Around the world, banks had been weakened by loan losses. Several European countries had devalued their currencies, leading the markets to conclude that the pound must be next - particularly because it was seen as being pegged at too high a rate. Faced with these pressures, the Government bowed to the inevitable, reversed its strong pound policy, and let sterling float.
That all happened 61 years ago, when, on 20 September 1931, Britain abandoned the gold standard. It was an event that has scarred political memories for two generations, for the financial crisis which preceded it led to the fall of the minority Labour administration and the decision by its leader, Ramsay MacDonald, to form the National Government with the help of the Conservatives. Electoral catastrophe followed for Labour, and many within the party never forgave MacDonald. Labour's suspicion of the international banking community, which played a part in the government's fall, dates from this experience, too.
Despite these parallels, the differences between the situation then and now are at least as great as the similarities. But until there is a secure recovery in the world economy, the memory of the 1931 crisis will remain a monument to the pursuit of an ideal at the expense of reality by politicians and bankers alike.
To understand the apparent pig-headedness of the world's political establishment as it fought to preserve the gold standard, one has to go back to the period immediately after the First World War. Until 1914, when it collapsed, most of the world was on the gold standard, under which a country was committed to exchange its currency for gold on demand. The gold standard was the anchor of international financial stability, which had made possible the most remarkable period of growth the world had ever known. It was natural to want to recreate those conditions. But the desire to return to the gold standard came not just from an emotional wish to put the clock back: it was also a response to the turmoil of the early Twenties.
The 1919-21 period saw a dramatic boom and slump, with prices rising and falling by as much as 50 per cent in Britain, France and the US, and businesses being bankrupted as a result. Germany, crippled by reparations, was already heading towards the hyperinflation of 1923. That experience helps explain the German commitment to sound money today; at the time it impressed upon the rest of the world the danger of monetary systems without an anchor.
The obvious anchor was gold. Much of the early Twenties was spent reconstructing a system which at least looked like the pre-war gold standard (brilliantly described in a new book by Barry Eichengreen ('Golden Fetters. The Gold Standard and the Great Depression 1919-1939' by Barry Eichengreen (OUP, pounds 32.50)). There were many difficulties, including the debt burden from the war, balance of payments deficits in the shattered economies, and in particular the rise in prices. For countries such as Britain, where prices had risen by less than 50 per cent since 1914, it seemed feasible to get back to gold at the old rate, which was equivalent to dollars 4.86; where inflation had been greater, there had to be devaluation.
Britain, at the insistence of the then Chancellor, Winston Churchill, returned to a form of the gold standard on 29 April 1925, at the old rate, even though it meant that sterling would be about 10 per cent overvalued. Some had misgivings, in particular John Maynard Keynes, the economist, who attacked the whole idea of returning to the gold standard. Keynes attacked the decision in his pamphlet, The Economic Consequences of Mr Churchill. The title parodied Keynes's earlier book on post-war reparations, The Economic Consequences of the Peace.
Churchill's decision led to six years of struggle, during which Britain had higher interest rates and lower growth than most of the industrial world. It was assumed that America would experience inflation, and that by holding prices steady in the UK the 10 per cent gap could be bridged. But this did not happen, and Britain was faced with the task of cutting prices and wages. The attempt to cut miners' wages led to the General Strike in 1926, the most dramatic result of deflation. Churchill was reviled.
During the late Twenties, the return to the gold standard put downward economic pressure on most other industrialised countries. The exception was the US, with an undervalued dollar, where the roaring Twenties finally ended in the great crash of October 1929.
That signalled the start of the Great Depression. Financial dislocation led to bank failures, a collapse of confidence and two years of falling output and soaring unemployment. By the summer of 1931, unemployment had reached 25 per cent in the US, 21 per cent in the UK and 34 per cent in Germany. The world was facing economic catastrophe.
The spring and summer of 1931 saw the series of banking crises on the Continent which led to Britain abandoning gold. In Austria, the collapse of the largest bank, Credit-Anstalt, led to a flood of money out of the country. To stem the flow, the government left the gold standard and imposed exchange controls. Hungary and Germany were forced to follow by similar flights of capital.
Britain had three months of financial crisis. The country's balance of payments was in deficit, hit by a fall in income from service exports. Tourist receipts fell, and income from abroad collapsed.
In July the run on the pound began. That month, the Bank of England lost pounds 56m of its gold reserves. To try to stem the flow, in late July the Bank rate (the rate at which it lent to the banking system) was increased twice, first to 3.5 per cent and then to 4.5 per cent,but the tactic failed. There were no further increases, a decision often attributed to the ill-health of Montagu Norman, the Governor of the Bank. But it must have also been caused by the dangers of increasing interest rates when the economy was so weak. The Bank realised that increasing its rate a third time would be seen as weakness, rather than determination.
Two other initiatives might have saved the gold standard: international support and a package of budget cuts. But the Bank had the greatest difficulty in raising international loans, and the government could not agree on a budget package. The Bank did raise pounds 25m from the Bank of France and the Federal Reserve Bank of New York at the end of July, but this was less than the loss of gold. It was told that further credits were unlikely unless the British government cut its budget deficit. The minority Labour government, which had come to power in 1929, led by MacDonald, said it was prepared to make some spending cuts, but not the sharp fall in unemployment benefit for which New York bankers were calling. Liberal supporters of the government were not prepared to vote for large tax increases. The result was deadlock and the government fell.
The new National government, led by MacDonald and supported by the Conservatives, produced its budget on 10 September. This increased taxes by pounds 75m and cut spending by pounds 70m: enough to enable the Government to raise dollars 200m from J P Morgan, the New York commercial bank, and a matching amount from Paris. But by then it was too late. The flight of gold continued, and by Saturday 19 September the credits were exhausted and the Bank's reserves were down to the bare minimum. It told the government it could not go on, and on the evening of 20 September suspended convertibility.
In one of those curious footnotes to history, Montagu Norman knew nothing about the decision. At the time, he was on a boat returning from America. His deputy sent him an obliquely-worded telegram ('Sorry to go off before you arrived') to warn him, but he misunderstood it and only learnt what had happened when he reached Liverpool the following Wednesday.
After devaluation, Britain managed a steady, though slow, economic recovery, but the US economy headed down for another two years; and in Germany came the tragedy of Hitler. Some might be tempted to see a parallel between the mind-set which led to a return to the gold standard in 1925 and our commitment to the exchange rate mechanism in 1990. But whatever one's views about the ERM, one should note these differences: so far, the world recession is limited compared with the Thirties; global indebtedness is far lower; the world banking system is far more secure, as are governments in most industrial nations.
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