Jon Catalan and David Glasner made comments about my post on free banking and the historical gold standard that are worth responding to, so here are some further thoughts on the subject.
Jon asked what influence Britain had on the world gold standard before World War I. Britain was the dominant financial power, because it was the leading country of the Industrial Revolution; market participants trusted the pound sterling to be as good as gold because of its comparatively good historical performance; and Britain’s huge empire led to many commercial and government financial transactions that were most easily settled in London, which then as now was the world’s largest financial center. All these factors gave Britain, the pound sterling and the Bank of England an importance that were not rivaled by China, the United States, or Germany, even though by the end of the period all had larger economies than Britain.
As I remarked, I do not consider that the Bank of England was the “conductor of the international orchestra” during the period. Its power was greater than that of any other bank, but limited by its avoidance of modern-style macroeconomic management and by the operation of the international gold standard as a system with few exchange controls. For instance, a period of falling prices affected Britain along with other countries on the gold standard from about 1873 to 1896. Falling prices resulted from increased demand for gold as Germany, followed by other countries, switched from silver or bimetallic systems (where both gold and silver were used as money, at a ratio set by the government) to gold. Government regulations regarding currency aggravated matters somewhat by erecting barriers to private coinage or issuance of notes that people might well have accepted as substitutes for gold coins in some countries. Countries that were on the silver standard or that were experiencing paper-money-based inflations did not have the same experience. It is currently hard to marshal the data, though. One of the goals of the Historical Financial Statistics data set, a spare-time project of mine, is to gather such data and make them readily available for public use. In many cases the data have been collected but not digitized, or digitized but not gathered conveniently together.
David Glasner said that “The adjustments at the margin that were sufficient to keep the prewar gold standard operating relatively smoothly most of the time were not sufficient in the interwar period after the enormous dislocations and inflations created by World War I and its aftermath.” The biggest dislocations were created by Britain and other countries trying to return to their prewar parities despite a large accumulation of inflation during the war. I think a second key factor in the instability of the interwar period was that central banks engaged in much more activist monetary policy than before the war. Moreover, an increasing share of the world’s countries had central banks. Glasner mentions that many observers think that if Benjamin Strong, president of the Federal Reserve Bank of New York, had not died prematurely in 1928, the Federal Reserve Board of Governors would have avoided many of the blunders it made that helped cause the Great Depression. I am inclined to agree, but the deeper question is why the financial fate of the world was so dependent on one man. The answer is that central banking by design had concentrated power to a degree that would not have occurred under free banking.