P16. The Essential Function of Gold. A Reserve for International Settlements

[Financial Times, 5 October 1937, p. 6. © Financial Times]

5 October 1937

The gold situation presents a curious dilemma. On the one hand, many have become convinced of the dangers of the Gold Standard, with fixed parities of exchange, which the authorities are committed by considerations of honour and prestige to defend. On the other hand, there is a strong desire that the value and status of gold as an international medium of payments shall be maintained. The Treasuries and Central Banks of the world have accumulated holdings of unprecedented size which they do not wish to see depreciated. [2] And the ebb and flow of capital between nations at the smallest breath of political alarm make it especially desirable to have large reserves of a liquid and reliable character to finance these movements so that they do not play havoc with the foreign exchange rates.

Higher value

The suspension of the Gold Standard by Great Britain in 1931 and by other countries produced, paradoxically, no adverse repercussions on the position of gold. Its value mounted and confidence in its reliability increased. [3]

In recent times alarms have arisen about the possibility of an opposite movement. The United States, after a period of indecision, has been the one important country to maintain a firm link between her currency and gold since 1934. [4] In the last two years she has received unwelcome accretions. If this process continues, might not the strain on her become intolerable? If she severed the link, might not the market price fluctuate wildly? Might not a severe depreciation set in? And in that case might not the reliability of gold holdings as a reserve for settling the balance of international payments be disastrously undermined?

With these considerations in mind, there have been those prepared to argue that it would be desirable to secure agreement at the earliest opportunity for the restoration of the Gold Standard in the leading countries. The case for maintaining fair stability in the value of gold in terms of currencies and its reliability as a reserve asset need not be disputed. The crucial questions are, would a general return to the Gold Standard automatically secure this? Are there not alternative means of securing it? And would not the disadvantages of a Gold Standard outweigh the benefits claimed for it?

Effect on bank rate

It is not necessary here to elaborate the case against the Gold Standard. Even if economic science were competent to determine the true equilibrium rates for the stabilisation of currencies against each other at any particular point of time, which is not, we have no assurance, and indeed there is no probability that the "true" rates for 1937 would secure equilibrium in 1939. Furthermore the Gold Standard, even when operated in the most favourable conditions possible, necessarily entails manipulation of the Bank Rate and the market rate of discount. It is generally agreed that such manipulation, required as it may be quite extraneous events, such as the change of Government in another country, is not likely to be identical with that required by a wise monetary policy, adapted to suit their home needs.

What, then, is the case for the Gold Standard? It is desired to maintain the reliability of gold as a medium of international settlement. Is the Gold Standard is necessary for this? Despite the abandonment of Gold Standards, the position of gold improved after 1931. Why was this? Precisely because, although gold was no longer the standard in certain countries, it continued to be used as a medium of reserve. And the choice immediately before us to-day is not between the use and disuse of gold but between its continued use, if this is feasible, as a reserve to meet international settlements without the fixing parities. If only it continues to be generally used as a reserve, its future is assured.

Fixed parities

Present alarms arise from the idea that its continued employment as a reserve in the absence of fixed parities may not be feasible, because one country, in this case the United States, may find itself accumulating an excessive amount of gold. Advocates of the Gold Standard are apt to argue that, if only we had fixed parities, this eventually would be impossible; that the Gold Standard so works as in some way automatically to prevent a maladjustment of this kind.

Experience does not altogether confirm this contention. In the period from 1926 to 1931, when the Gold Standard was in general operation, France absorbed an amount of gold which was excessive in relation to her requirements and imposed a severe strain on other countries. [5] The French authorities claimed, and with a good show of reason, that under the normal working of the Gold Standard they were powerless to prevent this. Too much confidence should not be placed on pre-war experience, since the commanding position of London was a factor that greatly facilitated matters and will not recur in the same degree.

We need not content ourselves with these inconclusive lessons of history. It is possible to penetrate more deeply into the matter by the aid of some simple reasoning.

A flow of gold occurs if and when there is a discrepancy in the total international balance of indebtedness. The flow of gold makes good the discrepancy for the time. A persistent discrepancy may lead to maldistribution of gold. The Gold Standard system and the free system each has its own peculiar way of making good the discrepancy, if it threatens to be lasting. Authorities under the former work through the Bank Rate and open market operations, in an inflationary sense if there is an inflow and in a deflationary sense if there is an outflow. Under the latter the authorities operate upon the exchange rates, letting them rise if there is an inflow and fall if there is an inflow. Maldistribution may occur under either system if the authorities fail to use the appropriate weapon; under either system it is the only weapon they have, short of tariff manipulation, etc., which lie outside monetary policy. Neither system of itself tends towards maldistribution. The maldistribution depends on all the forces governing the balance of payments and on the attitude of acquiescence or activity on the part of the authorities. It may be that in certain circumstances a discrepancy is so persistent that no known method will avert it; in this case resort to a control of all foreign dealings may be unavoidable. There is no reason to suppose that the weapon available under a free system is less effective than that available under a gold standard

Regulated balances

The choice then is clear. Does the country prefer to have its balance regulated in the last resort by controlled and well-ordered movements in its foreign exchange rates or by doses of inflation or deflation having no relation to its internal needs? It can make its choice freely without any arrière-pensée with regard to its effect on the value and status of gold.

One further point must be mentioned. Under the free system, a country (for example, the United States) experiencing an unwanted inflow may find that the most convenient way in which it can make its currency appreciate in terms of others is to mark down the price of gold. This technical method has its dangers. Other countries might later follow suit. Now, whereas the competitive depreciation of currencies in terms of gold does nothing to impair the prestige of gold, competitive appreciation might. Private individuals, banks and treasuries might begin to lose confidence in gold as a reserve asset, and this is what we wish to guard against.

Co-operation needed

The remedy is simple. Only a little international co-operation is needed. The country experiencing embarrassment can achieve the same results, if it can prevail upon the other leading countries to let their currencies run down in terms of its own. This does nothing to impair the prestige of gold. This is the kind of adjustment which occurred a year ago in the case of the French franc. It is a most welcome sign that the further fall in the franc has not been taken to invalidate the Tripartite Agreement.

  1. 1. There is no reason in logic why we should not have the best of both worlds, the advantages of the free system and the maintenance of the status of gold as an international medium. But there is danger that confused thinking may give us the worst of both. A precipitate return to gold standards might lead before long to the discrediting not only of the Gold Standard, on the occasion of the next breakdown, but of gold itself. On 6 October 1937, Harrod wrote to Wilhelmine Cresswell: "Though I did not know it, I find there was a large article by me in yesterday's Financial Times, not on the usual subjects. But it is boring enough." (in HPBL 72777/10).

    2. In its Banking Supplement of 16 October 1936, The Economist summarized as follows the state of the London gold market: "The demand for hoarding has been a very prominent feature in the market since 1934 when the United States startled the financial world by deliberately devaluating its currency. Nationals of the other gold standard countries naturally became apprehensive of the effect of this on their own currencies, and began to buy sterling which they invested in gold. During the state of monetary strain which culminated in the break-up of the gold bloc a year ago, this buying became so insistent that the price was often forced to a substantial premium over any possible arbitrage parity levels. Following the devaluation in September last year by France, Switzerland and Holland, the hoarding ceased and some selling of the immense stocks held in London took place. This liquidation was considerably hastened by the remarkable panic which developed earlier this year owing to the world-wide fear of a possible reduction by the United States of its gold buying price, and for several weeks during the summer gold was quoted in London at a discount below the dollar parity price. Recently, however, owing mainly to the still unstable state of French finances, the demand for hoarding purposes has revived and again has established a premium in the price over the dollar parity" ("The London Gold Market", p. 7).

    3. The price of fine gold steadily increased between 1931 and 1935 from 92.5 to 142.1 shillings per ounce (monthly averages), fell to 138 in September 1936 and stabilized at about 140 shillings per ounce in 1936-37 (The Economist, Trade Supplement, 30 October 1937).

    4. The United States remained on the gold standard for several months after Britain abandoned it in September 1931. The movement towards a reduction of the gold value of the dollar began in March 1933, when the international convertibility was suspended; on 18 April, President Roosevelt decided to halt support operations and the dollar exchange rate was left free to fluctuate; by December the domestic convertibility of gold was also virtually ended. In this period the dollar was sharply devaluated (the price of gold increased from $20.67 per ounce early in 1933 to $29.80 on October 28 and $34.45 in mid-January 1934). On 31 January 1934 the price was officially fixed at $35 per ounce, although the President retained the right to change the price between $34.45 an $41.34 an ounce. See for instance L. V. Chandler, American Monetary Policy 1928-1941 (New York: Harper & Row, 1971), pp. 274-77 and 289-91, and S. V. O. Clarke, The Reconstruction of the International Monetary System: The Attempts of 1922 and 1933 (Princeton: Department of Economics, International Finance Sections, 1973), chapter III.

    5. France began to accumulate gold reserves in 1928, as the franc was very low in gold content. In June 1928 French gold holdings amounted to 28 billion of francs, while in June 1932 they had raised to 82 billion (see for instance E. O. G. Shann, "The World Economic Conference", Economic Record, December 1933, p. 167).

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