International Monetary System Shifts: 19th Century to Interwar Period
Key Changes in the International Monetary System: 19th Century to Interwar Period
After the First World War, almost all European currencies were below par values, as inflationary financing and balance of payments deficits had caused currency depreciation, despite controls on the balance of payments. While all countries considered it desirable to restore the gold standard, only the dollar was able to do so quickly (1919), serving as a reference for the implementation of other currencies, as the pound had previously done. In addition to maintaining the suspension of the gold standard, other countries also continued to strengthen protectionism through tariffs, quotas, and exchange controls, as well as restrictions on immigration. In fact, the restoration of the gold standard was very problematic, as several cases reveal:
Hyperinflation in Germany
In Germany, the depreciation of money was so extreme that it lost all its functions. During hyperinflation, the monetary causes excessive depreciation of money and, therefore, increasing prices. The spiral reached a point where the public discarded money because it lost its function as a store of value, a medium of payment, a medium of exchange, and a unit of account. The mark was replaced by the dollar or any object that held some value or facilitated accounting. As the real demand for money decreased compared to the demand for goods, and the public discarded money, inflation did not stop. Instead, it continued until the price increase exceeded the growth in the amount of money, and printers could not keep up. This situation meant a shortage of means of payment, business operations returned to the barter system, and then the opportunity arose to introduce a new currency that allowed for the control of inflation, as the cost of printing paper money exceeded the benefits.
Stabilization was achieved by introducing a new unit of account, the Rentenmark, equivalent to one trillion old marks. The success of the operation rested on the limited nature of the issue. Full integration into the gold standard was delayed several months until August 30, 1924. Since then, monetary stability and external loans laid the foundation for Germany’s economic recovery and rapid growth, accompanied by significant modernization of the economic structure.
The British Case
Great Britain and some neutral countries managed to restore pre-war exchange rates, but at the cost of severe deflation. In 1925, Britain returned to the gold standard with the exchange rate from before 1914, but the so-called restoration of the pound was actually a revaluation. In practice, the restoration of the pound hurt the British economy in general, especially the export industry and, above all, workers. British prices were higher than international prices, resulting in a consequent loss of foreign markets. This forced an internal adjustment to regain the competitiveness of exports, a more difficult adjustment than the prices of consumer goods and wages, which showed remarkable rigidity downwards due to inflation and the spread of collective bargaining. Therefore, the virtual stagnation of the British economy in the 1920s had an eminently monetary background.
A third group of countries, most notably France, Belgium, and Italy, stabilized their currencies by returning to the gold standard, but at rates lower than before the war. Prices had risen sharply, and reducing them to pre-war rates would have been very expensive, even more so than in Britain.
As a result of all this, the gold standard restored during the interwar period responded in most countries to what is known as a gold exchange standard. The monetary authority of a country linked its currency to gold indirectly by maintaining a kind of currency pegged to the gold standard strictly adhered to, including the franc, the pound, and especially the dollar. Economic growth increased the demand for currency, but gold stocks were limited, so hard currency gained much importance among central bank reserves, alongside gold. Thus, currency reserves rose from 12% of central bank reserves worldwide in 1913 to 42% in 1927. Under such conditions, the gold exchange standard would have worked well if central bank reserves assured convertibility and international lending. However, international coordination was lacking, and the British proposal to extend reserves and adjust discount rates to curb speculation and stabilize the international monetary system was not supported by France or the United States.
Characteristics of the 1929-1933 Crisis and Worldwide Depression
The interwar period saw two important periods: the crash of 1929 and the depression of the 1930s. It was a crisis of overproduction that became latent in the United States around 1925. At the end of World War I, there was an economic boom in the 1920s as European countries rebuilt their economies and increased production. Until 1925, the US economy absorbed much of this production, but from that year onward, a problem of speculation began to be observed. The government and the central bank, upon observing this, stimulated inflation to increase credit and stabilize prices. Credit inflation in the US implied a glut of capital, especially in the short term, and between 1926 and 1929, speculative trends were set in motion.
The government believed that these funds were to be invested in industry. However, as the demand for loans grew in parallel with the interest rates on credits, capital was invested in the stock market instead of industry because it yielded greater returns. This led to the crash of 1929 (Black Thursday). There was a diffusion process of the crisis originating in the US, as its purchasing power plummeted, and it fostered a protectionist policy (very present in this period). Consequently, Europe was also compelled to reduce its prices to be more competitive. The consequences of this crisis in Europe were a breakdown of the credit system, plummeting stock prices, a decline in investment and prices, a contraction of economic activity, and reduced demand.
To combat the depression and the dismantling of the international economy, two types of solutions emerged: protectionist measures, either through trade or Keynesian policies (stimulating demand through investment, public expenditure, or credit provision), or through government investment, such as the New Deal in US policy (through a revival of consumption and investment). In contrast, in Germany, the Nazi party believed that by further practicing capitalism, they safeguarded the private sector and privatized banks, although they transferred to the state the capacity to decide how to revive the economy. This revival was carried out in two ways: through public works schemes and, from 1936, through rearmament (producing equipment and materials for rearmament, in addition to increasing the purchasing power of the Germans).