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Banking, Currency, and Finance in Europe Between the Wars$

Charles H. Feinstein

Print publication date: 1995

Print ISBN-13: 9780198288039

Published to Oxford Scholarship Online: November 2003

DOI: 10.1093/0198288034.001.0001

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International Economic Organization: Banking, Finance, and Trade in Europe Between the Wars

International Economic Organization: Banking, Finance, and Trade in Europe Between the Wars

(p.9) 1 International Economic Organization: Banking, Finance, and Trade in Europe Between the Wars
Banking, Currency, and Finance in Europe Between the Wars

Charles H. Feinstein (Contributor Webpage)

Peter Temin (Contributor Webpage)

Gianni Toniolo

Oxford University Press

Abstract and Keywords

Provides an overview of inter‐war international economic relations, with particular emphasis on the causes of the Great Depression of 1929–33. Four explanations for the failure of inter‐war policy and performance are identified and discussed. These are (1) the problems of structural imbalance arising from the disruptive effects of the First World War, and from post‐war changes in technology and in patterns of demand; (2) the inability of the UK and the unwillingness of the US to provide the central bank leadership necessary for the successful operation of the restored gold standard; (3) the grip on policy‐makers of outmoded political and financial ideologies, evident in the insistence on substantial payments of reparations and in the attachment to the gold standard; and (4) the absence of international cooperation between the major powers and their reluctance to abide by the ‘rules of the game’ under the gold standard.

Keywords:   central banks, demand, First World War, gold standard, Great Depression, international economic relations, policy‐making, reparations, structural imbalance, technology

1. Introduction

Chaos, crisis, and catastrophe are terms which feature prominently in the economic history of inter‐war Europe, applied to the functioning at various stages of prices and money supplies, foreign exchange rates, gold and capital movements, banking systems, and external trade. Early in the period there were several spectacular episodes of hyperinflation in central and eastern Europe, and many other countries suffered severe though less drastic inflation and corresponding depreciation of the external value of their currencies. There was a short‐lived post‐war boom followed by a slump, and a number of countries experienced serious banking crises in 1920–1. These inflationary and financial problems were a direct consequence of the First World War. So too was the colossal burden of inter‐Allied debts, and the attempt of the Allies, particularly France, to extract huge sums in reparations from Germany. The struggle to cope with these enormous obligations was one of the critical factors in the financial instability of the 1920s. A further aspect of great significance was the widespread belief in financial and political circles that it was essential to return to the pre‐war gold standard if the growth and prosperity of the pre‐1914 era were to be re‐established, whatever the sacrifices that would have to be made in order to force down wages and prices so that the pre‐war value of the currency could be restored. The attempt to achieve this reconstruction of the gold standard dominated the financial policies of Britain, France, Germany, Italy, Belgium, the Scandinavian countries, Czechoslovakia, and many other Central and Eastern European nations.

An apparent measure of progress was achieved by the mid‐1920s, and confidence and production revived. Improved economic understanding among the major powers was reflected in the acceptance in 1924 of the Dawes Plan for the future payment of reparations, and a new measure of political agreement was achieved with the ending of the French occupation of the Ruhr and the signing of the Locarno Pact. There was a brief interlude of relative stability and economic growth, but this could not be sustained. (p.10) In the mid‐1920s agricultural producers were hit by falling prices, especially for wheat and sugar, and signs of impending recession were evident in Germany from 1928. The following year saw the beginning of a series of damaging banking panics and failures in Europe, culminating in 1931 in the collapse of the largest Austrian bank, and serious bank crises in Germany and the USA. This financial crisis merged with steeply falling commodity prices, and the collapse in output and employment in both industrial and primary producing countries to create the ‘Great Depression’, a world‐wide cyclical decline of unprecedented intensity and duration. In September 1931 Britain was no longer able to meet her obligations to supply gold to her international creditors, and abandoned the gold standard. Numerous other countries followed her example and the international economic system established at such high cost in the 1920s was completely shattered at the beginning of the 1930s.

With the disintegration of the gold standard and the breakdown of international monetary co‐operation, the world economy fragmented into hostile blocs, with mounting economic and political competition between the sterling area, the gold bloc, and the group of countries dominated by Nazi Germany. The period was marked by successive currency devaluations, the introduction of exchange controls, and the imposition of a wide variety of barriers to trade, all taking the major countries further away from the orthodox ideals of laissez‐faire, free trade, and stable currencies. Britain and the Scandinavian countries, freed by devaluation from the need to protect their currencies, were able to initiate expansionary monetary policies and enjoyed five or six years of improving trade, rapid growth, and rising prosperity.

For other nations it was a time of considerable difficulty and slow recovery. This was true for the USA, even after the suspension of gold payments in 1933 and the devaluation of the dollar in early 1934. It applied, to an even greater extent, to those gold bloc countries who were determined to maintain their commitment to gold. As their competitive position deteriorated the attempt to cling to their pre‐1931 gold parities became increasingly untenable, and they were finally compelled to devalue. Belgium capitulated to the speculative pressures in 1935, France late in 1936, swiftly followed by Switzerland and the Netherlands. The collapse of the French franc and a growing sense of the need for political solidarity on the part of the democracies, pushed a reluctant France, Britain, and the USA to take some limited and tentative steps back towards a more co‐operative international framework. This was given formal expression in the Tripartite Agreement under which the three countries undertook to relax quotas and exchange controls and to avoid competitive devaluations. Germany and Italy stood outside this framework, with Hitler and Mussolini forcing their economies progressively further in the direction of state control, militarism, (p.11) and autarky, dragging with them many of the countries of central and south‐east Europe in a web of exchange controls, tariffs, and special bilateral trading arrangements.

The aim of this paper is to provide a brief description of these much‐discussed events, and to analyse the primary causes of the successive financial and economic developments and of their interrelationship.1 The Great Depression of 1929–33 and the financial crisis of 1931 are placed at the centre of the narrative, and are presented both as the culmination of the policies and practices of the 1920s, and as a powerful influence on the subsequent economic history of the 1930s. The unifying theme of the chapter is the impact of various forms and aspects of international economic organization on world economic stability. Four key propositions or hypotheses relating to the organization of international economic relations have been advanced by various writers to account for the failures of policy and performance in the years 1919–39. These recur throughout our account of this period, though with differing emphases in different phases, and we begin by briefly summarizing each of the propositions. We then revert to them and discuss their validity and applicability at appropriate points in the subsequent narrative.

Four Propositions About International Economic Organization

For the early 1920s the traditional explanation for the depth and persistence of the widespread post‐war difficulties is the problem of structural imbalance between countries. The origins of this dislocation are found in the changes in the composition of production and demand resulting from the wartime disruption of international trade, from the geopolitical effects of the Peace Treaty, and from post‐war changes in technology and in patterns of demand. Although the effects of these changes are not always clearly spelled out, they may be taken to relate particularly to a misallocation of resources which was responsible for the high rate of unemployment in Europe in the 1920s, and which also made the adjustment process longer and more costly. The effects of these structural changes were felt in both labour and in product markets, in each of which, it is argued, there was appreciably less flexibility after 1918.

(p.12) The next explanation which has received prominence in relation to the late 1920s, notably in Brown (1940) and Kindleberger (1973), is the lack of central bank leadership in the operation of the restored gold standard: the proposition summed up in the phrase: ‘no longer London, not yet Washington’. The diminished financial status of the United Kingdom meant that London was unable to act as sole conductor of the international orchestra; or—in more modern terminology—to operate as the hegemon, while the USA was not yet willing to take over this role despite the enormous improvement in its international economic standing. The ability of London to perform its traditional role as the dominant economic power was further undermined by the enhanced strength of France's relative financial position after the stabilization of the franc in 1926 and the large accumulation of gold by the Banque de France. The specific economic connotation of this lack of leadership was that there was no country able and willing to stabilize the global financial environment by acting as international lender‐of‐last‐resort.

The third factor emphasized in the literature is the hold on policy‐makers of old‐fashioned political and financial ideologies. The former is seen as responsible for the insistence on substantial reparations. This produced a new pattern of international settlements that made the smooth functioning of international payments dependent upon the capability and willingness of the USA to continue lending indefinitely to Europe. The destabilizing potential of this ‘arrangement’ is self‐evident. Even more important was the financial ideology reflected in the priority attached to the reintroduction of the gold standard, even where this could be achieved only by subjecting the economy to a severe programme of deflation and obstructing future trade by the imposition of an overvalued currency. Under the discipline which this doctrine enjoined—or the values it projected—country after country surrendered its ‘monetary sovereignty’ and restricted its ability to accommodate balance of payments disturbances by any means other than retrenchment.

Finally, the absence of international co‐operation between the USA, Britain, France, and Germany, and the failure of the major nations to co‐ordinate international economic policy, has been put forward as the primary explanation for the problems of the inter‐war period. Clarke (1967) has argued this specifically in relation to the period from mid‐1928 to the collapse of the gold standard in 1931, claiming that after the death of Benjamin Strong, governor of the Federal Reserve Bank of New York, the central bankers failed to achieve the necessary co‐ordination of policy. More generally, Eichengreen (1985, 1992) has suggested this as a central feature of the entire period, manifest particularly in the attempt of each of the main powers to secure for itself a disproportionate share of the world's limited stocks of monetary gold. Prior to the collapse of the gold standard in 1931 (p.13) their non‐co‐operative behaviour involved the imposition of tight monetary policies not only by countries in deficit, but also by those—notably the USA and France—which were in surplus. This added to the deflationary pressures on the world economy and also increased the vulnerability of the weak currencies, such as sterling and the mark, to speculative attack.

In other variants of this theme, the shortcomings of the inter‐war adjustment mechanism are explained by the unwillingness of central banks to operate the gold standard according to the ‘rules of the game’, under which all movements in gold should have been fully reflected in compensating changes in domestic money supplies. The main reason for this tendency to neutralize changes in gold and foreign exchange reserves rather than allow them to influence internal monetary conditions, was that post‐war governments were no longer willing to give unconditional support to external equilibrium and the defence of the reserves; democratic electorates increasingly required that they should attach greater weight to internal stability of prices and incomes. ‘When the precepts of the gold standard ran counter to the requirements of domestic monetary stability, it was the latter that usually prevailed’ (Nurkse, 1944: 105; see also Nevin, 1955). But the new position was not entirely symmetrical: there was always greater pressure to neutralize an outflow of gold than an inflow, and this imparted a deflationary bias to the whole system.

The inability of the powers to co‐operate was dramatically symbolized at the World Monetary Conference in the summer of 1933, meeting in London shortly after the USA had abandoned the gold standard and allowed the dollar to depreciate. The gathering had been specifically convened to promote the co‐ordinated stabilization of exchange rates, but in the middle of the proceedings Roosevelt announced that he was not willing to stabilize the dollar. He brusquely dismissed ‘the specious fallacy of achieving a temporary and probably an artificial stability in foreign exchanges on the part of a few large countries only’ (Hodson, 1938: 194). This disastrous meeting starkly exposed the total lack of any common ground between countries and hastened the further disintegration of the international monetary system. With global political relations also deteriorating rapidly the decade witnessed an epidemic of competitive currency depreciations, extended resort to exchange controls, the rise of protectionism, bilateralism, import quotas, and other barriers to trade, and the development of hostile, non‐co‐operating trade and currency blocs.

Elements of these four problems of international economic organization can be found throughout the inter‐war period, but the first has dominated explanations of the early 1920s; the lack of central bank leadership has been particularly invoked to account for the developments of 1925–30; the role of financial ideology and the acceptance of the gold standard is seen as specially important in accounting for the Great Depression and the (p.14) propagation of the financial crises of 1930–5; and the inability of the major nations to co‐operate in the co‐ordination of international economic policy is given as a crucial factor, underlying both the disintegration of the attempt to reconstruct the pre‐1914 gold standard and the emergence of rival trade and currency blocs.

The Legacy of the First World War

It is impossible to understand the economic history of inter‐war Europe and, more specifically, that of its international economic organization, without considering the long‐lasting effects of a war which was first bitterly fought on the battlefield and then continued, more subtly, in post‐war political and economic policies.

The First World War marked the true watershed between the nineteenth and twentieth centuries. This is especially true when we consider our central theme of international economic organization. In the nineteenth century this was characterized by a relatively well‐functioning international payment system based on the gold standard, in which London played a pivotal and stabilizing role, and the leading central banks co‐operated as necessary (Brown, 1940; Nevin, 1955; Bloomfield, 1959; Eichengreen, 1985). In addition, there was almost perfect mobility of factors of production reflected in large‐scale movements of labour and capital from Europe to the New World, and relatively free movement of goods, due partly to free trade in Britain and moderate tariff protection elsewhere, and partly to the existence of large ‘customs unions’ such as the Habsburg and Tsarist empires within which goods moved freely. The First World War brought down all three of these pillars of the nineteenth‐century international economic order.

The most enduring legacy of the war was instability. We have not the space to concern ourselves here with social and political instability (seen in its most extreme form in the forces which produced Mussolini in Italy, Primo de Rivera and civil war in Spain, and Hitler in Germany) though this played a major role in generating an unstable international economic environment, but confine our attention to those consequences of the First World War which adversely affected the post‐war organization and activity of the Continental economies, individually and collectively. Five such effects deserve special mention.

1. The war caused a major disruption of the real economy, both on the demand and on the supply sides. In every belligerent country there was a swift change in production and consumption patterns under the pressure to recruit men and women for the armed forces and provide military supplies for the war economy. Heroic efforts were made to increase productive capacity in war‐related industries such as engineering, iron and steel, and shipbuilding. Much of this became superfluous once the war was over, but (p.15) it proved exceptionally difficult to adjust to the required patterns of peacetime production. In part this was the consequence of the terrible devastation of transport networks and of fields, houses, factories, and mines during the fighting. The destruction was worst in France, Belgium, Italy, and Poland, but many other countries also endured considerable loss of fixed assets. In other cases the return to pre‐war patterns was impossible because extra‐European powers, notably the USA and Japan, had seized the opportunity created by the inability of British and other European manufacturers to maintain their normal trading activity, and had successfully invaded their markets. Japan, in particular, rapidly increased her sales to many Asian countries which had previously looked mainly to Britain for their imports. The war also stimulated domestic production, for example, of coal in Europe or of cotton textiles and other manufactures in India and Latin America, and so further reduced the markets on which the pre‐war output of the exporting nations had depended.

2. Further disturbance to trade and production occurred as a result of the way in which the political map of Europe was redrawn by the post‐war peace treaties. In many cases pre‐1914 trading patterns, communications, and financial relations were disrupted, and the creation of smaller nation states in the territories of the former Russian and Austro‐Hungarian Empires led to the creation of new currencies, additional trade barriers, and a less efficient allocation of resources. More generally, the imposition of tariffs (whether as a source of urgently needed revenue or as a means of protection), the loss of gold and exchange reserves, and the diminished possibilities for foreign borrowing by countries already overburdened by debts and/or claims for reparations, all helped further to restrict the scope for foreign trade.

3. Once the war was over, the greatest possible degree of flexibility in prices and practices was required in order to adjust to these devastating domestic and external shocks, but in fact the prevailing trend was towards greater rigidity. A long‐run tendency for the flexibility of price and wage structures to decrease is likely to be a feature of all advanced democratic economies which give high priority to the stability of nominal incomes, prices, and employment, but the war considerably hastened the process. In the post‐war labour market, wage flexibility was diminished as many more decisions were centrally negotiated in a greatly extended process of collective bargaining. Behind this change lay the growth of working‐class militancy and the dramatic rise in the membership and strength of the trade union movement. In part this reflected the new mood of solidarity generated by the experience of the long and bloody battles fought side by side in the trenches. Other reasons, also related directly or indirectly to the war, were disappointment with the failure of the politicians to keep the promises which they had made when sacrifices were needed both from those who fought at (p.16) the front and those who worked at home to supply them with arms and equipment; the high levels to which unemployment soared abruptly from the middle of 1920; and the success of the Bolshevik Revolution.

In the goods market there was again a tendency to reduced flexibility of property incomes and of prices. The war contributed to this by an increase in government intervention in economic life, the formation or strengthening of trade associations, and the imposition of numerous controls; each of these features survived in varying degrees into the post‐war period. More fundamentally, the war accelerated the trend towards larger business units, and in the extremely difficult circumstances of the 1920s many firms looked to collusion, to cartels, and to the exercise of monopoly powers to escape the consequences of increasing competition for shrinking markets. In Germany cartels and other forms of industrial combination were already well established before the war, and the increase in their scope and strength during the 1920s enabled them to resist falling prices by restricting production. In Britain a similar trend was strongly fostered by the government, which deliberately promoted legislation and other measures to reduce competition in industries such as cotton, shipbuilding, and coal‐mining.

4. The financial sector was also greatly affected, with extensive interference in the peacetime patterns of both domestic and international markets. Most obviously, the war and its aftermath gave rise to unprecedented needs for revenue: it is estimated that the direct cost of the war in constant pre‐war prices was the equivalent of five times the world‐wide national debt in 1914 (Woytinski, 1955 quoted in Aldcroft, 1977: 30). In all countries note issues and bank credits were expanded by immense amounts, with little or no attempt either to raise taxes or to borrow from the public on the scale needed to offset the additional demand on resources generated by the enormous military expenditures. The United Kingdom did more than any other nation to impose additional taxes, but even this was sufficient to cover only one‐third of its wartime expenditure; in France the proportion was about 15 per cent, in Germany at most 6 per cent (Morgan, 1952: 104; Patat and Lutfalla, 1986, English edn. 1990: 24; Holtfrerich, 1986: 105).

After the war further huge sums were required to service these swollen internal public debts, much of it short‐term, and to meet the external demands for payment of war debts and reparations. Yet further large outlays were necessary in order to make good the terrible destruction which so many countries had suffered during the savage campaigns, especially in France and Belgium. A large body of literature exists on some aspects of this financial dislocation, especially on reparations, on inter‐Allied debts (more generally on Europe becoming a net debtor) and on the new pattern of international lending—what Schuker (1988) calls American reparations to Germany. Less is known about changes in the web of international (p.17) banking that provided the grass‐roots connection for the international transfer of short‐ and long‐term capital, as well as for the actual day‐by‐day functioning of an international payment system.

5. Finally, the classic gold standard was an early casualty of the conflict. Within a few months of the declaration of war almost all European central banks, including those in countries that were to remain neutral, had unilaterally suspended gold payments. During the war, the powers of the Entente developed their own payment system backed by the inter‐Allied loans. This was designed to allow the belligerent countries to sustain the level of imports required to achieve the maximum military contribution to the common cause. However, once the war was over co‐operation ceased almost overnight. Inter‐Allied financial assistance was suspended, and creditor countries immediately made clear that they expected reimbursement of their war loans. At the same time, the victorious powers insisted on extracting an unrealistic amount of reparations from those they had defeated; with French retaliation for the terms which Germany had imposed on her after victory in 1870 as the dominant factor in preventing a more realistic settlement. A typical inter‐war British view of the overall financial outcome is given in the following scathing comment by Lionel Robbins (1934: 6):

The inordinate claims of the victors, the crass financial incapacity of the vanquished, the utter budgetary disorder which everywhere in the belligerent countries was the legacy of the policies pursued during the war, led to a further period of monetary chaos.

We turn now to consider the way in which these and other consequences of the Great War took effect in the course of the financial and economic developments of the 1920s.

2. The Crises of the 1920s

Accelerating Prices and Hyperinflation

During the war years prices rose rapidly in all the belligerent countries as demands increased and supplies were disrupted, and the neutral countries could not remain immune from this process. The extent to which prices surged upwards between 1914 and 1918 is shown for a selection of countries in the first column of Table 1.1. There was a brief respite immediately after the armistice, when commodity prices fell, but from the spring of 1919 inflation resumed its course during a boom which lasted until the spring or summer of 1920, and was especially strong in the United Kingdom and some of the neutral countries, and in the USA. As can be seen from column (p.18) (2) of Table 1.1 the extent of the inflation in 1920 varied widely, but the experience of rising prices was common to all countries.

Table 1.1. Consumer Price Indices, European Countries, 1918–1926 (1914 = 100)

1918 (1)

1920 (2)

1922 (3)

1924 (4)

1926 (5)

Countries with hyperinflation until 1922 or 1923













Countries in which inflation continued after 1920
























Countries in which inflation was controlled after 1920





































(a) Linked to base year via gold price. For Austria the index for 1923 on this basis was 76. For Germany the hyperinflation continued until late in 1923 and the price index for that year (1914 = 100) was 15,437,000,000,000.

Source: Maddison (1991: 300–3).

From the middle of 1920 the boom gave way to a world‐wide slump and this continued until 1921 or, in some cases, a year later. The depression was particularly severe in the United Kingdom and the USA; Germany was one of the few countries which escaped. During this cycle and the subsequent years experience diverged sharply, and three distinct trends in the behaviour of prices can be identified. In one group of countries, represented in the upper panel of Table 1.1 by Germany and Austria, monetary stability was completely destroyed and inflation gave way to hyperinflation. In a second group, represented by Belgium, Finland, Italy, and France in the middle panel, inflation continued but was not allowed to get completely out of control. The third group, consisting of the Scandinavian countries, Switzerland, Britain, and the Netherlands, imposed strict deflationary policies of dear money and fiscal restraint, and by this means succeeded in actually reducing prices and wages until 1922 or 1923. Thereafter prices in this group of countries were broadly stable or falling.

Five countries proved totally unable to contain the war and post‐war pressures and were ravaged by hyperinflation. These were Austria, Hungary, (p.19) Poland, Russia, and Germany. The latter was by far the most remarkable case, culminating in wholesale prices rising at the astronomical rate of 335 per cent per month from August 1922 to November 1923 (Holtfrerich, 1986: 17). Even as the inflationary spiral was gathering momentum there was heated controversy about its causes.2 Within Germany almost all officials, bankers, industrialists, and a great many economists adopted the balance of payments theory, according to which the root cause of the inflation was to be found in the burden of reparations and occupation costs imposed on a defeated Germany. It was claimed that it was this which was primarily responsible for the magnitude of the deficit on the balance of payments, and that this deficit in turn caused the extraordinary depreciation in the external value of the mark and forced up import prices. As the accelerating costs and prices spread through the economy the authorities were compelled to expand the issues of paper money, thus fuelling the inflation. This analysis was supported by some foreign scholars, notably Williams (1922) and Graham (1930).

Opponents of this view reversed the causal chain and advocated a quantity theory explanation. They argued that it was the excessive issue of paper money which initiated the vicious circle, and traced this back to the size of the massive budget deficit. An authoritative inter‐war exposition of the quantity theory explanation was given by Bresciani‐Turroni (1937). He argued that the crux of the problem was to be found not in reparation payments but in the enormous increase in state spending. This sprang both from the heavy reliance on borrowing during the war, and from the huge outlays required by post‐war economic and social programmes. The political parties were too weak to resist the pressure for this expenditure; the vested interests on either side were too bitterly divided to reach any agreement on how the necessary taxes should be allocated between labour and capital. The printing of paper money thus provided the only acceptable way out of the dilemma, and at least initially it could be argued by many of the contending social groups that the resulting inflation brought more benefits than costs.

The headlong expansion of the money supply in turn reduced the external value of the currency and so added further to the inflationary pressures. To make matters worse, the unexpectedly rapid pace of the inflation itself undermined attempts to balance the budget, since the real value of any revenue received was always less than had been anticipated when the taxes were imposed. Assessment of many taxes was also made more difficult in conditions of rapid inflation. The effect of the expanded note issue was then (p.20) intensified by a steep rise in the velocity of circulation. From the outbreak of war until the summer of 1921 the currency in circulation and the internal price level had increased broadly in line (apart from a brief ‘flight from the mark’ in 1919) so that there was virtually no change in the real value of the paper money in circulation. But then the signing of the London Ultimatum and the imposition of what were seen to be excessive demands for reparations changed expectations. From the summer of 1921 the flight from the currency became continually quicker as first Germans and then foreigners lost confidence in the value of the mark. By the second half of 1922 the demand for real money balances was falling steeply (i.e. there was an abrupt rise in the velocity of circulation) and the acceleration in the rate of price increase outpaced even the exceptionally rapid growth of the money supply (Bresciani‐Turroni, 1937: 162–75; Holtfrerich, 1986: 184–93).

This inability to cope with the abnormal fiscal problems created by the First World War and its aftermath was equally characteristic of post‐war governments in the other hyperinflation countries. It also applied, though to a lesser extent, to many of the countries in the second and third groups mentioned above, and was largely responsible for the inflationary trends in those countries. Apart from the enormous costs of the war and the post‐war restoration, the years of conflict had transformed social and political attitudes, weakening the old order and accelerating the rise of the working classes. In the tense and difficult situation created by defeat, devastation, and financial disorder the political parties in countries such as Austria, France, Belgium, and Italy could not agree on how the burden of taxation should be shared between the different social classes, and as in Germany distributional conflicts over taxes and incomes stand out as a principal source of financial instability in the post‐war years.

Stability and Crisis in the European Banking Systems

As noted above, the lively boom which followed the Armistice came to an end in the middle of 1920, and output, employment, and incomes began to fall in almost all countries; in a number of cases the recession proved to be fairly severe. Of the large countries of Europe, only Germany escaped a post‐war slump due to the temporarily beneficial effects of hyperinflation: investment was encouraged by the fall in real interest rates and exports were stimulated as long as the depreciation of the mark outpaced the relative rise in German prices. A number of countries also experienced a banking crisis in this period. Whether or not such a crisis developed, and the extent of its severity, depended on three main factors: the organization of the banking system, the severity of the depression in the real economy, and the policy‐stance of the central bank. Banks were more likely to fail in countries where they entertained close links with their industrial clients, on the German (p.21) model of ‘universal banking’, where the real slump was more severe and accompanied by a price deflation, and where the central bank was unwilling or unable to act as a swift lender‐of‐last‐resort. Where such crises occurred this, in turn, produced feedback effects on the real side of the economy.

Thus in Britain (see Chapter 15 by Capie) where there had been no panic or financial crisis since 1860, one would expect to find the highest degree of stability in the banking system, and 1920–1 was no exception. The separation between banks and industry was, by then, quite well established, so that banks did well in terms of profitability and currency/deposit ratios during the post‐war depression; the depression itself was rather mild; and the Bank of England had developed such a reputation as lender‐of‐last‐resort that it could defuse the possibility of banking panics by its very presence. The Irish system (described in Chapter 16 by Ó Gráda) also remained stable, both because of similar factors to those in Great Britain, and because of the close links between the two financial systems.

The French case, discussed in Chapter 11 by Lescure, is perhaps less clear‐cut, but the reasons for the overall stability of its banking system may nevertheless be traced back to the three factors mentioned above. During and after the war, most French enterprises continued in their time‐honoured tradition of self‐financing from retained profits. Universal banking existed in France but was normally confined to small provincial banks. The crisis of 1921 made some enterprises less reluctant than before to resort to long‐term bank credit but it was, on average, a rather limited phenomenon. Deposits fell in real terms during the first part of the 1920s as a response to inflation and to the high yields of state bonds, but the reaction of banks was prudent: they increased the liquidity of their portfolio. The Banque de France favoured this process by encouraging the placement of government securities with banks. The real recession was rather mild and—a very important point—was not coupled with price deflation.

The stability of the post‐war German financial system, examined in Chapter 9 by Hardach, is particularly interesting, and contrasts sharply with the collapse of 1931. From this particular point of view, inflation was a ‘blessing’ since it resulted in growth rather than a slump in the real sector, and in the economy being oversupplied with liquidity. Given the fact that central bank credit financed most of the government's expenditure, there could be no question about lending‐of‐last‐resort to financial institutions, which obviously proved to be unnecessary. Inflation also ensured the post‐war stability of the Austrian and Polish banking systems (see Chapter 12 by Weber and Chapter 13 by Landau and Morawski). In Austria, however, the stabilization of the currency, with the necessary deflationary pressure, produced a stock exchange crash in 1924, and the resulting crisis in the real and financial sector of the economy caused widespread failures among small‐ and medium‐sized universal banks.

(p.22) Elsewhere bank failures were more common; they characterized the post‐war economies of Italy, Spain, Portugal, and Norway (see the chapters in Part III by Toniolo, Martín‐Aceña, Reis, and Nordvik). In Italy the third and fourth largest universal banks in the country became insolvent between 1921 and 1923, partly as a result of overtrading during and soon after the war, and the difficulties were exacerbated by the cyclical downturn of 1920–1. One of these banks was declared bankrupt at the end of 1921, but deposits were to a large extent guaranteed by the central bank, which also saved a metal‐making and engineering concern—probably the most important in the country—owned by the bank. In the following year, fearing a run on deposits should another large bank go under, the central bank staged a large lending‐of‐last‐resort operation in favour of the fourth largest bank in the country. Thus, a pseudo‐financial crisis characterized post‐war Italy, due to the active policy‐stance of the central bank which gave priority to bank stability over other policy goals such as currency stabilization (Guarino and Toniolo 1993).

The Spanish central bank was not as ready as its Italian sister to accommodate the liquidity needs of credit institutions in serious difficulty. It, therefore, remained on the sidelines in 1920 when an early recession in manufacturing made a number of Catalan universal banks insolvent. The crisis hit the most developed region in the country, with the eventual failure of the oldest and most prominent Spanish credit institutions (see further Chapter 20 by Martín‐Aceña). The crisis was very severe in Barcelona but its effect on Madrid and Bilbao, the two other financial centres in the country, was relatively mild. However, a new wave of runs on bank deposits unfolded in the second half of 1924; after years of persistently falling prices, both of goods and of financial assets (industrial shares), during which industrial companies required continuous assistance from credit institutions, a number of banks were dragged into insolvency. Again, the central bank remained passive, only in the case of the Banco Central, one of the largest in Spain, was it forced to yield to pressure from the Government of Primo de Rivera and provide enough assistance so that the Banco could actually overcome its problems.

In the Netherlands and in Scandinavia, bank failure followed the slump of 1920. In Denmark the central bank took a fairly active stance and was able to avoid a major confidence shock. The Bank of the Netherlands seems to have been less successful in this respect, and the failure of one of the largest commercial banks shook public confidence. As Nordvik shows in Chapter 17, the Norwegian case stands out for the length of its banking troubles, which lasted from 1923 to 1928. As the wartime boom in the real sector was particularly buoyant, the slump was relatively more serious than elsewhere, particularly given the strong deflationary policy imposed to stabilize the currency and return to gold. Given the links between manufacturing (p.23) firms and banks, and the unwillingness of the central bank to let lending‐of‐last‐resort jeopardize its monetary stance, it is not surprising that bank failures followed one after the other for a longer period than anywhere else. It is likely that institutional innovation embodied in the Bank Administration Act made things worse rather than better.

To sum up: the post‐war slump in the real economy resulted in financial panics and runs on banks whenever (a) the latter had established close long‐term relationships with their client firms of the kind that characterized the so‐called universal banks, and (b) the central bank decided to refrain from providing the necessary liquidity either for policy reasons or for sheer prejudice. The story repeated itself on a larger scale ten years later, so that one may wonder why the lesson was not better learned.

Stabilization and the Return to Gold

As long as the post‐war fiscal problems persisted, prices continued to increase and currencies to depreciate. Eventually, however, even those social groups who found some benefit in inflation began to fear its continuation, and the compromises necessary to reduce spending, raise taxes, and restrict the creation of credit were agreed. In many cases the process was assisted by foreign stabilization or reconstruction loans and by temporary credits, both mainly from London and New York, but in some cases arranged through the League of Nations. The issue of domestic loans to fund the excessive short‐term debt was also important, notably in the French and Belgian stabilizations. At various dates between 1922 and 1927 the major countries in the first and second groups in Table 1.1 achieved the necessary degree of monetary and financial stabilization to restore the gold standard, with its commitment to sound money and fixed exchange rates. By the end of the decade only the Spanish peseta remained to be stabilized.

The dates at which this was achieved de facto (legal restoration was sometimes delayed for various reasons) are given in Table 1.2, together with a measure of the extent to which the foreign exchange value of each currency had depreciated as compared with its pre‐war parity. The countries are again arranged in three groups which correspond to those in Table 1.1. The extreme cases of inflation and hyperinflation leading to stabilization of the currency at 10 per cent of the pre‐war parity or less are in the upper group. At the other extreme, the six countries which imposed strict deflationary policies after 1920, and were able to return to gold at their pre‐war parities, are covered in the lower group. In the middle group are examples of countries which allowed serious inflation to continue after 1920, but eventually stabilized their currencies at between 10 and 30 per cent of the pre‐war rate.

The First World War had imposed heavy costs on Britain, but she had been less adversely affected than the Continental belligerents by physical (p.24) destruction and financial disruption and, despite Keynes's forceful dissent, prevailing opinion strongly favoured a return to gold at the pre‐war parity (Moggridge, 1972; Sayers, 1976). The objective, the method, and the price to be paid were clearly set out early in 1920 in a memorandum by the Bank of England to the Chancellor of the Exchequer (quoted in Howson, 1975: 18–19):

The first and most urgent task before the Country is to get back to the gold standard by getting rid of this specific depreciation of the currency. This end can only be achieved by a reversal of the process by which the specific depreciation was produced, the artificial creation of currency and credit, and for this the appropriate instrument is the rate of interest. The process of deflation of prices which may be expected to follow on the check to the expansion of credit must necessarily be a painful one to some classes of the community, but this is unavoidable.

Table 1.2. Post‐War Stabilization of European Currencies, 1922–1929

Year of de facto restoration of gold standard

New parity as percentage of pre‐war



Stabilization at less than 10% of pre‐war parities




























Stabilization at between 10 and 30% of pre‐war parities
















Stabilization at pre‐war parity










United Kingdom









Sources: Brown (1940: 393–402; 919 and 1,028); League of Nations (1944: 116); Nötel (1986: 181–3).

None of the other belligerents shared this determination, but among the neutrals the Scandinavian countries, Switzerland, and the Netherlands were (p.25) similarly committed to the restoration of the pre‐war parity of their currencies. In Denmark voices were raised among politicians, businessmen, and economists recommending stabilization at about 75 per cent of the old parity, but they were unable to ‘win the struggle for public opinion against the slogans of the deflationists who demanded return to “our old, honest krone” ’; there was a parallel debate in Norway where an even greater appreciation of the currency was required (Lester, 1939).

In the event a very high price had to be paid for this belief in the virtues of the return to gold at the old parity. In Britain the collapse of the export industries, and the sustained downward pressure on wages, employment, and working‐class living standards have frequently been seen as the sacrifice which the financial interests of the City imposed on industry in order to preserve the gold standard (Pollard, 1970; Ingham, 1984; Boyce, 1987). In Denmark and Norway it caused a depression lasting from 1925 to 1928 which was almost as severe as that in 1929–33, with sharply falling production and prices, an increased number of business failures, and very high unemployment (Lester, 1939). Sweden similarly experienced considerable difficulties at the beginning of the 1920s; the contrast with the developments in Finland which chose not to follow the deflationary path is brought out in Chapter 8 by Haavisto and Jonung. Italy, together with the two other ‘late stabilizers’, France and Belgium, initially enjoyed a brief period when their exports benefited from exchange rates more favourable than those of the countries which followed orthodox deflationary policies. However, once Mussolini had decided that the lira should be stabilized at the quota novanta, representing a substantial upward revaluation of the prevailing rate, it became necessary to impose painful deflationary measures, resulting in slower growth of output and investment, and higher unemployment (see Cohen, 1972 and Chapter 6 by Asselain and Plessis).

Once stabilization was achieved further problems were created by the extent of the relative over‐ and under‐valuation of currencies resulting from the haphazard and uncoordinated process by which each country selected its parity. Some currencies, notably those of Britain, Italy, Denmark, and Norway were probably overvalued; in other cases, including France, Belgium, and Poland, the rate selected provided a degree of undervaluation. These disparities had important consequences for competitiveness in foreign trade. However, other powerful forces were also at work, and these too contributed to the very varied pattern of export performance in the 1920s. The data are given in Table 1.3, listed in the order indicated by the level achieved by 1929 relative to 1913.

In the case of Britain it has been generally accepted that the decision to return to gold at the pre‐war parity of $4.86 resulted in an overvaluation of the currency by about 10 per cent. It would, however, be wrong to see this as the primary reason for the decline of the export sector shown in Table 1.3. (p.26) Coal, textiles, shipbuilding, and other major export industries were already confronted by an extremely difficult structural problem created by technological change; the growth of substitute products, and the opportunity which the war had provided for foreign competitors outside Europe, notably the USA and Japan, to capture a large share of Britain's traditional markets. Nevertheless, the overvaluation of sterling undoubtedly added significantly to the fundamental structural weakness, as did the high interest rates necessary to sustain the currency.

Table 1.3. Volume of Merchandise Exports, European Countries, 1924–1929 (1913 = 100)



















































































United Kingdom







Source: Maddison (1991: 316–19).

As Table 1.3 indicates, the 1929 volume of British exports was still 19 per cent below its level in 1913. Of the other European countries which re‐established their currencies at the pre‐war parity against gold only Switzerland was unable to expand her exports above the pre‐war level. Despite the probable overvaluation of their currencies, Norway increased the volume of her exports relative to 1913 by 67 per cent and Denmark by 81 per cent. Sweden and the Netherlands managed 56 per cent and 71 per cent respectively. For these countries, as for the less fortunate cases of Belgium, Germany, and Austria, other factors were clearly of more importance than the exchange rate.

The Rules of the Game

One consequence of the sequence of post‐war financial developments and policies which was heavily emphasized in contemporary accounts of the period was the destabilizing effect of massive flows of capital, both short‐term and long‐term. The process gained its initial momentum early in the 1920s with the flight from currencies such as the German mark, the French (p.27) franc, and the Italian lira, as those who could transferred their assets to what they perceived to be safer currencies. With the high interest rates necessary to defend the pound, London was a favoured haven. Once confidence in the stability of the French and other Continental currencies—and in their underlying public finances—was restored, the speculative funds flowed back again in eager anticipation of capital gains when the new parities were legally established. In 1925 and 1926 there was a large speculative movement which caused a sharp appreciation in the Danish and Norwegian krone in anticipation of their de jure restoration in January 1927 and May 1928 respectively (Lester, 1939: 197–8). Italy was similarly the recipient of a considerable capital inflow during the eighteen months preceding the de jure stabilization of the lira in December 1927.

From a British perspective the loss of gold as flight capital rushed back to France after the success of the Poincaré stabilization at the end of 1926 was always mentioned and often resented as a major cause of the weakening in Britain's external financial position. In the first place France had elected to stabilize the franc at one‐fifth of its pre‐war value, whereas Britain had accepted the discipline necessary to restore sterling at the pre‐war parity, and this was seen as a major source of balance of payments disequilibrium. Secondly, there was a dramatic increase in French reserves, accumulated at first in foreign exchange and later in gold, but the authorities did not respond to this by inducing a corresponding increase in the money supply. If they had done so this should have stimulated the rise in prices which might have restored equilibrium. In June 1928 French gold reserves were only 29 billion francs; by the end of 1932 they had increased by 53 billion but the increase in the note circulation over the same period was only 26 billion francs (Mouré, 1991: 55–6). Instead, the returning French capital was mainly used for the purchase of government securities, either directly by the private sector or by the commercial banks as their deposits increased. The government in turn was able to repay a substantial part of its debts to the Banque de France. As a result, the large increase in the central bank's holdings of gold and foreign currency was to a considerable extent neutralized. As seen from London the gold standard was thus not operated according to the rules, and the necessary adjustment process was frustrated. The position was exacerbated by the very low level of foreign investment by France; with their pre‐1913 assets largely wiped out by the war and the Russian Revolution, French rentiers had become extremely reluctant to trust any more of their savings to foreign governments and enterprises.

Treasury and central bank officials in Paris and London argued bitterly in public and private over the reasons for the movement of gold to France, over what action should or could be taken in order for the flow to be reversed, and over whose responsibility it was to take the corrective measures. Even when it was recognized that the final outcome was not the (p.28) result of a French policy wilfully designed to sterilize the inflow of gold, it was still regarded as a failing in the system leading to a serious maldistribution in international holdings of gold (for a modern summary of the controversy see Mouré, 1991). Eichengreen (1986) emphasizes that the Banque de France could in theory have reduced their high reserve ratio by means of expansionary open‐market operations, but were effectively precluded from doing so by statutory restrictions. These had been imposed by the 1928 stabilization law specifically to prevent a recurrence of the lax monetary policies which were held responsible for the searing inflation of 1922–6. The British thought these restrictions should be relaxed in the interests of international monetary co‐operation; the French were determined to protect their currency from any possibility of renewed inflation.

Similar issues were debated with respect to the USA, the one other country to show a substantial increase in its gold holdings during the 1920s. In the early part of the decade the American banking authorities considered that since this inflow was the result of the abnormal post‐war conditions in Europe most of the gold would in due course return to Europe and, therefore, should not be used as the basis for domestic credit creation in the USA. Neutralization was thus a deliberate policy, for which there were ‘sound and compelling reasons’ (Nurkse, 1944: 73–5). In the subsequent years the USA continued to neutralize any changes in the stock of gold, though on a less extensive scale, and in 1928 and 1929 the Federal Reserve Board actually initiated a progressive increase in interest rates in order to prevent what it saw as an alarming rise in speculation on the stock exchange. This action was taken regardless of its implications for the requirements of international stability. Countries such as Britain, which were running balance of payments deficits at this time, might well have asked, with the author of an official history of the United States in the World Economy (Lary, 1943: 166):

whether a more aggressive policy of credit expansion could have been safely followed with a view to supporting a higher level of prices and money incomes in the United States, thus helping to meet the foreign demand for dollars and relieving the strain on foreign exchanges and the general world deflationary pressure that developed in the latter part of the twenties.

Lary's answer was that, as was so often the case in the inter‐war period, considerations of internal policy were given far higher priority, and ‘the threat to international stability, although not overlooked, was regarded as a regrettable but necessary risk to be run in rectifying an unsound domestic situation’.

These controversies over the policies of the two surplus countries, France and the USA, are a special case of the more general debate about the degree (p.29) to which the recurrent inter‐war crises in the international monetary system could be attributed to the alleged failure of countries to operate the gold standard according to the rules followed in the pre‐1914 era, thus depriving the system of its fundamental equilibrating mechanism. On a strict interpretation the traditional policy required not merely that changes in holdings of gold should be automatically reflected in corresponding changes in the domestic currency, but that further purchases or sales of domestic assets should be made by the monetary authority so that the impact of movements in gold was magnified in proportion to the central bank's reserve ratio.

In his League of Nations study of the behaviour of twenty‐six countries during the years 1922–38, Nurkse (1944: 68) found that ‘from year to year, central banks' international and domestic assets, during most of the period under review, moved far more often in the opposite than in the same direction’. The extent of the inverse correlation was even greater in the five‐year period of fixed exchange rates when the restored gold standard was in operation: for 1927–31 international and domestic assets changed in the same direction in only 25 per cent of the possible cases, compared to 32 per cent for the inter‐war period as a whole. Various qualifications need to be made to this finding, such as the possibility that the response to the flows of gold might have been delayed, or that movements of private short‐term capital might have distorted the pattern, and it must also be recognized that even the classical gold standard was not quite as simple and automatic as the textbook models suggested (Bloomfield, 1959). Nevertheless, the broad conclusion was that there was an increasing tendency in the inter‐war years to use gold reserves as a buffer to protect countries from the transmission of external shocks, rather than as the means by which fluctuations originating abroad were automatically transmitted to the domestic credit base.

Just as it would be wrong to attribute the apparently smooth and efficient operation of the classical gold standard to the virtues of theoretically built‐in automatic adjustment mechanisms, so equally the collapse of the inter‐war system should not be attributed to their absence. Eichengreen (1992) has stressed the dual importance of co‐operation between central banks, and of the credibility of their commitment to gold, in explaining the good overall performance of the pre‐war gold standard. Before 1914 each of the ‘core’ countries had an important stake in the stability of the entire system, so that while they would not necessarily co‐operate routinely, they would certainly do so at times of major crises. Moreover, the role played by London as the pivot of the system was crucial in two respects: the dominant financial position of the City was enough to ensure the successful day‐by‐day operation of the classical gold standard, and, in an emergency, the existence of a de facto leader ensured stable results for the ‘co‐operative game’.

(p.30) After 1919 none of the above conditions could be applied to the resurrected system. The Versailles Treaty created instability at the heart of international economic and political relations. Transaction costs in the movements of goods, capital, and labour were considerably increased; balance of payments adjustments became slower, thus requiring stronger rather than weaker co‐operation if fixed exchange rates pegged to gold were to be maintained. The defeat of Germany, and in many respects of Europe as a whole, with the attendant provisions for reparations and debt payment, made the whole international monetary system entirely dependent on the ability or willingness of the USA to compensate for its trade surpluses by capital movements. These would inevitably be highly volatile. Neither governments nor public opinion understood the new situation well, much less did they know how to deal with it. Economists, with few exceptions, proved to be of little help; worse, they were often the slaves of dead teachers and their doctrines.

According to Kindleberger (1973) this situation required a higher degree of international leadership. Unfortunately, the international economic position of Great Britain had been gravely weakened by the war: it was no longer a net creditor for large amounts of capital; some countries—notably in Latin America—had left the economic orbit of the wider sterling area and joined that of the USA; Commonwealth countries had achieved a higher degree of economic independence. In these conditions Britain was no longer in a position to act as stabilizer of the international payment system. The USA, on the other hand, was not yet ready to assume this role. Isolationism was still a powerful factor in her foreign policy; the New York financial market did not possess London's experience or sophistication; the Fed, established only in 1913, was still feeling its way. In these conditions neither London nor Washington was able to exercise world leadership with the strength required by the unstable post‐war situation.

Eichengreen (1992) carries this argument further. He agrees on the importance of leadership, as reflected in the success of both the pre‐1914 gold standard and the post‐1944 Bretton Woods system. If however, leadership implies that the leader is able to stabilize the world by its own action—such as world‐wide last‐resort lending—then no single country can possibly guarantee a stable international economic environment. As shown by international economic organization before the First World War leadership was indeed useful, perhaps necessary, in so far as it was a precondition for co‐operation; but ultimately it was the co‐operation which mattered. Moreover, the policy which the co‐operation was designed to sustain had also to be credible. Before 1913 Britain, France, and other leading financial centres were willing to co‐operate as necessary, and their commitment to the preservation of the gold standard was credible. After 1918 both these vital qualities were lacking.

(p.31) The First World War produced conditions which both postulated and made impossible an even greater degree of co‐operation than had been necessary in the late nineteenth century. Lack of leadership was of course a problem, but not the only one. The war itself had created the most uncooperative of all worlds. Behind the failure of the successive economic conferences, from Brussels in 1920 to London in 1933, lie rancour, vindictiveness, and all the problems created by the pursuit of misplaced patriotism and self‐interest. The degree of international economic co‐operation achieved in the second half of the 1920s by central bankers, led by Norman and Strong, was simply not enough. The war had also undermined the credibility of the commitment to gold. Domestic political pressures meant that governments could no longer permit their central bankers to give unquestioned priority to external stability, regardless of the consequences for the internal economy.

International Capital Movements

In addition to the speculative flows stimulated by current and anticipated exchange‐rate fluctuations there were also enormous movements of international capital attracted by interest‐rate differentials and the prospects of long‐term gains. Interest rates in Europe were appreciably higher than in the USA, and those in Germany were among the highest in Europe. Capital flowed to selected European borrowers on a massive scale once stabilization had been achieved, and the adoption of the Dawes Plan provided—at least temporarily—a settlement of the dispute over reparations. In Europe, as elsewhere in the 1920s, it was the USA which was the dominant creditor, but the United Kingdom and France were also substantial net lenders. The gross inward flow (long‐ and short‐term) to the seventeen principal European borrowing countries amounted to approximately $10,000 million in the seven years from 1924 to 1930, with almost $7,000 million going to Germany and the balance in much smaller sums to a number of other countries, notably Austria, Italy, Romania, Poland, Greece, and Hungary. At the same time some of these borrowers were themselves lending to others, and there was an outflow from Germany amounting to some $2,500 million (for further details see Chapter 3 by Feinstein and Watson).

This movement of American capital to Europe in the 1920s contributed to international monetary stability by recycling the funds which flowed out to pay for the Continent's current account deficits with the USA. In comparison with the pre‐1913 period, Europe's trade balance had deteriorated because of the weakening in her relative industrial competitiveness. The net receipts on invisible account were also greatly reduced; in particular, because the loss of overseas assets as a result of the war and the Bolshevik Revolution eliminated a large part of the pre‐war inflow of interest and (p.32) dividends from abroad, while the inter‐Allied debts increased the payments which had to be made to the USA. The import of foreign capital after stabilization thus helped to preserve the external value of the mark and and other currencies, and helped sustain Europe's commitment to the gold standard.

The huge sums which poured into Germany were frequently portrayed by German politicians and financiers as the inward transfer necessary to permit the payment of reparations, but in reality these payments accounted for at most one‐third of the gross receipts from abroad. In the period 1924–30 the aggregate amount paid in reparations amounted to approximately $2,400 million (about 2.3 per cent of Germany's aggregate national income over these years), whereas the gross inflow of capital during the same period amounted to approximately $7,000 million, or 6.6 per cent of national income.3 Thus as long as US bankers and investors remained eager to invest their capital in Germany the much‐debated transfer problem created by the demand for payment of reparations to the Allies was effectively solved. There were, of course, expressions of concern both within Germany and outside that at a later date these loans would have to be repaid and Germany would then face an impossible double burden. But the hunger for external capital was too powerful to be stemmed by such remote considerations.

A number of recent American studies have developed the theme originally stated by Mantoux (1946) in opposition to the famous polemic by Keynes (1919). They argue that the domestic burden involved in raising the necessary sums through taxation was considerably exaggerated, and that after the downward adjustment made under the Dawes Plan—perhaps even before—the amounts were well within Germany's capacity to pay (see e.g. Marks, 1978; McNeil, 1986; Schuker, 1988). However, this analysis does not allow sufficiently for the prospect that payments could be progressively raised as the German economy expanded, or for the extreme reluctance of Germans to accept even a modest increase in taxation to meet what was universally regarded as an unjustified and oppressive imposition by hostile adversaries. Thus even if the economic aspects of the problem were not as crippling as had been assumed in the 1920s, the exaction of reparations was still of deep political and psychological significance for Germany. The payments were a paramount cause of instability and a barrier to international economic co‐operation.

The figures quoted above show that the average annual capital flow to Germany net of reparations was equivalent to over 4 per cent of her (p.33) national income. Given the low level of domestic savings, the willingness of foreigners to fund German capital expenditure enabled the country to live markedly beyond its means. There were several reasons for the acute shortage of domestic capital. The years of war and hyperinflation had wiped out virtually all liquid capital, including most of the reserves of the banking system, and fear of inflation remained a deeply inhibiting factor even when stability was restored. There was also considerable misallocation of available funds to unprofitable industries, including agriculture, and to desirable but not revenue‐yielding social amenities. Foreign capital thus permitted a higher level of investment and consumption than domestic resources would have supported; it enabled central and local government to spend more and tax less; the supply of imported goods was greater than it would otherwise have been; and the Reichsbank was able to add substantially to its reserves of gold and foreign exchange. The liquidity of the banking system was also greatly improved by the funds received from abroad, although the banks were following a risky strategy to the extent that they relied on short‐term deposits to make long‐term loans. The massive foreign borrowing contributed to Germany's industrial rationalization and revival, notably in the coal, iron and steel, electrical and chemical industries. However, only about 40 per cent of the long‐term foreign capital issued in Germany in 1924–30 was taken by private enterprises, the remainder going to various public and semi‐public bodies, such as the cities and municipalities. This enabled the local bodies to make substantial investments, partly in public utilities, urban transport, and housing, partly in social, cultural, and sporting facilities.

This position was stable only as long as the necessary imports of funds could be maintained, and the underlying problems and social conflicts meant that the economy was extremely vulnerable to any change in the preferences of American investors. The flow of long‐term capital from abroad fell sharply in the first half of 1927, following a bitter attack on foreign borrowing by the Reichsbank president, Dr Schacht, and the withdrawal of the tax concessions previously enjoyed by foreign subscribers to German bonds. This subjected the economy to great pressures, and after a decline in gold reserves the tax exemption was reinstated and the bond flotations quickly revived. They reached a peak in the second quarter of 1928, then fell abruptly and had virtually ceased by the spring of 1929. The flow of capital from abroad recovered to a limited extent in 1930, but in 1931 the situation was transformed and there was actually a net outflow of over $600 million. Several factors contributed to America's unwillingness to continue sending capital to Europe on the scale of earlier years. Internally, the tightening of monetary policy by the Federal Reserve referred to above raised interest rates sharply, thus weakening the incentive to lend abroad; and with the stock exchange indices soaring upwards through 1927 and 1928 (p.34) there was further strong encouragement to keep funds at home in the hope of more substantial gains from speculation on Wall Street. On the external side there was sharply growing alarm about the rising total of Germany's foreign liabilities, and her ability to continue to meet the obligations these imposed.

In the late 1920s Germany went into a slump of unparalleled severity. Real domestic product fell by 16 per cent between 1929 and 1932, industrial production by over 40 per cent, the value of exports by almost 60 per cent. Unemployment raced from 1.3 million in 1927 (less than 4 per cent of the labour force) to 5.6 million in 1932 (over 17 per cent).4 The sudden contraction of capital imports from the USA is often cited as the critical factor which precipitated this catastrophe (Lewis, 1949; Falkus, 1975; Sommariva and Tullio, 1987). However, other scholars have argued strongly that the source of Germany's economic troubles was primarily domestic in origin (Temin, 1971; Balderston, 1983; McNeil, 1986). Their case is supported by the fact that nominal short‐term interest rates were stable through the second half of 1928, and then fell in the first quarter of 1929, only moving up in the second quarter. If the exogenous view of the depression was correct it might have been expected that they would have risen sharply as soon as the foreign inflow was cut off, but the observed pattern is easily explained if the German economy was already moving into recession before the import of capital from the USA dried up.

Industrial production recovered strongly in 1927 after the depression of 1925–6, but then showed virtually no further growth in 1928 or 1929. Similarly unemployment dropped to 1,600,000 in the six winter months October 1927 to March 1928, and then increased sharply to 2,400,00 in the corresponding period of 1928–9. The same pattern is evident in the investment data. Gross fixed investment at current prices in the public sector (government and railways) expanded until 1927, and in other sectors the rise continued for a further year, though even at its peak in 1928 the investment ratio was low by comparison with the pre‐war period. Moreover, information on investment intentions shows that series for both non‐residential building permits and new domestic orders for machinery had already turned down in late 1927 or early 1928, well before the cessation of foreign lending. Balderston (1983) attributes the low level and early decline in investment primarily to an acute and persistent shortage of domestic capital, and claims that this provides a ‘thoroughly endogenous explanation’ for the decline in fixed investment. Borchardt (1979, English trans. 1991) also finds a domestic explanation for the Great Depression, but argues that the root of the trouble (p.35) was an excessive increase in wages relative to the growth of productivity, thus making the socio‐political distributional conflicts which emerged in the aftermath of the Great War the focus of the analysis.

Although the virtual cessation of capital imports from the USA and the subsequent net outflow did not initiate the depression, it undoubtedly added greatly to the problems facing the German policy‐makers and contributed to the adoption of measures which exacerbated the initial decline in activity. In principle their options were either to abandon the gold standard, boosting activity by allowing the mark to depreciate, or to follow orthodox policies of retrenchment, reducing imports and expanding exports by deflating the economy. In practice, the former was effectively ruled out, both by the powerful domestic fear of renewed inflation, and by international resistance to a reduction in the foreign currency value of reparations payments and of assets in Germany. The economy was thus gradually forced into a vicious spiral of restrictive financial policies and declining activity. Moreover, since the German ‘mixed banks’ had been borrowing short abroad and making long‐term financial loans to domestic enterprises, the repatriation of foreign funds contributed to their liquidity problems which, in due course, fuelled the banking crisis of 1931.

From late 1929 long‐term American capital was no longer available to sustain the budget deficits, but German investors—with the experience of 1922–3 still deeply etched in their memories—displayed great reluctance to purchase long‐term government bonds (Balderston: 1982). The government and the Reichsbank were thus inexorably driven to resort to short‐term borrowing; the more the short‐term debt increased the greater the perceived threat to stability, and the more energetic the efforts of domestic and foreign asset‐holders to withdraw their capital from Germany. The deterioration in the political situation provoked by the steadily deepening depression and the opposition to tax increases gave added grounds for distrust of the currency. The first of a succession of waves of capital flight occurred in the spring of 1929, and there were further massive losses of gold and foreign exchange in late 1930 and, on an even bigger scale, in 1931. The authorities were thus forced to adopt restrictive policies at precisely the point when the economy was in urgent need of counter‐cyclical measures to stimulate revival. Short‐term interest rates were raised in the second quarter of 1929, and the federal government, cities, and states initiated a succession of increasingly desperate efforts to raise revenues and restrict spending. From the end of 1930 and through 1931 Brüning introduced a succession of austerity decrees imposing progressively harsher increases in direct and indirect taxation. These were accompanied by reductions in civil service pay and in state welfare benefits. The descent into the Depression was cumulative and catastrophic.

(p.36) Elsewhere in central and eastern Europe the end of the foreign lending boom was an even more significant factor helping to initiate the Depression and contributing to its severity. Unlike Germany, most of these countries (Czechoslovakia was the exception) relied primarily on exports of agricultural products for their foreign revenues, and were in trouble as soon as primary product export prices began to tumble. They had borrowed heavily during the 1920s, frequently in the form of loans at fixed interest, and even when the funds had been productively invested—by no means always the case—they found themselves unable to service their debts from the rapidly diminishing proceeds of their exports. Thereafter they could only meet their external obligations as long as they could continue to attract fresh capital. After 1929, when the inflow of foreign capital ceased, the position could no longer be sustained and painful adjustment was inescapable.

Hungary was one of the worst affected of the agrarian producers in this region and provides a good illustration of the difficulties they confronted. Together with Poland she had been the most active of the East European borrowers in the mid‐1920s, and by the end of 1930 had an accumulated external debt of some $700 million, a large part of which had gone on unproductive expenditure (Berend and Ranki, 1974: 106–9). The export revenues on which she depended to service these debts came overwhelmingly from agricultural products, particularly wheat and maize. As their prices plunged the export proceeds went down with them; by 1931 their value was barely half the 1929 level and by 1932 less than a third (Nötel, 1986: 218). The resulting balance of payments problem was insuperable. In a period of some ten weeks from the beginning of May 1931 the central bank was compelled to pay out more in gold and foreign exchange than it had possessed in April: a drain only made possible because rescue credits of $50 million were obtained from abroad. With bankruptcy threatening urgent corrective measures were required.

By mid‐1931 Poland, Romania, Yugoslavia, and Bulgaria were in a similarly untenable position. Yet all five countries were inhibited by fear of inflation from following the example of primary producers elsewhere, such as Australia and Argentina, and depreciating their currencies. The deep prevailing fear of inflation in the minds of both politicians and the public is well indicated in the following comment of a contemporary Polish economist, Edward Lipinski (quoted by Nötel, 1986: 228):

After this [repeated] collapse [of the Polish currency] its preservation became a sacrosanct principle of popular belief . . . It was duly realised that any devaluation could easily lead to panic, price manipulation, ruin of saving institutions, and a further sharpening of the crisis . . . Stability of the currency thus was turned into a popular myth.

Deprived of this solution they turned increasingly to moratoria, rigorous exchange controls, and commercial policy restrictions.

(p.37) The problems which beset the agrarian producers emerged early in the cycle of events culminating in the Great Depression, and were particularly severe in the case of the two agricultural crops grown in this part of Europe, wheat and sugar. Australia, Canada, and the Argentine were also greatly affected. The underlying source of the trouble can again be traced back to the First World War, when European producers withdrew from the market and those elsewhere, particularly in North and South America, expanded their output in response to the rise in prices. After the war Europe attempted to restore the acreage previously under cultivation, and by 1925 it was impossible to find markets for the available supplies. The problem was made even more serious by various factors which tended to depress demand. It thus seems clear that in the case of agricultural foodstuffs a strong case can be made for the presence of overproduction, and for a downturn well before the break in activity in the industrial countries. The position was different for industrial raw materials, where it is more likely that the causal sequence ran from the decline in industrial activity to the fall in prices (Fleisig, 1972).

If all economic adjustments took place automatically and without friction this fall in agricultural prices would hardly matter from the standpoint of global economic stability. Any fall in the incomes of the producers of wheat would be offset by the rise in (real) incomes of the consumers of bread, and there would be no net effect on aggregate world demand. Unfortunately, this is not what happens in practice. The primary producing countries are forced to respond immediately to the deterioration in their international payments position, and do so by contracting activity and cutting their imports. By contrast, the consuming nations are slow to appreciate the improvement in their purchasing power and are under no urgent pressure to expand their activity.

The loss of income to the food‐growing countries combined with the cessation of foreign lending thus had substantial adverse consequences for others as well as for themselves. In the sphere of trade the decline in their export revenues undermined their ability to purchase manufactured goods from abroad, significantly reducing the exports of their customary suppliers, especially Britain. In the financial sphere, many of them were forced to devalue their currencies in 1929 and 1930, thus precipitating the period of instability on the foreign exchanges. Others turned to tariffs, exchange controls, and bilateral trading agreements and contributed to the contraction in world trade. Countries with strong links to sterling, both those within the Empire, such as Australia and New Zealand, and those in Latin America such as Argentina and Brazil, had traditionally kept their surplus balances in London, but now that they were in difficulty they were forced to run down these balances, thus adding to the pressures on the UK reserves.

(p.38) 3. The 1931 Financial Crisis and the Great Depression

The Crisis in Central Europe

After 1929 the downward slide in primary product prices continued relentlessly, and in the industrial countries output and trade declined rapidly with unemployment rising to unprecedented heights. The USA ceased to supply capital on the previous lavish scale, and from 1931 was actually a net recipient of long‐term capital fleeing from Europe in search of security. The only other country in a strong financial position was France, which attracted ever larger quantities of gold and foreign exchange. Both the American and the French authorities refused to take any steps to relieve the mounting crisis of confidence and liquidity in the rest of the world. The banking system was drawn inexorably into the gathering storm. As noted earlier, a succession of bank failures had occurred throughout the 1920s, and there were problems of varying magnitude in Spain in 1925, in Poland in 1926 and 1927, and in Norway in 1927 (see also Chapter 2 by Jonker and van Zanden). The problem then reached Germany in 1929, when the collapse of the Frankfurter Allgemeine Versicherungs was followed by the failure of smaller banks and withdrawals from savings banks in Frankfurt and Berlin.

However, the really serious troubles of the banking system emerged in Vienna in 1929 with the failure of the Bodencreditanstalt, the second largest Austrian bank. Under pressure from the government, the Rothschild's Creditanstalt agreed to a merger, but the rescuing bank was itself in a very weak position, and the enlarged institution could not provide a long‐term solution. The Creditanstalt, Austria's largest bank, had unwisely operated during the 1920s as if the Habsburg Empire had not been broken up. In fact the Viennese banks had been cut off from their original industrial base, especially in Czechoslovakia. There was never a sound basis for their business in the 1920s, and their heavy commitment to unprofitable industries meant that failures and losses were inevitable. In May 1931, after an auditor's report revealed the true position, the Creditanstalt went under and was forced to reorganize with the help of the Austrian government and of international credit and a partial standstill agreement with its foreign creditors. This collapse set off a run on the bank that spread to the Austrian schilling. The government quickly ran through its foreign‐exchange reserves in a vain attempt to adhere to the gold standard and only belatedly imposed foreign‐exchange controls (see Stiefel, 1989 and Chapter 12 by Weber).

The German banking system was heavily involved with Austria, and it went into crisis two months later when one of the major German banks, the (p.39) Darmstädter‐und‐Nationalbank (Danat) closed its doors. This threatened to precipitate the collapse of the entire German banking system, and a ruinous situation was only averted by government intervention and a banking moratorium. The German banking crisis of July 1931 is sometimes seen as the consequence of Austrian financial collapse in May. This presumption, however, has been hard to verify. The German crisis of July 1931 may well have been due to exclusively German causes, in which case the Austrian crisis foreshadowed—but did not cause—the more important German collapse.

German banks held the bulk of their reserves in cheques, bills of exchange, and Treasury bills that could be freely discounted at the Reichsbank. The bills earned more than deposits at the Reichsbank and were equally liquid as long as the Reichsbank stood ready to purchase them. The banks' reserve ratio fell sharply in June 1931, and again in July. Fully two‐thirds of the fall in each month was accounted for by a reduction in the amount of bills held by banks. This reduction was concentrated almost entirely in the six great Berlin banks, and it was paralleled by a rise in the Reichsbank portfolio of virtually the same size. The large Berlin banks were selling their bills to the Reichsbank. They sold over half of their bill portfolio in those two months (Temin, 1989). The problem created by the withdrawals was not primarily that the banks were losing reserves, except for one bank heavily invested in a major failed firm. It was that the Reichsbank ran out of assets with which to monetize the banks' reserves as withdrawals continued (James, 1985). Despite some credits from other central banks, the Reichsbank had fallen below its statutory requirement of 40 per cent reserves by the beginning of July, and it was unable to borrow more. The Reichsbank could no longer purchase the Berlin banks' bills by mid‐July.

The Reichsbank tried to replenish its reserves with an international loan, but tensions left over from the First World War disturbed the operation of the international credit market. The French, who had ample reserves to lend to the Reichsbank, were still fighting the First World War. They tied political strings around their offer of help that were unacceptable to the Germans. The Germans for their part tried to use the crisis to renegotiate the peace settlement and eliminate reparations, while the Americans pulled in the opposite direction to isolate the German banking crisis from any long‐run considerations (Bennett, 1962). The absence of international co‐operation was all too evident; no international loan was forthcoming.

Germany abandoned the gold standard in July and August 1931. A series of decrees and negotiations preserved the value of the mark, but eliminated the free flow of both gold and marks. In one of the great ironies of history, Chancellor Brüning did not take advantage of this independence of international constraints and expand. He continued to contract as if Germany (p.40) was still on the gold standard. It is vivid testimony to the power of ideology that leaders like Brüning were induced to cling to orthodoxy even as the world economy collapsed, and continued to advocate gold standard policies after abandoning the gold standard itself.

As a consequence of the German moratorium the withdrawal of foreign deposits was prohibited, and huge sums in foreign short‐term credits were frozen. As other countries saw that they would be unable to realize these assets they in turn were compelled to restrict withdrawals of their credits. Many other European countries suffered bank runs and failures in July, with especially severe crises in Hungary, where the banks were closely tied to those in Austria, and in Romania. As a result of the extensive foreign withdrawals from the Budapest banks it was again necessary to impose a partial moratorium on external obligations and to declare three days' ‘bank holiday’. In the same month a leading Swiss bank had to be rescued by a take‐over. In contrast, French banks were generally in a strong position by the end of the 1920s, and largely avoided the crisis of 1929–31, with only mild failures, largely confined to mixed banks, in 1930–1.

Disintegration of the Gold Standard

Almost immediately after Germany abandoned the gold standard the British pound was under pressure. The timing suggests that this was not the same process by which panic spread from Austria to Germany. German banks enjoyed a month of normal operation after the failure of the Creditanstalt. They felt pressure only after a delay and—we presume—from a new set of depositors. British banks had no such interlude. There was no internal drain. Pressure on the pound began as soon as the mark was restricted. Sales of sterling increased steadily after 14 July, and the Bank of England raised Bank rate on 22 July. The British troubles were accentuated when the standstill agreements froze some £70 million of British bankers' loans to Germany.

Although the banking crisis on the Continent had added to Britain's problems by simultaneously provoking a flight from sterling and freezing her foreign short‐term assets, the extremely weak balance of payments position on both current and capital account was arguably a more fundamental cause of the inability to sustain the gold standard. Britain's external financial position in the 1920s was undermined by several factors. On the current account these included the abrupt transwar collapse of export markets for coal, cotton, and other staple products; the forced sale of a substantial fraction of her overseas investments to help meet the costs of the First World War; the overvaluation of sterling as a result of the decision to return to gold at the pre‐war parity of $4.86; and the adverse impact on her traditional Empire and Latin American markets of the calamitous fall in primary product prices in the late 1920s.

(p.41) The capital account was a further source of weakness because Britain had attempted to maintain her pre‐1914 role as an exporter of long‐term capital to the developing countries, but in the 1920s could no longer achieve this by means of a surplus on current account and was forced to offset the outflow by substantial borrowing from abroad. However, much of the capital attracted to London was short‐term, leaving Britain very vulnerable to any loss of confidence in sterling. The increasing deficits on the current accounts of Australia and other primary producers who normally held a large part of their reserves in London compelled them to draw on these balances, thus further weakening Britain's position. By mid‐1930 the United Kingdom held about £175 million in gold and foreign exchange reserves, and this could be supplemented by other liquid assets of approximately £150 million. Since the corresponding short‐term liabilities amounted to roughly £750 million, Britain's defence against withdrawals was adequate only as long as confidence in the pound remained high.5 When confidence drained away in the course of 1931 Britain could no longer cope with the pressure from foreign liquidation of sterling assets and, despite assistance from France and the USA in July and August, was forced to capitulate. On 20 September the Government announced that it had become necessary to suspend for the time being the operation of the clause in the Gold Standard Act of 1925 which required the Bank of England to sell gold at a fixed price.

As so often in the economic developments of the inter‐war period, the history of the recent past played a critical role in shaping the attitudes which determined the course of events. Foreign concern about the scale of Britain's budget deficit had increased markedly with the publication of the Report of the May Committee in July 1931, and was the paramount reason for the final collapse in confidence in sterling. As Sayers (1976: 390–1) observed, it is difficult today to understand this obsession with the deficit given ‘the relatively trifling sums under discussion’:

The explanation lies . . . in memories of the currency disorders of the early twenties, which were, after all, less than ten years behind. In those troublesome times it had become accepted doctrine that an uncorrected budget deficit is the root of forced increase in the supply of money and depreciation of the currency, and that such depreciations become almost if not quite unmanageable. This view was not a mere academic fetish: it permeated the atmosphere in all financial markets . . . The Bank [of England] itself, in all the advice it tendered to the struggling central bankers of recovering Europe, year after year preached the gospel. It was not to be wondered (p.42) at, that in 1931 the physician should be expected to heal himself—and that when he seemed unwilling to set about it, his life should be despaired of.

Even so, it has been argued (as Balderston does in Chapter 5) that the suspension of the gold standard was not inevitable and could have been averted if the authorities had been more resolute in their defence of the parity adopted in 1925. This would have required a much more aggressive policy to raise interest rates and reduce the level of domestic activity. Such a policy might have involved severe damage to employment and enterprise, and perhaps to political stability, but if firmly implemented would have shown speculators that the United Kingdom was determined to maintain the gold standard. However, international economic organization is intended to be a means to an end, not an end in itself, and it is not surprising that the British Government was ultimately unwilling to perist with its commitment to the gold standard regardless of the cost exacted in terms of lost output and increased unemployment.

In considering the factors underlying Britain's departure from gold much contemporary and subsequent British comment attributed considerable significance to the undervaluation of rival currencies, especially the French franc, but recent research has shown that the importance of this factor was considerably overstated. It was not the exchange‐rate policy which was the basis for France's prosperity at the end of the 1920s, or for her successful resistance until 1931 to the slump from which almost all other countries suffered so grievously. Indeed the share of French exports in GDP was actually falling after 1927. Instead the strength of her economy should be attributed primarily to the ‘crowding in’ effect of Poincaré's fiscal policies, which induced an upsurge in domestic investment. Similarly in the case of Belgium, export growth on the back of a depreciated currency was not maintained after 1926, and the main sources of prosperity are to be found in the domestic economy associated with the expansion of the banking sector (Eichengreen and Wyplosz, 1990; and the analysis of the Belgian case in Chapter 7 by Cassiers).

The Bank of England, after an initial delay to rebuild its gold reserves, sharply reduced interest rates in 1932. As in Germany, British monetary authorities continued for a time to advocate gold‐standard policies even after they had been driven off the gold standard. But while the grip of this ideology was strong in the immediate aftermath of devaluation, it wore off within six months. British economic policy was freed by devaluation, and monetary policy turned expansive early in 1932. But the British devaluation was hardly the basis for international co‐operation. The British did not seek international leadership; instead they backed into devaluation, arguing they had no alternative. And while many smaller countries followed the British lead, the other major financial centres sought instead to protect themselves (p.43) from British policy. The British devaluation was a good policy—it broke the suffocating grip of the gold standard on economic policy—but it did not point the way toward international co‐operation.

By the time Britain was forced to abandon the gold standard seven other countries, including Australia, New Zealand, and Argentina had already done so. After her departure twenty‐four other countries followed rapidly, including Sweden, Denmark, Norway, Finland, the Irish Free State, Greece, and Portugal. As a British writer noted mournfully (Waight, 1939: 1): ‘If the foundations of the citadel of financial probity were unsound and the structure about to tumble, other centres could not remain for long unaffected.’ In many other countries there was no formal suspension but the gold standard was made ineffective by the imposition of a range of exchange controls and restrictions. This applied ultimately to Germany, Austria, Hungary, Bulgaria, Czechoslovakia, Romania, Estonia, and Latvia (Brown, 1940: 1074). By the middle of 1932 the institution which had been generally accepted as the best guarantee of international stability, trade, growth, and prosperity had completely shattered. In Europe only France, Belgium, the Netherlands, Switzerland, Italy, Poland, and Lithuania remained on the gold standard, and only the first four of these were truly committed to its spirit, refraining from the imposition of exchange controls and allowing relatively free movement of gold. The inability to make the gold standard function successfully in the inter‐war era was widely regarded as a symbol of failure even though the actual consequences for the real economy were largely highly favourable. Those countries which remained committed to gold did much less well subsequently than those which abandoned it (Eichengreen and Sachs, 1985).

At the same time as the gold standard was disintegrating there was also a renewed outbreak of tariff warfare provoked by the deterioration in economic conditions and by the introduction of the Smoot—Hawley tariff in the USA in 1930. Britain finally abandoned her long‐standing commitment to free trade, and a temporary measure in late 1931 was followed a few months later by an Act imposing duties on almost all imports of manufacturers. Numerous countries—including France, Italy, the Netherlands, Norway, Spain, Portugal, and Greece, and many others outside Europe—increased their tariffs in a desperate attempt to protect themselves from the deepening depression and the collapse of any attempt at international co‐operation. In the judgement of the League of Nations (World Economic Survey, 1932/3: 193–4):

There was probably never any period when trade was subject to such widespread and frequent alterations of tariff barriers. . . . Currency instability has led into a maze of new protectionist regulations and private trading initiative generally has given way to administrative controls.

(p.44) The financial panic also spread from Britain to the USA, jumping instantaneously over the Atlantic Ocean in September 1931. Bank failures rose, and the Federal Reserve banks lost gold. There were both internal and external drains. In one of the most vivid acts of poor monetary policy in history, the Federal Reserve raised interest rates sharply in October to protect the dollar—in the midst of the greatest depression the world has ever known. This was not a technical mistake or simple stupidity; this was the standard response of central banks under the gold standard. It shows how the ideology of the gold standard transmitted and intensified the Great Depression. The pressure against the dollar eased, but the American economy accelerated its decline. The Federal Reserve Bank had chosen international stability over domestic prosperity. The result was intensified deflation and accelerated economic decline. Unlike Britain, which arrested the decline in 1932, the USA had to wait an additional painful year. This delay was not only costly for America; it added to the deflationary forces in Europe, delaying European recovery as well.

The Banks in the Depression

Spain stands as the prime example of a country that avoided the worst excesses of the Great Depression by staying off the gold standard (Choudhri and Kochin, 1980). Spain tried to fix the peseta in the late 1920s as France and Italy stabilized their currencies, but the deflationists lacked the political muscle. The government continued to run deficits which were monetized by healthy banks. There was a run on Spanish banks contemporaneous with the failure of the Creditanstalt in Austria. Martín‐Aceña (see Chapter 20) cites internal causes, but the peseta was under pressure as well. Very few banks failed, and the experience is not thought of as a panic. The Bank of Spain acted as a lender‐of‐last‐resort, enabled to do so by two factors. The banks held large portfolios of government debt that could be sold for cash. And, unlike the Reichsbank, the Bank of Spain was not bound by the inflexible standards of the gold standard. It did have to raise Spanish interest rates to protect the value of the peseta, but it continued to lend freely—as Bagehot advised (Tortella and Palafox, 1984).

In Greece and Portugal the impact of the economic depression was relatively mild, and with minor exceptions the banks in each of these countries came through the period in reasonably good health (see further Chapter 18 by Dertilis and Costis and Chapter 19 by Reis). Where banking failures occurred in these and other countries it typically owed more to their involvement as universal banks with unsound or loss‐making industries than to inherent financial difficulties. In Greece, as in Britain and other countries in which mixed banking was not the normal practice, the banks were much better able to sustain their liquidity and solvency, although problems were (p.45) aggravated where the central bank was unable or unwilling to act as lender‐of‐last‐resort (Mazower, 1991).

There were no general banking crises in Italy and Poland, even though they were on the gold standard. Differences in banking policy between them and others on the gold standard may well be the cause of the difference in financial outcomes between them and other, less fortunate countries. On the assumption that the direction of causality runs in this way, it is tempting to ask if Austria and Germany could have adopted the Italian and Polish policies. The Credito Italiano, one of two large German‐style universal banks in Italy, found itself illiquid in 1930 as the economic downturn began. A holding company was formed to take the industrial assets of the bank, disguising its universal character without changing the fundamental financial status of the bank. This cosmetic change was not enough to deal with the problem. More action was needed at the start of 1931. The government reached an agreement with the Credito Italiano in February 1931, in which the bank gave up its holding company and its investment activities in return for a substantial grant of money from the government. The Credito Italiano was transformed from a universal bank to a commercial bank, but it was not allowed to fail.

The other ‘German’ bank needed help later in 1931. A similar agreement was reached with the Banca Commerciale in October. In return for an even larger infusion of cash, this bank too allowed itself to be restricted to short‐term activities. The banks were transformed. The Government became actively involved in the finance of industry. But there was no banking crisis (Toniolo, 1980). Secrecy was absolutely critical to the success of this policy. Depositors did not panic or move into cash; they did not spread difficulties from bank to bank in a contagion of fear. The lira was not subjected to unusual pressure. The policy decisions had been undertaken by a small group of men, and word of them did not filter out to the financial community. This secrecy was possible in the Fascist Government that ruled Italy. We can all speculate on the reasons why the secrecy did not result in the kind of self‐serving policies often associated with this kind of restricted decision‐making (see Chapter 10 by Toniolo).

In Chapter 13 Landau and Morawski reveal a similar, although less spectacular, story in Poland. There was no secrecy, and there were no secret agreements in the face of collapse. Instead there was a gradual state take‐over of troubled private banks. The first test of Polish banking policy came in 1925 as the result of an agricultural crisis. The State responded by taking over banks in difficulty. Another crisis came in 1929, at the start of the economic downturn. The world agricultural crisis caused prices to fall in Poland, threatening banks who had loaned on the security of crops. Again, the Government stepped in and took over troubled banks. A third crisis in 1931 followed the failure of the Austrian Creditanstalt, in which the (p.46) pattern of government expansion continued. Private banks held 40 per cent of Polish deposits and investments in 1926, but only 20 per cent by 1934. The Polish policy was not undertaken by a small group of secret financiers; it was not composed of a few large grants to banks. It was instead a policy‐stance extended to a large number of banks over a period of years. Its effectiveness came from the knowledge of its existence, that is, from the government's commitment to keeping credit markets stable.

Italy and Poland, therefore, were similar in the inter‐war period in that their governments directly supported banks in trouble. The form in which this overall policy was implemented was vastly different—almost diametrically opposite—in the two countries. But government take‐overs were common to both. Their common policies contrast sharply with those of Austria and Germany, in which failing banks were merged with other banks. This was a far less effective measure because the amalgamated banks then found themselves in trouble. It would be comforting to report that Italy and Poland were spared the worst excesses of the Depression as a result of their banking policies. But such was not the case. These countries were on the gold standard, and the gold standard was the primary transmission mechanism of the Great Depression. Unlike Spain, Italy and Poland experienced both deflation and falling production at about the rate of other gold‐standard countries (Bernanke and James, 1991; and Chapter 2 by Jonker and van Zanden). Only by breaking the ‘golden fetters’ of the gold standard, to use Eichengreen's term, was it possible to break the deflationary spiral (Eichengreen, 1992).

The End of the Contraction

Unhappily, it took a change of leadership to bring about a change in the policy regime. We can now see that restoration of the post‐war gold standard was the problem not the solution in the 1920s, because it imposed monetary constraints which prevented the authorities from taking the action necessary to contain the banking panics and failures. These crises amplified relatively modest initial disturbances and undermined the financial stability of the leading centres. However, in the inter‐war period the ideology of the gold standard was very strong, and it was extremely difficult for leaders to abandon it in this time of crisis. Not recognizing that this ideology was a large part of the problem, they instead held on to it as a drowning man holds on to a life raft. Alas, these ‘golden fetters’ only forced the European economy further under water. Only when national economies were freed of these constraints could the economic contraction be halted.

The change in policy regime can be seen most clearly in the USA. The Hoover administration followed a policy that became more orthodox over time. It was highly traditional in its support for the gold standard and its (p.47) focus on efforts to bolster the credit markets rather than the economy directly. Although not initially deflationary, Hoover drew exactly the wrong lesson from the currency crisis of 1931 and became a strong deflationist. The Federal Reserve maintained a passive stance in the early stages of the Depression, replaced by active contraction in response to the run on the dollar in 1931. The Federal Reserve's steps toward expansion in March to July of 1932 were halted when the open‐market purchases alarmed other central banks, and threatened the solvency of member banks by lowering the returns on bank portfolios (Epstein and Ferguson, 1984). The Glass–Steagall Act of 1932 reiterated support for the gold standard at the same time.

It was not clear during the presidential campaign of 1932 that Roosevelt would implement a change of policy regime. He had recently raised taxes in New York to balance the state budget, and he emphasized a balanced federal budget as well. He strongly criticized Wall Street, business, and utilities during the campaign and employed a generally anti‐business rhetoric. These were not features of a candidate one would expect to help the business environment.

The first sign that a new policy regime was on the way came after the election, in December 1932, when Roosevelt torpedoed Hoover's efforts to settle war debts and reparations multilaterally, signifying his opposition to continuation of the existing meagre international financial co‐operation. A change in regime became more tangible in February 1933, when the President‐elect began a serious discussion of devaluation as part of an effort to raise commodity prices. This talk led to a run on the dollar and helped cause the bank holiday in March. The New York Federal Reserve Bank found its gold supplies running dangerously low at the start of March. It appealed to the Chicago Federal Reserve Bank for help. But the Midwestern bank refused to extend a loan to its New York cousin, its different view of the world echoing the contrast between the German and French attitudes when the Reichsbank appealed for a similar loan in July 1931. The New York Fed then appealed to Roosevelt to shut down the entire national banking system, a draconian way to force co‐operation among the Federal Reserve banks (Wigmore, 1987).

Once inaugurated, Roosevelt responded by declaring the bank holiday. He also imposed controls over all foreign‐exchange trading and gold exports. He ended private gold ownership and took control over the sale of all domestic gold production. These controls allowed Roosevelt to avoid speculative disequilibrium when he began to devalue the dollar. He did so in April when he announced that he would support the Thomas amendment to the Emergency Farm Mortgage Act of 1933; this allowed him to set the price of gold. At the same time he prohibited the private export of gold by executive order. The dollar, freed from its official value, began to fall. It (p.48) dropped steadily until July, when it had declined between 30 and 45 per cent against the pound (Federal Reserve System 1943: 662–81).

The clarity of the change in policy was unmistakable. The USA was under no market pressure to devalue. Despite the momentary pressure on the New York Fed, the USA held one‐third of the world's gold reserves, ran a chronic foreign trade surplus, and dominated world trade in modern manufactures like automobiles, refrigerators, sewing‐machines, and other consumer durables. The devaluation was a purely strategic decision that appeared without precedent. Orthodox financial opinion recognized it as such and condemned it. Senator Carter Glass called it an act of ‘national repudiation’. Winthrop Aldrich, the new chairman of the Chase National Bank, thought devaluation was ‘an act of economic destruction of fearful magnitude’ (Temin and Wigmore, 1990). This was a change of regime of the type described by Sargent in his account of the end of several hyperinflations (Sargent, 1983). It was a dramatic change, clearly articulated and understood. It was co‐ordinated with fiscal and monetary policies. The new regime clearly was designed to increase both prices and economic activity. It was supported by a wide degree of consensus—professional, public, and congressional—despite the vocal opposition of some financial leaders. The remarks by Aldrich and Glass show that the shift in regime was clearly visible. They represent, however, only a minority opinion identified with the previous, failed regime. Aldrich himself quickly joined the bandwagon and became an enthusiastic proponent of the New Deal.

As with the British devaluation, the US action was the key to breaking free of the deflationary policies of the gold standard. It also was a national decision, taken without consultation or co‐operation with other nations. Sequential devaluation was the best policy in the circumstances, but it was hardly a co‐ordinated international response to the economic crisis. Devaluation was only one dimension of a multifaceted new policy regime. During Roosevelt's First Hundred Days, the passive, deflationary policy of Hoover was replaced by an aggressive, interventionist, expansionary approach. The New Deal has been widely criticized for internal inconsistency (Hawley, 1966; Lee, 1982). There was, however, a steadily expansionary bias in policy that added up to a marked change from the Hoover administration (Temin and Wigmore, 1990).

The story is similar, although not as clear‐cut, in Germany. Chancellor Brüning was replaced by Papen in late May 1932. The Lausanne Conference effectively ended reparations and cleared the major political hurdle from Germany's path. Brüning's deflation was replaced by Papen's first steps toward economic expansion. Brüning had initiated a small employment programme that had little effect in the context of his deflationary policy regime. This programme was expanded by Papen and complemented by some off‐budget government expenditures. In addition Papen introduced tax (p.49) credits and subsidies for new employment (Hardach, 1980). These were steps in the right direction, but they did not alter the perception of the policy regime. They still appeared to be isolated actions, not regime shifts.

The new policy measures (like the Federal Reserve's open‐market purchases earlier that year) nevertheless produced some effects. There was a short‐lived rise in industrial production and shipments. The recovery was only partial, and the data are mixed, but there was a definite sign of improvement (Henning, 1973). These tentative results seem to have had an immediate political impact as well. The Nazis had leapt to prominence in the 1930 election and increased their seats in the Reichstag from 12 to 107. They then doubled their large representation in the Reichstag in the election of July 1932. But that was their high point in free elections. They lost ground in the second election of 1932, in November, garnering 33 per cent instead of 37 per cent of the vote and reducing their representation in the Reichstag from 230 to 196 seats (Hamilton, 1982; Childers, 1983).

Further economic improvement could well have reduced the Nazi vote even more. If so, we need to ask whether the recovery begun under Papen could have continued. For if it had, then the political courage to hold out a little longer with the Papen or Schleicher Governments might have spared Germany and the world the horrors of Nazism. The question then is not simply about the recovery. It is also whether Germany—and hence the world—was balanced on a knife‐edge in 1933 between the continuation of normal life and the enormous costs of the Nazis.

There is, however, only a slim case for believing that the recovery could have been sustained. The instability of politics mirrored the instability of the economy. The policy regime was in the process of changing, but there was no clear signal of change like the American devaluation. There was no assurance that Papen's tentative expansionary steps would be followed by others. The recovery of 1932 consequently was neither sharp nor universal. Even though a trough can be seen in some data, other series show renewed decline into 1933. The economy fell back to its low point in the brief Schleicher administration, and it appeared that the Papen recovery was abortive.

For Nazism to have been a transitory aberration, the recovery would have had to resume in early 1933. It would have had to be strong enough to repair the damage to the political fabric caused by the social and political effects of extensive unemployment. The expansive policies already undertaken would have had to have further effects—which they probably did—and the American recovery would have had to spill over into Germany. Both factors are possible but neither was very strong, and the latter in addition could not have come for several months. One can argue that the future course of the German economy under elected governments would have limited the Nazis to continued minority status, but it is harder to argue that it would have led to a rapid decline in Nazi support.

(p.50) Hitler was appointed chancellor at the end of January 1933, and sustained economic recovery began only thereafter. The advent of the Nazi Government heralded the presence—as in the USA—of a new policy regime. Instead of focusing on the clear political discontinuity in 1933, we need to expose the clear change in economic policy. The Nazi Government was truly a new (and horrible) regime, both politically and economically. The Nazis set out immediately to consolidate their power and destroy democracy. They obliterated democratic institutions. They turned away from international commitments to the restoration of domestic prosperity. And they gave their highest priority to the reduction of Germany's massive unemployment. Hitler conducted a successful balancing act. He reassured businessmen that he was not a free‐spending radical at the same time as he expanded the job‐creation programmes and tax breaks of his predecessors. The first Four‐Year Plan embodied many of the new measures and gave them visibility as a new policy direction (Guillebaud, 1939).

Employment rose rapidly in 1933 as a result. The new expenditures must have taken time to have their full effects. The immediate recovery therefore was the result of changed expectations when the Nazis took power. It was the result of anticipated as well as actual government activities. Even though the specifics of the Nazi programme did not become clear—in fact were not formulated—until later, the direction of policy was clear. Hitler had been criticizing the deflationary policies of his predecessors for years, and the commitment of the Nazis to full employment was well known. As in the USA, a change in policy regime was sufficient to turn the corner, although not to promote full recovery.

4. A Divided World

The World Economic Conference

President Herbert Hoover of the USA had imposed a one‐year moratorium on payments of reparations and war debts in an effort to avert the German crisis in July 1931. But the Hoover moratorium was not sufficient to end the German financial panic. A special advisory committee of the Bank for International Settlements reviewed economic conditions in Germany in late 1931 and found that the schedule for reparations payments established by the 1929 Young Plan was no longer feasible. The plan had expected trade expansion and recovery, not world‐wide depression and the collapse of trade

The British Government led an effort to convene a conference to discuss reparations. German Chancellor Brüning stated in January 1932 that Germany would seek complete cancellation of reparations at the upcoming (p.51) conference. The French vehemently responded that they would not easily cede their right to reparations. The British and the Italians supported the Germans, leaving the French nearly isolated. The USA remained uninterested in reparations but adamantly opposed war‐debt repudiation. Even in their last moments, reparations were a source of international discord. There was no international leadership and no co‐operation.

Brüning's January statement and its repercussions in other capitals delayed the conference, as did impending elections in France and Germany, since neither Government would be in a position to make concessions prior to elections. The delay contributed to the collapse of Chancellor Brüning's Government. Brüning had launched Germany on a programme of deflation to end reparations by demonstrating to German creditors that the nation could not pay. He had succeeded in destroying the German economy along with reparations, a truly Pyrrhic victory.

The Lausanne Conference finally opened in June 1932 with statements of national views, with the French opposing substantial concessions, and the Italians, British, and Germans favouring a ‘clean slate’. The proceedings at Lausanne were complicated by a disarmament conference concurrently meeting in Geneva, where the USA informed the United Kingdom and France that it would not allow European default on war debts while funds sufficient to cover the payments were being used for armament spending. The Germans expressed willingness to offer compensation, but they wished to avoid mention of the word ‘reparations’. The British and the French favoured a clause linking reparations with an American war‐debt settlement. Germany objected to the American argument that there was no link between the two obligations, and that an agreement had to be definite and independent of America (Wheeler‐Bennett, 1933).

A breakthrough in negotiations led to the Lausanne Convention. An annexe to the agreement addressed the German reparations conflict, directing Germany to deposit bonds worth RM3 billion (£150 million) at the Bank for International Settlements. The bonds were to be issued by the BIS after a three‐year moratorium if Germany was judged to be capable of paying. The allocation of the bonds was to be settled in a future meeting of the creditors. (The bonds, never issued, were burned in 1948.) Beyond the issue of these bonds, Germany was permanently relieved of reparations obligations.

Another annexe of the Convention called for a World Economic Conference to address the remaining major international economic issues. The British Treasury had favoured a world conference since late 1930. France had blocked Britain's attempts to co‐ordinate an international economic conference in 1931, fearing both pressure to join in an artificial international redistribution of gold and German manipulation of the conference to obtain a reparations reprieve (Mouré, 1991). After the sterling devaluation of (p.52) September 1931 removed British pressure for gold redistribution, and the Lausanne Conference of June 1932 ended German reparations, these two obstacles to co‐operation had been surmounted.

The French and British asked President Hoover to postpone the December 1932 war‐debt payment, but Hoover refused. France and several other European nations defaulted on the instalment, and the English paid by earmarking gold in the Bank of England, angering American public opinion and increasing President‐elect Roosevelt's determination to keep war debts off the agenda for the World Economic Conference. Despite agreement to end reparations with the face‐saving bonds held by the BIS, war debts remained as an internationally divisive issue. Neither co‐operation nor effective leadership was possible on the eve of the 1933 economic conference.

The Lausanne Convention had called for a committee of experts to meet in advance of the large conference to establish an agenda. The British staked out a position requiring higher prices and recovered trade as conditions for a stabilization agreement. The French cautiously guarded their continued adherence to the gold standard, which remained free of attack, and their trade barriers that provided protection from depreciated currencies. The Hoover Administration, represented at the meetings of the experts, sympathized with the French arguments, while Roosevelt, initially unsure, eventually drifted towards the English policies (Eichengreen, 1992).

Roosevelt was inaugurated as president at the beginning of March 1933. He invited representatives of fifty‐three nations to the USA in April for preliminary discussions. But while the representatives of France and Britain were in transit to Washington, Roosevelt approved the Thomas amendment to the Agricultural Adjustment Act, allowing him to devalue the dollar. The US position had undergone a radical shift, making fruitful negotiations difficult if not impossible.

The Washington negotiations focused on war debts, a tariff truce, and monetary stability. The war‐debt talks resolved nothing, and the tariff truce was blocked by stiff resistance from the French, who insisted on currency stabilization agreements, especially of the dollar. The Americans proposed a common fund to stabilize the major currencies, with the dollar devaluation limited to 15 per cent. The French delegation avoided a negative response to this proposal, but they also withheld approval because they feared that the British would object to a 15 per cent dollar devaluation and because they were unwilling to support the USA without knowing US economic policy. Feis recalled that while Roosevelt was sincere in the offer, he was actually relieved that his own proposal fell through (Feis, 1966: 146).

As the conference approached, prospects for success grew ever dimmer. As the value of the dollar fell during May, Roosevelt became less interested in stabilization, reversing the co‐operative policies that he had advocated (p.53) during the Washington discussions. Meanwhile, the French Government conveyed to the US and British Governments its belief that exchange stabilization was a prerequisite for success in London. ‘The French sought not recovery, but security, in a world over which they exercised little control’ (Mouré, 1991: 99).

Early in the course of the conference a conflict emerged regarding whether a representative of the USA or of France should head the financial committee. The French were opposed to a representative of a non gold‐standard country presiding, and the Americans were opposed to a representative from a country that had defaulted on its war debts. The French completely defaulted on the 15 June war‐debt instalment, drawing no immediate retribution from the Roosevelt administration, but lessening Roosevelt's sympathy for French appeals for stabilization. The major industrial countries were moving away from, not toward, agreement.

Central bank representatives from Britain, France, and the USA decided in June that exchange stabilization was possible. Each agreed to buy and sell gold to keep their currencies within prescribed limits of 3 per cent either way. The provisions of the stabilization were to be kept secret, and the agreement was null if the details were made public. Declarations were prepared stating that the three governments intended to limit fluctuations of the dollar and sterling for the length of the conference, that stabilization on gold was the ultimate objective, and that they would avoid measures that might interfere with monetary stability.

Unfortunately, the news of dollar stabilization leaked to the press, and American markets responded quickly. The dollar strengthened and commodity and stock prices fell as investors anticipated a return to deflation. Roosevelt telegraphed his negotiators in London to reject the agreement, claiming that he did not wish to restrict his domestic policy options and that he was not certain at what level the dollar belonged. Roosevelt then left Washington for a sailing vacation, hindering communications with both Washington and London. After attempts to sway the president failed, Roosevelt's rejection was announced at the World Economic Conference, causing turmoil and intensifying speculation against the Dutch florin and the Swiss franc, but restoring the recovery of American markets.

After the collapse of this agreement, the French concentrated pressure on the British to stabilize and join the gold countries, warning of impending monetary anarchy in Europe. In response, the British asked for a currency declaration, which was quickly drafted and approved by the gold countries. To the consternation of the French, however, the British invited American participation in the agreement. The US representative revised the document until the only remaining points were a call for monetary stability, recognition that an eventual return to the gold standard was desirable, and a statement that individual nations would take action to avoid speculation. (p.54) He advised Roosevelt to accept the document, fearing that the USA would be held responsible for the collapse of the conference. Roosevelt none the less sent a rejection to London on 1 July. His infamous ‘bombshell’ message was released to the conference and the public on 3 July. The message, loaded with inflammatory rhetoric, accused the stabilization discussion of interfering with the real issues that the conference should address. In Roosevelt's words: ‘The world will not long be lulled by the specious fallacy of achieving a temporary and probably an artificial stability in foreign exchange on the part of a few large countries only. The sound internal economic situation of a nation is a greater factor in its well‐being than the price of its currency’ (Nixon, 1969: 269).

Roosevelt later admitted that the message was too heavy in rhetoric, but several economists agreed with his general argument; Keynes even said that Roosevelt was ‘magnificently right’ (Feis, 1966: 238). None the less, much of the logic of Roosevelt's message was contorted. His concerns about a US gold drain were offset by the American possession of one‐third of the world's gold reserves. His qualms about only two or three nations stabilizing were contradicted by the fact that the rest of the world would stabilize in terms of the dollar, franc, and pound. And the distinction between governments and central banks he stressed was essentially irrelevant in considering a stabilization agreement. The central message that domestic conditions needed to be given priority was correct.

The failure and collapse of the World Economic Conference traditionally is attributed to Roosevelt's bombshell message. But the conditions for international economic co‐operation were not present in mid‐1933. Each of the major countries had its own view of the economic crisis and was trying to formulate its own remedies. Instead of initiating international co‐operation or leadership, each of the major European industrial and financial powers would become the centre of a currency and trading block of its own.

The Sterling Area

Once Britain had devalued, the pressure to follow suit was especially great among countries with export‐based economies for whom the United Kingdom was the primary market. Denmark, Sweden, Norway, and Finland followed Britain off gold, but did not immediately peg to sterling. By January 1932 Japan, Venezuela, and Bolivia were adopting policies that increasingly resembled basing on sterling. The countries that pegged to sterling between 1931 and 1933 formed the sterling area, composed of the colonial Empire and India, the Dominions excluding Canada, some semi‐independent nations including Iraq and Egypt, and other foreign nations, particularly in Scandinavia (Drummond, 1981). The reasons for choosing to (p.55) link with sterling varied among these groups. India and the colonial Empire were compelled to do so by Britain; this was not unusual, as a sterling peg had previously been used to stabilize these currencies. Australia and New Zealand had already suffered exchange depreciation, and needed to link to sterling to retain competitiveness in the British market. South Africa, after initially trying to maintain its gold parity, was forced to devalue and peg to sterling for similar reasons.

Many smaller European and Latin American countries chose to link to sterling both because Britain was a primary export market and because they held large reserves of sterling for exchange transactions. The Brussels Conference of 1920 and the Genoa Conference of 1922 had encouraged holding foreign currency instead of gold, and unless these countries devalued and repegged to gold, they would suffer large capital losses on their sterling reserves. Just as there were multiple reasons for pegging to sterling, there were multiple mechanisms for maintaining this new parity. The currency board system implemented for the colonial Empire, Egypt, and Iraq provided an automatic relationship with sterling. A system of semi‐independence, in which the exchange rate was rigidly fixed and maintained through large sterling reserves, was maintained in India, Australia, New Zealand, South Africa, and Portugal. The third policy, an autonomous system of maintaining a target sterling parity without holding large sterling reserves, was attempted in Scandinavia (Drummond, 1981).

The British Government studiously avoided encouraging countries outside the colonial Empire and India to devalue or to peg to sterling because it wished to avoid responsibility for other nations' difficulties. Even though Britain avoided formal arrangements, it supported nations that voluntarily committed to the sterling area. In December 1931 the Bank of England provided a credit of £500,000 to the Bank of Finland, which was trying to maintain sterling parity through exchange controls. In the same month a credit of £250,000 was granted to Denmark. Throughout the 1930s Australia received sizeable credits which, while never used, demonstrated British willingness to stabilize exchange rates within the sterling area.

Soon after the devaluation of sterling in September 1931 British Treasury officials began to consider a monetary policy for the Empire. The British authorities shared the opinion of the leaders of the Empire that prices were too low, but they feared that the Empire countries might promote inflationary programmes of deficit monetization, public works, and deliberate credit expansion which could potentially destabilize sterling. In early 1932 the discussion of Empire monetary policy developed into preparations for the coming Ottawa Conference.

In the 1932 Ottawa meeting, the monetary policy issues of the conference were confined to a committee through which the British advanced their policies, reassuring the Dominions and India that monetary policy would be (p.56) directed towards higher prices and recovery, but avoiding discussion of stabilization. The primary discussion at the Ottawa Conference considered trade agreements. In February 1932 the National Government of the United Kingdom had supported the Import Duties Act, a ‘10 per cent duty on all goods except basic foodstuffs, raw materials, and goods already subject to duty’ (Howson and Winch, 1977: 98). The Ottawa Conference extended the British system of trade protection, granting preferential access to the British market to Commonwealth producers and giving preferential access to Commonwealth markets to British producers. The Commonwealth countries were unwilling to take any measures which would harm their emerging manufacturing industries, and despite her initial expectations the agreement did little to help increase Britain's sales of manufactured goods. It did, however, bring about a considerable shift in the direction of trade between Britain and the Commonwealth, at the expense of other countries. In 1929 Britain sold 51 per cent of its exports to the Commonwealth and the sterling area, and bought 42 per cent of its imports from these sources. By 1938, 62 per cent of her exports and 55 per cent of imports involved these countries.

When the World Economic Conference ground to a halt following Roosevelt's attack on attempts to stabilize currencies, the formation of the gold bloc led by France, with its intention of deflating world prices, caused alarm among the primary producing nations of the sterling area; they feared that the British might join the gold bloc. The Chancellor of the Exchequer's response was to reaffirm his commitment to cheap money and higher prices, but also to express concern that Europe, which eventually must abandon gold, should not fall apart in chaos during the conference (Drummond, 1981: 176–7). The British Commonwealth Declaration was signed on 27 July 1933 resolving to raise prices, to ease credit and money except for monetizing government deficits, to eventually restore the gold standard, and to keep exchange rates stable within the sterling area. The declaration succeeded in quieting talk of public works and further depreciation in the Empire, in distracting attention from the general failure of the World Economic Conference, and in reaffirming the Ottawa agreements.

As the dollar became more unstable and the USA did little to encourage pegging to the dollar, this declaration formalizing the sterling area made it a more attractive option for countries seeking to stabilize their exchange rates. Denmark, Sweden, and Argentina formalized their sterling pegs soon after the British Commonwealth Declaration. Norway had officially pegged to sterling in May 1933, having devalued 9.5 per cent from the sterling gold parity rate (see further Chapter 17 by Nordvik). From late in 1933 to 1938, the sterling to dollar exchange rate was reasonably stable, meaning that a large part of the world enjoyed five years of exchange stability. Following devaluation of the franc in September 1936, France associated with the (p.57) sterling area by trying to maintain a fixed sterling rate, much as the Scandinavian countries had from 1931 through 1933. In late September both Greece and Turkey devalued slightly and pegged to sterling, and Latvia moved from a franc peg to a sterling peg with a substantial devaluation.

The cheap credit policies of Britain allowed the sterling system to accommodate the cheap money policies of Scandinavia, Australia, South Africa, and other devaluing nations. London facilitated the operation of the system by supplying sterling‐area nations with the sterling reserves they needed. The stability of the pound throughout the decade encouraged a willingness to hold sterling balances, and the combination of increased production from South African mines and dishoarding in India supplied gold to the sterling area, ensuring convertibility. While British policy could not create the international co‐operation necessary to initiate world‐wide recovery, recovery was possible for any nations that wished to join the sterling area.

The Nazi Trading Area

After the banking and currency crises of July 1931, the German Government allowed banks to reopen only after freezing foreign deposits and limiting foreign‐exchange transactions to the Reichsbank. These initial exchange controls were ineffective, and were replaced in September, after the sterling devaluation, with more stringent controls. These required owners of gold and foreign assets to sell them to the Reichsbank, restricted the amount of foreign exchange available to importers, and required exporters to surrender their foreign exchange proceeds to the Reichsbank (Ellis, 1941).

Following the devaluation of sterling, foreign advisers advocated a German devaluation to restore equity in international markets, possibly in conjunction with joining the sterling area. The maintenance of the gold‐standard parity hurt exporters, especially as other nations devalued and protectionism increased, but depreciation of the mark was avoided. Historians differ on the question of whether another choice was possible. Those who say no point to the association of depreciation with the hyperinflation of the 1920s (Borchardt, 1984, 1990). Others point to the British example of successful devaluation (Temin, 1989). By contrast, the bilateral trading agreements that the Germans pursued offered the trade balance advantages of devaluation while giving the government control over the composition of imports and providing an instrument for international diplomacy (James, 1986).

In January 1933 Adolph Hitler and the Nazi Party came to power in Germany. Many of the Nazis' policies, including exchange control, work‐creation projects, government intervention in banking, and agriculture (p.58) intervention were inherited from the Weimar Republic. Germany had always had a high degree of government involvement in the economy and in foreign trade policy. But the Nazis used terror, the threat of concentration camps and possible death, to enforce compliance with economic controls, including exchange and trade controls (Temin, 1991).

The deterioration of world trade in the 1930s was magnified in Germany by the devaluations of sterling and the dollar, by the rise of protectionism, and by capital flight resulting from Jews fleeing persecution and from domestic and foreign response to Nazi policies (see further Chapter 3 below by Feinstein and Watson). For the short term, the response in 1934 was increased foreign‐exchange restrictions and a moratorium on interest payments on debt to foreigners. A long‐term strategy was devised with the New Plan of Hjalmar Schacht, the president of the Reichsbank and the minister of finance, which encouraged autarky by restricting imports and provided commodity boards to create greater administrative control of trade. In 1935 a scheme was initiated to extend subsidies to German exports that were not competitive on world markets because of the overvalued mark.

The trade policies of the Nazis, moving towards autarky, were unique among the Western economies because they were directed towards preparing for a war economy. German goals included military preparedness and administrative control over the domestic population, with politics taking precedence over economics. The price paid for this was fewer available import goods and increased labour intensiveness.

The Nazis initiated bilateral trade agreements that were to take several forms during the decade. One of the first systems was the private compensation procedure which created agencies that attempted to balance imports and exports by matching private exporters and importers to ensure offsetting trade. One characteristic of this system was the use of blocked marks, frozen funds held by foreigners and used at a discount to buy German exports. Through the use of blocked marks, German exporters could obtain higher prices in terms of marks for their products, and foreign importers purchasing these marks at a discount could purchase German exports at a lower price in terms of the foreign currency. Because this system was highly profitable for German exporters, its use was limited to ‘additional exports’, those goods that were not competitive in foreign markets due to the overvalued mark (Kitson, 1992).

A second, more flexible method was the bilateral exchange clearing system which attempted to balance credits and debits on a national level. The mechanism of this system was conducted through clearing accounts in the Reichsbank. German importers paid marks to the Reichsbank account of the trading partner, where the funds were held until they could be used to pay German exporters for goods sold to the other country. If the accounts (p.59) held insufficient funds, the exporters had to wait for imports to increase, and if there were excess funds, importers had to wait for increased exports. The central bank of the trading partner held similar clearing accounts for its exporters and importers. After the initial agreement with Hungary, arrangements of this type were made between Germany and Estonia, Latvia, Bulgaria, Greece, Yugoslavia, Romania, Czechoslovakia, and Turkey. While the details of each arrangement were different, all of these clearing agreements shared the common goal of opening trade controls to help export industries (Kitson, 1992).

The central banks of Germany's trading partners with clearing balances were forced to intervene to prevent the blocked marks from depreciating, which would decrease the competitiveness of the trading partner's exports in the German market. One alternative, pursued by Hungary and Bulgaria, two nations politically favourable to Germany, was to pay exporters in domestic currency for their holdings of blocked marks. A second alternative, pursued by Romania and Yugoslavia, two nations wary of German influence, was to allow the blocked marks to depreciate slightly until domestic importers purchased German goods and depleted the balance of blocked marks. Hungary, following the financing principle, experienced consistent trade surpluses with Germany, while Romania, following the waiting principle, experienced alternating surpluses and deficits. Germany's trading partners ‘found political opposition to Germany economically costly and acquiescence rewarding’ (Neal, 1979: 392).

Germany's trade with Western Europe, traditionally an area of export surpluses, was limited by the decline in international trade and the rise of exchange controls. Germany negotiated Sondermark agreements with Denmark, Switzerland, Sweden, Italy, France, Belgium‐Luxembourg, the Netherlands, Norway, Finland, Spain, and Portugal to preserve these valuable export markets. The Sondermark agreements involved partial rather than full clearing systems, with the establishment of clearing accounts for ‘additional trade’. Normal levels of trade were conducted according to foreign‐exchange quotas, and the special accounts for additional trade, the trade that developed beyond normal levels, operated in the same manner as the bilateral exchange clearing agreements between Germany and south‐east Europe.

In 1934 the ASKI (Ausländer Sonderkonten für Inlandszahlung) procedure was introduced, replacing the private compensation procedure which had been less restrictive and had been used to avoid strict exchange controls. The ASKI procedure established accounts at German banks where foreign exporters' proceeds were held. Foreign exporters needed to secure permission from German exchange control authorities to trade with Germany, with German imports limited to only those deemed necessary by the commodity control boards. ASKI balances could be used to purchase certain non‐essential German goods, but the goods had to be shipped to the (p.60) country of the account‐holder. Two types of ASKI accounts developed: accounts for individual foreign exporters, and accounts for foreign commercial banks which represented a group of foreign traders.

The New Plan also created a system of payment agreements with Great Britain, Belgium‐Luxembourg, Canada, France, and New Zealand. These agreements provided for the release of free foreign exchange to pay for imports and to transfer payment on old German debts. In addition, Germany agreed to import goods equal to a specified fraction of its exports to each country. The effect of the New Plan was to extend and develop the exchange controls of the early 1930s, replacing the ineffective ones with more stringent controls.

The exchange control system in place after the New Plan consisted of three different arrangements: the stringent ASKI agreements, the more moderate clearing agreements, and the more lax payments agreements. Germany's free trade was limited to only a small group of countries, including the USA, because the overvalued mark doomed Germany to a trade deficit where trading agreements were not in effect (Neal, 1979; Kitson, 1992).

Germany's bilateral trading agreements accounted for 50 per cent of Germany's trade by 1938. German trade with south‐east Europe is often overemphasized, as the Balkans bought only 7 per cent of Germany's exports in 1935 and 11 per cent by 1938. While these parts of Europe were regarded as prime areas for German economic and trade expansion, there was significant resistance to any kind of limiting relationships with Germany. Germany incurred trade deficits with most of her Balkan neighbours during the 1930s, and the largest German trade was conducted with Western Europe, Latin America, and the Middle East (Overy, 1982).

Kitson (1992) concludes that Germany sacrificed terms‐of‐trade advantages that could have been won from its position as monopolist in export markets and monopsonist in import markets. Other objectives replaced terms‐of‐trade gains, as isolation from the world market, reduced dependence on imports, and the reorientation of trade to safe, adjacent countries took precedence. According to Neal (1979: 392) ‘it was relatively costless, and often politically rewarding, for Germany to forgo the advantages of monopoly exploitation’.

While the United Kingdom, France, the Netherlands, and other economic powers increased trade within their empires, Germany, which had no empire, was forced to develop a currency bloc, altering its pattern of trade. German trade was reoriented in favour of southern and eastern Europe, the countries with which it conducted the stricter policies of ASKI and clearing agreements. As trade between Germany and south‐east Europe increased, these nations became more dependent on Germany for their markets for basic foodstuffs and raw materials. These countries were isolated in the (p.61) post‐Depression trade world, and Germany, paying prices 20–40 per cent above world prices for agricultural commodities, was the most attractive market. A trading bloc was effectively established, providing Germany with a dependable source of necessary commodities. Between 1929 and 1938 German exports to south‐east Europe rose from 5 to 13 per cent of total German exports, and her imports from this region rose from 5 to 12 per cent of the total (Kindleberger, 1973: 282). Although successful in reorienting German trade, the Nazi policies never made south‐eastern Europe one of Germany's major trading partners, and some of the increase which did occur was simply the re‐establishment of older trading patterns broken by the inflations of the 1920s and the Depression of the 1930s. Comparably, over the same period the share of German trade with the United Kingdom, France, the Netherlands, Belgium, and Scandinavia fell as these countries turned to the sterling area.

The Gold Bloc

The gold bloc of the 1930s had its origins in the Latin Monetary Union of 1865, in which the French, Belgian, and Swiss francs were established at equal parities (Kindleberger, 1973). In response to Roosevelt's message to the World Economic Conference and the turmoil that emerged in its aftermath, the representatives of France, Belgium, Holland, Switzerland, Italy, and Poland released a joint declaration that their governments would strive to maintain the gold standard and the stability of their currencies at their current parities, both to create a stable gold platform for the recovery of international exchange‐market stability and to promote social progress at home. Representatives of their central banks met in Paris, and on 8 July they pledged to support each other's currencies, reimbursing each other in currency or gold.

While the gold bloc was to develop a reputation for possessing ‘little cohesion and no organization’ (Mouré, 1991: 110), its initial declaration successfully ended the speculation against the Dutch florin and the Swiss franc that had persisted during the proceedings of the World Economic Conference. Despite this strong beginning, however, the gold bloc remained a symbolic organization. No progress was made in developing the connections between the central banks or the government policies of the member nations after the 8 July meeting.

Of all the trading blocs that emerged in the aftermath of the London Economic Conference, the gold bloc was the only one still constrained to follow the stringent deflationary policies demanded by the gold standard. The continuing efforts in these countries to hold their economies to this harsh course produced ever more economic declines. The commitment to the gold standard revealed by these actions in the presence of the beginning (p.62) of recovery in other countries was deep indeed. It is no wonder that this misguided ideological purity prevented international co‐operation and inhibited the emergence of leadership.

Within the constraints of the existing gold parities, countries had only two options to protect their trade balances: exchange controls and deflation. Among the central European nations, including the emerging Axis trading bloc, tariffs were supplemented by exchange controls, nominally leaving the countries on the gold standard but effectively rendering the system meaningless. The gold bloc regarded exchange controls as incompatible with the workings of the gold standard and completely against the spirit of the system. Continued deflation was its policy.

Czechoslovakia, a minor member of the gold bloc, devalued its currency in February 1934. Unemployment in Italy had risen to levels at which deflationary measures were no longer feasible. Mussolini placed pride in the stability and strength of the lira and was unwilling to devalue. Italy therefore gradually imposed exchange controls, maintaining only the illusion of retaining gold‐standard parity. In July 1935 the Italian Government prohibited gold exports. Not all the original members of the gold bloc could stand the strain of deflation for very long, as discussed in Chapter 6 by Asselain and Plessis.

The other gold bloc nations pursued policies of stringent deflation. The French had been successful in the early years of the decade in keeping their current account deficit small through trade barriers, but by 1933 the situation was steadily growing worse. The decline in economic activity was accompanied by lower government revenues, resulting in budgetary deficits that caused great alarm among the French populace who still bore the memory of the inflationary cycles of the mid‐1920s. The political effects of expenditure cuts and new taxes created a situation of turmoil in which there were four governments in 1932, three in 1933, and four in 1934. Even though the decline in prices left the real wages of pensioners, veterans, and government employees higher than their original levels, attempts to reduce fiscal expenditures by cutting payments to these groups were highly unpopular.

Within the gold bloc, the high prices resulting from the overvalued gold‐standard parities of the currencies discouraged trading among the bloc's members. French trade with Belgium decreased 13 per cent between 1933 and 1934, and French trade with Switzerland decreased by 40 per cent. To encourage trade among themselves, the gold bloc nations met in Geneva in September 1934 and signified their agreement to increase trade and tourism within the bloc and arrange another conference to meet in Brussels in October to discuss trade policy. Poland was not allowed to participate in either the Geneva or the Brussels conferences, ostensibly because its economy was structured differently from those of the other members of the gold bloc, but more likely because the other members were reluctant to (p.63) include a nation whose economy was in as desperate need of assistance as Poland's in 1934.

The Brussels conference convened in an atmosphere of pessimism and reluctance. The Italians were not interested in the conference and tried to use the absence of Poland as a pretext for postponing or cancelling the conference. Eventually Italy sent only one delegate to Belgium. The Dutch were reluctant to limit their preferential trade agreements to the members of the gold bloc. They favoured extending any trade barrier reductions to Germany and Britain, especially as they were concerned about German retaliation which might cost them the German steel market, one of their most important export markets. The Belgians, hosting the conference, were openly discussing devaluation, and there was speculation in the French Government that the Belgian Government wanted the conference to fail to provide justification for devaluation. France was constrained by limitations similar to those placed on the Dutch. While the French were interested in promoting the gold bloc, their most important export markets were in countries in other exchange blocs. The French were limited by most‐favoured‐nation trade agreements in the concessions that they could offer to their gold bloc trading partners.

The conference opened with the Italian and Dutch delegations expressing reluctance to reaffirm their countries' commitment to maintain the gold standard and their currency parities. Under French guidance the conference was brought to a close with an agreement for gold bloc countries to continue bilateral negotiations to allow for a 10 per cent increase in gold bloc trade by 30 June 1935. The conference therefore was successful to the extent that the gold bloc survived intact. But the results of the proposed negotiations were not the least bit encouraging for gold bloc unity. The French agreed in principle to increase Belgian trade, but the proposed 10 per cent rise was unattainable.

Belgium had been severely hurt by its loss of competitiveness in British markets with the sterling devaluation in 1931. In September 1934 the Belgian Government asked for French assistance, but neither loan arrangements nor proposals to lower French quotas on Belgian goods were enacted. In March 1935 the British Government limited steel imports, worsening Belgium's plight. In desperation, the Belgian Government reopened talks with France to seek economic assistance. Again, the French could not offer more than token relief. Returning from Paris essentially empty‐handed, the Belgian Government was forced to impose exchange controls. A new government devalued the Belgian franc on 30 March, repegging it 28 per cent lower at a level calculated to restore the prices of Belgian goods to the level of Britain and the USA (see further Chapter 7 by Cassiers).

When the gold bloc was officially declared in the aftermath of the World Economic Conference, French opinion was firmly opposed to devaluation of the franc as an alternative to deflation. As the disparity between the (p.64) recovery of countries with depreciated currencies and the stagnation of gold bloc countries became apparent, individuals within French political and journalism circles began to support devaluation, although public opinion remained strongly opposed. The primary danger to the franc was perceived to be the budget deficits that threatened to resurrect the debt monetization and the resulting inflationary cycles that had caused the economic chaos of the 1920s. Fearing these consequences, successive French governments struggled with programmes to reduce expenditure and augment decreasing revenues, but economic contraction and budget deficits persisted.

The Popular Front, a coalition of the Radical, Communist, and Socialist Parties led by Léon Blum, took office in June 1936 with a plan to restore economic growth with a French ‘New Deal’. Blum renounced deflationary policies, but did not devalue. France consequently suffered serious depletion of its gold reserves. The Popular Front introduced a shortened work‐week of forty hours without a reduction in wages, and it raised wages to stimulate consumption and ignite the economy. The Matignon Accords, which forced employers to sign a package of wage increases, were the Popular Front's solution to widespread labour unrest.

By mid‐1936, there was widespread support for devaluation among politicians, publicists, and banking and financial experts, but still not among the general populace. The opposition to devaluation during 1934 and 1935 had so effectively convinced the French public that devaluation would cause a return of inflation that this opinion persisted through 1936.

The Tripartite Agreement

As French gold losses mounted in the spring of 1936, Blum's Popular Front Government, whose appeal was largely based on its repudiation of deflation, was forced to make emphatic declarations that it opposed any change in the value of the franc. Even while Blum was defending the franc by publicly announcing that he would not devalue, his opinions were drifting in that direction and he privately began to explore the possibilities of an international accord to prevent competitive devaluation of the dollar or the pound in the event of a French devaluation. To defend the French gold reserves, the government was faced with a choice between deflation, devaluation, and exchange control. Deflation was eliminated as an option by its failure to achieve recovery, or even stability, during its many reincarnations in the first half of the decade. Faced with the choice between exchange control and devaluation, the financial and banking communities favoured devaluation as the lesser of two evils. Imposition of exchange controls would lead to French autarky, isolating France from its allies, the Western democracies. Exchange control was regarded as a fascist option, requiring extensive controls and administration, and severe penalties to be effective. (p.65) While many members of the right‐wing press and of financial circles favoured devaluation, the French public remained resolutely opposed, as were the Communist Party and many Radicals and Socialists.

The French Government's problem was unprecedented in the need to negotiate internationally before devaluing. Unlike the devaluations of the dollar and sterling, which were relatively simple, largely domestic decisions, the franc devaluation was jeopardized by the prospect of competitive devaluations or increased trade barriers in the devalued nations. The floating pound and the dollar were likely to respond to a change in the value of the franc.

The USA asked France in the summer of 1936 whether a joint American and British statement that the dollar and the pound would not depreciate in the event of a reasonable france devaluation would ease the process of lowering the value of the franc. The French opposed such a tripartite declaration as merely amounting to a unilateral devaluation, which the Blum Government could not readily accept after campaigning on the promise not to devalue. The British also did not want any commitment that would force them to support the franc and would link the pound to gold. They did not want France pegging to sterling; they wanted France to peg the franc on gold to allow continued British operations in francs. The British did express their willingness unofficially to keep the pound as stable as possible, while retaining control of the sterling rate, and in the spirit of co‐operation they agreed to devise some formula for the rates, preferably a meaningless one (Clarke, 1977).

France did not pursue negotiations immediately, expecting an improvement in the domestic situation, but the anticipated calm never developed. The government announced a 21 billion franc rearmament programme in September 1936 and proceeded to experience a massive gold outflow. France then responded by presenting a draft pre‐stabilization agreement to Britain and the USA. This called for nations to direct monetary policies toward maintenance of stability and consideration of the international effects of domestic policies. Washington and London objected to the excessive references to co‐operation and stability; they also disliked any reference to the gold standard. In addition, the USA objected to a reference to social classes, which would not be palatable to the American public, and to a formula for the French devaluation that would adjust the franc to world prices. The British were uneasy that the new French proposal did not clearly define the extent of the franc devaluation, which the Treasury feared might exceed 100 francs to the pound.

A revised French draft offered a compromise suggesting that the French and British co‐operate daily, allowing them to convert holdings of the other's currency into gold. This compromise was the basis of what became known as the 24‐hour gold standard. The two exchange authorities subsequently (p.66) agreed that each morning they would inform each other if they intended to engage in currency operations during the day. If they agreed on the operation and the rates that would be used, a gold price would be established at which currency could be redeemed for gold at the end of the day (Clarke, 1977).

The USA rewrote the second French proposal and submitted it to Britain and France on 19 September. The American version, which was to form the basis of the final agreement, retained flowery French allusions to peace and liberty, while offering reasonable dollar stability, accepting the French devaluation, and promising co‐operation with the French and British Governments. But with an agreement appearing imminent, an American confusion emerged to jeopardize the negotiations. The American officials had misinterpreted the British position on stabilization of currencies.

Washington informed London that the USA was interested in a $5 pound, plus or minus ten cents. US officials assumed that the British would consider it a reasonable level, as $5 had been the average rate for the past year while the British Exchange Equalization Account managed the exchanges. In fact, the British disliked the $5 parity, but had maintained that rate to avoid forcing devaluation of the franc and other gold bloc currencies. They immediately protested against the American message, claiming that no such agreement had ever been implied or arranged, and that there would be no stabilization of the dollar–pound exchange. To salvage the Tripartite Agreement, the Americans responded by agreeing to disagree: they retained the view that a $5 pound was appropriate, but were willing to concede the point to allow the announcement of the three declarations (Drummond, 1981).

The British, French, and American Governments released their Tripartite Declarations on 26 September 1936. A large fraction of the declarations was devoted to avowals of belief in peace, prosperity, increased living standards, and truth, beauty, and goodness that the French favoured. While the British were sceptical of this phraseology, the Americans took it seriously. Secretary of the Treasury Morgenthau believed that the declaration would be of value in restoring peaceful conditions to the world. More significantly, the declaration included the references to relaxing quotas and exchange controls that the British wanted, although France was not specifically mentioned, and the French did very little to lower trade barriers after the release of the agreement. The British agreed not to retaliate against the French devaluation, but there were no promises about rates because the British refused to constrain their domestic policy. The agreement also included announcements calling for increased co‐operation among the central banks and the equalization funds of the Tripartite Powers.

(p.67) The tangled negotiations needed to produce even this minimal agreement showed the tattered condition in which international organization existed at the end of the 1930s. Limited and partial co‐operation was possible among the three principal democratic powers with great strain, but more was unattainable. There was ‘little tripartite consultation and less co‐operation’ in the management of the franc after September 1936: ‘As far as France was concerned the tripartite understanding remained in existence only because Britain and the United States were prepared to ignore the way in which France ignored it.’ Much the same was true for sterling (Drummond, 1979, 1981). The French and British were too weak to provide effective leadership; the USA had turned inward, providing more of an obstacle than a stimulus to co‐operation. The prevailing spirit is vividly illustrated by the note in which the deputy governor of the Banque de France recorded the basis of the understanding reached in discussions with Britain leading to the Tripartite Agreement: ‘ni accord, ni entente, uniquement co‐opération journaliere’ (quoted in Sayers, 1976: 480). Germany and Italy remained outside even this limited agreement: they were not interested in co‐operation, nor welcome in international forums. A few of the smaller countries sought to respond to the invitation to co‐operate made in the British declaration; but nothing of any consequence followed from this.

The Tripartite Agreement did avoid a round of competitive devaluation at the end of the decade, though it would have been far better for all of Europe if an agreement for a co‐ordinated devaluation could have been concluded five years earlier. Currency movements were generally mild in the few remaining years of peace. The Agreement might perhaps be seen as some advance in international understanding as compared with the early 1930s, and it had significant political implications as the Nazi threat became more alarming. But, contrary to some assessments, it was neither a serious step towards genuine international co‐operation nor the precursor of Bretton Woods. It ‘brought a shadow of international co‐operation, but not its substance’ (Drummond, 1981: 223).6

The Netherlands and Switzerland followed France off the gold standard, officially ending the gold bloc, three years after its inception. Recovery was quick in these two nations, as it had been in Belgium. Export markets recovered and expansionary policies were implemented. The Italian Government used the occasion of the French devaluation as an excuse to devalue the lira and reduce exchange controls, and Czechoslovakia devalued the crown a second time. The Tripartite Agreement was received negatively in France, where it was commonly believed that the Blum Government had reneged on its promises not to devalue, and where the international accord was seen as a sham hiding the French devaluation.

(p.68) The benefits of devaluation were largely offset in France by the increase in French prices. In June 1937, under the pressure of gold losses and budget deficits, the Blum Government resigned and was replaced by a government that allowed the franc to float. The economy remained stagnant from 1936 to 1938 until a new government ended the forty‐hour working week, imposed new taxes and budgetary economies, and attacked fiscal fraud. The French economy rebounded rapidly, but it was too late. The Nazi menace was about to put an end to the period between the wars.

5. Concluding Remarks: The Past and the Present

As the Second World War was slowly drawing to a close, policy‐makers began to concern themselves with peacetime economic issues. The shade of depression and unemployment loomed large; in spite of wartime full employment the future of the economy looked uncertain. It was not clear whether democratic capitalism would be able to compete with central planning and dictatorship, right‐ or left‐wing, in generating sustained growth and full employment once the war economy had been dismantled. In this intellectual climate, it was natural to turn to recent history in the hope that a better understanding of the past would show what mistakes should be avoided in the future. In such a vein the Royal Institute of International Affairs invited H. W. Arndt to analyse the previous decade's economic policies; his deservedly famous study was published in 1944 under the significant title The Economic Lessons of the Nineteen‐Thirties. His contention was rigorously Keynesian: the Great Depression originated in a lack of aggregate demand and was made so exceptionally long and severe by misguided ‘orthodox’ policies. The better‐than‐average performance of Sweden, Britain, and Germany in the 1930s could be explained precisely by their decision to break away from such policies. Emphasis on Germany may seem peculiar. Arndt, nevertheless, was in good company: at the time, Balogh, Kaldor, and others were deeply impressed by the apparent success of German economic policies in fighting unemployment, and discussed how similar policies could be implemented in the context of the democratic political environment.

The concern for renewed depression and unemployment after the war proved to be misplaced, thanks partly to the understanding of history shown by the Allied Powers in avoiding some of the worse mistakes which had been made at the Versailles Conference of 1919. As a result, when another authoritative Keynesian‐flavoured interpretation of the Great Depression appeared in 1954 (Svennilson's Growth and Stagnation in the European Economy), it was already much less in touch with the current interest of policy‐makers and public opinion than its predecessor.

(p.69) For the following twenty‐odd years, the study of the inter‐war decades lost most of its appeal to economists and politicians alike: unprecedented growth led to full employment in a context of stability never seen before or since. It became the common belief that an adequate mix of monetary and fiscal policies could free mankind from future depressions; some economists went so far as to speak of the ‘conquest of the business cycle’.

The fortune of such visions was short‐lived: the so‐called ‘first oil shock’ showed conclusively that cycles had not been eliminated. By the mid‐1970s, the intellectual climate had almost taken a U‐turn: a question about the 1930s, unthinkable ten years earlier, had resurfaced: ‘can it happen again?’ Economists and historians turned enthusiastically to a search for lessons to be drawn from the inter‐war years. The resulting intellectual effort generated a quantum leap forward in the understanding of the period: the findings of the resulting work constitute the basis for many of the points made in the previous pages of this survey chapter.

There was a brief spell of optimism in the 1980s, lasting only the éspace d'un matin; but now, at the moment of writing these lines, the European economy is burdened with the highest level of unemployment since the 1930s. Is it time again to turn to Clio's lessons? As economists we are inclined to think so. As historians we are aware that the dictum historia magistra vitae has been too often abused in mechanical transpositions of the past into the present. History seldom imparts simple lessons, but it can provide a useful framework in which pertinent questions about the present can be posed, and its value is enhanced when it is matched with relevant economic theory.

The most striking similarity between the present state of distress in the international economic setting and that of the 1920s, is that in both cases the end of a long‐established ‘international order’ produced destabilizing effects. In section 1 of this chapter we discussed five consequences of the First World War which resulted in a major upset to the preceding status quo. Is the end of the cold war and the collapse of the Soviet empire likely to have equally far‐reaching effects?

All five of the deleterious effects of the First World War noticed above are to some extent present again after the cold war. In particular, the real economy of Europe and the world has been distorted by the huge arms build‐up of the past half‐century. Massive shifts of resources need to be made. Political boundaries have been redrawn in Eastern Europe, and indeed are still unsettled; trade flows have been upset by the collapse of Comecon; migration waves pose a major challenge to social stability at the very heart of Western Europe. The banking systems of Europe appear to be more fragile than they were in the past. And like the gold standard after the First World War, the European Monetary System has not withstood the (p.70) strain of developments since the end of the cold war, in particular of German unification.

Adjustments are needed in the 1990s as they were in the 1920s. But the need for economic change can create new demands which provide an opportunity for continued prosperity or, as in the inter‐war years, it can be the source of disaster. In the introduction to this chapter we set out four propositions which have been suggested as explanations for the failures of policy and performance in the inter‐war period. To what extent do similar factors inhibit creative economic policy today?

The first factor relates to the magnitude of the post‐war imbalance in the real economy and to the disruption in commodity and factor flows noted above. Western Europe and the USA need to shift resources from weapons production to the manufacture of civilian goods. Eastern Europe has the much larger task of establishing an effective market economy. The victors in the cold war need to show a breadth of vision similar to that which enlightened policy‐making after the Second World War. Resources hitherto allocated to armaments and the prosecution of the cold war should be used for the development of the ‘defeated’ Eastern European economies. Certainly, conditions there are very different from those of Western Europe in 1945. Nevertheless, the contrast between the attitude of the winning powers in 1919 and in 1945 is so striking, and the consequences for the policy outcomes so evident, that it should stimulate both generosity and intelligence in creating viable ways to provide the support necessary for the reconstruction of democracy and market economies.

The second complicating factor in the inter‐war period was the decline of Britain as an economic hegemonic power, and the inability or unwillingness of the USA to assume leadership in world economic affairs. Here again we find analogies with the situation today. While the American economy is still large and vigorous, economic policies are constrained by the large debt accumulated to fight the cold war during the 1980s, as British flexibility was hampered in the 1920s by the weakness of its post‐war economic position. The objectives of American foreign economic policy—and of its foreign policy tout court—seem at times to be uncertain and blurred, while new isolationist tendencies are apparent at the grass roots of American society. Germany and Japan are occupied with their internal problems and do not possess the economic strength and the international political status to take on the hegemonic mantle. If the world economy needs a single strong leader, then there are danger signs here.

Are we too prisoners of outdated economic ideologies, the third inhibiting factor of the inter‐war period? This is obviously an issue that only prophetic minds and future generations will be able to clearly decide. Some suspicions, however, cannot be avoided. There are more than a few similarities between (p.71) September 1992 and September 1931. The tie to the gold standard during the Great Depression seems to have been echoed by ties to the European Monetary System (EMS) in our day. Does the obsessive defence of the exchange rate of the DM resemble in any way the poor monetary policy pursued by the Federal Reserve Bank in October 1931? Is the current obsession with inflation, deriving from the two‐digit figures of the 1970s, in any way constraining policy, as the similar obsession with recent experience did in the early 1930s? We hope that the answers to these questions will turn out to be negative, given the implicit potential consequences if they are not. But these and similar issues surely need continuous monitoring and discussion in the light of the inter‐war history.

The last of our four factors, international co‐operation, is still a vital issue today. In the post‐cold‐war environment, co‐operation may turn out to be more difficult (or, at least, to appear less crucial) for European countries than it was when the continent was divided into two conflicting camps. Moreover, depressed activity levels and high unemployment make the temptation to resort to protectionism and competitive devaluations more difficult to resist. This is especially a problem for individual governments which come under pressure from their electorates to produce short‐term stimuli to the economy. However, if there is one clear ‘lesson’ from the 1930s, it is precisely that such temptations should be resisted at any cost, and that governments should help each other in avoiding such myopic policies that in the medium term are sure to result in a negative‐sum game. This is, in our opinion, a broad but safe conclusion.

For the rest, the scope for central bank co‐operation remains large, despite the de facto collapse of the EMS. The European Monetary Institute which started operating on 1 January 1994 is explicitly designed to foster cooperation: it is a novel institution with no precedents in the economic history of Europe. Its success, however, rests on the political willingness of individual governments to accept the consequences of co‐operation in monetary matters. As we have seen, the history of the 1920s and 1930s is full of conferences ending with well‐worded communiqués praising and promising co‐operation, soon followed by non‐co‐operative moves. While responsibility for co‐operative behaviour rests on the shoulders of all the participants in the game, the history of the inter‐war years indicates that some form of leadership should be exercised by the largest and most powerful player.

History does not repeat itself, and the present situation, for all its analogies with the 1920s, is in many ways distinct from that of the inter‐war period. Nevertheless, the presence of a substantial amount of dislocation now as then gives us pause. Will we be more successful in dealing with our problems than the inter‐war generation were with theirs? We hope so and are cheered by one great difference. We, after all, have (p.72) experienced the world‐wide collapse known as the Great Depression. Policy‐makers of the inter‐war period did not know such a thing was possible. We hope that this added historical experience—described in detail in this volume—will impart wisdom to our leaders. We take comfort in the successful navigation of the economic shoals after the Second World War.


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(1) There is a vast literature devoted to these topics and to the related political disputes. Recent general surveys of the economic issues in English include Moggridge (1989), Temin (1989), and Eichengreen (1992). The economic history of the 1920s has been covered by Aldcroft (1977) and the 1930s by Kindleberger (1973). There is also valuable material in earlier accounts such as those of Hodson (1938), Hawtrey (1939), Brown (1940) and the work done for the League of Nations, notably by Ohlin (1931) and Nurkse (1944). More specialized modern research is reported in Drummond (1981), Holtfrerich (1986), James (1986), McNeil (1986), Schuker (1988), Eichengreen (1990), James et al. (1991), Mouré (1991), and numerous other books and articles listed in the references at the end of this chapter.

(2) For a summary of the views of contemporary German participants in this debate, including the officials of the Reichsbank, see Bresciani‐Turroni (1937: 42–7) and Holtfrerich (1986: 156–72). Other recent studies of the phenomenon include Laursen and Pedersen (1964), Feldman et al. (1982), and Webb (1989).

(3) The reparations payments and national income estimates are taken from Holtfrerich (1986: 152); the former are the series used in the official balance of payments statistics. The data on capital flows are taken from the tables in Ch 3. See also Schuker (1988: 106–15).

(4) The sources for the data in this and the following paragraph are: GDP and unemployment, Maddison (1991: 212 and 1964: 220); industrial production and exports, Mitchell (1978: 180 and 304); interest rates, fixed investment, building permits, and new orders for machinery, Balderston (1983: 401–2 and 407).

(5) Information about Britain's short‐term liabilities to foreigners was first made public in the Macmillan Report in July 1931, but this covered only the sterling bills and deposits held by UK banks. A further sum of roughly £350m. was held by foreign banks and investors, so the true extent of Britain's position as a net short‐term debtor was far worse than foreigners appreciated. See further Williams (1963) and Cairncross and Eichengreen (1983: 50–1).

(6) For a somewhat more favourable view of the Tripartite Agreement see Kindleberger (1973: 257–61) and Rowland (1976: 51–6 and 250–1).