The Ethics of Money Production: Chapter 16

Chapter 16: International Banking Systems, 1871 - 1971

Gold was legal tender in Great Britain since 1821 and the de facto currency in the US since 1834 (the Coinage Act). Australia and Canada followed 20 years later. The breakthrough for gold and the era of the classic gold standard began after the war between France and Germany (1870-1871). The German government received war damages of 5 billion francs in gold and made it fiat currency instead of silver, that was losing popularity at the time. The Prussian Bank ('Preusische Bank') was turned into a central bank ('Reichsbank'). Its notes became legal tender in 1909 - all a copy of the British system.

Why was it gold? For once, Great Britain, with the largest capital market in the world was using it. Several major lands using silver (Russia, Austria) have suspended payments by the time. Finally, silver has less purchasing power than gold, making its weight for large transfers rather problematic.

Practically all western lands and their many colonies have followed suit. In the heyday of free trade, when monopolies were frowned upon as never before, a unified monetary system seemed like a great idea; it was another massive state intervention, this time unopposed.

The classical gold standard has eliminated the fluctuations between gold and silver (though they were less than between today's paper currencies, it is a positive point). It also caused a significant forced deflation, with all its effects.

But the gold standard was still coupled with the practice of fractional reserve banking, and hence unstable. The coming of World War I. finished it off before it could collapse.

2. In the "classical" gold standard was a central bank of each country expected to hold enough gold in its reserves, while the commercial banks would rely mainly on its banknotes (another English practice, that spread out). The advantage were greater possibilities of inflation for them and more power for the central bank.

The 'Gold Exchange Standard' enhanced the already existing international cooperation between banks by a manifold. The American Fed and the Bank of England were to be the central banks for the whole world (with a few exceptions, notably France). Inflating slowly, others would rely on the pound and the dollar for backing, and could inflate much more. This unstable system lasted only from 1925 to 1931, the Great Depression of 1929 caused a rise of protectionist policies and foreign exchange controls, that choked the international currency trade. The Bank of England could not renew its gold reserves and suspended its payments, followed by other banks. From then on currencies fluctuated freely, which lasted until the end of World War II.

3. A new system was designed in 1944 in Bretton Woods (New Hampshire US), to make the production of banknotes even more 'flexible'. The gold reserves of the whole world should be concentrated in a single pool, the Fed would redeem its notes while all others would keep the US dollar as reserve. It was a logical choice, as the United States have attracted much gold and after WWII became Fort Knox the largest storage in the world. (England, represented by Lord Keynes, tried to push for a pure paper money, but it didn't come to be.)

To reduce the resulting dependency on the Fed, and to make it politically acceptable, two organizations were created: the International Monetary Fund (IMF) and the World Bank, both to influence the distribution of new banknotes. They would supply short-term (IMF) and long-term (WB) credit to member states in trouble, primarily the board members.

The growth of inflation, the main purpose of the Bretton Woods, was so successful, that the Fed eventually ran out of gold and had to suspend its payments in 1971. That was the end of the so-called gold standard and its versions.

4. The IMF and the World Bank did not die with the Bretton Woods system and started to supply credit to third world countries, transferring the income of western taxpayers. Since responsible states can get credit easily, it is often given to those not paying their debts, those nationalizing foreign investments or regulating overly their own countries. Thus arises a tendency to support dictators and violent regimes, often in exchange for other concessions. Their rule tends to be prolonged and the declared goal of fighting against poverty becomes more than a little dubious.

(Aside: back in Introduction I remarked on the light, friendly tone of the book and it stayed so for the most part. But this chapter seemed to have so far the sharpest tone of all. Interesting.)