When Winston Churchill was named Chancellor in November 1924, he is said to have thought it was the most ceremonial position of Chancellor of the Duchy of Lancaster and was as surprised as anyone, due to his lack of interest in economics, to find out that it was the Chancellor of the Exchequer, constitutionally the second most powerful office in the British government. “I was surprised,” he wrote, “and the Conservative Party was surprised”.
The controversy that followed Churchill’s tenure has implications for policy debates today. Everything is related to macroeconomics and exchange rates: how they affect trade and development, whether they should be fixed or floating, and the problems these questions create for policy makers. In the short term, the decisions made by Churchill led to the General Strike of 1926, and these debates continue to reverberate in the long term.
Churchill inherited a difficult problem: returning to Britain the gold standard at the pre-World War I rate. In 1914, sterling was exchanged for gold at the rate of £4.25 per ounce, ie. dollar exchange rate for £1 for $4.87. When war broke out, the exchange was stopped to prevent the loss of gold and Britain, like other militaries—actually, to a much lesser extent—issued money to finance the war. Between 1914 and 1918, total metal reserves as a share of bank notes and deposits (income) decreased from 40% to 33%.
In 1918, the Cunliffe Committee recommended a return to reform, but currency mismatches and reserves threatened a run as holders of sterling exchanged for gold, a reserve. Britain’s post-war governments sought to build reserves by using balance of payments surpluses and maintaining tight monetary policy with high interest rates, which would also reduce the circulation of money. This raised sterling from a low of £1 per $3.38 in February 1920 to £1 per $4.78 in March 1925.
Churchill was skeptical about returning to gold at pre-War parity, but he also doubted his ability to match economic wits with Montagu Norman, Governor of the Bank of England, and a strong advocate of the policy to protect London’s position as the financial center of the world. “If [economists] it was soldiers or generals I would understand what they were talking about,” Churchill complained.” “As it is, they all speak Persian”.
He hoped that John Maynard Keynes—a public intellectual since publishing Economic Consequences of Peace in 1919—he would do it for him. In 1925, Keynes published a pamphlet entitled The Economic Results of Mr. Churchill, which argued that the high rate of unemployment in Britain “is a question of relative value both here and abroad. The problem, Keynes wrote, is that “the value of good money abroad has risen by ten per cent, while its purchasing power over British labor has not changed.” An American who buys £1 worth of produce would have had to give $4.33 for it before, but $4.78 now. Possibly, he argued, “we should accept 10 per cent less with our money” ($4.33 or 90 pence), which pushed profits into losses and caused economic depression.
“On this there is no difference of opinion,” Keynes wrote, and he was right. They all believed that the problem was excessive wages in exporting industries such as coal. The difference was that Norman and others proposed wage cuts and a lower home price level—i internal devaluation — return of profit.
Keynes believed that internal decline was impossible. It would require “a struggle with each different group in turn,” he wrote. “Those who are attacked first,” he continued, “face a depression in their standard of living, because the cost of living will not decrease until all others are successfully attacked; therefore, they have reason to defend themselves… Keynes’ solution was outside devaluation, lowering one price, the most expensive one, or the exchange rate, “to raise prices abroad,” so it will return to £1 for $4.33.
Norman, who described Keynes as “always completely likable, always completely wrong,” got his way. In April 1925, in a defense speech, Churchill announced Britain’s return to the gold standard at pre-war parity.
But in this case, Keynes was right. As their prices rose in foreign currency terms, British coal sales dwindled, profits turned to losses, mine owners demanded wage cuts, and unions refused. Miners, Keynes wrote, “must make these sacrifices to meet circumstances beyond their fault and control.” The government tabled the question the following year by setting up a commission and suspending subsidies, but when a government-appointed court of inquiry into the coal dispute reported in July 1925, one member, Sir Josiah Stamp, openly blamed “gold recovery” for the unrest. When the commission reported in March 1926 and recommended a reduction in wages, General Strike followed in May, the biggest industrial unrest in British history.
Arguments from the debate about returning to the gold standard under Churchill will resurface. Milton Friedman promotes floating exchange rates for reasons like Keynes’s, reasons that were the core of Margaret Thatcher’s opposition to British membership of the European single currency. As members outside the eurozone struggled with the debt crisis of 2010 to 2013, arguments for a possible pairing of Keynes and Friedman echoed again. When faced with imbalances, it was better, when possible, to fix the external price (exchange rate) than the internal price (price level).
An exchange rate is simply the price of one currency expressed in terms of another, and fixing this price is no better than fixing any other.
Churchill’s private secretary, Sir James Grigg, wrote in his memoirs that “Winston almost believed, that the decision to return to gold was the biggest mistake of his life.” Although he was a great man, there was stiff competition for the title, but he may have been right.
