In his critique of the standard interpretation of the
interwar gold standard, Richard Timberlake claims that “the Fed and other
central banks’ deliberate management of the gold-exchange standard prevented
monetary adjustment in the period 1929-33 from resembling the pattern of
equilibrium of the classical gold standard (2007, 326).” He goes on to equate a
“true” gold standard with the classical gold standard. In similar fashion,
Milton Friedman argues that the gold-exchange standard was a “pseudo gold standard”
because France and the United States engaged in sterilized gold inflows (1961).
Though they were avoided, the same policies were possible under the classical
gold standard, making the distinction dubious. The difference between the
classical gold standard and the interwar gold standard was a difference in
degree, not kind.
The gold standard grew continually more cumbersome after it was officially adopted
during the 1870s. That gold, and gold alone, was employed under all legal
tender regimes in the West altered the standard’s operation. If a major central
bank changed its gold reserve ratio or interest rate, this would certainly
impact the price of gold elsewhere. This was true during the classical standard
just as it was during the interwar gold standard. Before World War I, this was
obscured by informal coordination of central bank policies, led by the Bank of
England. As phrased by Barry Eichengreen, “when the Bank of England raised her
rate, the Bank of France and the Reichsbank were quick to follow (1989, 13).”
The stability offered by such an arrangement masked its underlying weakness.
When national governments
suspended the gold standard, both in law and in practice, and England gave up
her leadership, the managed gold standard lost its coordinating mechanism. The
problem was augmented by another feature of the gold standard: the tendency
toward centralization of gold reserves in the previous half century. In 1914,
most of the world’s monetary gold was stored at a small number of central banks.
By 1922, “the world market in gold was practically coterminous with the
monetary demand of one great country” as nearly half of the world’s monetary
gold resided at the Federal Reserve (Hawtrey 1947, 97). Consolidation made
prices even more sensitive to changes in the demand and supply of gold. When
coordination of independent central banks from the Bank of England ceased, the
price of gold became unhinged, swinging wildly between 1914 and 1920 and again
between 1929 and 1932.
This
problem was inherent in the system. It was not a defect of the gold standard per se. It was a defect of management
under a system of fixed exchange rates where deflation must almost inevitably
follow an unbacked expansion of the money stock by the central bank. Under a
system of floating exchange rates, on the other hand, the economy probably
would have adjusted to a higher price level and “the subsequent collapse would
almost surely not have occurred (Friedman 1961, 68).” Of course this also could
have been avoided by a return to the gold standard at adjusted parities, but
such an option was politically unpalatable.[1] In
light of political constraints, the economic instability associated with the
latter decades of the gold standard was not a glitch, but
rather the logical end of a monometallic legal tender regime.
[1]
“The implications drawn by Cassel from this situation were that countries
should not go back to prewar parities, or if the objective was price stability,
to the prewar system at all. A much talked of advantage of the prewar system
was its ‘high degree of stability’, and which ‘we should now endeavor to
restore’. Adopting mispriced currencies and squabbling over inadequate gold
reserves were not the ways to do it. He was ignored by policymakers and
rejected by most economists.” (Mazumder and Wood, 2013, 162)
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