V. ENGLAND, 1919–1925: CHURCHILL (SORT OF) CHOOSES RESUMPTION

The interwar years were not kind to Great Britain. Before the war it was still the greatest nation in the world, the center of the global trading networks, the sagacious manager of the world’s monetary system. Until the rise of the United States, Great Britain had been the path-breaking nation, the maker of the Industrial Revolution. No European nation was as free, as democratic, or gave as much scope to the individual. While it was nominally ruled by a languid upper class, Great Britain, unlike a France or an Italy, allowed room for energetic climbers in the middle; indeed, successful inventors and industrialists were often knighted or otherwise honored solely on their merits, irrespective of their birth or connections.

But the fate of first movers can be cruel. The 1880s marked the peak of the Victorian era, for by the end of that decade, American industrial output had already surpassed Great Britain’s. By 1900, the American edge had grown to about a quarter larger, and by the eve of the war, a stunning 2.3 times larger. In 1860, Great Britain accounted for about 20 percent of world industrial output, and the United States only about 7 percent; by 1913, the American share was 32 percent, while Great Britain’s had slid to 14 percent. For the total period from 1870 to 1913, American industrial output grew at a compound annual rate of 4.9 percent, Germany’s at 3.9 percent, and Great Britain’s at 2.2 percent. As for the other “great powers,” France steadily lost ground to both Great Britain and Germany, while Russia was still at the threshold of modernity. On a per capita basis, America’s industrial output grew sixfold from 1860 to 1913, compared to only 1.8 times in Great Britain. Only Germany among the major powers showed per capita growth rates (5.6 times) comparable to that in America, but the Germans started from a much lower baseline—prewar British per capita output was still about a third higher than Germany’s.⁴⁰

Loss of leadership in steel was especially painful for Britons. Steel was the foundation industry for the late-Victorian period, much as information technology is today. Military power, high-technology capital equipment, and mass production of consumer goods all depended on steel, and British steel had been the global benchmark for centuries. So when reports of massive, highly mechanized American steel factories began to circulate in the 1880s, they were met with disbelief on the part of British experts. It was not until the turn of the century that knowledgeable Britons actually investigated American practices. They found to their alarm that American steel and pig iron production was already more than British and German production combined, and because of extensive mechanization, American rail and rod mills routinely produced three times the output of British mills with fewer than half the men.⁴¹

D. E. Moggridge, a historian of the British return to gold, comments on the near-blissful ignorance of top British industrialists and political mandarins of the trouble they were in.

A country’s current account is a statement of income on sales and loans to other countries. On its current account, as Figure 4.3 shows, Great Britain normally ran a deficit on its merchandise account—it imported more physical goods than it sold—but balanced that with a big surplus on its “invisibles”—shipping receipts, banking fees, investment income, and the like. The British financial objective was to run a sufficient surplus on the current account to capitalize its global financial network, maintain its status as the premier global financial partner in all weather, and feed the golden stream of interest, dividends, and capital returns that kept the city financial machinery humming.

The current account data in Figure 4.3, however, should have sounded an alarm. The merchandise account was in total collapse, with a deficit that swallowed up nearly all of the returns on invisibles. That was scary enough, but if a diligent number-cruncher had dug into the sub-accounts, she would have found that of the thirteen markets tracked by British statisticians, only one showed any growth. That happened to be Central and Southeast Europe, perhaps the most vulnerable to a revivified German trade push—which was a top priority of the new Dawes plan.

There were also ominous trends on the invisibles account, strong as it looked at first glance. Nearly half the total receipts came from investment and other banking services, which were rapidly migrating to New York. The second largest item was shipping receipts, but the British merchant fleet had suffered considerable damage during the war, and the Scandinavians were winning substantial British business.

The current account is paired with the capital account, which is an investment account, recording inward and outward investments, loans, and other capital transfers. The capital account presented problems of its own. Superficially, it was in the black. The government and private lenders were creditors on loans of some £2.1 billion, about 80 percent on the government tab. That was financed primarily by borrowing, but also by selling securities, and collecting repayments of matured paper, leaving a net surplus of £55 million. If our number-cruncher dug a little deeper, however, she would notice that the country’s biggest creditor was the United States, and its biggest debtors were default-prone France, Russia, and Italy—in other words, the national financial balance sheet was very shaky.⁴²

Moggridge points out that the decision to return to a gold standard was assumed from the outset with hardly anything in the way of analysis. In 1918, as the war seemed to be nearing a favorable conclusion, a number of parliamentary committees were convened to plan the transition from a war footing. One committee, chaired by Lord Cunliffe, the governor of the Bank of England, was to plot a path to resuming the gold standard. Virtually all the experts argued that Great Britain could not regain its status as a financial superpower until it stabilized the pound at the prewar conversion ratio of £1=$4.86. Converting at precisely the prewar rate was considered essential, since a nation without permanent standards could not serve as the world financial bellwether. Despite the consensus on the goal, witnesses were cautious on the timing. The wartime inflation in Great Britain had been much greater than in the United States, so the majority thought it could take a long time to realign the currencies. The British budget deficit was about two-thirds of total expenditure, there was a mountain of debt, much of it short-term, and because of the super-heated rate of wartime spending, the public was awash with cash.⁴³

Over the next few years, however, the Treasury and the Bank of England, working together, made real progress on their financials. By 1920–1921, government spending had been cut by almost 60 percent, revenues had increased by more than a quarter, and the budget was in surplus. With sharp cuts in borrowing and a contracting money supply, wage indexes obediently fell. By 1922, the pound had risen from $3.40 immediately after the war, all the way to $4.63, close enough to start thinking seriously about resumption. Opinion spread that it would be a great boost to public confidence if the return to full resumption could be made at an early date.⁴⁴

Benjamin Strong weighed in forcefully, writing that a failure to resume would be “too serious really to contemplate,” and “would mean violent fluctuations in the exchanges, with probably progressive deterioration of foreign currencies vis-à-vis the dollar.” A return to gold by Great Britain would also help Strong redistribute the huge buildup of gold in the United States, which he had to “sterilize”^* to prevent its becoming an engine of inflation. Strong acknowledged that British prices for internationally traded commodities were about 10 percent higher than America’s, roughly consistent with Keynes’s estimate. So long as sterling wasn’t directly linked to gold, the price differential could be accommodated in the exchange rates; alternatively if a fixed peg was desirable, the British could choose a sterling/gold rate sufficiently below the canonical $4.86 rate to equalize the $/£ average price for traded commodities. $4.30–$4.35 or so may have been about right.⁴⁵

Neither Strong, nor Norman, nor any of their advisers showed much, if any, interest in fixing a lower dollar value for the pound—leaving aside a few nonmainstream economists like Keynes, Cassel, and Irving Fisher, all of whom regarded gold as a “barbarous relic.” There was in fact a nearly irrefutable case for returning to a gold standard, if only because so many other countries were in the process of doing so. But the casual consensus on sticking with the prewar exchange rate was misguided: compounded of a thoughtless reverence for tradition and a thick-headed refusal to recognize the uncompetitiveness of British industry. Pundits pointed to excessive wages in mining and heavy manufacturing, which was certainly part of the problem. The harder challenge was the obsolescence of great swaths of British industry. What was needed was new management, new plant and investment, and only then, new pay scales and work rules. Civil servants nattered about “reorganizing industry,” but it was hot air. The lords of British industry, beribboned and admired as they were, had no interest in scorched-earth industrial reform, while the trade unions, which had acquired immense political power, were firmly for the status quo.⁴⁶

The return to gold had been put on a back burner by the inflationary chaos in Germany, the French invasion of the Ruhr, and spats over reparations and war debts. With the acceptance of the Dawes plan in 1924, however, the path to resumption began to clear. More clarity came in the October election, in which the Tories, by resounding majorities ushered out a short-lived Labour government. Labour feared the downward pressure on wages that would accompany the return to gold, while Conservatives were reflexive gold bugs, irrespective of the cost. Stanley Baldwin, the new prime minister, sprang a surprise with the appointment of Winston Churchill as chancellor of the exchequer. He was a lifelong Tory who had apostasized to the shrinking Liberal party, and Baldwin wanted to harness Churchill’s talents for the new government. Although Churchill insisted that he knew nothing about finance, he plunged into the arcana of budgets and taxes with characteristic gusto.⁴⁷

P. J. Grigg, who was the private secretary to five chancellors, including Churchill, and later a permanent secretary of war, has a left a memoir that documents the care and circumspection that Churchill put into his decision both to resume gold payments and to do so at the time-honored price. Early in the process, he created an “exercise” of detailed questions for each adviser to answer. Why, Churchill asked, was there such a fixation on employing a “rudimentary and transitional stage in the evolution of finance?” Why was the United States so “singularly anxious to help us do this?” Why were the advocates of resumption so dismissive of its harmful effects on the merchant and the worker, favoring instead “the special interests of finance at the expense of the special interest of production?” And why the rush, when the economy seemed to be performing rather well—why not wait a few more years, especially with such a safe majority?⁴⁸

Otto Niemeyer, a senior Treasury official and one of Churchill’s informal advisers, gave a classic answer: the gold standard decision was “probably the most important financial decision of the present decade,” and Churchill would be criticized no matter what he did. But “governments of all political shades” were confidently expecting the decision, and there would be a price to pay if those expectations were dashed. A failure to resume gold payments, he warned, “would reverberate throughout a world which has not forgotten the uneasy moments of the winter of 1923; and would be more convinced than ever that we never meant business about the gold standard because our nerve had failed.”⁴⁹

Churchill’s response to Niemeyer said, in part, “The Treasury have never, it seems to me, faced the profound significance of what Mr. Keynes calls ‘the paradox of unemployment amid dearth.’” After paying his respects to the Treasury view, he concluded: “but the fact that this island with its enormous resources is unable to maintain its population is surely a cause for the deepest heartsearching.” Churchill especially courted Reginald McKenna, a former chancellor and a friend of Keynes, who was the chairman of the Midland Bank, one of England’s Big Five. McKenna had been defending the return to gold, but in what to Churchill seemed to be a “deliberately weak” manner.⁵⁰

While Churchill pondered, Norman and Strong were laying the groundwork for the British resumption. The standard way a central banker lowers market prices is to engineer a recession. Strong helped by making London more attractive than New York as a destination for loose capital. New York money rates were generally higher than those in London, so through the spring of 1924, Strong started bringing them down from 4.5 percent to 4 percent on May 1, to 3.5 percent on June 12, and to 3 percent on August 8. At the same time, he began purchasing securities from the reserve banks—pumping up their cash holdings—creating a broad easing in the American money markets.⁵¹

Norman had less flexibility, because Great Britain was already in recession, but he managed to keep British rates firm and significantly higher than in New York, despite the effect on employment. Investors with money to park naturally gravitated toward London, and the inflow of cash helped push up the $/£ exchange rate. But Strong could carry on the easing only for a limited time. When he started pushing down rates, the United States was in a minor recession, which justified his actions for Fed watchdogs. By the spring of 1925, however, the US recession was clearly over, and Strong had to tighten up a bit, but by then he and Norman were coordinating almost perfectly, and so still managed to keep an attractive rate gap in favor of London. When they began the process, the $/£ rate had been in the $4.30s; by the summer of 1924, it had reached the $4.50s; and by April 1925, it had reached $4.84–$4.90. Bingo.⁵²

To their credit, both Strong and Norman understood that they had been lucky as well as good. They knew that the pound’s rise mostly reflected the market’s bet that the old parity would be restored. But other global developments—in grain and meat products, gold and silver, and most agriculture prices—had conspired to push the monetary currents in a favorable direction. The downside was that achieving parity by such a benign alignment of the stars did not speak well of its sustainability. Strong, therefore, insisted on extra insurance, arranging a $200 million gold British credit at the Federal Reserve and brokering a line of credit from the Morgan bank for an additional $100 million.⁵³

Nineteen twenty-five was the last year that Great Britain could remain off the gold standard without new enabling legislation. Conservatives were acutely aware of the Labour jeering that would greet any such attempt to extend the date of resumption. According to Grigg, the decision was made in the early spring—on March 17, in fact. That was the night when Churchill organized a dinner at his residence, pitting Keynes and McKenna on the antiresumption side, against Niemeyer and Lord Bradbury, a former permanent secretary to the Treasury. Grigg was in attendance, and later wrote that after McKenna and Keynes had made a case for the negative, Churchill asked McKenna:

“But this isn’t entirely an economic matter; it is a political decision, for it involves proclaiming that we cannot… complete the undertaking which we all acclaimed as necessary in 1918.… You have been a politician; indeed you have been Chancellor of the Exchequer. Given the situation as it is, what decision would you take.” McKenna’s reply—and I am prepared to swear to the sense of it—was: “There is no escape: you have got to go back; but it will be hell.”

Which Grigg took to mean “the ayes had it.”⁵⁴

Roy Jenkins, Churchill’s biographer and himself a former chancellor, described Churchill’s plight:

As the Gold battle unfolded there was a sense of even such a dominating minister as Churchill being swept downstream by the force of a compelling current, protesting but nonetheless essentially impotent. The Treasury was against him, the Bank was against him, the Select Committee… was against him. Baldwin… in fact, played no part in the decision, but would have been very unhappy had Churchill decided against Gold. The two tufts of ground—Keynes and McKenna—on which Churchill attempted to stand proved, for various reasons, unsatisfactory footholds. The momentum of conventional wisdom swept them away.⁵⁵

When Churchill made his chancellor’s presentation on April 28, which included the announcement of the return to gold, he said, probably correctly, “If we had not taken this action the whole of the rest of the British Empire would have taken it without us, and it would have come to a gold standard not on the basis of the pound sterling, but a gold standard of the dollar.”⁵⁶

Keynes memorialized the occasion with a newspaper series and a blistering pamphlet, The Economic Consequences of Mr. Churchill, dripping with sarcasm. For example, he notes that a high exchange rate would increase imports and discourage exports. The Bank of England therefore, to protect its gold, would be obliged to curtail British lending abroad, while at the same time attracting US lending to England by keeping its bank rate higher than New York’s (as Strong and Norman did). “The efficacy of these two methods for balancing our accounts is beyond doubt,” Keynes writes.

Before the war our capacity to lend abroad was… about £181,000,000… and even in 1923… our net surplus [was] £102,000,000. Since new foreign investments bring in no immediate return, it follows that we can reduce our exports by £100,000,000 a year, without any risk of insolvency, provided we reduce our foreign investments by the same amount. So far as the maintenance of the gold standard is concerned, it is a matter of indifference whether we have £100,000,000 worth of foreign investment or £100,000,000 worth of unemployment.⁵⁷

The pamphlet is a brilliant polemic, and was spot-on in forecasting the result of the new policy. It is, unfortunately, far stronger and much more focused than the evidence Keynes gave to the parliamentary committee charged with making a recommendation to the government. In that presentation, Keynes stressed the likelihood of American inflation, which would likely force the true parity rate higher than $4.86, possibly causing an inflationary surge of gold in London. Otherwise, he made long and seemingly off-point disquisitions on systems for licensing gold and his conception of price stability. Robert Skidelsky, Keynes’s biographer, writes:

The Committee could well conclude that Keynes expected parity to be regained, without deflationary exertion, in the not too distant future, by a rise in American prices. This was what the Committee, and most of the witnesses, believed anyway.… Keynes’s testimony helped to crystallize the view that the pre-war parity could be regained and maintained without detrimental effect on the real economy.⁵⁸

Keynes was at heart a controversialist, a master of stinging repartee. But writing seems to have energized him more than mere speaking before an official body. In this case, at least, writing the pamphlet led him actually to do some research. For example, almost all the evidence leading up to the gold decision mentioned a British price disadvantage, variously put at 10 percent by Keynes and others. But as the pound’s value drifted upward on the exchanges, the price gap shrank dramatically, to only 2 or 3 percent, which seemed hardly worth worrying about.

In the pamphlet, for the first time, Keynes pointed out that the best data on price behavior come from price behavior of traded or “unsheltered” goods, which are subject to external price competition. He expanded the point in later testimony, estimating that the cost of sheltered goods increased England’s cost of living as much as 18 percent higher than in its main trading partners. He also suggested that the most important sheltered good was labor, which sold at a high premium in England compared to the rest of Europe. Great Britain’s trade unions were very powerful, with nationwide bargaining in their main trades, and no amount of monetary meddling could force them to lower wages just for workers in unsheltered industries. To make a $4.86 exchange rate stick would have meant pushing down all wages, which would have required a deep recession. (Keynes, with his academic’s airy view of practicalities, suggested a “social contract” calling for a 5 percent pay cut for all wage earners, along with an additional income tax of a shilling in the pound for dividend holders.)⁵⁹

Churchill seems not to have complained about Keynes’s pamphlet. Warrior that he was, flesh wounds were part of the daily routine. For his sins, however, when the million-strong miners’ strike exploded in May 1926, Churchill was made point man for the government. As in many extractive industries, mining was virtually the sole industry in the coal regions, with a culture and an ethos, and a militancy, of its own. British mining may have been further down the curve of obsolescence than any—most production was still by pickaxe, rather than by cutting machines, as in most advanced countries. With considerable reason, the mine owners were also widely regarded as the most “stupid” of bosses.⁶⁰

To make British coal prices competitive at the $4.86 exchange rate, the owners attempted to impose both a 13 percent pay cut and a return to an eight-hour day, against the contractual seven hours. The miners walked out, and the national Trades Union Congress (TUC) called for a general strike, creating a paralyzing walkoff of virtually all of the country’s unionized workers. When the printing trades struck, newspapers ceased to publish, and the government created its own paper—The British Gazette, managed primarily by Churchill, of course, who was in his glory. It took only about a week and a half for the TUC leaders to lose their nerve and leave the miners on their own. The hyperloyal workers in the coal districts maintained the strike for nearly a year, until many were at the point of starvation. The strike finally ended when the Baldwin government provided a public subsidy, allowing the owners to impose the pay cuts but with the taxpayers putting up the difference for the miners. Keynes had predicted just such an outcome—unable to reduce real costs, the country would resort to deficits and inflation. Churchill swallowed his defeat, for defeat it was, with good grace, and allowed to his intimates that by the end of the confrontation, his sympathies were almost entirely with the miners.⁶¹

The general strike of 1926, protesting the treatment of coal miners, fizzled out after just a few weeks, although the miners held out for nearly a year. Pictured are Londoners walking to work due to solidarity strikes in public transportation.