Economics and The Public Welfare

Chapter 34

1931 Continued—England’s Abandonment of the Gold Standard

First Austria, then Germany, then England—each in turn was tested and each in turn yielded. Austria and Germany each made a strenuous fight. Both had to contend with the political fears of France and with a divided attitude on the part of the outside world. England, although supported by ready cooperation on the part of New York and Paris, and by great forbearance in Amsterdam and other minor financial centers, made no fight at all.

Summary of Background. Previous chapters have shown the growing weakness of the British economic and financial structure. We have seen the growing rigidities in the internal economic structure. We have seen trade union policy holding British wage rates well above the supply-and-demand level, with resultant chronic unemployment, buttressed by doles. We have seen price-fixing combines and quota agreements among British industries which ought to have been competing. A structure of this sort is extremely vulnerable to alterations in world trade conditions. Moderate recessions in world prices, not met by internal readjustment, cut heavily into such a country’s export trade.

We have seen, too, how Britain, yielding to cheap money theories and yielding to the doctrine that increasing credit would make prosperity, had progressively expanded bank credit in a volume not justified by her gold reserves and to an extent that had greatly impaired the liquidity of her banking position. We have seen how this expansion of credit—increasing loans and advances on the part of the British banks matched by increasing deposits in British banks—had led to an excessive flow of sterling balances into foreign hands, in particular into the hands of the Bank of France and the Paris money market. This situation had become dangerous by the spring of 1927. It had grown ominous in the years that followed. London was vulnerable.

Run on England Begins, July 13, 1931. With the collapse in Austria and in Germany, there came a disposition to question the credit of other countries. Men and institutions outside of England, who had an excess of pound sterling on their hands, readily grew worried. Was sterling as good as gold? They undertook to find out.

The effects of the German crisis were felt heavily in the London stock exchange on July 13, 1931, and there were adverse movements in sterling exchange. The Bank of England’s statement for the week ending July 15 reveals losses in gold holdings—the first in thirteen weeks. On Wednesday, July 15, the foreign exchanges suffered their most severe dislocation since the war. London, as the principal European depository of Europe’s liquid funds, was drawn upon heavily, with the result that sterling exchange fell 2 1/4¢ at one time to a price at which New York and other centers could profitably draw gold from the Bank of England. The New York Times in its account of developments in London that day said: “In preparation for the expected demands, the Bank of England boxed 100 million dollars of gold ready for shipment abroad as a measure for maintaining the price of sterling.” On Wednesday, July 22, withdrawals from the Bank of England were very large. The Bank had lost $125,000,000 in gold in nine days. Bank Rate was raised from 2 1/2% to 3 1/2%.

Bank Rate at 2 1/2%. It must be observed that for the Bank of England to have come into a situation of this sort with its rate at 2 1/2% was in itself an evidence of financial shell shock. An alert, competent management would have had Bank Rate high above 3 1/2% early in the year, and would, indeed, never have allowed the rate to go as low as 3 1/2% with the overextended position of England. The next week showed further huge gold exports from London to the Continent, and on Thursday, July 30, the Bank of England again raised its discount rate from the low figure of 3 1/2% to the very modest figure of 4 1/2%.

$250,000,000 from Federal Reserve Banks and Bank of France. Meanwhile, the Bank of England turned for help to the Bank of France and the Federal Reserve banks. On August 1, it was announced that the Bank of France and the Federal Reserve banks would each lend $125,000,000. Gold was going out of England. They replenished it by borrowing. There was no disposition to let the outflowing gold operate to tighten the money market and to bring into operation counteracting forces which would check the outflow of gold.

There was a great deal of discussion in England about balancing the budget and cutting the dole. Prime Minister Ramsay MacDonald and his Labor Ministry resigned August 24 because the Labor Party was opposed to cutting the dole. MacDonald then promptly organized a National Government containing leading members of the Conservative and Liberal parties. Certain Labor leaders also joined this cabinet, but were repudiated by the Labor Party, which refused, as a party, to join the coalition. This coalition Cabinet was expected to save the gold standard.

$400,000,000 More Loaned England by United States and France. On August 28 an additional credit of $400,000,000 was given to London, divided between France and the United States, and provided this time, not by the Bank of France or the Federal Reserve banks, but by a consortium of commercial banks and private bankers. The expectation was that this would surely be enough if Britain made the necessary readjustments. But Britain did not fight. As gold went out, it was not allowed to make any real reduction in the reserve funds of the British money market.

But England Did Not Fight—Money Market Kept Easy. The Bank of England bought government securities in the open market, providing reserve funds for the British banks which tended to offset the depletion of their reserves as gold went out.1

In addition, the Bank was discounting bills for the money market at 2 1/2% until July 22, at 3 1/2% until July 30, and at the absurdly modest rate for a panic period of 4 1/2% through the rest of the debacle.

Netherlands Bank and Bank of England. The Bank of France cooperated loyally during this period. The holdings of the Bank of France in sterling were so enormous that any serious break in sterling would strip the Bank of all of its capital and very much more. The Netherlands Bank, which had great holdings of sterling, did not withdraw its funds from London. On Friday, September 18, Doctor Vissering, head of the Netherlands Bank, phoned Governor Montagu Norman 2 of the Bank of England to inquire if it were safe for him to continue to hold sterling, and received unqualified assurance that England would remain on the gold standard. He held his sterling.

Impending collapse of sterling was definitely signaled to New York on Saturday, September 19, as the Bank of France, concluding that the matter was hopeless and wishing to save as much as possible, gave orders to each of six New York banks by cable to sell a million pounds sterling, a total of six million pounds. These orders, coming to New York near the end of the short Saturday trading day, broke the price of sterling exchange in New York by over 2¢.

Announcement on Sunday, September 20, of Suspension of Gold Payment Next Day—New York’s Policy. On Sunday, September 20, the announcement was made that England would abandon the gold standard, and Sunday conferences were hurriedly called in New York with respect to bank policy next day, first, among the officers of individual banks and then, late in the evening, by the heads of the great banks meeting together.3

New York Meets Shock Calmly. The decisions made by the heads of the banks in New York as they got together that night were courageous decisions. The banks would oppose any closing of the Stock Exchange. The banks would carry on as usual. New York met the shock on September 21 calmly.

One compromise was made with the fears of those who wanted to close the Stock Exchange. On September 21, short selling was forbidden by the Stock Exchange authorities. This rule was rescinded September 23. But on October 5 restrictions on short selling were renewed, and these restrictions were tightened 4 on November 23 and January 22, 1932. Partly as a result of this the downward movements in stock prices which followed, down to the summer of 1932, were more extreme, and the rallies were far feebler than would otherwise have been the case. The short seller is a very irritating person at the beginning of a decline, but an extremely comforting person as the decline goes on. He must buy again in order to take his profits, and when he buys, rallies come. He provides a cushion at the bottom.

England Leaves Gold Standard with Bank Rate at 4 1/2%. England went off the gold standard with Bank Rate at 4 1/2%.5 To a British banker in 1913, this would have been an incredible thing. In a much less grave crisis Bank Rate would have gone to 10% long before anything like so much gold had left the country. The Bank of England would have supplied needed credit to the London market, but at a stiff rate, and on discounts. The Bank of England would not have bought Government securities to ease off the market.

Abandonment of Gold Unnecessary. The collapse of the gold standard in England was absolutely unnecessary. It was the product of prolonged violation of gold standard rules, and, even at the end, it could have been averted by the return to orthodox gold standard methods.

Even in the summer of 1931 the position could have been saved. Had Bank Rate gone to 8% when the Bank of England obtained its first credit of $250,000,000 from the Federal Reserve banks and the Bank of France, or to 9% when the second credit of $400,000,000 was obtained from the French and American money markets, England would not have gone off the gold standard.6

How Tight Money Policy Would Have Saved Gold Standard. A tight money policy in England during the run would have led to the following developments: (1) many foreigners indebted in London would have borrowed elsewhere to pay off their debts; (2) British people having funds abroad and debts in London would have been compelled by their London bankers to bring home their funds to pay their debts; (3) British people who had debts in London and the ability to borrow abroad would have been under heavy pressure to do so; (4) the prices of securities in London would have fallen drastically, making attractive bargains for informed outsiders; (5) British people holding foreign securities and having debts in London would have sold their securities abroad to pay their debts at home; (6) many foreigners and foreign banks, watching the good fight which London was making, would have taken a “sporting chance” and would have put funds in London, attracted by a 9% rate, whereas a 4 1/2% rate was uninteresting as offering no compensation for risk; (7) very speedily the pressure on import credits in England would have slowed down imports, while the credit pressure on British producers of goods would have forced them to reduce prices, wages, and other costs, so that outsiders could buy British exports.

Possible Explanations of England’s Course. Why did not the Bank of England adopt the traditional policy? One possible reason was the strength of the labor unions, which resisted any reduction in money wages. Another possibility was that the internal banking picture in England had grown so illiquid that great banking institutions would have been pulled down by heavy money market pressure, and that a good many weak industries would have been forced into bankruptcy, including some large ones which had long been financially weak. A third possibility was the fear of the drop in security prices which would have helped to turn the tide in London’s favor, but this break in security prices the London stock market got in any case.

One cannot be sure of the facts with respect to the basis of England’s decision, and with respect to the reasons for the Bank of England’s policy of buying government securities to prevent pressure on the market as the gold went out. There is good reason to believe that British labor leaders did inform the British Government that they would consent to a reduction in British wages if it were necessary to save the gold standard.

There is good reason to believe that the positions of the “Big Five,” the great Joint Stock banks—Lloyds, Midland, Barclays, Westminster, and National Provincial—were strong enough so that they could unquestionably have withstood the shock and that, in general, the clearing house banks could have withstood the shock and the pressure.

It has been said that the crux of the matter lay in the position of two 7 great acceptance houses which had given a large volume of acceptance credits to Germany, whose liabilities for acceptance on Germany account constituted a multiple of their capital, and that it was feared that an extreme money pressure would pull those houses down. This would surely have been an inadequate reason. In the first place, the disaster to England of the collapse of these houses would have been nothing like so great as the disaster of abandonment of the gold standard and the breaking of faith with the world. In the second place, even in a greater crisis it would have been possible for concerted action to have saved these houses. Acceptance houses had proved a weak spot at the time of the outbreak of the first World War, and they had been rehabilitated without disaster to the general situation. It could have been done again.

The opinion has been expressed that, once the scare was on, nothing could have stopped it. But if this had been the opinion of the British financial authorities, they would hardly have felt justified in borrowing $650,000,000 from New York and Paris to throw into the maelstrom.

The most reasonable interpretation of their failure to raise Bank Rate and tighten the money market at the time when the run first began was partly financial shell shock, partly a reliance upon the great prestige of England and the pound sterling, partly that the long surrender to the cheap money policy had induced a kind of paralysis with respect to the use of the old methods, and partly a belief that the foreign credits combined with the prestige of the pound would suffice.

Prestige of the Pound. The pound sterling and England had immense prestige, even when the trouble came. The prestige was not completely destroyed by the abandonment of the gold standard. Following the abandonment of the gold standard and the break in sterling, there came a great buying of sterling from the Far East, from India, and from other parts of the world. The pound at the new low levels looked cheap to many experienced foreign exchange traders. England threw away an immense asset, but not all of it. Even with the abandonment of the gold standard, it took years more of unsound financial policy to bring her to the pitiful picture that the pound exhibited at the outbreak of World War II in 1939.

Had England used orthodox measures in the summer of 1931, these measures, combined with her still great financial prestige, would have sufficed.

The Myth That England Gained by Dropping Gold Standard. A myth has arisen in the intervening years that England gained greatly by the abandonment of gold and that there came an immediate stimulus to British industry and trade. The figures do not reveal it. There was a kind of psychological relief. The worst had happened. The strain was over. The surrender had been made. The humiliation had been gone through with. Man could pause and take stock and see the extent of the damage. England still stood. There was, moreover, a cessation in the downward trend of the British industrial figures. But the year that followed showed no real improvement in the British industrial position. Despite the sharp drop in the value of the currency, wholesale prices made a very modest response. The following table shows British wholesale prices on the 1913 base for the years 1931 and 1932, by months.

Wholesale Prices in England (1913 = 100)
Foods		Industrial products
1931		1931
Jan	113	Jan	104
Feb	112	Feb	113
Mar	111	Mar	113
Apr	113	Apr	102
May	113	May	100
June	113	June	98
July	110	July	98
Aug	108	Aug	95
Sept	108	Sept	95
Oct	113	Oct	100
Nov	115	Nov	102
Dec	113	Dec	102
1932		1932
Jan	114	Jan	101
Feb	114	Feb	101
Mar	116	Mar	99
Apr	115	Apr	96
May	114	May	94
June	112	June	91
July	108	July	92
Aug	107	Aug	95
Sept	107	Sept	99
Oct	106	Oct	98
Nov	107	Nov	98
Dec	108	Dec	97

It will be seen that there was a modest jump in wholesale prices between September and October, 1931, but that the wholesale prices of British industrial products began to go down again with January of 1932, and by August of 1932 they had fallen to the level of August and September of 1931. The prices of foods also showed a modest rise, but again by August of 1932 had gone below the levels of August and September of 1931.

If the abandonment of the gold standard had magic in it for British industry, the figures do not reveal the fact. The following table gives a comprehensive picture of British economic life for the years 1931 and 1932. The general index shows a loss of one point in 1932 as compared with 1931. Taken as a whole it cannot be said to reveal any improvement at all.

Volume of Production—United Kingdom *
	Genl. index	Mining	Industries, manufactures	Iron, steel prod.	Other metals	Engineering, shipbuilding	Textiles	Chem. prod.	Leather footwear	Foodstuffs	Gas and elect.
1930	100	100	100	100	100	100	100	100	100	100	100
1931	91	89	91	74	84	81	97	96	98	99	103
1932	90	85	92	75	81	76	107	99	95	93	106

* Statistical Yearbook of the League of Nations, 1938-39, p. 195.

Effect Disastrous for World as a Whole. The one thing that is sure is that the effect of England’s abandonment of the gold standard upon the economic picture of the world as a whole was disastrous in the extreme. The ten months that followed for the rest of the world were months of the deepest gloom.

Immense Damage to World Confidence in Promises. Fear gripped the world regarding the value of every currency. There is no worse fear than this, from the standpoint of economic functioning.

First of all, and obviously, there was a great shock as it developed that the Bank of France had lost seven times its capital through its holdings of sterling, through trusting the Bank of England, and the perhaps even more shocking discovery that the Netherlands Bank, trusting the word of the Bank of England, had lost all of its capital in the decline in sterling. The officials of the Bank of France could hardly be blamed by the French Government. They had been in closest coöperation with the Government, and they had warned the Government again and again, in the period when their sterling holdings were being accumulated, that the policy involved was dangerous, and that a de jure stabilization of the franc, which would permit them to receive gold at a fixed rate in Paris, would prevent it. The Bank of France made a pathetic effort to revalue certain of its assets, including even the furniture of the Bank, in the effort to wipe out some of the loss on its balance sheet. But the real relief came when the French Government gave the Bank of France non-interest bearing government securities which, for bookkeeping purposes, restored the capital of the Bank as a bookkeeping item.

The Netherlands Bank was severely blamed by the Netherlands Government. It meant personal shipwreck for Doctor Vissering, who was a fine person and an able and upright man. The Netherlands Government made good half the capital of the Netherlands Bank by turning over government securities to it, but with a severe warning against a repetition of the occurrence. Governments could no longer trust governments in financial matters, and the confidence of central banks in one another was gravely shaken. An immense world asset was destroyed when the Bank of England and the British Government broke faith with the world. Years later, after we in the United States had also broken faith with the world, the head of the national bank of one of the Scandinavian countries said, “I have lost money in sterling. I have lost money in dollars. I have never lost money by holding gold.”

Gold’s Greatest Competitor. The value of gold rose all over the world following England’s abandonment of the gold standard, because of the immense weakening which this involved for gold’s greatest competitor. Gold’s greatest competitor is the confidence men have in the paper promises of governments and central banks to pay gold.

United States Hard Hit. The figures on page 254 for industrial production and security prices show how hard we were hit in the United States in the months following August of 1931, the months coinciding with and following England’s abandonment of the gold standard.

The table on page 255 makes it very clear that the abandonment of the gold standard in England was followed by a violent decline in exports, both in the United States and in Europe, as measured in gold.

Industrial Production and Security Prices in the United States
	Production		Prices of Common Stocks
	Federal Reserve Board (seasonally adjusted) 1923-25 = 100	New York Times (Seasonally adjusted) Estimated normal = 100	New York Times average of 50 industrials and rails
1931			High	Low
April	88	86.4	155.82	133.15
May	87	85.1	143.54	119.33
June	83	82.6	144.78	112.25
July	82	83.1	142.82	122.53
August	78	78.9	129.34	119.65
September	76	76.3	123.60	88.27
October	73	72.6	100.1 I	79.07
November	73	72.2	104.95	78.82
December	74	72.1	83.46	67.61
1932
January	72	70.1	80.88	65.36
February	69	68.1	80.56	64.70
March	67	66.7	79.57	64.40
April	63	63.2	65.30	48.79
May	60	60.9	52.13	38.64
June	59	60.4	44.15	35.48
July	58	59.7	47.75	33.98
August	60	61.3	68.71	44.97
September	66	65.2	72.38	57.27
October	67	65.4	65.57	51.63
November	65	64.7	62.1 2	51.70
December	66	64.8	58.83	51.38

Exports of Five Countries in Dollars, 1929-1932 (Sterling figures * reduced to dollars at current rates of exchange—000 omitted)
	1929	1930	1931	1932
United States—
January	480,384	404,309	245,727	146,785
February	434,531	342,884	220,666	150,997
March	481,716	363,131	231,077	156,000
England—
January	325.472	283,532	182,805	106,783
February	270,894	252,688	154,721	103,680
March	285,289	262,528	165,407	113,522
Germany—
January	246,537	245,822	172,457	126,246
February	219,144	228,910	174,601	128,152
March	221,526	248,204	195,800	125,531
France—
January	145,118	145,589	100,901	70,795
February	161,426	157,506	108,074	69,306
March	163,856	155.154	120,579	67,424
Holland—
January	61,181	88,428	47.265	28,122
February	49,693	80,694	44,016	30,311
March	70,387	90,934	46,819	29,185

* Even as measured in sterling, British exports declined. Comparing the first nine months of 1931 with the first nine months of 1932, we find a decline of 7% in British exports measured in sterling. We find a decline of 19% in the case of Sweden, again measured in her domestic currency. Sweden followed England in abandoning the gold standard.

In the midst of this conference, there came a call from a banker in another city who had been subject to a run, and whom we had been helping. He reported that he had been having very little sleep for three nights, but that he had succeeded in raising $7,000,000 of new capital among the capitalists and industries of his community. His bank was safe. He would pay off next day a loan we had made him of $5,000,000, and he wished to inquire if that loan could be obtained again in the event that he needed it. This was heartening news in the midst of the British disaster. The banker of the other city, of course, received the assurance that the loan that he was to pay the next day could be reinstated if he needed it.

• 1This point will be discussed at length in Chap. 34.
• 2I have not been able to find that this article was ever published. However, the reader will find much of it in two books by Veblen: Imperial Germany and the Industrial Revolution, New York, 1915; and The Nature of Peace and the Terms of Its Perpetuation, New York, 1917.
• 3See my book The Effects of the War on Money, Credit and Banking in France and the United States, published by the Carnegie Endowment for International Peace, Oxford University Press, New York, 1919. For London, see the interesting articles by Mr. J. M. Keynes in the British Economic Journal in late 1914.
• 4O. M. W. Sprague: “Crisis of 1914 in the United States,” American Economic Review, September, 1915; H. G. S. Noble: “The New York Stock Exchange in the Crisis of 1914,” Garden City, N. Y., Country Life Press, 1915. These two papers are classics of permanent value.
• 5The figures of all the State and National banks and trust companies appear only once a year in the Comptroller’s report as of approximately June 30. For dates other than June 30, it is necessary to make estimates. During the war period these estimates are made on the basis of variation in the National Bank figures.
• 6War Industries Board Price Bulletin No. 3, Government Control Over Prices, by Paul Willard Garrett, assisted by Isador Lubin and Stella Stewart, Washington, Government Printing Office, 1920, p. 550.
• 7Mr. Herbert Hoover, in particular, did a superb job in bringing the grain and milling interests into the service of the country. I shall later find occasion to criticize his policies as President, but I wish to pay high tribute to his work in feeding the Belgians before we entered the war, to his work in food control at home during the war, to his postwar work in feeding stricken countries, and to his work under President Truman along similar lines after World War II.