Winston S. Churchill’s greatest mistake; the gold standard, hobbled the British Empire, wrecked British industry, and hastened the coming of the Great Depression and World War II.
Conversely, Churchill’s greatest peace time mistake; returning the United Kingdom to the gold standard was more destructive than his wartime blunders. To explain, the Gold Standard’s damage went on for several years and affected many more people than WSC’s wartime mistakes. In contrast, both the Gallipoli Campaign and the Bengal Famine ended after a few months.
What is the Gold Standard and why is it so destructive?
The gold standard is destructive and disruptive because it offers the illusion of stability and permanence.
Under a gold standard, a government or central bank pegs a nation’s fiat currency (paper money) to gold. Hence, anybody can go to the central bank and redeem their dollars or pounds for gold.
The theory behind the gold standard is that gold always retains its value. Hence, a dollar pegged to gold will always be worth $1. Another attraction of the gold standard is the ability to limit inflation by keeping the price of money high.
In reality, the gold standard is a scam. To explain, most people who use paper money will never redeem it in gold. Most governments made it hard to redeem money for gold. For instance, in the UK you had to go to the gold window at the Bank of England to exchange your cash for gold.
The Bank of England in 1821 invented the gold standard to get people to accept paper currency. In 1821, banknotes were a new and easily counterfeited technology.
Predictably, many people refused to accept banknotes. By claiming that gold backed banknotes, the Bank of England got ordinary people to accept pound notes.
The United States adopted the gold standard in 1834 when President Andrew Jackson (D-Tennessee) killed the Bank of the United States, America’s central bank. America officially adopted the gold standard with the Gold Standard Act of 1900 that set the price of gold at $20.67 an ounce. The Federal Reserve set the official price of gold and enforced America’s gold standard between 1913 and 1971.
The Danger from the Gold Standard
The danger from the gold standard is that the gold supply determines the value of money. For example, America suffered inflation in the 1850s after the California gold rush flooded markets with the yellow metal.
Hence anybody who controls the gold supply controls the money. If your country is on a gold standard, another nation can control your currency if it has more gold than your government.
Britain, and most major powers, stayed on the gold standard from 1821 until the outbreak of World War I. When World War I began, most countries including Britain went off the gold standard because of hysteria.
To explain, ordinary people, fearing military defeat could make their money worthless, redeemed their cash for gold. Central banks and governments, fearing the loss of gold reserves, went off the gold standard.
By 1918, the gold standard was dead. However, many bankers wanted to resurrect the standard because of the stability gold created. Unfortunately, the stability came from the pre-1914 political order, not gold.
Churchill and the Gold Standard
By 1925, Britain was in serious economic decline despite its “victory” in World War I.
The world’s financial center had moved from the City of London to Wall Street. British bankers could not compete with their American counterparts.
Moreover, British industry was having a hard time competing with American producers and a resurgent Germany in the world markets. In the United Kingdom, unemployment and political unrest were growing.
Against this background, Prime Stanley Baldwin asked Churchill to join his government as Chancellor of the Exchequer (the British equivalent of the US Secretary of the Treasury). Effectively, Baldwin asked Churchill who had no business experience or knowledge of finance to become Chief Financial Officer (CFO) of the British Empire.
Baldwin’s decision was purely political. Britain’s Liberal Party was collapsing and Churchill was a famous Liberal who had recently rejoined Baldwin’s Conservative Party. Baldwin hoped to attract Liberal votes by adding Churchill to his cabinet.
Since had no knowledge of economics or finance, Churchill relied on bankers and Treasury officials for advice. The Bankers wanted a return to the gold standard. To elaborate, the bankers mistakenly believed they could make Britain the world’s dominant power again by adopting the gold standard.
Churchill took the bankers’ advice and returned Britain to the gold standard in July 1925.
The problem with Churchill’s action was that the United States held most of the world’s gold. That mean the US Federal Reserve and Wall Street had indirect control of the British economy, as the great economist John Maynard Keynes pointed out.
The Economic Consequences of Mr. Churchill
Keynes was so horrified by the Chancellor’s action that he wrote a book called The Economic Consequences of Mr. Churchill*
“We must warn you that this latter policy is not easy,” Keynes warned.“It is certain to involve unemployment and industrial disputes.” Keynes feared that the gold standard could increase the value of the pound and make British exports uncompetitive in world markets.
History proved Keynes right. Britain’s unemployment rate rose to over 8% in 1926. British employers began cutting salaries, which led to a General Strike in May 1926. With over 1.5 million men on strike and the country paralyzed, the government called out the Army.
They settled the strike but Britain limped along through the 1920s before plunging into the Great Depression in 1929. However, Churchill was gone, because Baldwin’s government collapsed in 1929.
In 1931, His Majesty’s Government ended the gold standard. Consequently, British unemployment, which peaked at around 15% in 1932, fell to pre-depression levels 8% by 1937. The inference is obvious had Britain stayed off the gold standard, the country could have avoided economic stagnation and political unrest.
One consequence of Britain’s economic weakness was to help trigger the Great Depression. To explain, the Stock Market Crash of 1929 began on 20 September 1929 in the City of London, not Wall Street. On that day, British industrialist Clarence Charles Hatry admitted he did not have enough money to pay for his acquisition of several steel companies.
When the British press publicized Hatry’s fraud, stocks collapsed in London. The contagion soon spread across the Atlantic where stocks were already falling.
Between 3 September and 23 October 1929, the New York Stock Exchange (NYSE) lost 21% of its value. One reason stocks fell was that British investors pulled their money out of the US market to cover the Hatry losses.
The next day on Black Thursday, 24 October 1929, the Dow Jones Industrials fell by 11%. The Great Wall Street Crash and the Great Depression had begun.
How the Gold Standard helped Start World War II
The economic pain was greatest in Germany, where the nation’s leaders, fearing a Communist revolution turned the government over to Adolph Hitler and his Nazis in 1933. Things were a little better in Britain in the 1930s because the economy was already terrible.
One consequence of Mr. Churchill that Keynes did not expect was the devastation of British industry. By the late 1930s, British industry, which had supplied most of the Entente or Allies’ weapons in World I, could not supply basic equipment such as rifles and bullets to its forces.
By 1938, British officers were buying planes from American manufacturers because British factories could not produce enough aircraft to equip the peacetime Royal Air Force. By 1940, ads were appearing in US newspapers asking Americans to send rifles to Britain to equip the Home Guard. That’s right, the British could not produce enough rifles to arm their reserves.
Churchill spent the 1930s in the political wilderness estranged from the Conservative Party because of his relentless opposition to Indian independence. When he finally became Prime Minister in 1940, Churchill begged the United States for basic military supplies.
One reason Britain was so militarily unprepared in 1940 was the decline of British industry. A major reason for the deterioration of British industry was the Gold Standard.
The Gold Standard Returns and dies once and for all
US economists tried to revive the Gold Standard with the Bretton Woods Agreement in 1944.
Ironically, Keynes, the British representative to the Bretton Woods Conference, argued against reviving the gold standard. Keynes wanted an international credit system based on a global currency he called the Bancor, instead. However, US economists wanted to revive the gold standard because it put America, the largest holder of gold, in charge of the world’s economy.
The Bretton Woods System lasted until 1971, when President Richard M. Nixon (R-California) took America off the gold standard. On 15 August 1971, Nixon closed the “gold window” and announced the US government would not convert dollars into gold at any price.
Nixon took the US off the gold standard because gold was leaving the United States for Europe. Nixon, fearing the loss of America’s gold, ended the convertibility of US dollars to gold. Ironically, one reason Nixon ended the gold standard was that the British government had asked for payment in gold which could empty the Federal Reserve.
The Nixon Shock killed the gold standard and created our modern monetary system of fiat currencies with values determined only by the currency markets, University of Chicago Professor Jonathan Levy observes. In his excellent book Ages of American Capitalism, Levy writes that Nixon’s action triggered an Age of Economic Chaos.
Fortunately, the Nixon Shock makes a repeat of Churchill’s greatest mistake impossible. Unfortunately, our leaders today still listen to economic experts such as bankers as Churchill did. Notably, President Joe Biden (D-Delaware) appointed former Federal Reserve Chair Janet Yellen as US Treasury Secretary. Similarly, Biden’s predecessor Donald J. Trump (R-Florida) appointed former Goldman Sachs (GS) investment banker Steven Mnuchin as Treasury Secretary.
Thus, our leaders will not repeat Churchill’s gold standard mistake. Unfortunately, our leaders can repeat Churchill’s mistake of following poor advice from economic experts and wrecking the economy.