What was the link between the gold standard and the collapse of world trade in the 1930s? John Phelan

1 - Background – The pre-war gold standard Key features Convertibility between paper and gold at fixed rate Free export and import of gold Internal and external convertibility

First World War Convertibility suspended Import and export prohibited Combatants issue currency and debt to fund war efforts

Effects of the First World War Gold flowed into US which held 1/3 of world monetary gold at end of the war Other combatants faced with a problem; with an increased amount of money circulating relative to a country’s gold stock the parity prices of gold were far below the market prices. This would lead to massive outflows of gold once convertibility was re-established Price levels disturbed

2 – The scramble for reserves Three paths out of post war monetary dilemma 1 Internal devaluation - shrink the amount of currency relative to gold (Britain, 1925) 2 External devaluation - accept the wartime inflation and set the new parity price at the market price (France, 1926)

The scramble for reserves cont. 3 Increase reserves. Can’t increase gold but by adding gold backed securities (sterling, dollar) to reserves the shortage of reserves vis-à-vis liabilities could be ameliorated The gold exchange standard (Genoa, 1922) “By late 1920s the share of foreign exchange in international reserves was at least 50% above pre war levels” (Eichengreen 1992)

3 - Problems with the gold exchange standard Exogenous Price-specie flow mechanism adjusts misaligned prices/exchange rates via exports/imports of goods and capital Both were constricted in the interwar period Capital did not move to offset trade movements but frequently amplified them – Some countries (U.S.) exported/lent goods and capital, others (Germany) imported/borrowed Trade was impeded - Safeguarding of Industries Act, U.K Fordney-McCumber Act, U.S. 1922

3 - Problems with the gold exchange standard – cont. Endogenous Gold backed assets had to be (or thought to be) ‘good as gold’. As UK balance of payments worsened from 1928 this became increasingly doubtful Countries with sterling securities (notably France) sought to swap them for gold, draining UK of reserves

UK balance of payments,

4 - The Collapse of world trade Countries used monetary and fiscal policies to protect their reserves Fiscal – Even higher tariffs Monetary – Higher interest rates

4 - The Collapse of world trade cont. Eventually countries choose internal balance over external balance and devalue – ‘Beggar thy neighbour’ (?) Countries which devalue resort less to protectionism (Eichengreen & Irwin 2009)

Was the gold standard to blame? No, the gold exchange standard was – inherent flaws Political unwillingness/inability to let gold standard mechanism work to rebalance financial system