The Gold Standard and the crisis. (1931)

From the November 1931 issue of the Socialist Standard

Each of the periodic economic crises brings its own particular explanation. Publicists, orthodox economists, and politicians of every shade of opinion, are agreed that on this occasion the nigger in the wood-pile is the “gold standard,” or rather the failure of France and the U.K.A. to operate that standard “according to the rules of the game.” But despite their unanimity our scepticism is reasonable when it is recalled that there have been 16 crises during the past 150 years, and that a different explanation has been forthcoming each time. All of those crises, including the present one, have exhibited, in greater or less degree, the same features, viz., an accumulation of stocks of all commodities, a decline in production owing to the inability to sell the products of agriculture and industry at a profit, bankruptcies and banking difficulties as a consequence of the general fall of prices, falling money wages, growing unemployment, and for the mass of the population want in a time of superabundance.

This general similarity between one crisis and another points to there being a general explanation for all of them. Instead of which the explanations are always changing. This time we are told that the trouble has been caused by the attempt to operate the gold standard in a world split up by tariff walls and burdened by war debts. Can this explanation be accepted? To answer the question it is necessary to consider what the gold standard is and what its history has been.

First of ail it must be noticed that while the gold standard implies a monetary systen based on gold, it does not require that gold coins shall actually circulate. For all practical purposes there is no difference between a country whose monetary unit consists of a gold coin which circulates and is used as money in ordinary commercial transactions, and a country in which there is a paper currency convertible into gold. Both are on the gold standard. Before the war this country had, as its monetary unit, the sovereign, which passed freely from hand to hand in every-day transactions. Between 1925 and September of this year monetary settlements were effected in paper pounds which (above a minimum value of £1,700) were exchangeable into gold at a fixed rate. At both periods Great Britain was on the gold standard. What is necessary for a country to be on the gold standard is, then, not that there should actually be gold coins circulating, but that the unit of currency must, if it is a paper unit, be exchangeable on demand at some central institution, whether a bank, mint, or Government department, without charge to the holder, for a known and fixed amount of gold. Conversely any holder of gold must have the right to exchange it for currency, either coin or paper, at the same rate. Finally free importation and exportation of gold must be permitted so that a holder of currency who has to settle a debt abroad may do so by exporting gold obtained at the central institution in exchange for his currency at the fixed rate; while anyone having funds abroad must be able to convert them into the currency of his own country by importing gold and exchanging it for the currency of his own country at the central institution. In order to avoid complicating the question later it should be pointed our that free importation and exportation of gold is not necessary for this purpose provided that the central institution is compelled by law to buy and sell gold-backed foreign exchange, i.e., the currencies of other gold standard countries, at fixed rates corresponding to the amount of gold in the monetary units of the respective gold standard countries.

Given that these conditions are observed the country is on the gold standard, the significance of which is twofold. The first is that the value of the currency is the same as, and is dependent on, the value of gold. In other words, the amount of commodities that can be bought with £1 will be determined by the amount of commodities that will exchange for 113 grains weight of gold, that being the amount of gold for which £1 can by law be exchanged. Movements in the value of gold will be accompanied by corresponding changes in the purchasing power of the currency unit. As the value of currency reflects itself in the form of prices this is the same as saying that, under the gold standard, if the value of gold falls, prices will rise, and the amount of commodities which can be purchased with a £1 will diminish. Conversely if the value of gold rises, prices will fall. The second significant feature about the gold standard is that the general level of prices in two gold standard countries must be in equilibrium. This follows from the fact that, as has been pointed out, gold moves freely between the two countries. The price levels will not be exactly the same in the two countries for reasons which, however, are of no importance from the point of view of the present article and can therefore be ignored. The two price levels will tend to move up or down together, in accordance with changes in the value of gold.

So much for the value of a currency in terms of commodities, i.e., its internal value. Now let us consider the value of one currency in terms of another, usually referred to as its external value. Under the gold standard the value of one currency in terms of another, expressed in what is known as the foreign exchange rate, is fixed within narrow limits. For example, when this country was on the gold standard £1 was exchangeable by law for 113 grains of gold, and the American dollar was exchangeable by law for 23.22 grains. If 113 is divided by 23.22 the result is approximately 4.86. So that, apart from certain small variations that can be ignored here, the value of £1 was automatically fixed at 4.86 dollars. The exchange rate with francs, marks, etc., was similarly fixed.

To sum up the argument to this point we see the following consequences of an international gold standard :—

1. The value of the currencies of all gold standard countries is determined by, and fluctuates with, the value of gold.

2. Prices in all gold standard countries tend to move up or down together.

3. Exchange rates between gold standard countries remain stable.

After this brief survey of the principles of the gold standard now let us turn to its history.

As soon as division of labour resulted in individuals and social groups ceasing themselves to produce all the articles they consumed, a system for exchanging the products of various forms of human activity became necessary. In the first place recourse was had to simple barter. Cattle, for example, would be exchanged direct for corn or some other article. In the course of time direct barter became too cumbersome and a “universal equivalent” was evolved for the purpose of effecting exchanges. For a variety of reasons the universal equivalent that ultimately came to be generally adopted was a given weight of metal. In Western Europe this metal was silver. It soon came to be realised that it was more convenient to have coins of a known weight of metal instead of having to measure out quantities of the metal for each transaction. Gold coins were introduced in the 15th century, and finally this country led the world in making gold the basis of its currency, relegating silver coins to the position of “token” money, their value being fixed by law as a proportion of that of the gold coin. During the second half of the 19th century most of the leading countries of the world also abandoned the silver standard, and reorganised their currencies on a gold basis. When the war broke out in 1914 all the leading commercial countries were on the gold standard, and their currencies were gold coins winch actually circulated. At the same time there were in circulation bank notes which were redeemable into gold coin or bullion. The war saw the collapse of the old gold standard and the replacement of gold coins, as circulating media, by paper money. After the war, when the gold standard came to be restored, certain countries, including Great Britain, did not restore gold coins to circulation. Instead they retained their paper currencies, but made them convertible into gold, and permitted the export of gold. The notes, therefore, had the character of gold.

Another significant difference between the post-war and pre-war systems was that after the war certain countries did not revert to the simple gold standard, but to a developed standard known as the “gold exchange standard.” Under the pre-war system it had been the rule for each country to keep its own separate gold reserve for cashing notes. Under the gold exchange standard a country—Austria is an actual example— keeps part of its reserves not in the form of actual gold in the vaults of its own Central Bank, but in the form of balances with the Central Banks in other gold standard countries. As these balances could always be withdrawn in gold and taken back to the country of origin, it was thought that they were “as good as gold”; as indeed they were, so long as conditions remained normal. But the system had one important consequence. Gold deposited, say, by the Austrian National Bank with the Bank of England, was not only the basis of currency issued in Austria, but also provided the Bank of England with funds which it proceeded to utilise in this country. Under the pre-war system the withdrawal of gold from the Austrian National Bank would only have affected, directly, that bank. But under the new system the Bank of England would aiso be affected. In other words, under the “gold exchange system” events affecting the credit situation in one country would be likely to have immediate consequences in other countries, because the credit structure of more than one country had come to be based on the one lot of gold.

There remains another aspect of the post-war situation to be examined. The gold standard was never intended, as is so frequently alleged, to provide for the liquidation of an adverse balance of payments between two countries by the shipment of gold. Under the gold standard the function of gold shipments is to produce conditions in which an adverse balance of payments is eliminated. To reduce the matter to its simplest terms, the position can be explained as follows :—If people in country A are buying more goods and services from country B than B is buying from A, it must be because commodities are cheaper in B than in A. As the currencies of both countries are based on gold this is equivalent to saying that the purchasing power of gold is lower in A than in B. Consequently, gold will be sent from A to B. The gold for shipment will be obtained by changing notes into gold in A, and sending it to B. When it reaches B this gold will be converted into the currency of that country. The result will be to cause monetary stringency and a probable rise in the bank-rate in A, thereby lowering prices there. While in B the monetary situation will be eased and prices will rise. This will tend to discourage people in A from buying goods in B, and will encourage people in B to buy goods in A. This will continue to the point where A’s exports are increased and its imports diminished, sufficiently to eliminate the former adverse balance. From the foregoing it will be seen that under the gold standard the function of gold shipments is to cause adjustment of prices in the countries between which gold shipments take place, such that their international payments and receipts shall balance by the exchange of goods and services.

Owing to conditions arising out of the war gold shipments in recent years have been resorted to for the purpose of adjusting unfavourable balances of payments. What these conditions were can only be referred to here very briefly. Among the more important are the post-war system of tariffs, particularly in America, which prevented debtor countries from liquidating their indebtedness in goods, and compelled them to pay in gold; the flow of international payments in one direction, principally to U.S.A. and France, owing to Reparations, etc. ; and finally deliberate action by Central Banks to neutralise the effects that gold shipments would otherwise have had on the credit structure and the price levels. So that the adjustment of adverse trade balances by means of goods and services, in the manner discussed earlier, was impeded. In Great Britain, for example, the Bank of England consistently counterbalanced withdrawals of gold by what is known as its “open market” policy. In other words, when gold was withdrawn, and credit as a consequence became scarce, the Bank of England restored the position by buying securities, so that the funds that the money market lost as a result of the gold shipments were restored to it by the payments made by the Bank of England for the securities it bought. One of the main reasons why the Bank of England did this was probably that it was seeking to keep interest rates as low as possible in order that the Treasury should not have to pay more interest on its large floating debt. Whatever the reason may have been, the important fact is that Central Bank action frequently operated to make gold shipments of no avail, so far as concerns the adjustment of international balance of payments, by means of alterations in the relative amount of commodity imports and exports. This means that the gold standard in recent years was called upon to achieve purposes it was never designed to fulfil and which it was incapable of achieving; gold was used to liquidate adverse balances instead of operating to promote conditions in which adverse balances would disappear. Finally the inevitable happened. The gold standard broke down.

What will happen in the future to the gold standard need not be discussed here. For us the problem is, “Was the crisis caused by the failure of the gold standard ? Can it be overcome and economic welfare assured to all by a re-establishment of the gold standard, as we have known it or in some revised form, or by its supersession by some other currency system?” The answer to both questions is an emphatic “No.” The reasons for this answer must be reserved for a later article. Here it will suffice to point out that the recent acute world depression started, and has been most pronounced, in U.S.A. If gold is the cause of all the trouble this is rather strange seeing that U.S.A. was crammed with gold. Secondly, it is hard to see how the world in general,, and the working-class in particular, would have benefited if, before the crisis, there had been another £100 million, or even £1,000 million, of gold available in the world. What could have been done with it that would have overcome the fact that world stocks of all kinds, and especially of raw materials, were so high tthat they could not be disposed of at prices which would yield a profit ? The plain truth is that capitalism had again run up against its permanent and insoluble problem of being unable to distribute all the goods produced, because capitalist production is for sale at a profit and not for use. Therein is the cause of this, as of every other economic crisis of the past 150 years.

B. S.