Slouching Towards Utopia?:
The Economic History of the Twentieth Century
-IX. How the Pre-World War
I World Economy Worked: International Finance, the Gold Standard, and Politics-
J. Bradford DeLong
University of California at Berkeley
The Gold Standard before World War I:
What made the upward leap in international trade,
the creation of an integrated world economy-a world economy where for the
first time trade was not confined to luxuries and intoxicants
but extended to staples and necessities-possible in the years before World
War I? Falling costs of ocean transportation was one major factor. The development
and extension of the international political and economic order called the
gold standard was another.
The gold standard was in its origins a very
simple thing: governments and central banks all over the world declared
that their currencies were as good as gold-show up with £100 note,
or a $100 bill, at the British Bank of England or the U.S. Treasury and
the man behind the counter would give you a specified, fixed,
unchanging quantity of gold: about 4.5 (troy) ounces in the case of the
$100 bill, and about 22 (troy) ounces in the case of the £100 pound
Why did this matter? It mattered because as long
as the gold standard stood entrepreneurs could make their plans for and
build their factories engaged in international trade without having to worry
about what we today call foreign exchange risk. Consider the plight
of an American manufacturer deciding in 1980-when one British pound sterling
sells for $2.32-to compete with British producers by exporting to London;
spending the early 1980s building factories to expand capacity, and then
finding in 1985 that one pound sterling sells not for $2.32 but for
$1.30 on the foreign exchange market. The simple movement in exchange rates
since 1980 has raised the manufacturer's costs relative to those of British
competitors by 80 percent. You can bet that a very large number of productive
operations and markets that looked profitable to American businesses
in 1980 no longer looked profitable in 1985.
This is foreign exchange risk: the risk
that governments following sensible or nonsensical policies or international
currency speculators responding to their own "animal spirits"
will cause exchange rates to shift in a way that destroys a particular line
of trade or bankrupts importers and exporters. This foreign exchange risk
is in large part avoided under a gold standard. And this near-absence of
foreign exchange risk was one powerful factor driving the expansion of international
trade and finance in the years before World War I.
How did the gold standard reduce foreign exchange
risk-and close to eliminate the risk that a country would embark on a policy
of in_ation that would endanger established wealth? In its idealized form,
the gold standard carried out these tasks by virtue of its working as an
automatic equilibrating mechanism.
If ever a central bank or a Treasury printed "too
many" banknotes under a gold standard, the first thing that would
happen would be that those excess bank notes would be returned to the Treasury
by individuals demanding gold in exchange. Thus each country's domestic
supply of money was linked directly to its domestic reserves of gold.
Suppose a country under the gold standard ran a
trade deficit in excess of foreigners' desired investments. It, too,
would find those who had sold goods to its citizens lining up outside
the Treasury looking to exchange banknotes for gold. And these foreign suppliers
of imports would then ship the gold back to their countries. The money stock
at home would fall as gold reserves fell. And with a falling money stock
would come falling prices, falling production, and falling demand for imports.
So balance of payments equilibrium would
be restored, and countries' price levels kept in roughly appropriate competitive
alignment, by the gold standard as sources of disequilibrium were removed
by shipments of gold, or threatened shipments of gold, that raised and lowered
nations' reserves. Monetary authorities would find themselves restrained
from pursuing over-in_ationary policies by fears of the gold drains that
And since central bankers in every country were
all working under the same gold standard system, they would all find
their policies in rough harmony without explicit meetings of G-7 finance
ministers or explicit international policy coordination.
The pre-World War I gold standard was not invented.
It just grew, starting in the 1870s when Germany joined Britain, which had
defined its currency primarily in terms of gold since 1717, when Sir
Isaac Newton was Master of the Mint. Increased German demand for gold pushed
up its price; increased American mining of silver pushed down its price.
Countries that had long tried to keep both gold and silver coins legal tender
found their gold reserves falling, as people would buy cheap silver on the
world market, exchange it for currency, and then bring the currency into
the Treasury for gold. By the end of the 1870s nearly the whole world was
on the gold standard.
That exchange rates were stable under the pre-World
War I gold standard is indisputible. Devaluations were few, and rare. Exchange
rate risk was rarely a factor in economi decisions.
Thus not only did trade expand under the gold standard,
but international capital markets expanded in the years before World War
I as well. It became a commonplace for rich people in Europe or North America
to have their money invested in far-_ung enterprises on other continents.
This out_ow of capital from the industrial core to the industrializing,
mineral-rich periphery was also greatly assisted by the gold standard.
Certainly those economies that received in_ows
of capital before World War I benefitted enormously. It is not so clear
that the free _ow of capital was beneficial to those in the capital
-exporting countries. France subsidized the pre-World War I industrialization
of Czarist Russia (and the pre-World War I luxury of the court and expansion
of the military) by making investments in Russian government and railroad
bonds a test of one's French patriotism. A constant of French pre-World
War I politics was that someday there would be another war with Germany,
during which France would conquer and re-annex the provinces of Alsace and
Lorraine that Germany had annexed as part of the settlement of the Franco-Prussian
War of 1870-71. (And that France had taken from the feeble and oddly-named
Holy Roman Empire of the German Nation as part of the settlements of the
Thirty Years' War of 1618-48 and the Wars of Louis XIV of 1667-1715.) French
military strategy depended on a large, active, allied Russian army in Poland
threatening Berlin and forcing Germany to divide its armies while the French
marched to the Rhine. Hence boosting the power of the Czar by buying Russian
bonds became a test of French patriotism.
But after World War I there was no Czar ruling
from Moscow. There was Lenin ruling from Petrograd-subsequently renamed
Leningrad-subsequently returned to its original name of St. Petersburg.
And Lenin had no interest at all in repaying creditors from whom money had
been borrowed by the Czar.
British investors did better from their overseas
investments, but they still did not do very well The year 1914 saw close
to 40 percent of Britain's national capital invested overseas. No other
country has ever matched Britain's high proportion of savings channeled
to other countries. Britain's overseas investments were concentrated in
government debt, in infrastructure projects like railroads, streetcars,
and utilities, and in securities guaranteed by the local governments.
However, in the forty years before World War I,
British investors in overseas assets earned low returns, ranging as low
to perhaps 2% per year in in_ation-adjusted pounds on loans to dominion
governments. Such returns were far below what presumably could have earned
by devoting the same resources to the expansion of domestic industry. British
industry in 1914, and British infrastructure, were not as capital intensive
as American industry and infrastructure were to become by 1929. It is difficult
to argue that Britain's savings could not have found productive uses at
home, if only British firms could have been challenged appropriately
and managed productively. And the difference in rates of return cannot be
attributed to risk: overseas investments were in the last analysis more
exposed to risk than were domestic investments.
But for capital importing countries, like the U.S.,
Canada, Australia, and others like India and Argentina, the availability
of large amounts of British-financed capital to speed development of
industry and infrastructure was a godsend. It allowed for earlier construction
of railroads and other infrastructure. It allowed for the more rapid development
Of course, the actual, real-world gold standard
did not work as smoothly as the idealizations of economic theorists. Butit
did provide a stable underpinning to the growth of the world economy in
the years before World War I.
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The Business Cycle Under the Gold Standard:
However, there is a negative side to the gold standard.
The gold standard was good not only at encouraging international trade expansion
and boosting international capital _ows, but also at quickly transmitting
business cycles and financial panics around the world as fast as the
telegraph wire could carry them. So borrowing foreign capital from Britain
had costs as well: it tied the borrower's economy to the financial
and employment cycles of Great Britain. "When London sneezes,"
the saying went, "Argentina [or Canada, or the U.S.] catches pneumonia."
this work? Look in some detail at the industrialization of the United States
to see how the typical pre-1929 depression had its origin in the United
States' gold-standard links with the London-centered world economy.
The years between the Civil War and the 1890's
saw the great railway booms. In 1870 and 1871 U.S. railroad construction
reached its first post-Civil War peak. The number of miles of operated
railroad in the U.S., then around 50,000, grew at about twelve percent per
year. The construction of 6,000 miles of railroad track each year employed
perhaps one-tenth of America's non-farm paid labor force and half of the
production of America's metal industries.
Four years later, railroad construction had collapsed.
In 1875, railroad mileage grew at only three percent. Railroad construction
employed less than three percent of America's non-farm paid labor force,
and required perhaps fifteen percent of the production of America's
The depression of 1873 had its origins in British
investors loss of confidence that American railroads and infrastructure-that
day's equivalent of investments in the Pacific Rim. The largest investment
house in the United States-that of Jay Cooke, politically well-connected
industrial visionary who financed Abraham Lincoln's armies, and whose
picture hangs in the Treasury Department's antique collection in the General
Counsel's office-went bankrupt.
As a result of the collapse of Jay Cooke and Company the City of London sneezed. The U.S. economy caught pneumonia. The share of America's non-agricultural labor force building railroads fell from perhaps one in ten in 1872 to perhaps one in forty by 1877-a seven percentage point boost to non-agricultural sector unemployment from this source alone.
Such a wave-first of expanded railroad construction
as capital _owed in, and then of contraction as capital _owed out-must have
been difficult to absorb just as the Mexican recession of 1995 proved
very painful. Each wave of railroad building required an expansion of capacity
in iron and steel for rails, timber for ties, equipment for locomotives
and cars, furniture to equip the cars to carry passengers on the new lines,
and most important the redirection of one million workers to railroad construction.
As the wave passed, suppliers and workers would have to find new markets
and new jobs. The dislocation generated may well have been extreme and severe.
But we know little about how it was accomplished, or about what workers
who built railroads in 1871 were doing in 1875.
It is hard to attribute such spasms of construction
to independent disturbances in finance: railroad finance was
then more-or-less the sole business of Wall Street. By default such depressions
appear to have been driven by waves of optimism about future growth, followed
by recognition of overbuilding and contraction until the economy had grown
enough that it seemed that shipping by rail was a railroad's and not a farmer's
The gold standard appears also in the depression
of the 1890's. The possibility that "free silver" might sweep
American politics made investors and financiers uneasy. Relative to
what they would earn if they kept their cash, investments, and capital in
London, a free-silver victory and subsequent devaluation might well have
cost them a third of their wealth as measured by the international yardstick
of the gold standard. Perhaps the free-silver movement was powerful enough
to cause capital _ight, investment shortfall, and depression, but not strong
enough to secure devaluation and monetary expansion to reduce the debt burdens
of farmers and create a booming labor market for urban workers. The U.S.
thus got the worst of both worlds: it suffered the disadvantages of being
on the gold standard without reaping the gold standard advantage of keeping
financiers confident and investing.
And the panic of 1907 and depression of 1908 followed
a recession in Great Britain. As a result of the recession, the Bank of
England raised interest rates to pull gold to London to boost its reserves.
This left the United States short of currency to be paid out to farmers
and middlemen during the fall shipment of the harvest to the East. Financial
panic followed, and recession followed the financial panic
Whether the depressions that did occur were worse
back before the Great Depression than they have been since World War II
remains disputed; given our limited quantitative knowledge, it is likely
to remain so.
That depressions before 1929 were more painful
is, however, very clear. Those who lost their jobs had no welfare state
to cushion them. Individual states had sketches of a future welfare system,
but such embryonic systems did not have the resources to cope with episodes
of widespread unemployment. Extended families, friends, and local benevolent
associations must have provided support for those who lost their jobs to
remain, for the most part, fed and housed. American cities during depressions
at the turn of the century were centers of poverty and want, but apparently
not of mass near-starvation.
All in all, the balance for the pre-World War I gold standard was probably positive: the boost it gave to world economic growth through making trade expansion easier and capital _ows larger probably outweighed any costs from tieing the whole world to Great Britain's business cycle. However, it is hard to argue that the post-World War I attempted restoration of the gold standard was beneficial, as we will see below.
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Europe's sixteenth century overseas empires, in
Latin America, in the Philippines, and in the spice islands of Indonesia,
had firm economic rationales: in the wrods of the chronicler of the
Spanish Conquistadores, Spain's warriors conquered the New World "to
spread the word of God, and to get rich." Control over the high-value
low-weight luxury goods of East Asia, or over the precious metals of Latin
America, could make individuals' fortunes and provide a healthy boost to
any early modern European royal treasury.
Europe's seventeenth and eighteenth century overseas
empires also had an economic component: obtaining a near-monopoly of the
tobacco or the slave trade, or conquering the sugar-growing islands of the
Caribbean, could boost mercantile prosperity.
But by the nineteenth century little was needed
in the way of luxuries that could not be made more cheaply in the industrial
core of the world economy, and little was to be found in raw materials from
further extensions of European empires. Yet the nineteenth century saw the
European great powers complete their conquest of the world.
In the last years before World War I, only Ethiopia,
Siam, Persia, Afghanistan, the Ottoman Empire (the core of which is now
Turkey), China, and Japan could claim to be neither a colony nor an ex-colony
of Europe's great powers. And the independence of all those save Ethiopia
(which had slaughtered an invading Italian army) and Japan (with its junior
empire of Taiwan, Korea, and scattered Pacific islands, along with
large chunks of Manchuria) was heavily compromised.
ß ß ß ß
Democracy and Plutocracy:
"They control the people with the people's
own money." So Louis Brandeis, strong Democratic political activist,
wrote of the turn of the century financiers who he saw as controlling
the American economy through their domination of the commanding heights
of finance. The answer that Brandeis saw was simple: separate ownership
from control, so that the bankers who collected the savings of the people
through the acceptance of deposits would be unable to use those savings
to increase their bargaining power vis-a-vis the managers of American enterprise.
It is doubtful that Louis Brandeis's proposed solution
was any solution at all. Large-scale businesses borrow from banks, true.
But remove some power to control and in_uence the managers of large-scale
enterprises that borrow from the bankers, and where does it go? It _ows
to the managers of the oligopolies and the monopolies that no longer have
to look over their shoulders to make sure that Wall Street is satisfied;
it does not _ow to the "people."
But if Brandeis's cure-to destroy the "money
trust"-was false cure, it was a response to a real disease. For the
United States as of the turn of the twentieth century was a much more economically
and socially unequal place than it had been even thirty years before.
On the eve of the American Revolution, the United
States-to-be had been a relatively egalitarian society. The richest one
percent of households owned perhaps fifteen percent of the total wealth
in the economy-a very low value for such an inequality statistic. Even by
the immediae aftermath of the Civil War wealth was still not that
concentrated: the top one percent of households appear to have had a little
more than a quarter of the wealth of the country.
By 1900, however, the U.S. had become the Gilded
Age country of industrial princes and immigrants living in tenements of
our political memory. On the one hand, Andrew Carnegie building the largest
mansion in Newport, Rhode Island with gold water faucets. On the other hand,
146 largely-immigrant workers dying in the 1911 Triangle Shirtwaist Factory
fire in Manhattan because the exits had been locked to keep workers
from taking fabric out of the building for their own clothes.
Surveys suggest that in 1929 the richest one percent
of U.S. households held something like 45 percent of national wealth, and
that the concentration of wealth had been sharply rising in the 1920s. We
strongly suspect that World War I had seen substantial deconcentration,
as in_ation eroded the value of bondholders' wealth and as high demand for
labor boosted workers' earnings. It is my guess that the second was stronger
than the first; that the concentration of wealth was eroded more during
World War I than it was boosted in the 1920s, and that the concentration
of wealth in the United States peaked sometime in the twenty years before
World War I, with the richest one percent of households owning some 50%
or so of total national wealth.
Attempts to count the wealth of the merchant princes
themselves reinforce the suspicion that the pre-World War I U.S. was more
unequal than at any time before or since.
A country of immigrants and plutocrats is very
different from the country of yeoman farmers that the United States had
been in its Founding Fathers' imagination, and in large part in reality,
in the late eighteenth century.
Alexis de Tocqueville, a keen-eyed commentator
on American society in the first half of the nineteenth century, had
feared the growth of such a class of plutocrats, such an "aristocracy
The territorial aristocracy of past ages was obliged
by law, or thought itself obliged by cutom, to come to the help of its servants
and relieve their distress. But the industrial aristocracy of our day, when
it has impoverished and brutalized the men it uses, abandons them in time
of crisis to public charity to feed them.... Between workman and master
there are frequent relations but no true association.
I think that, generally speaking, the manufacturing
aristocracy which we see rising before our eyes is one of the hardest that
have appeared on the earth....
In the United States the rising concentration of
wealth provoked a widespread feeling that something had gone wrong with
the country's development. The rich (and many of the native-born not-so-rich)
blamed foreigners: aliens born in China, Japan, Italy, Spain, Poland, and
Russia who were incapable of speaking English, or understanding American
values, or contributing to American society. Many of the middle class, especially
the farmers, blamed the rich, the easterners, and the bankers.
Populism in America
Progressivism in America
European politics were very different. In Europe
the trend was not toward greater inequality but toward greater equality,
as rising wealth and incomes submerged the wealth of the descendants of
old aristocracies in a deeper pool, and as a competing elite of manufacturers
and bankers grew up alongside the older elite of landlords, ministers, royal
favorites, and successful generals.
The fear of socialism
The spread of reform
G.H.M.'s views as to what is a "living wage" for a college professor are a mark of a profound shift in the American economy over the past century, a profound compression (even taking account of the widening of real wage differentials and the growth of inequality in the 1980's) in the U.S. relative wage structure. There is a strong sense in which America today is a much more egalitarian country than it was a century ago. The boast has always been that America is a country of independent middle-class people, lacking both a proletariat (although we have always had a "rural poor" and now have an "underclass") and an aristocracy. This was not true around the turn of the twentieth century. It has been much more true in the era after World War II.
I brag and chant of Bryan, Bryan, Bryan,
Candidate for president who sketched a silver Zion...
There were truths eternal in the gab and tittle-tattle,
There were real heads broken in the fustian and the rattle,
There were real lines drawn;
Not the silver and the gold,
But Nebraska's cry went eastward against the dour and the old,
The mean and the cold.
* * * * * *
He scourged the elephant plutocrats
With barbed wire from the River Platte.
The scales dropped from their mighty eyes.
They saw that summer's noon
A tribe of wonder coming
To a marching tune.
Oh, the longhorns of Texas,
The jay hawks from Kansas,
The plop-eyed bungaro and giant gassicus,
The varmint, chipmunk, bugabo,
The horned-toad, prarie-dog, and ballyhoo,
From all the newborn state arow,
Bidding the eagles of the west fly on...
Against the towns of Tubal Cain,
Ah,-sharp was their song.
Against the ways of Tubal Cain, too cunning for the young,
The longhorn calf, the buffalo, and wampus gave
* * * * * *
And all these in their helpless days
By the dour East oppressed,
Making their mistakes for them,
Crucifying half the West,
Till the whole Atlantic coast
Seemed a giant spider' nest.
* * * * * *
July, August, suspense.
Wall Street lost to sense.
August, September, October,
And the whole East down like a wind-smashed fence.
Then Hanna to the rescue,
Hanna of Ohio,
Rallying the roller-tops,
Rallying the bucket-shops.
Threatening drouth and death,
Rallying the trusts againt the bawling flannelmouth;
Invading misers' cellars,
Melting down the rocks,
Pouring out the long green to a million workers,
Spondulix by the mountain-load, to stop each new tornado
And beat the cheapskate, blatherskite,
Election night at midnight:
Boy Bryan's defeat.
Defeat of western silver.
Defeat of the wheat.
Victory of letterfiles
And plutocrats in miles
With dollar signs upon their coats,
Diamond watchchains on their vests
And spats on their feet.
Victory of custodians,
And all that inbred landlord stock.
Victory of the neat.
Defeat of the aspen groves of Colorado valleys,
The blue bells of the Rockies,
The blue bonnets of old Texas,
By the Pittsburg alleys.
Defeat of alfalfa and the Mariposa lily.
Defeat of the Pacific and the long Mississippi.
Defeat of the young by the old and silly.
Defeat of tornadoes by the poison vats supreme.
Defeat of my boyhood, defeat of my dream.