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The most important was, of course, the one between Germany and France, which paved the way for Germany's admission to the League of Nations. At end of the s, the drying-up of American credit made it difficult for Germany to pay reparations, and another American plan was required. Morgan, Jr. The Young Plan, which thus had the backing of the American banking community, eased the burden of reparation payments by spreading them over a longer period of time. The USA had gotten along without a central bank for a long time since, for all practical purposes, the Bank of England had played this role for the country, although it did not issue American currency.

A severe financial panic in caused the great American bankers, led by J. Morgan , to aim at the construction of such a bank as a lender of last resort.


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Morgan was assisted by a resourceful young banker, Benjamin Strong , in this venture. It so happened that the Fed was established just in time to coordinate the financing of war loans to the Allies. Strong was the central figure in this.

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With the best of intentions, Strong paved the way for the Great Depression, which he actually predicted before his sudden death in Although the combatant nations had abandoned the gold standard in , the United States had effectively retained it, and after the war, Strong felt that it was his duty to assist the nations wishing to return to it. In doing so, he was caught on the horns of a dilemma. According to the doctrine of the gold standard, this should have caused an inflation in the receiving country and a deflation in the countries losing gold.

High prices due to inflation in one country and low prices caused by deflation in others would then lead to a return of the flow of gold. But the Fed was pledged to maintain domestic price stability. It could do this only by sterilizing gold by hoarding it, thus upsetting the automatism of the gold standard. While this solved the problem for the USA, it put increasing deflationary pressure on the countries losing gold. Strong wanted to relieve this pressure by providing ample credit to those nations. With an enormous treasure of hoarded gold, the Fed could create any amount of federal credit, which could be calibrated by its governors.

With its inflationary monetary policy, the Fed mimicked the effect that the inflow of gold should have had. There were two flaws in this procedure: first of all, the debt service of these generous credits would lead to an additional flow of gold to the USA. Strong tried his best to restore the world order after the war, but his attempts were bound to fail. He actually fueled an inflation which he could then no longer reign in and which triggered the Great Depression. The international gold standard, in whose contribution to world order Strong had firmly believed, had never worked automatically in the past.

It had previously been managed by the City of London, which, as the hub of international finance, supported the free flow of gold.

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World War I Economic Impact

Returns received by Great Britain on this capital covered more than the annual outflow. After the war, the British capital export dwindled to about 40 million pounds per year. Nevertheless, the Governor of the Bank of England, Montagu Norman , strove to return to the gold standard at the pre-war parity.

The Battlefront

He worked for this strenuously with the help of his friend Benjamin Strong, and achieved this aim in In earlier times, the post of the Governor of the Bank of England had been filled at short intervals by elderly bankers. This bank, which performed all the functions of a central bank, was in fact a private bank owned by its shareholders. It was a sign of turbulent times that, instead of serving the usual short term, Norman held his post from to Norman was very active in organizing the cooperation of central banks throughout the world, but came into conflict with the Bank of France.

Norman reached the zenith of his fame in when TIME magazine lionized him, printing his picture on the cover. Norman had to defend the overvalued pound by following a severely deflationary monetary policy; [24] this is what he meant when quoting the biblical metaphor. When an international banking crisis loomed large on the horizon, Norman made a valiant attempt to stave it off through an international cooperation of central banks. The leading American banker J. It was starved of funds and could not even attempt to aid ailing financial giants such as the Austrian Creditanstalt, which collapsed in , setting off an avalanche of bank failures throughout Europe.

Instead of showing the power of central bank cooperation, the BIS demonstrated its helplessness. The British finally abandoned the gold standard in September The pound was then allowed to float, and it depreciated by about 30 percent. The text of the announcement in which the British government explained its momentous decision was drafted by the staff of J. Morgan was the greatest creditor of Great Britain at that time, and he endorsed the move at a press conference in London, expressing his faith in British creditworthiness.

Norman was in the United States while all this happened, and later on pretended he had not known about the decision. He conducted vast open market operations that enabled him to calibrate money supply, as well as to adjust the exchange rate of the floating pound. As Ben Bernanke has shown in his studies of the Great Depression, such a crisis increases the cost of financial intermediation i.

In the industrial countries, this was accompanied by another counterproductive phenomenon: sticky nominal wages. According to orthodox views, the labor market is a market like any other, and is therefore governed by the rules of market clearing. Unemployment should thus not really exist, as every worker should find employment at the right price wage for his or her work.

The US Economy in World War I

Sticky nominal wages, which imply rising real wages when prices fall, should not exist either in a functioning labor market. Instead, however, the credit famine was accompanied by a wage freeze.


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The employer may thus find it easier to fire workers than to reduce wages. The war and its aftermath had caused the rise of the welfare state in the industrial countries. Its most important achievement was the introduction of unemployment benefits. Conservative politicians were against it, arguing that such benefits distorted the labor market.

But socialist leaders defended it, and Germany added a Labor Ministry to its cabinet in It introduced unemployment insurance in , as well as a state-run labor exchange. The war had impoverished many Germans, and 6 million soldiers had to be demobilized after the war. While these problems plagued the industrial sector, the agricultural sector experienced its own bitter fate during the Depression. Peasants working in a subsistence economy would not have been touched by the Depression, but by the s, there were very few pockets of subsistence economies left at the periphery of the world market.

Most peasants on the periphery depended on the market and on credit for their operations. This fall was more dramatic than anything that happened in the industrial sector, and could also be traced to the fate of the gold standard. The gold standard supported the expansion of the worldwide trade in food grains, particularly wheat.

As long as the gold standard prevailed, credit was freely available. This also helped to finance the storage of wheat, which could be used as a collateral to obtain further credit.

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The trade in wheat futures helped to stabilize prices internationally. Huge machines performed the work for which thousands of laborers used to be required.


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In Argentina , huge estates of cattle breeders were partly converted into land cultivated by itinerant tenants, who lived in huts but owned modern combine harvesters. The previous year had been a bad one — world production only amounted to a total of 68 million tons — but and were good years.

World production climbed to 82 and then 92 million tons, and prices began to fall. Although was once more a bad year 77 million tons , prices did not recover. The storages were filled to the brim. In the meantime, the Fed had raised the bank rate in order to control the exuberance of the stock market. But speculators deposited stocks with their banks, using them as collateral for buying more stocks. The higher interest rates hit those who stored wheat on credit. Up until then, storage had provided the ratchet which prevented the decline of the wheat price, but in , the ratchet broke, and an avalanche of wheat flooded the world market.

Supply and demand held fairly stable, but they no longer determined the price of commodities, which remained depressed for a long time. The steep fall in wheat prices affected the peasants on the periphery of the world market. India is a case in point: wheat prices declined even more precipitously there than elsewhere. From to , the wheat price fell by more than half. Most of the peasants were indebted to moneylenders, and their debt service and revenue demands were not adjusted to make allowance for their loss in income. Even more crushing than the fall of the wheat price, which affected Northern and Western India, was the sudden and unexpected collapse of the rice price in January , which hit Eastern India.

Rice was not overproduced and was not stored in great quantities. It was mostly produced and consumed in Asia. By , the price of rice was lower than that of wheat: an unprecedented event.

Economic Conditions That Helped Cause World War II

It was a drastic case of contagion by credit contraction. In October , there had been a good rice harvest in Japan. The Japanese price of rice then dropped by about 30 percent. This was also due to a deflationary monetary policy pursued in order to keep Japan on the gold standard, which it had rejoined only one year earlier.

Japan neither imported nor exported rice at that time, but in November , the news from Japan affected the international rice market of Liverpool, where the rice price was halved. This was communicated to Rangoon, the chief rice market of British India, where the price also fell by half when the winter harvest reached the market in January The impact of the Great Depression on the periphery of the world market could be noted in many other countries, too. A curious case of a delayed impact of the Great Depression was that of China , which had been on a silver standard.

The price of silver fell steeply in parallel with that of all other commodities in , and Chinese living abroad in gold standard countries then bought silver and invested it in China. This gave rise to a short-lived boom at the very time when other countries were hit by the Depression. But the Silver Purchase Act of obliged the US government to hold a quarter of its currency reserves in silver. The silver price doubled within a year and once more attained the level of In , the price of silver increased by another 50 percent. Silver was sucked out of China with a vengeance, and fierce deflation followed.

In other countries on the periphery, gold flowed out in torrents after Great Britain had left the gold standard in September and was floating the pound. This immediately increased the price of gold. But the imperial rulers saw to it that India disgorged its gold, following a deflationary policy that deepened the Depression and helped to squeeze out more gold.

The steep fall in commodity prices had deprived the rulers of this benefit. They now held on to the colonies as creditors. The trend towards decolonization emerged in the s. An age of empire-breaking is following an age of empire-making.