The 1931 sterling crisis and the independence of the Bank of England
This article was published in the Journal of Post-Keynesian Economics as a contribution to a symposium on the question: Is an Independent Central Bank Necessary or Desirable? It directly derives from my Cambridge Ph.D. thesis on The Economic Policies of the Labour Government, 1929-1931, work which permanently drove my interest in the problematic and contested frontier between the functioning of two, necessarily overlapping sets of institutions: the market economy and the political process. The opportunity to reflect on the international financial crisis that destroyed the Labour Government in 1931 led me (albeit implicitly) to revise the conclusion of my thesis in one important respect. The Bank of England did not play an independent role in enforcing austerity on the Government. On the contrary, its drive to escape from merely serving as the manager of the massive national debts incurred in waging World War I led it to become the slave of the international financial markets which it had once ruled in the halcyon days of the pre-War Gold Standard. Written when the independent central bank was being celebrated as the one legitimate state institution in the neoliberal regime, today it provides a relevant perspective on a world whose “global financial imbalances” remain unresolved a decade after they culminated in the most extreme crisis since 1931.
Britain abandoned the gold standard in September 1931 in the context of a multidimensional crisis. Internationally, Austria and Germany had already been driven off gold and, domestically, the minority Labour government had fallen, to be replaced by a nominally "National" coalition. The crisis was the hinge of Britain's interwar experience as a nation and, as such, has been the subject of intense political debate, as well as historical scrutiny, for more than sixty years. The fact that Keynes was a direct participant in the contemporaneous policy debates, whose sterility helped set the stage for the crisis, lends weight to the theoretical argumentation in which the failure of policy was embedded.(1)
Within the grander scope of British history, the crisis of 1931 terminated the Bank of England's attempt to reestablish its position of independence from the government of the day through the institution and practices of the gold standard. The story has been obscured by the final drama of the Labour government's demise, when Bank of England officials participated to an unprecedented degree in Cabinet and interparty deliberations, thereby inviting the charge of forcing a "Banker's Ramp." Inaccessible to view at the time, however, was the extent to which the Bank of England had escaped from its recent status as a virtual appendage of H.M. Treasury only to become the prisoner of the capital markets that it had once dominated.
This history is replete with irony. For six years "under the harrow," from April 1925 through September 1931, the Bank managed its money markets substantially in order to insulate a depressed British economy from what, in principle, were supposed to be the autonomous workings of the gold standard. For six increasingly stressful months, through the first half of 1931, the Bank explicitly sought to educate British ministers on the radical reforms in social and economic policy that it deemed the markets required if continued adherence to the gold standard were to be possible. When the Bank finally got a national government willing and able to implement the program of "retrenchment" it had sponsored in perverse response to the deepening industrial and commercial depression, those markets took less than a month to drive sterling off the gold standard regardless. And it was, finally, the collapse in September 1931 of its entire post-World War I strategy that at last freed the Bank to implement and sustain a cheap money policy appropriate to domestic economic conditions and supportive of politicians anxious for industrial recovery.
The Significance of the Gold Standard
The pre-1914 Bank of England stands as the epitome of the independent central bank. It had evolved into a unique institution through the nineteenth century: a privately owned bank vested with public purposes. "If there had been an articulate Governor (they do not seem to have been born that way)," Sayers writes,
he might have said that fundamentally he had three functions. He had a statutory duty to maintain the convertibility of the note into gold coin; he had a political duty to look after the financial needs of government; and he had a commercial duty to maintain an income for the stockholders. Whenever possible, he was running all three horses at once, but if there was a conflict, he knew which he had to put first. He would think of his primary duty as the maintenance of the gold standard. [Sayers, 1986, p. 8]
The mechanics of the "free" gold standard turned on: first, the commitment of the Bank to buy and sell gold at the fixed official price; second, the unrestricted right of private citizens to import and export gold; and, third, the direct linkage of the Bank of England's gold reserves to the national money supply. The autonomy of the Bank in managing this system was unquestioned. Clarke cites the 1930 testimony before the Macmillan Committee on Finance and Industry of two of the leading Treasury Knights whose careers spanned the prewar and postwar worlds:
"Before the outbreak of the War," Bradbury recollected . . . , "we certainly never regarded ourselves as entitled to meddle or even ask questions." Niemeyer was characteristically trenchant in saying that a "change in bank rate was no more regarded as the business of the Treasury than the colour which the Bank painted its front door." [Clarke, 1990, p. 35]
The great test of the prewar gold standard came in 1907, where the banking panic in New York that ultimately led to the creation of the Federal Reserve triggered an international liquidity run. In response, the then governor raised the Bank rate to 7 percent, the highest level since 1873, and sterling remained untouched. The consequent "spectacular" rebound in the Bank's reserves, Sayers notes, added to the
"confidence . . . [of] a whole generation, among them the newest of the Bank's Directors, M.C. Norman, . . . in the Bank's power to maintain convertibility" (1986, p. 59).
The decision not to suspend gold payments with the outbreak of war in 1914 reflected the fundamental position of the gold standard in the system of the time and in the minds of both those who analyzed and those who operated the system. The view of the young Keynes is indicative: "the case that was said to have won [the then Chancellor of the Exchequer] Lloyd George," Sayers writes,
was that made by Keynes, but one at least of Keynes's reasons would have been well understood and echoed by the Governor [Cunliffe]. "The future position of the City of London as a free gold market . . . will be seriously injured if at the first sign of emergency specie payment is suspended." [Sayers, 1986, pp. 83-84]
The monetary history of the 1914-18 war is of one expedient after another "to maintain to the last ditch the principle of external convertibility . . . of the pound sterling" (Sayers, 1986, p. 85). Appeals to patriotism could enable the Bank to violate virtually every practice of the prewar gold standard and included even a quasi-voluntary mobilization of privately held securities for conversion either directly into foreign exchange or as collateral for foreign loans. In the meantime, Treasury borrowings flooded the London capital market with liquid securities: the price at which the Treasury could roll over its short-term debts and incur new obligations preempted utterly the prewar autonomy of the Bank in setting interest rates. When, in March 1919, the coalition government that had won the war refused to allow the Bank to raise the Bank rate in response to the postwar speculative "restocking" boom, the jig was up. The decision finally to embargo gold exports had the support of the City as it was universally understood to be a temporary expedient (Sayers, 1986, pp. 83-95).
Even before the end of the war, the determination to reestablish the prewar order had been definitively enunciated in August 1918 by the Interim Report of the Committee on Currency and Foreign Exchanges after the War (the "Cunliffe Committee"). "Somehow, sometime," Sayers summarizes its message,
a free gold standard without artificial props was to be restored; discrimination between domestic and foreign interest rates was to go; a great funding drive was to reduce the threatening mass of the floating debt; and the note issue was to be brought under control of the pre-war type. [P. 99]
The Bank's loss of control was symbolized by the suspension of specie payments. But the substantive cause lay in the elevation of the Bank's "political" duty to "look after the financial needs of government" above all other responsibilities. By 1921, "the Bank felt so frustrated and threatened by the weakness of governmental finances," Sayers writes,
that it made no bones about its call for budgetary reform... a habit of mind had been formed and throughout the inter-war years the Bank looked with suspicion on any ideas with a deficiteering smack about them. [P. 114]
In fact, six years passed before gold convertibility of sterling was achieved in April 1925 at the prewar parity to the dollar of $4.86. In retrospect, it seems scarcely credible that the decision to restore the old exchange rate went unquestioned. The overriding consideration, so dominant as to be unspoken, was the sanctity of the debt contracts previously entered into at the old exchange rate (Sayers, 1986, p. 118). In fact, the debate leading up to the restoration of convertibility was about the timing of the event, not about the exchange rate. And, on this question, the decision to return in early 1925 was taken in the teeth of the Committee on Currency and Bank of England Note Issues (the "Chamberlain Committee"), jointly sponsored by the governor and the chancellor, whose "broad position" Sayers summarizes:
a gap remained between American and British prices, . . . because of this there should not be an immediate return but a hopeful wait for American prices to rise, and . . . meanwhile the improvement in sterling should be firmly held by a tight monetary policy and restraint on overseas lending. [P. 140]
Some awareness existed of the deflationary consequences of convertibility at too high a rate: this is clear from the expressed hope that inflation in the United States would ease the path, avoiding the need for
"differential deflation" in Britain? However, Keynes' Economic Consequences of Mr. Churchill, published immediately after the fact, was virtually alone in drawing out the economic and policy entailments: as chancellor, Churchill was "committing himself to force down money wages and all money values, without any idea how it was to be done" (quoted in Clarke, 1990, p. 39). In the event, the return to gold was enabled—a most dangerous harbinger—by an outflow of American capital from New York "on an unprecedented scale, obscuring any judgment, at the time or by posterity, on the equilibrium values of currencies in terms of each other." Credits to support the move, obtained by the Bank from its opposite number in New York, did not in fact have to drawn upon (Sayers, 1986, pp. 139-140).
In considering the economic and political consequences of Britain's return to gold, it is critical to appreciate the actual circumstances in which Norman and his colleagues had operated in the years since 1914. The determination to restore the gold standard was not merely an exercise in unthinking nostalgia. It was driven by the experience of the war that carried over into the early 1920s, "when extreme inflation was in many countries linked with political pressures to finance government" (Sayers, 1986, p. 159). The return to gold, thus, represented a conscious effort to construct a bastion—the autonomous central bank—against real financial and economic evils. Confusion lay in the (not quite universal) inability to read the profound changes in the economic and political context that had accompanied—indeed, had been largely generated by—mobilization for total war and which survived the outbreak of peace.
The Economic Context
At the onset of the Great Depression, Britain had already suffered nearly a decade of unemployment in excess of one million insured workers. This was the central economic fact that constrained monetary policy throughout the period, but the underlying causes of unemployment generated further pressures on the Bank. British unemployment was concentrated in the "unsheltered" staple export trades: coal, iron, and steel, engineering, shipbuilding, and cotton and wool textiles. According to statistics developed by Colin Clark for the Prime Minister's Economic Advisory Council in 1930 (Janeway, 1971, p. 1), in June 1929 the 470,000 unemployed in those industries accounted for 40 percent of the total, although those seeking work employed in these trades were only 25 percent of all insured workers. The unemployment situation was clearly linked to the postwar export performance of the British economy. In 1929, British exports by value amounted to 729 million pounds, or 18.2 percent of net national income; in 1913, 525 million pounds of exports had accounted for 24.9 percent of net national income. Between 1913 and 1929 the volume of British exports fell by more than 18 percent, and Britain's share of the world market declined substantially in virtually every market and commodity grouping. Clark summarized the causes of Britain's loss of competitiveness as follows:
Firstly, our prices must be higher than those of competing industrial countries . . . and secondly, that (sic) we as a country concentrate and specialise too much on certain of the older industries such as cotton, the demand for which is both relatively and absolutely shrinking, and fail to obtain our full share of the world's demand for products of the newer industries such as motor cars or electrical goods. [Quoted in Janeway, 1971, p. 2]
In terms of the balance of payments, a significant offset was the sharp improvement in the barter terms of trade, by some 22 percent between 1913 and 1925, with no further change through 1929. The benefit throughout the 1920s was great: on average, from 1921 to 1929 Britain's exports were 13.2 percent lower by volume than in 1908-13, while imports by volume were 13.0 percent higher. The rise in import volume from the prewar period, however, more than offset the decline in import prices relative to export prices (Janeway, 1971, pp. 2-4).
The net result of the favorable shift in the terms of trade and the unfavorable shift in Britain's competitive position was a visible trade deficit in the 1920s more than twice that experienced in 1913. Even excluding the exceptional result in the general strike year of 1926, the visible trade deficit averaged some 388 million pounds from 1924 through 1929; including 1926, the average was 400 million. Against this deterioration, invisible exports rose less than commensurably. The 1929 visible trade deficit, at 382 million pounds, was 236 million greater than in 1913, while the surplus on invisibles rose 145 million pounds to 484 million pounds. The current account surplus of 103 million pounds was barely half the 193 million pound surplus of 1913 (Janeway, 1971, p. 4).
Even this reduced surplus was precariously dependent upon dividend income in the neighborhood of 100 million pounds that was exceptionally vulnerable to any deterioration in foreign economic conditions and, as well, on an improvement of nearly 50 million pounds on government account between 1924 and 1929 that was dependent upon the maintenance of reparation payments. The fragility of the current account surplus is emphasized by the shifts in its components in real terms since 1913. At 1913 import prices, the invisible surplus in 1929 was worth only 346 million pounds, while the 1929 visible trade deficit at 1913 import and export prices amounted to nearly 370 million pounds (Janeway, 1971, pp. 4-5).
The reduced size of the current account surplus entailed adjustments on capital account. New issues for overseas borrowers averaged 121 million pounds in the quadrennium 1927-30 as against 177 million pounds in 1910-13, and accounted for only 42 percent of all new issues as compared with 80 percent in the earlier period. Fears of "overlending" abroad induced unofficial restraints by the Bank of England on new foreign issues, particularly from late 1928. Changes in the structure of the short-term money market, as international deposit banking supplanted international acceptance banking, weakened London's hold on balances and complicated the task of monetary management. And the existence of a major alternative financial center in New York raised liquidity requirements for the international systems as a whole and carried the potential for disruptive movements in short-term deposits between money markets, especially given the relatively greater weight of domestic factors in determining interest rates in New York (Janeway, 1971, pp. 5-6).
The Political Context
British political history in the 1920s is the story of the split and decline toward insignificance of the Liberals and the rise of Labour as an alternative party of government. The Liberal split was driven by the choice forced on all its adherents: to be for or against the strongest political personality of his generation, Lloyd George. Further, the rise of a genuine "People's Party" threatened to render redundant those Liberal principles whose pursuit had led to its dominant position in the prewar decade: political reform to widen the franchise, economic reform to create a social safety net. For its part, Labour's parliamentary leadership had rejected "direct action" as a means toward implementing its vision of a fair society and was dedicated to proving to all the significant constituencies of Britain's polity its worthiness to govern.
From 1918, four general elections within six years saw Lloyd George's wartime coalition yield, in 1922, to a Conservative government determined to challenge eighty years of free trade orthodoxy, followed in turn by the first ever Labour government, whose tenuous hold on power—it was not only a minority government but held fewer seats than the Tories and survived only by direct Liberal support—lasted less than a year. But the general election of 1924 appeared to introduce a new era of normalcy: the clear majority of Baldwin's Conservatives was mirrored by the emergence of Labour as unquestionably the second party both in popular vote and in parliamentary seats; the divided Liberals collectively held only forty seats (Williamson, 1986, pp. 21-22).
Beyond Westminster, the war-generated distortions in economic organization and activity appeared over. Moderation at the political center predominated, overcoming both the "red scare" propagated by die-hard Tories in the 1924 election campaign and the general strike of 1926, doomed from the start to demonstrate that Labour's only path to power lay through constitutional processes. Baldwin's cabinet included leading former Liberals, notably Churchill and Neville Chamberlain. And its progressive programs included expanded state subsidies for housing and pensions. Critical to the events of 1931, the Baldwin government allowed the Unemployment Insurance Fund, supported by statutory contributions from employers and employees and the Treasury, to maintain benefits by borrowing to cover a persistent deficit: it also initiated a direct state "dole"—transitional benefit—as an entitlement for those who had exhausted their insurance. The verdict of the previous general election was accepted as a mandate for maintenance of free trade, at the expense of increasingly intense strain behind the scenes and between the Tory political leadership and the Tory popular press (Williamson, 1986, p. 45).
Baldwin's determination to prevent "the class war becoming a reality" (Williamson, 1986, p. 45) was matched by a Labour leadership determined to play the political game by the rules. The radical wild card in British politics remained Lloyd George, whose efforts to formulate an activist program on which to establish a Liberal revival—presented, with Keynes' participation and support, as Britain 's Industrial Future in time for the 1929 general election—failed in the face of widespread suspicion of his motives and character. In the event, Labour emerged in May 1929—with 288 seats—as the largest party for the first time and formed a government dependent only on the passive acquiescence of less than half of the 59 Liberals. Prime Minister Ramsey MacDonald had dedicated his life to rendering Labour acceptable as a party of government: neither the captive representatives of the Trades Union Congress nor a band of impractical, let alone threatening, theoreticians. In his chancellor, Philip Snowden, MacDonald was partnered by a social radical whose orthodox rectitude in fiscal matters was matched only by his unwavering commitment to free trade (Williamson, 1986, pp. 34-43).
In this context, the autonomy of the Bank of England to pursue its duties was assured. It had been Lloyd George, unsurprisingly, who had threatened to "take over the Bank" in the heat of a wartime conflict with the governor over the control of foreign-exchange reserves (Sayers, 1986, pp. 105-107). And, in principle, Labour's commitment to state ownership of key economic institutions included the Bank; but, in practice, no program of nationalization was available to a minority Labour government. More important still, Snowden was at one with his Treasury officials in the belief that an independent Bank, free from political pressures and constraints, was a public good—able to adopt unpopular but necessary measures of monetary discipline as required. And adherence to the gold standard, the potential source of such required discipline, was to Snowden a "knave-proof' check on politicians and markets whose abandonment would "have disastrous consequences" (quoted in Williamson, 1986, p. 74).
And yet, the appearance of normalcy was deceptive. " `Laissez-faire' capitalism in its late nineteenth-century sense no longer existed," as Williamson summarizes:
German payments of war reparations (which the French insisted upon) and Allied payments of war debts (which the Americans insisted upon) distorted international capital and commercial movements. With the national debt increased twelve-fold, debt charges swallowed a third of budget expenditure. Social service expenditure had risen seven-fold. Budgets which before the war balanced at under 200 million pounds now did so at over 750 million pounds. [Williamson, 1986, p. 59]
And, as noted, the depression in the traditional export industries generated unemployment and a weakened balance of payments that jointly constrained the practical independence of the Bank in its maintenance of the gold standard to an extent unimaginable in the prewar world.
The wartime politicization of the Bank rate carried over to the March 1919 veto by Lloyd George's chancellor of a proposed increase, the event that triggered the embargo on gold exports. In May 1923, Sayers notes:
the action of the Bank in raising Bank Rate aroused, as the Treasury had expected, criticism on the ground of aggravation of the trade depression. In this the incident marked the beginning of a new tide that was destined to affect policy, or at least the atmosphere in which policy was taken, for the remainder of the decade. [Sayers, 1986, pp. 129-130]
Early in his tenure as chancellor in the Baldwin government of 1924-29, Churchill expressed his concern about an increase: "the effect was to put an end to all thoughts of a traditionally flexible Bank Rate" (Sayers, 1986, p. 216). During the first four years of the restored gold standard, four changes of Bank rate in 1925 were followed by no changes in 1926, one change (a decrease) in 1927, and no changes in 1928: "the Bank was, in short, accepting a greater stickiness in Bank Rate than had been implicit in its policy of restoration of the gold standard" (Sayers, 1986, p. 217). The Wall Street boom in 1928 and on into 1929 placed intense pressure on London as liquid capital flowed westward across the Atlantic: an increase in Bank Rate from 41/2 percent to 51/2 percent was tolerated, but only in September did the Bank rate follow the New York discount rate up another point in the final days before the crash. Subsequently, the Bank was able to follow the New York Fed all the way down to 21/2 percent, the low point in the Bank rate reached in March 1931, just before the international financial crisis began in Vienna (Sayers, 1986, pp. 223-227).
Beyond the loss of autonomy in its management of interest rates, the Bank's mystique was further exposed by the deliberations of the Committee on Finance and Industry (the "Macmillan Committee"). Reluctantly created by Snowden in response to widespread concern about the state of the British economy, the hearings and report of the Macmillan Committee were dominated by Keynes, who used them to expound his evolving analysis then inadequately crystallized in the Treatise. Unused to public discussion, let alone criticism, of their manner of working, the leading officials of the Bank—led by Norman—were variously arrogant and inarticulate in their attempts to respond to Keynes (Williamson, 1986, pp. 103-141).
What manifestly fails to come through the Bank's testimony is the extent to which, by 1930, it was consciously seeking to "manage" the gold standard in order to insulate the British economy from its disciplines. "Have you in view when you raise or lower the Bank Rate what are or may be the consequences to the industrial position of the country?" the chairman asked Norman directly. Norman's response was at once equivocal and dramatic:
I should answer by saying that we do have them in view, yes, but that the main consideration in connection with movements of the Bank Rate is the international consideration, and that especially over the last few years as far as the international position is concerned . . . we have been continuously under the harrow. [Quoted in Sayers, 1986, p. 211]
Two years previously Norman had expressed, privately, his rationale for offsetting gold movements to and from the Bank's reserves, rather than taking them as triggers for automatic monetary inflation or deflation in the orthodox Ricardian mode:
Neither the inflow nor the outflow of gold was in settlement of trade balances, but reflected chiefly movements of capital in response to conditions that were far from normal. [Sayers, 1986, pp. 312-313]
Invisible to its progressive critics whose intellectual leader was Keynes, but in direct testimony to the weight of their criticism, as Sayers comments, the Bank's market operations invited "Ricardian critics with a simple creed" to complain that "the Bank was not playing the gold standard game according to the rules" (Sayers, 1986, p. 219).
The failure of central bank management
The Labour government enjoyed less than one year of grace before the impact of the world depression transformed its position. By March 1930, seasonally adjusted unemployment had risen from 1.2 million to 1.6 million and then rose with only brief pauses to 2.5 million in March 1931. Politically, the contraction was measured by the government's need to ask Parliament for successive increases in the borrowing powers granted to the Unemployment Insurance Fund: from 40 million pounds, authority was increased to 50 million in April 1930, 60 million in August 1930, 70 million in December 1930, 90 million in February 1931, and 115 million in June 1931 (Janeway, 1971, pp. 171-188).
Pressure on the budget grew in parallel. Snowden' s commitment to Gladstonian rectitude was unquestioned (unlike his adventurous predecessor, Churchill). Not only was current balance between revenue and expenditure required, but the budget included statutory provision for substantial debt repayment: in practice, at least 50 million pounds annually. In April 1930, Snowden managed to meet the emergent deficit with relatively modest increases in taxation (Janeway, 1971, pp. 69-72, 78-79).
By the start of 1931, any room for an activist program aimed at reducing unemployment and redistributing income, even on the margin, had disappeared. On January 7, Snowden presented the cabinet with a memorandum on "The Financial Situation": "The Budget prospect for 1931 is a grim one," he began: the 1930-31 deficit "may reach 40 millions" and he had "to face the possibility of a deficit next year in [sic] the order of 50 millions" and possibly "even . . . upwards of 70 millions." He dismissed as "completely fallacious" the argument that there is no "real deficit" since "the Budget provides a Sinking Fund which should more than offset any deficit" on three grounds: (1) "the great bulk" of budgeted debt redemption was devoted to specific contractual sinking funds; (2) borrowing outside the budget, specifically for the Unemployment Fund, should be reckoned together with the budget deficit; and (3) attempting to meet the budget deficit by curtailing the Sinking Fund "would not even pay" since it "would immediately depreciate the whole of 7,000,000,000 pounds of Government securities" (CP3, CAB/219 quoted in Janeway, 1971, p. 84).
The core of Snowden's memorandum was the warning that "this country cannot afford a Budget with any sort of deficit." Internally, a deficit would end "cheap money . . . and the whole improvement in the long-term rate of interest." Externally, the threat was even greater:
There are already signs that London is losing the confidence of foreign markets and it is believed that there is a steady trickle of money being transferred abroad. . . . Any flight from the pound would be fraught with the most disastrous consequences—not merely to the money market but to the whole economic organisation of the country. [Janeway, 1971, p. 85]
Snowden was reflecting the consensus of City and industrial opinion. "Retrenchment" in expenditure had become the common theme of both the Conservative and Liberal oppositions, divided as they remained on free trade (Williamson, 1986, pp. 69, 131).
By the winter of 1930-31, the Bank's primary challenge had been transformed. No longer under pressure to defend sterling from the magnetic pull of Wall Street, the Bank focused on the emergent threat to financial confidence represented by the government's finances. From managing its markets in order to insulate Britain from the gold standard, the Bank set about mobilizing influential opinion in order to educate the
cabinet on the financial prerequisite for adherence to the gold standard (Williamson, 1986, pp. 200-201). The Bank even rejected offers from the French authorities of credits and market collaboration in defense of sterling as they "might easily be counter-productive in postponing the solution—measures to balance the budget and reduce costs" (Williamson, 1986, p. 200).
The fall of the Labour government in August 1931 came as the culmination of its successive acquiescence in the transfer of authority over its most fundamental priorities. The first came in December 1930, with the appointment of the Royal Committee on Unemployment Insurance, chartered to consider how to make the system "solvent and self-supporting" (Janeway, 1971, p. 177). In February 1931, the second came with the creation of the Committee on National Expenditure (the "May Committee"), a Liberal initiative that enabled the government to avoid defeat in Parliament by subjecting the finances for which it was responsible to an independent body dominated by accountants and businessmen (Williamson, 1986, pp. 221-222). The third came with the arrival in London, on July 13, of the international flight to liquidity that had begun in Vienna with the crash of the Credit Anstalt and had then driven Berlin to suspend the free gold standard (Sayers, 1986, p. 391). The threat to London's continued adherence to the gold standard projected the Bank into the center of policy formulation and political bargaining in an altogether unprecedented manner.
In mid-July, the freezing of the City's claims on Vienna and London were accompanied by the publication of the Macmillan Committee's report which highlighted the illiquidity of London's international position. As gold began to flow outward, the looming crisis of confidence posed two alternatives for the Bank. "Traditionalists" called for the Bank to "emphasize its insistence on gold standard behavior by openly allowing gold to go and stepping up Bank Rate sharply." The new "Internationalist" view saw "an occasion for London to repeat its 1925 reliance on credits . . . with the optimistic suggestion that [as in 1925] the knowledge of their existence would be sufficient to stop withdrawals from London." Either approach would depend on accelerating "action on the government deficit which all were now emphasizing as the root of the trouble" (Sayers, 1986, pp. 392-393).
In the event, the Bank secured dollar and franc credits of 25 million pounds each, buying time for an intensive campaign to win the Labour cabinet to retrenchment: most particularly, to a reduction in the rate of unemployment benefit. The publication of the May Committee report at the start of August was a critical event, with its "grossly exaggerated" (in Sayer's words, 1986, p. 393) presentation of the prospective budget deficit. The May report set the agenda for the cabinet and for the international financial markets. From August 10 through August 23, Bank officials had at least eight meetings with the prime minister and, with his concurrence, met with the leaders of the opposition parties. As Sayers comments:
This was an extraordinary step; that it was proposed and that it was permitted__________ both without parallel—show how deeply the crisis had struck and how the political atmosphere was developing. [Sayers, 1986, p. 397]
To all, the Bank's message was the same: retrenchment was essential to the restoration of confidence and the maintenance of the gold standard.
On August 5, the Bank made one pass at the traditional policy, letting sterling fall below the gold export points. The result was near-panic in the markets and bitter reprimands from the central bankers in Paris and New York. Henceforth, the Bank used its foreign-exchange reserves, augmented by the credits, to peg sterling above the gold export point. As the credits ran down, the specific political flashpoint became the conditions on which new foreign-exchange reserves could be secured. The Bank advised the politicians that additional borrowings would have to be for the account of the government and, as the Federal Reserve by statute could not lend to other governments, they would have to be secured by means of a syndicated loan in the market (Sayers, 1986, pp. 395-397).
There followed an extraordinary dance, dissected in exquisite detail in the literature (Clarke, 1967, pp. 200-213; Sayers, 1986, pp. 394-399; and Williamson, 1986, pp. 285-333), whereby the Bank, the opposition leaders in London, and the House of Morgan in New York each sought to place on the other's shoulders responsibility for defining the terms and conditions that the cabinet would have to meet for a loan to go forward. All concurred that a cut in unemployment benefit was essential and, on this point, the cabinet fractured and the government fell on August 23. Intense negotiations, in which the king participated directly, led MacDonald and Snowden to abandon their party in order to lead a nominally "national government" whose primary support came from the Conservatives and all Liberals save Lloyd George and his remnant of followers.
With respect to the future of the gold standard, the essential fact is that not only the Bank of England, but even the New York Fed, had been reduced from the status of principals:
the central bankers were not now the real negotiating parties. [Deputy Governor] Harvey in London and [Fed President] Harrison in New York became little more than channels of information, whose duty it was to ascertain the conditions on which dollars could be borrowed from a number of independent . . . banks. [Sayers, 1986, p. 398]
On August 28, the national government secured 80 million pounds of new credits equally in New York and Paris. With the presentation of Snowden's emergency budget the crisis, as defined for the Labour cabinet, should have been resolved. In fact, on September 16 the run on London began again. The definitive loss of confidence was compounded by reports of "mutiny" in the Royal Navy against legislated cuts in pay and, more broadly, fear of a victory by the now radicalized Labour Party in the looming general election. As the drain of the government credits accelerated, the Bank did not even consider the traditional crisis exercise of raising the Bank rate to dramatic levels. Consideration was given to the wartime expedients of exchange controls and the mobilization of private holdings of foreign assets but rejected as impractical. Rather, the Bank prepared to suspend specie payments rather than lose its gold reserves—cover for the 130 million pounds of credits now exhausted and soon due for repayment (Sayers, 1986, pp. 408-412).
On September 20, Britain again left the gold standard, with the whimper of a government statement that drew a distinction-_____ most significant for interpreting the event—with the conditions of the 1919 suspension:
It is one thing to go off the gold standard with an unbalanced Budget and uncontrolled inflation; it is quite another thing to take this measure, not because of internal financial difficulties, but because of excessive withdrawals of borrowed capital. The ultimate resources of this country are enormous, and there is no doubt that the present exchange difficulties will prove only temporary. [Quoted in Sayers, 1986, p. 413]
It is one among many ironies that in the subsequent general election in October, the Conservative-dominated national government won the largest majority in British history (554 of 615 seats), with the radicalized Labour Party reduced to an insignificant fraction.
London's vulnerability was a function of its relatively illiquid position, attributable in part to the chronic weakness of Britain's postwar trade position; in part to Norman's deliberate sponsorship through the 1920s of the maintenance of foreign balances in London for the account of nations adhering to the gold standard; and, most dangerously, to the reliance on interest rate differentials relative to New York to hold funds in London. "The dependence of the international monetary system on interest-rate differentials," Sayers concludes,
was indeed, from London's point of view, the snare and delusion of the whole affair. Whatever has been said by the theorists, the tradition of 1914 . . . was that the convertibility of the pound into gold was maintained by the manipulation of short interest rates, which could be relied upon to produce adjustment of international capital flows sufficient to avoid intolerable disturbance of industry and trade at home. [Sayers, 1986, p. 213]
Sayers refers to the "Ricardian myth" of the automatic gold standard:
Whether a theory of this kind provides a satisfactory explanation of the international gold standard in the thirty years before 1914 is a doubtful question . . . ; but it can fairly be described as the mythological basis of the assurance with which post-War Europe had gone back to the gold standard, a process in which the central bankers had whole-heartedly co-operated. [Sayers, 1986, pp. 334-335]
Sayers cites two fundamental economic flaws as compromising the exercise: "the internal price structure could not be trusted to respond quickly or easily to the international gold flows" and "international capital movements could be predominantly disturbing instead of predominantly equilibrating." The latter undoubtedly was, is, and will remain the case. But the former consideration is too simple.
As Stephen Clarke concluded in his definitive analysis of Central Bank Cooperation 1924-31:
The priorities that the monetary authorities were expected to give to their respective domestic needs discouraged the discussion of how the burdens of adjustment should be distributed among deficit and surplus countries. . . . The authorities failed to develop any genuine understanding of the international adjustment problem and of how and on what terms such adjustment should be financed. [Clarke, 1967, p. 107]
Clarke was writing in 1967, when the cracks in the foundations of the post—World War II gold exchange standard were becoming visible. In retrospect, the ultimate failure of Bretton Woods can inform our understanding of the previous generation's failure.
Independent central banks, charged exclusively with enforcing the disciplines of any set of pegged exchange rates, inevitably must come into conflict with politicians elected to respond to economic constituencies damaged by those disciplines. And that conflict will be magnified through the positive feedback mechanisms of the money markets into capital flows inconsistent with the coexistence of fixed exchange rates and national monetary policies. For all his haughty secretiveness, Norman grasped this fact of postwar life.
It is not that the Bank failed to enforce domestic adjustment in Britain to accommodate the $4.86 rate: the fact is that it did not try. The abandonment of the Bank rate as an active instrument of policy right through the final crisis is decisive evidence. The drive for retrenchment in 1931 was a doomed exercise in attempting to manage the psychology of the international capital markets. It was not a serious exercise in enforcing further deflation on an economy in which commercial and industrial activity was contracting, prices were falling, and profits were disappearing.
Like the determination to return to gold in the first place, the manner in which Britain left gold in 1931 tells a story about the Bank's perception of its role relative to the role of government in the market economy. The postwar consensus to reestablish the "free" gold standard was the basis for the Bank's escape from domination by the Treasury as funding agent for a vastly expanded and more activist state. In dealing with a Labour cabinet, dedicated in principle to the mobilization of political power to redress market-generated inequalities of opportunity and outcome, the defense of the gold standard for its own sake became the instrument for testing beyond the breaking point Labour's willingness to sacrifice "sectional" for "national" interest. Masterful improvisation by the Conservative leadership not only secured Labour's division and abandonment of office, but the extraordinary coup of Labour's former leaders signing on to reduce, in the name of financial responsibility, the redistributive scope of governmental power.
The international liquidation of financial assets and institutions, it is clear in retrospect, could not have been prevented from forcing, sooner or later, an end to free trading of sterling and gold at the existing parity. The relevant alternatives lay between comprehensive exchange controls with the maintenance of the notional party—as in 1914-18—and a free exchange market with substantial depreciation of sterling. The Labour government had been presented with only one course of action by the alliance of the financial authorities and the opposition parties: to balance the budget on specified lines. That this course was intended as a symbolic act to restore the market's loss of confidence, not as a hopeless effort to force domestic costs down to the ever descending level necessary for international equilibrium (in parallel with Bruening' s radically destructive program in Germany), is evidenced by the fact that more deflation, beyond Snowden's emergency budget, was never presented as an alternative to the national government. With Labour gone from office and the principle of balanced budgets reaffirmed in the most dramatic manner imaginable, in a fundamental sense the gold standard was no longer necessary to the Bank or to Britain.
The final irony of this history, of course, is how fortunate the Bank and Britain were in being forced off gold as early as September 1931. Freed from its imprisoning commitment to defend the gold standard in pursuit of independence from the Treasury, its highly centralized and actively supervised banking system untouched by any threat of a domestic run the Bank was able to sponsor the cheap and easy credit conditions that engendered domestic recovery in Britain years before the New Deal could enjoy signs of significant recovery across the Atlantic.
1 Williamson (1992) stands as the definitive account of political and policy developments, relying appropriately on Sayers (1986) and Clarke (1990).
2 In March 1923, the Bank even conceived of a remarkable initiative: to repay in gold a then due dollar loan amounting to 100 million pounds in the hope that this further increase in the already excessive gold holdings of the Federal Reserve would induce inflation in the United States (Sayers, 1986, pp. 127-129).
Clarke, Peter. The Keynesian Revolution in the Making 1924-1936. Oxford: Oxford University Press, 1990.
Clarke, Stephen V.O. Central Bank Cooperation 1924-31. New York: Federal Reserve Bank of New York, 1967.
Janeway, William H. The Economic Policy of the Second Labour Government 192931. Unpublished Ph.D. dissertation. Cambridge University, 1971.
Sayers, R.S. The Bank of England 1891-1944. Cambridge: Cambridge University Press, 1986.
Williamson, Philip. National Crisis and National Government: British Politics, the Economy and Empire, 1926-1932. Cambridge: Cambridge University Press, 1992