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This PDF is a selection from an out-of-print volume from the NationalBureau of Economic Research
Volume Title: The International Gold Standard Reinterpreted, 1914-1934
Volume Author/Editor: William Adams Brown, Jr.
Volume Publisher: NBER
Volume ISBN: 0-87014-036-1
Volume URL: http://www.nber.org/books/brow40-1
Publication Date: 1940
Chapter Title: Book I, Part II: The Effect of the War on the Formof the International Gold Standard
Chapter Author: William Adams Brown, Jr.
Chapter URL: http://www.nber.org/chapters/c5938
Chapter pages in book: (p. 25 - 130)
PART IiThe of thethe Form of theIflterna/j01
Gold Standard
CHAPTER 2
The Sacrifice of Some of the External Forms of theGold Standard in Order to Preserve Others
The crisis of 1914, by suddenly reversing the distribution ofinternational credit, laid bare in a remarkable way the finan-cial anatomy of the pre-war international gold standard sys-tem. It demonstrated the dependence of that system upon theregular and uninterrupted operation of the financial machin-ery of the City of London, and showed the difficulties thatarise when an attempt is made to force gold to serve as abalancing item in international payments when credit is dis-organized. The crisis caused moratoria, suspensions of speciepayments, and legal or de facto gold export embargoes inmany countries. Nevertheless it did not break down the inter-national gold standard completely or all at once. It inaugurateda gradual and piecemeal alteration in the external forms ofthe gold standard within individual countries. Since the goldstandard up to this time had the attributes of an internationalconvention simply because it existed simultaneously as adomestic institution within the various countries adhering toit, these internal changes greatly modified but did not whollydestroy its functioning as an international convention. Conse-quently no simple statement with respect to the breakdownof the gold standard during the war can be true.1It is a popular belief expressed in many American writings that during the
war the United States alone remained on the gold standard while all othercountries abandoned it. Writing in 1932 B. M. Anderson, Jr. said, for example:
has been no time in the past thirty-six years when there has beenjustifiable ground for doubt as to our ability to maintain the gold standardin its full integrity . . In 1914 we were obliged to close our stock exchangeto prevent an avalanche of foreign selling of American securities in our]narket, but the question of the maintenance of our gold standard, even
27
28 BREAKDOWN
The Gold Standard, Form and SubstanceIn order to establish the exact sense in which it is true to saythat various countries 'went off' gold during the war, it ishelpful to distinguish carefully between the external form ofthe gold standard and its substance.
By the external form of the international gold standardwe mean:i) the juridical concept that gold is the monetary standard of agiven country2) the legal systems established in countries in which this juridi-cal concept exists to give formal expression to it8) the domestic banking regulations necessarily implied by theexistence of these legal systems4) the code of financial practice and conduct necessary to givethese legal systems their intended effect
and finally5) the system of foreign exchange rates established as a result ofthe simultaneous existence of such legal systems in several coun-tries.
By the substance of the international gold standard we
though virtually all the rest of the world abandoned it, did not arise at all." *Yet it is difficult, from either a legal or an administrative viewpoint, to find
vital differences between the gold standard in England and America duringthe period of America's participation in the war. The date when England'returned to gold' after the war is a landmark in world history, but it is verydifficult to determine the date when England left the gold standard to whichshe returned in 1925. The only generalizations that really allow for the com-plexities of the situation are of the following type: "For the greater part ofthe war substantially all the commercial countries of the world were moreor less off the gold monetary standard." ** Such statements certainly invitea more precise answer to the question of how much of the gold standard didsurvive the war.* Chase Economic Bulletin, Nov. io, 1932, p. (our italics). Cf. also theopening passages of L. A. Rufener's textbook, Money and Banking (Hough.ton, Muffin, 1934).** C. J. Bullock, J. H. Williams, and R. S. Tucker: 'The Balance of Tradein the United States,' Review of Economic Statistics, Vol. I, 1919, p. 239 (ouritalics).
PRESERVATION OF EXTERNAL FORMS 29mean the whole institutional pattern of trade and of financethat breathes life into these forms of law and practice, andthat works out its contribution to economic progress throughthem. In the pre-war world this was the London-centered sys-tem of international finance based upon British predomi-nance in international trade.
The Retention of the Juridical Concept ofGold as Standard
The modifications made during and after the crisis of 1914 inthe monetary systems and banking laws of most countries didnot in general alter the legal conception that gold was theultimate standard of value. Unlike silver after 1870, gold wasin no sense demonetized. From the legal point of view thetheory of the gold standard was maintained and the utmostchange accomplished by law was the temporary suspensionof certain rights and obligations that might tend to dissipategold reserves and force a genuine abandonment of the goldstandard as a juridical concept as well as an economic mechan-isnl.2
The Minimum Change in Legal Form Consistentwith the Necessary Changes in Practice
Because the gold standard was maintained in legal theoryevery country sought to accomplish the changes in financialpractice made necessary by war-time conditions with a mini-mum change in legal form. This may be seen clearly by abrieE review of legal enactments concerning gold in the prin-cipaJi countries.
2 The persistence of a rigid judicial conception of gold as standard is demon-strateci by many court decisions after the war. It was then responsible in largemeasure for the dedine in the authority of law in Central Europe, for de-cisions to the effect that 'a mark was a mark' long after the mark had greatlydepreciated in value were repugnant to the innate sense of justice of the popu-lation. For a general discussion of the governing principles of law and courtdecisions on this matter cf. F. A. Mann, The Legal Aspects of Money (London,Oxford University Press, 1938), Part I.
30 BREAKDOWN
The Legal Framework of the International Gold Standardduring the WarThe gold standard exists as an international legal conventionwheni) the monetary units of the several countries adhering to it aredefined as fixed weights of gold;2) these monetary units, and all other means of payment in theseveral countries expressed in terms of these units, and gold bul-lion, are freely convertible into one another at the rate estab-lished by the legal definitions of the units by
a) free melting, free coinage, and the redemption of notes ingold; or byb) the establishment of some agency that is obliged to buyand sell gold at fixed prices in unlimited amounts;orbyc) some combination of (a) and (b);
3) when no restriction is placed upon either the import or theexport of gold.
UNITED KINGDOM
The legal system embodying these requirements in the UnitedKingdom came through the war virtually unscathed. Thedefinition of the gold content of the sovereign has remainedunchanged until the day of writing (June '939). The legalright of the citizen to bring gold bullion to the Mint forcoinage into sovereigns and to demand the redemption ofBank of England notes in coin at the rate established by thelegal definition of the sovereign was not withdrawn untilthe passage of the Gold Standard Act of 1925. Until that timethe cost of obtaining gold from the Bank of England by theredemption of notes, expressed in shillings and pence, was77 s. d. per ounce 11/12 fine. This equivalent is referredto in these studies and in common parlance as the Bank ofEngland selling price for gold, for in practical effect thoughnot in form it was a selling price. By the Act of 1925 this was
PRESERVATION OF EXTERNAL FORMS 31
recognized in terms, for that Act introduced a limitation inthe legal right of redemption, restricting it to redemption ingold bullion in amounts of not less than 400 ounces troy offine gold (L1,699), and directed the Bank of England to sellsuch gold bullion for legal tender moneys at the price of 77 S.101/2 d. per ounce 1 1/12 fine. As a necessary corollary of thischange the Act of 1925 restricted the right of free coinage ofbullion into sovereigns at the Mint to the Bank of England.Not until the Gold Standard (Amendment) Act of 1931 wasthe c:onvertibility of Bank of England notes into gold legallywithdrawn, and even then the selling price of the Bank wasnot officially changed. The obligation laid upon the Bank bySection IV of the Peel Act to purchase all gold offered at 77 S.9 d. per ounce remained in force without alteration or amend-meni: until the passage of the Currency and Bank Notes Actof lc)39, when it was repealed. During the war the right toimport gold was not legally impaired, but gold produced inthe Empire was purchased in the countries of origin by thegovernment through the Bank of England at prices varyingfrom 77 S. 9 d. to 77 s. ioi,4 d. per ounce, and in igi6 im-porters of other gold were requested to sell all gold importedto the Bank of England at its buying price.3 The inability to
any other buyer with imported gold acted in the samemanner as a legal restriction on imports, though it was notone in legal form. The first legal restriction on right toexport gold was imposed by an Order in Council issued onApril 1, 1919, at the same time that the import restrictionwas lifted.4 Aside from the impounding of gold imports, theonly break in the legal system governing the adherence of theUnited Kingdom to the gold standard as an international con-vention actually made during the war was the prohibition ofgold melting under the Defense of the Realm Act in Decem-ber igi6.
and Goldsmid's Annual Circular, 1919, p. 4.4Boarc1 of Trade Journal, April 3, 1919, p. 434.
32 BREAKDOWN
CONTINENTAL BELLIGERENTS
The suspension of specie payments at the central banks ofGermany, Austria-Hungary, Russia, and France, and the im-position of gold export embargoes by these countries has al-ready been referred to in Chapter i. The smaller powers ofCentral Europe followed suit, and in many of these countriesthe transport of gold even within their own borders was pro-hibited. Because of her creditor position France was able topostpone her gold export embargo until July 1915, and Italyis not included in the list because, before the war, the lira wasnot convertible into gold at a fixed ratio, but was kept rela-tively stable by the efforts of the Bank of Italy and the Minis-try of Finance. In considering the vitality of the idea of goldas standard during the war it is important to emphasize thatthese measures represented the breakdown of a part only ofthe legal framework embodying the gold standard in the con-tinental belligerent countries. The rest was preserved intact.The definition of the gold content of the standard coins ofFrance, Germany, Austria-Hungary, and Russia remained un-changed. The obligation of the central banks and treasuriesof these countries to purchase gold at fixed prices based uponthe mint price was not altered, and no restrictions wereplaced upon the import of gold.
NEUTRAL COUNTRIES
At the outbreak of the war the Dutch government placed anembargo on gold exports and authorized the NetherlandsBank to suspend specie payments. Argentina, likewise, im-posed an embargo on gold exports on August 2, 1914, and onAugust 8 made the notes of the Caja de Conversion legaltender and established gold depositories at the Argentineembassies abroad, providing that gold held in these deposi-tories was to count as part of the gold holdings of the Caja.Such measures were not, the most common form ofinterference with legal goTd standard arrangements in neutral
PRESERVATION OF EXTERNAL FORMS 33countries, which was, rather, to place obstacles in the way ofgold imports. Argentina, herself, for example, changed hergold policy when her foreign gold deposits began to increaseunduly. In the summer of 1915 the Caja refused to accept goldat its foreign depositories except at a discount of i ½ to 2 percent plus a deduction for the cost of shipment to Argentina olf2 per cent. A similar change of policy took place in Holland.When, in 1915, Dutch imports began to fall more rapidlythan Dutch exports, and capital payments were heavily infavor of Holland, gold began to move toward Holland inlarge volume in spite of obstacles in the countries ofThe Netherlands Bank then adopted the policy of not pur-chasing any gold, or accepting any deposits of gold abroadunless it was fully informed of the origins and purposes ofthese shipments and considered them to be in the nationalinterest. The Bank was able to do this without fresh legisla-tion as it was not bound either by law or by its statutes to buyall gold offered, but maintained a fixed buying price for gold
as a matter of policy. This gold repulsion policy wascontinued in 19 16,6 but in the later stages of the war Hollandwas often forced to accept payment for her exports in goldbecause no other means of payment was available, and she inturn tendered gold to other countries in payment for Dutch im-ports. These offers created difficulties with the Scandinaviancountries which were themselves practicing a gold repulsionpolicy.7 On February 8, 1916 the Swedish Riksbank was re-lieved of its obligation to give 2478.8 kr. for 1 kilogram ofgold, and free coinage was suspended. For Sweden thereforeto accept payment for goods in gold required a regular politi-
"It is certainly remarkable that the export of goid took place quite regularlyand practically without difficulty from those countries which had prodaimeda general prohibition on the export of gold while nearly all shipments to theNetherlands of gold from America, the country which had not prohibited theexport, were exposed to serious obstades." Netherlands Bank, Annual Report,1915—16, p. 15.6 Ibid., pp. 15—17; 1916—17, p. 16.7lbid., 1917—18, pp. 12—13.
34 BREAKDOWNcal treaty, such as that concluded between the Bank of theNetherlands and the Swedish Riksbank for the payment ofDutch purchases of Swedish coal in gold. Gold as a commoditywas not absolutely prohibited from importation into Sweden,but its entry into the monetary system was prevented. In prin-ciple, Denmark and Norway went along with Sweden andagreed to pass similar measures when it became necessary.8Spain also was reluctant to accept gold. The buying priceof the Bank of Spain for foreign gold coins was temporarilyreduced, only 4.90 pesetas being given for the American golddollar in 1917 instead of the mint price of 5.18 pesetas.
Ti-fE UNITED STATES
In the United States, the country commonly regarded as com-ing through the war with the gold banner flying moreproudly than anywhere else, there was no change in the legaldefinition of the gold dollar, and the obligation placed uponthe Secretary of the Treasury by the Gold Standard Act ofigoo to keep all the moneys of the United States at par withgold was not changed, though the mechanism for accomplish-ing this was altered by the passage of the Federal Reserve Act.The import of gold also was not restricted but in September1917 the right to export gold was limited to those who couldobtain licenses from the Federal Reserve Board acting withthe consent of the Secretary of the Treasury.
The International Gold Standard as a Code of Practice duringthe WarThe retreat from the international gold standard as a code ofpractice was far more complete than the retreat from it as alegal system, especially in Great Britain. England did not 'sus-pend specie payments' during the war, nor did she place anembargo on the export of gold. In practice, however, bothdomestic convertibility and free export were abandoned. Dur-ing the early months of the war while England was insistent8 Blankart, op. cit., pp. 55—9.
PRESERVATION OF EXTERNAL FORMS 35that the obligations of the international gold standard belived up to by her debtors, in particular by the United States,and that debts due her should be paid in gold, the positionof the exchanges rendered the Bank of England immune froma foreign drain on its reserves. The attitude of the Britishpublic and of the banks saved it from a domestic drain afterthe first days of the crisis. As the situation gradually changed,however, increasing pressure was brought to bear upon thosewho wished to redeem notes in gold by an appeal to theirpatriotism and by a rigid inquisition into the purposes andmotives of everyone who presented notes for redemption.This finally amounted in practice to a refusal of the right ofconversion except in a few cases in which the purpose waspurely and simply to assert the holder's legal rights. Early in
the sterling-dollar rate fell for the first time below thepeace-time gold export point to the United States. In Febru-ary the Treasury took steps to place difficulties in the way ofredemption of Currency Notes. During most of 1915 the de-preciation of sterling in terms of the dollar offered on thesurface a substantial motive for a demand for gold for export,but in January 1916 the pound was pegged at 4.767/16 whereit was held during the rest of the war. At that rate the profitmotive, in the absence of other impediments, was probablyinsufficient to have resulted in the presentation of notes forredemption at the Bank of England to obtain gold for exportto the United States.9 The incentive to the redemption ofnotes was further lessened by the issue of regulations underDORA on December 5, igi6 prohibiting the melting of goldcoin or its use otherwise than as a currency. It was reduced tozero by the regulation of May i8, 1918, which made it illegalto buy or sell gold at a premium within England.
These piecemeal measures were not, however, the majordeparture of England from adherence to the international
The rates of insurance on gold were fixed by the British government at arate so high that gold exports were unprofitable with the exchange at 4.767Ae.S. E. Harris, Monetary Problems of the British Empire (Macmillan, 1931), pp.247—8.
36 BREAKDOWNgold standard as a code of practice during the war. Londonceased to be a free gold market not because insurance was un-obtainable, or because the holder of a five pound note couldnot get gold for it, or because the holder of a sovereign couldnot legally melt it, but primarily because the bullion marketdid not carry out gold transactions. The failure of the marketto do so was at first defended on the ground of lack of reci-procity upon the part of other nations. In the summer of1915 E. L. Franklin of Samuel Montagu and Company gavethis explanation:"notwithstanding that there is no prohibition placed on the ex-port of gold to neutral countries, no bank or banker can be foundwho will avail himself of the benefits accruing from such trans-actions because it is the general opinion that it is against the in-terests of this country for gold to leave England as long as othergovernments do not allow gold exports from their country." 10
Under war-time conditions the gold from new productioncoming on the London market would soon have been used upby shipments to neutrals and would have proved a very weak'first line of defense' for the Bank of England gold reserves.Gold embargoes on the continent would have rendered quiteimpossible the repetition of the experience of 1907 when aheavy loss of gold to America was offset by the exercise ofEngland's 'pull' over the continental exchanges. The impor-tance of protecting the reserves was not called in question, forEngland was not felt to be 'off' the gold standard. Conse-quently, the 'gold income' of Great Britain was not madeavailable for distribution to the higest bidder, but was re-tained in England. The Bank of England reserves were pro-tected from demands from the market whether based uponthe exchange rates or not.1'10 Kirkaldy, Credit, Industry., and the War (London, Pitman, 1915), p. 249(our italics) Cf. the attitude of certain gold bloc countries, especially theNetherlands after September 1931.11 This war-time practice of suspending the functioning of the bullion marketwas unobtrusively followed during the difficult times preceding the suspensionof the gold standard in September ig3i. Cf. Ch. 27, pp. 1013—4.
PRESERVATION OF EXTERNAL 37After the United States became a belligerent, difficulties
were placed in the way of the redemption of American papermoney in gold similar to those in England. For example, thewriter knows of a holder of a Federal Reserve note who wasobliged to carry his demand for its redemption in accordancewith its terms up to one of the highest Treasury officials be-fore he could enforce his rights. The export of gold, as al-ready stated, was subject to license from September 1917 toJune 1919.
In both Great Britain and the United States, therefore, bya combination of legal enactment, administrative control, andprivate practice, the fulfillment of two of the cardinal re-quirements of the gold standard as a formal legal institution,namely, interconvertibility of notes and gold and free inter-national movement of gold, were suspended, as they had beenby the continental belligerents by outright suspension ofspecie payments and embargoes on the export of gold, and inneutral countries in varying degree by limitations on the rightof free coinage and interferences with the import of gold. Thestatement, however, that these measures took either the be!-ligerents who interfered with the export of gold or theneutrals who interfered with its import off the gold standardmust be carefully qualified.
The Objectives of the Changes in Gold Standard Legal Rulesand Gold Standard PracticeEvery belligerent country was forced to draw the physical re-sources for waging war from every available source both athome and abroad. The means of supporting civilian popula-tions had to be provided from resources, domestic and for-eign, that had been greatly depleted by the use and destruc-tion of wealth for war purposes. The resulting unprecedenteddomestic and international diversion of productive powersinto new channels and transfer of ownership and control of
made credit expansion a necessity. Because of theworld-wide distribution of the physical resources consecrated
38 BREAKDOWNto the purposes of war, this credit expansion was spread overthe world of neutrals as well as over the world of belligerents(cf. Ch. 4). Every country directly affected by the war was
also faced by another requirement of war finance, hardly lessimpelling: the maintenance of the confidence of its peoplein the 'soundness' of its money and of its banking system. Thisconfidence was fostered by the preservation, as far as possible,of the traditional system of exchange rates established underthe pre-war international gold standard. Had the gold re-sources of the belligerent countries with weak exchanges beendispersed, it would have been difficult to obtain the creditsand mobilize the securities that were the main means of main-taining these rates. Confidence was fostered also by the preser-vation of something like the relationship between publishedgold reserves and the volume of notes and of deposit creditsthat had long been familiar before the war. Even when it wasimpossible to preserve these familiar ratios, confidence in thecurrency and in the banks was promoted and preserved, insurprising degree, merely by the continued presence of thephysical volume of gold held in central banks and treasuriesbefore the war. Every country rejoiced in its successes and wasalarmed by its failures in keeping intact these familiar land-marks of financial 'soundness' and thus preserving in theminds of the people the conviction that the gold standard wasstill in being in their own country, or, at worst, was merelytemporarily suspended.
Every country therefore struggled to preserve as far as pos-sible the pre-war gold standard forms. Some parts of the pre-war legal system relating to gold were maintained by mostcountries throughout the war, notably the obligation placedon central banks and treasuries to buy all gold offered at afixed price. Prohibition of gold export and inconvertibility ofcurrencies gave to those in control of financial policy freedomin the choice of means by which to protect and increase goldreserves—the outward and visible symbol of the existence ofthe gold standard as a domestic institution—and to perpetu-
PRESERVATION OF EXTERNAL FORMS 39ate, as far as possible, the pre-war system of exchange rates—the outward and visible symbol of the existence of the goldstandard as an international system. It is a paradox that dur-ing the war countries 'went off' gold in order to preserve tothe maximum possible degree the psychological and economicadvantages of these two great traditional characteristics ofthe gold standard.
The four major objectives of the retreat from fulfilling thelegal obligations and banking codes of practice traditionallyrequi:red of countries on the gold standard were toi) maintain unimpaired the juridical concept of gold as a mone-tary standard;2) carry forward until more normal times the essential legalframework of the institution so that it could be easily restored tofull operation in time of peace;3) preserve as far as possible the place of gold in the bankingsystems of gold standard countries, even if only as a confidence-inspLring factor;4) preserve as far as possible the traditional system of exchangerates defined by the system of mint pars existing in 1914.
These objectives were all in one way or another associatedwith an effort to preserve rather than to destroy the goldstandard as a social institution. It is therefore fundamentallytrue to say that during the war some of the external forms ofthe gold standard were abandoned in order to preserve others.
Major Characteristics of Gold Distributionduring the War
As a result of the extraordinary situation we have describedas the abandonment of some of the external forms of the goldstancEard in order to preserve others, the distribution of goldduring the war had four major characteristics: gold concen-tration, gold payment, gold arbitrage, and gold repulsion.Gold ConcentrationIn order to preserve the nominal place of gold in their mone-tary and banking systems, when these were subject to strong
40 BREAKDOWNinflationary influences, and at the same time to maintaintheir exchanges as nearly as possible in their pre-war relationto other currencies, the governments of belligerent countriesfelt under heavy pressure to accumulate gold from every pos-sible source. The suspension of specie payments and actualor de facto gold export embargoes left them free to pursuean intensive policy of gold accumulation and gold concen-tration. This was of two main types:i) the accumulation of gold from new production, its with-drawal from circulation and from private banks, and its concen-tration in the hands of central banks and treasuries2) the concentration of gold in the hands of the principal finan-cial powers in the two belligerent groups as a pledge for advancesto their allies.
In this process Great Britain was the most important singlefactor.
GOLD ACCUMULATION AND CONCENTRATION IN ENGLAND
For reasons already discussed, England was able to draw goldfrom all over the world at the outbreak of the war. In addi-tion, as head of the British Empire she enjoyed peculiar ad-vantages in the war-time hunt for gold. She was able to ar-range for the use of gold held in London by Empire coun-tries, such as the £8 million of the Egyptian gold reserveunder the control of the International Debt Commission thatwas deposited in London, and to influence the movement ofgold to or from the Indian gold reserve. Far more importantwere the arrangements made in South Africa, Australia, andIndia to ensure a steady flow of new gold into the Britishgovernment's hands. Early in the war an agreement was madegiving the Bank of England the exclusive right to purchasethe product of the: South African mines at 77 s. 9 d. perounce, and measures were taken in South Africa to preventproduction from falling in spite of rising costs and a fixedprice for the output.'2 The Australian government placed an12W. A. Brown, Jr., England and the New Gold Standard, 1919—192 6 (London.
PRESERVATION OF EXTERNAL FORMS 41
officia.l embargo on the export of gold, but newly producedAustralian gold was purchased by the Bank of England inAustralia at 77 S. 10½ d. per ounce. This inward flow of Em-pire gold was protected from Indian demand by requiringall gold imported into India after June 1917 to be sold tothe government at a price that did not recognize any depreci-ation of sterling in terms of gold and therefore did not effec-tively compete with the bid of the Bank of England (cf. Ch.g), then the only buyer of gold in England. These imperialpolicies were based upon the theory that England was still'on' the gold standard.
Moreover, since England's position as middleman in thepurclaase of war supplies for her allies increased the difficultyof supporting the sterling-dollar exchange, it was arrangedthat large parts of the gold reserves of France, Russia, andItaly should be sent to England. The first Russian gold ship-ment to London was made in October As early asApril 1915 the Bank of France sent £20 million of gold tothe :Bank of England, as part of a transaction by which theFrench Treasury borrowed £62 million from the BritishTreasury. This gold was actually sold to the Bank of England.In 1916 and 1917 much larger sums were obtained on thebasis of a 'loan' of gold to the Bank of England, and the item'gold held abroad' first appeared on the balance sheet of theBank of France.'4 England also acted as middleman on a largeKing, 1929), pp. 23—4; this matter has also been treated by C. J. Smit in anunpublished manuscript.
The item 'gold held abroad' appeared on the balance sheet of the RussianState Bank in November 1914. The figures under this head were partly fic-titious, as British credits were treated 'gold abroad' by the Bank. S. S.Katznellenbaum, Russian Currency and Banking, 1914—1924 (London, King,1925), pp. 52 if.'4Whether these shipments involved a transfer of ownership of the gold wasseriously disputed after the war; cf. Harris, op. cit;, pp. 305—7; also GastonJèze and Henri Truchy, The War Finance of France (London, Milford, 1927),pp. 297 if. The final settlement of the 1916 advances was not reached until1926, and then only after difficult negotiation. For this settlement, cf. EmileMoreau, 'Le Relèvement Financier et Monétaire de Ia France, 1926—28,' Revuedes Deux Mondes, March 15, 1937, pp. 299—319. This is the second in a series
42 BREAKDOWNscale in the use of Japanese and Russian gold to build updollar balances after 1915.
At the same time gold was concentrated within the UnitedKingdom. The Bank of England was able to avoid losses ofgold to domestic circulation, and even add to its reserves fromthat source, and in August 1915 certain joint stock bankstransferred about £20 million in gold from their own hold-ings to the Bank.
From these multifarious sources, many of which were evi-dence of Great Britain's unique position in the world's bank-ing system, a large but unknown 15 amount of gold was ac-cumulated in the hands of the Bank and of the British gov-ernment.
GOLD CONCENTRATION IN FRANCE
Like England, though in less degree, France was able earlyin the war to draw gold from abroad. For further accumula-tion of reserves, however, the only great resource open toFrance was the domestic circulation. Very strenuous effortswere made to get gold into the Bank of France. Large enter-prises, such as the Chemin de Fer du Nord, were forced togive up their gold reserves. The patriotism of the peoplewas appealed to systematically in an effort to counteract thevery active gold hoarding that continued throughout the war.Gold in the French stocking was replaced to some degree bynotes. Comités d'Or were formed throughout the country,and, by the end of 1917, 2,277 million francs in gold had beentaken from commerce and hoarding. During one period ofsix weeks 300 million gold francs were obtained in this way.'°
of four articles by M. Moreau which appeared in the March i, March 15,April i,and April 15, 1937 numbers of the Revue.15 Figures of gold movements were not published after igi6. Substantialamounts imported into England and bought by the government did not appearin any published account at the time; Messrs. Samuel Montagu & Co., WeeklyReview of the Foreign Exchanges, Aug. igt6.
Jeze and Truchy, op. cit., p. zoo; Blankàrt, op. cit., p. 67.
PRESERVATION OF EXTERNAL FORMS 43
'GOLD CONCENTRATION IN THE UNITED STATES
During the latter part of the neutrality of the Unitedat the inflationary possi-
bilities of the gold coming to her shores. This anxiety found,however, no stronger expression than intimations to the En-tente powers that if the large flow of gold to America con-tinued, some definite steps to check it would be necessary.Before an actual gold repulsion program was formulated,however, the United States became a belligerent, and herattitude on this point changed completely. To prevent anoutward flow of gold to the countries that still remainedneutral, the gold export embargo was imposed, and the goldimports that continued to come in were regarded as a we!-come addition to reserves. In addition, a vigorous policy ofgold concentration within the country was pursued. Thistook the form of impounding gold in the Federal Reserve•banks by the following means:i) the encouragement of state banks to become members of theFederal Reserve system in order to get gold from them in pay-:rnent of Federal Reserve bank stock and for the establishment of
reserve balancesthe passage from a system in which part of the legal reserves
of member banks could be held in gold in their vaults to one in'which only deposits with the Federal Reserve banks could countas reserves'3) an appeal to holders of gold certificates to exchange them forFederal Reserve notes in order to increase the reserve ratio of theFederal Reserve banks.
GOLD CONCENTRATION IN GERMANY AND OTHER CONTINENTALBELLIGERENTS
Germany every effort was made to accumulate gold andconcentrate it in the hands of the Reichsbank. The measurestaken were often extreme. Gold accumulated before 1913i.n Spandau amounting to i 20 million marks, and another 120
44 BREAKDOWNmillion marks accumulated in 1913 and the first half of 1914,were transferred to the Reichsbank.'7 During the war everyconceivable method of propaganda was adopted to get goldfrom the people.'8 Lotteries were even arranged in whichwinning tickets were given to those bringing gold to thebanks. The people were called upon to give up their goldornaments. In July 1918 a 'gold buying week' was instituted.For Germany, moreover, the domestic circulation was notthe only means of building up central gold reserves. Goldwas taken from the occupied districts of Belgium, Roumania,and Russia. Gold estimated at 400 million marks was ac-quired by the Treaty of Brest-Litovsk. Also almost all thegold reserve of the Austro-Hungarian Bank was transferredto the Reichsbank in 1915 to cover foreign payments.
Like France and Germany, Italy and Russia (until thedebacle of 1917) both engaged in the world-wide hunt forgold. In March 1917, for example, Italy offered a loan in pay-ment for which Italian gold lire were accepted at a premiumof per cent, sovereigns at the rate of 32.70 per lira, andgold dollars at 6.70 per lira. The subscribers were given theright to recover their gold six months after peace was declaredin exchange for Italian notes at par. This was a curious pro-ceeding in a country in which the appearance of a gold pre-mium was prohibited by law. The Russian Treasury used adifferent device, giving foreign exchange to importers at parless a 2 per cent commission against delivery of gold.'9
All the continental belligerents, in their efforts to concen-trate gold, were faced by a steady contraband trade and do-mestic hoarding. They all tried to exchange state obligationsfor gold rather than for notes. The drafts they made uponthe domestic gold circulation in order to support their ex-
Gaston Jeze, 'Les Finances de Guerre de la France,' Revue de Science et deLegislation Financieres, Vol. '3, 1915, p. 6i8.18 The same policy of gold concentration was carried out by Germany's allies.In Turkey the death penalty was imposed for making payments in gold.19 details concerning gold concentration by continental belligerents aretaken from Blankart, cit., pp. 64—9.
PRESERVATION OF EXTERNAL FORMS 45changes and keep the gold supplies of the central banks fromfalling constituted a concerted passage from the forms of theso-called 'full' or orthodox gold standard to those of the goldbullion standard. The sacrifice of the gold circulation, likethat of free export and the right of convertibility, was partof an effort to preserve, rather than destroy, the externalforms of the international gold standard by protecting bankreserves and supporting exchange rates.
Gold PaymentUpon these large accumulations of gold liberal drafts weremade to support the exchanges. The pledge of portions ofthe French, Russian, and Italian reserves to England in ex-change for credits and the use of the reserves of Austria-Hungary by Germany were part of this process.2° Englanddrew freely upon her accumulated gold stocks to support thesterling exchange in New York and in other neutral markets,and on several occasions in 1915 and 1916 even permitted thereserve of the Bank of England to be drawn down. Substantialamounts of gold were shipped from France to the UnitedStates in 1915 and igi6 and the theory was popularly dis-cussed in France, especially in the form known as the Moronischeme, that the exchange might be supported by chokingAmerica with gold and thereby raising American prices.Large payments to neutrals were made in gold by Germanyon her own behalf and on behalf of Austria-Hungary directlyfor goods and to support the exchanges.
This use of the accumulated gold reserves of the belligerentpowers constituted in effect the use of gold as a substantialmerchandise item in the balance of payments—a direct means20 During the war France shipped 1.955 million francs in gold to England forwhich credits of roughly three times this amount were secured (Annual Re-ports of the Bank of France; cf. Jêze and Truchy, cit., p. From 0€-tober to July 1917 Russia shipped 450 million roubles of gold to England(Katzenellenbaum, cit., p. 6o) . Italy, beginning in July 1915, shipped in all562,300.000 lire of gold to England (C. E. McGuire, Italy's International Eco-nomic Position (Macmillan, 1926), p. 371).
46 BREAKDOWNof settling foreign debts and acquiring the material resourcesnecessary for the prosecution of the war. It was possible onlybecause of the continued existence of part of the legal frame-work of the international gold standard—the willingness ofcentral banks to fulfil their legal obligations to buy all goldoffered them at fixed prices.
Gold ArbitrageUntil the United States entered the war, gold arbitrage trans-actions of the pre-war type were frequent in neutral markets.They were influential in keeping the dollar exchange fromdepreciating in terms of certain continental European neu-tral markets and those of certain South American countries.They caused a secondary redistribution of the gold flowingfrom the belligerents to America and increased the amountmoving to these smaller neutral countries.
Gold RepulsionThe international distribution of gold through gold paymentand gold arbitrage during the war was a danger to the main-tenance of gold in its traditional place in the monetary andbanking systems of both the gold losing and the gold receiv-ing countries. Both England and France parted with gold re-luctantly because the loss of gold reserves was felt to be athreat to the solvency of their banking systems. The sameconflict between the demand made upon available gold sup-plies to build up reserves and that made to support the ex-changes was present in Germany, where great importancecontinued to be attached to the preservation of the gold re-serves of the Reichsbank, and in other belligerent countries.The circumstances that gave rise to alarm in belligerent coun-tries lest gold reserves prove inadequate gave rise also to anxi-ety in neutral countries lest the inward flow gold should re-suit in excessive reserves and lead to rapid inflation. Thevarious impediments to the inward flow of gold establishedby Sweden, Spain, the Netherlands, and Argentina, already
OF EXTERNAL FORMS 47described, were part of a definite gold repulsion policy bycreditor countries. This was as truly an abandonment of partsof the formal legal requirements of the international goldstandard in order to preserve as nearly as possible the systemof monetary and banking regulations long sanctioned by tra.dition as was the suspension of specie payments and the im-position of export embargoes by the belligerent powers.
The Subordinate Role of GoldWhen applied to the pre-war period, our distinction betweenthe form and the substance of the international gold standardwould emphasize the role of gold as an instrument used tosecure certain economic and financial objectives by a world-wide system of international credit having its principal centerin London. During the war the role of gold was even moresubordinate to that of credit. Gold movements were con-trolled by the conscious, purposeful, and political directionof central banks and treasuries which supplanted in large de-gree the banking forces that had directed gold distributionin time of peace. This is strikingly apparent, when the proc-esses of gold concentration, gold payment, gold arbitrage,and gold repulsion are examined in their relation to thewhole' effort of the world's credit and banking system tomaintain the gold standard as a traditional system of ratesand a domestic institution during the war.
CHAPTER 3
The International Gold Standard as a TraditionalSystem of Rates during the War
One of the striking facts of the history of exchange rates dur-ing the war is that they diverged widely from a familiar sys-tem of gold pars which still remained in existence in law.Yet it cannot be said that that system of gold pars did notexert a profound influence upon the course of the exchanges.It persisted throughout as the common conception of 'nor-mal,' and any deviation from it was regarded as a deprecia-tion or appreciation in terms of gold. Every country madeextraordinary efforts to keep the deviation of their exchangesfrom the old system of parities as small as possible. Theseefforts included unprecedented control of merchandise im-ports by government, the restriction and control of capitalexports, the use of private and governmental internationalcredits, and a wholesale mobilization and alienation of for-eign securities; also a whole series of measures to distributethe available supply of foreign exchange and to prevent spec-ulation by means of one form of exchange control or another,and measures to fill by official dealings the gaps left by thewar in the mechanism of exchange arbitrage; finally, con-trolled and directed distribution of gold. As a result, a solidnucleus of relatively stable exchange rates was maintainedthroughout the war, from which there was occasionally afanlike dispersion of certain other rates. At the time of theArmistice there was a remarkable gravitation of the wholesystem of rates toward the old pars.
Chart i indicates the composition of this central nucleusand the dispersion of the various important exchange rates
48
OV
ER 30
soua
cz: F
eder
al R
eser
ve B
ulle
tinA
ug. 1
g14:
War
cris
is (N
o qu
otat
ions
for Y
okoh
ama,
Rio
de
Jane
iro, S
tock
holm
,Z
uric
h,B
omba
y, M
adrid
, Bue
nos A
ires)
Dec
. 193
4: P
rem
ium
of s
terli
ng in
New
Yor
k di
sapp
ears
(No
quot
atio
ns fo
r Yok
o-ha
ma,
xci
o U
t jan
circ
, Stc
.rkho
lzn.
Mad
rid,
Bue
nos
Aire
s, B
omba
y)A
ug.
Con
trol o
f ste
rling
-dol
lar e
xcha
nge
bcsu
ii (N
o qu
otat
ions
for R
io d
eJa
neiro
)Ex
trem
e qu
otat
ions
(in
pare
nthe
ses)
are
giv
en a
s per
cent
ages
of p
re-w
ar p
ars
28-3
0
OV
ER 30
Jan.
191
6: S
terli
ng-d
olla
rex
chan
ge p
egge
dN
ov. i
gi6:
Alli
ed re
sour
ces n
early
exh
aust
edA
pril
igi7
: Am
eric
an T
reas
ury
supp
ort o
f the
exc
hang
es (N
ofo
r Ber
linan
d V
ienn
a)A
pril
igi8
: Max
imum
dis
pers
ion
due
to A
mer
ican
gol
d em
barg
o (N
o qu
otat
ions
for
Ber
lin a
nd V
ienn
a)N
ov. z
g;C
:(N
o au
otad
ons f
or B
erlin
, Vie
nna,
and
Pet
rogr
ad)
0 a z In C, I- z frJ 0 p.
14-1
6
16-1
8
18-2
0
20-2
2
22-2
4
24-2
6
26-2
8
28-3
0
Petro
grad
Val
para
iso
Mila
n.
Rio
de
Jane
iro
Ber
linM
ilan
Mila
nR
io d
e Ja
neiro
Mila
n
Vie
nna
Petro
grad
Mila
nR
io d
e Ja
neiro
Val
para
iso
Rio
de
Jane
iroR
io d
ejan
eiro
Ber
lin
14-1
6
i6-iB
18-2
0
20-2
2
22-2
4
24-2
6
26-2
8
- -
nfl -
nfl
--
—
Vie
nna
(63.
7)Pe
trogr
ad (5
g.7)
Mila
n (5
9.0)
Petro
grad
(58.
2)V
ienn
a (5
8.5)
Petro
grad
(56.
1)Pe
trogr
ad (2
8.2)
Exch
ange
Rat
es o
n N
ew Y
ork,
191
4-19
18H
ighe
stR
ates
on
New
Yor
k du
ring
the
Giv
en M
onth
as P
erce
ntag
es o
f Pre
- War
Par
sA
UG
UST
DEC
EMB
ERA
UG
UST
JAN
UA
RY
NO
VEM
BER
APR
ILA
PRIL
NO
VEM
BER
1914
1914
1915
1916
ipi6
1917
1918
1918
Lond
on11
4.3
100.
597
.998
.296
.997
.897
.797
.8
Mila
n10
5.8
99.1
83.2
79.1
77.9
75.2
59.0
8x.6
Am
ster
dam
104.
510
1.0
100.
311
4.1
102.
010
3.9
120.
010
5.1
Cop
enha
gen
102.
694
.296
.610
4.1
101.
310
7.8
118.
5io
o.8
Ber
lin97
.286
.78o
.673
.7Pa
riszo
i.610
14gi
.888
.988
.791
.290
.696
.1V
ienn
a10
0.3
88.7
74.9
63.7
58.5
Petro
grad
99.3
83.5
71.8
58.2
59.7
56.1
28.2
Mon
treal
100.
010
0.75
99.9
799
.87
100.
0398
.07
96.4
498
.56
Val
para
iso
88.6
73.8
84.4
89.6
115.
211
4.1
163.
213
5.7
Zuric
h10
0.0
97.6
101.
010
0.2
102.
812
1.9
105.
3B
omba
y10
1.7
101.
799
.810
0.2
114.
811
0.1
Mad
rid10
0.3
99.1
106.
511
3.5
154.
210
7.3
Yok
oham
a99
.110
1.3
102.
310
2.6
104.
110
9.8
Stoc
khol
m98
.610
5.0
106.
211
3.1
128.
710
8.2
Bue
nosA
ires
99.2
102.
210
1.0
103.
310
7.2
Rio
deJ
anei
ro72
.473
.975
.!79
.683
.2
SOU
RC
E: F
eder
al R
eser
ve B
ulle
tin, r
gr8,
pp.
837-
9 an
d 11
99; M
ontre
al ra
tes p
rovi
ded
by th
e B
ank
of N
ova
Scot
ia.
50 BREAKDOWNaround it. A single chart showing a large number of rateswould be difficult to read because of the crossing of manylines and because, to include extreme quotations, the scalewould have to be so small that the fluctuations within thecentral nucleus would be hard to distinguish. A tabular pres-entation would not bring out sharply the relationships hereemphasized. Therefore a few important rates on New Yorkhave been given for selected months and the grouping anddispersion is indicated by showing the position of each rateon a common scale of percentage deviations from pre-warparity. In spite of the emphasis in these studies on the centralposition of London in international finance it has seemedwise to take New York as a base because of the terms in whichthe foreign exchange problem was universally discussed from1914 to 1925. Some base must be chosen and both writer andreader, and especially both chart maker and chart interpreter,must not forget that by choosing a base every movement inthe system is shown as related to that base. The whole situa-tion may be seen in quite a different light if the base isshifted. The fanlike dispersion of rates around a central nu-cleus during the war is an important fact, but it does notappear if one glances at Dr. Blankart's admirable chart ofthe behavior of exchange rates on Switzerland during thewar. There, with a few exceptions, one sees only various de-grees off 'depreciation.'
The Key Rate in the SystemThe Dispersion of Rates, December 1914By December 1914 the foreign exchange deadlock was sub-stantially broken. Sterling was at par in New York, and theexchanges of France, the United States, Spain, Italy, theNetherlands, Switzerland, and Great Britain, as a group, didnot deviate from their respective parities by more than 4per cent whether Paris, New York, London, or Zurich istaken as a base.11 These relationships are clearly shown by the charts at the close of Dr. Blank.art's book, and in Bullock, Williams, and Tucker, op. cit., p. 243.
PRESERVATION OF EXTERNAL FORMS 51
The record is very incomplete, however, because of theabsence of published quotations for the yen,2 the Argentinepeso, and the milreis. Among the recorded rates the impor-tant breaks in the pre-war system were the depreciation ofthe currencies of Germany, Austria-Hungary, Russia, Den-mark, and Chile.
Sources of InstabilityA great strain was being put upon this system of rates. Evenlfl 1915 the world's currents of trade were becoming moreand more dominated by the movement of goods from neutralsto belligerents—especially to the Entente powers. A glanceat the figures of war-time merchandise trade (Table 2) willrecall this extraordinary revolution in the direction of worldtrade. The large increase in imports relative to exports inthe United Kingdom, France, Russia, and Italy, and the largeincrease in exports relative to imports in the United States,Argentina, Japan, Brazil, and Spain are striking features ofthis table. The German and Austro-Hungarian trade figuresshow the same sort of increase in the passive merchandisebalance as do those of the other belligerents, until the Britishblockade became effective and America entered the war. Theinfluence of these events can be seen clearly in the Germanfigures which, in the absence of any official data, are taken
Taking New York as the base, the French franc, the peseta, and the poundsterling were at about parity with the dollar. The lira was depreciated about
or 4 per cent; the mark 8 per cent; the Swedish krona 15 per cent; and therouble per cent.
Taking Zurich as the base, the lira, the dollar, the French franc, the guilder.tile pound sterling, and the peseta were within about 3 per cent of par. Theit ark was depreciated about 8 per cent, and the rouble and the Austro-Hungarian krone about 15 per cent.
Taking Paris as a base, the pound sterling, the guilder, the dollar, the Swissfranc, the peseta, and the lira were at par or not depreciated more than about3 per cent. The Swedish krona was depreciated about 8 per cent and therouble about i8 per cent.
Taking London as the base, the French franc, the dollar, the peseta, andthe guilder were at about par. The lira was depreciated about per cent, theSwedish krona about per cent, and the rouble about to per cent.2 :[nouye, op. cit., gives no quotations for November and December 1914.
TAB
LE 2
Mer
chan
dise
Tra
de o
f Var
ious
Cou
n fr
ies,
1914
-191
8N
et e
xpor
ts +
, Net
impo
rts —
(tho
usan
ds)
Mon
etar
y U
nit
1914
1915
1956
1917
1918
Gre
at B
ritai
nPo
und
—17
0,44
0—
367,
963
—34
4,66
0—
467,
408
—78
3,78
7Fr
ance
Fran
c—
1,53
3,33
5—
7,09
8,42
5—
14,4
25,8
25—
21,5
41,2
67—
17,5
83,6
41Ita
lyLi
ra—
712,
944
—2,
170,
106
—5,
301,
996
—10
,681
,695
—12
,693
,967
Rus
sia
Rou
ble
(191
3va
lue)
—14
2,00
0—
736,
000
—1,
241,
000
1—
1,50
2,00
0 1
—53
,000
Aus
tria
2K
rone
—80
7,00
0—
2,46
5,00
0—
4,47
5,00
0—
3,22
6,00
0G
erm
any
1M
ark
—I,i
oo,o
oo—
4,20
0,00
0—
4,50
0,00
0—
3,60
0,00
0—
2,40
0,00
0U
nite
dSt
ates
Dol
lar
+470
,654
+1,
094,
420
+2,
135,
599
+3,
630,
693
+2,9
74,0
56Ja
pan
Yen
—5,
000
+17
6,00
0+
371,
000
+59
4,00
0A
rgen
tina
Peso
+75,
000
+33
1,00
0+
326,
000
Bra
zil
£ st
erlin
g+1
1,05
4+
22,8
8!+
14,6
40+
15,0
00D
enm
ark
Kro
ne+6
2,43
5—
50,4
14—
72,2
84—
54,4
30—
199,
721
Net
herla
nds
Gui
lder
—33
2,77
8—
135,
102
—37
0,75
4—
145,
486
—22
7,14
7N
orw
ayK
rone
—15
7,25
5—
191,
208
—36
5,33
1—
869,
935
—49
7,50
8Sp
ain
Pese
ta—
167,
775
+53,
750
+97
,006
+4,
555
+386
,922
Swed
enK
rona
+45,
447
+173
,859
+4-
I 7,8
10+
590,
941
+11
7,12
3S
witz
erla
ndFr
anc
—24
7,08
0—
6,59
7+7
8,23
5—
71,7
52—
429,
433
SO
UR
CE
: Com
mis
sion
of C
old
and
Silv
er In
quiry
(U.S
. Sen
ate,
Ser
ial 9
, 192
5),V
ol.
Ove
r Eur
opea
n bo
rder
onl
y.an
d II
, Sta
tistic
al A
ppen
dice
s; fo
r Jap
an, A
rgen
tina
and
Bra
zil,
Cha
rles B
lan-
Stat
istic
al A
bstra
ct o
f U.S
., 19
19,
p.38
9.ka
rt, D
ie D
evis
enpo
litik
wae
lzre
nd d
es W
eltk
riege
s (Zu
rich,
Are
ll Fu
ssli,
s919
),p.
I4;
no o
ffic
ial f
igur
es p
ublis
hed
for B
elgi
um.
2K
indl
yfu
rnis
hed
to th
e w
riter
by
the
Rei
chs-
Kre
dit G
esel
lsch
aft,
Ber
lin.
Kle
ine-
Nat
rop,
Dev
isen
polil
ik in
Deu
tsch
land
vor
dem
Krie
ge a
nd in
der
Krie
gr- a
nd-
Xac
/z/c
riegs
zeit,
p. 'I
.
PRESERVATION OF EXTERNAL FORMS 53Ifrom a small volume by Dr. Kleine-Natrop published in
The trade of the northern European neutrals also was
German Merchandise Trade (milliards of paper marks)IMPORTS EXPORTS EXCESS OF IMPORTS
i9i4, Aug.—Dec. 2.1 1.4 0.71915 7.1 3.' 4.11916 8.4 3.8 4.51917 7.1 3.5 3.61918 7.1 4.7 2.4
influenced profoundly by the blockade, and they too weresubject in the later years of the war to great pressure fromboth sides to supply them with essential commodities. Therewas even a regular trade between Germany and Englandthrough the Netherlands known to both war offices. The lackof definite trend, except in the case of Norway, may be partly,if fbi: predominantly, due to these pressures, though thematter has never been adequately studied. Some idea of theirseverity may be gleaned from a passage in the Annual Reportof the Netherlands Bank for 1916—17 (English ed. p. 89)"The Netherlands constantly had to supply many goods to for-eign countries, more especially to the belligerent powers.The Netherlands have supplied these goods, not only because theywould thereby earn money, but especially because such supplyhad practically become a duty. On the one hand the country wasforced to find a market for its own agricultural products of whichthe quantities produced considerably exceeded the home require-
against which the Netherlands could demand other goods,particularly raw materials, fertilizer and cattle food from foreigncountries in order to keep its own industry and agriculture going.On the other hand a certain pressure was placed on the countryby foreign powers which required our products for their own con-sumption and who would have considered it as an unfriendly actif we had stopped supplies; this imagined unfriendliness theythreatened to retaliate by impeding our free navigation across thesea and by placing difficulties in the way of our import of grain,
Devi.cenpolitik in Deutschland var dem Kriege und in der Krieg's- und Nach-kriegszeit (Berlin, Hans Preiss, 1922) . A photostatic copy of this work waskindly sent to the author by the Institut fuer Weltwirtschaft at Kiel.
54 BREAKDOWNiron, coal, etc. In the end it therefore became a matter of life anddeath for this country to maintain as much as possible the exportsof its own products."
The extraordinary war-imposed changes in the flow ofmerchandise trade tended toi) weaken the exchanges of all belligerents against neutral cur-rencies and Japan: that is, to strengthen the American, Japanese,and South American exchanges, and those of the smaller Euro-pean neutrals against England, France, Italy, Russia, and Ger-many and Austria-Hungary;2) break up the British Empire exchanges by strengthening theIndian rupee and Canadian dollar in sterling;8) detach the French, Italian, and Russian exchanges from theirformer relationships to sterling;4) separate the German and Austro-Hungarian exchanges fromthose of the Entente countries and of the neutrals.
That is to say, they threatened to disintegrate completely thepre-war system of exchange rates and, indeed, to prevent theestablishment of any alternative system of rates.
Such a situation would have greatly increased the cost ofimports into the Entente countries and have seriously dis-turbed their domestic price structures by causing erratic fluc-tuations in the prices of imported goods. It would have intro-duced an incalculable speculative element into all their inter-national transactions and have increased the difficulties offinancing the war through foreign credit. Even more impor-tant, it would have had the grave psychological disadvantageof undermining the confidence of peoples in the strength andin the future of their own currencies.
The Central Importance of the Sterling-Dollar ExchangeThe sterling-dollar rate was the key rate in the effort to re.sist these forces of disintegration. In the battle to preserve asystem of exchange rates Great Britain stood in a centralplace, first, because as head of the Empire she was the repre-sentative of a large group of countries maintaining stable
PRESERVATION OF EXTERNAL FORMS 55exchanges among themselves; second, because as financierand supplier of her continental allies the sterling rate was ofimmense direct importance to France, Italy, and Russia;finally, because London continued to be during the war, as;it had always been, the market for dollars for all Europe. Aslong as the dollar-sterling rate remained relatively stable, andthe British Empire constituted a unit in currency matters, anucleus was established sufficiently broad to serve as the basisIfor other stabilization operations. There was a link betweeni:he Empire, the Continent, and the Americas. The Frenchfranc could be supported against the world, and the Canadiandollar did not have to choose whether to follow the Americandollar or the pound.
The pound sterling itself, however, was subject to pressurefrom a multitude of causes. Not only British, but French,][talian, and Russian purchases of war materials in Americatended to weaken sterling in New York, as did large Britishpurchases of goods in America for resale to the continent.The requirements of the continental allies for dollars couldbe prcvided only in small part by direct remittance, for therelatively small supply of dollars offered in the continentalmarkets was soon exhausted, and indirect remittance throughLondon tended to be the cheaper method of payment toAmerica. Under more normal conditions arbitrage transac-tions would have kept the cost of the two methods of re-mnittan.ce the same, while marginal adjustments in the moreflexible items in the balances of payments of the continentalcountries would have relieved the pressure on sterling. Be-fore the war the use of London as a clearing house for conti-riental transactions with America did not mean that sterlingwas urtder steady pressure in New York whenever continentalcurrencies were weak. But during the war there was a con-stant tendency for the continental exchanges to be weakerin New York than in London. Arbitrage opportunities in-volving the purchase of sterling tended to be infrequent andto be closed before any new equilibrium in the system oF ex-
56 BREAKDOWNchange rates could be established. Arbitrage opportunitiesinvolving the sale of sterling tended to appear regularly. Inthe language of the market, sterling tended to decline inNew York 'in sympathy with' the weakness of the continentalexchanges.
Under these circumstances efforts to support the Conti-nental exchanges in London without supporting them inNew York sharply accentuated the pressure on the sterling-dollar rate by placing impediments in the way of an appro-priate adjustment of the whole system of exchange rates. Ifthe essential weakness of the continental exchanges could notexpress itself in a decline of these exchanges both in Londonand New York, it had to express itself in a decline of theseexchanges in New York and a decline of sterling in NewYork.4 These influences on the sterling-dollar rate were mag-nified many fold by the role of England as financier of thewar for her continental allies. When France and Italy madepurchases in America with borrowed sterling, the poundrather than the franc was weakened. When England boughtgoods for cash or short credit in America and sold them onthe continent on liberal terms the same result followed.
The problem, therefore, of preventing the depreciation ofthe currencies of the Entente countries other than Englandboth in London and New York became inseparably linkedwith the problem of preventing the depreciation of sterlingin New York.
Measures of SupportIn 1915 England began a highly selective use of her accumu-lated gold in support of her exchanges; $ioçj million in gold
Cf. Ch. 29, The Possible Modes of Behavior of any Foreign Exchange Tn-angle.5 Where devices other than gold shipments could be used they were; e.g., theissue of British treasury bills in Amsterdam against gold in London to pro-vide the means of payment for goods bought in the Dutch East Indies (Harris,op. cit., p. 303); and the whole poUcy adopted with reference to the Indianrupee which reduced gold imports into india far below the pre-war average(Brown, op. cit., pp. 30 if.).
PRESERVATION OF EXTERNAL FORMS 57was shipped directly from England to the United States, andtwice that amount ($219 million) was shipped from Canada,mostly from the English depositary in Ottawa. These Ca-nadian shipments were the beginning of a new and increas-ingly important phase in the history of that depositary. SirThomas White has described these operations in the articlealready quoted in connection with the 1914 crisis:"At the time that Great Britain was commandeering the Ameri-can investments of British subjects, she was requisitioning goldin all parts of the world for the same purpose, making paymentfor the purchases of herself and her Allies in the United States.This gold came principally from Great Britain, South Africa andRussia, although small consignments were made from Brazil andBorneo. It consisted of a miscellaneous assortment of Britishsovereigns, American, Russian, German, Austrian, Japanese andFrench coin, together with fine gold bars. . . . Of a total of$1,200,000,000 handled by the Department of Finance from the be-ginning, $546,000,000 was for the account of the Bank of England,and $658,000,000 for the account of the Imperial government.From the United States $104,000,000 was received on the firstmovement: on the reverse movement $491,000,000 came to handfrom Great Britain, $353,000,000 from South Africa, $253,000,000from Russia, $692,000 from Borneo and $172,000 from Brazil.More than three quarters of the entire amount was represented bybullion.
It will be of interest to know that $253,000,000 was received forthe Imperial Russian government. The gold was shipped fromPetrograd and Moscow to Viadivostock, there to Vancouver orEsquitnalt via Japan in Japanese war ships. . . . In all four con-signments of this gold were received from February 1916 to May1917. . .
Smaller shipments of gold were made for similar purposesfrom London to the Netherlands and Argentina. In additionthe Bank of France, after exhausting the supplies of foreignexchange acquired in the second half of 1914, amounting,according to Professor Jeze, to 400 million francs, began inAugust 1915 to export gold to England, America, and Spain.
58 BREAKDOWNThese exports amounted to i6o million francs, but thismethod of supporting the exchange directly was soon aban-doned for the policy already referred to of lending gold tothe Bank of England in exchange for British credits to theFrench Treasury. The proceeds of these credits were in largepart made available to the French in the form of dollars, butthe debt was a sterling debt, a point vigorously insisted on byM. Moreau in the negotiations of 1926. The French authori-ties never deviated from their contention that it was an essen-tial condition of these loans that on repayment of the creditsthe gold should be returned to th.e Bank of France.°
It soon became evident, however, that gold shipmentsalone could not meet the situation: they interfered with theeffort to maintain domestic gold reserves; they caused un-easiness to the receivers and were inadequate in amount.From the outset they were supplemented by credit. The Brit-ish Dominions received advances sufficient to enable them tomaintain their London balances in the early months of thewar. The French government placed about 400 million francsin treasury bills abroad in December and early en-couraged French bankers to borrow collectively in America.In November 1914 a $20 million revolving acceptance creditwas arranged for French account by Brown Brothers andCompany, which opened the doors of Federal Reserve creditto the war needs of the Allies. In April 1915 a $50 millionissue of French 5 per cent bonds was offered in the Americanmarket by a Morgan syndicate, and at the same time the Rus-sian exchange was supported by French and British creditsand by the sale of treasury bills in London.
Jeze and Truchy, op. cit., pp. 298—9; Moreau, bc. cit.7 E. L. Dulles, The French Franc, 1914—1918 (Macmillan, 1929), p. MissDulles quotes the authority of Decamps for this statement. Jeze and Truchyrefer to a £2 million issue of French treasury bills placed in London by Messrs.Rothschild in October 1914 and a £'O million issue placed by the Bank ofEngland in January 1915, as well as to an issue of $io million treasury billsplaced in New York in November 1914. Op. cit., pp. 307,
PRESERVATION OF EXTERNAL FORMS 59
The Formation of the Sterling-Dollar-Franc NucleusThe 1)ispersion of Rates, August 1915In spite of the mounting difficulties that had called forththese measures of support, there was still, in August 1915, a
certain cohesion in the whole structure of exchange rates.The exchanges of Switzerland, Spain, Sweden, the Nether-lands, Great Britain, Argentina, India, Canada, Japan, andDenmark on New York stood at some time during that monthwithin 4 per cent of their pre-war parities. Those of the conti-nental, belligerents, however, had moved with reference tothis group as a whole. The French franc had depreciated 8per cent and the lira i6 per cent in New York. The mark haddepreciated i i per cent in Zurich and 15 per cent in NewYork; the Austrian krone 20 per cent in New York, andthe rouble per cent in Zurich, 22 per cent in Paris, and 25per cent in New York.
Pegging and Exchange ControlThese relationships were not stable. In spite of all measuresof support the disintegrating forces were getting the better ofthe effort to preserve a system of relatively stable exchange:rates in the latter part of 1915. The tendency of the neutralexchanges, especially those of the Netherlands, Sweden,Spain, and Argentina, to rise, and of the Italian, Austrian,German, and Russian exchanges to fall in terms of sterlingand dollars was very strong. The presence of strain withinthe Empire group itself is abundantly evidenced by the diffi-culties experienced in preventing the rupee from rising inLondon. Finally, the difficulties of preserving a constant re-1.ationship between the pound and the franc and the dollarwere becoming very great. Gold shipments to the UnitedStates were continued on a large scale and, as was truethroughout the war, the exchanges continued to be supportedthrough the accumulation of balances in London, Paris, and
6o BREAKDOWNItaly by private shippers who wished to postpone remittanceshome until a more favorable exchange situation prevailed.A $500 million Anglo-French loan was negotiated in August,signed in September, and subscribed in October 1915, butthis large amount, though less than the Allied negotiatorswished, was too large for the American market. The loanwas not very successful, and large portions of it remained inthe hands of the underwriters. Very large public loans inAmerica were thus shown not to be feasible, and the Anglo-French loan was followed by a program of regular borrowingin New York as dollars were required. In this program theplacing of short term treasury bills was the chief instrument.Private credits continued to be arranged, such as those openedfor British banks in New York in November 1915, and theexchanges received support through substantial subscriptionsby Americans to the war loans of belligerents, particularlyto the French war loans of December 1915.
These various devices for strengthening the exchangeswere supplemented by the systematic mobilization of foreignsecurities and by their sale or pledge in America. In this,England took the lead. By various gradual approaches theBritish Treasury moved from the encouragement of the pri-vate sale or loan of foreign securities to the government tothe forcible taking over of such securities. The program wasinitiated in July 1915, and by December the government hadpurchased £46 million of such securities. In January 1916the American Dollar Securities Committee was formed tocarry on this mobilization of securities, the sale of which be-came the backbone of the support of the sterling-dollar ex-change until April 1917 and one of the major factors in trans-forming the United States into a creditor country.8 Canada
The Committee reported on December 1919 that the total securities pur-chased, including Canadian and South American issues, amounted to £216million, while £406 million were lent to the Treasury. Of these amounts £178million and £73 million respectively were American securities. German ownedsecurities in England were made subject to this mobilization.
PRESERVATION OF EXTERNAL FORMS 6imade a special contribution to the support of sterling by lend-ing securities to the British government which were suitablefor pledging in New York, and also relieved the sterling ex-change by placing refunding issues of Canadian municipali-ties in New York rather than London. Other currencies weresupported by similar means. The French government did notresort to compulsion, but published lists of securities it wouldborrow or buy, reserving the right to extend the loans or, incase of need, to sell the securities, and by the middle of 1916it had received 1,200 million francs in such securities. TheGernian government did not approach the people directlyby a popular press campaign, but at first requested the banksto induce their clients to sell securities or pledge them abroadwith the idea of recalling them after the peace. That is tosay, the banks were to urge their clients to embark upon along run foreign exchange speculation. The motive appealedto illustrates the importance of the concept of normal ex-change rates during the war, for only if the exchange ratesreturned to 'normal' after the war could the transaction proveprofitable. The practical results of this suggestion in provid-ing Germany with foreign exchange during the war werenot great, for foreign securities when sold abroad by Germanswere for the most part exchanged for liquid balances abroadand not used for the purchase of marks with pounds, francs,or dollars. Not until March 1917 did Germany resort to theforcible taking over of foreign securities and even then em-phasized the loan aspect of the transaction by undertakingto replace the commandeered securities three years afterpeace was made with England.
The resources assembled in this way were used by the bel-ligerents in a systematic effort to control the exchanges. Con-trol of the sterling-dollar rate began in August 1915 and inJanuary 1916 the dollar rate in London was definitely peggedat 4.767/b. The actual method of stabilization was the pur-°
J. M. Keynes, A Treatise on Money (Harcourt, Brace, 1930), I, ig.
BREAKDOWNchase and sale of British treasury bills in New York and theuse of the proceeds to buy sterling.'0 In addition a fund of$50 million was made available in London by New Yorkbankers to help control daily fluctuations." The Bank ofFrance began to extend its influence in the foreign exchangemarkets in the summer of 1915 by undertaking to sell ex-change to those who could prove their genuine commercialinterest at a cheaper price than the market. In August 1915an exchange control mechanism was set up, but even so itwas impossible to prevent the appearance of a 'cours horscote' lower than the official rate of the Bank.12 The general de-cline of the franc in New York was, however, halted and onApril 14, 1916 the British and French governments agreed tostabilize the franc. It was under this arrangement that Bankof England credits were obtained against gold, neutral securi-ties, and French treasury bills. In this way a nucleus of rela-tively stable exchange rates—the sterling-dollar-franc nucleus—was definitely established and endured throughout the restof the war.
Great efforts were put forth in Germany and Austria-Hungary to keep the exchanges of the Central Powers rela-lively stable with reference to this nucleus. In Germany ex-change control was introduced in the form of Devisencen-tralen which, like other agencies of exchange control, under-took to distribute the available supply of exchange and topermit no exchange transactions the purpose of which wasnot known to the authorities and regarded as necessary. Thiscontrol first took legal form on January 28, 1916 when theReichsbank and twenty-six elected banking firms of Berlin,Frankfurt, and Hamburg were formed into a foreign cx-lOJ. P. Morgan & Co., as British fiscal agents in New York, purchased from1915 to 1919 approximately £840 million of sterling exchange. E. M. Fried-man, International Finance and its Reorganization (Dutton, 1922), p. 377."Jaeger, op. cit., pp. 21—2.'2Through its own resources and through credits secured in London and NewYork the Bank of France purchased i8 milliard francs of French exchangeduring the war. Friedman, op. cit., p. 377.
PRESERVATION OF EXTERNAL FORMS 63
change monopoly with headquarters in Berlin. The repre-sentatives of these firms, together with the sworn brokers andin the presence of the Staatskommissar, met in their respec-tive cities and, after telephone communication with the othercenters, fixed the buying and selling rates on the Nether-lands, Denmark, Sweden, Norway, Switzerland, Austria-Hun-gary, Bulgaria, and the United States. The Devisencentralencarried out the foreign exchange and security arbitrage busi-ness of the country at these rates, and their authority wasearly extended to include also supervision of the underlyingtransactions. All incoming exchange had to be turned overto the Consortium, which became the sole seller of drafts onForeign countries. In Austria-Hungary a somewhat differentform of Devisencentral organization was set up consisting oftwo central offices, one in Vienna and one in Budapest. Oper-ating at first on the basis of voluntary cooperation by banksit was a failure, and even when all dealings in foreign ex-changes outside these offices were forbidden in the early partof 19L7, it proved ineffective.13
Stability of the World's Exchanges, January 1916 to Novem-ber 1916As a consequence of all these measures the structure of theworld's exchange rate system was on the whole remarkablystable during 1916. The American, British, French, Italian,and Russian exchanges on Zurich were in November 1916within 2 per cent of what they had been in January igi6, theGerman exchange was within 4 per cent, the Dutch andSpanish within 7 per cent, and the Austrian within 10 percent.
The United States, Swedish, British, Italian, and Russianexchanges on Paris were in November 1916 within 2 per centof what they had been in January 1916, the Swiss exchangewas within 5 per cent, the Dutch within i i per cent.L8 Except where otherwise noted, the details of the support and control of theexchanges in continental countries given in this section are taken fromBlankart, op. cit., pp. 75—139.
0
64 BREAKDOWNThe Swedish, United States, French, Italian, and Russian
exchanges on London were in November igi6 within 3 percent of what they had been in January 1916, and the Spanishand Dutch exchanges within 8 per cent.
The Swedish, British, French, German, Italian, and Rus-sian exchanges on New York were in November igi6 within2 per cent of what they had been in January 1916, the Argen-tine exchange was within 5 per cent, and the Spanish withinio per cent.
These relationships appear from an examination of averagemonthly rates and also from Chart 1, which indicates thatthe Japanese, Canadian, Indian, Brazilian, and Austrian ex-changes in New York shared in the general stability of rates.
The area of relative exchange stability included the ex-changes of many countries which had a strong tendency torise in London. Since the dollar was pegged to sterling, italso, through the influence of arbitrage, experienced weak-ness in these exchanges. Opportunities arose for the purchaseof sterling exchange with Argentine pesos, pesetas, and otherneutral currencies, and with the Japanese yen, the sale of thissterling for dollars and the purchase of gold with these dol-lars. As a consequence, these exchanges were prevented fromrising as much as they would otherwise have done againststerling, and a substantial portion of the gold sent to NewYork to stabilize sterling and the franc was passed on to theseneutral countries. Therefore, the pegging at the center, inconjunction with the continued observance of the require-ments of the international gold standard by the United Statesduring the major part of her neutrality, bound the outlyingcurrencies to the central nucleus.
The Exhaustion of European Resources available for the Sup-port of the ExchangesFrom the opening of the war to April i, 1917 the Allies pur-chased $7 billion of goods from the United States. In pay-ment $i,6oo million of visible and normal invisible items
PRESERVATION OF EXTERNAL FORMS 65were imported, together with $i,ioo million in gold. Theliquidation of $500 million of American short term debtabroad, the sale of $1,400 million of American securities andother assets, collateral loans of $1,400 million, and unsecuredloans of approximately $i billion provided the balance.14 Byautumn igi6 the resources available for exchange peggingbegan to be exhausted. The beginnings of a disintegrationof the system of rates maintained at such great cost fromJanuary to November 1916 were already apparent in theactua]. quotations. The exchanges of the Central Powers werebreaking away from the sterling-dollar-franc nucleus and theanxieties of the British Treasury reached a peak eloquentlydescribed by J. M. Keynes in his Economic Consequences ofthe Peace (p. 273) in these words:"The financial history of the six months from the end of the sum-mer of igi6 up to the entry of the United States into the war inApril., 1917 remains to be written. Very few persons outside thehalf dozen officials of the British Treasury who lived in dailycontact with the immense anxieties and impossible financial re-quirements of those days can fully realize what steadfastness andcourage were needed and how entirely hopeless the task wouldsoon have become without the assistance of the United StatesTreasury."
The Fanlike Spread of the Exchanges around the Nucleusafter America's Entry into the War
Preservation of the NucleusWith the entry of the United States into the war, the wholeaspect of foreign exchange pegging was altered by the substi-tution of advances from the United States Treasury for thenearly exhausted resources of the British and the French. Thenucleus of stable exchange rates between Paris, London, andNew York was maintained fundamentally through these14 Statement of J. P. Morgan & Co., New York Ti,nes, January 7, 1936, p. 8.The principal collateral loans were loans of $8oo million to England secured by$i. billion of collateral, and loans to France of $2oo million secured by $240million of collateral.
66 BREAKDOWNAmerican credits, and the Paris rate was gradually broughtinto a closer approximation to the pre-war pars.
The Fanlike Spread of the Exchanges and the Measures takento Modify ItThe preservation of the central nucleus was not, however,achieved without some sacrifice in general exchange stability.The German and Austrian exchanges continued to movedownward with reference to it and constituted more than evera separate system because this great of Americancredit was not available to support them. Moreover, the tend-ency of the other heutral exchanges to rise against sterlingand the dollar was now accentuated by very heavy purchasesin certain neutral countries by the United States for warneeds. The shipment of gold to the United States, which hadbeen so great during 1915 and 1916 and the first half of 1917,was shut off, while the forces making for the movement ofgold out of the United States to neutral countries not onlycontinued in operation but were greatly strengthened. Likeother belligerents, the United States embarked, with herentry into the war, upon a vigorous policy of gold concentra-tion. The drain of gold to neutrals became an impediment tothe execution of this policy and caused the gold export em-bargo of September 1917. This embargo removed the checkthat had kept the exchanges of the neutrals from rising inLondon and New York. During 1917 also the military re-verses of Italy and the general disintegration of Russia as anAllied power caused a rapid depreciation of the lira and therouble in terms of dollars, francs, and pounds.
Exchange rates therefore spread like a fan around thecentral group, the northern European, South American, andJapanese exchanges tending to rise above; the Italian, Rus-sian, and the German and Austrian group falling below.
In order to counteract the tendency of the neutral ex-changes to split off from the nucleus, many credit arrange-ments were entered into, and the extraordinary spectacle was
PRESERVATION OF EXTERNAL FORMS 67presented of the great powers of the world demanding creditsfrom many small countries. France borrowed from Spain,Uruguay, Switzerland, Argentina, the Netherlands, Norway,Sweden, and Japan as well as from the United States andGreat Britain. England borrowed from Argentina, theNetherlands, and Japan as well as from the United States.The United States borrowed from Spain, India, Argentina,and Bolivia. Russia borrowed from Italy, France, and Japanas well as from Great Britain and the United States. Theextraordinary amount and variety of these loans is shownby the accompanying list compiled by Dr. Blankart (op. cit.,p. 172).
MILLIONSOF SWISS
TYPE OF LOAN FRANCSAdvances of U.S.A. abroad until April 7, 1917 13,866Advances of U.S. Treasury to December 1918 42,087Advances of British Treasury to its Allies to end of July 1918 37,748Advances of the Banque de France to the Allies to October 2, 1918 3,490Direct Advances of the French government to its Allies to end of 1917 3,207Italian Advances to Russia 250Advances of Japan to its Allies to January 1918 2,781Advances of Argentina to U.S.A. to May igz8 1,030Advances of Argentina to France to September 1918 472Advances of Germany to Austria-Hungary to December 5, 1917 4,608Advances of Germany and Austria to Italy to end of 1917 4,700Advances of Germany to Bulgaria to end of 1917 1,350Advances of Roumania to Austria in September igi8 155Advances of Neutrals to France to September igi8 570
to Great Britain 6ooto Germany (estimated) 8oo
117,714
In addition, very large open book credits were extendedby neutrals to the belligerents. These credits were often un-willingly granted. In some countries, the Netherlands forexample, they were a consequence of the accumulation ofbalances in the belligerent countries which could be broughthome by individual holders only if funded by domestic creditinstitutions. Often the borrowers did not hesitate to usecompulsion in extorting credits as a price for continuing topurchase in neutral markets. The belligerents threatened tointer:Eere with the necessary imports of neutrals unless theygave credits for the import of these goods and even granted
68 BREAKDOWNstabilization loans. Such loans were ostensibly arranged uponthe basis of the common interest of the parties in a return tonormal exchange rates after the war. A series of Swiss andDutch loans to Germany, Spanish loans to France and theUnited States, and Dutch loans to Austria were examples ofsuch pressure. Roumanian loans to Austria were an extremecase. They represented in effect a sort of war contribution.5
This system of public and private credit, of whichUnited States Treasury advances were the core and center,was supplemented by a general tightening of exchange con-trol devices. In France an Exchange Commission was set upon July 6, 1917 in the Ministry of Finance and given over-sight over the foreign exchange markets and over the arrange-ment of credits to support the franc, and on April 2, 1918 adecree prohibiting capital exports from France gave a mo-nopoly of foreign exchange transactions to firms keeping aforeign exchange register. Italy introduced a legal monopolyof the foreign exchange business in 1917 and government ex-change control in the spring of 1918.16 In many countries, es-pecially Germany, Austria, and Italy, these devices weregradually integrated with measures to control imports. Amer-ican policy was in this respect quite different. In the UnitedStates control of the exchanges was carried to an extremepoint in order to fulfil a fourfold policy: (1) to cut downunnecessary sales of the Allied exchanges; (2) to cut downunnecessary purchases of neutral exchanges; (3) to preventthe enemy from securing aid through dealing in neutral ex-changes; (4) to prevent the process of credit inflation in theUnited States from meeting a check due to a drain of gold or
Blankart, cit., p. i6o. Dr. Blankart gives the following further instances.In 1917 Switzerland had to purchase from Germany the lifting of the pro.hibition of the importation of silk, docks, and embroidery by giving a credit toGermany of i8 million Swiss francs (ibid., pp. 152 if.) . French credits were ex-torted from Switzerland under threat of payment by the French of their ad-verse trade balance in silver under the rules of the Latin Monetary Union.During the later years of the war Germany insisted, as a condition of import-ing certain goods from Switzerland, that the proceeds of the sale in marksmust remain in Germany until the end of the war (ibid., p. 177).16Ibid., pp. 84—97.
PRESERVATION OF EXTERNAL FORMS 69
leading to the formal abandonment of the gold standard.Under the terms of regulations issued in January 1918 noperson could engage in a very comprehensive list of transac-tions in the exchanges without obtaining a registration cer-tificai:e or specific approval for each particular transactionfrom the Federal Reserve Board. All holders of registrationcertificates had to report to the Federal Reserve Board all ac-Counts or securities carried with or for foreign correspond-ents, and all changes in such accounts and all purchases, sales,and other transactions in the foreign exchanges or securitiesfor or through foreign correspondents. All dealers had to ob-tain from customers declarations showing the exact purposeof each purchase or sale of foreign exchange. All dealers'books were open to the inspection of the Federal ReserveBoard, which had power to prohibit or postpone the consum-mation of any foreign exchange transaction. The Secretaryof Treasury was given arbitrary powers to prohibit, eitherthrough the Board or directly, any such transaction, and thisvast fund of information was used to control the shipment ofgoods, especially to neutrals.17
In addition to measures of exchange control, arbitrage op-erations were undertaken deliberately in order to reducefluctuations in the exchanges, which were naturally great dur-ing a period when transactions were restricted and ordinaryspeculative operations prevented. In Great Britain these op-erations were conducted secretly in all markets through theBritish foreign banking system and through agents. In Francethey were conducted directly from Paris by the Bank ofFrance, which used the foreign branches of French banks asits agents.
Exchange control was successful in preserving the sterling-dollar-franc nucleus, but not in preventing a considerable ap-preciation of the neutral exchanges over these central cur-rencies. Nor could it prevent the steady depreciation of cer-tam exchanges in terms of the nucleus, in particular those ofthe Central Powers. The link between the sterling-dollar-
Beckhart, cit., IV, 234—49.
70 BREAKDOWNfranc system and the system centered about the mark waschiefly the mark-Swiss franc rate. Germany made very greatefforts to prevent the mark from falling in the Swiss markets,but these definitely failed in January 1918. Thereafter thetwo systems of exchange rates became quite distinct.
The Approach to 'Normal,' November 1918, andthe Idea of Par
During the concluding months of the war a stabilization ofthe Italian lira, similar to that of the franc, was finallyachieved by an agreement between the British, French, andItalian treasuries. The lira was stabilized at a discount of 17per cent from the pre-war parity with the pound sterling. Atabout the same time the control of the neutral exchanges inNew York began to be so complete that their high premiumsover the dollar, and consequently over sterling, began to dis-appear. Furthermore the approaching end of the war inducedspeculation based upon the hope that exchange rates wouldsoon return to normal. At the time of the Armistice, there-fore, the exchange rates of the Netherlands, Spain, the UnitedStates, Great Britain and the British Empire, Japan, France,Sweden, Argentina, Brazil, and Italy differed remarkablylittle, in view of all the circumstances, from those which pre-vailed before the war. The approximation to the old systemof pars was so close that the general public and even informedopinion in the belligerent countries retained unshaken a be-lief in an early return to 'normal' rates as established by thepre-war international gold standard system. If deviationsfrom parity with the pound sterling are taken as a measure,it is a striking fact that at the close of hostilities the Dutch,Spanish, and Swedish exchanges were less than io per centabove parity, the American exchange 2 per cent above, theFrench exchange 2 per cent below, and the Italian 17 percent below. If, however, the Swiss franc were taken as a pointfrom which to measure, one would have to say that all theseexchanges were depreciated from 2 to 25 per cent.
CHAPTER 4
The International Gold Standard during the Waras a System of Pegged Exchanges
The eKtraordinary use off credit during the war to preservethe external form of the international gold standard as atraditional system of rates brought out in sharp relief certainaspects of the relationship of foreign lending to international(:learance, and greatly magnified the ordinary effects of for-eign loans upon the banking systems of both lending andborrowing countries.
Loans in Support of the Foreign Exchanges in TheirRelation to International Clearance
The history of international lending during the war is inpart the history of a conflict, already present before the war,between two principles governing the attitude of lenders to-ward the use by borrowers of the proceeds of foreign loans.The fi:rst is the principle that the proceeds of foreign loansshould be used in the lending country to give employment todomesi:ic capital and labor, as exemplified in the foreign loanpolicies of France and Belgium. The second is the principlecf allowing free use of the proceeds by the borrower and rely-i:ng upon their return to the lending country through theinternational clearings, as exemplified in British policy.
In a world in which international lenders are few the rigidapplication of the first principle is a force that comes in con-flict with the promotion of a world-wide distribution of goodsin international trade, the encouragement of increased pro-duction in the borrowing country from which the loans mustultimately be repaid, and, according to free trade doctrine,
7'
72 BREAKDOWNthe improvement of the standard of living of countries eco•nomically interdependent. Before the war it was not allowedto prevail over the second principle. Granting free use of theproceeds to the borrower by the lender was the dominantcharacteristic of international lending under the interna-tional gold standard of pre-war days because it was the prac-tice of the dominant lender. It was British practice until theeve of the war because it was consistent with the particularinterest of Great Britain as the country most dependent uponthe growth of international trade in general and bestequipped to be a world financial center.
Because this was the practice of the dominant lender, theeffects of foreign loans, as a time-bridging device filling gapsin the balances of payments of many countries, were diffusedthroughout the world, and lent general support to the wholesystem of foreign exchange rates.
The Attitude of Governments toward the Use of the Proceedsof Foreign LoansThe assumption by governments of the role of internationallenders on a vast scale during the war greatly strengthenedall the considerations leading to restrictions on the use ofthe proceeds of foreign loans. Under war-time conditions,especially in Great Britain, it was no longer safe to rely uponthe international clearings to bring home the proceeds offoreign loans. To justify large extensions of credit to foreignpowers from public funds, all governments, particularly dem-ocratic governments, must be able to point to clearly demon-strable domestic advantages accruing from such advances. Fora government to put foreigners in possession of public fundsin order to enable them to purchase the goods of other for-eigners and thus employ foreign capital and labor gives at notime a domestic advantage clearly or easily demonstrable tothe electorate, even when these foreigners are allies or as-sociates in a great war. If, at the same time, the result of suchadvances is to weaken the exchanges the government is trying
PRESERVATION OF EXTERNAL FORMS 73to support against the pressure of purchases abroad requiredby a life and death struggle, it is natural for such a govern-.ment to be reluctant to make advances of this kind or evento permit them to be made by private lenders.
1t is not surprising therefore that the lending governmentsusually tried to arrange for the proceeds to be spent withintheir own borders. A Treasury Minute of November 17, 1914,for example, stated that only under exceptional circumstanceswere British government credits to the Dominions to be usedoutside the United Kingdom; and the British agreementwith France of April 30, 1915 provided that the French gov-ernnient was to spend in Great Britain one-third of the cred-its pul; at its disposal by the British government.
This principle was strongly entrenched in the mind of theAmerican government, which willingly granted credits to itsallies for purchases in America but frequently objected tomaking such advances for the support of the foreign ex-changes in general, for the reimbursement of credits pre-viously granted by Great Britain to other allies, or for theIlnancing of purchases in Great Britain, the Empire, or neu-tral countries.
Modifications of Policy forced by the Requirements of For-eign Exchange PeggingThere were, however, many modifications of this attitude byboth Great Britain and the United States. Great Britain madeloans to France and other allies to finance the purchase ofgoods in the United States and neutral countries. WhenAmerica entered the war it was agreed that the burden ofadvances to allied countries to finance purchases of goods inneutral countries should be divided between Great Britainand the United States. A certain number of credits were ob-tained. in the United States for the reimbursement of GreatBritain for credits extended to finance purchases in GreatBritain and the Empire,' though all these credits were in-L These details are taken from Harris, cit., pp. 246—59.
74 BREAKDOWNconsistent with the principle of restricting the use of theproceeds to expenditures in the lending country. So also werethe large loans made by both Great Britain and the UnitedStates to support the sterling-franc and sterling-dollar rateswithout direct reference to the purchases of France in GreatBritain and of Great Britain in the United States. Table 3
TABLE 3Summary of Advances by the United States Treasury toForeign Governments and Expenditures reported by themApril 6, 1917—NOvember I, 1920 (millions of dollars)
GREATBRITAIN FRANCE' ITALY1
Advances by U.S. YreasuryNet Cash Advanced 4,196 2,966 1,631
Expenditures ReportedExchange and cotton purchases 1,682 8o6 88Other commodities and services 4,444 1,595 6o6Interest 388 269 58Maturities 354 290Silver 262 6Miscellaneous 70 184 I i6Reimbursements i 1,046 784
Total Reported Expenditures 7,219 4,196 1,652
Minus:Reimbursements from U.S. credits to other
governments 1,854 19Dollar payments by U.S. government for
foreign currencies 449 1,025 14Proceeds of rupee credits and gold from India 8i
Total Deductions 2,384 1,044 14
Net Expenditures 4,835 3,151 1,638Condensed from Exhibit 26, Annual Report of the Secretary of the Treasury,19201 Many credits obtained by France and Italy and other borrowers in the UnitedStates were for the purpose of reimbursing Great Britain for purchases made byher in America on behalf of these borrowers. Such lending was consistent withthe principle of the expenditure of the proceeds of loans in the United States,for it merely eliminated the middleman position of Great Britain by establishingdirect obligations between those who had really purchased the goods in theUnited States and United States lenders. These loans were, however, unwelcometo the United States government precisely because they substituted for a Britishobligation the obligations of others.
PRESERVATION OF EXTERNAL FORMS 75indicates the extent of American deviation from this prin-ciple.
These modifications in the declared policies of govern-ments with respect to foreign loans were forced by the majorrequirements of war finance. It was an imperative physicalrequirement for waging war that war supplies should bedrawn from the entire world. As long as this requirement hadto be met it was impossible for the financiers of the war tocontinue successfully to support the exchanges and at thesame time adhere to the principle that the proceeds of foreignloans should be spent at home.
The Relation of Foreign Lending in War Time to Interna-tional Clearance, A bstractly Considered'The interconnections of all types of international lendingand their relation to the effort to preserve the internationalgold standard as a traditional system of rates may be seenfrom an abstract statement of the effects of certain major typesof British and American foreign loan upon the exchangesduring the war. The basic reason for these loans was to makeit possible for belligerents to purchase the means of wagingwar without harmful repercussions on the exchanges. Twoassum;ptions are therefore made in this discussion: first, thatcurrently accumulating credits were insufficient to providepayment for essential purchases of goods without forcingdown exchange rates; second, that the essential purchaseswould have been made even at the cost of declining exchangerates.
The cases chosen for illustration are all connected with theprovis:ton of British credits to France to enable her to makepurchases in England, in America, and in neutral countries.
Case 1: British Loans to Finance French Purchases of BritishGoods in England. When Great Britain made loans to Franceto enable her to buy goods in England the direct effect of thecredits upon the exchange market was that an increased offer
76 BREAKDOWNof francs was met by an increased supply of sterling. Therewere no repercussions in other exchange markets, but thatfact was in itself of great importance to other countries. Hadthe French purchases been made without the British creditsthe attempt to pay for them would, under our general as-sumptions, have weakened the French exchange on Londonbut would not have influenced the sterling-dollar or the franc-dollar rates directly. Therefore between these three coun-tries 2 an opportunity for arbitrage profit would have beenopened through the sale of francs for dollars, dollars forpounds, and pounds for francs.3 Arbitrage operations of thistype would have diffused the initial weakness of the franc, atfirst concentrated in the sterling-franc rate, for they wouldhave set up a tendency for the franc to recover in London butfall in New York, and for the pound to rise in New York.The pound would have appeared to be generally strong,but stronger against francs than against dollars, and the francgenerally weak, but weaker in pounds than in dollars. A newtriangular relationship would have been in process of forma-tion, a result inconsistent with the policy of maintaining asclosely as possible the traditional system of rates of the goldstandard. Moreover the new system would not have beenstable unless, with the decline in the franc in the other mar-kets, the French purchases in England had been compensatedfor by some increase in French exports, some attraction offoreign funds to France, a compensating contraction in otherFrench imports, or some similar movement of the Frenchbalance of payments into a new equilibrium at the new ex-change rates. By the hypothesis of an insistent war-time de-mand for goods any contraction in imports is ruled out, andthe other adjustments made very improbable. Consequently2 These three markets, of course, were in practice not the only markets inwhich arbitrage adjustments were in progress, but these cases are outlined inabstract form to provide the basis for a general argument, not as illustrationsof the exact practice of the markets during the war.
The initiative in taking advantage of this opportunity could, of course, havecome from any of the three markets or from a fourth market.
PRESERVATION OF EXTERNAL FORMS 77the franc's depreciation in London would probably have con-tinued, but its power to pull down the dollar in sympathywould probably not have been prolonged. For any tendencyof the dollar to decline in sterling would have had a stimulat-ing effect upon American exports and a contracting effectupon American imports since the peculiar inelasticity as-sumed. with reference to the French powers of adjustmentdid not apply to America in war time. Depreciation in ster-:ling would indeed have strengthened tendencies alreadystrongly at work in the American balance of payments. Thesereactions would have checked the decline of the dollar inLondon and increased its strength in Paris, without influenc-ing directly the sterling-franc rate. The effect would havebeen that the arbitrage opportunities caused by the originalweakness of the franc in London would not have beenclosed until the franc had depreciated equally in bothLondon and New York. The initial weakness of the francwould now have become diffused in a different way, but thiswould have been a result just as repugnant to the principleof maintaining the traditional system of rates as the initialeffects of the French purchases in England had been. There-fore unless that objective was abandoned it would have beennecessary, as soon as the franc began to fall in London, forthe French to obtain credits in America. They could thenhave offered dollars for sterling and made payment for their
in England without excessive offers of francs inthe London market. The consequent strength of the francin London and of sterling in New York would then have re-inforced the tendencies already at work in these two ex-changes through arbitrage operations. Consequently the useof these American credits would soon have closed the pre-vious arbitrage opportunities and substituted exactly oppositeOfleS. It would have become profitable to sell dollars for
Strictly speaking, an arbitrage opportunity does not remain open for morethan a minutes, but it may continually be renewed ii the underlying forcesare continued. The term is used here in the latter sense.
78 BREAKDOWNfrancs, francs for pounds, and pounds tor dollars, and thiswould have continued until the reestablishment of the formerequilibrium of rates had rendered further credits unneces-sary.
To summarize: The extension of British credits to Franceto finance the purchase of British goods left the task of peg-ging the sterling-dollar and the dollar-franc rates exactlywhat it had been before, but if these credits had not been ex-tended, then (i) the French purchases would have had to beforegone, an eventuality ruled out by hypothesis, or (2) thesystem of fixed exchange rates between the three currencieswould have had to be abandoned and a new system estab-lished under which the French could substantially increasetheir exports, or a continuously unstable system of ex-change rates would have come into existence as a result ofpersistent weakness the franc, or the old system ofrates would have been preserved by American credits, ex-tended, as far as the use of the proceeds was concerned, indirect contradiction to the expressed policy of the Americangovernment.
Case British Loans to France to finance French Purchasesin the United States. When Great Britain made loans toFrance to enable her to buy goods in America, sterling wasplaced in French hands and the first direct effect on the ex-change markets was to weaken the pound in New York asexpenditures were made in the purchase of goods. Thesetransactions did not directly affect either the sterling-francor the franc-dollar rates. Therefore, between these threecountries an arbitrage profit presented itself, again throughthe sale of francs for dollars, dollars for pounds, and poundsfor francs. Arbitrage operations of this type diffused theinitial weakness of the pound, at first concentrated in thesterling-dollar rate, for they set up a tendency for the poundto recover in New York but to fall in Paris, and for the dollarto rise in Paris. A new triangular pattern tended to be estab-
PRESERVATION OF EXTERNAL FORMS 79:lished on this basis; that is, the franc tended to be 'draggeddown by' or to decline 'in sympathy with' the pound. But theestablishment of a new relationship between the three rateswas not, in this case any more than in Case i, consistent withthe policy of maintaining as closely as possible the tradi-i.ional system of rates of the gold standard. Therefore, inorder not to abandon that objective, both France and Eng-
had to obtain credits in America. As a result sterlingwas strengthened in New York from three sources—fromi:he proceeds of their American credits offered by the Frenchto repay part of their sterling debt to England, from the in-creased supply of dollars available to the English from theirAmerican credits, and from the demand for sterling incident1:0 arbitrage operations. The resulting rise of sterling did nothave to proceed far before it closed the previously existingarbitrage opportunities, but it had to be carried far enough1:0 open exactly opposite arbitrage opportunities before theold system of rates could be reestablished by sales of dollars
francs, francs for pounds, and pounds for dollars.Had French purchases in America been made without
British credits, the attempt to pay for them would haveweake:ned the franc in New York. This weakness of the francwould have opened arbitrage opportunities to sell dollarsfor francs, francs for sterling, and sterling for dollars, andwould have set up a tendency to establish a new system ofrates in the manner described above. Weakness in New Yorkwould now have spread from the franc to the pound ratherthan in the opposite direction, but the new relationshipswould probably not have been stable, and the balance ofpayments adjustments would, in the manner described underCase i, probably have produced in the end an equal and per-sistent weakness of the franc in both sterling and dollars. Toprevent this, American credits would have had to be extendedto France to cover French purchases in America.
To summarize: The consequences of British loans toFrance to purchase goods in the United States were to in-
8o BREAKDOWNcrease the pressure for American loans to England by makingthe task of pegging the dollar-sterling rate more difficult,and to increase the pressure for American loans to Francethrough the reflection in the franc exchange of the weaknessof the pound. The increase in loans to England fromAmerica on this account would have made her a principal ina system of debts involving a British debt to America and aFrench debt to England in which Great Britain was an inter-mediary.
Had British credits not been forthcoming three possibili-ties would have been present:i) for French purchases in the United States not to have beenmade at all—an eventuality ruled out by hypothesis;2) for the traditional system of exchange rates to be abandonedas a consequence of attempts to pay for these French purchases;3) for America to make loans to France in strict accordance withthe stated policy of the government.
Case British Loans to France to finance French Purchasesin Neutral Countries. When Great Britain lent sterling toFrance to enable her to buy goods in neutral countries thefirst direct effect on the exchange market was to weaken thepound in neutral markets through the offer of sterling inthose markets by the French. This transaction did not di-rectly affect the franc-neutral exchange rates or the sterling-franc rate. It therefore opened an arbitrage opportunity forthe sale of francs for neutral exchanges, of neutral exchangesfor pounds, and of pounds for francs. The initial weakness ofsterling, therefore, at first concentrated in the sterling-neutralmarkets, tended to be diffused by these arbitrage operations,for they set up a tendency for the pound to recover in neutralmarkets, but to weaken in Paris, and for the franc to weakenin neutral markets. in the manner described it set up a tend-ency toward a new relationship between the pound, the franc,and neutral exchanges, with the franc and the pound bothdepreciated in neutral markets, though in unequal degree.If that occurred it was impossible for the dollar, though its
PRESERVATION OF EXTERNAL FORMS 8irelations to other currencies were not affected in any wayby the original transaction, to maintain stable exchange ratesin neutral countries, in sterling, and in francs. The originalweakness of sterling in neutral currencies would not haveaffected the sterling-dollar rate directly, any more than itaffected the sterling-franc rate, and arbitrage opportunitieswould have arisen which would have tended to make thedollar move with the franc through the sale of neutral cur-rencies for sterling, the sale of sterling for dollars, and thesale of dollars for neutral currencies. In order to preventthese deviations from the old system of rates, American creditsto England would have been necessary, and in addition cred-its from neutral countries to support the whole sterling,franc, dollar group.
Had British credits not been given, but the French pur-chases in neutral markets nevertheless been made, the conse-quences would have been the same, except that the firstdeviations from the old system of rates would have been aweakness in the franc and would have been concentrated inthe franc-neutral markets, and that this weakness would havespread from the franc to the pound, rather than vice versa.The tendency of the dollar would have been to move withthe pound, and ultimately balance of payments adjustments,assuming an insistent French demand for goods in neutralmarkets, would probably have forced the new system ofrates to resolve itself into a common depreciation of the francin terms of the dollar, the pound, and the neutral exchanges.
To summarize: The consequences of British loans toFrance to finance French purchases in neutral countries wereto increase the pressure on America for loans to support thesterling exchange, and at the same time to widen the geo-graphical distribution of war-time international lending byincreasing the pressure for American borrowing from neu-trals.
Had British credits not been extended the three possibili-ties would have been:
82 BREAKDOWNi) for the French purchases in neutral countries not to havebeen made at all—an eventuality ruled Out by hypothesis;2) for a new system of exchange rates to have been establishedtending ultimately toward a general weakness of the franc in allmarkets;3) for American and neutral loans to be made to support the ex-changes in the same manner as if the British credits had beenextended, but differently distributed. Such American loans tosupport the exchanges would have been in contradiction to thepolicy of the government as far as the use of the proceeds wasconcerned.
The discussion of the three types of British loan to Francehas revealed one situation in which no additional pressurewas brought upon America to make foreign loans, one inwhich America was placed under pressure to lend to financepurchases in her own market, and four situations in whichpressure was placed upon America to make loans to Englandor France to stabilize the exchanges without direct referenceto American exports. If British credits were not forthcomingto finance French purchases in England, then the repercus-sions in the exchanges shifted the burden of financing thesepurchases to America. If British credits were granted to fi-nance French purchases in America, then the repercussionsin the exchanges placed America under pressure to make loansto support the sterling exchange, to relieve England of theburden she had assumed, and to make her an intermediaryin the transfer of American credit basically extended to fi-nance American exports. If British credits were forthcomingto finance French purchases in neutral countries, the reper-cussions in the exchanges placed America under pressure toextend credits to England to support sterling, and if theywere not forthcoming, America was placed under pressure tomake loans to France to support the franc.
These three cases are sufficient to illustrate the difficultiesof maintaining at one and the same time a free movement ofgoods in the world's commerce, a stable system of exchange
PRESERVATION OF EXTERNAL FORMS 83
rates, and a policy of restricting the use of the proceeds offoreign loans to purchases of goods in the markets of thelender The world-wide geographical distribution of goodsentering into international trade influences the exchangerates in a host of different ways and thus gives the signalsthat show that credit is needed to bridge the gaps in the ex-change of goods. Under an international gold standard systemthe whole functioning of the world credit structure respondsto these signals through the intricate mechanisms of bankingadjustment described in these studies. The credit that isforthcoming is mobile and finds its way by devious channels1:0 the original source of temporary lack of balance, whosefar-reaching repercussions are expressed in forms not easilytraceable. If the international credit required for the freeflow of goods in every direction is not made available, thealternatives mentioned must be faced—either some of thegoods cannot move or the system of stable exchange rates can-not be maintained. If the principle is rigidly applied, thatforeign làans shall be made only when the disturbances in theexchanges that indicate they are needed happen to be directlyconnected in the first instance with the trade of the creditgiver, then the free flow of goods is directly impeded. Gapsin the international distribution of goods that do not arisefrom the trade of the relatively few creditor countries are notbridged by credit, and the resulting disturbances in the ex-chang'es are not prevented.
Du:ring the war the double necessity of enabling goods tomove and maintaining a stable system of exchange rates asfar as possible was stronger than the principle of restrictingthe use of the proceeds of loans to purchases in the lendingcountry. It is impossible of course to disentangle the effects ofthese loans upon the exchanges during the war by an examina-tion of the quotations. The operations in support of the ex-changes were directed to resist pressures wherever they ap-peared, including those resulting from the international lend-ing itself. Because loans were made available to meet these
84 BREAKDOWNpressures, in spite of the desire of governments to restricttheir lending to a narrower basis, the effects of foreign loans,as a time-bridging device filling the gaps in the balances ofpayments in many countries, were diffused throughout theworld and lent support to a whole system of exchange rates.They also influenced, in a manner to be described in the nextsection, both the demand for and supply of bank credit in allthe countries adhering to this system of rates.
The Support of the Foreign Exchanges during the Warin its Relation to the Supply of and Demand
for Bank CreditThe effort to maintain the international gold standard as atraditional system of rates had certain close connections withthe effort to preserve the gold standard as a domestic institu-tion. These connections are found in the complicated in-fluence that foreign exchange pegging exercised over the de-velopment of the banking position both in countries withweak and in those with strong exchanges. In discussing theseconnections a sharp distinction has always to be borne inmind between the effects of the accumulation of the resourcesused in pegging upon the supply of bank credit and the ef-fects of the success of pegging upon the demand for it.
Effects of the Accumulation and Use of the Resources em-ployed in Pegging on the Supply of Bank CreditAs a general rule making payment for imports decreases de-posits and receiving payment for exports increases deposits,but this rule, like so many others, is subject to certain im-portant exceptions.
When a country makes payment for its imports in a foreigncurrency, its banks give up foreign assets and cancel part oftheir own deposits by charging the importers' accounts, whilein the country receiving payment there is a transfer of de-posits from foreign to domestic control through charges tothe accounts of foreign banks and credits to exporters.
PRESERVATION OF EXTERNAL FORMS 85
When a country receives payment for its exports in aforeign currency, its banks add to their foreign assets andincrea.se their deposits by crediting the accounts of exporters,while in the country making payment there is a transfer ofdeposits from domestic to foreign control, through charges tothe accounts of importers and credits to foreign banks.
The settlement of any single transaction therefore involvesa change in the amount of deposits in only one country, eithera decline in deposits in the importing country or an increasein deposits in the exporting country. What is true of a singleimport or a single export considered in isolation is true of thetotal of imports and exports whose settlement involves changesin the mutual indebtedness of the banking systems of thecountries concerned. For the bulk of imports and exports,however, the interbank deposits cancel out, the settlementresults merely in credits to exporters and debits to importersin each country, and the general rule applies. When balancesof international payments are in relatively stable equilibrium,the few interbank deposits that do not cancel out act asbalancing items,5 appearing first on one side of the interna-tional accounts and then on the other. These deposits formpart of the mobile international loan fund often referred toin other parts of these studies. When the balancing item takesthe form of a reduction in the foreign assets of the banks ofthe importing country this fund is reduced. When it takesthe form of an increase in the foreign assets of the banks ofthe exporting country this fund is increased. When, as be-fore the war, the balancing items are not all on one side ofthe account and are reasonable in amount, fluctuations inthe size and distribution of this international loan fund andits wise administration can provide an admirable instrumentfor promoting stability in the exchanges.
When, however, a country finds that its imports tend per-
In statements of the international balance of payments increases in depositsdue foreigners and decreases in balances held abroad are exports. and the op.
changes in balances are imports.
86 BREAKDOWNsistently to exceed its exports, the balances owed by its ownbanks to foreign banks tend to grow and• the deposits ofbanks in foreign countries tend to expand. A point is soonreached at which foreign owned deposits in the importingcountry substantially exceed the amounts necessary for pur-poses of clearing or other customary needs, and pressure fortheir remittance home appears. Payment for part of the coun-try's imports then takes the form of a net loss of foreign assetsand a net cancellation of domestic deposits, and consequentlyin the exporter's country a net increase in foreign assets andin domestic deposits is replaced by a transfer of deposits fromforeign to domestic control. Interbank deposits no longermove in the direction required to prqmote stability of the ex-changes, but in the opposite direction. Payment for importsunder these conditions involves a contraction in the creditsuperstructure of the importing country, and is a deflationaryinfluence. It also results in pressure on the exchanges as thebanks in the importing country attempt to find some meansof replenishing their dwindling deposits abroad. The wholemechanism of the adjustment of balances of payments not instable equilibrium comes into play at this point. If the neededexports from the importing country are provided in the formof gold the contraction in the credit superstructure alreadytaking place, will, for reasons to be discussed, probably not bechecked, and an added deflationary force, a contraction ofthe credit base, may be added to it.
After the exchange deadlock largely caused by the callingin of their foreign assets at the beginning of the war wasbroken, Great Britain and the Allied Powers were countriesin this position. Their banking systems were under greatpressure to provide ever increasing credit facilities to theirwar industries and their governments. The deflationary in-fluence of continued payment for imports upon the super-structure of credit could therefore at most be an offset againsta pressure for expansion. To allow the exchanges to depreci-ate was contrary to the entire effort of war finance to preserveconfidence and to buy necessary imports as cheaply as pos-
PRESERVATION OF EXTERNAL FORMS 87
sible. To decrease imports and increase exports was to makethe conduct of the war more difficult. Goods and servicesbought abroad were essential to the economic life and mili-tary success of all belligerents. To divert home resources tothe production of exportable goods to pay for imports wouldhave weakeneçl their military power. The continued flow ofimports to the Allied Powers, while imports to the CentralPowers were seriously impeded, might easily become a deci-sive factor in the whole struggle. Since neither deflation nordepreciating exchanges were a remedy for their problems,Great Britain and the Allies turned to the replenishment offoreign balances and the building up of domestic bank de-posits by finding exportable commodities that would notweaken their material strength, to holding down the un-avoidable increase in imports by selecting and controllingthem, and to foreign borrowing. The two great exportablegoods used for the replenishment of foreign balances weregold and securities. The mobilization and export of securi-ties performed not only this function but also that of build-ing up domestic deposits in exactly the same way as any ex-port commodity. The influence of foreign credits and goldexports upon foreign balances and domestic deposits, how-ever, is more complex and requires separate analysis.
EFFECTS OF GOLD EXPORTS ON THE CREDIT BASE AND CREDITSUPERSTRUCTURE
Gold exports and imports have, under certain circumstances,a limilted power to induce or create transactions that appearon the opposite side of the international balance of payments.In thi:s they are not unique, but when they are functionallyrelated to important capital movements they become part ofa transaction that affects the credit base and credit superstruc-ture differently from ordinary exports and imports of goods.Moreover the majority of gold exports and imports are madeby banks acting as principals in the transaction, and this alsoresults in effects on the credit base and credit superstructurewhich. differ from those of ordinary exports and imports.
88 BREAKDOWNWhen gold is exported by private boarders or by produc-
ers and sold for foreign currencies the gold appears as anexport and the increase in foreign balances as an import onthe country's statement of its international balance of pay-ments. If these balances are retained or are used to buy se-curities or other foreign assets a functional connection isestablished between gold exports and certain particular im-ports, and the gold shipment is part of a transaction thatswells both sides of the international account but does notaffect the bank deposits of the gold exporting country. Ifthe gold exporters bring home their foreign balances by sell-ing them to banks in their own country, then both the do-mestic deposits and foreign balances of these banks increase.The banks may retain their increased foreign balances, em-ploy them, or sell them to importers. To the extent that theyretain or employ them abroad the functional connection be-tween the gold exports and a corresponding amount of thecountry's imports is maintained and the increase in domesticdeposits continues. To the extent that they sell them to im-porters the banks' domestic deposits and foreign assets arereduced. If they sell all the new foreign balances to importers,then the gold exports of the hoarders and producers have,like other exports, made possible a corresponding amount ofimports without reducing the foreign currencies held by thebanks, domestic deposits, or bank reserves.
When gold is exported by banks as an arbitrage transactiona different result follows. No functional connection betweengold exports and particular imports is possible, for remit-tance home of the proceeds is essential to the completion ofthe transaction. Since the banks have now entered the trans-action as principals, the behavior of the credit base and creditsuperstructure is also different. The sale of the gold in thefirst instance reduces bank reserves and increases the banks'foreign balances, but no one's account is credited since thebanks are themselves the exporters. Remittance home is ac-complished by the sale of the foreign exchange to domestic
PRESERVATION OF EXTERNAL FORMS 8g
importers whose bank accounts are debited. Like the goldexports of hoarders or producers who have brought homethe proceeds of their shipments, gold arbitrage exports haveoffset a corresponding amount of imports without affectingthe foreign assets of the banks of the exporting country. Butthey have not left either the credit base or credit superstruc-ture unchanged. The final result has been that both bankreserves and domestic deposits have been reduced.
From the viewpoint of a gold importing country, of course,gold is an import which, like all other imports, has to be paidfor. If, as was true of many gold imports into England duringand after 1933, it is bought by individuals and held by themin domestic hoards, domestic bank deposits are reduced. Thisis also true when the government is the purchaser, providedthe government pays in ordinary commercial bank funds andholds the gold in treasury vaults or in inactive accounts in acentral bank. In either case it is correct to speak of the goldas being, from a banking point of view, 'sterilized.' 6 If thesellers, for example foreign hoarders or foreign producers, orthe foreign banks to whom the original sellers transfer theirdeposits, do not remit the proceeds home, there is simply atransfer of deposits from domestic to foreign control. In thestatement of the international balance of payments the goldis an import and the increase in balances due foreigners anexport. If the new balances are employed in the purchase of
or other assets, the deposits are passed on to theof these assets, which are then recorded as exports.
A functional connection has been established between goldimports and certain particular exports, and the gold importis part of a transaction that swells both sides of the interna-tional. account but does not affect the bank deposits of thegold importing country. If the gold sellers do remit the pro-ceeds home, making payment for gold imports reduces do-mestic deposits and the foreign exchange held by the banks6 The only real sterilization policy is the sale of imported gold, not to banks,but to customers of banks (cf. Swedish policy during the war).
90 BREAKDOWNin exactly the same way as making payment for any otherimport. Gold imports offset a corresponding amount of ex-ports in the international balance of payments, without af-fecting either the foreign currencies held by the banks, do-mestic deposits, or bank reserves. These effects are exactlythe opposite of those that follow the export of gold by hoard-ers and producers.
If, however, imported gold is bought by banks from foreignhoarders, producers, or other sellers, a different result follows.If the sellers do not remit the proceeds home both the depositsand the reserves of the banks of the gold importing countryare increased. No one's account is debited, as in the case ofpurchases by individuals or governments drawing on ordinarycommercial banking funds. Instead of a transfer of depositsthere is a creation of new deposits. The gold import becomespart of a transaction that increases both sides of the interna-tional balance of payments, but does not leave deposits un-changed.7 If the proceeds of the sale of gold are not retainedin the gold importing country but are remitted home to thesellers, then the newly created deposits are canceled and theforeign exchange holdings of the banks are reduced. Thepurchase of the gold and the remittance of the proceeds com-bine to increase the reserves of the banks, and decrease theirforeign assets, deposits remaining unchanged. This cancelsthe increase in foreign balances resulting from a correspond-ing amount of exports, but does not cancel the increase indeposits due to such exports. In the international balance ofpayments gold imports offset a corresponding amount of ex-ports, but the banking effects are not offsetting. The finalresult is an increase in reserves and deposits, foreign exchangeremaining the same. These are precisely the effects that followwhen gold is imported as an arbitrage transaction.
The purchase of gold abroad by banks as an ordinary gold
Such a relationship between gold imports and the purchase of American se-curities by foreigners was a subordinate feature of the American balance ofpayments after 1935.
PRESERVATION OF EXTERNAL FORMS 91
arbitrage transaction is not functionally related to any itemin the export side of the international balance of payments.It constitutes payment for current exports instead of beingpart of a transaction that may swell both sides of the interna-tional trading account because payment in foreign currenciesis essential to the completion of the transaction. To pay forthe gold the foreign exchange holdings of the banks are re-duced, but no one's account is debited, for the banks arethemselves the importers. The banks' foreign exchange is re-plenished by purchases from exporters whose transactions arequite independent of the gold arbitrage operation. The finalresult of the two parts of the operation is a net increase in
deposits and reserves, while foreign assets remainunchanged; that is, the exact opposite of the final ofgold exports as an arbitrage operation.
Since these are the usual effects of gold arbitrage, it is oftenasserted that gold exports decrease deposits and gold imports.tncrease them, but this statement is elliptical and thereforeoften misleading. It is indeed something of a paradox, forother kinds of exports and imports are admitted freely tohave t:he opposite result. The paradox arises because it is easyto fail to distinguish between the two parts of the completedarbitrage transaction. Strictly speaking, the offsetting of ordi-nary exports and imports in the international trade balanceby go].d bought and sold by banks has the effect of fixingpermanently in the credit superstructure a portion of the re-duction in deposits resulting from imports and a portion ofthe increase in deposits created by exports. These results fol-low so].ely because gold is an imported or exported commoditythat is bought and sold by banks and not by customers of
During the war Empire gold was sold to the Bank of Eng-
8 Gold shipped by governments and central banks for special purposes mayhave the banking effects of an ordinary arbitrage transaction or of a purchasefrom foreign hoarders who invest the proceeds in the importing country, de-pending on the purposes of the shipments.
92 BREAKDOWNland for its own account or for the Treasury, and reexportedto other countries. The effects of the purchase were to in-crease bank reserves and to fix in the British banking systemdeposits. created by exports to the gold producing countries,so far as these exports were not made by banks acting asprincipals. Among the exports to the Empire were large in-creases in Empire balances in London and reductions in Em-pire debt to England, which illustrate the capacity of non-arbitrage gold imports to induce to some degree offsettingexports of certain types. To the extent, however, that Empireindebtedness to London banks was reduced, the gold importsfrom the Empire did not cause a corresponding increase inEnglish deposits, and consequently did not fully offset thedeflationary effects of the reexport of the Empire gold. Theimport and reexport of Empire gold made it possible forGreat Britain to conserve foreign assets outside the Empire(in this connection 'the Empire' stands chiefly for SouthAfrica and Australia) and to import goods from countriesoutside the Empire without any reduction in bank reserves,and with only a moderate reduction in deposits, by the useof exports to the Empire. Other gold shipped by Great Britainand other belligerents in support of the exchanges built upforeign balances but diminished reserves and did not offsetthe deflationary effects of imports upon the credit superstruc-ture.
EFFECTS OF FOREIGN CREDiTS ON THE CREDIT SUPERSTRUCTURE
Gold and securities were not available in sufficient amountsto maintain the sterling-dollar-franc foreign exchange nucleus.They had from the outset to be supplemented in ever in-creasing degree by credit. Credits accumulated abroad inwhatever form serve to increase the bank deposits of theborrowing country. Import credits postpone the reduction ofbank deposits required by payment for imports. Exportcredits anticipate the additions to domestic deposits createdby receiving payment for exports. Foreign credits therefore
PRESERVATION OF EXTERNAL FORMS 93tend to prevent deflationary pressure in a country whose im-ports (exclusive of changes in balances) are regularly largerthan its exports.Credits in the Form of Bank Balances. The simplest formof obtaining credit abroad is to retain balances accumulatingunder the control of foreigners as a result of their exports.There is a certain flexibility in the relations between thebanking systems of countries with large international transac-tions that makes possible modification, within limits, of theordin.ary effects of payment for goods shipped in internationaltrade. For, as already indicated, though payment for importsalways reduces bank deposits under domestic control, suchpayment may be accompanied by either a reduction in foreignassets or an increase in deposits under foreign control. Simi-larly, though receiving payment for exports always increasesbank deposits under domestic control, it may be accompaniedby either an increase in foreign assets or a decrease in de-posits under foreign control. The increase in deposits underforeign control therefore is, within limits, a means open to acountry attempting to support its exchanges to offset thereduction of bank deposits and the loss of foreign assets re-sulting from an adverse balance of payments. This means wasused by England during the war. Because of difficulties in re-mitting home, the expectation of a post-war return to 'normal'exchange rates, and special inducements offered by Britishbanks, foreign balances accumulated in London far in excessof the need for them (cf. Ch. 7)Other Credits. The accumulation of balances in this way was,of Course, but a small part of the total accumulation of creditused. to support the exchanges during the war. A vast networkof new international indebtedness, in the form of open bookcredit, bank loans, government advances, sale of treasury billsabroad, and long term capital imports was built up. In allthese various forms it was essentially export credit, whichanticipated for longer or shorter periods the ultimate build-
94 BREAKDOWNing up of the domestic bank deposits and foreign assets ofthe banking systems of the borrowing countries through theshipment of goods and the rendering of services. Becausethese were the effects of retaining foreign-owned balancesand obtaining foreign credits, it was possible for belligerentcountries that had borrowed heavily in foreign markets toimport vast quantities of goods without reducing their owndomestic bank deposits. The actual payment for these importsdid reduce the foreign assets and deposits of these bankingsystems, but they had previously been built up by variousforms of credit. The use of the proceeds of foreign credits topay for imports resulted in debits and credits of equal amounton the books of the importing countries.9 In contrast, thefailure of the Central Powers to obtain sufficiently largecredits in the Netherlands, Denmark, and Sweden meant thattheir imports from these countries, having to be paid for incash, had a deflationary effect in Germany and Austria-Hun-gary.
One further effect of foreign borrowing upon the creditsuperstructure should be noted. The building up of outstand-ing foreign credits required the maintenance of more balancesby the borrowing countries in the lending countries. Ameri-can foreign lending thus created a new requirement for themaintenance of necessary balances in New York. As a by-product of the use of credit to support the exchanges duringthe war there grew up, in addition to the great sterling inter-national loan fund, a second international loan fund in dol-lars in New York.
EFFECTS OF PEGGING ON THE SUPPLY OF BANK CREDIT, SUMMARY
The accumulation and use of resources to support the ex-changes added to the difficulties of maintaining the outwardaspect of the gold standard as a domestic institution in those°Kirkaldy, cit., p. 71: "When a loan is floated in the United States ofAmerica and the credit to be created in America is drawn against to pay forexports from the States to the United Kingdom, debits and credits of equalamounts will be created on the books of banks in the United Kingdom."
PRESERVATION OF EXTERNAL FORMS 95countries whose exchanges were being supported. For it re-duceci the credit base in those countries, and at the same timeprevented the credit superstructure from being diminishedby p2lyments for imports. The use of credit to support theexcha.nges may, on the latter account, be described as infla-tionary. Under war conditions, however, exchange peggingprevented the adoption of •other courses of action whichwould probably have been even more inflationary in theireffects. In the absence of foreign credits the goods essentialfor war would have had to be obtained in part from additionaldrafts on domestic production, in part through the diversionof banking resources to financing the production of goods forexport, and in part through the purchase of imports at con-tinually rising cost because of a depreciating exchange. Thesewere the means to which the Central Powers had to resort.In Great Britain it is almost certain that the tendency towarddomestic bank credit inflation that would have resulted fromsuch a course would have been greater than the inflationaryinfluence actually experienced through the acquisition offoreign credits. In this sense it may be said that the accumula-tion of foreign resources in support of the foreign exchangesactually did, on balance, release the banking system of bur-dens it would otherwise have had to bear. Foreign credits,moreover, when extended to the British government• andused by it to import goods that were subsequently sold to thepublic, provided an admirable means for the transfer of pur-chasing power from the public to the government.
Gold imports into countries whose exchanges were stronghad the inflationary effect of fixing in the credit superstruc-ture deposits resulting from a corresponding volume of ex-ports. Whether, aside from this, the receipt of gold, the pur-chase of securities, and the provision of foreign credits bysuch countries was an inflationary process depended uponthe use made of such gold as reserve, the sources of the pur-chasing power used to buy the securities, and the manner inwhic:h the credits were granted.
96 BREAKDOWN
Effects of Pegging on the Demand for CreditAny judgment concerning the total effect of the process ofexchange pegging must take account not only of these factorsbut also of the indirect influence of pegging upon the demandfor bank credit. The successes achieved in maintaining a sub-stantial nucleus of relatively stable exchange rates not deviat-ing far from the pre-war system of mint pars greatly influencedthe international distribution of the demand for bank credit.They reduced the inflationary pressure of financing the warin some countries and increased it in others. This they didthrough their influence on prices.
It is, of course, true that the effort to peg the exchanges dur-ing the war failed to hold price levels together because otherforces were too great. When in peace-time special influencesaffecting the price levels of particular countries force themout of relation to world prices, as in countries dependent ona single crop or those subject to domestic political upheavalor a deliberate inflationary policy, the gold standard as apegging device breaks down. During the war the importanceof supporting the exchanges was regarded as so gTeat that theeffort to peg the exchanges was continued even after largedifferences between relative price levels and exchange ratescame into existence. There is no doubt, however, that theprice levels of countries whose exchanges were kept stablewere held more closely together than internal inflationaryforces of unequal strength would otherwise have allowed. Allprices are part of a general system and those directly affectedby exchange rates influence those which are not. The preser-vation of the sterling-dollar-franc nucleus introduced intothe economy of the allied countries a volume of importswhose cost was less than it would have been had the ex-changes not been pegged.1° Yet owing to the elaborate system1.0 The extent of this advantage is difficult to measure. Professor Harris hasshown that import prices do not adjust themselves completely to exchange de-predation, citing particularly the small rise in import prices in Great Britain
PRESERVATION OF EXTERNAL FORMS 97cif import controls adopted by the government as part ofthe technique of pegging, it did not cause a rush of importsother than those needed for war purposes. On the other hand,it discouraged exports and consequently reduced the scarcityof goods within the allied countries which was at certaintimes responsible in part for the tendency of their pricelevels to rise.1' Exchange control therefore constituted on thewhole a check to rising prices in the allied countries. It con-sequently reduced the demands for credit upon their bank-:ing systems. At the same time, the effective demand forAmerican and neutral exportable goods was increased by thepegging of the exchanges and this introduced an elementtending toward inflation in the United States and otherneutral countries. In this way part of the burden of financingthe war was transferred from the banking systems of the Al-lies to the banking systems of the United States and in lessdegree to those of the smaller neutrals by the mere fact ofrelatively stable exchanges. This was; however, accomplishedat the cost of an increase in the internal dispersion of priceswhich left a legacy requiring internal readjustment in thepost-war period. The pegging of the sterling-dollar rate madeit possible to introduce a large volume of relatively cheapimports into England and therefore altered the distribution ofpurchasing power within England. It helped to provide arelatively intense demand for certain classes of commoditiesin the United States and thereby altered the distribution ofpurchasing power in the United States. It was not neutral in
to the formation of the internal price structure ofafter September The greater the inelasticity of the supply of importedcommodities, the more important the market of the country with a de-predated exchange to the producers of imported goods, and the more elasticthe demand of that country for imports, the less complete is this adjustmentlikely to be. Cf. S. E. Harris, Exchange Depreciation (Harvard UniversityPress, 1936), pp. 70—4. During the war, however, the conditions leading to arelatively restricted rise in import prices if the sterling exchange depreciatedwere not present to the same degree as after September 1931.11 Cf. S. E. Harris, Monetary Problems of the British Empire (Macmillan,1931), pp. 162 if.
98 BREAKDOWNthe two countries. Such effects are always present under theinternational gold standard system and through them in partthe tendency of that system to bring the prices of all countriesto a common basis works itself out. When, as in the war, strongtendencies are present leading toward unequal degrees of in-flation arising from domestic causes and the exchanges remainstable, their very stability introduces a dispersion of priceswithin the various countries. It is the same phenomenon thatoccurs when the exchanges are allowed to move rapidly whilethere is no great tendency for inflation or deflation withinthe various countries.1212 Miss Dulles has admirably presented evidence bearing on this point drawnfrom the behavior of internal prices in France after the war; op. cit., pp. 301—
This point also has a direct bearing upon the American monetary experi-meiits of '933—34.
CHAPTER 5
The Gold Standard as a Domestic Institutionduring the War
During the war exchange pegging contributed to check themovement of national price levels away from the positionsthey occupied in 1914 relative to one another, and thereby itredistributed the burdens of war financing and produced amore even distribution of war-time inflation throughout theworld. The task of preserving the outward forms of the goldstandard as a domestic institution was to that extent madeeasier in both belligerent and neutral countries. It was, how-ever, made more difficult by the modifications in the actualphysical redistribution of gold that exchange pegging madenecessary.
The Physical Redistribution of GoldThe combined effect of the four currents of war-time golddistribution (cf. Ch. 2) was to leave the banking systems ofmost countries in possession of undiminished or increasedsupplies of gold, and at the same time to divide both be!-ligerent and neutral countries into five definite groups as faras the behavior of their gold reserves was concerned. This isshown in Table 4 in which the percentage changes in theamount of gold held by the central banks and treasuries ofthirteen countries are grouped as follows:') the principal financiers of the war2) neutral countries not adopting successful gold repulsion poli-
and Japan3) neutral countries in which special impediments to gold ac-cumulation existed
99
100 BREAKDOWNTABLE 4Gold Reserves of Selected CountriesPercentage Change during the War
CURRENCY DECEMBER PERCENTAGECOUNTRIES BY GROUPS (millions) 1913 1918 INCREASE
IUnited Kingdom Pound
Bank of England 35 8o 109Bank of England plus
Currency Note Reserve 35 108.5 210United States Dollar
Monetary Gold Stock 1,924 3,08! 6oGermany Mark
Reichsbank 1,170 2,262II
Netherlands GuilderNetherlands Bank 151 689 356
Spain PesetaBank of Spain 472 2,223 371
Japan YenBank of Japan 285 733 157Government plus Bank of
Japan 376 1,588 322III
Sweden KronaBank of Sweden 102 286 i8o
Switzerland Franc 170 415 144Argentina Peso
Caja de ConversionIn Argentina 233 279 20In Argentina and in
legations abroad 233 379 63Caja de Conversion plus
Banks 433 47Iv
France FrancBank of France
In France 3,517 3,441 —2In France and abroad 3,517 5,478 56
Italy LiraThree Banks of Issue and
the TreasuryIn Italy 1,493 1,054 —29In Italy and abroad 1,493 1,642 10
Russia RoubleIn RussiaIn Russia and abroad 125
VAustria-Hungary Krone 1,241 262 —79SOURCE: League of Nations, Memorandum on Currency and Central Banks, 1913-1925II, 34 if.'July 1914—Oct. 1917; calculated from Table 6.
PRESERVATION OF EXTERNAL FORMS 101
4) continental belligerents successful in preventing substantialdissipation of gold reserves5) continental belligerents unable to preserve gold reserves.
Changes in the physical quantities of gold held, in combi-nation with very unequal rates of inflation, broke down inmany countries the pre-war relationship between andthe volume of notes and deposits. In some neutral countriesthe accumulation of gold resulted in a very high set of reserveratios, while in some belligerent countries reserve ratios wereso reduced as to lose touch completely with pre-war norms.Even in the latter, however, gold retained its place in thebanking and monetary system as evidence of the soundness ofcentral banks, as a symbol of national prestige, and as apromise of a post-war return to normal. The general im-portance still attributed to gold reserves in these respects isattested in a letter written to President Wilson by Secretaryof State Lansing on September 6, 1915, and published in theNew York Times of January i 1, 1935. In discussing the meansavailable to European countries for the payment of purchasesin America, Mr. Lansing wrote:"It is estimated that the European banks have about three and ahalf billions of dollars in gold in their vaults. To withdraw anyconsiderable amount would disastrously affect the credit of theEuropean nations, and the consequence would be a general stateof bankruptcy."
Dr. Blankart has presented the figures of the note issues,gold reserves, and the ratios of gold reserves to note issues inthe major countries during the war. Since these figures areall expressed in Swiss francs at pre-war gold parity, they makepossible direct comparisons between the various countries,and provide the basic statistical background for a brief reviewof the attitude of individual countries during the war towardthe gold standard. Such a review serves to break down Mr.Lansing's generalization into its component parts and to em-phasize the vitality of the concepts of gold as standard andgold. as reserve during the war.
102 BREAKDOWN
The Psychological Importance of Gold in Countriesin which Gold Reserves Steadily Declined
The gold reserve ratios of all the major continental bellig-erents declined steadily and persistently, but none exceptAustria-Hungary and Russia after the revolution of 1917 wasforced to abandon completely the facade of a gold standard.
FranceIn spite of the vigorous efforts made to concentrate, preserve,and increase the country's stock, gold continued to representa continually decreasing percentage of the note issue of theBank of France. The legal limit of note issue was repeatedlyincreased. By secret agreements made in 1911 the Bank ofFrance had undertaken, in case of a French mobilization, toadvance to the state 2,900 million francs, provided the lawwas simultaneously altered to permit an expansion of noteissue of a like amount and to relieve the Bank of its obligationto redeem its notes in gold. These agreements were approvedby the law of August 5, 1914, which raised the pre-war legallimit from 6,8oo million to 12,000 million francs, and em-powered the government to increase it still further by decree.Within two months the new limit was reached, and decreesof this sort became a regular feature of French finance untilthis delegated power was withdrawn by the law of March 5,1919.1
The persistent decline in the ratio of gold, even includinggold pledged abroad, to notes at the Bank of France from 59.7to 17.7 per cent during the war (Table 5) caused grave con-cern in France. It was regarded as a threat to the safety of theFrench banking system and a blow to French prestige, eventhough in a technical sense the ratio had lost all significance.As early as 1915 the Bank of France declared in its annual re.port that further demands for gold would endanger thesafety of the French banking system. Therefore when gold'Jeze and Truchy, op. cit., pp. 229, 238.
PRESERVATION OF EXTERNAL FORMS 103
had to be shipped to England in connection with the stabiliza-l:ion of the franc in 1916 great care was taken to assure thepublic that there was really no diminution in French goldreserves. In speaking of this transaction M. Ribot said:"England is anxious to augment her reserves of gold in order tomaintain her gold standard and to increase her credits in the
States. The Ban.k of France, even in the present phase ofthe war has a gold reserve in excess of 4,000,000,000 francs. Con-
TABLE 5Bank France, Gold Reserves, Xote Issue, and Advances
(millions of Swiss francs at par)JULY END OF YEAR OCT.1914 1914 1915 1916 1917 1918
GOLD RESERVES AND NOTE ISSUENote circulation 6,912 10,042 13,309 16,679 22,337 30,782Gold at home 4,104 4,158 5,015 3,489 3,315 3,406Gold abroad 592 2,037 2,037Gold as percent-
age of note circulationexci. gold abroad 59.7 41.4 37.6 20.9 14.4 11.1
gold abroad 24.4 23.9 17.7
ADVANCES AGAINST WHICH NOTES WERE ISSUEDAdvances of Bank of
France to:French gOvernment 200 4,103 5,701 7,600 12,700 19,000AiLed governments 630 i,8oo 3,220 3,490
'rotal government ad-vances for which noteswere issued 200 4,103 6,331 8,400 15,920 22,490
SOURCE: Blankart, cii., pp. 20-21
sequently, we are now in a position to promise England a con-sum drawn from our own abundance; we shall put this
at the disposition of the British Treasury, and the Treasury'will open a credit in our favor in London in pounds sterling.The gold lent by us will reenter the coffers of the Bank of Franceafter the war." 2
.As late as the dark days of 1918 M. Clemenceau made an im-passioned appeal for the preservation of the gold reserves ofFrance.2 Blankart,. op. cit., p. '57 (our italics). M. Ribot was speaking of the resultsof a conference with Messrs. Asquith and McKenna on August 24, igi6.
TAB
LE 6
Gol
d R
eser
ves a
nd N
ote
Issu
e of
Con
tinen
tal C
ount
ries
and
Japa
n, 1
914-
1918
(mill
ions
of S
wis
s fra
ncs a
t par
)JU
LYEN
D O
F Y
EAR
AU
G.
OC
T.19
141
1914
1915
1916
1917
1918
1918
GE
RM
AN
YR
eich
sban
k N
otes
2,36
46,
231
8,64
7io
,o68
54,3
3520
,577
Not
es o
f the
priv
ate
issu
ing
bank
s19
316
5i8
g19
520
!26
6R
eich
skas
sens
chei
ne in
circ
ulat
ion
255
245
402
441
243
5 1
Dar
lehe
nska
ssen
sche
ine
in c
ircul
atio
n55
11,
200
3,69
66,
313
211
,576
Tota
l pap
er c
ircul
atio
n2,
812
7,59
210
,438
14,4
0021
,196
32,8
54R
eich
sban
k go
ld re
serv
e1,
566
2,56
52,
856
3,15
13,
008
3,14
4R
eser
ve,
priv
ate
issu
ing
bank
s (m
ci. s
mal
l am
ount
of si
lver
)8g
848g
9810
487
Tota
l gol
d re
serv
e1,
655
2,64
92,
945
3,24
93,
112
3,23
1G
old
rese
rve
as p
erce
ntag
e of
not
e ci
rcul
atio
n58
.836
.127
.222
.614
.7
ITA
LYN
otes
of t
he 3
Ban
ksof
Issu
e2,
265
2,93
63,
968
5,01
38,
424
Big
lietti
del
lo S
tato
310
700
1,08
21,
500
1,50
0To
tal p
aper
circ
ulat
ion
2,57
53,
636
5,05
06,
513
9,92
4G
old
rese
rve
of th
e 3
bank
sof
issu
e1,
530
1,55
01,
527
1,32
81,
267
Gol
d re
serv
e as
per
cent
age
of n
ote
circ
ulat
ion
59.4
42.6
30.2
20.3
12.7
RU
SSIA
Not
e ci
rcul
atio
n4,
357
7,52
6'4
,547
22,5
6646
,507
182,
000
Gol
d at
hom
e4,
269
3,92
94,
298
3,92
33,
456
3,00
0G
old
abro
ad38
472
05,
735
6,15
7G
old
rese
rve
as p
erce
ntag
e of
not
e ci
rcul
atio
nex
cl. g
old
abro
ad97
.752
.030
.317
.37.
41.
9m
ci. g
old
abro
ad57
.235
.542
.92q
.8
SPA
INB
ank
of S
pain
Not
esC
old
ltcck
Gol
d re
serv
e as
per
cent
age
of n
ote
circ
ulat
ion
NET
HER
LAN
DS
Net
herla
nds B
ank
Not
esG
old
stoc
kG
old
rese
rve
as p
erce
ntag
e of
not
e ci
rcul
atio
n
JAPA
NB
ank
of Ja
pan
Not
esG
old
stoc
kG
old
rese
rve
as p
erce
ntag
e of
not
e ci
rcul
atio
n
SWED
ENSw
edis
h R
iksb
ank
Not
esG
old
stoc
kG
old
rese
rve
as p
erce
ntag
e of
not
e ci
rcul
atio
n
SWIT
ZER
LAN
DSw
iss N
atio
nal B
ank
Not
esB
unde
skas
sens
chei
neD
arle
hens
kass
ensc
hein
eTo
tal p
aper
circ
ulat
ion
Gol
d su
pply
, md.
War
Res
erve
Gol
d re
serv
e as
per
cent
age
of n
ote
circ
ulat
ion
SOU
RC
E: B
lank
art,
op. c
it., p
p. 2
1-5
1,96
52,
100
2,36
02,
783
572
867
1,25
11,
967
29.!
41.3
53.0
70.6
890
984
1,20
01,
577
1,85
2
337
433
893
1,22
21,
455
38.9
44.0
74.4
77.5
78.5
933
1,10
91,
550
1,69
056
264
01,
058
1,52
956
.457
.794
.2
2,95
42,
185
1,97
I1,
478
74.9
1,68
7
98.4
317
422
456
58!
796
957
144
150
174
256
338
366
45.4
35.5
38.!
44.0
42.4
409
456
466
537
27I
0.3
835
2440
949
!50
256
1.3
192
238
250
345
46.8
48.4
49.8
61.4
tGer
man
y an
d Sw
itzer
land
, Jul
y 23
, 191
4; Ja
pan,
end
of D
ecem
ber 1
913.
892 25 917
38!
41.5
tFeb
ruar
y 8,
191
8.'E
nd o
f Oct
ober
, '91
7.O
ctob
er 1
5, 1
918.
6 En
d of
July
, igz
8.
1,93
9
545
28.1
1,09
957
852
.6
38.2
702
0.! 7
709.
!
357
50.3
io6 BREAKDOWN
Germany and other Continental BelligerentsIn Germany the greatest importance was attached to the pres-ervation of the gold reserves of the Reichsbank. These weresteadily increased during the first half of the war and main-tained approximately stationary thereafter. This was, how-ever, accomplished only by measures that deprived the reserveratio of any real economic function in the banking system.From the very outbreak of the war the old relationships ofthe German note issue to gold were broken and means ofpyramiding the amount of notes issued against a given amountof gold were quickly devised. The Reichsbank law waschanged to permit the Reichsbank to accept single name com-mercial paper as part of its two-thirds reserve of paper againstnotes. It was also provided that Reichskassenscheine andDarlehenskassenscheine be counted as gold reserve, and thefour private note issuing banks were authorized to use Reichs-bank notes as gold reserve. The course of note inflation andthe rapidly diminishing gold reserve ratio are shown in Table6. In Italy and Russia the same motives were at work. Bothcountries were able to prevent substantial dissipation of theirgold reserves during the greater part of the war (Table 6).Until the revolution of 1917, Russia was even able to increaseher total reserves, if in her case, as in that of France, goldheld abroad is included in the figures. In Austria-Hungaryalone of the major belligerents the gold reserve could not bepreserved even as a confidence inspiring factor, owing to thetransfer of most of the gold reserves of the Austro-HungarianBank to Germany in exchange for the latter's cooperation insupporting the Austro-Hungarian as well as the mark ex-change.
Increase in Gold Reserves in Neutral Countriesand Japan
In many neutral countries, on the other hand, the physical in-crease in gold that resulted from the forces of war-time gold
PRESERVATION OF EXTERNAL FORMS 107
distribution was more than sufficient to keep pace with theconcurrent expansion of credit (Table 6). This was true ofSpain, the Netherlands, and Argentina, as well as of Japan(cf. Ch. 14) , whose economy was affected by the war in manyways like those of neutral countries. Sweden, which tookdefinite steps to prohibit imported gold from affecting itsbanking system, and Switzerland, which was forced by theother countries of the Latin Monetary Union to accept pay-ment for part of its export surpluses in silver and to meet alarge demand for gold for the arts, were exceptions. In bothcountries the reserve ratios of the war years did not changegreatly. Gold was maintained in its traditional place in theirbanking systems, at least in outward seeming.
The Gold Standard as a Domestic Institution inGreat Britain
It was of particular importance for the whole cause of theAllies that confidence in the stability and strength of theBritish banking system should be completely maintained.The almost universal belief that the gold standard still existedin Great Britain contributed powerfully to this feeling. Thepersistence of this belief is not surprising, for the Britishbanking system was able to preserve the appearance of con-tinuit.y of practice and stability through a combination offactors which was not, perhaps could not, have been presentin other belligerent countries in the same degree. Exchangepegging and price control reduced the demand for bankcredit in England as in other countries, but no other countryused the taxing power so ruthlessly or occupied so strategica position in the world-wide race for gold. The British peopletransferred real resources to the government through taxesand genuine lending from savings to a degree unequaled byother peoples, and thereby relieved the government of thenecessity of forcing these transfers through inflation. TheBritish financial authorities used the available gold reserveswith great skill so as to contribute in maximum degree to
io8 BREAKDOWNthe expansion of credit with a minimum of violence to thetraditional system of reserve ratios. At no time during thewar was there a premium on gold in England in the sense ofa distinction between gold and paper prices, such as appearedin the United States during the greenback period.3 No officialaction was taken which recognized or implied that GreatBritain was 'off' the gold standard. The exchanges werepegged. Above all, the familiar accounting landmarks in thebanking system continued to give an appearance of solidityin accordance with long established tradition.
The Reserves of the Bank of England and its ProportionThe first and most important of these accounting landmarks,from a psychological point of view, were the gold reserves ofthe Bank of England and its proportion.
It is not the intention of these studies to follow ProfessorHarris and other investigators into the difficult realm of specu-lative interpretation of the war-time changes in the Bank ofEngland's published statements. We shall merely indicatebriefly the manner in which the general aspect of that state-ment was prevented, not indeed from showing serious strainsunder the burden of war finance, but from giving any evi-dence of an actual or potential loss of its traditional character.
The crisis of 1914, to recapitulate briefly, more than tripledthe Bank of England's 'other deposits' and reduced its re-serves, and consequently reduced the proportion in the Bank-ing Department from 52 to i8 per cent between July 22 andAugust 26, 1914. The measures devised to meet the crisis in-cluded, however, effective means for replenishing the reservesand restoring the proportion. The device of issuing CurrencyNotes relieved the Bank of England of the obligation of issu-ing its own notes to meet the needs of additional circulationand therefore removed a pressure upon the gold stock of theBank which would have made adherence to the conditions of
Cf. Harris, cit., pp. 3o8 if., for a discussion of the reasons why such apremium did not appear.
PRESERVATION OF EXTERNAL FORMS 109
the Peel Act and the preservation throughout the war of thefamiliar appearance of the statement of the Issue Departmentimpossible. At the same time the transfer of gold from thejoint stock banks already mentioned helped to build up thereserves of the Banking Department so that the proportionreached 34 per cent on November i8, 1914.
In the first quarter of 1915, however, the proportion againfell, reaching i8 per cent on March 31. The emergency ad-
CHART 2
Bank of England, Note Circulation, Coin and Bullion,Other Deposits and Public Deposits, 1913-1919
I ;0
140
120
'00
60
60
40
20
0
vances of the crisis were substantially reduced, but the conse-queni; reduction in 'other deposits' was offset by a large in-crease in 'public deposits' as a result of the receipt by the gov-ernment of the proceeds of large popular war loans. At thesame time shipments of gold to support the exchanges and
U. S. .4 SiI,,r (Yo.ng 1025, S.n,I 9, V.1.1, pp. 4423
110 BREAKDOWNthe setting aside of a gold reserve against Currency Notesmade such drafts on current gold accumulations that theBank's gold reserve was drawn down.
In the summer of 1915 the reserve was again replenished,and the proportion rose to 30 per cent. In the autumn thetechniques for preventing wide fluctuations in the govern-ment's deposits at the Bank were perfected and 'public de-posits' declined very sharply. The proportion, however, wasreduced to 22 per cent at the close of the year by a renewedoutflow of gold.
The reserve was for the third time replenished early inigi6 and as deposits declined the proportion was raised to 32per cent by June 14. Once again, however, exports to support
CHART 3Bank of England, Ratio of JVotes and Coin in the Banking Departmentto Deposits, 1913-1918, weekly
so
30
20
O0
0
the exchanges were required. The government was makinggreat demands upon the banks and late in December 'otherdeposits' were sharply increased by open market operations.The proportion gradually fell and at the end of the year wasonly 181/2 per cent.
These declines in the gold reserves of the Bank of Englandbecause of shipments in support of the exchanges causedalarm, and voices were raised in protest, proclaiming that thegold standard was in peril. It was even understood that one of4The first deposit of gold in the Currency Note Account was made on Sep-tember 9, 1914. The amount was increased to £28,500,000 by May 12, 1915 andremained unchanged thereafter. Kirkaldy, cit., p. 26, and p. 125, note.
PU Ufli60
PRESERVATION OF EXTERNAL FORMS 111
the reasons for the rise in Bank rate from 5 to 6 per cent onJuly ]2, igi6 was to discourage an outflow of gold, thoughat that time the bullion market was not functioning, andEngland's gold was, in the quaint phrase of the Cunliffe Com-mittee, being 'protected' by the submarine menace.
After America's entry into the war these periodic draftsupon the Bank of England's gold reserve were not repeated.The proportion was in fact stabilized at something under 20per cent by additions to the reserve in rough proportion tothe increase in 'total deposits.' The growth of deposits, how-ever, was very slight because a rise in 'other deposits' was off-set by continued reduction in 'public deposits.' These changesare readily traceable in Chart 2, showing the chief items inthe Bank of England statement, and Chart showing theproportion in the Banking Department during the war. Theinfluence of gold exports upon the proportion of the Bankof England is greatly magnified by the maintenance of virtu-ally a ioo per cent gold reserve in the Issue Department. Atthe close of 1918 metallic reserves were 32.6 per cent of notesand other sight liabilities compared with 34.6 per cent at theend of '9 13, while the proportion had been cut in half. Yetthere was little to alarm the average Englishman in the aspectof the Bank statement or to raise fears in his mind concerningthe safety of the Bank, once he had become accustomed to astable proportion of 20 per cent instead of a stable proportionof from 40 to 50 per cent.
Building an increased Credit Superstructure on the increasedCredit BaseIn these ways the Bank of England was able during the war topermit a rapid expansion in its 'other deposits,' which in-cluded, probably as its main constituent, the growing balancesof the joint stock banks, without presenting a statement de-structive of confidence in its own strength and 'soundness.'
The expansion of the joint stock bank balances at the Bankof England was the result of a combination of factors, nearly
112 BREAKDOWNall of which contributed in greater or less degree to buildingup their own deposits as well as to the preservation or in-crease of their reserves. Among these were, of course, theBank's own purchases of securities, its advances, includingadvances to the government, and gold deposited with it, withthe exception of gold already held by the joint stock banksas part of their reserves at the outbreak of the war.
The relationship between government borrowing at theBank of England and the growth of bank credit was con-trolled by the development of a complicated technique ofcentral bank administration of government funds. This tech-nique played a major role in the history of credit control inEngland, not only during but also after the war, and meritsthe most careful consideration. During the war itself, thecreation and turnover of government deposits at the Bankbore a threefold relation to the reserve position of the jointstock banks:i) The Turnover of Bank of England Balances created byAdvances to the Government. Balances obtained by the gov-ernment by borrowing at the Bank of England were paid outby the government to its creditors and deposited by them inthe joint stock banks. This operation increased the depositliabilities and the balances at the Bank of England of thejoint stock banks in equal amount. It made available Bank of.England funds which the joint stock banks could use as thebasis for making advances to the Treasury or for buying gov-ernment securities. When they did so, Bank of England fundswere again made available to the government and joint stockbank reserves were reduced. Fresh government expenditures,however, again replenished the reserves of the joint stockbanks and again increased their deposits. The turnover ofBank of England balances created by advances to the govern-ment therefore resulted in the provision of new reserves forthe joint stock banks and the building up of their holdings ofgovernment securities and their deposits from the public.This process could be continued until the impetus of the
OF EXTERNAL FORMS 113
origmal Bank of England advance to the government wasexhausted by the reestablishment of the customary reserveratios of the joint stock banks.2) The Turnover of Bank of England Balances used to Pur-chase Currency Notes. The transfer of joint stock bank bal-ances at the Bank of England to the government through theCurrency Notes Account and their subsequent expenditureby tlie government had the effect of providing the countrywith hand to hand circulation without making any draftsupon the reserves of the banks. The steps in this process werevery simple. The joint stock banks, upon feeling a demandfor currency from the public or themselves experiencing in-creased requirements for till money owing to the expansionof credit, the increase in business activity, and the rise inprices, purchased Currency Notes from the government byhaving their accounts at the Bank of England debited. TheCurrency Notes Reserve Account was credited and the gov-ernment replaced the Bank of England balances in that ac-count with their own securities. The government then ex-pended these balances and, as before, they returned to thejoint stock banks through the deposits of government credi-tors. When Currency Notes were purchased to meet a de-mand from the public, this turnover of deposits on the booksof the Bank of England had no net effect upon the reservesand deposits of the joint stock banks, but relieved them froma pressure they would otherwise have been sub-jected to. While the deposits of the government creditorswere built up the deposits of those who had withdrawn cur-rency for hand to hand circulation were reduced. At thesame time joint stock bank reserves at the Bank of Englandremained intact, having been drawn down to purchase Cur-rency Notes and replenished by the deposits of checks drawnby the government. The process created therefore an increasein the public debt in the form of government paper moneyoutstanding in the hands of the public without trenching atall upon commercial banking reserves, or, except in the case
114 BREAKDOWNof an increase in till money, expanding bank credit. Thisprocess rendered unnecessary the original plan for the issueof Currency Notes to the banks under the form of advances ofnot more than 20 per cent of their capital and surplus andbearing 2 per cent interest. When the Currency Notes pur-chased were held as till money by the joint stock banks boththe cash component of their reserves and their deposits wereincreased.3) The Turnover of Bank of England Balances lent to theGovernment through Special Deposits. Beginning in March1916 the Bank of England offered to 'borrow' from the jointstock banks some of the foreign balances that were accumu-lating with them as part of the process of supporting theexchanges. This transaction took the form of three day loansto the Bank, which were given the name of 'special deposits,'and these special deposits were re-lent by the Bank to thegovernment. The method by which this double operation wasdealt with in the accounts of the Bank of England has notbeen made public. The 'special deposits' did not appear assuch in the published statements of the Bank, nor were thecorresponding loans to the government separately recorded.These loans may have been included in the annual statementof the Bank under the heading 'exchequer bills purchased,'or the whole transaction may simply have been carried in amemorandum account.5 Whatever the accounting treatment,the 'lending' of foreign balances by the joint stock banks tothe government through the Bank of England as intermediarymust have been an operation that in the first instance reduced'other deposits' at the Bank, while the subsequent expendi-
These suggestions are made in Harris, op. cit., p. and Kirkaldy, op. cit.,p. 44. Professor Harris has made the following estimate in millions of poundssterling (op. cit., pp. 56—7) of the amount of the special deposits:
1919 1919 1919
Jan. 5, rgi6 o April 12 199 June 30 469 Sept. 13 1571917 65 May 3 212 July 12 635 Sept. 20 2011918 125 May 3! ig6 July19 485 Oct. 1'
1919 182 June 7 308 July 26 319 Oct. z8 92June 14. 383 Aug. 206 Oct. 25 14June 21 435 Sept. 6 178 Nov. i 14
PRESERVATION OF EXTERNAL FORMS 115
ture of the Bank of England funds so received by the govern-ment must have increased 'other deposits1 again. The finaloutcome was as if the joint stock banks had purchased securi-ties directly from the government, and the government hadspent 'the proceeds. It was a turnover of Bank of Englandfunds that had the effect of keeping joint stock bank reserveswith the Bank of England unchanged while at the same timebuildmg up joint stock bank deposits. The increase in thedeposits of government creditors in the joint stock banks,however, was not offset, as in the case of the issue of Cur-rency Notes to the public by a reduction in the deposits ofother customers. It was offset by a new asset, namely 'specialdeposits at the Bank of England.' This asset was treated by thejoint stock banks either as 'cash' or as 'money at call and shortnotice,' and therefore it did increase their actual reserves andpermitted a still further secondary expansion of bank credit.6
These three operations had one feature in common. Theyplaced the government in control of deposits at the Bank ofEngland which were thereupon converted into deposits withthe joint stock and other banks by being spent by the govern-inent. But in other respects their results were different.
The first operation increased the balances of joint stockbanks at the Bank of England and increased their deposits.It was an inflationary operation increasing the credit base andthe credit superstructure in equal amount.
The second maintained the balances of the joint stockbanks at the Bank of England and maintained their depositsby relieving them of the burden of providing hand to handcirculation to the public. When new Currency Notes were6 Kirkaldy points out that during igi6 the cash items of the joint stock banksincreased £95 million, whereas their balances in the Bank of England in-(Teased only £14 million and probably their additional reserves of CurrencyNotes increased not over £20 million. This leaves about a £61 million increaseiii cash to be explained. At the same time, in the government accounts, Waysand Means Advances increased more rapidly than government securities in theBank of England. The condusion follows that the joint stock banks consideredas cash the loans they had made of spare balances to the government throughthe Bank of England. Harris, op. cit., p. 52; Kirkaldy, op. cit., pp. 83 if.
ii6 BREAKDOWNadded to till money this operation increased both the cashand deposits of the joint stock banks. It was an inflationaryoperation because it removed a very important check uponthe expansibility of the banking system.7
The third maintained the balances of the joint stock banksat the Bank of England and increased their deposits. It alsoincreased either their cash or their secondary reserves, depend-ing on whether 'special deposits' at the Bank of England were
TABLE 7
Joint Stock Banks of England and Wales (except Bank ofEngland), Reserves and Deposits, 1913-1918 1 (millions of pounds)
1913 1914 ff915 1916 1917 zg'Or Deposits and current ac-
counts 809.4 895.6 992.6 "54.9 1,365.3 1,583.42 Cash and at Bank of Eng-
land 115.8 169.9 179.0 248.0 238.5 270.13 Money at call and short
notice 120.1 106.2 83.5 121.5 189.4 211.14 Percentage line 2 is of I 14.3 19.0 i8.o 21.5 17.5 17.25 Percentage lines 2 plus 3
is of 29.2 30.8 26.5 32.0 31.3 30.4
SOURCE: The Economist, Vol. 78, 8o, 82, 84, 86, 88, Banking Supplement, May1914-191 Most of these figures are as of Dec. x, though a few balance sheets, of relativelyminor importance, are included as of other dates during the year.
treated as 'cash' or as 'money on call or short notice.' It hadtherefore an inflationary effect similar to the first.
There was one other means by which the joint stock bankswere able to increase their reserves. This was by an increasein the float which accompanied a rising level of prices andgreat activity of busiPess.
Cf. the excellent treatment of the difference in the American banking systembetween the legal powers of expansion permitted by the Federal Reserve Actand the practical limits imposed by the necessity of providing an increasednote circulation when bank credit is expanding in Rufener, Money and Batik-ing (Houghton, Mifflin, 1934), pp. 562 if. The American example is the mostsuitable for the exposition of this point because the legal reserve requirementspermit a certain definiteness in the calculation impossible under the Britishcustomary system.
PRESERVATION OF EXTERNAL FORMS 117
In these ways the reserves of the British banks kept pace(as shown in Table 7) with the demands made upon them bythe requirements of war finance, and their deposits were in-creased seven times as fast as during the average pre-war yearswithout undue change in their customary reserve ratios. An-other of the great accounting symbols of a banking systemsound in accordance with long established tradition was thuspreserved in England during the war.
'The Ratio System of the Joint Stock BanksFor a decade before the war the joint stock banks had main-ttained. their 'cash' plus 'money at call and short notice' at
'rABLE 8
7oint Stock Banks of England and Wales (except Bank of England),Principal Assets as Percentages of Total Deposits, 1913-19 19 (mit-lions of pounds)
1913 1914 1915 1916 19r7 1918 1919
r Deposits 809.4 895.6 992.6 1,154.9 1,365.3 1,583.4 1,874.2Discounts andadvances 539.8 553.5 503.6 542.8 685.7 834.7 1,129.6
3 Percentage line2 is of i 66.7 6i.8 50.7 47.0 50.2 52.7 60.3
4 Cash and moneyat Ca].! and short
236.0 276.0 262.5 369.5 427.9 481.2 452.8Percentage line4 is of i 29.2 30.8 26.5 32.0 31.3 30.4 24.2
6 Investments 121.2 146.5 310.8 323.0 339.7 347.2 398.6Percentage line6 is of i 15.0 16.4 31.3 28.0 24.9 21.9 21.3
souRcE: The Economist, Vol. 1 io (1930), Banking Supplement, May io, p. i8
close to 28 per cent of their 'total deposits.' They had an un-usually strong reserve position in 1913 when this ratio was29.15 per cent. All through the war, except during 1915, itwas even higher; over 30 per cent. In 1915 it was 26.5 percent, only slightly below the average for the pre-war decadeand above that of the decade preceding. Moreover, the 1915
ii8 BREAKDOWNdecline was caused not by a drop in primary reserves butwholly by a drop in secondary reserves, 'money at call andshort notice.' It was a reflection of the response of the jointstock banks to the government's demand for accommodationthrough the purchase of government securities (Chart 46).For the same reason certain of the other customary ratios ofthe joint stock banks changed radically in 1915. The ratio of'investments' to 'total deposits' rose from 16.4 per cent in1914 to 31.3 per cent in 1915, while that of 'discounts and
Per cent70
60
CHART 4Joint Stock Banks of England
40 and WalesPrincipal Assets as Percent-
30 ages of Total Deposits, 1913-1919
20
tO
advances' to 'total deposits' fell from 6i.8 to 50.7 per Cent.During the ensuing years of the war these two ratios beganmoving back to their pre-war magnitudes. Many changes ingovernment financing contributed to this result. The shortterm debt was built up and treasury bills came in increasingamounts to the joint stock banks through the discount mar-ket. A better system of distributing government securities toinvestors was developed. Bank funds were liberally used toassist purchasers of government bonds, and government bondsbecame an increasingly important type of collateral for bank
0
PRESERVATION OF EXTERNAL FORMS 119
advances. The tendency to restore the pre-war ratio systemwas accelerated after the actual close of hostilities. By 1919published statements of the joint stock banks showed theresults of war finance in a great increase in all the majoritems,. As far as the distribution of assets is concerned, theydid not differ very greatly from the statements of pre-waryears. Before the war the relative rigidity of this system ofratios was important in increasing the control of the Bankof England over credit. It was at the heart of the stable creditconditions in Great Britain which contributed so much tothe 'perfection' of the international gold standard system ofpre-war days.
The war-time disturbances in the ratio system of the Britishjoint stock banks and the tendency toward a return to thepre-war 'normal' after the first shocks of the war were metare shown in Table 8 and Chart 4.
The Gold Standard as a Domestic Institution in theUnited States
The gold standard in America proved to be a flexible and ex-pansible instrument under the extraordinary conditions pre-vailing during the war. From June 30, 1914 to June 30, 1918,American banks increased their cash assets (cash and duefrom banks) 133 per cent and their deposits 152 per cent.Commodity prices meanwhile more than doubled. For acountry on the gold standard to increase its total deposits oneand one half times and to double its commodity prices infour years is truly remarkable. Yet no question ever arose inthe public mind that the American gold standard "in its fullintegrity . . . was ever in danger" (cf. Ch. 2, note i). InAmerica, alone among the major financiers of the war, thejoint process of gold accumulation and concentration morethan kept pace with the war-time increase in the credit super-structure. There was never a shortage of reserves to meet therequirements of law and of tradition.
120 BREAKDOWN
Surplus Gold in the United StatesThe three reasons for this abundance of reserves were:i) the outbreak of the war at a moment when the Federal Re-serve Act had just reduced the legal reserves required of the com-mercial banks of America by probably as much as $400 million 82) the command of the United States over the gold of the bellig-erent world, in combination with the defenses introduced againstlosses to the neutral world, which increased the monetary goldstock of the country i6o per cent
the passage of amendments to the Federal Reserve Act inJune 1917, which increased the amount of notes and deposits thatcould be legally created upon a given amount of gold.
During the entire war both the gold reserves and the de-posits of the Federal Reserve banks grew rapidly, and it wascharacteristic off the Federal Reserve banks to have an 'excess'gold reserve over requirements as shown in the accompanyingtable.
Ratio of Total Cash Reserves to Xet Deposit and Federal ReserveLiability Combined of the Twelve Federal Reserve Banks
PER PER PER PER1914 CENT 1916 CENT 1917 CENT 1918 CENT
Dec. 31 95.5 March3z 73.9 March30 86.2 March 29 62.71915 June 30 71.2 June 29 72.4 June 28 61.7
March26 89.3 Sept. 68.g Sept. a8 76.4 Sept.27 51.6July 25 93.8 Dec. 29 66.2 Dec. 28 61.3 Dec. 27 50.6Sept. 24 89.7Dec. 30 86.7
The steady decline in this ratio does not measure the declinein the cash basis of bank credit in the United States untilnearly the end of the war. These were the years of the build-ing up of the Federal Reserve system. Member bank depositswith the Reserve banks were becoming a rapidly increasingproportion of total bank reserves, and the deposits of memberbanks were simultaneously becoming a rapidly increasingproportion of the bank deposits of the whole country (Chart37). By igi8, however, the growth of the member bank re-8 Beckhart, op. cit.. Ii. 26.
PRESERVATION OF EXTERNAL FORMS 121
serves and deposits exhibited the same characteristics as thatof the reserves and deposits of all the banks of the countryand was the dominant influence in that growth. For thatreason the power of the banking system to expand in con-sonance with the requirements of the gold standard is re-flectecE accurately in the reserve position of the Federal Re-serve banks from that time on. The presence, therefore, onNovember 29, 1918, of an 'excess' gold supply above legal re-quirements of $509 million in the hands of the Federal Re-serve banks may be considered as the most striking visibleproof of the exuberant capacity of the gold standard as adomestic institution in the United States to live and flourishin an inflationary environment.
Building an increased Credit Superstructure on the increasedBase
'The deposits of member banks with the Federal Reservebanks, like those of the joint stock banks with the Bank ofEngland, were built up by the deposit of gold and by the
of securities by the central bank. They were not,howe'ver, expanded as a result of the turnover of balancescreated at the Federal Reserve banks by advances to the gov-ernment. Nor were the American banks relieved of the drainupon them created by supplying hand to hand currency. Theissue of Federal Reserve Notes to the public continued tocause an equal reduction in member bank reserves and de-posits. On the other hand, the American banks had directaccess to central bank credit through the rediscount of corn-inercial paper, largely secured by government bonds, andthrough borrowing on their own notes secured by governmentbonds. This access was made progressively easier by changesin banking law and in the interpretation of banking lawunder the ever increasing demands of war finance.
In these ways American banks were able to maintain with-out difficulty the increasing legal reserves required of them byan increasing deposit liability. The contribution of the fiscal
122 BREAKDOWNoperations of the government to the growth in this depositliability was both vast in amount and original in technique.
On December 1, 1917 the credit resources of the FederalReserve system—Federal Reserve banks and member bankstogether—employed by the government are estimated to havebeen $2,563 million and on December 1, 1918, $5,736 million.0This was accomplished partly through direct investments bythe banks in government securities and partly by loans tocustomers against government securities as collateral. Thedeposit liability standing over against this great direct andindirect investment of bank credit in government securitiesforms part of, but does not measure completely, the contribu-tion of government fiscal operations to the increase in bankdeposits.
It was the aim of the United States Treasury Department toprevent government borrowing operations and the adminis-tration of government funds from disturbing the money mar-kets. For this purpose the Treasury endeavored to transferthe fluctuations in its cash balances from the Federal Reservebanks to the commercial banks. A new system of depositarybanks therefore was created. Government deposits were builtup in these banks through the redeposit in them of the pro-ceeds of government securities, paid for by subscribers in cash.Depositary banks, moreover, were allowed to pay for theirown subscriptions and for those made on behalf of theirclients by credit on their books. No reserves were requiredagainst government deposits thus created. This proceduremade it easy for banks subscribing to government bonds tocreate entirely new deposits against these bonds, and thusto place the government in possession of bank funds createdad hoc and not transferred to the government from alreadyexisting deposits. These new deposits were put into circula-tion by being transferred to the government's account at theFederal Reserve banks and checked out by the governmentto meet its expenses. They reappeared in the banking system° Beckhart, op. cit., IV, gig. The estimate is the writer's.
PRESERVATION OF EXTERNAL FORMS 123
as ordinary deposits of the government's creditors. They werethereby transformed from deposit credit requiring no reserveto deposit credit requiring reserve, and at this point a basicconn€ction between government fiscal operations and thegold concentration policy was established. When and to theextent that it was used in this manner, the special depositorysystem was an effective, simple, and inconspicuous inflation-ary device through which the growth of the public debt inAmerica contributed to the increase in American bank de-
The successive stages in the expansion of the credit super-structure in the United States during the war are shown inAppendix Table i. From June 30, 1915 to June 30, 1917,
when America was well established as a supplier of the war-ring nations and gold was flowing into the country the ex-pansion of investments kept pace with that of deposits, butthe expansion of loans and discounts did not. The effect ofgold imports in fixing in the credit superstructure a large'volum.e of deposits created by exports is clearly apparent inthe decline of loans and discounts as a proportion of deposits.From June 30, 1917 to June 30, igig, which included most ofAmerica's active participation in the war, total loans and in-vestments again approached their pre-war relationships to de-posits, but investments grew much more rapidly than loans,largely owing to the progressive application of a quota sys-tem under which the banks were obliged regularly to placea fixed proportion of their deposits in government certificatesof indebtedness. Loans and discounts consequently declinedstill further as a proportion of individual deposits.'° Thegranting of government loans to Great Britain and the AlliedI'owers was responsible for a large part of the growth of theAmerican public debt, and therefore for the quota systemi:rnposed on the banks as part of the marketing machinery for
From 1914 to igig deposits other than inter-bank deposits increased 8i6per cent., and loans plus investments increased 79 per cent, but investmentsincreasei i, 8 per cent and loans only 62.9 per cent.
124 BREAKDOWNAmerican government issues. The support of the exchanges,therefore, by gold imports before and by government loansafter America entered the war, contributed substantially notonly to the increase in total American bank deposits, but alsoto the change in the ratios between loans, investments, anddeposits of American banks.
CHAPTER 6
The General Significance of the Effort to PreserveGold Standard Forms in War Time
The fundamental social and economic function of and justi-for the gold standard is that it facilitates the domestic
and international exchange of goods. The great effort putforth during the war to preserve as far as possible the externalforms of the gold standard was an effort to make the goldstandard do in war what it had done in peace. The traditionalmeans of gold standard adjustment were employed on a scalenever before witnessed, but because the domestic exchangeof goods in belligerent countries was dominated by the neces-sity of diverting productive powers to making war suppliesand maintaining military forces, and the international ex-change of goods was dominated by the overwhelming need ofbelligerents for imports, these means had to be used with analmost total disregard of long run consequences.
The Use of GoldConfidence in the 'soundness' of money and in the stabilityof domestic credit was essential to facilitate the domestic ex-change of goods. To preserve this confidence and to promotethis stability, gold was concentrated in the hands of govern-ments and central banks in order to increase, or to preventthe dissipation of, gold reserves. At the same time, gold re-serve requirements were not allowed to interfere with thedegree of inflation necessary to force the application of humanand material resources into the channels required by war. Inthe building of the credit superstructure upon the availablecredit base long run considerations of the effects of domestic
125
126 BREAKDOWNinflation were swept aside. The dangers that such inflationentailed were merely masked in varying degree by conservingor building up visible gold supplies.
The maintenance of stable exchanges was essential to facili-tate the international exchange of goods. To supporL the ex-changes, gold was used to an unprecedented extent as a meansof international payment for goods. The refined techniqueby which it had served as one of the marginal balancing itemsin international settlements was modified or abandoned. Thelong run relationships previously existing between the inter-national distribution of gold and the varying rates of growthof the banking systems of the world were superseded by anew international concentration of gold holdings. For thesame reasons, the considerations that had long governed thedistribution of international credit were disregarded.
The Use of International CreditThe use of international credit during the war was, on thewhole, inflationary in its direct effects upon the world's bank-ing systems. It was part of the grand total of war-time infla-tion. Through a complicated interaction of prices arisingfrom international trade between countries whose exchangeswere pegged but which were subject to very unequal inflation-ary pressure at home, this total war-time inflation was dis-tributed more evenly through the world than it would havebeen had the exchanges been free. The use of internationalcredit to support a nucleus of stable exchanges therefore con-tributed indirectly to the international spread of war-timeinflation as well as to its total amount. Furthermore, duringthe war foreign lending was not, in a true sense, a time-bridging credit operation, for foreign loans were made with-out primary consideration for the requirements of repayment.
Before the war foreign lending was, in the main, carriedout under expert banking direction and with detailed con-sideration of the prospects and means of repayment. Foreignloans were a means of financing the production and exchange
PRESERVATION OF EXTERNAL FORMS 127
of goods through an international distribution of accumu-]ated savings and of bank credit granted in accordance withbanking principles. They were therefore not inflationary inthe lending countries. They expanded the superstructure ofbank credit in the borrowing countries and thereby enabledthem to import goods without a decline in bank assets andbank deposits. This new bank credit was utilized to finance anincrease in production from which an increase in exportswas expected that would create bank deposits and bank assetswith which to repay the loans. The expansion of bank creditin the borrowing countries through loans was merely ananticipation of its expansion through exports. Under theseconditions foreign lending performed the economic functionof facilitating long term growth in international trade with-out inflation and without sacrifice of the stability of the ex-changes. During the war there was no room for the forwardLooking banking point of view. It could not dominate inter-national lending. To a large extent the resources from which:Eoreig:ri loans were made were drawn from domestic credit:inflation, particularly in the United States, instead of from:past savings. In the borrowing countries these loans expanded
the credit superstructure and production. But they ex-panded production in a way that accentuated certain pre-wari:rends of economic strain and undermined the basic balanceof the world's exchanges of goods. These loans, therefore,were not productive of the means of repayment. They couldnot, under the circumstances, take into account the impera-tive but delayed requirement of all truly time-bridging inter-national financial operations, namely, the long run assimila-tion their repayment and service into the economic bal-ance of the unknown future.
Carrying forward Unsolved Economic ProblemsThe maintenance of some of the external forms of the goldstandard during the war facilitated the domestic and inter-national exchange of goods and inspired confidence in banks
128 BREAKDOWNand in money. Because it accomplished these objectives onlyby disregarding the long run consequences of the means em-ployed, certain grave problems were left over for the post-warperiod. Many were still unsolved in 1925, but this fact wasmasked by the seemly and comfortable facade of the goldstandard. Indeed a somewhat unexpected similarity may benoted between the gold standard of 1925—28 and of 1914—18.As was true during the war, a force of unusual strength tendedto compel the extension of a large volume of internationalcredit. The productive capaCity of the United States and othercountries had become adjusted to an export market firstcreated by the war and then restricted by many post-war re-adjustments. Though not as powerful as the need of importersduring the war, this need of exporters for markets was astrong motive for the use of the methods of financial adjust-ment characteristic of the gold standard after 1925 in a wayappropriate to the needs of the moment but not to the slowand even development of a balanced international economy.The capacity and willingness of the American banking sys-tem to respond to that need translated this motive into action.The international exchange of goods was facilitated from1925 to 1928 as it had been from 1914 to 1918. Confidencewas maintained. When, however, in 1928 a combination ofcauses cut off the supply of loans from the United States,which had served the requirements of American export trade,the inflationary process to which these loans had contributedwas brought to an end and underlying economic weaknessesdisclosed. The results were similar to those which followedthe war itself.'
For the interpreter of the international gold standard boththe similarities of and the contrasts between these two periodsare of the utmost significance. They demonstrate that finan-cial adjustments which, when utilized as part of a world-widecredit and banking system operating in a gradually develop-tThis comparison is drawn fully in Ch. 21, Carrying forward Unsolved Eco-nomic Problems—General Comparison with the War-Time System.
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ing economic environment and under centralized control bya country with a fundamentally strong basic pull on all otherexcha:nges, give both flexibility and stability to the world,cannot be used with the same results under different con-ditions no matter how compelling the economic pressure.They suggest that the fundamental problem of reestablishingthe gold standard after the war was to adjust a changed in-stitutional financial structure to a changed economic environ-ment. It is because of the profound influence of the war uponboth that we have not called 1914—19 a period of 'Suspensionand Modification,' but rather a period of 'Breakdown.'