Owing to the author’s and editors’ participation in this weekend’s Gaza protest, the following has been posted a little later on the scheduled publication day than usual.
Almost exactly 100 years ago, on June 28, 1914, shots rang out in the city of Sarajevo, then part of the Austro-Hungarian Empire. Assassinated on that day were the heir to the throne of Austria-Hungary, Archduke Franz Ferdinand, and Sophie, his wife and Duchess of Hohenberg. Serbians and other “south Slav” nationalists struggling to create a federation of the small south-Slav nations—Yugoslavia, in their language—were held responsible. Within little more than a month, the entire world order as it had existed prior to June 28 completely unraveled. First Europe and eventually the world plunged into what was to become known as World War I.
Among the pillars of the world order that collapsed in 1914 was the international gold standard. Under this system, central banks issued banknotes that were actually promissory notes payable in gold coin of a definite fineness and weight to the bearer on demand. As late as mid-1914, in the imperialist countries, gold coins still circulated side by side with banknotes, which along with bank checks were used for large transactions. Everyday purchases and wages were paid in coins made out of silver or base metals.
The fact that currencies of the imperialist nations were defined as a certain weight of gold of a given fineness meant that there was, within the narrow limits of the “gold points,” fixed rates of exchange among the imperialist countries. In effect, a single currency—gold—existed among the imperialist countries, with pound-sterling, dollars, marks, francs, and rubles merely local names for the universal currency, gold.
The international gold standard encouraged a massive growth of world trade and international investment rivaling today’s “globalization.” Individual countries on the gold standard had to remain on it or their access to the London-based capital markets would be undermined.
Things had not always been this way. In the mid-19th century, currencies of most European countries—with the exception of Britain—were defined in terms of weights of silver, not gold. The Russian ruble was a paper currency and was not convertible into either gold or silver at the state bank. In contrast, the United States defined both a silver and gold dollar, along with a fixed legal rate of exchange between the two. This system was known as bimetallism.
But since the value of gold and silver—the quantity of abstract human labor needed to produce a given weight of gold and silver bullion—constantly changes, it was the “cheaper” dollar that actually circulated. Originally, this had been the silver dollar, but by the middle of the 19th century after the gold dollar was made slightly lighter—in effect devalued—the U.S. was, like Britain, for all practical purposes on the gold standard.
By mid-1914, all these currencies, including the Russian ruble, were on the gold standard. Only the currencies of semi-colonial or colonized countries such as China and Mexico were still defined in terms of weights of silver or were paper currencies. And in 1914, after years of populist resistance to central banking, the U.S. Federal Reserve System began operations establishing the centralized management that the U.S. gold standard had previously lacked.
Before 1914, the U.S. gold standard was managed by a combination of private for-profit bankers, such as J.P. Morgan, and the U.S. Treasury. The flaw in this system was that there was no mechanism to meet a sudden increased demand for currency as a means of payment such as tends to develop during crises. Under the old U.S. national banking system, when a crisis hit, panic-stricken depositors would attempt all at once to convert their deposits into cash. As a result, the crisis would rage unchecked until money capital, in the form of gold bullion eager to take advantage of the sky-high U.S. interest rates caused by the panic, arrived from overseas.
The cyclical crisis of overproduction that hit with full force in the fall of 1907, as had happened periodically during the 19th century, triggered a panicky run on U.S. commercial banks as depositors rushed to convert their deposits into cash. But the changing conditions of the early 20th century made bank runs much more dangerous than they had been earlier.
By 1907, the U.S. had emerged as the world’s leading industrial power. Far fewer of the unemployed could return to their family farms to ride out the crisis like many still could during the 19th century. But there was another factor at work. Because the U.S. had now emerged as the world’s leading industrial as well as agricultural power, a run on the U.S. commercial banking system threatened to crash the entire global capitalist economy. Therefore, a U.S. central banking system had to be created to allow a rapid expansion of the quantity of means of payment in a crisis.
The danger was that if this were not done, during a crisis so much money capital in the form of gold bullion in search of the highest rate of interest would be shipped to the U.S. from Europe and elsewhere that the European central banks would be forced off the gold standard. To protect the international gold standard, it was therefore necessary for the U.S. to create a system of central banking just as the European countries already had done that would make it easy to issue extra dollars in a crisis. The very knowledge by bank deposit owners that extra dollars could be created during a crisis would make bank runs far less likely. When the Federal Reserve System began operations at the beginning of 1914, the international gold standard was now secure. Or so it seemed.