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THE CRISIS
by
Ernest Bevin and G.D.H.Cole
II.—THE GOLD STANDARD
[THE PURPOSE IT SERVES]
The gold standard, though many intelligent people seem to be afraid of trying to understand it, is in essence quite simple. It is above all a device for keeping the national currencies of different countries at a fixed relative value. If a unit of each currency—a pound, or a franc, or a dollar—can be at any time exchanged for a fixed quantity of gold, it is evident that the relative values of these currency units cannot vary much, though of course their purchasing power may vary a great deal, in accordance with changes in the world level of prices. The gold standard is a means of keeping stable, not the price level, but the relative values of the monies of different nations.
This relative stability is obviously, in normal times, a great advantage from the standpoint of international trade. For it means that traders of different countries can make bargains in terms of one another’s currencies with full knowledge of the amounts they will get or pay in their own money. As most trade is done on a credit basis this is highly important; and where the relative values of national currencies are liable to vary a new and dangerous uncertainty is added to the normal risks of trade.
For this reason the countries which were forced off the gold standard during the war made a great effort to return to it when the war was over; and most of them had succeeded in re-establishing it before the present world crisis began. But somehow, in the years since the war, the gold standard has not been working as it used to do. Where it has been in operation, it has kept the relative value of money almost stable; for it is bound to do that by its very nature. But the struggles in which the countries have been involved in order to keep on it at all have brought most inconvenient and even disastrous consequences in their train. High bank rates, restriction of credits to industry, and a rapidly falling price-level—these have been the results of the gold standard in recent years.
Countries which are on the gold standard in any full sense have to keep in their banks a supply of actual gold. This gold serves two purposes. In the first place, if their currencies are exchangeable for gold at a fixed rate, they must be prepared to sell gold at that rate to those who ask for it in exchange for currency. As the gold is of no use to the buyer within the country, this usually means that he wants to export it, in order to pay a bill which he owes in some other country, or in order to change it into the money of some other country. If, for example, the same sum of money will buy more goods or earn higher profits in America than in Great Britain, a number of persons will want to change British money into American money in order to get the benefit of the difference. There may thus arise a demand for gold to be exported to America; and Great Britain, as long as she was on the gold standard, had to be prepared to supply gold for this purpose to those who demanded it. Moreover, a country like the United States, which exports more than it imports, has somehow to be paid by other countries for this excess; and, unless Americans are prepared to leave this excess on loan in the debtor countries, the payment can only be made in gold. That, incidentally is why America has sucked up so large a part of the world’s total gold supply since the war.
The second purpose for which gold standard countries use gold is to keep a reserve, usually fixed by law, as a backing for their issues of paper money. The precise arrangements vary from country to country: in Great Britain the Bank of England is allowed to print a fixed amount of paper money without gold backing, but must have a pound for pound backing in gold against all notes issued beyond that amount. A great many people think that this is quite unnecessary; and that all the gold a country needs in order to work the gold standard is enough to meet demands for export. But at present the keeping of a gold reserve against notes is almost everywhere enforced by law; and legislation would be needed to remove the obligation. It has actually at the present time been temporarily modified in Great Britain.
The real object of compelling the banks to keep reserves of gold against their notes is simply to limit the amount of currency they are able to issue, so as to prevent any undue rise in prices. For if the banks went on printing paper money irrespective of any increase in the supply of things to be bought and sold, prices would be bound to rise, as they did in Germany and in other countries during the period of inflation. Inflation is, indeed, simply an increase in the supply of money without a corresponding increase in the quantity of things for sale.
A country that is on the gold standard cannot inflate. For if it did, its price-level would rise. It would therefore pay financiers better to change its currency into gold, and export the gold to a country where prices were lower. The country with the inflated currency would soon find itself losing all its gold. It would be compelled before long to refuse to give gold in exchange for its currency, at all events at the old fixed rate. In other words it would be driven off the gold standard.
In this indirect way, the gold standard does regulate a country’s price-level, as well as the relative value of its currency and those of other countries. But it does not keep prices stable. Speaking very broadly, it causes them to fluctuate in accordance with the movements of prices in the world as a whole, or rather in other gold standard countries.
[RETURNING TO THE GOLD STANDARD IN 1925 - CONSEQUENCES OF DEFLATION]
As we have seen, after the war most countries came back to the gold standard. Some, indeed, such as the United States, remained on it throughout the war; but all the belligerent nations in Europe were temporarily driven off gold as a basis for their currencies. When they came back to it, they did not all do this in the same way. There were two alternative courses open to them—deflation and devaluation. Great Britain deflated; France, Italy, Germany and Belgium all in various ways devaluated.
Deflation is the opposite of inflation. It means a reduction in the quantity of money without a corresponding reduction in the volume of things to be bought and sold. This reduction brings down the price-level, and so makes each unit of the currency worth more in terms of goods, and therefore of gold as well—for gold has a value like other commodities. The effect of deflation is therefore to increase the value of the deflated currency in terms of gold and of currencies based on gold. In the case of Great Britain after the war, deflation was pushed to the point at which it became just possible to restore the gold standard at pre-war parity—that is, to offer to give for a pound sterling the same quantity of gold as before the war. This brought the pound back to pre-war parity with the American dollar, which was also exchangeable for the same quantity of gold as in 1914.
The French and the Germans, equally with ourselves, came back to the gold standard. But their method was not deflation, but devaluation. The French did not attempt to make a franc worth as much gold as it had been in 1914, but only to fix for it a new and greatly reduced gold value (roughly one-fifth of its pre-war value) and then keep it stable at the new value. This was fully as effective and complete a restoration of the gold standard as ours; but it had quite different effects. The Germans went further than the French, by wiping out their old inflated paper currency altogether, and starting a new one, with a fixed value in gold.
Our policy of deflation had apparent advantages to us as a great creditor country. It compelled our debtors, who mostly owed us debts reckoned in our own currency, to pay us more in real things as the value of the pound went up. But it had far more serious disadvantages. In order to carry it through, the bankers kept bank rates of interest high and restricted the amount of credit, thus hampering industry and increasing unemployment. Moreover, as the value of the pound rose, the burden of the National Debt, and of all fixed interest charges, rose with it, putting a tremendous strain on our system of taxation, and burdening productive industry with higher real charges on all sorts of mortgages and debentures as well as in bank interest. A huge addition was made by these means to the unearned incomes of the rentier classes, and the seed sown which has sprouted into the unbalanced Budget of to-day.
Moreover, even though deflation compelled the countries which owed us money to pay us more in goods or gold, it is more than doubtful whether we got any advantage from laying this extra burden upon them. The increase in their indebtedness helped in the long run to destroy their power to purchase our exports. This in turn caused severe unemployment in our export trades; and we had to maintain those who were thrown out of work. This meant that we had to take back in taxes to maintain the unemployed quite as much as we had exacted from the debtor countries. And, in addition, by pressing these countries too hard, we caused them to threaten to default in their payments; so that we ran the risk of losing what they owed us altogether and still being left with the unemployed to maintain. The gain from scaling up the debts due to us from other countries by means of deflation was therefore illusory. So far from gaining by it, we were heavy losers in the long run.
Devaluation, the alternative open to us when we decided to restore the gold standard, would have meant some loss on our foreign investments which bore a fixed rate of interest in pounds sterling. But it would have avoided the necessity of high bank rates and credit restriction, and it would not have made the huge unnecessary present which deflation made to the rentier class. It would have kept down the burden of the National Debt, and released the proceeds of taxation for more useful purposes, such as a policy of national development and the extension of the social services. Undoubtedly, devaluation was the right policy, and deflation hopelessly wrong.
Nor is this the whole of the case against deflation. When, in 1925, Mr. Churchill and the Bank of England restored the gold standard on a basis of pre-war parity, deflation had not really been carried far enough to enable the value of the pound to be easily maintained at the new fixed level. British prices and costs of production had not really been forced down far enough to make the pound sterling worth as much as we insisted on valuing it at, in terms of gold and dollars. Consequently, there has been ever since persistent pressure to bring down wages still further, in order to reduce costs, and the policy of restricting the supply of credit has had to be maintained. We have lost export trade because we have been charging more than the world-prices for our exports in terms of gold and of our over-valued currency.
In order to retrieve these losses of trade, we have been driven ever since 1925 to a series of unsound and dangerous expedients. The first was the coal subsidy. Then came the Conservative De-rating Act—a deliberate attempt to lower costs of production by transferring burdens from local rates upon industry—which increase costs—in part to the national taxpayers and in part to the local house-holders. This meant in effect an indirect reduction in wages all round, as well as a bonus to profits in a number of flourishing trades which needed no help. Our point here is that this measure arose directly out of our folly in restoring the gold standard. In doing so, we unnecessarily varied the prices of our exports; and we were then driven to one bad expedient after another in our attempts to get costs down again to a competitive level.
These expedients have failed. We have been left with a large persistent mass of unemployment; and the maintenance of the unemployed has combined with De-rating and the excessive interest on the National Debt to make our taxation the highest in the world. High taxation in itself need not be bad—that depends on how the proceeds are used. High taxation devoted mainly to keeping people in idleness is certainly very bad indeed. Yet this was the necessary result of deflation. It caused widespread unemployment; and it grossly increased the incomes of the rentier class—the latter being of course by far the heavier burden on the Exchequer.
Ever since 1925, Great Britain has been struggling vainly against the disastrous consequences of this colossal blunder. Our troubles arose, and arise, mainly not from the fact that we went back to the gold standard, but from our folly in doing this by deflation instead of devaluation. The mistake lay in forcing the pound back to prewar parity, and so putting on it a value which exceeded its real worth.
[RETURNING TO THE GOLD STANDARD IN 1931 - DEFLATION OR DEVALUATION?]
We have now, in the midst of the world slump, been driven off the gold standard, in an attempt to reverse the consequences of our folly. By prohibiting the export of gold, or rather refusing to give gold in exchange for our currency, we have removed the pin which fixed the relative value of sterling and other currencies, and for the moment we are letting the gold value of the pound fluctuate. But we are told by those in authority that this is meant to be a purely temporary measure, and that, as soon as the present emergency is over, we are to go back to the gold standard.
What does this mean? It may mean either of two things—either that we are to aim at bringing the pound back yet again to its old parity with gold and with other gold standard currencies, or that we now mean to devaluate, and, as soon as the emergency is over, to fix a new and lower gold value for the pound, as France has done for the franc and Italy for the lira. On this point, those in authority give us no clear information; but the hints which they drop sound as if they were still hankering after a return of the pound to the old parity.
This would be a disastrous policy. It would again force up the real burden of the National Debt, and of all fixed interest payments. It could be brought about only by a drastic reduction of wages and salaries, designed to force down costs of production, and by a continuance of high bank rates and credit restriction. It could be put into operation only over the prostrate body of the working-class movement. And, above all, it is entirely unnecessary.
The effect of allowing the pound to become worth less in terms of other currencies is, of course, to increase the cost in pounds of our imports, and to cheapen the prices of our exports to foreign purchasers. This is on the assumption that other countries do not follow our example, and devaluate their currencies as well. If they do, and devaluate to the same extent as ourselves, the position is as you were —we buy their goods, and they buy ours, on the same terms as before. Probably a substantial number of countries, in addition to those which had gone off the gold standard before we did, will, in fact, follow our example—as Denmark and Sweden, for instance, have done already. But at least France and America, with their huge stocks of gold, can hardly embark on a policy of devaluation. The effect of our going off gold is therefore likely to be a stimulus to our export trade at the expense of French and American exports, and of those of any other countries which remain on the gold standard.
A second effect will be some restriction of imports into Great Britain, at least from countries which still keep to gold as a basis. For, as we shall have to pay more in pounds for their goods, we shall tend to buy less from them, and either to make the goods at home, or to buy them from countries which are not on the gold standard. The tendency of our departure from the gold standard will thus be to reduce the British adverse balance of trade, and to hit seriously the export trade of those countries which, for one reason or another, do not follow our example.
To some extent, these effects will be temporary. If costs and prices in Great Britain were to rise to the full extent of the fall in the gold value of the pound, they would disappear altogether; for our manufacturers would then be charging so many more pounds for their exports as to make them no cheaper to foreign buyers than the exports of France and America, and imports from gold standard countries would again be able to compete at the higher prices with our own products or those of other countries with depreciated currencies. There is, however, no reason to suppose that, for some time at least, the internal price-level will rise to the same extent as the external value of the pound falls. The prices of many imported goods will doubtless rise, and this will cause the cost of living to increase to the extent to which we live on goods imported from gold standard countries. But there is no reason why the prices of goods and services produced at home should rise, or at any rate why they should rise to anything like the same extent. For some time at least the devaluation of sterling is likely to give a considerable stimulus to our export trade—the more powerful the further the depreciation goes.
If we attempted to restore the pound to its pre-war gold parity, we should totally throw away this most necessary advantage, and plunge our export trades back into the difficulties from which the suspension of the gold standard gives them a chance of emerging at last. For this as well as for the other reasons given above, it would be the worst sort of folly to attempt to go back to the old gold parity.
There remains the second policy, of returning to the gold standard at a new and lower gold parity—that is, of permanent devaluation of the pound in terms of gold. After allowing the pound to fluctuate for a time in terms of other currencies, so as to let it find its natural level, we can, if we will, stabilize it at a new gold value, based on its new actual ratio of exchange with the currencies of countries still on the gold standard.
This would be a far better policy than to attempt to restore the pound to its old parity. It would retain, at least for a long time, the advantage to our export trade; and it would reduce permanently the real burden of the War Debt and of other fixed interest obligations. Of course, it would mean some rise in prices, which would have to be met in due course by increasing wages and salaries; but, as we have seen, there is no reason why prices should rise to at all the same extent as the gold value of the pound falls.
This policy of permanent devaluation has therefore much to recommend it. The chief argument used against it is its effect in reducing the sums owing to this country as interest on our investments abroad. But we shall find it far more to our advantage to reduce this interest than to provoke defaults all over the world by pressing for payment on the old terms. Countries like Australia and India, Chile and Brazil, the prices of whose products and the value of whose currencies have already suffered a severe fall, cannot possibly afford much longer to go on paying interest on their borrowings in pounds measured at the old rate. Unless their burdens are made lighter, they will default altogether. Devaluation, which does lighten their burdens, is from this standpoint a positive advantage.
But, although stabilization of the pound at a new and lower gold parity is a possible policy with a good deal to recommend it, can we be at all certain at this stage that we shall wish to go back to the gold standard at all? For that standard, while it has the advantage of being international, has shown itself to possess very serious disadvantages. May it not be better to replace it by a new international standard, worked out in common among the countries which the crisis has driven off gold; or even, in default of this, to leave the pound to fluctuate in terms of other currencies, and concentrate on an attempt to stabilize our own internal prices? To the case for and against the gold standard itself—as distinct from the question of prewar parity of the pound with gold and other currencies—we must next turn our attention.