International Gold Standard and US Moentary Policy from World War ...

The International Gold Standard andU.S. Monetary Policy from World War Ito the New Deal

Leland Crabbe, of the Division of Research andStatistics at the Board of Governors, preparedthis article, which is the second in a seriescelebrating the seventy-fifth anniversary of thefounding of the Federal Reserve System.

Before the First World War, most of the world,including the United States, Great Britain, andevery country in Europe, maintained gold stan-dard. In the United States, the Resumption Acthad restored the gold standard in 1879, and theGold Standard Act of 1900 had established goldas the ultimate standard of value. Internationally,the gold standard committed the United States tomaintain a fixed exchange rate in relation to othercountries on the gold standard, a commitmentthat facilitated the flow of goods and capitalamong countries. Domestically, the gold stan-dard committed the United States to limit theexpansion of money and credit, and thus itrestrained inflationary pressures.

The international gold standard did not func-tion ideally, however. Although the gold stan-dard provided a basis for nominal stability overthe long run, the U.S. and world economy suf-fered in the short run through periods of depres-sion and inflation due to changes in the world'ssupply of and demand for gold. Moreover, theU.S. commitment to the international gold stan-dard had a cost: It confined, though it did notpreclude, discretionary management of the do-mestic economy.

From the First World War to the New Deal,amid upheaval in international and domestic fi-nancial markets, the United States honored itscommitment to redeem dollars for gold at $20.67per ounce. Maintenance of the gold standard,however, recurrently interfered with the FederalReserve's broader objective of stabilizing the

domestic economy. During the First World War,the United States and other belligerents fully orpartly suspended the gold standard, de jure or defacto, to prevent it from hampering the wareffort. In 1920, when the United States aloneoperated the gold standard without restrictions,the Federal Reserve imposed a severe monetarycontraction, which defended the gold standardbut contributed greatly to a depression. Hopingto stabilize the world economy in the 1920s, theindustrial nations, notably Britain and France,restored the international gold standard. Therestoration—which must be judged a failure—compelled the Federal Reserve to make choicesbetween its international and its domestic objec-tives. Indeed, throughout the 1920s and early1930s, Federal Reserve policy alternated be-tween management of the international gold stan-dard and management of the domestic economy.With the devaluation of the dollar in 1933, theUnited States established the principle that do-mestic policy objectives had primacy over thedictates of the gold standard. (See table 1 for themajor events covered in this paper and the inserton page 425 for definitions of terms regarding thegold standard.)

THE FIRST WORLD WAR

The First World War nearly demolished theinternational gold standard. While none of thecountries at war demonetized gold or refused tobuy gold at a fixed price, none adhered strictly tothe tenets of the gold standard. When the warbegan, belligerent governments instituted severallegal and practical changes in the gold standard,which they viewed as a temporary suspension ofthe rules rather than as a permanent abandon-

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

424 Federal Reserve Bulletin • June 1989

1. Major events in the history of the internationalgold standard, 1914-34

Date

August 1914November 16, 1914January 13, 1916April 6, 1917November 11, 1918

1920

January 1923January 1924April 28, 1925July 1926July 1927October 23, 1929

September 21, 1931March 6, 1933

June-July 1933

January 30, 1934

Event

World War I beginsFederal Reserve Banks openBritain pegs the pound at $4.76United States enters the warArmistice declared

Federal Reserve defends the goldstandard

France and Belgium invade the RuhrDawes PlanBritain returns to the gold standardFrench currency crisisInter-central-bank agreementU.S. stock market crashes

Britain abandons the gold standardBank holiday; U.S. suspends the

gold standardWorld Monetary and Economic

Conference convenesGold Reserve Act passed

ment of the international monetary system. Pre-vious wars had often forced suspension; peacehad always brought restoration.

U.S. Response to the 1914 Crisis

Although the United States did not enter the waruntil 1917, the outbreak of war in Europe in 1914immediately disrupted U.S. financial and com-modity markets, the latter being heavily depen-dent on London for the financing of exports. InJuly 1914, U.S. firms had a large amount ofshort-term debts payable in Europe, primarily inLondon; but this position was normal in thesummer, as borrowers expected to use the pro-ceeds from exports of cotton and grain to pay offtheir liabilities in the fall. As Europe movedtoward war, the world's financial markets be-came highly disorganized, especially after ac-ceptance and discount houses in London shutdown their operations. Late in July, as foreignersbegan liquidating their holdings of U.S securitiesand as U.S. debtors scrambled to meet theirobligations to pay in sterling, the dollar-poundexchange rate soared as high as $6.75, far abovethe parity of $4.8665. Large quantities of goldbegan to flow out of the United States as thepremium on sterling made exports of gold highlyprofitable. Under the pressure of heavy foreignselling, stock prices fell sharply in New York.The banking and financial systems in the UnitedStates seemed on the verge of collapse.

Relief came without the suspension of the goldstandard in the United States. On July 31, theNew York Stock Exchange joined the world'sother major exchanges in closing its doors, thuseasing pressure on the gold standard by prevent-ing the export of gold arising from foreign sales ofU.S. corporate securities. In August, unsafeshipping conditions and the unavailability of in-surance further slowed gold exports. Still, withthe export sector in disarray and with $500million in short-term debts coming due in Eu-rope, the United States needed to implementadditional actions to defend the exchange valueof the dollar. The most important relief measurecame on August 3, when Secretary of the Trea-sury William McAdoo authorized national andstate banks to issue emergency currency byinvoking the Aldrich-Vreeland Act. Because itallowed banks to use such notes to meet cur-rency withdrawals and to safeguard reserves,this emergency measure kept panic from sweep-ing over the banking system. In early September,less than a month after its first members took theoath of office, the Federal Reserve Board, inconjunction with the Secretary of the Treasury,organized a syndicate of banks that subscribed$108 million in gold to pay U.S. indebtedness inEurope. Less than $10 million was actually ex-ported from this gold fund, however, because theorganization of the fund itself provided foreigncreditors with the assurance they required.

Although the international financial machinerybroke down more fundamentally in 1914 than ithad in previous crises, the U.S. domestic econ-omy fared surprisingly well. Primarily becausethe issuance of emergency currency providedliquidity, the volume of loans made by banks wasmuch higher than in past crises. Because banksin the country actually increased their loansoutstanding, in contrast to their past practices,the crisis of 1914 did not unduly burden banks inNew York. Although interest rates in the UnitedStates rose and remained high through the au-tumn, rates did not soar to the levels reached inpast panics. By the time the Federal ReserveBanks opened, on November 16, 1914, the finan-cial crisis in the United States had nearly passed.In November, commercial banks began to retireAldrich-Vreeland notes. In December, gold be-gan to flow toward the United States, and the


International Gold Standard 425

New York Stock Exchange reopened. By Janu-ary, with exports surging, the neutral dollar hadrebounded to move past parity with the pound.

Attempts to Maintain Exchange RateParities during the War

The durability of the international gold standardbefore the First World War can be traced to awell-founded trust in the stability of the principalreserve currency, the British pound. The preser-vation of confidence in the gold standard in GreatBritain during the war relied on keeping thepound above the gold export point of the princi-pal neutral currency, the U.S. dollar. With GreatBritain and all of the other warring nations hun-gering for commodity imports to feed their econ-omies, gold shipments to the United Stateshelped hold exchange rates near parity during theperiod of U.S. neutrality. From August 1914 toApril 1917, the United States imported a total of$1.12 billion in gold, and the monetary gold stockswelled from $1.57 billion to $2.85 billion. Whilethe British wanted to support the pound and to

import war supplies, they realized that gold ex-ports could not satisfy indefinitely these dualobjectives without undermining confidence in thepound. From January 13, 1916, to March 19,1919, J.P. Morgan and Company, acting asagents of the British Treasury, pegged the dollar-pound rate in New York at $4,765.

Gold exports, pegging operations, and largesales of foreign securities partially shielded thefixed structure of the world's exchange rates, butGreat Britain and its allies depended on interna-tional borrowing as the key weapon in theirdefense of exchange rate parities. As the warstretched from months into years, an extraordi-nary network of international lending emerged,which fortified the strained structure of exchangerates. In general, neutrals lent to belligerents.Most important, the United States lent to Britain.As the volume of debt burgeoned, the structureof the debt intertwined: Neutrals lent to neutrals;belligerents lent to their allies. The diversion ofwar-financing pressures partly sheltered theworld exchange rate structure at the cost ofcontorting the world debt structure. When the

THE GOLD STANDARD: DESCRIPTIONS ANDDEFINITIONS

Fixing the value of a country's monetary unit interms of a specific weight of gold constituted theessence of the gold standard. For example, theUnited States went back on the gold standard in1879 by defining a dollar to equal 23.22 fine grains ofgold or, equivalently, by setting a price of $20.67for one troy ounce of gold. Before the First WorldWar, most countries were on a form of the goldcoin standard. These countries minted gold coinsthat circulated, along with notes that were fraction-ally backed by gold reserves, in the paymentssystem as legal tender. To economize on goldreserves after the war, many countries, includingBritain but not the United States, stopped circulat-ing gold coins. Instead, these countries instituted agold bullion standard, under which notes could beexchanged for gold bars.

Under the international gold standard, curren-cies that were fixed in terms of gold were, neces-sarily, tied together by a system of fixed exchangerates. The fixed relative quantity of gold betweentwo currencies in the system was known as theparity. The prewar parity between the dollar andthe pound sterling was $4.8665 to 1 pound, but the

dollar-pound exchange rate could move in eitherdirection away from the parity benchmark by asmall amount to the gold export point, where itbecame profitable to ship gold to the country withthe stronger currency.

Before the First World War, many central banksheld pounds as a reserve asset, and the poundusually served in lieu of gold in international trans-actions; this system was known as the sterlingexchange standard. At the Genoa Conference of1922, all European governments declared the rees-tablishment of the international gold standard to betheir ultimate and common financial objective and,to economize further on gold reserves, resolved toadopt a gold exchange standard under which gold-based assets would serve as reserve assets. Thisgoal was achieved by the mid-1920s. However, theextensive holdings of foreign exchange reserves(primarily dollar- and pound-denominated depositbalances) under the gold exchange standard wentbeyond what the participants at the conference hadenvisioned. In the ten years before World War I,total foreign exchange reserves in European centralbanks fluctuated between $250 million and $400million. In contrast, at the end of 1924, foreignexchange holdings totaled $844 million; at the endof 1928, they were $2.513 billion.



United States entered the war in April 1917,loans by the U.S. government to its allies replen-ished the nearly exhausted resources of the pri-vate financial markets. From April 1917 to No-vember 1920, U.S. net cash advances to Britaintotaled $4.20 billion; to France, $2.97 billion; andto Italy, $1.63 billion. After the war, Britainretained its status as a central creditor nation; butby 1920, British foreign assets had fallen toone-fourth of their 1914 level, while more than$11 billion in capital exports during the war hadtransformed the United States from a debtor intoa creditor nation.

Suspension of the International GoldStandard during the War

To be on the gold standard a country needed tomaintain the convertibility between notes andgold and to allow gold to flow freely across itsborders. In the early days of the war, Austria-Hungary, France, Germany, and Russia all wentoff the gold standard as they suspended speciepayments and instituted legal or de facto embar-goes on the export of gold by private citizens.Like the British Treasury, the governments ofthese warring countries exported gold and bor-rowed heavily to finance the war, but thesetactics raised only a fraction of the large sums ofmoney that the war required. Because new taxesdid not and could not make up the difference, thecontinental belligerents financed a large share ofthe war by printing money, which caused pricesto soar and complicated the return of thesecountries to the gold standard after the war.Unlike other belligerents, Britain did not for-mally suspend specie payments or institute anembargo on gold exports during the war. Severalfactors, however, effectively prevented conver-sion of Bank of England notes into gold: Frus-trating procedural obstacles at the Bank andappeals to patriotism dissuaded would-be hoard-ers of gold; the pegging operations and highinsurance rates undercut the incentive to export;and, most important, dealers in the London goldmarket refused to ship gold to countries that didnot reciprocate with gold exports in trade trans-actions.

During its period of neutrality, the UnitedStates maintained specie payments and permit-

ted gold to flow freely to and from other coun-tries. Five months after the United States en-tered the war, President Wilson issued aproclamation that required all parties whowished to export gold from the United States toobtain permission from the Secretary of theTreasury and the Federal Reserve Board. Be-cause most of these applications were denied, theUnited States effectively embargoed the exportof gold, and this embargo partially suspended thegold standard from September 1917 until June1919. Although unwilling to let the gold standardinterfere with the war effort, the United Statescontinued to maintain it in a limited sense, asbanks did not suspend specie payments. In prac-tice, however, even the redemption of notes forgold became difficult until the end of the war.

The struggle to restore the international goldstandard after World War I differed significantlyfrom past experience. In the half century beforethe war, the pound sterling and a growing familyof gold-standard currencies provided a reliablepoint of reference for nongold currencies. Duringthis period, the many countries that had eitheradopted or restored the gold standard coulddepend on the Bank of England to provide pre-dictable policy in which changes in the Bank ratecarefully regulated the Bank's reserve position.In 1919, almost every country regarded the goldstandard as an essential institution; but, amongthe world powers, only the United States couldbe counted as a gold-standard country. For othermajor countries, four years of inflation, pricecontrols, exchange controls, and massive goldshipments complicated the problem of restora-tion. Many governments weighed the pros andcons of returning to par versus devaluation, thelatter involving the problematic selection of anew parity. Deflation and unemployment awaitednations that aspired to reinstate prewar goldparities. More, the general reestablishment of theinternational gold standard promised to precipi-tate large and discontinuous increases in theworld demand for gold. Rather than subjectingtheir economies to undue turmoil, most govern-ments preferred to wait, at least until the poundsterling—the key currency to which otherslooked for leadership—had stabilized. By de-fault, the Federal Reserve assumed the office ofmanager of the gold standard.


International Gold Standard All

FEDERAL RESERVE'S POSTWAR DEFENSEOF THE GOLD STANDARD

Every Federal reserve bank shall maintain reservesin gold or lawful money of not less than thirty-fiveper centum against its deposits and reserves in goldof not less than forty per centum against its Federalreserve notes in actual circulation.1

The Federal Reserve Act had legally preservedgold as the ultimate monetary standard in theUnited States. The gold standard, however, didnot play an active role in the implementation ofpolicy, as the act required that Federal ReserveBanks maintain only a minimum ratio of goldreserves to currency and deposits. (The goldstandard would have played a more active rolehad the act stipulated the maintenance of aspecific gold reserve ratio.) Because the goldreserve requirement rarely restrained policy be-tween 1914 and 1933, the Federal Reserve hadbroad discretionary powers to manage the na-tion's money supply in the advancement of do-mestic objectives.2 However, the gold standardremained as a latent check on the Federal Re-serve: The required minimum ratio limited theFederal Reserve's authority to augment themoney supply, which could continue to expandonly so long as gold flowed into reserves.

From the opening of the Federal ReserveBanks in November 1914 to the signing of theArmistice in November 1918, wholesale prices inthe United States doubled, and the money supply(currency held by the public plus demand depos-its) grew 70 percent. Under normal conditions, ahuge credit expansion and sizable inflation wouldhave endangered the gold standard. However,the flood of gold imports during the period of

1. Federal Reserve Act, P.L. 63-43 (December 23, 1913),sec. 16.

2. "During most of their life the Federal Reserve Bankshave held large amounts of reserves in excess of require-ments, and the actual amount of excess reserves and reserveratio have not been of particular significance. At times,however—especially in 1920 and during the banking holidayin 1933—reserve ratios were close to the legal limit. Ingeneral, Federal Reserve credit policy is determined on thebasis of the broad needs of the credit and business situationand not on the basis of variations in the reserve ratio." SeeBoard of Governors of the Federal Reserve System, Bankingand Monetary Statistics, 1914-1941 (Board of Governors,1943), p. 329.

U.S. neutrality had pushed the ratio of goldreserves to deposit and Federal Reserve noteliabilities to 84.1 percent in March 1917. Al-though the gold reserve ratio declined fairlysteadily after the United States entered the war,it stood at 48.3 percent at the end of the war, anadequate distance above the legal minimum.

After the war, two factors combined to lowerthe gold ratio; consequently, the gold standard inthe United States encountered a challenge. First,the Federal Reserve supported the Treasury'splacing of Liberty Bonds with banks by keepingthe discount rate below market interest rates andthus postponed the reversal of the wartime mon-etary and price expansion. From the end of thewar to January 1920, as member banks borrowedheavily from the Federal Reserve, the moneysupply rose 18 percent and the price level rose 16percent. Second, the repeal by the United Statesof the gold export embargo in June 1919 made thegold standard fully operative. As a result, theUnited States exported gold in every month fromJune 1919 through March 1920, for a total for theperiod of $300 million. In hindsight, BenjaminStrong, the Governor of the New York ReserveBank, conceded that an increase in the discountrate in the first quarter of 1919 "would have beenas close to an ideal 100 per cent policy ofperfection as could have been adopted."3 ByDecember 1919, the combination of gold exportsand money supply growth had reduced the goldreserve ratio to 43.5 percent.

The Federal Reserve responded to these infla-tionary developments by choking off the creditexpansion in 1920. Early in the year, the FederalReserve Banks increased their discount rates1.25 percentage points to 6 percent—the largestjump in the seventy-five-year history of the Fed-eral Reserve—just as the economy entered aslump. Both the wholesale price level and themoney supply peaked in the spring of 1920, and,partly because of gold exports, the gold ratiocontinued to edge down, to 40.9 percent in May.

3. W. Randolph Burgess, ed., Interpretations of FederalReserve Policy in the Speeches and Writing of BenjaminStrong (Harper & Brothers, 1930), p. 85, from a hearingbefore the Joint Commission of Agricultural Inquiry, August2-11, 1921. Strong stated that the Federal Reserve resistedcontracting the money supply in 1919 to prevent high interestrates from interfering with the flotation of the Victory Loan.



In June 1920, the Federal Reserve Banks in NewYork, Chicago, Boston, and Kansas City pushedthe discount rate to 7 percent, and they held itthere until May 1921. Dear money plunged theeconomy into a depression. From the peak inJanuary 1920 to the trough in July 1921, realoutput fell 4 percent; prices, 40 percent; and themoney supply, 11 percent. During the eighteen-month depression, high interest rates attractedgold imports of $351 million, mitigating the ad-justment to the monetary stringency. By July1921, the gold reserve ratio had recovered to 61.7percent. As the economy rebounded, prices sta-bilized and gold continued to flow into the UnitedStates; and from the end of 1921 to the end of1925, the gold reserve ratio remained above 70percent.

The decisive policy actions of 1920 attest to theFederal Reserve's limited scope for discretionunder the gold standard. Had trends in monetaryexpansion persisted, the gold reserve ratio wouldhave fallen below the legal minimum, a situationrequiring a modification, suspension, or aban-donment of the gold standard. Playing accordingto the rules, the Federal Reserve tightenedcredit, a move that attracted gold from abroadand caused notes to reflux. The Federal Reservehas been criticized for moving too late, for actingwith too much force, and for keeping money deartoo long. Its defense of the gold standard, how-ever, conformed broadly to the European tradi-tion of central bank policy.

DELAYED RESTORATIONOF THE INTERNATIONAL GOLD STANDARD

In theory, the "strict rules" of the internationalgold standard regulated the international pricestructure and anchored the international pricelevel over the long run. Consider a simplifieddescription of the price-specie flow mechanism.Following an increase in a country's monetarygold stock (arising from, say, new discoveries ofgold) and an expansion of the money supply, thedomestic price level would rise, and the relativeprice of foreign goods would fall. This change inrelative prices would induce an increase in im-ports and a reduction in exports, with gold ex-ports balancing the trade deficit. The gold out-

flow would reduce pressure on the domesticprice level and increase foreign prices. Domesticand foreign prices would converge, with theinternational price level determined by theworld's monetary gold stock.

Federal Reserve Sterilizationof Gold Flows

In practice, under the gold standard centralbanks had the ability—within limits—to managethe effects of gold flows. When a country im-ported gold, its central bank could sterilize theeffect of the gold inflow on the monetary base byselling securities on the open market. When acountry exported gold, its central bank couldsterilize the gold outflow with open market pur-chases. For countries with gold reserve require-ments, the legal ratio would limit the ability ofthe central bank to sterilize exports. For all goldstandard countries, continued sterilization ofgold exports would reduce the ratio of gold tonotes, increasing the risk of a forced suspensionof the gold standard should citizens attempt toredeem central bank notes for gold.

Sterilization of gold flows shifted the burden ofthe adjustment of international prices to othergold standard countries. When a country steril-ized gold imports, it precluded the gold flow fromincreasing the domestic price level and frommitigating the deflationary tendency in the restof the world. Under the international gold stan-dard, no country had absolute control over itsdomestic price level in the long run; but a largecountry could influence whether its price levelconverged toward the world price level or worldprices converged toward the domestic pricelevel.

In the early 1920s, the United States bid ahigher price for monetary gold than any othercountry did. As a result, gold flowed toward theUnited States and afforded considerable slack tothe manager of the gold standard, the FederalReserve. Instead of letting gold imports expandthe money supply and raise the domestic pricelevel, the Federal Reserve sterilized gold inflowsand stabilized the domestic price level. Chart 1,which presents evidence of the sterilization,shows that changes in Federal Reserve Bankcredit outstanding offset changes in the monetary



gold stock in the 1920s.4 Chart 1 also displays thesuccess of the sterilization operations: After Jan-uary 1921, the wholesale price level fluctuatedwithin a narrow 6 percent band.

Traditionally, economists and politicians havecriticized the Federal Reserve for not playing by thestrict rules of the gold standard during the 1920s. Forexample, William A. Brown stated the followingabout the Federal Reserve policy of sterilization:

From 1914 to 1925 it was true that the influenceof American policy alone on American pricesand therefore on the world value of gold was sodominant as to deprive the expression "main-taining the dollar at parity with gold" of thesignificance properly attributed to it when aninternational gold standard system is inforce. . . . Though this large measure of controlover the traditional standard was freely recog-nized and taken advantage of under the exigen-cies of war and post-war finance, this was notenough to alter by a hair's breadth the deepunderlying conviction that the United States wasanchored to a sound monetary base and thattherefore her currency was safe. The UnitedStates was dragging her golden anchor. Indeed,she was carrying it on deck, but as long as shewas still attached to it, she felt safe even thoughit was no longer fast to the ocean bed.5

This traditional judgment may have been tooharsh: What were the "rules" of the interna-tional gold standard in a period when no majorcountry other than the United States maintaineda commitment to buy and sell gold at a fixed pricewithout export restrictions? The gold standardcould "anchor" the price level only if the worlddemand for gold were stable. In consideration ofthe international uncertainty, Federal Reservesterilization in the early 1920s probably servedthe best interests of the United States.

Britain's Slow Return to Parity

After the war, Britain and all European countrieswanted to restore the legal gold-backing for their

SOURCE. Monthly data for the gold stock and for Federal ReserveBank credit are from Board of Governors of the Federal ReserveSystem, Banking and Monetary Statistics, 1914-1941 (Board of Gov-ernors, 1943), table 101; monthly data for wholesale prices are fromGeorge F. Warren and Frank A. Pearson, Gold and Prices (JohnWiley, 1935), table 1, p. 14.

currencies. However, wholesale prices in Britainhad increased 115 percent from August 1914 toMarch 1919; and, after the British Treasurystopped pegging the pound in March 1919, thepound reeled to 69.5 percent of its prewar parity—to $3.38—in February 1920. Meanwhile, as thegovernment removed wartime price controls,prices in Britain surged another 41 percent.6

Although determined to restore the prewar goldparity, the British had to wait for price deflationand sterling appreciation. While they waited, theformal embargo of exports on gold protected theBank of England's gold reserve. The restockingboom propelled deposits and note circulationupward in 1919, but when the Bank of Englandpushed the Bank rate to 7 percent in April 1920and held it there for an unprecedented 54 weeks,prices began to fall, the credit expansion slowlyceased, and the economy entered a depression.

4. Federal Reserve Bank credit was the sum of the earningassets of the Federal Reserve Banks. The principal assetswere bills discounted, bills bought, and government securi-ties.

5. William Adams Brown, Jr., The International GoldStandard Reinterpreted, 1914-1934, vol. 1 (National Bureauof Economic Research, 1940), p. 286.

6. France's difficulties were even more serious than Brit-ain's: French wholesale prices rose 249 percent from 1914 to1919 and another 43 percent from 1919 to 1920. In February1919, the French franc was at 95.1 percent of the prewarparity; by February 1920, it had fallen to 36.5 percent of theprewar parity.



From 1920 through 1922, many of Europe'scurrencies were converging toward a fixed pointof reference, but continental governments foundit in their interest to have their currencies followthe world's main currency, the pound, in lieu ofpegging to the dollar and gold. Fluctuation in thedollar-pound rate, therefore, meant general fluc-tuation of European currencies in terms of gold.By December 1922, Britain's decision to restorethe prewar gold parity seemed sagacious andreasonable, as the dollar-pound exchange ratehad reached $4.61, within grasp of the prewarparity of $4.8665. Prices in Britain had fallen 50percent since February 1920, and the monetarybase and credit structure had stabilized. More-over, the British expected that recent additionsto the U.S. monetary gold stock would increaseU.S. prices and, consequently, ease the adjust-ment process in Britain.

Political and economic tensions on the conti-nent combined with sterilization of gold importsby the Federal Reserve forced Britain to con-tinue delaying restoration of the gold standard.The London Ultimatum of May 1921 had set theGerman reparations at $33 billion (approximately$230 billion in 1989 dollars). In January 1923,France and Belgium invaded the industrial Ruhrvalley in Germany, offering the failure of Ger-many to meet reparation payments as justifica-tion. The Germans responded with passive resis-tance, and output in the Ruhr fell two-thirds. TheGerman government printed money to supportthe unemployed in the Ruhr and thus launchedthe German mark on its famous hyperinflation.The Ruhr occupation induced capital to flee fromBritain and Europe to the United States, trifur-cating the world currency structure into dollar,sterling, and French franc areas and causing thedollar-pound exchange rate to slip to $4.25 byJanuary 1924. The prospects of a restoration ofthe international gold standard seemed distant.

The United States emerged from isolationismin January 1924 with the Dawes Plan, which allbut insured the success of the German currencyreform of October 1923. The plan rescheduledreparation payments and provided a loan toGermany, which allowed Germany to meet trans-fer payments and still have resources availablefor domestic industrial expansion. From 1924 to1929, Germany borrowed $5 billion, half of it

from the United States. The World War I allies,in turn, used reparation funds to repay war debtsto the United States. The Dawes Plan, which hadthe commitment of the financial resources of theUnited States as its foundation, demonstratedthe ability of international cooperative agree-ments to allay financial crises.

The continental governments with new cur-rency systems had to choose between pegging tothe gold-backed dollar or stabilizing in terms ofsterling. Uncertain leadership in the foreign ex-change market in itself marked the waning powerof the pound. Pressure on Britain to restore thegold standard mounted in 1924 as membership inthe dollar group waxed: Sweden restored thegold standard in March; Germany adhered to thedollar group after Dawes loans stabilized theReichsmark; Australia and South Africa, tired ofwaiting for Britain, decided independently toreturn to the gold standard. The pound sterlingremained the predominant instrument in worldtrade and finance; yet the dollar, not sterling,gained respect for being as good as gold. By theend of 1924, the group of twenty-five currenciesthat had stabilized in terms of the dollar includedthe pound sterling.

The Federal Reserve's Role in theRestoration of the Gold Standardin Britain

In the spring and summer of 1924, the FederalReserve assisted Britain as it prepared to restorethe gold standard. Between May and August, theFederal Reserve Bank of New York cut thediscount rate three times—overall, from 4.5 per-cent to 3 percent—and from the end of Junethrough December 1924, Federal Reserve Bankcredit outstanding rose from $831 million to$1,302 million, an unusually large increase evenafter accounting for seasonal movements. TheUnited States had imported gold in every monthfrom September 1920 to November 1924—a totalof $1.47 billion—but from December 1924through April 1925, U.S. gold exports totaled$172 million. In January 1925, as Britain nearedrestoration, the Federal Reserve Banks agreed tosell the British Treasury up to $200 million ingold, and a banking syndicate led by J.P. Morgan



and Company provided it with a $100-million lineof credit.

Lower interest rates undoubtedly expeditedBritain's return to the gold standard. In thesecond half of 1924, this policy also stimulatedthe U.S. economy as it climbed out of a moderaterecession. In the first quarter of 1925, however,the Federal Reserve moved to check the over-heating domestic economy. In particular, onFebruary 27, the Federal Reserve Bank of NewYork increased its discount rate to 3.5 percent, amove that complicated Britain's return to thegold standard. On March 5, 1925, the Bank ofEngland increased the Bank rate from 4 percentto 5 percent to maintain the attractiveness ofsterling assets.

On April 28, 1925, Winston Churchill, thenChancellor of the Exchequer, returned Britain tothe gold standard by announcing that the Goldand Silver (Export Control) Act, which was dueto expire at year-end, would not be renewed. OnMay 13, Parliament passed the Gold StandardAct of 1925, which obligated the Bank of Englandto sell gold bullion in exchange for notes at theprewar par of 77s. 10.5d. per standard ounce. Atthe end of 1925, thirty-nine countries had re-turned to par, had devalued their currency, orhad achieved de facto stabilization with the dol-lar.

Fiscal Crisis and the Restorationof the Gold Standard in France

In the first half of the 1920s, the French govern-ment, already saddled with onerous debts in-curred during the war, resorted to deficit fi-nancing in its campaign to rebuild the economy.During this period, the French franc fluctuatedwith the misfortunes of the German mark, as theprospective, but improbable, flow of Germanreparation payments promised to mitigate thefiscal burden in France. The German currencycrisis thwarted French plans to collect repara-tions, and the franc depreciated from 14.97francs per dollar in January 1923 to 22.63 francsper dollar in February 1924. After the DawesPlan, the franc stabilized, holding steady below20 francs per dollar from March 1924 until June1925.

But the stabilization did not last, as the Frenchgovernment continued to run large budget defi-cits, a situation that led to a confrontation be-tween the nation's monetary and fiscal authori-ties. Because the economy had a limited capacityto absorb more debt, the French governmentcould not continue to float bonds without resort-ing to monetization. The Bank of France acqui-esced. Advances to the state and the issuance ofnotes to purchase government securities roserapidly, bumping against their ever-rising legallimits. From the Ruhr invasion in January 1923 tothe climax of the crisis in July 1926, wholesaleprices in France surged 116 percent, and thefranc-dollar rate soared to 49 francs per dollar.Fearing a repetition of the hyperinflation that hadswept across central Europe three years earlier,French investors poured their capital into gold-based assets.

In August, the Poincare government broke thecrisis by raising taxes. New legislation allowedthe Bank of France to buy gold and foreignexchange at a premium and to issue notes againstthese assets without a legal limit. The fiscalstabilization plan succeeded as prices stoppedrising, and the franc recovered in the foreignexchange market. In December, the French francstabilized around 25 francs per dollar—an 80percent devaluation from the 1914 parity. Thestabilization of the French franc at an underval-ued rate largely completed the de facto establish-ment of the international gold exchange stan-dard. The restoration of the gold standard,however, provided only an illusion of stability tothe international monetary system because ex-change rates were misaligned. As a result of thatmisalignment, first Britain and later the UnitedStates had to engage in costly struggles to main-tain the gold backing of their currencies.

Following the stabilization, the franc rose ininfluence, phoenix-like, out of the crisis thatravaged it. A substantial proportion of the flightcapital of the summer of 1926 had landed indeposit balances in London and New York,where it lay, awaiting repatriation, capable ofaugmenting the strength of the undervalued francin foreign exchange markets. Britain settled intoan uneasy stability. Its restoration of the goldstandard in 1925 had initiated a depression, butthe unemployed could not rely on relief from the



Bank of England, which had to keep interestrates competitive with those in New York. InFebruary 1927, the French government eased theappreciation of the franc by beginning to pay offwar and foreign loans. The overvalued pound,however, hovered around the gold export pointduring the first half of the year, as bids fromFrance, Germany, Argentina, India, and theUnited States arrived in the London gold market.Continuation of the gold standard in Britainappeared dubious after the Bank rate fell from 5percent to 4.5 percent on April 27.

INSTABILITY UNDER THE GOLD EXCHANGESTANDARD

Under an inter-central-bank agreement in July1927, the Federal Reserve relieved pressure onthe pound by agreeing to lower interest rates, anaction that diverted the French demand for re-serves from Britain to the United States. OnAugust 5, the discount rate fell from 4 percent to3.5 percent. Larger-than-seasonal open marketpurchases from the end of July to the end ofDecember supplemented the discount policy,raising Federal Reserve Bank credit outstanding$563 million to $1,655 million. While the UnitedStates had imported $80 million in gold in the firsthalf of 1927, gold exports totaled $234 millionduring the last half of the year. The cooperativepolicy initiative achieved its aim as the poundrose steadily in the second half of 1927.

The Federal Reserve abandoned the inter-central-bank agreement in 1928. A resurgence instock prices followed the mild, thirteen-monthrecession (October 1926 to November 1927),compelling the Federal Reserve to reversecourse. From February to July 1928, the discountrate rose from 3.5 percent to 5 percent; theLondon-New York interest rate spread, whichfavored London in January, had turned to favorNew York by June. While exports of gold con-tinued during the first half of 1928, by July highyields in New York had begun to draw gold backtoward the United States, strengthening the dol-lar relative to the pound. As chart 2 shows,throughout the last half of the 1920s the dollar-pound exchange rate displayed high sensitivity to

2. Dollar-pound exchange rate andLondon-New York interest rate spread,1925-1930

SOURCE. Monthly data. Banking and Monetary Statistics, 1914-1941: New York City, 90-day bankers acceptances, table 120; UnitedKingdom, 3-month bankers acceptances, table 172; and the dollar-pound exchange rate, table 173.

the spread between interest rates in London andNew York.

The policy of the Federal Reserve in 1927 and1928 paralleled its policy in 1924 and 1925. Inboth episodes, the Federal Reserve initially low-ered the discount rate during the final stages of arecession. The relaxation of credit also amelio-rated the international situation. In both epi-sodes, the Federal Reserve pulled back as theU.S. economy showed signs of recovery. In1925, the moderate policy reversal slightly ob-structed Britain's return to the gold standard. In1928, the severe reversal significantly disruptedBritain's struggle to retain gold.

When the Federal Reserve turned to managethe domestic economy in 1928, French investorsbegan to repatriate capital en masse, and theBank of France intervened to support the pound.As table 2 indicates, foreign exchange reserves atthe Bank of France ballooned more than tenfoldfrom the end of 1926 to the end of 1928.7 Themonetary law of June 25, 1928, stabilizing thefranc, obligated the Bank of France to buy andsell gold on demand but revoked its power to buyforeign exchange; before the de jure stabiliza-tion, the Bank purchased foreign exchange fordelivery in the forward market in the second halfof 1928. Unfortunately, the accumulation of for-

7. Foreign exchange reserves in the Bank of France aver-aged only $4 million from 1906 to 1913; see Brown, Interna-tional Gold Standard, vol. 2, p. 748.



2. Gold and foreign exchange reserves in European central banks, 1924-32Millions of dollars

1. Combined figures for 23 European central banks, including theBank of France and excluding the Bank of England and the RussianState Bank.

SOURCES. Ragnar Nurkse, "The Gold Exchange Standard" in

Barry Eichengreen, ed., The Gold Standard in Theory and History(Methuen, 1985), appendix II; and William Adams Brown, Jr., TheInternational Gold Standard Reinterpreted, 1914-1934, vol. 2 (Na-tional Bureau of Economic Research, 1940), table 59.

eign exchange reserves only suppressed, and didnot solve, the major problem of the restorationyears, that is, a strong French franc and a weakBritish pound.

Abandonment of the Gold Standardby Britain

In 1929, European central banks, in general,became apprehensive about speculation in theU.S. stock market. While the Bank of Franceand other European central banks began to re-duce foreign exchange reserves and to importgold, the Bank of England endeavored to guardits dwindling gold reserves by increasing theBank rate, from 4.5 percent to 5.5 percent inFebruary and to 6.5 percent in September. Highas interest rates were in London, they were nothigh enough to attract funds from Wall Streetduring the final months of frenzy. In a sense, thestock market crash rescued the beleaguered goldstandard in Britain: after October 1929, foreignfunds fled from New York, and sterling gained arespite.

In times of financial stress, funds generallyflow toward the world's safest and strongestfinancial center. Before the First World War,when this center was London, the world's finan-cial markets were sensitive to changes in the

Bank rate, which the Bank of England adjustedto sustain a normal level of gold reserves. A dropin gold reserves significantly below normal wouldbe followed by an increase in the Bank rate, areduction of capital exports from Great Britain, ashift from long-term to short-term lending, areflux of gold to London from country banks, andimports of gold as funds moved to high rates inLondon. In 1929, however, two financial centers,London and New York, attracted gold. Althoughgold in the Issue Department of the Bank ofEngland rose in the final two months of 1929,Britain exported $74 million in gold for the year1929, $41 million of which went to the UnitedStates. In contrast, even though heavy exports ofgold followed the crash on Wall Street, theUnited States imported a net of $120 million ingold for 1929. The financial centers continued toattract gold in 1930: Britain imported $23.6 mil-lion in gold with little change in the Bank ofEngland's reserve condition, while the UnitedStates imported $278 million in gold.

From the spring of 1925, when the gold stan-dard was restored, to the fall of 1931, when it wasabandoned, the Bank of England resisted forayson the exchange value of the pound sterling. InMay 1931, a run on the Kreditanstalt, the largestAustrian bank, initiated the final defense of thegold exchange standard in Britain. From March

Year-end or month-end

192419251926 .19271928192919301931

MarchJune ..September...December .

1932MarchJune ..SeptemberDecember

Gold reserves

European central banks1 Bank of France

2,278 7102,364 7112,565 7112,900 9543,488 1,2543,839 1,6334,314 2,099

4,379 2,1934,311 2,2224,784 2,3515,271 2,699

5,569 3,0175,876 3,2535,865 3,2405,875 3,257

Foreign exchange reserves

European central banks1 Bank of France

844 14916 13

1,158 1162,142 8502,513 1,2872,286 1,0212,296 1,027

2,013 1,0271,995 1,0311,509 8991,212 842

846 488591 240563 185504 176



to September 1931, the National Bank of Austrialost 55 percent of its large foreign exchangereserves as it tried to fight back capital flight. InJune 1931, panic spread from Austria to Ger-many, and German banks scrambled to exchangesterling deposits for gold in London. From May30 to June 30, the Reichsbank lost 34 percent ofits gold and foreign exchange reserves. In July,with foreigners storming its gold reserve, theBank of England shielded the domestic creditsystem by purchasing securities on the openmarket, by arranging a £50 million credit with theFederal Reserve Bank of New York and theBank of France, and by transferring securitiesfrom the Banking to the Issue Department toprovide for new fiduciary issue. With the ex-change rate below the gold export point, theBank of England barricaded its gold reserves byraising the Bank rate from 2.5 percent to 3.5percent on July 23 and to 4.5 percent on July 30.In spite of these protective efforts, gold reservesin the Issue Department shrank £30.9 million—29percent—from June 24 to July 29. Late in Au-gust, the Bank of England secured an additional£80 million in emergency credits, but the conti-nental and American demand for gold continuedto assault the London bullion market.

In the last two months of its defense of the goldstandard, Britain exported £200 million in goldand foreign exchange. On Wednesday, Septem-ber 16, withdrawals from Britain totaled £5 mil-lion; on Thursday, £10 million; on Friday, £18million; on Saturday, a half day, more than £10million. On Monday, September 21, 1931, theBritish abandoned the gold standard. On thatday, the London Times provided the followinganalysis:

The real crux of the present crisis is the unprec-edented fall in prices which has driven mostcountries off the gold standard and left them in aposition in which default upon their contrac-tual obligations in gold is unavoidable. Worldprices have fallen below the pre-War level. Mostcountries are carrying much greater obligationsin gold than before the War, and though theycould easily meet these when prices were 50 percent or more above the pre-War level, they areunable to do so now. . . . The internationaleconomic crisis has played a large part in thetemporary abandonment of the gold standard.The responsibility for this belongs to those coun-

tries which have hoarded gold on an unprece-dented scale. Creditor countries which insistupon payment in gold are asking for the impos-sible. Prohibitive tariffs keep out goods, andunless the creditor nations re-lend the creditsdue to them the debtor nations must pay in goldto the extent of their resources and then default.The gold standard game can only be playedaccording to its well-proven rules. It cannot beplayed on the new rules practised since the Warby France and the United States.8

Britain had restored the gold standard but hadnot been able to restore the unchallenged su-premacy of the pound sterling. In the six years ofthe restoration, the unemployment rate amonginsured workers in Britain averaged 12.9 percentand never fell below 8.5 percent; in the first ninemonths of 1931, it averaged 21 percent. So longas the Bank of England rendered gold bullion fornotes, the unemployed in Britain were sentencedto serve time with deflation and high real interestrates.

Federal Reserve Policy after BritainAbandoned the Gold Standard

Britain's abandonment of the gold standard cre-ated a conflict between domestic and interna-tional policy objectives at the Federal Reserve.On the one hand, two years of uninterrupteddeflation and mounting unemployment called forthe Federal Reserve to stimulate the domesticeconomy with an expansion of the money sup-ply. On the other hand, international responsibil-ities and the threat of gold exports called for theFederal Reserve to tighten credit and demon-strate its commitment to the gold standard. Theabrupt depreciation of the pound—in October itplunged from the parity of $4.86 to $3.89, and byDecember it was at $3.37—had inflicted capitallosses on Europeans who held sterling assets.With the pound no longer backed by gold, thedollar became the gold standard's major reservecurrency just when European central banks de-sired to prevent further losses on foreign ex-change reserves by discarding the gold exchangestandard and adopting a gold bullion standard.

8. "Gold Standard Suspension: Cause of the WorldCrisis," London Times, September 21, 1931.



Even though foreign exchange reserves in Euro-pean central banks fell 25 percent during thesummer attack on sterling, foreign exchange stillconstituted a substantial percentage of total Eu-ropean reserves in September 1931. The Bank ofFrance, in particular, still held large foreignexchange reserves.9 To prevent a wholesale liq-uidation of dollar reserves, the Federal Reserveneeded to assure the Bank of France of the U.S.intention to remain on the gold standard.

Although these domestic and international ob-jectives conflicted, they were not mutually exclu-sive: The Federal Reserve could have sterilizedgold exports with open market purchases. In thefourth quarter of 1931, however, the FederalReserve bought only $75 million in governmentsecurities, while gold exports, including goldearmarked for export, totaled $294 million.Moreover, the New York Federal Reserve Bankincreased the discount rate from 1.5 percent to2.5 percent on October 9 and to 3.5 percent onOctober 15. These actions demonstrated the Fed-eral Reserve's commitment to the internationalgold standard. Nevertheless, European discon-tent with the gold exchange standard did notsubside. From late September 1931 to late June1932, the combined foreign exchange holdings oftwenty-two European central banks (not includ-ing the Bank of France) fell 42 percent; andforeign exchange reserves in the Bank of Franceplunged 73 percent.

Under pressure from the Congress, the Fed-eral Reserve embarked on a program of openmarket purchases in the spring of 1932, by pur-chasing $912 million of government securities.The net effect of monetary policy was onlyslightly expansionary, however, since the goldstock fell $417 million and the total of bills boughtand bills discounted fell $199 million. The Fed-eral Reserve could have expanded the openmarket purchase program without threatening

9. In September 1931, foreign exchange reserves as apercentage of total reserves totaled 27.7 percent in France, 35percent in Italy, 51.6 percent in Danzig, 61.9 percent inFinland, 68.2 percent in Hungary, 71 percent in Latvia, 58.3percent in Lithuania, 43.6 percent in Czechoslovakia, 79.1percent in Greece, 73 percent in Portugal, and 24 percent forthe combined balance sheet of twenty-three European centralbanks. See Brown, International Gold Standard, vol. 2,p. 748.

the gold standard: Although the gold reserveratio had edged down to 56.3 percent in July1932, it still remained well above the legal mini-mum. Because the Federal Reserve was unableto reach a consensus on open market policy, theprogram faded in the summer of 1932. In January1933, the Federal Reserve voted to reduce itsgovernment bond portfolio.10

Low nominal interest rates in the UnitedStates during the 1930s persuaded many politicalleaders and economists at the time of the impo-tence of monetary policy. With the benefit offurther analysis of the evidence, many econo-mists now maintain that, although nonmonetaryand international shocks played a role, the con-traction was substantially exacerbated by thepolicy of the Federal Reserve.11 In particular,during the Great Depression, the Federal Reseve [Reserve]allowed the money supply to fall substantially.After Britain abandoned the gold standard, thatfall accelerated.

SUSPENSION OF THE GOLD STANDARD INTHE UNITED STATES: 1933-34

From October 1929 to March 1933, wholesaleprices in the United States fell 37 percent, andfarm prices plummeted 65 percent. The 30 per-cent devaluation of the pound after September1931 undermined the competitiveness of the U.S.export sector and exacerbated deflationary pres-sures. The 900 duties imposed under the Smoot-Hawley tariff of 1930 provoked retaliation, andboth the value and the volume of internationaltrade fell with each successive year. Reparationshad been abolished; and in the United States, thedebt burden had reached the breaking point. Themoney supply had fallen one-third since thestock market crash. The annual number of banksuspensions, which had never exceeded 1,000during the 1920s, totaled 1,350 in 1930; 2,293 in1931; and 1,453 in 1932. Stocks had decreased invalue more than 50 percent since 1926 and more

10. Milton Friedman and Anna Jacobson Schwartz, AMonetary History of the United States, 1867-1960 (PrincetonUniversity Press for the National Bureau of Economic Re-search, 1963), chap. 7.

11. Ibid., Monetary History, chap. 7.



than 80 percent since the 1929 peak. Real outputlanguished at two-thirds of its 1929 level. OnInauguration Day in 1933, more than 12 millionpeople were unemployed.

An internal run on deposits and an externaldemand for gold combined to assault the goldstandard in the United States after the abandon-ment of the gold standard in Britain. FederalReserve notes in circulation rose from $1.87billion in October 1929 to $2.02 billion in Septem-ber 1931. Then, as a panicky public cashed indeposit balances, the total swelled to $4.04 bil-lion in March 1933. The Federal Reserve ratio ofgold to note and deposit liabilities, which stood at81.4 percent a month before Britain left the goldstandard, slumped to 51.3 percent in March 1933,the lowest level since 1921. In contrast to Euro-pean governments, which had adopted the goldbullion standard in the restoration period, thegovernment of the United States continued tomint and circulate gold coins in 1933. In the firsttwo years of the Great Depression, gold flowedto the United States, causing the monetary goldstock to increase from $4.10 billion in October1929 to $4.45 billion in September 1931. In theeighteen months after Britain's departure fromthe gold standard, the United States supplied theworld demand for hoarding with gold exports,and the monetary gold stock fell to $3.99 billion.Domestic hoarding of gold coins emerged in early1933 as suspicion about banks devolved intodistrust of paper money. Gold reserves fell $300million during the banking crisis in February andMarch. By the day of Franklin D. Roosevelt'sinauguration—Saturday, March 4, 1933—all theleading domestic exchanges and the Federal Re-serve banks had closed, and every state hadwholly or partly suspended banking operations.

President Roosevelt and the Suspensionof the Gold Standard

President Roosevelt solved the dilemma ofchoosing between domestic and international ob-jectives: He placed domestic objectives first. OnMarch 6, 1933, he proclaimed a bank holiday andsuspended gold convertibility and gold exports,leaving the gold standard in limbo. Four dayslater, an executive order authorized Secretary ofthe Treasury William Woodin to issue licenses to

reopen sound member banks; nonmember bankscould reopen with licenses from state bankingauthorities. The Emergency Banking Act ofMarch 9, 1933, boosted confidence in the bankingsystem. Between March 13 and March 15, nearly70 percent of the commercial banks reopened,but an executive order still prohibited banks frompaying out gold coin, bullion, or certificates, andgold exports were forbidden except under li-censes issued by Secretary Woodin. An execu-tive order on April 5 quickened the reversal ofthe internal drain by requiring the rendering ofgold coins, bullion, and certificates to FederalReserve Banks on or before May 1. By April,Federal Reserve notes in circulation had fallen to$3.53 billion, and the gold reserve ratio hadrebounded to 61 percent.

On April 19, the Roosevelt Administrationrevealed that its list of principal objectives didnot include the words "gold standard." Duringthe previous month, Secretary Woodin hadfreely granted gold export licenses; on April 18,however, he refused to do so. On April 19,Roosevelt ordered a prohibition on gold exports,except for gold already earmarked to foreigngovernments. On the same day, the Presidentand his staff met with Senator Elmer Thomas fortwo hours and drafted an amendment that passedon May 12 as part of the Agricultural AdjustmentAct. The Thomas amendment, also known as theInflation Bill, gave the President permission toreduce the gold content of the dollar 50 percent,granted him sweeping powers to purchase silver,and charged the Federal Reserve to issue green-backs and to purchase $3 billion in governmentsecurities. In response to these developments,J.P. Morgan stated that "the effort to maintainthe exchange value of the dollar at a premium asagainst depreciated foreign currencies was hav-ing a deflationary effect upon already severelydeflated American prices and wages and employ-ment" and gave his imprimatur to the suspensionof the gold standard "as being the best possiblecourse under existing circumstances."12

The Administration's orchestrated suspensionof the gold standard on April 19 incited a marked

12. "Morgan Praises Gold Embargo as the 'Best PossibleCourse,' " New York Times, April 20, 1933.



response in the markets. The dollar sank 11.5percent against gold standard currencies. Thedollar-pound rate leaped 23 cents to $3.85, thehighest level since October 31, 1931. Stock pricesposted strong gains in a heavy volume of trading,and spot prices on the Chicago commoditiesexchanges soared.

The suspension of the gold standard in Marchand April 1933 resembled standard interludes inthe ongoing historical drama, rather than anoverture to devaluation. The prohibition on goldhoarding freed the United States from its techni-cal handicap of having gold circulate as a mediumof exchange. A simple resumption of convertibil-ity would have restored the gold standard—agold bullion standard—in the United States. Res-toration of the gold standard did not involveinsurmountable problems: Legislative initiativeswere rebuilding confidence in the banking sys-tem; notes were returning to deposit accounts;the gold reserve ratio was recovering; and thedollar was clinging near the gold export pointthroughout the period. Had it so desired, theRoosevelt Administration could have preservedthe gold parity.

President Roosevelt suspended the gold stan-dard in April 1933 because it encumbered ad-vancement toward the major domestic monetaryobjective: reflation. Leaders in the White House,in the Senate, and on Wall Street expressed hopefor the restoration of a metallic standard; how-ever, they regarded it as a distant objective. Theyvoiced concern about the instability of exchangerates but designated export growth, which wouldbe prompted by competitive devaluation, as aprimary objective. Relieving unemployment, in-stituting a massive public works program, andincreasing domestic prices were foremost in theobjectives of the New Deal. The new administra-tion saw the need to subordinate the gold stan-dard to the pursuit of these domestic objectives.The United States suspended the gold standardnot out of necessity but out of a change ofattitude.13

13. The United States was not the only country to becomedisillusioned with the gold standard. Between Britain's de-parture in September 1931 and the U.S. suspension in April1933, twenty-six countries went off the gold standard.

The World Monetary and EconomicConference

On June 12, 1933, the World Monetary andEconomic Conference convened in London tosolve the problems of the Great Depressionthrough international cooperation. The partici-pants recognized that retaliatory tariffs had sig-nificantly contributed to the worldwide crisis.Any agreement, therefore, would have to build aframework for exchange rate stabilization andrequire credible pledges for abstention from com-petitive devaluations. At the time, the world'sfinancial leaders believed that the basis for inter-national monetary stability would be gold.

The conference failed to achieve its goalsbecause the United States refused to agree toanything that might endanger its domestic recov-ery. In June 1933, spurred by the devaluation ofthe dollar, the U.S. economy was three monthsinto the strongest peacetime expansion in thenation's history, albeit an uneven one thatstarted from a low level. From March to June1933, wholesale prices in the United States rose8 percent, and farm prices and stock pricesjumped 36 percent and 73 percent respectively.The dollar had depreciated, and the new admin-istration in its reflation policy counted on furtherdepreciation. On June 5, 1933, the U.S. Congressundid the final link between the gold standardand the domestic economy when it abrogated thegold clause in government and private contracts.

In late June, the conference participants drewup a weak policy declaration, which called for areturn to the international gold standard butwhich permitted each country to choose the timeof restoration and the par value. On July 3,Roosevelt issued this strongly worded rejectionof the proposal:

The world will not long be lulled by the speciousfallacy of achieving a temporary and probably anartificial stability in foreign exchange on the partof a few large countries only. The sound internaleconomic system of a nation is a greater factor inits well-being than the price of its currency inchanging terms of the currencies of othernations. . . . Old fetishes of so-called interna-tional bankers are being replaced by efforts toplan national currencies with the objective ofgiving to those currencies a continuing purchas-ing power which does not greatly vary in terms



of the commodities and need of modern civiliza-tion. . . . Our broad purpose is permanent sta-bilization of every nation's currency. Gold orgold and silver can well continue to be a metallicreserve behind currencies, but this is not thetime to dissipate gold reserves. When the worldworks out concerted policies in the majority ofnations to produce balanced budgets and livingwithin their means, then we can properly discussa better distribution of the world's gold andsilver supply to act as a reserve base of nationalcurrencies.14

Gold Purchases and Devaluation

Throughout the last half of 1933, the Administra-tion's policy of reflation raised the price of goldwell above the par of $20.67 per ounce. By earlySeptember, the dollar had depreciated 35 percentagainst the French franc, and by mid-Septemberthe dollar-pound rate had spiraled up to $4.80.On October 22, with the price of gold at $29 anounce, Roosevelt, hoping that the programwould raise commodity prices, authorized theReconstruction Finance Corporation to purchasegold newly mined in the United States and, ifnecessary, to buy gold in the world market. OnOctober 25, the RFC set its price for domesticgold purchases at $31.46, which was 27 centsabove the world price. After the RFC beganpurchasing gold in the world market, the price ofgold rose almost daily—to $34.01 on December1—and the pound appreciated to $5.18. FromApril to December 1933, the Federal Reserveincreased its holdings of government securitiesfrom $1.84 billion to $2.43 billion. During thisinterval, currency flowed into deposit balances,the money supply rose 4 percent, and the goldreserve ratio stayed above 60 percent. The NewYork Federal Reserve Bank assisted the openmarket policy by lowering the discount rate from3.5 percent in March to 3 percent in April, to 2.5percent in May, and finally to 2 percent inOctober.

These expansionary policies communicatedthe Roosevelt Administration's goal of higherprices. After the initial surge in the spring of1933, however, the price level scarcely stirred

14. "Roosevelt Rebuke Stuns Gold Bloc, but ConferenceLikely To Go On; President Turns to Domestic Drive: Text ofPresident's Statement," New York Times, July 4, 1933.

from its position in June, and it tarried 26 percentbelow the 1929 level. Disappointed, Rooseveltinvoked a provision of the Thomas amendment inDecember 1933, instructing the U.S. mint topurchase newly mined silver at 64.65 cents perounce, a 47 percent premium above the marketprice of 44 cents per ounce. (Early in 1933, silverhad traded at 25 cents per ounce.) The SilverPurchase Act of June 1934 furthered the hugeaddition to the silver stock. Because it enabledthe Treasury to base an expansion of currency incirculation on silver, the silver purchase programlegally elevated silver's status in monetary policyand, concomitantly, diminished the influence ofgold.

The New Monetary Regime

In January 1934, the United States relegated goldto a subordinate role in monetary policy. OnJanuary 15, the Roosevelt Administration sentlegislation to the Congress vesting title of allmonetary gold in the United States in the Trea-sury and giving the President the authority tolower the gold content of the dollar to between 50percent and 60 percent of its earlier level and tochange the value of the dollar within this 10percent range at any time. On January 16, theFederal Reserve took over the gold-purchasingprogram from the RFC and began buying gold at$34.45 per ounce. Finally, on January 30, 1934,the Congress gave Roosevelt what he wanted:the Gold Reserve Act. The act transferred title ofgold from the Federal Reserve to the UnitedStates government, prohibited gold coinage, andbanned gold from circulation. By proclamation,on January 31, 1934, Roosevelt fixed the price ofgold at $35 per ounce, a devaluation of the dollarto 59.06 percent of the par instituted in 1879under the Resumption Act; this action increasedthe official value of the monetary gold stock from$4,033 million to $7,438 million. Because all goldhad been nationalized, the government gained a$3 billion paper profit.

When it flourished, the international gold stan-dard facilitated the flow of goods and capitalamong countries and promoted internationalprice stability over the long run. When it floun-dered, the international gold standard became aweapon for large countries to wield in the ad-



vancement of domestic objectives. After theUnited States fixed the price of gold in 1934, theworld's gold poured into the United States Trea-sury, and the already disquieted world marketsfell into a frenzy. Gold imports for Februarytotaled $454 million, of which $239 million flowedfrom London and $124 million from France. In1934, the United States imported $1.22 billion ingold; in 1935, $1.74 billion.

The term competitive devaluation understatesthe magnitude of the monetary metamorphosis.In 1934, the United States registered surpluses inthe international accounts of commodity trade($478 million) and of interest and dividends ($93million), while it imported both short-term capi-tal ($184 million) and long-term capital ($202million). The decline of the dollar set back theefforts of countries that were off the gold stan-dard to contrive domestic recovery through ex-port growth. The dollar-pound rate averagedmore than $4.88 in every year from 1934 until1939. Dollar devaluation forced gold-bloc coun-tries to abandon the gold standard, to devaluetheir currencies, or to suffer through more defla-tion. The French franc eventually succumbed todevaluation in 1936.

The shift in the focus of U.S. monetary policytoward domestic objectives culminated with theGold Reserve Act, which greatly diminished theinfluence of the gold standard. While the actrestored the commitment by the United States tobuy gold at a fixed price, it restricted sales tothose involving international settlements. Amer-icans could no longer redeem dollars for gold.The act allowed the President to change the goldcontent of the dollar at any time. As a result ofthe act, concern about the level of gold reserveswas all but completely obviated. The institutionalframework that ensued defies easy description.Friedman and Schwartz named it a "discre-tionary fiduciary standard," and Brown coinedthe term "administrative international gold bul-lion standard."15 The Federal Reserve called it"our modified gold standard."16 Without doubt,

the United States did more than devalue thedollar in 1934. It changed its monetary regime.

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