The International Gold Standard and U.S. Monetary Policy from World War I to the New Deal Leland Crabbe, of the Division of Research and domestic economy. During the First World War, Statistics at the Board of Governors, prepared the United States and other belligerents fully or this article, which is the second in a series partly suspended the gold standard, de jure or de celebrating the seventy-fifth anniversary of the facto, to prevent it from hampering the war founding of the Federal Reserve System. effort. In 1920, when the United States alone operated the gold standard without restrictions, Before the First World War, most of the world, the Federal Reserve imposed a severe monetary including the United States, Great Britain, and contraction, which defended the gold standard every country in Europe, maintained gold stan- but contributed greatly to a depression. Hoping dard. In the United States, the Resumption Act to stabilize the world economy in the 1920s, the had restored the gold standard in 1879, and the industrial nations, notably Britain and France, Gold Standard Act of 1900 had established gold restored the international gold standard. The as the ultimate standard of value. Internationally, restoration—which must be judged a failure— the gold standard committed the United States to compelled the Federal Reserve to make choices maintain a fixed exchange rate in relation to other between its international and its domestic objec- countries on the gold standard, a commitment tives. Indeed, throughout the 1920s and early that facilitated the flow of goods and capital 1930s, Federal Reserve policy alternated be- among countries. Domestically, the gold stan- tween management of the international gold stan- dard committed the United States to limit the dard and management of the domestic economy. expansion of money and credit, and thus it With the devaluation of the dollar in 1933, the restrained inflationary pressures. United States established the principle that do- The international gold standard did not func- mestic policy objectives had primacy over the tion ideally, however. Although the gold stan- dictates of the gold standard. (See table 1 for the dard provided a basis for nominal stability over major events covered in this paper and the insert the long run, the U.S. and world economy suf- on page 425 for definitions of terms regarding the fered in the short run through periods of depres- gold standard.) sion and inflation due to changes in the world's supply of and demand for gold. Moreover, the U.S. commitment to the international gold stan- THE FIRST WORLD WAR dard had a cost: It confined, though it did not preclude, discretionary management of the do- The First World War nearly demolished the mestic economy. international gold standard. While none of the From the First World War to the New Deal, countries at war demonetized gold or refused to amid upheaval in international and domestic fi- buy gold at a fixed price, none adhered strictly to nancial markets, the United States honored its the tenets of the gold standard. When the war commitment to redeem dollars for gold at $20.67 began, belligerent governments instituted several per ounce. Maintenance of the gold standard, legal and practical changes in the gold standard, however, recurrently interfered with the Federal which they viewed as a temporary suspension of Reserve's broader objective of stabilizing the the rules rather than as a permanent abandon- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 424 Federal Reserve Bulletin • June 1989 1. Major events in the history of the international Relief came without the suspension of the gold gold standard, 1914-34 standard in the United States. On July 31, the Date Event New York Stock Exchange joined the world's other major exchanges in closing its doors, thus August 1914 World War I begins easing pressure on the gold standard by prevent- November 16, 1914 Federal Reserve Banks open January 13, 1916 Britain pegs the pound at $4.76 ing the export of gold arising from foreign sales of April 6, 1917 United States enters the war November 11, 1918 Armistice declared U.S. corporate securities. In August, unsafe shipping conditions and the unavailability of in- 1920 Federal Reserve defends the gold standard surance further slowed gold exports. Still, with January 1923 France and Belgium invade the Ruhr January 1924 Dawes Plan the export sector in disarray and with $500 April 28, 1925 Britain returns to the gold standard July 1926 French currency crisis million in short-term debts coming due in Eu- July 1927 Inter-central-bank agreement rope, the United States needed to implement October 23, 1929 U.S. stock market crashes additional actions to defend the exchange value September 21, 1931 Britain abandons the gold standard March 6, 1933 Bank holiday; U.S. suspends the of the dollar. The most important relief measure gold standard came on August 3, when Secretary of the Trea- June-July 1933 World Monetary and Economic Conference convenes sury William McAdoo authorized national and January 30, 1934 Gold Reserve Act passed state banks to issue emergency currency by invoking the Aldrich-Vreeland Act. Because it ment of the international monetary system. Pre- allowed banks to use such notes to meet cur- vious wars had often forced suspension; peace rency withdrawals and to safeguard reserves, had always brought restoration. this emergency measure kept panic from sweep- ing over the banking system. In early September, U.S. Response to the 1914 Crisis less than a month after its first members took the oath of office, the Federal Reserve Board, in Although the United States did not enter the war conjunction with the Secretary of the Treasury, until 1917, the outbreak of war in Europe in 1914 organized a syndicate of banks that subscribed immediately disrupted U.S. financial and com- $108 million in gold to pay U.S. indebtedness in modity markets, the latter being heavily depen- Europe. Less than $10 million was actually ex- dent on London for the financing of exports. In ported from this gold fund, however, because the July 1914, U.S. firms had a large amount of organization of the fund itself provided foreign short-term debts payable in Europe, primarily in creditors with the assurance they required. London; but this position was normal in the Although the international financial machinery summer, as borrowers expected to use the pro- broke down more fundamentally in 1914 than it ceeds from exports of cotton and grain to pay off had in previous crises, the U.S. domestic econ- their liabilities in the fall. As Europe moved omy fared surprisingly well. Primarily because toward war, the world's financial markets be- the issuance of emergency currency provided came highly disorganized, especially after ac- liquidity, the volume of loans made by banks was ceptance and discount houses in London shut much higher than in past crises. Because banks down their operations. Late in July, as foreigners in the country actually increased their loans began liquidating their holdings of U.S securities outstanding, in contrast to their past practices, and as U.S. debtors scrambled to meet their the crisis of 1914 did not unduly burden banks in obligations to pay in sterling, the dollar-pound New York. Although interest rates in the United exchange rate soared as high as $6.75, far above States rose and remained high through the au- the parity of $4.8665. Large quantities of gold tumn, rates did not soar to the levels reached in began to flow out of the United States as the past panics. By the time the Federal Reserve premium on sterling made exports of gold highly Banks opened, on November 16, 1914, the finan- profitable. Under the pressure of heavy foreign cial crisis in the United States had nearly passed. selling, stock prices fell sharply in New York. In November, commercial banks began to retire The banking and financial systems in the United Aldrich-Vreeland notes. In December, gold be- States seemed on the verge of collapse. gan to flow toward the United States, and the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis International Gold Standard 425 New York Stock Exchange reopened. By Janu- import war supplies, they realized that gold ex- ary, with exports surging, the neutral dollar had ports could not satisfy indefinitely these dual rebounded to move past parity with the pound. objectives without undermining confidence in the pound. From January 13, 1916, to March 19, Attempts to Maintain Exchange Rate 1919, J.P. Morgan and Company, acting as Parities during the War agents of the British Treasury, pegged the dollar- pound rate in New York at $4,765. The durability of the international gold standard Gold exports, pegging operations, and large before the First World War can be traced to a sales of foreign securities partially shielded the well-founded trust in the stability of the principal fixed structure of the world's exchange rates, but reserve currency, the British pound. The preser- Great Britain and its allies depended on interna- vation of confidence in the gold standard in Great tional borrowing as the key weapon in their Britain during the war relied on keeping the defense of exchange rate parities. As the war pound above the gold export point of the princi- stretched from months into years, an extraordi- pal neutral currency, the U.S. dollar. With Great nary network of international lending emerged, Britain and all of the other warring nations hun- which fortified the strained structure of exchange gering for commodity imports to feed their econ- rates.