Table of Contents

Tragedy and Hope

A History of the World in Our Time

By Carroll Quigley

PART SEVEN







Part Seven: Finance, Commercial and Business Activity: 1897-1947

Chapter 19: Reflation and Inflation, 1897-1925

     We have already seen that valiant efforts were made in the period 1919-1929 to build up an international political order quite different from that which had existed in the nineteenth century. On the basis of the old order of sovereignty and international law, men attempted, without complete conviction of purpose, to build a new international order of collective security....

     For these reasons, a real understanding of the economic history of twentieth century Europe is imperative to any understanding of the events of the period. Such an understanding will require a study of the history of finance, commerce, and business activity, of industrial organization, and of agriculture. The first three of these will be considered in this chapter from the beginning of the twentieth century to the establishment of the pluralist economy about 1947.

     The whole of this half-century may be divided into six subdivisions, as follows:

               1. Reflation, 1897-1914

               2. Inflation, 1914-1925

               3. Stabilization, 1922-1930

               4. Deflation, 1927-1936

               5. Reflation, 1933-1939

               6. Inflation, 1939-1947

     These periods have different dates in different countries, and thus overlap if we take the widest periods to include all important countries. But in spite of the difference in dates, these periods occurred in almost every country and in the same order. It should also be pointed out that these periods were interrupted by haphazard secondary movements. Of these secondary movements, the chief were the depression of 1921-1922 and the recession of 1937-1938, both periods of deflation and declining economic activity.

The Financial Capitalists At Their Worst

     Prices had been rising slowly from about 1897 because of the increased output of gold from South Africa and Alaska, thus alleviating the depressed conditions and agricultural distress which had prevailed, to the benefit of financial capitalists, from 1873. The outbreak of war in 1914 showed these financial capitalists at their worst, narrow in outlook, ignorant, and selfish, while proclaiming, as usual, their total devotion to the social good. They generally agreed that the war could not go on for more than six to ten months because of the "limited financial resources" of the belligerents (by which they meant gold reserves). This idea reveals the fundamental misunderstanding of the nature and role of money on the part of the very persons who were reputed to be experts on the subject. Wars, as events have proved since, are not fought with gold or even with money, but by the proper organization of real resources.

The International Bankers Devise a Secret

Scheme to Enrich Themselves

     The attitudes of bankers were revealed most clearly in England, where every move was dictated by efforts to protect their own position and to profit from it rather than by considerations of economic mobilization for war or the welfare of the British people. The outbreak of war on August 4, 1914, found the British banking system insolvent in the sense that its funds, created by the banking system for profit and rented out to the economic system to permit it to operate, could not be covered by the existing volume of gold reserves or by collateral which could be liquidated rapidly. Accordingly, the bankers secretly devised a scheme by which their obligations could be met by fiat money (so-called Treasury Notes), but, as soon as that crisis was over, they then insisted that the government must pay for the war without recourse to fiat money (which was always damned by bankers as immoral), but by taxation and by borrowing at high interest rates from bankers. The decision to use Treasury Notes to fulfill the bankers' liabilities was made as early as Saturday, July 25, 1914, by Sir John Bradbury (later Lord Bradbury) and Sir Frederick Atterbury at the latter's home. The first Treasury Notes were run off the presses at Waterlow and Sons the following Tuesday, July 28th, at a time when most politicians believed that Britain would stay out of the war. The usual Bank Holiday at the beginning of August was extended to three days during which it was announced that the Treasury Notes, instead of gold, would be used for bank payments. The discount rate was raised at the Bank of England from 3 percent to 10 percent to prevent inflation, a figure taken merely because the traditional rule of the bank stated that a lo percent bank rate would draw gold out of the ground itself, and gold payments need be suspended only when a 10 percent rate failed.

Governments Accept the Secret Plan of the Bankers

     At the outbreak of the war, most of the belligerent countries suspended gold payments and, to varying degrees, accepted their bankers' advice that the proper way to pay for the war was by a combination of bank loans with taxation of consumption. The period within which, according to the experts, the war must cease because of limited financial resources eventually passed, and the fighting continued more vigorously than ever. The governments paid for it in various ways: by taxation, by fiat money, by borrowing from banks (which created credit for the purpose), and by borrowing from the people by selling war bonds to them. Each of these methods of raising money had a different effect upon the two chief financial consequences of the war. These were inflation and public debt. The effects of the four ways of raising money upon these two can be seen from the following table:

          a. Taxation gives no inflation and no debt.

          b. Fiat money gives inflation and no debt.

          c. Bank credit gives inflation and debt.

          d. Sales of bonds give no inflation but give debt.

Paying for the War

     It would appear from this table that the best way to pay for the war would be by taxation, and the worst way would be by bank credit. However, taxation sufficient to pay for a major war would have such a severe deflationary effect upon prices that economic production would not increase enough or fast enough. Any rapid increase in production is spurred by a small amount of inflation which provides the impetus of unusual profits to the economic system. Increase in public debt, on the other hand, contributes little of value to the effort toward economic mobilization.

     From this point of view, it is not easy to say what method of financing a war is best. Probably the best is a combination of the four methods mixed in such a way that at the end there is a minimum of debt and no more inflation than was necessary to obtain complete and rapid economic mobilization. This would probably involve a combination of fiat money and taxation with considerable sales of bonds to individuals, the combination varying at different stages in the mobilization effort.

At the End of the War the Governments Are

in Debt to the Bankers

     In the period 1914-1918, the various belligerents used a mixture of these four methods, but it was a mixture dictated by expediency and false theories, so that at the end of the war all countries found themselves with both public debts and inflation in amounts in no wise justified by the degree of economic mobilization which had been achieved. The situation was made worse by the fact that in all countries prices continued to rise, and in most countries public debts continued to rise long after the Armistice of 1918.

     The causes of the wartime inflation are to be found in both financial and economic spheres. In the financial sphere, government spending was adding tremendous amounts of money to the financial community, largely to produce goods which would never be offered for sale. In the economic sphere, the situation was different in those countries which were more completely mobilized than in those which were only partly mobilized. In the former, real wealth was reduced by the diversion of economic resources from making such wealth to making goods for destruction. In the others, the total quantity of real wealth may not have been seriously reduced (since much of the resources utilized in making goods for destruction came from resources previously unused, like idle mines, idle factories, idle men, and so on) but the increase in the money supply competing for the limited amounts of real wealth gave drastic rises in prices.

The Financial Leaders Use Deceptive Methods

     While prices in most countries rose 200 to 300 percent and public debts rose 1,000 percent, the financial leaders tried to keep up the pretense that the money of each country was as valuable as it had ever been and that as soon as the war was ended the situation existing in 1914 would be restored. For this reason they did not openly abandon the gold standard. Instead, they suspended certain attributes of the gold standard and emphasized the other attributes which they tried to maintain. In most countries, payments in gold and export of gold were suspended, but every effort was made to keep gold reserves up to a respectable percentage of notes, and exchanges were controlled to keep them as near parity as possible. These attributes were achieved in some cases by deceptive methods. In Britain, for example, the gold reserve against notes fell from 52 percent to 18 percent in the month July-August 1914; then the situation was concealed, partly by moving assets of local banks into the Bank of England and using them as reserves for both, partly by issuing a new kind of notes (called Currency Notes) which had no real reserve and little gold backing. In the United States the percentage of reserves required by law in commercial banks was reduced in 1914, and the reserve requirements both for notes and deposits were cut in June 1917; a new system of "depositary banks" was set up which required no reserves against government deposits created in them in return for government bonds. Such efforts were made in all countries, but everywhere the ratio of gold reserves to notes fell drastically during the war: in France from 60 percent to 11 percent; in Germany from 59 percent to 10 percent; in Russia from 98 percent to 2 percent; in Italy from 60 percent to 13 percent; in Britain from 53 percent to 32 percent.

Inflation and Public Debts Continue after the War

     The inflation and increase in public debts continued after the war ended. The causes for this were complicated, and varied from country to country. In general, (1) price fixing and rationing regulations were ended too soon, before the output of peacetime goods had risen to a level high enough to absorb the accumulated purchasing power in the hands of consumers from their efforts in war production; thus, the slowness of reconversion from war production to peace production caused a short supply at a time of high demand; (2) the Allied exchanges, which had been controlled during the war, were unpegged in March 1919 and at once fell to levels revealing the great price disequilibrium between countries; (3) purchasing power held back during the war suddenly came into the market; (4) there was an expansion of bank credit because of postwar optimism; (5) budgets remained out of balance because of reconstruction requirements (as in France or Belgium), reparations (as in Germany), demobilization expenses (as in the United States, Italy, and so on); and (6) production of peacetime goods was disrupted by revolutions (as in Hungary, Russia, and so on) or strikes (as in the United States, Italy, France, and so on).

Postwar Inflation Had Evil Results

     Unfortunately, this postwar inflation, which could have accomplished much good (by increasing output of real wealth) was wasted (by increasing prices of existing goods) and had evil results (by destroying capital accumulations and savings, and overturning economic class lines). This failure was caused by the fact that the inflation, though unwanted everywhere, was uncontrolled because few persons in positions of power had the courage to take the steps necessary to curtail it. In the defeated and revolutionary countries (Russia, Poland, Hungary, Austria, and Germany), the inflation went so far that the former monetary units became valueless, and ceased to exist. In a second group of countries (like France, Belgium, and Italy), the value of the monetary unit was so reduced that it became a different thing, although the same name was still used. In a third group of countries (Britain, the United States, and Japan), the situation was kept under control.

Public Debt and Economic Depression in America

     As far as Europe was concerned, the intensity of the inflation increased as one moved geographically from west to east. Of the three groups of countries above, the second (moderate inflation) group was the most fortunate. In the first (extreme inflation) group the inflation wiped out all public debts, all savings, and all claims on wealth, since the monetary unit became valueless. In the moderate-inflation group, the burden of the public debt was reduced, and private debts and savings were reduced by the same proportion. In the United States and Britain the effort to fight inflation took the form of a deliberate movement toward deflation. This preserved savings but increased the burden of the public debt and gave economic depression.

Chapter 20: The Period of Stabilization, 1922-1930

     As soon as the war was finished, governments began to turn their attention to the problem of restoring the prewar financial system. Since the essential element in that system was believed to be the gold standard with its stable exchanges, this movement was called "stabilization." Because of their eagerness to restore the prewar financial situation, the "experts" closed their eyes to the tremendous changes which had resulted from the war. These changes were so great in production, in commerce, and in financial habits that any effort to restore the prewar conditions or even stabilize on the gold standard was impossible and inadvisable. Instead of seeking a financial system adapted to the new economic and commercial world which had emerged from the war, the experts tried to ignore this world, and established a financial system which looked, superficially, as much like the prewar system as possible. This system, however, was not the prewar system. Neither was it adapted to the new economic conditions. When the experts began to have vague glimmerings of this last fact, they did not begin to modify their goals, but insisted on the same goals, and voiced incantations and exhortations against the existing conditions which made the attainment of their goals impossible.

     These changed economic conditions could not be controlled or exorcised by incantations. They were basically not results of the war at all, but normal outcomes of the economic development of the world in the nineteenth century. All that the war had done was to speed up the rate of this development. The economic changes which in 1925 made it so difficult to restore the financial system of 1914 were already discernible in 1890 and clearly evident by 1910.

Britain's Supremacy as the Financial Center of the

World Is Threatened

     The chief item in these changes was the decline of Britain. What had happened was that the Industrial Revolution was spreading beyond Britain to Europe and the United States and by 1910 to South America and Asia. As a result, these areas became less dependent on Britain for manufactured goods, less eager to sell their raw materials and food products to her, and became her competitors both in selling to and in buying from those colonial areas to which industrialism had not yet spread. By 1914 Britain's supremacy as financial center, as commercial market, as creditor, and as merchant shipper was being threatened. A less obvious threat arose from long-run shifts in demand—shifts from the products of heavy industry to the products of more highly specialized branches of production (like chemicals), from cereals to fruits and dairy products, from cotton and wool to silk and rayon, from leather to rubber, and so on. These changes presented Britain with a fundamental choice—either to yield her supremacy in the world or reform her industrial and commercial system to cope with the new conditions. The latter was difficult because Britain had allowed her industrial system to become lopsided under the influence of free trade and international division of labor. Over half the employed persons in Britain were engaged in the manufacture of textiles and ferrous metals. Textiles accounted for over one-third of her exports, and textiles, along with iron and steel, for over one-half. At the same time, newer industrial nations (Germany, the United States, and Japan) were growing rapidly with industrial systems better adapted to the trend of the times; and these were also cutting deeply into Britain's supremacy in merchant shipping.

America Becomes the World's Greatest Creditor

     At this critical stage in Britain's development, the World War occurred. This had a double result as far as this subject is concerned. It forced Britain to postpone indefinitely any reform of her industrial system to adjust it to more modern trends; and it speeded up the development of these trends so that what might have occurred in twenty years was done instead in five. In the period 1910-1920, Britain's merchant fleet fell by 6 percent in number of vessels, while that of the United States went up 57 percent, that of Japan up 130 percent, and that of the Netherlands up 58 percent. Her position as the world's greatest creditor was lost to the United States, and a large quantity of good foreign credits was replaced by a smaller amount of poorer risks. In addition, she became a debtor to the United States to the amount of over $4 billion. The change in the positions of the two countries can be summarized briefly. The war changed the position of the United States in respect to the rest of the world from that of a debtor owing about $3 billion to that of a creditor owed $4 billion. This does not include intergovernmental debts of about $10 billion owed to the United States as a result of the war. At the same time, Britain's position changed from a creditor owed about $18 billion to a creditor owed about $13.5 billion. In addition, Britain was owed about $8 billion in war debts from her Allies and an unknown sum in reparations from Germany, and owed to the United States war debts of well over 54 billion. Most of these war debts and reparations were sharply reduced after 1920, but the net result for Britain was a drastic change in her position in respect to the United States.

Modification of the Basic Economic Organization of the World

     The basic economic organization of the world was modified in other ways. As a result of the war, the old organization of relatively free commerce among countries specializing in different types of production was replaced by a situation in which a larger number of countries sought economic self-sufficiency by placing restrictions on commerce. In addition, productive capacity in both agriculture and industry had been increased by the artificial demand of the war period to a degree far beyond the ability of normal domestic demand to buy the products of that capacity. And, finally, the more backward areas of Europe and the world had been industrialized to a great degree and were unwilling to fall back to a position in which they would obtain industrial products from Britain, Germany, or the United States in return for their raw materials and food. This refusal was made more painful for both sides by the fact that these backward areas had increased their outputs of raw materials and food so greatly that the total could hardly have been sold even if they had been willing to buy all their industrial products from their prewar sources. These prewar sources in turn had increased their industrial capacity so greatly that the product could hardly have been sold if they had been able to recapture entirely all their prewar markets. The result was a situation where all countries were eager to sell and reluctant to buy, and sought to achieve these mutually irreconcilable ends by setting up subsidies and bounties on exports, tariffs, and restrictions on imports, with disastrous results on world trade. The only sensible solution to this problem of excessive productive capacity would have been a substantial rise in domestic standards of living, but this would have required a fundamental reapportionment of the national income so that claims to the product of the excess capacity would go to those masses eager to consume, rather than continue to go to the minority desiring to save. Such a reform was rejected by the ruling groups in both "advanced" and "backward" countries, so that this solution was reached only to a relatively small degree in a relatively few countries (chiefly the United States and Germany in the period 1925-1929)

International Bankers Began to Set Gold Aside

     Changes in the basic productive and commercial organization of the world in the period 1914-1919 were made more difficult to adjust by other less tangible changes in financial practices and business psychology. The spectacular postwar inflations in eastern Europe had intensified the traditional fear of inflation among bankers. In an effort to stop rises in prices which might become inflationary, bankers after 1919 increasingly sought to "sterilize" gold when it flowed into their country. That is, they sought to set it aside so that it did not become part of the monetary system. As a result, the unbalance of trade which had initiated the flow of gold was not counteracted by price changes. Trade and prices remained unbalanced, and gold continued to flow. Somewhat similar was a spreading fear of decreasing gold reserves, so that when gold began to flow out of a country as a result of an unfavorable balance of international payments, bankers increasingly sought to hinder the flow by restrictions on gold exports. With such actions the unfavorable balance of trade continued, and other countries were inspired to take retaliatory actions. The situation was also disturbed by political fears and by the military ambitions of certain countries, since these frequently resulted in a desire for self-sufficiency (autarchy) such as could be obtained only by use of tariffs, subsidies, quotas, and trade controls. Somewhat related to this was the widespread increase in feelings of economic, political, and social insecurity. This gave rise to "flights of capital"—that is, to panic transfers of holdings seeking a secure spot regardless of economic return. Moreover, the situation was disturbed by the arrival in the foreign-exchange market of a very large number of relatively ignorant speculators. In the period before 1914 speculators in foreign exchange had been a small group of men whose activities were based on long experience with the market and had a stabilizing effect on it. After 1919 large numbers of persons with neither knowledge nor experience began to speculate in foreign exchange. Subject to the influence of rumors, hearsay, and mob panic, their activities had a very disturbing effect on the markets. Finally, within each country, the decline in competition arising from the growth of labor unions, cartels, monopolies, and so on, made prices less responsive to flows of gold or exchange in the international markets, and, as a result, such flows did not set into motion those forces which would equalize prices between countries, curtail flows of gold, and balance flows of goods.

Most Countries Leave the Gold Standard

     As a result of all these factors, the system of international payments which had worked ... before 1914 worked only haltingly after that date, and practically ceased to work at all after 1930. The chief cause of these factors was that neither goods nor money obeyed purely economic forces and did not move as formerly to the areas in which each was most valuable. The chief result was a complete mal-distribution of gold, a condition which became acute after 1928 and which by 1933 had forced most countries off the gold standard.

     Modifications of productive and commercial organization and of financial practices made it almost impossible after 1919 to restore the financial system of 1914. Yet this is what was attempted. Instead of seeking to set up a new financial organization adapted to the modified economic organization, bankers and politicians insisted that the old prewar system should be restored. These efforts were concentrated in a determination to restore the gold standard as it had existed in 1914.

The Money Power Seeks to Create a World System of Financial

Control in Private Hands Able to Dominate Every Nation on Earth

     In addition to these pragmatic goals, the powers of financial capitalism had another far-reaching aim, nothing less than to create a world system of financial control in private hands able to dominate the political system of each country and the economy of the world as a whole. This system was to be controlled in a feudalist fashion by the central banks of the world acting in concert, by secret agreements arrived at in frequent private meetings and conferences. The apex of the system was to be the Bank for International Settlements in Basle, Switzerland, a private bank owned and controlled by the world's central banks which were themselves private corporations. Each central bank, in the hands of men like Montagu Norman of the Bank of England, Benjamin Strong of the New York Federal Reserve Bank, Charles Rist of the Bank of France, and Hjalmar Schacht of the Reichsbank, sought to dominate its government by its ability to control Treasury loans, to manipulate foreign exchanges, to influence the level of economic activity in the country, and to influence cooperative politicians by subsequent economic rewards in the business world.

International Bankers Seek and Make Agreements on

All the Major Financial Problems of the World

     In each country the power of the central bank rested largely on its control of credit and money supply. In the world as a whole the power of the central bankers rested very largely on their control of loans and of gold flows. In the ... system, these central bankers were able to mobilize resources to assist each other through the B.I.S., where payments between central banks could be made by bookkeeping adjustments between the accounts which the central banks of the world kept there. The B.I.S. as a private institution was owned by the seven chief central banks and was operated by the heads of these, who together formed its governing board. Each of these kept a substantial deposit at the B.I.S., and periodically settled payments among themselves (and thus between the major countries of the world) by bookkeeping in order to avoid shipments of gold. They made agreements on all the major financial problems of the world, as well as on many of the economic and political problems, especially in reference to loans, payments, and the economic future of the chief areas of the globe.

The Bank for International Settlements Becomes the Mechanism for Allowing the

Three Financial Centers of the World to Act As One

     The B.I.S. is generally regarded as the apex of the structure of financial capitalism whose remote origins go back to the creation of the Bank of England in 1694 and the Bank of France in 1803. As a matter of fact its establishment in 1929 was rather an indication that the centralized world financial system of 1914 was in decline. It was set up rather to remedy the decline of London as the world's financial center by providing a mechanism by which a world with three chief financial centers in London, New York, and Paris could still operate as one. The B.I.S. was a ... effort to cope with the problems arising from the growth of a number of centers. It was intended to be the world cartel of ever-growing national financial powers by assembling the nominal heads of these national financial centers.

Montagu Norman Was the Commander-in-Chief of the

World System of Banking Control

     The commander in chief of the world system of banking control was Montagu Norman, Governor of the Bank of England, who was built up by the private bankers to a position where he was regarded as an oracle in all matters of government and business. In government the power of the Bank of England was a considerable restriction on political action as early as 1819 but an effort to break this power by a modification of the bank's charter in 1844 failed. In 1852, Gladstone, then chancellor of the Exchequer and later prime minister, declared, "The hinge of the whole situation was this: the government itself was not to be a substantive power in matters of Finance, but was to leave the Money Power supreme and unquestioned."

The Currency Dictator of Europe

     This power of the Bank of England and of its governor was admitted by most qualified observers. In January, 1924, Reginald McKenna, who had been chancellor of the Exchequer in 1915-1916, as chairman of the board of the Midland Bank told its stockholders: "I am afraid the ordinary citizen will not like to be told that the banks can, and do, create money.... And they who control the credit of the nation direct the policy of Governments and hold in the hollow of their hands the destiny of the people." In that same year, Sir Drummond Fraser, vice-president of the Institute of Bankers, stated, "The Governor of the Bank of England must be the autocrat who dictates the terms upon which alone the Government can obtain borrowed money." On September 26, 1921, The Financial Times wrote, "Half a dozen men at the top of the Big Five Banks could upset the whole fabric of government finance by refraining from renewing Treasury Bills." Vincent Vickers, who had been a director of the bank for nine years, said, "Since 1919 the monetary policy of the Government has been the policy of the Bank of England and the policy of the Bank of England has been the policy of Mr. Montagu Norman." On November Il, 1927, the Wall Street Journal called Mr. Norman "the currency dictator of Europe." This fact was admitted by Mr. Norman himself before the court of the bank on March 21, 1930, and before the Macmillan Committee five days later.

     Montagu Norman's position may be gathered from the fact that his predecessors in the governorship, almost a hundred of them, had served two-year terms, increased rarely, in time of crisis, to three or even four years. But Norman held the position for twenty-four years (1920-1944), during which he became the chief architect of the liquidation of Britain's global preeminence.

Norman Viewed Governments and Democracy As

Threats to the Money Power

     Norman was a strange man whose mental outlook was one of successfully suppressed hysteria or even paranoia. He had no use for governments and feared democracy. Both of these seemed to him to be threats to private banking, and thus to all that was proper and precious in human life. Strong-willed, tireless, and ruthless, he viewed his life as a kind of cloak-and-dagger struggle with the forces of ... [sound] money .... When he rebuilt the Bank of England, he constructed it as a fortress prepared to defend itself against any popular revolt, with the sacred gold reserves hidden in deep vaults below the level of underground waters which could be released to cover them by pressing a button on the governor's desk. For much of his life Norman rushed about the world by fast steamship, covering tens of thousands of miles each year, often traveling incognito, concealed by a black slouch hat and a long black cloak, under the assumed name of "Professor Skinner." His embarkations and debarkations onto and off the fastest ocean liners of the day, sometimes through the freight hatch, were about as unobserved as the somewhat similar passages of Greta Garbo in the same years, and were carried out in a similarly "sincere" effort at self-effacement.

Montagu Norman's Devoted Colleague in New York City

     Norman had a devoted colleague in Benjamin Strong, the first governor of the Federal Reserve Bank of New York. Strong owed his career to the favor of the Morgan Bank, especially of Henry P. Davison, who made him secretary of the Bankers Trust Company of New York (in succession to Thomas W. Lamont) in 1904, used him as Morgan's agent in the banking rearrangements following the crash of 1907, and made him vice-president of the Bankers Trust (still in succession to Lamont) in 1909. He became governor of the Federal Reserve Bank of New York as the joint nominee of Morgan and of Kuhn, Loeb, and Company in 1914. Two years later, Strong met Norman for the first time, and they at once made an agreement to work in cooperation for the financial practices they both revered.

     These financial practices were explicitly stated many times in the voluminous correspondence between these two men and in many conversations they had, both in their work and at their leisure (they often spent their vacations together for weeks, usually in the south of France).

Norman and Strong Seek to Operate Central Banks Free from

Any Political Control

     In the 1920's, they were determined to use the financial power of Britain and of the United States to force all the major countries of the world to go on the gold standard and to operate it through central banks free from all political control, with all questions of international finance to be settled by agreements by such central banks without interference from governments.

Norman and Strong Were Mere Agents of the Powerful Bankers

Who Remained Behind the Scenes and Operated in Secret

     It must not be felt that these heads of the world's chief central banks were themselves substantive powers in world finance. They were not. Rather, they were the technicians and agents of the dominant investment bankers of their own countries, who had raised them up and were perfectly capable of throwing them down. The substantive financial powers of the world were in the hands of these investment bankers (also called "international" or "merchant" bankers) who remained largely behind the scenes in their own unincorporated private banks. These formed a system of international cooperation and national dominance which was more private, more powerful, and more secret than that of their agents in the central banks. This dominance of investment bankers was based on their control over the flows of credit and investment funds in their own countries and throughout the world. They could dominate the financial and industrial systems of their own countries by their influence over the flow of current funds through bank loans, the discount rate, and the re-discounting of commercial debts; they could dominate governments by their control over current government loans and the play of the international exchanges. Almost all of this power was exercised by the personal influence and prestige of men who had demonstrated their ability in the past to bring off successful financial coupe, to keep their word, to remain cool in a crisis, and to share their winning opportunities with their associates. In this system the Rothschilds had been preeminent during much of the nineteenth century, but, at the end of that century, they were being replaced by J. P. Morgan whose central office was in New York, although it was always operated as if it were in London (where it had, indeed, originated as George Peabody and Company in 1838). Old J. P. Morgan died in 1913, but was succeeded by his son of the same name (who had been trained in the London branch until 1901), while the chief decisions in the firm were increasingly made by Thomas W. Lamont after 1924. But these relationships can be described better on a national basis later. At the present stage we must follow the efforts of the central bankers to compel the world to return to the gold standard of 1914 in the postwar conditions following 1918.

International Banker's Viewpoints Expressed in

Government Reports and Conferences

     The bankers' point of view was clearly expressed in a series of government reports and international conferences from 1918 to 1933. Among these were the reports of the Cunliffe Committee of Great Britain (August 1918), that of the Brussels Conference of Experts (September 1920), that of the Genoa Conference of the Supreme Council (January 1922), the First World Economic Conference (at Geneva, May 1927), the report of the Macmillan Committee on Finance and Industry (of 1931), and the various statements released by the World Economic Conference (at London in 1933). These and many other statements and reports called vainly for a free international gold standard, for balanced budgets, for restoration of the exchange rates and reserve ratios customary before 1914, for reductions in taxes and government spending, and for a cessation of all government interference in economic activity either domestic or international. But none of these studies made any effort to assess the fundamental changes in economic, commercial, and political life since 1914. And none gave any indication of a realization that a financial system must adapt itself to such changes. Instead, they all implied that if men would only give up their evil ways and impose the financial system of 1914 on the world, the changes would be compelled to reverse their direction and go back to the conditions of 1914.

Restoration of the Gold Standard of 1914

     Accordingly, the financial efforts of the period after 1918 became concentrated on a very simple (and superficial) goal—to get back to the gold standard—not "a" gold standard but "the" gold standard, by which was meant the identical exchange ratios and gold contents that monetary units had had in 1914.

     Restoration of the gold standard was not something which could be done by a mere act of government. It was admitted even by the most ardent advocates of the gold standard that certain financial relationships would require adjustment before the gold standard could be restored. There were three chief relationships involved. These were (1) the problem of inflation, or the relationship between money and goods; (2) the problem of public debts, or the relationship between governmental income and expenditure; and (3) the problem of price parities, or the relationship between price levels of different countries. That these three problems existed was evidence of a fundamental disequilibrium between real wealth and claims on wealth, caused by a relative decrease in the former and increase in the latter.

Paying the Public Debt

     The problem of public debts arose from the fact that as money (credit) was created during the war period, it was usually made in such a way that it was not in the control of the state or the community but was in the control of private financial institutions which demanded real wealth at some future date for the creation of claims on wealth in the present. The problem of public debt could have been met in one or more of several fashions: (a) by increasing the amount of real wealth in the community so that its price would fall and the value of money would rise. This would restore the old equilibrium (and price level) between real wealth and claims on wealth and, at the same time, would permit payment of the public debt with no increase in the tax rates; (b) by devaluation—that is, reduce the gold content of the monetary unit so that the government's holdings of gold would be worth a greatly increased number of monetary units. These latter could be applied to the public debt; (c) by repudiation—that is, a simple cancellation of the public debt by a refusal to pay it; (d) by taxation—that is, by increasing the tax rate to a level high enough to yield enough income to pay off the public debt; (e) by the issuance of fiat money and the payment of the debt by such money.

     These methods were not mutually exclusive, and in some cases overlapped. It might, for example, be argued that devaluation or use of fiat money were forms of partial repudiation. Nor were all these methods equally practical. For example, the first (increase real wealth) was by far the soundest method to achieve a re-stabilization.... The fourth (taxation) would have put a burden on the economic system so great as to be self-defeating. In Britain, the public debt could have been paid only by a tax of 25 percent for about three hundred years. Such heavy taxes might have had such a depressing effect on production of real wealth that national income would decline faster than tax rates rose, making payment by taxation impossible. Nor were all these alternative methods of paying the public debt of equal practicality in respect to their effects on the two other financial problems occupying the minds of experts and statesmen. These other two problems were inflation and price parities. These problems were just as urgent as the public debt, and the effects upon them of the different methods for paying the public debt could have been completely different. Efforts to pay the public debt by fiat money would have made the inflation problem and perhaps the price-parity problem worse. Taxation and increasing real wealth, on the other hand, would have reduced the inflation problem at the same time as they reduced the public debt, since both would have increased the value of money (that is, they were deflationary). Their effects on the problem of price parity would differ from case to case.

Use of Taxation to Pay Public Debt

     Finally, these methods of paying the public debt were not of equal value in theory. Orthodox theory rejected repudiation, devaluation, and fiat money as solutions to the problem, and, since it showed no way of increasing the production of real wealth, only taxation was left as a possible method of paying public debts. But the theorists, as we have shown, could call taxation a possible way only if they neglected the economic consequences. These consequences in most countries were so disastrous that taxation, if tried, soon had to be supplemented by other, unorthodox, methods. Great Britain and the United States were the only Great Powers which continued to use taxation as the chief method of paying the public debt.

The Problem of Inflation

     The second problem which had to be faced before stabilization was possible was the problem of inflation. This was caused by the great increase in claims on wealth (money), and showed itself in a drastic increase in prices. There were three possible solutions: (a) to increase the production of real wealth; (b) to decrease the quantity of money; or (c) to devaluate, or make each unit of money equal to a smaller amount of wealth (specifically gold). The first two would have forced prices back to the lower prewar level but would have done it in entirely different ways, one resulting in prosperity and a great rise in standards of living, the second resulting in depression and a great fall in standards of living. The third method (devaluation) was essentially a recognition and acceptance of the existing situation, and would have left prices at the higher postwar level permanently. This would have involved a permanent reduction in the value of money, and also would have given different parities in foreign exchanges (unless there was international agreement that countries devaluate by the same ratio). But it would have made possible prosperity and a rising standard of living and would have accepted as permanent the redistribution of wealth from creditors to debtors brought about by the wartime inflation.

International Bankers Regarded Deflation as a Good Thing

     Since the third method (devaluation) was rejected by orthodox theorists, and no one could see how to get the first (increase of real wealth), only the second (deflation) was left as a possible method for dealing with the problem of inflation. To many people it seemed axiomatic that the cure for inflation was deflation, especially since bankers regarded deflation as a good thing in itself. Moreover, deflation as a method for dealing with the problem of inflation went hand in hand with taxation as a method for dealing with the problem of public debts. Theorists did not stop to think what the effects of both would be on the production of real wealth and on the prosperity of the world.

The Problem of Price Parities

     The third financial problem which had to be solved before stabilization became practical was the problem of price parities. This differed because it was primarily an international question while the other two problems were primarily domestic. By suspending the gold standard and establishing artificial control of foreign exchanges at the outbreak of war, the belligerent countries made it possible for prices to rise at different rates in different countries. This can be seen in the fact that prices in Britain rose 200 percent in seven years (1913-1920), while in the United States they rose only 100 percent. The resulting disequilibrium had to be rectified before the two countries went back on the old gold standard, or the currencies would be valued in law in a ratio quite different from their value in goods. By going back on gold at the old ratios, one ounce of fine gold would, by law, become equal to $20.67 in the United States and about 84s. 11 ฝ d. in Britain. For the $20.67 in the United States you could get in 1920 about half of what you could have bought with it in 1913; for the 84s. 11 ฝ d. in Britain you could get in 1920 only about a third of what it would buy in 1913. The ounce of gold in the United States would be much more valuable than in Britain, so that foreigners (and British) would prefer to buy in the United States rather than in Britain, and gold would tend to flow to the United States from Britain with goods flowing in the opposite direction. In such conditions it would be said that the pound was overvalued and the dollar undervalued. The overvaluation would bring depression to Britain, while the United States would tend to be prosperous. Such disequilibrium of price parities could be adjusted either by a fall of prices in the country whose currency was overvalued or by a rise in prices in the country whose currency was undervalued (or by both). Such an adjustment would be largely automatic, but at the cost of a considerable flow of gold from the country whose currency was overvalued.

     Because the problem of price parities would either adjust itself or would require international agreement for its adjustment, no real attention was paid to it when governments turned their attention to the task of stabilization. Instead, they concentrated on the other two problems and, above all, devoted attention to the task of building up sufficient gold reserves to permit them to carry out the methods chosen in respect to these two problems.

America Returns to the Gold Standard

     Most countries were in a hurry to stabilize their currencies when peace was signed in 1919. The difficulties of the three problems we have mentioned made it necessary to postpone the step for years. The process of stabilization was stretched over more than a decade from 1919 to 1931. Only the United States was able to return to the gold standard at once, and this was the result of a peculiar combination of circumstances which existed only in that country. The United States had a plentiful supply of gold. In addition it had a technological structure quite different from that of any other country, except perhaps Japan. American technology was advancing so rapidly in the period 1922-1928 that even with falling prices there was prosperity, since costs of production fell even faster. This situation was helped by the fact that prices of raw materials and food fell faster than prices of industrial products, so that production of these latter was very profitable. As a result, America achieved to a degree greater than any other country a solution of inflation and public debt which all theorists had recognized as possible, but which none had known how to obtain—the solution to be found in a great increase in real wealth. This increase made it possible simultaneously to pay off the public debt and reduce taxes; it also made it possible to have deflation without depression. A happier solution of the postwar problems could hardly have been found—for a time, at least. In the long run, the situation had its drawbacks, since the fact that costs fell faster than prices and that prices of agricultural products and raw materials fell faster than prices of industrial products meant that in the long run the community would not have sufficient purchasing power to buy the products of the industrial organization. This problem was postponed for a considerable period by the application of easy credit and installment selling to the domestic market and by the extension to foreign countries of huge loans which made it possible for these countries to buy the products of American industry without sending their own goods into the American market in return. Thus, from a most unusual group of circumstances, the United States obtained an unusual boom of prosperity. These circumstances were, however, in many ways a postponement of difficulties rather than a solution of them, as the theoretical understanding of what was going on was still lacking.

Taxation as a Cure for Public Debts

     In other countries the stabilization period was not so happy. In Britain, stabilization was reached by orthodox paths—that is, taxation as a cure for public debts and deflation as a cure for inflation. These cures were believed necessary in order to go back on the old gold parity. Since Britain did not have an adequate supply of gold, the policy of deflation had to be pushed ruthlessly in order to reduce the volume of money in circulation to a quantity small enough to be superimposed on the small base of available gold at the old ratios. At the same time, the policy was intended to drive British prices down to the level of world prices. The currency notes which had been used to supplement bank notes were retired, and credit was curtailed by raising the discount rate to panic level. The results were horrible. Business activity fell drastically, and unemployment rose to well over a million and a half. The drastic fall in prices (from 307 in 1920 to 197 in 1921) made production unprofitable unless costs were driven down even faster. This could not be achieved because labor unions were determined that the burden of the deflationary policy should not be pushed onto them by forcing down wages. The outcome was a great wave of strikes and industrial unrest.

Britain Goes Back on the Gold Standard

     The British government could measure the success of their deflation only by comparing their price level with world price levels. This was done by means of the exchange ratio between the pound and the dollar. At that time the dollar was the only important currency on gold. It was expected that the forcing down of prices in Britain would be reflected in an increase in the value of the pound in terms of dollars on the foreign exchange market. Thus as the pound rose gradually upward toward the pre-war rate of $4.86, this rise would measure the fall in British prices downward to the American (or the world) price level. In general terms, this was true, but it failed to take into consideration the speculators who, knowing that the value of the pound was rising, sold dollars to buy pounds, thus pushing the dollar down and the pound upward faster than was justified in terms of the changes in price levels in the two countries. Thus the pound rose to $4.86, while the British price level had not yet fallen to the American price level, but the Chancellor of the Exchequer, Winston Churchill, judging the price level by the exchange rate, believed that it had and went back on the gold standard at that point. As a result, sterling was overvalued and Britain found itself economically isolated on a price plateau above the world market on which she was economically dependent. These higher British prices served to increase imports, decrease exports, and encourage an outflow of gold which made gold reserves dangerously low. To maintain the gold reserve at all, it was necessary to keep the discount rate at a level so high (4 ฝ percent or more) that business activity was discouraged. The only solution which the British government could see to this situation was continued deflation. This effort to drive down prices failed because the unions were able to prevent the drastic cutting of costs (chiefly wages) necessary to permit profitable production on such a deflationary market. Nor could the alternative method of deflation—by heavy taxation—be imposed to the necessary degree on the upper classes who were in control of the' government. The showdown on the deflationary policy came in the General Strike of 1926. The unions lost the strike—that is, they could not prevent the policy of deflation—but they made it impossible for the government to continue the reduction of costs to the extent necessary to restore business profits and the export trade.

Britain Goes into Financial Bondage to France

     As a result of this financial policy, Britain found herself faced with deflation and depression for the whole period 1920-1933. These effects were drastic in 1920-1922, moderate in 1922-1929, and drastic again in -1933. The wholesale price index (1913=100) fell from 307 in 1920 to 197 in 1921, then declined slowly to 137 in 1928. Then it fell rapidly to 120 in 1929 and go in 1933. The number of unemployed averaged about 13/4 millions for each of the thirteen years of 1921-1932 and reached 3 million in 1931. At the same time, the inadequacy of the British gold reserve during most of the period placed Britain in financial subjection to France (which had a plentiful supply of gold because of her different financial policy). This subjection served to balance the political subjection of France to Britain arising from French insecurity, and ended only with Britain's abandonment of the gold standard in 1931.

     Britain was the only important European country which reached stabilization through deflation. East of her, a second group of countries, including Belgium, France, and Italy, reached stabilization through devaluation. This was a far better method. It was adopted, however, not because of superior intelligence but because of financial weakness. In these countries, the burden of war-damage reconstruction made it impossible to balance a budget, and this made deflation difficult. These countries accepted orthodox financial ideas and tried to deflate in 1920-1921, but, after the depression which resulted, they gave up the task. Belgium stabilized once at 107 francs to the pound sterling, but could not hold this level and had to devaluate further to 175 to the pound (October 1926). France stabilized at 124.21 francs to the pound at the end of 1926, although the stabilization was made de jure only in June 1928. Italy stabilized at 92.46 fire to the pound sterling in December 1927.

Achieving Stabilization through Devaluation

.

     The group of countries which reached stabilization through devaluation prospered in contrast with those who reached stabilization through deflation. The prosperity was roughly equal to the degree of devaluation. Of the three Latin countries—Belgium, France, and Italy—Belgium devalued the most and was most prosperous. Her stabilization was at a price level below the world level so that the belga was undervalued by about one-fifth. This served to encourage exports. For an industrial country such as Belgium, this made it possible for her to profit by the misfortunes of Britain. France was in a somewhat similar position. Italy, on the contrary, stabilized at a figure which made the lira considerably overvalued. This was done for purposes of prestige—Mussolini being determined to stabilize the lira at a value higher than that of the French franc. The effects of this overvaluation of the lira on the Italian economy were extremely adverse. Italy was never as prosperous after stabilization as she had been immediately before it.

     Not only did the countries which undervalued their money prosper; they decreased the disequilibrium between wealth and money; they were able to use the inflation to increase production; they escaped high taxes; they moderated or escaped the stabilization crisis and the deflationary depression; they improved their positions in the world market in respect to high-cost countries like Britain; and they replenished their gold stocks.

America Rebuilds the Industrial Structure of Germany

through the Dawes Plan

     A third group of countries reached stabilization through reconstruction. These were the countries in which the old monetary unit had been wiped out and had to be replaced by a new monetary unit. Among these were Austria, Hungary, Germany, and Russia. The first two of these were stabilized by a program of international assistance worked out through the League of Nations. The last was forced to work out a financial system by herself. Germany had her system reorganized as a consequence of the Dawes Plan. The Dawes Plan, as we have seen in our discussion of reparations, provided the gold reserves necessary for a new currency and provided a control of foreign exchange which served to protect Germany from the accepted principles of orthodox finance. These controls were continued until 1930, and permitted Germany to borrow from foreign sources, especially the United States, the funds necessary to keep her economic system functioning with an unbalanced budget and an unfavorable balance of trade. In the period 1924-1929, by means of these funds, the industrial structure of Germany was largely rebuilt so that, when the depression arrived, Germany had the most efficient industrial machine in Europe and probably the second most efficient in the world (after the United States). The German financial system had inadequate controls over inflation and almost none over deflation because of the Dawes Plan restrictions on the open-market operations of the Reichsbank and the generally slow response of the German economy to changes in the discount rate. Fortunately, such controls were hardly necessary. The price level was at 137 in 1924 and at the same figure in 1929 (1913=100). In that six-year period it had reached as high as 142 (in 1925) and fallen as low as 134 (in 1926). This stability in prices was accompanied by stability in economic conditions. While these conditions were by no means booming, there was only one bad year before 1930. This was 1926, the year in which prices fell to 134 from the 1925 level of 142. In this year unemployment averaged 2 million. The best year was 1925, in which unemployment averaged 636,000. This drop in prosperity from 1925 to 1926 was caused by a lack of credit as a result of the inadequate supplies of domestic credit and a temporary decline in the supplies of foreign credit. It was this short slump in business which led Germany to follow the road to technological reorganization. This permitted Germany to increase output with decreasing employment. The average annual increase in labor productivity in the period 1924-1932 in Germany was about 5 percent. Output per labor hour in industry rose from 87.8 in 1925 to 115.6 in 1930 and 125 in 1932 (1928=100). This increase in output served to intensify the impact of the depression in Germany, so that unemployment, which averaged about three million in the year 1930, reached over six million late in 1932. The implications of this will be examined in detail in our study of the rise to power of Hitler.

The Use of the Gold Bullion Standard Instead of the

Old Gold Standard

     The stabilization period did not end until about 1931, although only minor Powers were still stabilizing in the last year or so. The last Great Power to stabilize de jure was France in June, 1928, and she had been stabilized de facto much earlier. In the whole period, about fifty countries stabilized their currencies on the gold standard. But because of the quantity of gold necessary to maintain the customary reserve ratios (that is, the pre-1914 ratios) at the higher prices generally prevailing during the period of stabilization, no important country was able to go back on the gold standard as the term was understood in 1914. The chief change was the use of the "gold exchange standard" or the "gold bullion standard" in place of the old gold standard. Under the gold exchange standard, foreign exchange of gold standard countries could be used as reserves against notes or deposits in place of reserves in gold. In this way, the world's limited supplies of gold could be used to support a much greater volume of fictitious wealth in the world as a whole since the same quantity of gold could act as bullion reserve for one country and as gold exchange reserve for another. Even those countries which stabilized on a direct gold standard did so in a quite different way from the situation in 1914. In few countries was there free and gratuitous convertibility between notes, coin, and bullion. In Great Britain, for example, by the Gold Standard Act of May 1925, notes could be exchanged for gold only in the form of bullion and only in amounts of at least 400 fine ounces (that is, not less than $8,268 worth at a time). Bullion could be presented to the mint for coinage only by the Bank of England, although the bank was bound to buy all gold offered at 77s. 10 ฝ d. per standard ounce. Notes could be converted into coin only at the option of the bank. Thus the gold standard of 1925 was quite different from that of 1914.

The Money Power Creates a Facade of Cardboard and Tinsel

     This would indicate that even in its most superficial aspects the international gold standard of 1914 was not reestablished by 1930. The legal provisions were different; the financial necessities and practices were quite different; the profound underlying economic and commercial conditions were entirely different, and becoming more so. Yet financiers, businessmen, and politicians tried to pretend to themselves and to the public that they had restored the financial system of 1914. They had created a facade of cardboard and tinsel which had a vague resemblance to the old system, and they hoped that, if they pretended vigorously enough, they could change this facade into the lost reality for which they yearned. At the same time, while pursuing policies (such as tariffs, price controls, production controls, and so on) which drove this underlying reality ever farther from that which had existed in 1914, they besought other governments to do differently. Such a situation, with pretense treated as if it were reality and reality treated as if it were a bad dream, could lead only to disaster. This is what happened. The period of stabilization merged rapidly into a period of deflation and depression.

Financial Capitalists Focus Entirely on Wealth

     As we have said, the stage of financial capitalism did not place emphasis on the exchange of goods or the production of goods as the earlier stages of commercial capitalism and industrial capitalism had done. In fact, financial capitalism had little interest in goods at all, but was concerned entirely with claims on wealth—stocks, bonds, mortgages, insurance, deposits, proxies, interest rates, and such.

Financial Capitalists Discover New Ways to Make Money Out of Nothing

     It invested capital not because it desired to increase the output of goods or services but because it desired to float issues (frequently excess issues) of securities on this productive basis. It built railroads in order to sell securities, not in order to transport goods; it constructed great steel corporations to sell securities, not in order to make steel, and so on. But, incidentally, it greatly increased the transport of goods, the output of steel, and the production of other goods. By the middle of the stage of financial capitalism, however, the organization of financial capitalism had evolved to a highly sophisticated level of security promotion and speculation which did not require any productive investment as a basis. Corporations were built upon corporations in the form of holding companies, so that securities were issued in huge quantities, bringing profitable fees and commissions to financial capitalists without any increase in economic production whatever. Indeed, these financial capitalists discovered that they could not only make killings out of the issuing of such securities, they could also make killings out of the bankruptcy of such corporations, through the fees and commissions of reorganization. A very pleasant cycle of flotation, bankruptcy, flotation, bankruptcy began to be practiced by these financial capitalists. The more excessive the flotation, the greater the profits, and the more imminent the bankruptcy. The more frequent the bankruptcy, the greater the profits of reorganization and the sooner the opportunity of another excessive flotation with its accompanying profits. This excessive stage reached its highest peak only in the United States. In Europe it was achieved only in isolated cases.

Finance Capitalism Opened the Way for Centralization of World

Economic Control in the Hands of the International Banking Fraternity

     The growth of financial capitalism made possible a centralization of world economic control and a use of this power for the direct benefit of financiers and the indirect injury of all other economic groups. This concentration of power, however, could be achieved only by using methods which planted the seeds which grew into monopoly capitalism. Financial control could be exercised only imperfectly through credit control and interlocking directorates. In order to strengthen such control, some measure of stock ownership was necessary. But stock ownership was dangerous to banks because their funds consisted more of deposits (that is, short-term obligations) than of capital (or long-term obligations). This meant that banks which sought economic control through stock ownership were putting short-term obligations into long-term holdings. This was safe only so long as these latter could be liquidated rapidly at a price high enough to pay short-term obligations as they presented themselves. But these holdings of securities were bound to become frozen because both the economic and the financial systems were deflationary. The economic system was deflationary because power production and modern technology gave a great increase in the supply of real wealth. This meant that in the long run the control by banks was doomed by the progress of technology. The financial system was also deflationary because of the bankers' insistence on the gold standard, with all that this implies.

The Money Power Creates an Ingenious Plan to Create and

Control Giant Monopolies

     To escape from this dilemma, the financial capitalists acted upon two fronts. On the business side, they sought to sever control from ownership of securities, believing they could hold the former and relinquish the latter. On the industrial side, they sought to advance monopoly and restrict production, thus keeping prices up and their security holdings liquid.

     The efforts of financiers to separate ownership from control were aided by the great capital demands of modern industry. Such demands for capital made necessary the corporation form of business organization. This inevitably brings together the capital owned by a large number of persons to create an enterprise controlled by a small number of persons. The financiers did all they could to make the former number as large as possible and the latter number as small as possible. The former was achieved by stock splitting, issuing securities of low par value, and by high-pressure security salesmanship. The latter was achieved by plural-voting stock, nonvoting stock, pyramiding of holding companies, election of directors by cooptation, and similar techniques. The result of this was that larger and larger aggregates of wealth fell into the control of smaller and smaller groups of men.

The Money Power Used Monopoly Capitalism to

Increase Wealth and Power

     While financial capitalism was thus weaving the intricate pattern of modern corporation law and practice on one side, it was establishing monopolies and cartels on the other. Both helped to dig the grave of financial capitalism and pass the reins of economic control on to the newer monopoly capitalism. On one side, the financiers freed the controllers of business from the owners of business, hut, on the other side, this concentration gave rise to monopoly conditions which freed the controllers from the banks.

     The date at which any country shifted to financial capitalism and later shifted to monopoly capitalism depended on the supply of capital available to business. These dates could be hastened or retarded by government action. In the United States the onset of monopoly capitalism was retarded by the government's antimonopoly legislation, while in Germany it was hastened by the cartel laws. The real key to the shift rested on the control of money flows, especially of investment funds. These controls, which were held by investment bankers in 1900, were eclipsed by other sources of funds and capital, such as insurance, retirement and investment funds, and, above all, by those flows resulting from the fiscal policies of governments. Efforts by the older private investment bankers to control these new channels of funds had varying degrees of success, but, in general, financial capitalism was destroyed by two events: (1) the ability of industry to finance its own capital needs because of the increased profits arising from the decreased competition established by financial capitalism, and (2) the economic crisis engendered by the deflationary policies resulting from financial capitalism's obsession with the gold standard.

Chapter 21: The Period of Deflation, 1927- 1936

     The period of stabilization cannot be clearly distinguished from the period of deflation. In most countries, the period of deflation began in 1921 and, after about four or five years, became more rapid in its development, reaching after 1929 a degree which could be called acute. In the first part of this period (1921-1925), the dangerous economic implications of deflation were concealed by a structure of self-deception which pretended that a great period of economic progress would be inaugurated as soon as the task of stabilization had been accomplished. This psychological optimism was completely unwarranted by the economic facts, even in the United States where these economic facts were (for the short term, at least) more promising than anywhere else. After 1925, when the deflation became more deep-rooted and economic conditions worsened, the danger from these conditions was concealed by a continuation of unwarranted optimism. The chief symptom of the unsoundness of the underlying economic reality—the steady fall in prices—was concealed in the later period (1925-1929) by a steady rise in security prices (which was erroneously regarded as a good sign) and by the excessive lending abroad of the United States (which amounted to almost ten billion dollars in the period 1920-1931, bringing our total foreign investment to almost 27 billion dollars by the end of 1930). This foreign lending of the United States was the chief reason why the maladjusted economic conditions could be kept concealed for so many years. Before the World War, the United States had been a debtor nation and, to pay these debts, had developed an exporting economy. The combination of debtor and exporter is a feasible one. The war made the United States a creditor nation and also made her a greater exporter than ever by building up her acreage of cotton and wheat and her capacity to produce ships, steel, textiles, and so on. The resulting combination of creditor and exporter was not feasible. The United States refused to accept either necessary alternative—to reduce debts owed to her or to increase her imports. Instead, she raised tariffs against imports and temporarily filled the gap with huge foreign loans. But this was hopeless as a permanent solution. As a temporary solution, it permitted the United States to be both creditor and exporter; it permitted Germany to pay reparations with neither a budgetary surplus nor a favorable balance of trade; it permitted dozens of minor countries to adopt a gold standard they could not hold; it permitted France, Britain, Italy, and others to pay war debts to the United States without sending goods. In a word, it permitted the world to live in a fairyland of self-delusions remote from economic realities.

Economic Realities

     These realities were characterized by (a) fundamental maladjustments, both economic and financial, which made it impossible for the financial system to function as it had in 1914, and (b) the steady deflation.

     The fundamental maladjustments were both economic and financial. The economic maladjustments were those which we have already indicated: the industrialization of colonial areas; the overproduction of raw materials and food as a result of wartime high prices, the overexpansion of heavy industry as a result of wartime needs, the obsolescence of much of heavy industry in Europe and in Britain which made it impossible to compete with newer equipment or to cope with the shifts in consumer demand, and the steadily increasing disadvantage of producers of raw materials and food in contrast with producers of industrial goods. To these old factors were added new ones such as the great increase in productive efficiency in Germany and the United States, the return of Russia and Germany to the European economy about 1924, and the return of Europe-to the world economy in the period 1925-1927. Many countries sought to resist these factors, both old and new, by adopting political interference with economic life in the form of tariffs, import quotas, export subsidies, and so on.

     The financial maladjustments served to create an insufficiency of gold and a mal-distribution of gold. The inadequacy of the supply of gold arose from several causes. It has been estimated that the world's stock of gold money needed to increase by 3.1 percent per year in the 1920's to support the world's economic development with stable prices on the gold standard. The production of new gold after 1920 was below this rate.

     Moreover, as a result of the activities of the League of Nations and financial advisers like Professor E. W. Kemmerer of Princeton University, every country was encouraged to get on the gold standard. This led to a "gold rush" as each country tried to obtain a supply of gold large enough to provide adequate reserves. Because there were more countries on gold in 1928 than in 1914 and because prices in general were higher, more gold was needed in reserves.

     The efforts to get around this by using a gold exchange standard rather than a gold standard were helpful in dealing with the problem of inadequate supplies of gold but increased the difficulty of the problem of mal-distribution of gold, since the gold exchange standard did not respond to the flow of gold as readily and thus did not serve so well to stem such flows of gold. The need for gold was made greater by the existence of large floating balances of political or panic funds which might well move from one market to another independent of economic conditions. The need was increased by the fact that in 1920 there were three major financial centers which had to make payments by shipments of gold in contrast to the single financial center of 1914 where payments could be made by bookkeeping transactions. To rectify this problem to some degree, the Bank for International Settlements was created in 1929.... Finally, the need for gold was increased by the enormous growth in foreign indebtedness, much of it of a political nature such as the war debts and reparations.

The Financial System of 1914 Had Broken Down

     On top of this insufficiency of gold was superimposed a drastic mal-distribution of gold. This was conclusive proof that the financial system of 1914 had broken down, for the old system would have operated automatically to distribute gold evenly. This mal-distribution resulted from the fact that when gold flowed into certain countries the automatic results of such a flow (such as rising prices or falling interest rates) which would have restored equilibrium in 1914 were prevented from acting in 1928. In this period, about four-fifths of the world's gold supply was in five countries, and over half was in two, the United States and France. The gold had been brought to these two for quite different reasons—to the United States because it was the world's greatest creditor and to France because of its devaluation of the franc. Britain, on the other hand, had floating balances of about ฃ800 million, and handled each year ฃ20,000 million in transactions with a gold reserve of only ฃ150 million. Such a situation made it possible for France to use gold as a political weapon against Britain.

Wholesale Prices

     As a result of these conditions and the deflationary economic conditions described in Chapter 11, prices began to fall, at first slowly and then with increasing rapidity. The turning point in most countries was in 1925-1926, with Great Britain one of the earliest (January 1925). In the first half of 1929, this slow drift downward began to change to a rapid drop. The following table will show the changes in wholesale prices for five principal countries:

Wholesale Price Indices (1913 = 100)

          United      Britain     France     Italy          Germany

1924          141          166          489          554               137

1925          148          159          550          646               142

1926          143          148          695          654               134

1927          137          142          642          527               138

1928          139          137          645          491               140

1929          137          120          627          481               137

1930          124          104          554          430               125

1931          105          102          520          376               111

1932           93           90          427          351                97

1933           95           90          398           320                93

1934          108           92          376          313                98

1935          115           93          339          344               102

1936          116           99          411          385               104

1937          124          114          581          449               106

The Facade of Prosperity

     The economic effects of these soft prices after 1925 were adverse, but these effects were concealed for a considerable period because of various influences, especially the liberal credit policies of the United States (both foreign and domestic) and the optimism engendered by the stock-market boom. The facade of prosperity over unsound economic conditions was practically worldwide. Only in France and the United States was it a boom in real wealth, but in the latter it was by no means as great as one might think from a glance at stock prices. In Britain, the boom appeared in the form of the flotation of new stocks of unsound and fraudulent companies and a minor stock-market boom (about one-third as fast a rise in security prices as in the United States). In Germany and in much of Latin America, the boom was based upon foreign borrowing (chiefly from the United States) the proceeds of which were largely put into nonproductive construction. In Italy, held down by the over-evaluation of the lira in 1927, the boom was of short duration.

The Crash of 1929

     The history of the slump begins about 1927 when France stabilized the franc de facto at a level at which it was devalued and undervalued. This led to a great demand for francs. The Bank of France sold francs in return for foreign exchange. The francs were created as credit in France, thus giving an inflationary effect which can be seen in the behavior of French prices in 1926-1928. The foreign exchange which France received for its francs was largely left in that form without being converted into gold. By 1928 the Bank of France found that it held foreign exchange to the value of 32 billion francs (about $1.2 billion). At this point the Bank of France began to transfer its exchange holdings into gold, buying the metal chiefly in London and New York. Because of the inadequate gold reserves in London, a meeting of central bankers in New York decided that the gold purchases of France and Germany should be diverted from London to New York in the future (July 1927). To prevent the resulting outflow of gold from having a deflationary effect which might injure business, the New York Federal Reserve Bank dropped its discount rate from 4 percent to 3 ฝ percent. When the French gold purchases became noticeable in 1928, the Federal Reserve Bank adopted open market operations to counterbalance them, buying securities to a value equal to the French purchases of gold.

     As a result there was no reduction in money in the United States. This money, however, was going increasingly into stock-market speculation rather than into production of real wealth. This can be seen from the following table of indices of average stock prices for both England and the United States in the years indicated:

Industrial Shares Prices

(1924 = 100)

          Year               United Kingdom          United States

          1924                    100                    100

          1925                    109                    126

          1926                    115                    143

          1927                    124                    169

          1928                    139                    220

          1929                    139                    270

          1930                    112                    200

          1931                     87                    124

          1932                     84                     66

          1933                    103                     95

          1934                    125                    116

     The stock-market boom in the United States was really much more drastic than is indicated by these index numbers, because these are yearly averages, and include sluggish stocks as well as market leaders. The boom began as far back as 1924, as can be seen, and reached its peak in the fall of 1929. By the spring of 1929 it had become a frenzy and was having profound effects on business activity, on domestic and international finance, on the domestic affairs of foreign countries, and on the psychology and modes of life of Americans.

Credit Was Diverted from Production to Speculation

     Among the financial results of the stock-market boom were the following: In the United States credit was diverted from production to speculation, and increasing amounts of funds were being drained from the economic system into the stock market, where they circulated around and around, building up the prices of securities. In Germany it became increasingly difficult to borrow from the United States, and the foreign loans, which kept the German financial system and the whole system of reparations and war debts functioning, were shifted from long-term loans to precarious short-term credits. The results of this have been examined in the chapter on reparations. In other countries, funds tended to flow to the United States where they could expect to roll up extraordinary earnings in capital gains in a relatively short time. This was especially true of funds from Britain where the stock-market boom ceased after the end of 1928. By that time the fundamentally unsound economic conditions were beginning to break through the facade. The decline in foreign loans by both London and New York began to be noticeable by the last half of 1928 and made it evident that the chief support of the facade was vanishing. But the continued rise of security prices in New York continued to draw money from the rest of the world and from the productive and consumptive systems of the United States itself.

A Financial Disaster of Unparalleled Magnitude

     Early in 1929, the board of governors of the Federal Reserve System became alarmed at the stock-market speculation, especially at its draining credit from industrial production. To curtail this, in April 1929, the Federal Reserve authorities called upon the member banks to reduce their loans on stock-exchange collateral. At the same time, it engaged in open-market operations which reduced its holdings of bankers' acceptances from about $300 million to about $150 million. The sterilization of gold was made more drastic. It was hoped in this way to reduce the amount of credit available for speculation. Instead, the available credit went more and more to speculation and decreasingly to productive business. Call money rates in New York which had reached 7 percent at the end of 1928 were at 13 percent by June 1929. In that month, the election of a Labour government in England so alarmed British capital that large amounts flowed to the United States and contributed further to the speculative frenzy. In August, the Federal Reserve discount rate was raised to 6 percent. By this time it was becoming evident that the prices of stocks were far above any value based on earning power and that this earning power was beginning to decline because of the weakening of industrial activity. At this critical moment, on September 26, 1929, a minor financial panic in London (the Hatry Case) caused the Bank of England to raise its bank rate from 4 ฝ percent to 6 ฝ percent. This was enough. British funds began to leave Wall Street, and the overinflated market commenced to sag. By the middle of October, the fall had become a panic. In the week of October 21st on the Stock Exchange and the Curb Exchange in New York, total stocks sold averaged over 9 million a day, and on Thursday, October 24th, almost 19 1/4 million shares changed hands. The shrinkage in values was measured by several billion dollars a day. Some stocks fell by 100 or even 140 points in a day. Auburn fell 210 points, General Electric 76 points, and U.S. Steel 26 points in 4 ฝ days. By November 6th these three stocks had fallen respectively 55, 78, and 28 points more. It was a financial disaster of unparalleled magnitude.

The Stock Market Crash Reduces Real Wealth

     The stock-market crash reduced the volume of foreign lending from the United States to Europe, and these two events together tore away the facade which until then had concealed the fundamental maladjustments between production and consumption, between debts and ability to pay, between creditors and willingness to receive goods, between the theories of 1914 and the practices of 1928. Not only were these maladjustments revealed but they began to be readjusted with a severity of degree and speed made all the worse by the fact that the adjustments had been so long delayed. Production began to fall to the level of consumption, creating idle men, idle factories, idle money, and idle resources. Debtors were called to account and found deficient. Creditors who had refused repayment now sought it, but in vain. All values of real wealth shrank drastically.

The Crisis of 1931

     It was this shrinkage of values which carried the economic crisis into the stage of financial and banking crisis and beyond these to the stage of political crisis. As values declined, production fell rapidly; banks found it increasingly difficult to meet the demands upon their reserves; these demands increased with the decline in confidence; governments found that their tax receipts fell so rapidly that budgets became unbalanced in spite of every effort to prevent it.

     The financial and banking crisis began in central Europe early in 1931, reached London by the end of that year, spread to the United States and France in 1932, bringing the United States to the acute stage in 1933, and France in 1934.

The Largest Bank in Austria Collapses

     The acute stage began early in 1931 in central Europe where the deflationary crisis was producing drastic results. Unable to balance its budget or obtain adequate foreign loans, Germany was unable to meet her reparation obligations. At this critical moment, as we have seen, the largest bank in Austria collapsed because of its inability to liquidate its assets at sufficiently high prices and with enough speed to meet the claims being presented to it. The Austrian debacle soon spread the banking panic to Germany. The Hoover Moratorium on reparations relieved the pressure on Germany in the middle of 1931, but not enough to permit any real financial recovery. Millions of short-term credits lent from London were tied up in frozen accounts in Germany. As a result, in the summer of 1931, the uneasiness spread to London.

The Wealthy Were Causing the Panic

     The pound sterling was very vulnerable. There were five principal reasons: (1) the pound was overvalued; (2) costs of production in Britain were much more rigid than prices; (3) gold reserves were precariously small; (4) the burden of public debt was too great in a deflationary atmosphere; (5) there were greater liabilities than assets in short-term international holdings in London (about 407 million to ฃ153 million). This last fact was revealed by the publication of the Macmillan Report in June 1931, right at the middle of the crisis in central Europe where most of the short-term assets were frozen. The bank rate was raised from 2 ฝ percent to 4 ฝ percent to encourage capital to stay in Britain. ฃ130 million in credits was obtained from France and the United States in July and August to fight the depreciation of the pound by throwing more dollars and francs into the market. To restore confidence among the wealthy (who were causing the panic) an effort was made to balance the budget by cutting public expenditures drastically. This, by reducing purchasing power, had injurious effects on business activity and increased unrest among the masses of the people. Mutiny broke out in the British fleet in protest against pay cuts. Various physical and extralegal restrictions were placed on export of gold (such as issuing gold bars of a low purity unacceptable to the Bank of France). The outflow of gold could not be stopped. It amounted to ฃ200 million in two months. On September 18th New York and Paris refused further credits to the British Treasury, and three days later the gold standard was suspended. The bank rate still stood at 4 ฝ percent. To many experts the most significant aspect of the event was not that Britain went off gold, but that she did so with the bank rate at 4 ฝ percent. It had always been said in Britain that a 10 percent bank rate would pull gold out of the earth. By 1931, the authorities in Britain saw clearly the futility of trying to stay on gold by raising the bank rate. This indicates how conditions had changed. It was realized that the movement of gold was subject to factors which the authorities could not control more than it was under the influence of factors they could control. It also shows—a hopeful sign—that the authorities after twelve years were beginning to realize that conditions had changed. For the first time, people began to realize that the two problems—domestic prosperity and stable exchanges—were quite separate problems and that the old orthodox practice of sacrificing the former to the latter must end. From this point on, one country after another began to seek domestic prosperity by managed prices and stable exchanges by exchange control. That is, the link between the two (the gold standard) was broken, and one problem was made into two.

The British Suspension of Gold

     The British suspension of gold was by necessity, not by choice. It was regarded as an evil, but it was really a blessing. As a result of this mistake, many of the benefits which could have been derived from it were lost by trying to counterbalance the inflationary results of the suspension by other deflationary actions. The discount rate was raised to 6 percent; valiant efforts to balance the budget continued; a protective tariff was established and a program of fairly stiff taxes installed. As a result, prices did not rise enough to give that spur to production which would have been necessary to increase prosperity and reduce unemployment. No system of exchange control was set up. As a result, the depreciation of sterling in respect to gold-standard currencies could not be prevented, and amounted to 30 percent by December 1931. Such a depreciation was regarded by the authorities as an evil—chiefly because of orthodox economic theories which considered parity of exchanges as an end in itself and partly because of the need to pay the ฃ130 million in Franco-American credits—a burden which increased as sterling depreciated in respect to dollars and francs.

The Central Core of the World's Financial System Was Disputed

     As a result of the British abandonment of the gold standard the central core of the world's financial system was disrupted. This core, which in 1914 was exclusively in London, in 1931 was divided among London, New York, and Paris. London's share depended on financial skill and old habits; New York's share depended on her position as the world's great creditor; Paris's share depended on a combination of a creditor position with an undervalued currency which attracted gold. From 1927 to 1931, these three had controlled the world's financial system with payments flowing in to the three, credits flowing out, and stable exchanges between them. The events of September 1931 broke up this triangle. Stable exchanges continued for dollar-franc, leaving dollar-pound and pound-franc to fluctuate. This did not permit an adjustment of the maladjusted exchange rates of 1928-1931. Concretely, the undervaluation of the franc in 1928 and the overvaluation of the pound in 1925 could not be remedied by the events of 1931. A sterling-franc rate which would have eliminated the undervaluation of the franc would have resulted in a sterling-dollar rate which would have overcorrected the overvaluation of sterling. On the other hand, the depreciation of the pound put great pressure on both the dollar and the franc. At the same time, Britain sought to exploit as much as possible her economic relations with her home market, the empire, and that group of other countries known as the "sterling bloc." The home market was set aside by the establishment of customs duties on imports into the United Kingdom (special customs duties November 1931, and a general tariff in February 1932). The empire was brought into closer economic ties by a group of eleven "Imperial Preference" treaties made at Ottawa in August 1932. The sterling bloc was reinforced and enlarged by a series of bilateral trade agreements with various countries, beginning with Norway, Sweden, Denmark, and Argentina.

The World Divided into Two Financial Groups

     Thus the world tended to divide into two financial groups—the sterling bloc organized about Britain and the gold bloc organized about the United States, France, Belgium, the Netherlands, and Switzerland.

     The depreciation of sterling in relation to gold made the currencies of the gold bloc overvalued, and relieved Britain of that burdensome status for the first time since 1925. As a result, Britain found it easier to export and more difficult to import, and obtained a favorable balance of trade for the first time in almost seven years. On the other hand, the gold countries found their depressions intensified.

Britain Frees Herself from Bondage to France

     As a third result of the British abandonment of the gold standard Britain freed herself from her financial subjection to France. This subjection had resulted from the vulnerable position of the British gold reserves in contrast to the bulging appearance of the French reserves. After 1931 the financial positions of the two countries were reversed. When Britain was able to add a financial superiority after 1931 to the political superiority she had possessed since 1924, it became possible for Britain to force France to accept the policy of appeasement. Moreover, the financial crisis of 1931 was to bring to power in Britain the national government which was to carry out the policy of appeasement.

Trade Barriers Arise

     As a fourth result, the countries still on gold began to adopt new trade barriers, such as tariffs and quotas, to prevent Britain from using the advantage of depreciated currency to increase her exports to them. The countries already off gold began to see the value in currency depreciation, and the possibility of races in depreciation began to form in the minds of some.

     As a fifth result of the abandonment of gold, it became possible to rearm without the resulting unbalancing of the budget leading to financial jeopardy as under a gold standard. Little advantage was taken of this, because pacificism on the Left and appeasement on the Right were regarded as substitutes for arms.

     Because of the deflationary policy which accompanied the abandonment of gold in Great Britain, recovery from depression did not result except to a very slight degree. Neither prices nor employment rose until 1933, and, from that year on, the improvement was slow. The depreciation of sterling did result in an improvement in the foreign trade balance, exports rising very slightly and imports falling 12 percent in 1932 in comparison with 1931. This led to a revival of confidence in sterling and a simultaneous decline in confidence in the gold-standard currencies. Foreign funds began to flow to London.

Control of Credit in Britain Left to the Bank of England

     The flow of capital into Britain early in 1932 resulted in an appreciation of sterling in respect to the gold currencies. This was unwelcome to the British government since it would destroy her newly acquired trade advantage. The pound sterling appreciated in respect to the dollar from 3.27 on December 1, 1931, to 3.80 on March 31, 1932. To control this, the government, in May 1932, set up the Exchange Equalization Account with capital of ฃ175 million. This fund was to be used to stabilize the exchange rates by buying and selling foreign exchange against the trend of the market. In this way, the old automatic regulation by the market of the internal credit structure through the international flow of funds was broken. Control of the credit structure was left to the Bank of England, while control of the exchanges went to the Exchange Equalization Fund. This made it possible for Britain to adopt a policy of easy and plentiful credit within the country without being deterred by a flight of capital from the country. Since the Exchange Equalization Fund was not a system of exchange control but merely a government management of the regular exchange market, it was not in a position to handle any very considerable emigration of capital. The easy credit policies of Britain (designed to encourage business activity) had thus to be combined with deflationary prices (designed to prevent any powerful flight of capital). The bank rate was dropped to 2 percent by July 1932, and an embargo was placed on new foreign capital issues to keep this easy money at home. The chief exceptions to this embargo arose from loans to be used in the general policy of binding the sterling bloc to Britain, and the proceeds of these had to be used in Britain.

     On this basis, although sterling fell to 3.14 by the end of November 1932, a mild economic revival was built up. Cheap credit permitted a shift of economic activity from the old lines (like coal, steel, textiles) to new lines (like chemicals, motors, electrical products). The tariff permitted a rapid growth of cartels and monopolies whose process of creation provided at least a temporary revival of economic activity. The continued low food prices permitted the income from this increase in activity to be diverted to necessities of a different kind, especially dwelling construction. The budget was balanced, and early in 1934 showed a surplus of ฃ30 million.

     The improvement in Britain was not shared by the countries still on gold. As a result of the competition of depreciated sterling, they found their balances of trade pushed toward the unfavorable side and their deflation in prices increased. Tariffs had to be raised, quotas and exchange controls set up. The United States could hardly do the first of these (her tariff of 1930 was already the highest in history), and rejected the others in principle.

The Crisis in the United States, 1933

     As a result of the British crisis, the gold countries of Europe sought to modify their financial basis from the gold exchange standard to the gold bullion standard. When Britain abandoned gold in September 1931, France was caught with over ฃ60 million in sterling exchange. This was equal to about 30 percent of her foreign-exchange holdings (7,775 million francs out of 25,194 million). The loss exceeded the total capital and surplus of the Bank of France. To avoid any similar experience in the future, France began to transfer her holdings of exchange into gold, much of it called from the United States. As confidence in the pound rose, that in the dollar fell. It became necessary to raise the New York discount rate from 1 ฝ percept to 3 ฝ percent (October 1932) and to engage in extensive open-market buying of securities to counteract the deflationary effects of this. However, the gold exports and gold hoarding continued, made worse by the fact that the United States was the only gold standard country with gold coins still circulating.

The American Banking System Began to Collapse

     As a result of the decline of confidence and the demand for liquidity, the American banking system began to collapse. The Reconstruction Finance Corporation was set up early in 1932 with $3 ฝ billion in government money to advance to banks and other large corporations. By the end of the year, it had lent over $1 ฝ billion. When the details of these loans were published (in January 1933), runs on the banks were intensified. A bank holiday was declared in Nevada in October 1932, in Iowa in January 1933, in six states during February, and in sixteen states in the first three days of March. From February 1st to March 4th the Federal Reserve Bank in New York lost $756 million in gold; it called in $709 million from the other Federal Reserve Banks, which were also subject to runs.

Banks in the U.S. Were Closed

     The banks of the whole United States were closed by executive order on March 4 to be reopened after March 12th if their condition was satisfactory. Export of gold was subjected to license, convertibility of notes into gold was ended, and private holding of gold was made illegal. These orders, completed on April 20, 1933, took the United States off the gold standard. This was done in order that the government could pursue a policy of price inflation in its domestic program. It was not made necessary by the American international financial position, as this continued very favorable. This was quite different from the situation in Britain in 1931. London had left gold unwillingly and had followed an orthodox financial program afterward; Washington left gold in 1933 voluntarily in order to follow an unorthodox financial program of inflation.

The Central Exchange Triangle Was Disrupted

     As a result of the abandonment of the gold standard by the United States, the central-exchange triangle between London, Paris, and New York was further disrupted. All three exchange rates were able to fluctuate, although the Exchange Equalization Account kept two of them relatively steady. To the worldwide problem of economic distress was now added the problem of exchange stabilization. A dispute ensued among Britain, France, and the United States over which of these two problems should be given priority. France insisted that no economic recovery was possible until exchanges were stabilized. It surely was true that as long as the franc remained on gold at the same valuation, France would suffer from the depreciation of the pound and the dollar. The United States insisted that economic recovery must have priority over stabilization, since the latter would hamper the process of price reflation which the administration considered essential to recovery. Britain, which had supported the priority of recovery over stabilization as long as the pound was the only one of the three currencies which was depreciated, insisted on the importance of stabilization as soon as the advantages of depreciation began to be shared by the dollar. This depreciation of both the dollar and the pound put great strain on the franc. To keep France from being forced off the gold standard, Britain, on April 28, 1933, lent her 30 million to be repaid out of the sterling exchange with which France had been caught in September 1931. Until the middle of 1933, the Exchange Equalization Account was used by Britain to prevent any appreciation of the pound. This was countered in the United States by the inflationary Thomas Amendment to the Agricultural Adjustment Act (May 12, 1933). This Amendment gave the president the power to devaluate the dollar up to 50 percent, to issue up to $3 billion in fiat money, and to engage on an extensive program of public spending.

The World Economic Conference, 1933

     This dispute over the priority of stabilization or recovery reached its peak in the World Monetary and Economic Conference held in London from June 12 to July 27, 1933. A Preparatory Commission of Experts drew up a series of preliminary agreements for countries on gold or off, with exchange controls or without, but no agreement could be obtained at the conference itself. Britain and France tried to get the dollar to join them in a temporary de facto stabilization in preparation for a real agreement. The franc and pound had already been pegged to each other at 84 francs per pound, which gave a London gold price of 122 shillings. The United States refused to join in any temporary stabilization because of the success of the administration's domestic recovery program. The general price index in the United States rose by 8.7 percent from February to June 1933, and farm products rose by 30.1 percent. The mere hint of a stabilization agreement was sufficient to cause a sharp break in the rise of security and commodity prices (June 14, 1933), so Roosevelt broke off all negotiations toward stabilization (July 3, 1933).

Four Great Negatives

     The World Economic Conference, as Professor William Adams Brown wrote, broke up on four great negatives: the countries which had adopted trade restrictions refused to abandon them without currency stabilization; the countries on the gold standard refused to accept price increases as a road to recovery because of fear of inflation; Great Britain wanted price increases but refused to permit an unbalanced budget or a public works program; and the United States, which was seeking recovery through inflation and public works, refused to hamper the program by currency stabilization.

The Countries of the World Divide into Three Groups

     As a result of the failure of the Economic Conference, the countries of the world tended to divide into three groups: a sterling bloc, a gold bloc, and a dollar bloc. The gold and sterling blocs were formally organized, the former on July 3rd and the later on July 8th. A struggle ensued among these three in an effort to shift the economic burdens of past mistakes from one to another.

The Failure of the World Economic Conference

     A great deal has been written since 1933 in an effort to apportion the blame for the failure of the World Economic Conference. It is a futile task. From the point of view of narrow self-interest in the short run, all countries were correct in their actions. From the wider point of view of the world as a whole or of the long-run results, all countries were worthy of blame. By 1933, the day in which any country could follow a policy of short-run self-interest and remain under liberal capitalism was past. For technological and institutional reasons, the economies of the different countries were so intertwined with one another that any policy of self-interest on the part of one would be sure to injure others in the short run and the country itself in the long run. Briefly, the international and the domestic economic systems had developed [by the Money Power] to a point where the customary methods of thought and procedure in regard to them were [considered] obsolete [by the Money Power].

The Whole Banking System in America Is Insolvent

     The reason why a policy of short-run self-interest on the part of one country was in such sharp conflict with any similar policy pursued by another country does not rest on the fact that the interests of one country were adverse to those of another. That would have been a problem to be treated by simple compromise. The conflicts between economic nationalisms were based on the fact that, viewed superficially, the crisis took entirely different forms in the chief countries of the world. In the United States, the most obvious manifestation of the crisis was low prices, which by 1933 made the whole banking system insolvent. High prices became, thus, for the United States, the chief goal of debtors and creditors alike. In Britain, the most obvious manifestation of the crisis was the outflow of gold which jeopardized the gold standard. A rectification of the international balance of payments rather than a rise in prices thus became the chief immediate aim of British policy. In France, the crisis appeared chiefly as an unbalanced internal budget. The French gold supply was more than adequate, and prices, as a result of the substantial devaluation of 1928, were considered extremely high. But the unbalanced budget created a great problem. If the deficit were filled by borrowing the result would be inflationary and injurious to the creditor classes who had suffered so greatly in the 1920's. If the deficit were filled by taxation, this would lead to deflation (with its decline in business activity) and a flight of capital out of the country. To the French government the only way out of this dilemma was to be found in an increase in business activity, which would increase the tax yield without any rise in rates. It could see no value in the American concern with higher prices or the British concern with trade balances as short-run objectives.

     This contrast between the various kinds of impact which the economic and financial crisis made on the various countries could be extended to lesser countries. In Switzerland (where gold reserves were well over 100 percent) the chief problem was "hot money." In Germany, the chief problem was foreign debts, but this soon developed into a combination of all the ailments which were afflicting other countries (low prices, unfavorable balance of trade, unbalanced budget, panicky short-term loans, and so on). In the Netherlands and in the countries of eastern Europe, the chief problem was "segmentation of prices" (that is, that prices of food and raw materials, which they sold, fell faster than prices of manufactured goods which they bought).

Nations Begin to Pursue Policies of Economic Nationalism

     As a result of the crisis, regardless of the nature of its primary impact, all countries began to pursue policies of economic nationalism. This took the form of tariff increases, licensing of imports, import quotas, sumptuary laws restricting imports, laws placing national origin, trade-mark, health, or quarantine restrictions on imports, foreign-exchange controls, competitive depreciation of currencies, export subsidies, dumping of exports, and so on. These were first established on an extensive scale in , and spread rapidly as a result of imitation and retaliation.

World Trade System Breaks into Segregated Markets

     As a result of such economic nationalism, it soon appeared that the disappearance of the old multilateral system of world finance centering in London would be followed by the breaking of the multilateral system of world trade (also centering in Britain) into a number of partially segregated markets operating on a bilateral basis. International trade declined greatly as the following figures indicate:

Value of Trade in Millions of Dollars

                    1928           1932           1935          1933

Europe's Trade          58,082          24,426          20,762          24,065

World's Trade               114,429      45,469      40,302          46,865

The Crisis in the Gold Bloc, 1934—1936

     After the breakup of the World Economic Conference, the United States continued its policy of domestic inflation. As the dollar depreciated, the pressure on the franc increased, while the pound, through the use of the Exchange Equalization Account, tried to follow a middle ground in a depreciated, but stable, relationship to the franc. In this way, by purely artificial means, the pound was kept at about 85 francs. In the late summer of 1933 (September 8th) the United States Treasury began to depreciate the dollar by buying gold at constantly increasing prices (about $30 an ounce, compared to the old stabilization rate of $20.67). This put pressure on the franc as well as on the pound. Deflation became increasingly severe in France, and, in October 1933, a budget deficit of over 40 billion francs gave rise to a Cabinet crisis. By the end of 1933, the gold price in New York reached $34, and the dollar, which had been at 4.40 in relation to the pound in August, fell to 5.50. On February 1, 1934, the United States went back on the gold standard at a considerable devaluation under the old price. The gold content was cut to 59.06 percent of the 1932 amount. At the same time, the Treasury set up a standing offer to buy gold at $35 an ounce. This served to remove much of the uncertainty about the dollar, but stabilized it in regard to the franc at a level which put great pressure on the franc. At this price for gold, the metal flowed to the United States, France losing about 3 billion francs' worth in February 1934.

France

     Thus the world depression and the financial crisis which France had escaped for over three years were extended to her. France had been able to escape because of her drastic devaluation in the 1920's, her well balanced economy, and her ability to keep down unemployment by placing restrictions on the entrance of seasonal labor from Spain, Italy, and Poland. The crisis of the pound in September 1931 had begun to spread the crisis to France, and the crisis of the dollar in 1933 had made the situation worse. The American actions of 1934, which gave the world a 59-cent dollar and $35 gold, made the position of the gold bloc untenable. They had to suffer a severe deflation, or abandon gold, or devaluate. Most of them (because they feared inflation or because they had foreign debts which would increase in weight if their currency was to depreciate) permitted deflation with all its suffering. Italy even ordered deflation by decree in April 1934, in order to maintain business activity by forcing costs down as much as prices. Eventually, all members of the gold bloc had to abandon gold to some extent because of the pressure from the dollar.

Belgium

     Belgium was the first member of the gold bloc to yield, setting up exchange controls on March 18, 1935, and devaluating the belga to about 72 percent of its former gold content on March 30th. The final blow which forced the change was the British tariff on iron and steel established on March 26, 1935. As a result of this quick and decisive devaluation, Belgium experienced a considerable amount of economic recovery. Almost at once, production and prices rose, while unemployment fell.

France Defends the Franc

     The other members of the gold bloc did not profit by the example of Belgium, but determined to defend the gold content of their currencies to the limit. France was the leader in this movement, and by her policy was able to influence the other members of the bloc to resist with the same vigor. This determination of France to defend the franc is to be explained by the fact that the great mass of Frenchmen were creditors in some way or other, and having lost four-fifths of their savings in the inflation of 1914-1926 did not view with any pleasure another dose of the same medicine. In this effort to defend the franc, France was aided greatly by the activity of the British Exchange Equalization Account which bought francs in enormous quantities whenever the currency became very weak. By 1935, the resources of the Account capable of being devoted to this purpose were largely expended, and the franc fell below the gold export point for long periods. The Bank of France raised its discount rate from 2 ฝ percent to 6 percent (May 23-28, 1935) with depressing economic results. Laval in July obtained emergency powers from the Assembly, and adopted a policy of deflation by decree, cutting ordinary public expenditures for the year from 40 billion to 11 billion francs, cutting all public salaries by lo percent, and also reducing all rents, the cost of public utilities, and the price of bread.

Gold Begins to Leave France

     In this way, the strain on the gold reserves (which fell to 16 billion francs during 1935) was relieved at the cost of increased depression. By September, the franc was still overvalued (as far as cost of living was concerned) by about 34 percent as compared to the pound and by about 54 percent as compared to the dollar. The deflation necessary to bring French prices down to parity with the prices in the depreciated-currency countries could not be obtained. By the end of 1935, the government had abandoned the effort, and by borrowing to meet budgetary deficits had turned France toward inflation. Gold began to leave the country again, and this exit became a flood after a government of the Left led by Blum came to power in June 1936.

     The Blum "Popular Front" government tried to follow an impossible program: "inflation on gold." It sought inflation to relieve depression and unemployment and sought to remain on gold because this was insisted on by both the Communist and bourgeois supporters of the government. In an effort to restore confidence and slow the "flight from the franc," it became necessary for Blum formally to disavow any intention of installing a Socialist program. The Right thus discovered that it could veto any actions of the Left government merely by exporting capital from France. The flight of such capital continued through the summer of 1936, while Blum negotiated with Britain and the United States regarding devaluation of the franc. On September 24, 1936, the bank rate was raised from 3 percent to 5 percent, and, on the following day, a Three-Power Currency Declaration announced that the franc would be "adjusted," exchange stability would be maintained thereafter (through the stabilization funds), and trade restrictions would be relaxed.

The French Devaluation of 1936

     The French devaluation (law of October 2, 1936) provided that the gold content of the franc would be reduced to an amount from 25.2 percent to 34.4 percent of the old figure of 65 ฝ milligrams. From the profits obtained by thus revaluing French gold reserves, an exchange stabilization fund of 10 billion francs was set up.

France Is Blackmailed by the Wealthy

     Although the French devaluation of September 136 shattered the gold bloc and forced the other members of the bloc to follow suit, it did not end the period of deflation. The reasons for this were chiefly to be found in the complete mismanagement of the French devaluation. This decisive event was delayed too long—at least a year after it should have been done—a year during which gold steadily flowed from France. Moreover, when the devaluation came, it was insufficient and left the franc still overvalued in relation to price levels in the other Great Powers. Furthermore, the devaluation was shrouded with uncertainty, since the law permitted the government to devalue to any gold content between 43 and 49 milligrams. By stabilizing at about 46 milligrams, the government prevented any revival of confidence because of the danger of a further devaluation to 43 milligrams. By the time the government realized that a further devaluation was necessary, the situation had deteriorated so far that a devaluation to 43 milligrams was worthless. Finally, in the devaluation law the government took punitive measures against gold hoarders and speculators, seeking to prevent them from reaping the profits they would obtain by converting their gold back into francs at the new value. As a result, the exported and hoarded gold did not return but stayed in hiding. Thus the financial, budgetary, and economic difficulties in France continued. By the middle of 1937, they had become so bad that the only possible solutions were exchange control or a drastic devaluation. The former was rejected because of the pressure from Britain and the United States based on the Tripartite Agreement of 1936 and the support which their stabilization funds afforded the franc; the latter was rejected by all politicians likely to obtain power in France. As a result, the franc passed through a series of depreciations and partial devaluations which benefitted no one except the speculators and left France for years torn by industrial unrest and class struggles. Unable to arm or give foreign affairs the attention they needed, the government was subjected to systematic blackmail by the well-to-do of the country because of the ability of these persons to prevent social reform, public spending, arming, or any policy of decision by selling francs. Only in May 1938 was a decisive step made. At that time the franc was drastically depreciated to 179 in the pound, and pegged at that figure. Its gold content (by a law of November 12, 1938) was fixed at about 27.5 milligrams nine-tenths fine. By that time France had suffered years of economic chaos and governmental weakness. These conditions had encouraged German aggression, and, when a decisive financial action was made in 1938, it was, because of the rising international crisis, too late to reap any important economic benefits.

The Gold Bloc Was Destroyed

     We have said that the gold bloc was destroyed by the French devaluation of September 1936. This was accomplished almost immediately. Switzerland, the Netherlands, and Czechoslovakia devalued their currencies by about 30 percent and Italy by about 40 percent before the end of October. In each case, like Belgium rather than France. the devaluation was large enough in amount and abrupt enough in time to contribute to a noticeable reflation and improvement in business activity. Each country of the former gold bloc set up a stabilization fund to control exchange rates, and joined the Tripartite currency agreement of September 1936.

The Banker-Engendered Deflationary Crisis Became a

Chief Cause of World War II

     The historical importance of the banker-engendered deflationary crisis of 1927-1940 can hardly be overestimated. It gave a blow to democracy and to the parliamentary system which the later triumphs of these in World War II and the postwar world were unable to repair fully. It gave an impetus to aggression by those nations where parliamentary government collapsed, and thus became a chief cause of World War II. It so hampered the Powers which remained democratic by its orthodox economic theories that these were unable to rearm for defense, with the consequence that World War II was unduly prolonged by the early defeats of the democratic states. It gave rise to a conflict between the theorists of orthodox and unorthodox financial methods.... And, finally, it impelled the whole economic development of the West along the road from financial capitalism to monopoly capitalism and, shortly thereafter, toward the pluralist economy.

The Banker's Formula for Treating a Depression

     The controversy between the bankers and the theorists of unorthodox finance arose over the proper way to deal with an economic depression. We shall analyze this problem later, but here we should say that the bankers' formula for treating a depression was by clinging to the gold standard, by raising interest rates and seeking deflation, and by insisting on a reduction of public spending, a fiscal surplus, or at least a balanced budget. These ideas were rejected totally, on a point-by-point basis, by the unorthodox economists (somewhat mistakenly called "Keynesian"). The bankers' formula sought to encourage economic recovery by "restoring confidence in the value of money," that is, their own confidence in what was the primary concern of bankers. This formula had worked in the past only when it had, more or less incidentally, reduced costs (especially wages) faster than wholesale prices so that businessmen regained confidence, not in the value of money but in the possibility of profits. The unorthodox theorists sought to achieve this latter more quickly and more directly by restoring purchasing power, and thus prices, by increasing, instead of reducing, the money supply and by placing it in the hands of potential consumers rather in the banks or in the hands of investors....

Ivar Kreuger Sells Worthless and Fraudulent Securities

     The end of financial capitalism may well be dated at the collapse of the gold standard in Britain in September 1931, but, on the personal side, it might be dated at the suicide of its most spectacular individual, the "Match King," Ivar Kreuger, in Paris in April 1932.

     Ivar Kreuger (1880-1932), after several years' experience as an engineer in America and South Africa, set up in Stockholm in 1911 the contracting firm of Kreuger & Toll. By 1918 this firm was a financial company with a capital of 12 million kronor, and chiefly interested in the Swedish Match Company, a holding company organized by Kreuger. Within a decade, Kreuger had control of over 150 match companies in 43 countries. The securities of these firms were controlled through a Delaware corporation (called International Match Company). This holding company sold millions of dollars of securities with no voting rights, while control was exercised through a small bloc of voting stock held by Kreuger & Toll. By granting loans to the governments of various countries, Kreuger obtained match monopolies which brought in substantial sums. In all, ฃ330 million was lent to governments in this way, including $75 million to France and $125 million to Germany. In return Kreuger obtained control of 80 percent of the world's match industry, most of Europe's paper and wood-pulp production, fourteen telephone and telegraph companies in six countries, a considerable part of the farm-mortgage systems of Sweden, France, and Germany, eight iron-ore mines, and numerous other enterprises, including a considerable group of banks and newspapers in various countries. The whole system was financed in a sumptuous fashion by selling worthless and fraudulent securities to investors through the most prominent investment bankers of the world. In all, about $750 million in such securities was sold, about one-third in the United States. The respected Lee, Higginson, and Company of Boston sold $150 million of these securities to 600 banks and brokers without making any investigation into their value or honesty and received about $6 million in fees for doing so. The money thus raised by Kreuger was used to advance loans to various countries, to pay interest and dividends on securities issued previously, and to finance the further exploits of Mr. Kreuger. As examples of these exploits, we might mention that Kreuger & Toll paid dividends of 25 percent from 1919 to 1928 and 30 percent after 1929, mostly from capital; Swedish Match Company usually paid 15 per cent dividends. This was done in order to persuade the investing public to buy more of Kreuger's securities and thus keep the system going. In order to encourage this public, prospectuses were falsified, letters were forged, and the stock market was manipulated at heavy cost. Bonds were issued against the same security several times over. Most brazen of all, bonds were issued against the receipts of the match monopolies of Italy and Spain. Although Kreuger possessed neither of these, he carried them on his books for $80 million and had bonds forged by himself to substantiate the claim. The long-drawn out depression of 1929-1933 made it impossible to keep the system afloat, although Kreuger avoided no degree of corruption and deceit in his efforts to do so. In March 1932 a note for $11 million from International Telephone and Telegraph fell due, and Kreuger, unable to meet it, killed himself. He left claims against his estate of $700 million, while his personal debts were $179 million with assets of $18 million.

Large Combinations and Cartels Formed

     The death of Kreuger is merely a symbol of the end of European financial capitalism. For about fifty years before this event, the centralized control made possible by the financial system had been used to develop monopolistic tendencies in industry. These had been furthered by the growth of large combinations, by the formation of cartels and trade associations between units of enterprise, and by the increase of those less tangible restrictions on competition known as imperfect and monopolistic competition. As a result, competition had been declining, control of the market had been increasing, and self-financing by industrial units had been growing. This last development made it possible for industry once more to free itself from financial control as it had been in the owner-management period which preceded financial capitalism. But, unlike this earlier stage, control did not revert from financiers back to the owners of enterprise but instead tended to shift into the hands of a new class of bureaucratic managers whose powers of control were out of all relationship to the extent of their ownership of the enterprises concerned. In France, the bankers, although in retreat when war came in 1939, had been so strengthened by the unorthodox financial policies of the 1920's that they were able to prevent any important victory for monopoly capitalism in the 1930's, with the result that the shift from financial to monopoly capitalism did not appear in France until the 1940's. In the United States, also, the transition was not complete when war came in 1939, with the result that the United States, like France, but unlike any other important country, had not shaken off the world depression even as late as 1940.

Chapter 22: Reflation and Inflation, 1933-1947

     The period of reflation began in some countries (like Great Britain and the United States) long before the period of deflation had ended elsewhere (as in France). In most countries the recovery was associated with rising wholesale prices, with abandonment of the gold standard or at least devaluation, and with easy credit. It resulted everywhere in increased demand, rising production, and decreasing unemployment. By the middle of 1932, recovery was discernible among the members of the sterling bloc; by the middle of 1933 it was general except for the members of the gold bloc. This recovery was halting and uncertain. Insofar as it was caused by government actions, these actions were aimed at treatment of the symptoms rather than the causes of the depression, and these actions, by running contrary to orthodox economic ideas, served to slow up recovery by reducing confidence. Insofar as the recovery was caused by the normal working out of the business cycle, the recovery was slowed up by the continuation of emergency measures—such as controls over commerce and finance and by the fact that the economic dis-equilibriums which the depression had made were frequently intensified by the first feeble movements toward recovery. Finally, the recovery was slowed up by the drastic increase in political insecurity as a result of the aggressions of Japan, of Italy, and of Germany.

     Except for Germany and Russia (both of which had isolated their economies from world fluctuations) the recovery continued for no more than three or four years. In most countries the latter half of 1937 and the early part of 1938 experienced a sharp "recession." In no important country had prices reached the 1929 level at the beginning of the recession (although within 10 percent of it), nor had the percentage of persons unemployed fallen to the 1929 level. In many countries (but not the United States or the gold bloc), industrial production had reached 1929 levels.

The Recession of 1937

     The recession was marked by a break in wholesale prices, a decline in business activity, and an increase in unemployment. In most countries it began in the spring of 1937 and lasted for about ten months or a year. It was caused by several factors: (1) much of the price rise before 1937 had been caused by speculative buying and by the efforts of "panic money" to seek refuge in commodities, rather than by demand from either consumers or investors; (2) several international commodity cartels created in the period of depression and early recovery broke down with a resulting fall in prices; (3) there was a curtailment of public deficit spending in several countries, especially the United States and France; (4) the replacement of capital goods worn out in the period 1929-1934 had caused much of the revival of 1933-1937 and began to taper off in 1937; (5) the increase in political tension in the Mediterranean and the Far East as a result of the Civil War in Spain and the Japanese attack on North China had an adverse effect; and (6) a "gold scare" occurred. This last was a sudden fall in the demand for gold caused by the fact that the great increase in gold production resulting from the United States Treasury price of $35 an ounce gave rise to rumors that the Treasury would soon cut this price.

Ownership of Gold Ended in the U.S.

     As a result of the recession of 1937, the governmental policies of 1933-1935, which had given the first recovery, were intensified and gave rise to a second recovery. Bank rates were lowered—in some cases to 1 percent; deficit spending was resumed or increased; all efforts to get back on a gold standard were postponed indefinitely; in the United States, the sterilization of gold was ended, and all thoughts of reducing the buying price of gold were abandoned. The chief new factor after the recession was one which was of minor but rapidly growing importance. The deficit spending which had been used to pay for public works projects before 1937 was increasingly devoted to rearmament after that date. Britain, for example, spent 186 million on arms in the fiscal year 1936-1937 and ฃ262 million in the year 1937-1938. It is not possible to say to what extent this increase in armaments was caused by the need for deficit spending and to what extent it was the result of the rising political tensions. Similarly, it is not possible to say which is cause and which effect as between political tensions and rearmament. Indeed, the relationships between all three of these factors are mutual reactions of cause and effect. At any rate, after the recession of 1937, armaments, political tensions, and prosperity increased together. For most countries, the political tensions led to the use of arms in open conflict long before full prosperity had been achieved. In most countries, industrial production exceeded the 1929 level by the end of 1937, but because of the increase in population, efficiency, and capital this was achieved without full utilization of resources. In the United States (with Canada as an appendage) and in France (with Belgium as an appendage) production continued low throughout the 1930's, reaching the 1929 level in the first pair only in the late summer of 1939 and never reaching the 1929 level in the second pair. As a result of the failure of most countries (excepting Germany and the Soviet Union) to achieve full utilization of resources, it was possible to devote increasing percentages of these resources to armaments without suffering any decline in the standards of living. In fact, to the surprise of many, the exact opposite resulted—as armaments grew, the standard of living improved because of the fact that the chief obstacle in the way of an improving standard of living—that is, lack of consumers' purchasing power, was remedied by the fact that armament manufacture supplied such purchasing power in the market without turning into the market any equivalent in goods which would use up purchasing power.

The Existence of Imprisoned Capital

     The recovery from depression after 1933 did not result in any marked reduction in the restrictions and controls which the depression had brought to commercial and financial activity. Since these controls had been established because of the depression, it might have been expected that such controls would have been relaxed as the depression lifted. Instead, they were maintained and, in some cases, extended. The reasons for this were various. In the first place, as the political crisis became more intense the value of these controls for defense and war was realized. In the second place, powerful bureaucratic vested interests had grown up for enforcing these controls. In the third place, these restrictions, which had been established chiefly for controlling foreign trade, proved very effective in controlling domestic economic activity. In the fourth place, under the protection of these controls the difference in price levels between some countries had grown so great that the ending of controls would have torn their economic structures to pieces. In the fifth place, the demand for protection from foreign competition remained so great that these controls could not be removed. In the sixth place, the debtor-creditor relationships between countries still remained valid and unbalanced and would have required new controls as soon as the old ones were lifted to prevent unbalanced payments and deflationary pressure. In the seventh place, the existence of "imprisoned capital" within national economic systems made it impossible to raise the controls, since the flight of such capital would have been disruptive of the economic system. The chief example of such imprisoned capital was the property of the Jews in Germany, amounting to over lo billion marks.

     For these and other reasons tariffs, quotas, subsidies, exchange controls, and government manipulations of the market continued. The moment at which these controls could have been withdrawn most easily was at the beginning of 1937, because by that time recovery was well developed and the international dis-equilibriums were less acute because of the disruption of the gold bloc late in 1936. The moment passed without much being accomplished, and, by the end of 1937, the recession and the mounting political crisis made all hopes of relaxing controls utopian.

The Hull Reciprocal Trade Program

     Such hopes, however, were found both before and after 1937. These included the Oslo Agreements of 1930 and 1937, the Ouchy Convention of 1932, the Hull Reciprocal Trade Program of 1934 and after, the Van Zeeland Mission of 1937, and the constant work of the League of Nations. Of these, only the Hull Program accomplished anything concrete, and the importance of its accomplishment is a subject of dispute.

The United States Became the World's Chief Defender of Free Trade

     The Hull Reciprocal Trade Program is of more importance from the political than from the economic point of view. It openly aimed at freer and multilateral trade. The act, as passed in 1934 and renewed at regular intervals since, empowered the executive branch to negotiate with other countries trade agreements in which the United States could reduce tariffs by any amount up to 50 percent. In return for lowering our tariffs in this way, we hoped to obtain trade concessions from the other party to the agreement. Although these agreements were bilateral in form, they were multilateral in effect, because each agreement contained an unconditional most-favored-nation clause by which each party bound itself to extend to the other party concessions at least as great as those it extended to the most favored nation with which it traded. As a result of such clauses any concessions made by either tended to be generalized to other countries. The interest of the United States in removing the restrictions on world trade was to be found in the fact that she had productive capacity beyond that necessary to satisfy articulate domestic demand in almost every field of economic activity. As a result she had to export or find her hands full of surplus goods. The interest of the United States in multilateral trade rather than in bilateral trade was to be found in the fact that her surpluses existed in all types of goods—foodstuffs, raw materials, and industrial products—and the markets for these would have to be sought in all kinds of foreign economies, not in any single type. The United States had excess supplies of food like wheat, pork, and corn; of raw materials like petroleum, cotton, and iron; of specialized industrial products like radios, automobiles, and locomotives. It was not possible to sell all these types to a food-producing country like Denmark, or to a raw-material-producing country like Canada or the Malay States, or to an industrial country like Germany or Britain. Accordingly, the United States became the world's chief defender of freer and multilateral trade. Her chief argument was based on the fact that such trade would contribute to a higher standard of living for all parties. To the United States, whose political security was so sound that it rarely required a moment's thought, a higher standard of living was the chief aim of existence. Accordingly, it was difficult for the United States to comprehend the point of view of a state which, lacking political security, placed a high standard of living in a position second to such security.

Nazi Germany Seeks Independence

     In sharp contrast to the United States in its attitude toward the problem of international trade was Nazi Germany. This and other countries were seeking "independence" (that is, political goals in the economic sphere), and they rejected "dependence" even if it did include a higher standard of living. They frequently rejected the argument that autarky was necessarily injurious to the standard of living or to international trade, because by "autarky" they did not mean self-sufficiency in all things, but self-sufficiency in necessities. Once this had been achieved, they stated their willingness to expand the world's trade in nonessentials to an extent as great as any standard of living might require.

Third World Countries to be Deprived of Sovereignty and

Reduced to Vassal States

     The basic key to the new emphasis on autarky is to be found in the fact that the advocates of such economic behavior had a new conception of the meaning of sovereignty. To them sovereignty had not only all the legal and political connotations it had always held, but in addition had to include economic independence. Since such economic independence could, according to the theory, be obtained only by the Great Powers, the lesser states were to be deprived of sovereignty in its fullest sense and be reduced to a kind of vassal or client condition in respect to the Great Powers. The theory was that each Great Power, in order to enjoy full sovereignty, must adopt a policy of autarky. Since no power, however great, could be self-sufficient within its own national boundaries, it must extend this sphere of autarky to include its weaker neighbors, and this sphere would have political as well as economic implications, since it was unthinkable that any Great Power should permit its lesser neighbors to endanger it by suddenly cutting off its supplies or markets.

The Rise of Continental Blocs Made It Possible that the World

Would Be Integrated into Large Political Units

     The theory thus led to the conception of "continental blocs" consisting of aggregates of lesser states about the few Great Powers. This theory was entirely in accord with the political development of the late nineteenth and early twentieth century. This development had seen an increasing disparity in the powers of states with a decreasing number of Great Powers. This decline in the number of Great Powers occurred because of the advance of technology, which had progressed to a point where only a few states could follow. The theory of continental blocs was also in accord with the growth of communications, transportation, weapons, and administrative techniques. These made it almost inevitable that the world would be integrated into increasingly large political units. The inevitability of this development can be seen from the fact that the wars of 1914-1945, waged for the preservation of the small states (like Poland, Czechoslovakia, Holland, and Belgium), succeeded in reducing the number of Great Powers from seven to two.

Integration of States Sought by Illegitimate Methods

     This integration of states into continental or other large blocs was, as we have seen, a quite legitimate and attainable ambition, but it was sought by the aggressor states (like Germany, Japan, and Italy) by quite illegitimate methods. A better method for attaining such integration would have been based on consent and mutual penetration. But this federalist method of integration could have succeeded only if it were honestly offered as an alternative to the authoritarian solution of the aggressor states. This was not done. Instead, the "liberal" states refused to recognize the inevitability of integration and, while resisting the authoritarian solution, sought as well to resist the whole process of integration. They sought to preserve the atomistic world structure of sovereign states which was so out of keeping with technological developments both in politics (new weapons, speedy transportation, and quicker communications) and in economics (mass production and increasing need for exotic materials such as tin, rubber, or uranium found in small and scattered amounts). As a result the liberal Powers resisted the German efforts to cope with the real world developments without putting any realistic or progressive substitute program in its place.

The Majority of the Countries Were Put into the

Position of Needing Integration

     The policy of negativism on the part of the liberal Powers was made worse by the fact that these Powers had put Germany and others into a position (as debtors) where they were driven in the direction of greater integration of the world on a voluntary basis. This appeared in the fact that these Powers had to adopt freer and increased trade in order to pay their debts. Having put the majority of the countries of the world into this position of needing increased integration in order to pay their debts, the liberal countries made it impossible to obtain such integration on a federalist basis by adopting policies of isolationist, economic nationalism for themselves (by high tariffs, ending of long-term loans, and so on). This dog-in-the-manger policy in economic matters was quite similar to their policy in political matters where, after setting up an organization to achieve peace, they declined to permit Germany to be a part of it and, later, when Germany became a part they refused to use the organization for peaceful goals but instead tried to use it to enforce the Treaty of Versailles or to build up a power balance against the Soviet Union.

The Instruments of International Organization Were Not Sufficiently

Developed to Prevent the Rise of Nationalism

     This failure of the liberal states in the 1920's becomes more obvious when we examine the great increase in restrictive economic and financial policies in the 1930's. It is usually said that the excesses in these were caused by the great increase in nationalism resulting from the depression. This is not true, and the increase in such restrictions cannot be quoted as a proof of increasing nationalism. No country entered upon these policies for nationalistic reasons—that is, for the closer integration of its own people, or to distinguish them more sharply from other people, or for the aggrandizement of its own people over another. The increase in economic nationalism was based on a much more practical cause than that—on the fact that the nation was the only social unit capable of action in the emergency resulting from the depression. And men were demanding action. For this the only available agency was the national state. If a broader agency had been available, it would have been used. Since it was not, the state had to be used—used, not with the purpose of injuring one's neighbors, but solely with the purpose of benefitting oneself. The fact that neighbors were injured was a more or less accidental result, regrettable, but inevitable so long as the largest unit of political organization (that is, the largest unit capable of complete action) was the nation-state. When a theater catches fire, and persons are trampled in the resulting panic, this is not because anyone desired this, but merely because each individual sought to escape from the building as soon as possible. The result is disaster because the individual is the only unit available capable of action. And the individual is too small a unit of action to spare many individuals from tragedy. If a larger unit of organization exists (as, for example, if the persons in the theater are a company of infantry with its officers), or if some cool-headed person can organize the group into a unit of action larger than the individual, all might escape safely. But the chances of forming an organization after the panic has begun are almost nil. In 1929-1934, the panic started before any unit of action larger than the nation-state existed. As a result, all suffered, and the puny efforts to form an organization after the panic began were vain. This is the real tragedy of the 1920's. Because of the conservatism, timidity, and hypocrisy of those who were trying to build an international organization in the period 1919-1929, this organization was so inadequate by 1929 when the emergency began that the organization which had been set up was destroyed rather than strengthened. If the instruments of international cooperation had been further advanced in 1929, the demand for action would have made use of these instruments, and a new era of political progress would have commenced. Instead, the inadequacy of these instruments forced men to fall back on the broadest instrument which was available—the nation-state; and there began a retrogressive movement capable of destroying all Western Civilization.

The Rise of Economic Nationalism

     The economic nationalism which arose from the need to act in a crisis—and to act unilaterally because of the lack of any organ able to act multilaterally (that is, internationally) was intensified after the breakdown in finance and economics of 1931-1933 by several developments. In the first place, it was increased by the discovery, by Germany in 1932, by Italy in 1934, by Japan in 1936, and by the United States in 1938, that deflation could be prevented by rearming. In the second place, it was increased by the realization that political activity was more powerful and more fundamental than economic activity—a realization which became clear when it was found that every step toward a unilateral economic solution resulted in reprisals from other nations which canceled out that step and made necessary another step, which, in its turn, called forth new reprisals; this soon showed that except in a nation capable of self-sufficiency such actions in the economic sphere could accomplish little and that unilateral action, if taken at all, must be accompanied by political steps (which would permit no reprisals). In the third place, economic nationalism was increased, and internationalism reduced, by the great increase in political insecurity, since the preservation of an international economic organization involved entrusting one's economic fate, to some degree, to the hands of another. Rather than this, economic nationalism was increased in the name of autarky, security, economic mobilization, and so on. Self-sufficiency, even if it involved a lower standard of living, was held preferable to international division of labor, on the grounds that political security was more important than a high— and insecure—standard of living.

International Trade Suffers a New Injury

     As a consequence of these three causes, international trade began to suffer a new injury. The old nineteenth century transfer of goods between industrial and colonial areas (producers of food and raw materials) had begun to decline by a purely natural evolution as the result of the industrialization of colonial areas. But now, as a result of the increase in economic nationalism, another kind of transfer was disrupted. This was the transfer among industrial nations resulting from an international division of labor and an uneven distribution of raw materials. An example of this can be seen in the iron and steel industry of western Europe. There British and German coal, French and Belgian low-grade iron ores, Swedish high-grade iron ores were mingled and combined to permit production of high-grade surgical steels in Sweden, of low-grade building steels in Belgium, of heavy machine products in Germany, and of light steel products in France. This transfer of goods began to be disrupted in the onslaught of economic nationalism after 1929. As a result, history turned backward, and the older interchange of colonial for industrial products increased in relative importance.

Economic Nationalism Strengthens Bilateralism

     Economic nationalism also increased the trend toward bilateralism. This received its chief and earliest impetus from Germany, but it was soon followed by other countries until, by 1939, the United States was the only important supporter of multilateral trade. Most countries justified their acceptance of bilateralism on the grounds that they were compelled to accept it because of economic pressure from Germany. In many cases, this was not true. Some states, like Austria or Romania, were compelled to accept bilateralism because that was the only way they could trade with Germany. But other, more important, states, including Britain, did not have this excuse for their actions, although they used it as an excuse. The real reasons for Britain's adoption of bilateralism and protection are to be found in the structure of the British domestic economy, especially the growing rigidity of that economy through the great and rapid increase in monopolies and cartels.

Britain's New Trade Policy

     The new trade policy of Britain after 1931 was the complete antithesis of that pursued by the United States, although the more extreme and spectacular methods of Germany concealed this fact from many persons until 1945. The United States sought multilateralism and expansion of world trade. Britain sought debt collection and increase of exports through bilateralism. Without equality of treatment, its trade agreements sought to reduce debts first and to increase exports second, if this second was compatible with the reduction of debts. In some cases, in order to reduce outstanding debts, it made agreements to curtail exports from Britain or to reduce quotas on such goods (Anglo-Italian agreements of April 1936, of November 1936, and of March 1938, as amended March 1939). It established payment agreements and clearings with debtor countries. Current trade was subordinated to liquidation of past debts. This was the direct opposite of the American theory which tended to neglect past debts in order to build up present trade in the hope that eventually past debts could be liquidated because of the increased volume of trade. The British preferred a smaller volume of trade with rapid payments to a larger volume with delayed payments.

     These tactics did not work very well. Even with clearings and restricted exports Britain had great difficulty in bringing into existence an unfavorable balance of trade with debtor countries. Its balances generally remained favorable, with exports higher than imports. As a result, payments continued to lag behind (two and a half years in respect to Turkey), and it was necessary to rewrite the commercial agreements embodying the new bilateralism (in the case of Italy, four agreements in three years). In some cases (like Turkey in May 1938), special joint trading organizations were set up to sell products of the clearing country in free-exchange markets so that debts owed to Britain from the clearing country could be paid. This, however, meant that the free exchange countries had to obtain Turkish products from Britain and could sell none of their own products in Turkey because of lack of exchange.

     Because of the failure of Britain's bilateral agreements to achieve what she had hoped, she was driven to replace these agreements by others, always moving in the direction of more control. Clearing agreements which were originally voluntary were later made compulsory; those which were earlier one-ended became later double-ended. Britain made barter agreements with various countries, including one direct swap of rubber for wheat with the United States. In 1939 the Federation of British Industries went so far as to seek an agreement with Germany dividing markets and fixing prices for most economic activities.

     As a result of all this, the international commodity markets in which anything could be bought or sold (if the price was right) were disrupted. The center of these (chiefly in Britain) began to disappear, exactly as the international capital market (also centering in Britain) was doing. Both markets were broken up into partial and segregated markets. In fact, one of the chief developments of the period was the disappearance of The Market. It is an interesting fact that the history of modern Europe is exactly parallel in time with the existence of the market (from the twelfth century to the twentieth century).

The Period of Inflation, 1938—1945

     The period of reflation, which began in most countries in the first half of 1933, merged into the following period of inflation without any sharp line of demarcation between the two. The increase in prices, prosperity, employment, and business activity after 1933 was generally caused by increases in public spending. As the political crisis became worse with the attacks on Ethiopia, on Spain, on China, on Austria, and on Czechoslovakia, this public spending increasingly took the form of spending on armaments. For several years it was possible in most countries to increase the output of armaments without reducing the output of consumers' goods or of capital goods merely by putting to work the resources, men, factories, and capital which had been standing idle in the depression. Only when there were no longer any idle resources and increased armaments had to be obtained by diverting resources to this purpose from the production of consumers' or capital goods did the period of inflation begin. At that point, a competition began between the producers of armaments and the producers of wealth for the limited supply of resources. This competition took the form of price competition, with each side offering higher wages for manpower, higher prices for raw materials. The result was inflation. The money which the community obtained for the production of wealth as well as for the production of arms was available to buy the former only (since arms are not usually offered for sale to the public). This intensified the inflation greatly. In most countries, the transition from reflation to inflation did not occur until after they had entered the war. Germany was the chief exception and possibly also Italy and Russia, since all of these were making fairly full utilization of their resources by 1938. In Britain, such full utilization was not obtained until 1940 or 1941, and in the United States not until 1942 or even 1943. In France and the other countries on the Continent overrun by Germany in 1940 and 1941, such full utilization of resources was not achieved before they were defeated.

     The period of inflation 1938-1947 was very similar to the period of inflation 1914-1920. The destruction of property and goods was much greater; the mobilization of resources for such destruction was also greater. As a result, the supply of real wealth, both producers' and consumers', was curtailed much more completely. On the other hand, because of increased knowledge and experience, the output of money and its management was much more skillfully handled. The two factors together gave a degree of inflation which was somewhat less intense in the Second World War than in the First. Price controls and rationing were better applied and more strictly enforced. Surpluses of money were taken up by new techniques of compulsory or voluntary savings. The financing of the war was more skillful so that a much larger increase in production was obtained from a similar degree of inflation.

The Use of Lend-Lease

     Much of the improvement in financing World War II in comparison with World War I arose from the fact that attention was concentrated on real resources rather than on money. This was reflected both in the way in which each country managed its domestic economy and in the relationships between countries. The latter can be seen in the use of Lend-Lease rather than commercial exchange as in World War I to provide America's allies with combat supplies. The use of commercial exchange and orthodox financing in the First World War had left a terrible burden of intergovernmental debts and ill-feeling in the postwar period. In World War II the United States provided Great Britain under Lend-Lease with $27,000 million in supplies, received $6,000 million in return, and wrote off the account with a payment of about $800 million in the postwar settlement.

The Rise of Centralized Planning

     In domestic economies even more revolutionary techniques were developed under the general category of centralized planning. This went much further in Great Britain than in the United States or Germany, and was chiefly remarkable for the fact that it applied to real resources and not to money flows. The chief of these controls were over manpower and materials. Both of these were allotted where they seemed to be needed, and were not permitted, as in World War I, to be drawn here and there in response to rising wages or prices. Rises in prices were controlled by sopping up excess purchasing power by compulsory or semi-compulsory saving and by rationing of specific necessities. Above all, price rises in such necessities were prevented by subsidies to producers, which gave them more payment for production without any increase in the final selling price. As a result, in Britain the cost of living rose from 100 in 1939 to 126 in 1941, but rose no more than to 129 by the war's end in 1945. In the United States wholesale prices of all commodities rose only 26 percent from 1940 to 1945, but were twice as high as in 1940 in 1947. Most of this increase in the United States came after the war's end, and may be attributed to the refusal of the Republican-controlled Congress, led by Senator Taft, to profit from the errors of 1918-1920. As a result, most of the mistakes of that earlier period, such as the ending of price controls and rationing and the delays in reconversion to peacetime production, were repeated, but only after the war itself had been won.

A New Economic System Emerges

     Outside the United States, many of the wartime control mechanisms were continued into the postwar period, and contributed substantially to the creation of a new kind of economic system which we might call the "pluralist economy" because it operates from the shifting alignments of a number of organized interest blocs, such as labor, farmers, heavy industry, consumers, financial groups, and, above all, government. This will be analyzed later. At this point we need only say that the postwar economy was entirely different in character from that of the 1920's following World War I. This was most notable in the absence of a postwar depression, which was widely expected, but which did not arrive because there was no effort to stabilize on a gold standard.... This has been brought about by the new concern with real economic factors instead of with financial counters, as previously. As part of this process, there has been a great reduction in the economic role of gold. From this has flowed two persistent postwar problems which would have been avoided by the gold standard. There are (1) slow worldwide inflation arising from the competing demands for economic resources by consumers, by investors, and by defense and government needs; and (2) the constant recurrence of acute exchange difficulties, such as the "dollar shortage" in world trade, arising from the inability of gold shipments or foreign demand to influence domestic prices sufficiently to reverse these foreign movements. But these inconveniences, associated with the absence of a gold standard and the inadequacies of the financial arrangements in substitute for it, were generally regarded as a small price to pay for the full employment and rising standards of living which advanced industrial countries were able to obtain under planning in the postwar era.

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