Challenges to the Global Monetary Structure
PART TWO

Edward J. Dodson

The Central Banks: Willing Partners In Crime?

European banking during the mid-nineteenth century remained to a surprising extent the domain of a small number of financiers, with London emerging as the hierarchical apex. From the beginning, the primary clients of the bankers were the rival empire-building governments of Europe. As commerce and industrialization expanded, a new class of merchant bankers appeared; these banks were organized as joint-stock companies and solicited deposits from and made loans to thousands of individuals and businesses. At the same time, European economies were becoming increasingly susceptible to problems directly related to the expansion of credit availability. As noted by one recent observer, Anthony Sampson:

[T]he more the depositors, the greater the risk that a temporary panic could cause a run on the bank[s]; and a panic in one capital could quickly spread to another.

Bank regulation not being one of the strengths of late nineteenth or (as we are experiencing even today) twentieth century governments, over issuance of bank notes virtually dictated an endless series of bank failures. Intense speculation in land and securities also shortened the boom to bust cycles, precipitating widespread panics and recessions. Nevertheless, for good or ill, much of the world was fast becoming tied together by a little understood system of political economy weighed down heavily by the legal sanctioning of monopoly privilege. This change was also accompanied by the transformation of the political economist from the important role as commentator on socio-political arrangements into a professional servant to governments. By the beginning of the twentieth century, a growing percentage of economists were earning their living by analyzing data and providing advice to government agencies and industrial corporations. Few carried on the tradition of looking at socio-political arrangements for the causes of recession, depression, mass unemployment or runaway inflation. The individuals who then and today hold university chairs in political economy are too frequently schooled not in the liberal arts as were Adam Smith and John Stuart Mill, but in a very narrow and statistically-oriented interpretation of market operations. Yet, markets are subject to shocks caused directly by natural and political occurrences. And so, economists have been severely criticized in recent years, even from within their own ranks. Robert Lekachman (a socialist who strongly believed in government's role as manager of the economy) wrote of his colleagues: "When bright people say stupid things, the question inevitably arises, why is their perception of reality so blurred?"

The answer, I suggest, is that a clear perception of reality demands a willingness to thoroughly question the status quo and existing socio-political arrangements. Economists, when speaking as economists, like to think of themselves as scientists whose observations are value free. Unfortunately for the economist, human civilization functions only within the constraints of values defined by human reason and experience.

Ironically, the period during which political economists arose and fell as the dominant analysts of human behavior and socio-political systems roughly parallels the life span of the British empire. European plundering of so much of the world's natural resources and peoples had, of course, been begun in earnest during the sixteenth century. Under British domination, the European nation-states continued their conquests slowed only occasionally by indigenous resistance. These efforts were aided considerably by technological advances achieved during the great industrial revolution -- advances that also had a tremendous impact on the socio-political organization within these industrializing nation-states. What emerged the late nineteenth century was a more sophisticated socio-political structure, one best described by the term industrial-landlordism. (Industrial-landlordism is used here to describe a society characterized by significant and expanding concentrations of control over land, labor, physical plant and finance.) Without referring to this structure by name, British economist John Maynard Keynes described the impact on the citizenry of Europe:

Europe was so organized socially and economically as to secure the maximum accumulation of capital. While there was some continuous improvement in the daily conditions of life of the mass of the population, Society was so framed as to throw a great part of the increased income into the control of the class least likely to consume it. The new rich of the nineteenth century were not brought up to large expenditures, and preferred the power which investment gave them to the pleasures of immediate consumption. In fact, it was precisely the inequality of the distribution of wealth which made possible those vast accumulations of fixed wealth and of capital improvements which distinguished that age from all others.

What also distinguished that age were the frequent and deep financial panics and recessions that occurred throughout, the fundamental causes of which were beginning to come under more systematic study.

Turn of the century economists developed theoretical models of how economies functioned, based for the most part on a widespread assumption that price was the ultimate determinant of whether markets would clear (i.e., return to an equilibrium relationship between supply and demand). John Maynard Keynes would dispell this myth in the 1930s, going on to recommend the intervention of government to use fiscal and monetary policies as market clearing devices. Virtually all economists from Keynes on have largely ignored the arena of political economists and limited their efforts to a comparative analysis of available policy options defined for them by existing socio-political systems. At best, they concerned themselves with what could be done to mitigate the effects of what were largely inevitable crises -- without really doing anything to dismantle the socio-political arrangements under which the few had for so long enjoyed so much privilege and benefit.

The incremental approach to socio-political change failed to satisfy the millions of peasants and industrial laborers suffering under the weight of industrial-landlordism. The Russian people, for one, would wait no longer and violently overthrew the czarist aristocracy (to what advantage during the ensuing six decades is another subject that arouses considerable debate). By forcing large numbers of their urban and rural poor to migrate to other lands, the continental European states managed to continue their quests for empire under authoritarian, but pro-industrialist regimes. Japan also emerged as a strong competitor in this era under an even stronger central government and a quest for colonial empire. Britain, as is well-documented, was already suffering the first stages of a long decline that continues even to this day. Oddly, British socio-political arrangements retain many of the trappings of empire and the privilege of aristocracy, despite periods during which government fell to factions advocating highly socialistic policy agendas. One reason is, I suspect, that while British fortunes have declined, Britain has not actually been defeated in war or been subject to occupation by a foreign military force. Thus, its institutions have remained even if their purposes have disappeared with the loss of empire.

The decline of Britain, as with so many other empires, had very much to do with the burdens imposed by the privileged on producers. As R.H. Tawney observed even as recently as 1952:

[P]roperty can hardly be said to be a national institution in England, in the sense in which it was a national institution in some earlier ages, or as it is a national institution in some other countries today. Where conditions are such that two-thirds of the wealth is owned by approximately one per cent of the population, the ownership of the property is more properly regarded as the badge of a class than as the attribute of a society.

Despite the intrusions of Fabian socialists and trades unionists into Britain's political arena, the best that could be achieved within the constraints of law was a gradual widening of government's powers of redistribution -- through the imposition of an income tax, death duties and subsidies to some of the disadvantaged. Instead, to a greater or lesser degree across the broad spectrum of nation-states, industrial-landlordism was mitigated by legislation that favored quasi-monopolistic labor unions and government regulation of commerce and industry. Beginning in the 1880s the governments of nearly every major industrializing society imposed an income tax on at least some of their citizens. As historian Richard Hofstadter concluded in The Age of Reform (1955):

[R]eluctantly rather than gradually, the average American tended more and more to rely on government regulation, to seek in government action a counterpoise to the power of private business. In his resentment against the incursions of business organization upon his moral sensibilities and his individualistic values, he began to support governmental organization and to accept more readily than he had been willing to do before the idea that the reach of government must be extended.

Liberalism arose as the great compromise between those who demanded sweeping reforms and those who sought to preserve as much of the status quo as could be preserved in that Age of Reform.

As one would expect, within each industrializing society there existed strong constituencies for specific changes in the institutional structure of domestic finance. Statists, industrial-landlords and established financiers each sought to use government's legislative and administrative powers to gain and/or consolidate control over the medium of exchange and credit creation. They instinctively used whatever influence could be garnered to advance either and often both private and state monopoly interests.

Relative peace and very low expenditures for infrastructure or social services during the last quarter of the nineteenth century and first decade of the twentieth had enabled most governments to balance their budgets (including the payment of interest on national debt) with tax revenues. Britain's national debt, for example, actually dropped somewhat and in 1900 stood at 639 million pounds. France, Germany and many of the other European states experienced similar positive declines in national debt. Yet, the mentality of those in government was then (as today) rarely focused on the debt itself; rather, the concern was directed to raising funds to cover annual interest payments. Sidney Homer adds that: "Nineteenth-century Ministers of Finance or Chancellors of the Exchequer thought of the burden of their national debts in terms of the annual interest charge against the revenues rather than in terms of a principal amount which must be repaid. Principal repayment only occurred when it was considered a benefit to the state. Refundings were almost always conversions at lower rates."

What is evidenced by the historical record is a general pattern of serious irresponsibility on the part of those who governed. The promise of the professional (within the confines of liberalism) to instill the discipline of benefit/cost analysis on public policies remained largely unfulfilled and subverted by the privileged position of those who possessed tremendous wealth and political power. As historian William L. Shirer wrote of the French experience:

Those who had gained control or ownership of the most lucrative commercial, financial, and transportation enterprises in France owed their good fortune in most cases to grants from the state. ...It was around the citadel of the Bank of France, whose shareholders became immensely wealthy without having to risk any money or even put up much, that the important business and financial interests entrenched themselves.

The French experience was far from isolated. Germany's Reichsbank, for example, had been organized in 1876, virtually without discussion following several years of financial panic, bringing Berlin into the London-dominated hierarchy. The Japanese chose the route of self-sufficiency, which (arguably by design) resulted in a version of industrial-landlordism even more highly directed by the interests of the state than that in Germany. With respect to Japan, G.B. Sansom observes, in fact, that: "[T]he result of the cautious policy of Japanese statesmen was to accentuate certain characteristic features of Japanese capitalism, such as the growth of state enterprise, the concentration of private capital in a few hands, and the unequal distribution of the burden of taxation, which served industry at the expense of agrarian well-being."

One issue that has greatly interested historians and some economic writers is the question of whether Britain's economic power was the result of a true hegemonic position for sterling as the currency of international commerce during the late nineteenth and early twentieth centuries. This was the widely held conclusion of many analysts until fairly recently. The historical evidence now strongly suggests that sterling, while a key currency, should more appropriately be viewed as the leading currency among a hierarchy of key currencies. In his 1976 contribution to a book of essays on this subject, Robert J. A. Skidelsky retraced the operation of the late nineteenth-century system, concluding:

An increasingly important component of Britain's current account surplus derived from profits received by the City of London for specialized financial services, particularly insurance and sterling bills of exchange. The latter mark the start of sterling's career as international money. The classic balance-of-power theorists, writing at a time when all European powers were roughly at the same stage of economic development, could not conceive of the immense disparity of economic power which made possible such developments. On this immense disparity, not on the supposed balance of power, was built the nineteenth-century monetary system.

In this sense, Britain had already matured (in consequence of its very limiting socio-political arrangements) as an industrial state and was poised for the emergence of a service-oriented economy. Similarly, Britain's period of empire-building had nearly run its course, the causes of lost empire inherent in the very building process. Skidelsky's also makes this important observation with regard to empire building:

[T]he imperialist tour de force cannot be sustained and that therefore a system which depends on the exertions of a preponderant power is inherently unstable in the long run. The reason is that imperial functions weaken the power performing them, so that a system "managed" by a single power is always tending to revert to a plural system.

Nevertheless, although the claim for British hegemony over the international monetary system of that era is not supported by the historical evidence, the Bank of England did serve as a model emulated by other central bankers.

With the decline of the British empire, the world was gradually moving away from a world system in which control in relationships between peoples required colonial rule enforced by a military presence. The process would be long and characterized by much bloodshed, but the world's industrial-landlords gradually learned that direct occupation was seldom necessary in order to dominate the production and distribution of wealth in many societies. Thus, even by the early twentieth century the international financiers and industrialists made their peace with other power brokers within the modern, industrial states. Historian Carroll Quigley suggested that what the world's dynastic bankers now pursued was "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." And, to some extenton the basis of Professor Quigley's revelations, others (including others within the world of academia) advanced a conspiracy theory that has slowly gained momentum and support over the last few decades. In Quigley's own words:

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.

That those who controlled the boards of the world's major banks (and corporations) feared nationalization of their activities is certainly understandable. In the face of mounting public pressure against monopolies in general, these same individuals also certainly conspired to diffuse and mitigate this pressure. In the United States, for example, the money trusts had by the first decade of this century become a prime target of progressives. During 1914, for example, Louis D. Brandeis wrote a series of articles attacking the nation's entrenched financiers which appeared in Harper's Weekly. The analogy he made to Old World tyrannies struck a responsive cord in a public weary of financial panics and bank closings:

The development of our financial oligarchy followed ... lines with which the history of political despotism has familiarized us -- usurpation, proceeding by gradual encroachment rather than by violent acts; subtle and often long-concealed concentration of distinct functions, which are beneficent when separately administered, and dangerous only when combined in the same persons. It was by processes such as these that Caesar Augustus became master of Rome. The makers of our own Constitution had in mind like dangers to our political liberty when they provided so carefully for the separation of governmental powers.

The end result in the United States was legislation that created the Federal Reserve System -- privately-owned, run by the bankers themselves, but ostensibly chartered to protect the public interest. In the form of Federal Reserve notes (by law, 40 percent of the face value to be backed by gold deposits) the United States government now had its own legal tender. At the same time, creation of a central bank also pulled the United States into the global system and onto the gold standard.

While Progressives such as Brandeis fought the U.S. money trusts during the first and second decades of the twentieth century, the European financial arena was rapidly consolidating. As R.H. Tawney observed:

[T]he amalgamation of financial interests, which in England reduced the number of joint-stock banks from 104 in 1890 to 18 in 1924, 84 percent of the aggregate deposit and current accounts being held, at the latter date, by five among them; ...

In Tragedy and Hope, Carroll Quigley points out that some seventeen merchant banking firms, controlled by less than a hundred active partners held a firm grip over the financial affairs of Britain. France's financial system, as we have already seen, functioned similarly. Nevertheless, as powerful as the world's financiers were, perhaps what they failed to take account of was the ability of politicians riding the crest of nationalism to subvert their plans for an international monetary cartel.

War, Depression, War, and -- Managed Economies

The historical and economic literature leaves no doubt that the First World War ended with the United States firmly in place as Britain's replacement as the world's great economic power -- even if a very strong link in a very weak chain. Nearly all the land battles and destruction of capital had occurred in France and Belgium. The United States benefitted not only as a major supplier to Britain but also as a safe harbor for European financial reserves. The war, in fact, had created new fortunes and increased the size of old ones -- generally at the expense of the masses, whose meager savings were eroded by increases in the price of essential but scarce commodities. For more than one reason, then, the commentary provided by John Maynard Keynes after the war became prophetic:

Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. ...

By directing hatred against this class, therefore, the European Governments are carrying a step further the fatal process which the subtle mind of Lenin had consciously conceived. The profiteers are a consequence and not a cause of rising prices. By combining popular hatred of the class of entrepreneurs with the blow already given to social security by the violent and arbitrary disturbance of contract and of the established equilibrium of wealth which is the inevitable result of inflation, these governments are fast rendering impossible a continuance of the social and economic order of the nineteenth century. But they have no plan for replacing it.

Wilson's overtures for a meaningful reconstruction of Europe in conjunction with a new era of participatory democracy were rejected, most importantly by France, in favor of narrow and very nationalistic economic interests. Keynes' own view of what needed to be done was, however, also somewhat unclear.

During the early 1920s Keynes wrote with great concern about the unstable price of gold and warned against any attempt at a return to the gold standard at pre-1914 parities. When in 1925 Winston Churchill (then Chancellor of the Exchequer) restored Britain to the gold standard at a level that could not be supported by a British trade surplus, Keynes wrote that Churchill "was just asking for trouble." By 1931 the British government suspended convertibility of sterling into gold and Keynes again shifted his attentions; sterling fell against other key currencies, and Keynes anticipated as a result a significant increase in British exports. Unfortunately, a trade surplus did not materialize. One of the underlying reasons is identified by historian Roy Douglas:

[T]he peace settlement had considerably increased the number of sovereign states in Europe. ...Each asserted the right to regulate commerce according to its own whim. Whatever the ethnic or political advantages of the new arrangements, these were counterbalanced by grave economic disadvantages when the new countries of Europe proceeded to erect trade barriers with even more enthusiasm than did the old countries. ...Such new barriers broke established trade links, and fostered acrimony in various ways. People who had once traded freely in areas where new frontiers had been established, resented the impediments. But instead of pressing for abolition of barriers they were more likely to demand retaliatory barriers from their own governments.

There is widespread agreement among historians and economists that such protectionist policies were a major factor in bringing on global depression. When U.S. legislators pushed through the Hawley-Smoot tariff bill in 1930, a deepening of the contraction was inevitable. The U.S. had already accumulated gold reserves amounting to over forty percent of the world's total stock; absent revenue from exports, the overwhelming majority of other nations had no hope of living up to further convertibility requirements of the gold standard. Then, in 1933 (and under global circumstances that demanded virtually the opposite policy decision), the U.S. government suspended convertibility of dollars into gold, fearing a drain on its massive gold reserves.

Milton Friedman and Anna Schwartz, after examining the writing and testimony of depression-era economists, wrote that they could identify "only an occasional sign that the academic world even knew about the unprecedented banking collapse in process, let alone that it understood the cause and the remedy." Similarly, Keynes's earlier chastisement of Churchill's return to the gold standard at pre-1914 parities was softened by allowing that Churchill had "no instinctive judgment to prevent him from making mistakes;" that "he was deafened by the clamorous voices of conventional finance; and, most of all, because he was gravely misled by his experts." By "experts" Keynes was referring to the Treasury Committee on the Currency. Keynes had, in fact, chaired a Committee of Economists, recommending what the politicians were not yet ready to accept; namely, creation of an international agency empowered to provide assistance to financially-troubled governments. In addition to Keynes, the Committee included Lionel C. Robbins, A.C. Pigou, Josiah Stamp and H.D. Henderson. Nearly sixty years later, professional economists still cannot agree on what is and what is not appropriate fiscal or monetary policy. Perhaps that is one reason why politicians so rarely listen to the pronouncements and warnings of their economic advisers.

Relations between nations in the 1930s virtually dictated that a global depression would continue. A destructive cycle of protectionist barriers, retaliation, followed by stronger tariffs and quotas ensued. Bank after bank fell victim to uncollectible loans and, from time to time, runs on reserves by depositors. In May 1931 the Credit-Anstalt of Vienna collapsed, signalling a long period of financial problems in Austria, Germany, Britain and eventually France. Research by Friedman and Schwartz concerning the United States revealed that between August 1929 and March 1933 "the stock of money fell by over a third" and that over "one-fifth of the commercial banks ... holding nearly one-tenth of the volume of deposits at the beginning of the contraction suspended operations because of financial difficulties."

The clearly inept and vested control over the medium of exchange by the world's most powerful states not only resulted in destructive and protectionist domestic policies, but also greatly contributed to the rise of despotic regimes in Germany, Italy, Spain and Japan. The use of the phrase "despotic regime" here may be considered by some as arbitrary; however, these regimes repeatedly employed oppressive means to secure objectives of the State. One could argue that the socio-political arrangements of all states proved themselves (by reason and the evidence of wealth distribution) to be inherently unjust; therefore, any government the actions of which sanctioned and protected such arrangements is a despotic regime. Germany under the Nazis instituted a highly centralized command economy designed to make the nation as self-sufficient as possible. In this process, an expansionary monetary policy was carried out with amazing success under the ministry of Dr. Hjalmar Schacht. Of Schacht's program, historian William Shirer writes: "He manipulated the currency with such legerdemain that at one time it was estimated by foreign economists to have 237 different values. He negotiated amazingly profitable (for Germany) barter deals with dozens of countries and to the astonishment of orthodox economists successfully demonstrated that the more you owed a country the more business you did with it."

Both Britain and the United States adhered to orthodox (if ill-timed and inappropriate) economic policies until well into their respective depressions; these policies brought on prolonged deflation, putting both labor and capital out of work. In the end, they were forced to abandon convertibility in a desperate hope to increase exports. Belgium and France had, however, allowed their currencies to fall against sterling during the 1920s and thereby temporarily benefitted from British free trade policies. Another short-run result was that France was able to greatly increase its stock of gold during the 1920s and into the early 1930s.

Under such an imbalance of gold reserves -- with France and the United States the principal holders -- maintaining even a facade of the gold standard became impossible. By 1936, even the French government was facing the problems of mass unemployment and a drain of gold reserves. Its Socialist Premier, Leon Blum, restructured the Bank of France, replacing its entrenched Board of Regents (elected by the Bank's two hundred largest stockholders) with a Board of Councilors more representative of the wider citizenry. William Shirer notes that despite these changes "the Bank continued to be the citadel of conservative, orthodox finance."

Consistent with the historical record, rather than denying themselves the power to self-create credit, the world's major governments sought refuge within a subterfuge masking as an international monetary structure. Their solution to an economic disaster caused by incredible privilege built into their respective systems of socio-political arrangements was to attempt another massive transfer of purchasing power from producers to themselves. Faced with dwindling reserves of gold, they simply scrapped the gold standard (flawed as it was by the acceptance of fractional reserves) in favor of a system that finally severed the link of paper currency to gold stocks; the subterfuge is evident in the name given to the new paper only system (i.e., the gold exchange standard).

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