the Gold Standard, Edwin Kemmerer describes this new “gold-exchange” standard as a “changed and weakened gold standard.” This new system would supersede the “gold-coin standard” which was a central characteristic of the classical gold standard. He writes:
Outside the United States and a few minor countries, the predominately ante bellum gold-coin standard, with its free coinage of gold and full convertibility of fiduciary money into gold coin on demand, gave way to the gold bullion standard and the gold-exchange standard. In both cases, the minting and circulation of gold coin were usually nonexistent, and in both it became difficult for people of small means to obtain monetary gold. Under these new-type standards, the hoarding of gold, which creates ‘a varying demand for the yellow metal and often serves as a check against inflationary forces, was rendered difficult for the masses of the people.2
This new faux gold standard removed the private marketplace from its crucial role in acting as “a check against inflationary forces”—inflation usually fueled by central bank manipulation. Now, under the new system, “it became easier for governments and central banks to manipulate the currency supply.”
Thanks to Brussels and Genoa, the new so-called gold standard was one in which central banks overwhelmingly controlled the flow of gold, with coinage removed from the equation, and government regulation guiding international monetary exchange.
Joseph Salerno further explains how the gold-exchange standard was anything but the classical gold standard:
Unfortunately, the new gold standard of the 1920s was fundamentally different from the classical gold standard. For one thing, under this latter version, gold coin was not used in daily transactions. In Great Britain, for example, the Bank of England would only redeem pounds in large and expensive bars of gold bullion. But gold bullion was mainly useful for financing international trade transactions.
Other countries such as Germany and the smaller countries of Central and Eastern Europe used gold-convertible foreign currencies such as the US dollar or the pound sterling as reserves for their own domestic currencies. This was called the gold-exchange standard.
While the US dollar was technically redeemable in honest-to-goodness gold coin, banks no longer held reserves in gold coin but in Federal Reserve notes. All gold reserves were centralized, by law, in the hands of the Fed and banks were encouraged to use Fed notes to cash checks and pay for checking and savings deposit withdrawals. This meant that very little gold coin circulated among the public in the 1920s, and residents of all nations came increasingly to view the paper IOUs of their central banks as the ultimate embodiment of the dollar, franc, pound, etc.
This state of affairs gave governments and their central banks much greater leeway for manipulating their national money supplies. The Bank of England, for example, could expand the amount of paper claims to gold pounds through the banking system without fearing a run on its gold reserves ...
As a percentage of GDP, the wartime debts of the Napoleonic wars exceeded those of the first world war. Yet, thanks to the rising power of the economic liberals in western Europe, and owing to a lack of centralization in the monetary system, the UK was forced to return to the gold standard following the wars. Since the British ruled the global financial system at the time, this ultimately forced other major states—any that sought to compete with the British as economic powers—to return to the gold standard as well.
Yet, by 1920, the old liberalism of the nineteenth century had gone into decline. Meanwhile, central banks and the paper economy had greatly expanded. Industrialization had further centralized the financial world in a way that allowed for central banks to exercise grater power and influence over money. So, the gold standard did not survive the first great war of the twentieth century.
The gold-exchange standard that came afterward was but a pale imitation. Moreover, the states of Europe, and the United States still faced immense debt obligations as the Great Depression hit. States could not pay their debts and simultaneously finance enormous new government programs that were taking shape under Depression-era politics. Ultimately, by the early 1930s, national governments began abandoning even the gold-exchange standard, opting for a new monetary orthodoxy that would allow states to borrow and spend at levels that had never before been known in peacetime. The new inflationary policies cheapened the old war debts while allowing for massive amounts of new borrowing.
The old shackles of the gold standard had been destroyed at last. The ordinary people of Europe, so devastated by the shells of the First World War, would again be victimized by the new inflationary national currencies that would destroy savings and investment across the European middle class. The wealthy and the ruling classes, on the other hand, weathered the storm quite well, just as they had during the Great War that they had so capriciously started.
- 1
There is debate over the extent of inflation, depending on measuring methods. For instance, Kemmerer writes:.”In some belligerent countries-like Germany, Russia, and Poland-prices rose to astronomical heights. In others the inflation, though severe, was not astronomical; for example, in France, Belgium, and Italy price advances reached magnitudes of the order of 300 to 600 per cent. In some other countries inflation, although real, was of still lower magnitude. In England, for example, between 1914 and 1920 the wholesale price level rose 195 per cent; in Norway from January, 1915, to December, 1920, 128 per cent, and in the United States from September, 1917, to the end of June, 1919—the brief period of 21 months of the gold embargo—wholesale·prices rose 10 per cent.” See Edwin Walter Kemmerer, Gold and the Gold Standard (New York: McGraw-Hill, 1944), pp. 108-109.
- 2
Kemmerer, Gold and the Gold Standard, p. 118.
