Reflections on the Monetary History of the West – 1700-1974

Written by Lewis E. Lehrman

Monday, January 03, 2011

World War I ended the preeminence of the classical European states system and the world monetary system, the true gold standard, to which it gave rise. No less significantly, on the eve of war, the rules of the international gold standard – proven guarantor of one hundred years of price stability – was suspended by the belligerents. The onset of war, the inevitable fear, and the prospect of inflationary war finance made untenable from the standpoint of the politicians the link between European currency and credit monies and to gold. From the standpoint of today, we know that all-out war destroys all the institutions of civilization, and money could be no exception. No monetary standard can survive total war. In order to stem a run by fear-stricken citizens on the limited gold supplies of the central banks, the governments of Europe ceased to honor the gold clauses which for a century had anchored the value of bank deposits and currency in circulation. Between 1914 and 1924 expansionary central bank credit policies of war-torn European nations destroyed or depreciated most national paper currencies. The Age of Inflation was upon us. While attending the Paris Peace Conference of 1919, before his later social-democratic phase, John Maynard Keynes argued that there was no surer means of “overturning the existing basis of society than to debauch the currency.” The process of inflation, he warned, unconscious of the future irony of his influence, “engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.” Keynes was a shrewd man, and in this single phrase he depicted the satanic force released by the destruction of the value of money. Keynes understood inflation. He knew its effects destroyed the future because he observed them first hand after the war. Shortly after World War I, he wrote that under the conditions of inflation “a country can, without knowing it, expend in current consumption those savings which it thinks it is investing for the future; … When the value of money is greatly fluctuating, the distinction between capital and income becomes confused. It is one of the evils of a depreciating currency that it enables a community to live on its capital unawares. The increasing money value of the community’s capital goods obscures temporarily a diminution in the real quantity of the [capital] stock… For these profound reasons Europe is in danger of a lasting degradation of her standards, unless bold and conservative wisdom can take control.”

But Keynes was more than a mere analyst of the defects of inflation. He knew something about its remedies, for he wrote after World War I as if for our own age:

“If gold standards could be introduced throughout Europe, we all agree that this would promote, as nothing else can, the revival not only of trade and production, but of international credit and the movement of capital to where it is needed most. One of the greatest elements of uncertainty would be lifted…and one of the most subtle temptations to improvident national finance would be removed; for it a national currency had once been stabilized on gold basis, it would be harder (because so much more openly disgraceful) for a Finance Minister so to act as to destroy this gold basis.”

So much for the man who, when he found it in England’s interest and his own, would later expediently and contemptuously dismiss the discipline of the gold standard as “a barbarous relic.” It is not fortuitous that the decline and fall of British capitalism is closely associated with the first British suspension of the gold standard (1914 amidst World War I), and the second British suspension (1931 and Depression).

The end of the international gold standard in 1914 lead, during the next decade, to the great paper and credit money inflations in France (1924-1926) Germany (1920-1923) and Russia (1916-1918) – among other European countries. The ensuing convulsions of the European social order, and the virtual obliteration of the savings of its middle classes led directly to the rise of Bolshevism in Russia and Nazism in Germany. Revolution, during and following the great War of 1914, was closely associated with the ruination of inconvertible European paper currencies. Given the disorders of war and inflation we have learned that to desire a peaceful and prosperous world trading system is to desire the means by which to achieve it. A world trading system needs leadership and a common currency, independent of national currencies. To avoid war requires military preparedness of the leader. To desire a global market is to desire a common currency painstakingly developed and therefore accepted after centuries of trial and error. To desire an end without desiring the correct means by which to attain it is foolish. I would go so far as to say that under current circumstances to desire peace and world economic order is to desire U.S. leadership and the international gold standard. As history suggests, to desire insolation and to deny the gold standard is, unknowingly, to desire currency depreciation, beggar-thy-neighbor policies, protectionism, tariff and trade wars, and ultimately, autarky and military conquest.

Today, three generations after the Great War of 1914, one observes – at home and abroad – the rapid disintegration and fluctuation of the value of all paper and credit monies. The scourge of inflation is again upon us; but today it is simplistically described as “too much money chasing too few goods.” In fact, inflation represents a decline in the value of the preeminent economic institution of civilization – money. Similarly, the astronomical rise of the price of gold – from $20 to $35 per ounce in 1934, from $35 per ounce in 1971 to $500 in March of 1981 is merely the other side of the same coin – the decline and fall of the dollar. This corrosive process of inflation got underway in 1913 with the founding of the Federal Reserve System. World War I intensified the breakdown of monetary institutions, a process which temporarily corrected itself between 1920 and 1922. After the international monetary conference of Genoa in 1922, inflation picked up momentum again in Europe. After the early phase of the Great Depression (1929-1932) the process of worldwide inflation got underway which carries on to this very day. The historic signal for the great American inflation occurred in 1933-1934 when Franklin D. Roosevelt abruptly terminated the domestic gold standard (1933), and collected by force of law and paid $20 for all gold coins owned by United States citizens. In 1934 he reduced the value of the monetary standard by reducing the weight of the gold dollar; or as it is incorrectly stated, by raising its price from $20 to $35 per ounce. The effect of this devaluation was, overnight, to collect for the government the higher value for the gold which had rightfully belonged to the owners of the gold currency who had been dispossessed by the authorities. In this sense, the depreciation of the law of contract in a free society went hand-in-hand with the depreciation of the currency.

It is important to remember that, under the gold standard, there is no such thing as “the dollar price for gold.” This phrase improperly construes the definition of the monetary standard. Under the gold standard, the dollar is defined by statute as a weight of gold. The dollar is so many fractions, or grams, of a troy ounce of gold. Confusion arises when one refers to the “price of gold” in 1932 being $20.67, or $35.00 in 1934 or 1970. There are 480 grams of gold in a troy ounce. Therefore, if the dollar by law is c. 24 grams of gold; then 480 divided by 24 grams (one dollar) = 20.67 dollars. That is, 20.67 gold dollars can be coined from the weight of one troy ounce, or 480 grams of gold metal. This essential point must be kept in mind later, when we consider the riddle of the dollar price of gold under a future international gold standard.