Throughout the 19th century, steadily more countries joined the international gold standard led by Britain and the Bank of England. During the First World War, this system was suspended virtually everywhere and currencies were allowed to float freely for the first time. The 20th century would see several changes in the global monetary order, in part because an effort to rebuild the international gold standard in the 1920s failed. Some would say it failed spectacularly. The project lasted anywhere from a few months to, at best, a bit more than a decade depending on the country.
Why did returning to this old system fail when attempted in the years between the first and second world wars? As we will see, the world monetary order was transformed so much in the early 20th century that the foundational basis for the gold standard no longer held. There was no leader to marshal the system, every government and central bank looked out primarily for its own objectives, and the amount of money in the world was allowed to outstrip gold stocks which, in the absence of the regular gold rushes of the 19th century, couldn’t keep up. This post is the first of two parts on the gold standard between the two world wars
First World War
In the early 20th century, adherence to the gold-standard was the most common means of managing the world’s monetary systems. Gold standards were adopted by the United States, Britain, and every country in Europe. Practically, this meant that paper money was convertible into gold and this gold could be transferred internationally and converted into other monies. This in turn meant that currency exchange rates were more-or-less fixed, except for small movements which were inevitable given that exchanging monies into gold and transferring that gold abroad was not without its costs. Despite its prevalence, this international gold standard came to an end with the First World War, which began in 1914.
Nearly all countries previously employing a gold standard suspended it during the war years. The reason was that war finance was incompatible with maintaining the parity between gold and other forms of money. Government borrowing, particularly borrowing from the central banks, required more money be created and this issuance was not matched with any corresponding increase in gold reserves. Printing money itself also funded the war spending in several countries. As a result, governments imposed limits on, or altogether ended, the redemption of banknotes for gold. They also restricted exchanges of currency and capital outflows; gold coins disappeared from circulation as well.
During the war years, European currencies depreciated against the U.S. dollar and exchange rates, previously fixed but now floating freely, became much more volatile. Some currencies, like that of Britain, Switzerland, and the Netherlands, depreciated about 20% against the dollar. Meanwhile, the currencies of Italy, Belgium, and France depreciated more like 60% to 80%. Some of this occurred during the war and some after war-time currency interventions ceased with the end of the fighting. As for the German mark, it was down 80% by the time of the Treaty of Versailles and would in due course lose all its remaining value in the country’s infamous hyperinflation of the early 1920s.
Britain’s Return to Gold
The chaotic experience in Germany did further support for the gold standard in that country. However, in addition to the usual argument based on price stability, there was a desire to return to the gold standard after the war on the grounds that it would promote trade and financial integration.
The United States, which never officially left the gold standard but which imposed restrictions on exporting gold, lifted those restrictions in 1919 and was, in 1920, the only major economy with an intact gold standard. To be sure, the United States had also seen wartime inflation; wholesale prices doubled between November 1914 and November 1918 and the money supply surged by 70%. However, the gold standard was not quite so imperiled in America as it was in Europe since the U.S. also saw large inflows of gold during the war. Extending this restoration of gold to Europe would be much more difficult.
Still, international conferences in Brussels and Genoa in 1920 and 1922 respectively, resulted in resolutions recommending a return to gold. Britain resolved to re-establish its gold standard in 1922. Deflation in Britain reversed much of the wartime increase in prices there and the increase that followed the removal of rationing measures. Indeed, prices had fallen 50% between February 1920 and December 1922. This strengthened the currency in the early 1920s. To rebuild its gold stock, the Bank of England kept interest rates high and Britain also continued to block gold exports. Helpfully, the Federal Reserve in the United States had cut its interest rates and allowed credit to expand in America, prompting gold to stop flowing there in any meaningful quantities.
Britain used the occasion of reaching its pre-war exchange rate against the dollar to restore its gold standard in April 1925. This came after substantial delays caused by currency fluctuations and geopolitical crises. Britain was also prompted to do this since it expected other countries to restore their gold standards and did not want to be beat to this objective, worrying that further delay in re-adopting gold would lead to outflows of the metal from London and reduced confidence in the country and the pound.
Because the pound had by this point come close to its pre-war level, Britain was able to affect a return to gold at the same exchange rate as existed before the war. This was not accomplished in the other major economies in Europe. Still, making this possible did require years of painful deflation and despite that, many believed the restored pre-war valuation against the U.S. dollar and gold to be too high to sustain.
Rest of the World
During the 1920s, the international gold standard was rebuilt country by country. Whereas about 10% of nations were on the gold standard in 1921 and this had only increased to around 20% by 1924, the portion reached 70% by 1928 and 90% by 1929. Like the British pound, the Swiss franc and Dutch guilder also returned to their pre-war exchange rates against the U.S. dollar. Other currencies stabilized too, if at lower levels. Many European countries restored the gold standard at these far lower valuations, reflecting the larger intervening depreciation they experienced.
Germany re-introduced the gold standard as part of reforms intended to end hyperinflation, as did Austria and Hungary in 1923 and 1924 respectively. In all three countries, the restored gold standard coincided with, or was followed up by, the introduction of altogether new currencies.
Italy returned to the gold standard in 1927, like Britain at a rate judged too high. The high exchange rate, or quota novanta, was something of a vanity project for Mussolini. France was delayed in returning to gold as inflation remained high through the mid-1920s. It finally restored its gold standard in 1928 but did so at a much lower exchange rate and just as capital was flowing briskly back into France after earlier capital flight. The country had also accumulated very large reserves in dollars and sterling. Thus, by pegging the franc at its low point perhaps on the eve of what would have been a recovery, many believed the new French exchange rate undervalued the franc, especially relative to overvalued sterling.
Smaller countries generally followed the monetary decisions of these larger countries, their principal trading partners. Switzerland and the Netherlands followed Britain and also returned their currencies to pre-war levels. Belgium followed France, re-linking its currency to gold at a reduced rate, a value just 14% of pre-war levels. Besides China, which had a silver standard, Spain was one of the only middle- to larger-sized economies to remain off the gold standard and even that was not so much intentional as because of internal disorders.
The number of countries on the gold standard peaked in 1931. Japan was one of the last larger economies to return to gold, doing so in 1930, just as this restored international gold standard was beginning to fall apart. In the meantime though, the gold standard seemed like a good thing. World trade increased and the world economy grew in the late 1920s. Financial integration also resumed as governments and firms lent and borrowed in foreign financial markets.
This new gold standard was similar to the old one insofar as it fixed exchange rates. However, the actually manner in which gold backed countries’ currencies differed significantly than pre-war systems. Rather than hold sufficient gold to back the currency issued, some central banks held a combination of gold and foreign currencies, the later typically invested in short-term instruments abroad. This approach, recommended at the 1922 monetary conference in Genoa, was a ‘gold exchange standard’ rather than a ‘pure gold standard’.
Foreign currency assets now became key parts of central bank portfolios. The portion of central bank reserves held in foreign exchange reserves, largely denominated in U.S. dollars or sterling, rose from 19% on the eve of the First World War to 42% in 1927. In dollar terms, the increase in central bank foreign currency reserves was a leap from $844 million in 1924, already more than a doubling from the usual pre-war levels, to $2.5 billion in 1928.
The precise mix between physical gold and foreign currency assets varied tremendously from country to country. Some operated on more-or-less a pure gold standard while others held primarily foreign currency assets. In Austria for example, a gold-standard country, the central bank held virtually no gold; 97% of its reserves were in foreign currency assets.
The goal of the new gold exchange standard was to stretch a limited supply of gold to the limits and prevent a run up in the price of gold as several nations simultaneously tried to build their gold reserves. Needless to say, actually coining circulating money in gold largely became a thing of the past. In the 19th century, the international gold standard was supported by large gold finds in America, Canada, Australia, and South Africa. However, the system now had to make due with only the gold it already had.
The recommendation of a gold exchange standard was a recognition that restoring the gold standard after the war would not be straightforward. That said, besides allowing less gold to support an enlarged global money supply, the new system had other practical advantages. Central banks could now earn interest income on their foreign reserves, something they could not do with gold coin or bullion.
Still, this system introduced some risks. On the one hand, while the world economy grew, demand for the currencies of core countries, like Britain and the United States, also grew. This should have encouraged them to expand their money supply to meet that demand. However, expanding the money supply without an increase in gold reserves would cast doubts on the durability of the gold standard.
On the other hand, when the world economy shrank, perhaps due to some crisis, countries would draw on their foreign currency holdings, pulling money out of Britain and America. By doing so, these countries would reduce credit availability in the rest of the world. As such, these withdrawals could imperil other countries’ commitments to their monetary systems.
This post is the first of two parts. The full lesson to be learned by the return to gold in the 1920s will reveal itself in the following post. That said, there were remarkable aspects to the first half of the story. One is how quickly the gold standard was restored. The restoration in any one country, from a domestic point of view, hardly seemed rapid. The return to gold had to be postponed in Britain and they were one of the very first to reestablish their gold standard.
However, within five years of Britain, virtually the entire world was using a gold standard once more. Given the promises offered by the gold standard, the disadvantages to staying outside it, from reduced trade to reduced access to the global markets, seemed to outweigh the challenges and risks. Thus, reestablishing the role of gold appeared the right move for each country or so it seemed until the entire system fell apart within a few years.
More from the Tontine Coffee-House
Read about Montagu Norman, who served as Governor of the Bank of England for the entirety of this short-lived restoration of the gold standard and indeed for the entire period from 1920 to 1944. Also, read about the daily ‘fixing’ of benchmark gold prices in London. Consider subscribing to this blog’s newsletter or checking out book recommendations, which include many of the sources often referenced in my posts.
1. Accominotti, Olivier, and Youssef Cassis. “Chapter 25 – International Monetary Regimes: The Interwar Gold Exchange Standard.” Handbook of the History of Money and Currency, edited by Stefano Battilossi and Kazuhiko Yago, Springer, Singapore, 2020, pp. 633–664.
2. Bernanke, Ben, and Harold James. “The Gold Standard, Deflation, and Financial Crisis in the Great Depression: An International Comparison.” Essays on the Great Depression, 2000.
3. Crabbe, Leland. “The International Gold Standard and U.S. Monetary Policy from World War I to the New Deal.” Federal Reserve Bulletin, June 1989, pp. 423–440.
4. Eichengreen, Barry, and Jeffrey Sachs. “Exchange Rates and Economic Recovery in the 1930s.” The Journal of Economic History, vol. 45, no. 4, Dec. 1985, pp. 925–946.
5. Wandschneider, Kirsten. “The Stability of the Interwar Gold Exchange Standard: Did Politics Matter?” The Journal of Economic History, vol. 68, no. 1, Mar. 2008, pp. 151–181.