The Return to Gold: Churchill's 1925 Parity and Britain's Lost Decade

On the evening of 17 March 1925 the Chancellor of the Exchequer gave a dinner at 11 Downing Street and invited four men to argue in front of him. Winston Churchill had held the Treasury for four months. He had never run a financial department, and the question he had to settle by the end of the year was whether Britain would put the pound back on gold at its pre-war rate of $4.86.

Two of his guests said yes. Sir John Bradbury, who had been Joint Permanent Secretary to the Treasury through the war, argued that the gold standard was knave-proof — that its virtue lay precisely in taking discretion away from politicians. Otto Niemeyer, Controller of Finance and the Treasury's dominant official voice, held that no alternative existed that would not cost Britain its position as the world's banker.

Two said no, or something close to it. John Maynard Keynes told the table that the pound was worth less than $4.86 and that forcing it up there would mean grinding money wages down by a tenth in an economy where wages did not grind. Reginald McKenna, a former Chancellor and by then chairman of the Midland Bank, gave the answer that P. J. Grigg, Churchill's private secretary, wrote down and that has been quoted ever since: there was no escape, they had got to go back, and it would be hell.

Churchill went back. Six weeks later he announced it in his first Budget, and for the next six years British economic policy was organised around defending a number chosen in 1717 by Isaac Newton.

The Deadline Nobody Chose

Britain's gold standard had died quietly. When war came in August 1914 the Currency and Bank Notes Act authorised Treasury notes in denominations of one pound and ten shillings, sovereigns drifted out of circulation, and moral pressure rather than law kept citizens from asking for the metal. Sterling was held near $4.76 through the war by borrowing and by J. P. Morgan's support in New York. That support was withdrawn on 20 March 1919, and the pound floated. By February 1920 it had touched about $3.20.

Meanwhile the machinery for going back had already been built. A committee chaired by Lord Cunliffe, the Bank of England's wartime Governor, reported in August 1918 that the pre-war standard should be restored at the old parity as soon as conditions allowed. Its reasoning was almost entirely about credibility and almost not at all about the price level implied. Contraction did the rest: British wholesale prices fell by roughly half between 1920 and 1922, and sterling climbed back to $4.43 by 1922 and $4.57 by 1923.

Then a piece of housekeeping turned into a deadline. The Gold and Silver (Export Control) Act of 1920 had continued the wartime export embargo, and Parliament had given it a fixed expiry: 31 December 1925. Doing nothing meant the embargo lapsed with no standard behind it. Churchill inherited a decision with a clock already running.

Mr Churchill's Exercise

Churchill was not a passive customer for official advice. In late January 1925 he began circulating memoranda to his officials that asked the questions his officials were not asking themselves, and on 22 February he sent round the document known in the Treasury as the exercise. It is the best evidence that the Chancellor understood exactly what he was being asked to buy.

He put the trade-off in a sentence his critics would later use against the policy he adopted. The Governor of the Bank, he wrote, showed himself perfectly happy in the spectacle of Britain possessing the finest credit in the world simultaneously with a million and a quarter unemployed. Churchill said he would rather see finance less proud and industry more content.

Niemeyer's reply was uncompromising. Unemployment, he argued, was the product of wage rigidity and of trade unions pricing their members out of work, not of the exchange rate; the state could not create employment by cheapening money without inflating. Montagu Norman, Governor of the Bank of England since 1920 and the policy's most immovable advocate, offered less argument and more certainty. Six years later, giving evidence to the Macmillan Committee, Norman was asked for his reasons and replied that reasons could not be given — the grounds for his convictions were instinctive.

Support also arrived from New York. Benjamin Strong, Governor of the Federal Reserve Bank of New York, wanted sterling back on gold as the anchor of a restored international system and made the transition easier to contemplate: a two-year credit of $200 million from his own institution and a further $100 million arranged through J. P. Morgan & Co. Neither line was drawn on in any serious amount. Their function was to tell speculators that a raid on the new parity would meet dollars.

The Budget and the Act

Bank Rate went from 4 to 5 per cent on 5 March 1925, which was the preparation rather than the announcement. Churchill delivered the announcement on 28 April, in the middle of a Budget speech that also cut income tax and introduced contributory pensions. He told the Commons that the embargo would not be renewed and that Britain was resuming its place on the gold standard.

Royal Assent for the Gold Standard Act followed on 13 May 1925. What it restored was not what had existed in 1914. Sovereigns did not come back into circulation, and no bank clerk was obliged to hand a customer a gold coin for a banknote. Instead the Bank of England was required to sell gold bullion at the old Mint price of £3 17s 10½d per standard ounce, but only in bars of approximately four hundred fine ounces. A bar cost the better part of £1,700 — several years of a skilled worker's earnings. Gold had become a settlement asset for central banks and arbitrageurs, and a legal fiction for everyone else.

That design was deliberate. A bullion standard economised on the metal, which was the point of the whole inter-war effort to rebuild a system on a gold stock that had not grown with the volume of world trade (Eichengreen, 1992). It also meant that the discipline of the standard reached the public not through convertibility but through Bank Rate, wages, and the dole queue.

The Economic Consequences of Mr Churchill

Keynes lost the argument at dinner and took it outside. In July 1925 he published three articles in the Evening Standard, collected almost immediately as a pamphlet by the Hogarth Press under a title that borrowed the form of his attack on the Versailles settlement six years earlier.

His arithmetic was simple and his prose was not kind. Sterling had been pushed about 10 per cent above the level consistent with British costs, so British exporters were being asked to accept a 10 per cent cut in the sterling value of what they sold abroad, and the only way the economy could deliver that was by cutting money wages across the board. Deflation, he wrote, did not reduce wages automatically; it reduced them by causing unemployment, and the policy therefore worked by deliberately intensifying unemployment until workers gave way.

Why had Churchill done it? Keynes answered that he had no instinctive judgment to prevent him from making mistakes, that lacking it he had been deafened by the clamorous voices of conventional finance, and that most of all he had been gravely misled by his experts (Keynes, 1925).

How wrong the parity actually was has been argued about ever since. D. E. Moggridge's reconstruction of the Treasury and Bank papers, published under a subtitle drawn from a contemporary jibe about the Norman Conquest of $4.86, broadly endorsed the 10 per cent figure and showed how little the officials had examined it (Moggridge, 1972). John Redmond, recalculating on a multilateral basis rather than against the dollar alone, found a smaller average overvaluation — closer to 5 per cent by the end of 1925 — while conceding it ran far higher against some European currencies (Redmond, 1984). K. G. P. Matthews later argued that sterling had not been meaningfully overvalued at all, and that Britain's troubles lay in the structure of its export industries (Matthews, 1986). What nobody disputes is that Britain spent the second half of the 1920s trying to force its costs down while its competitors did not.

Coal

The industry that met the exchange rate first was the one with the thinnest margins and the oldest pits. Coal was a third of British export earnings before the war, and it had been losing ground since — to French and Belgian reparations coal, to reopened Ruhr production after the Dawes Plan, to oil, and to its own geology.

Repricing sterling upward took the last of the margin. Mine owners gave notice on 30 June 1925 that from 31 July wages would be cut and the minimum percentage addition on standard rates withdrawn. A. J. Cook, the Miners' Federation secretary, answered with the slogan that defined the next eighteen months: not a penny off the pay, not a minute on the day. With the railwaymen and transport workers pledged to an embargo on coal movements, Baldwin's government blinked. On 31 July — Red Friday to the union side — it granted a subsidy to maintain wages for nine months and appointed a royal commission under Sir Herbert Samuel.

Samuel reported on 10 March 1926. It rejected longer hours, recommended reorganisation and amalgamation of the pits, and accepted that wages would have to fall in the meantime. Nobody could build a settlement on that. The subsidy ran out on 30 April, the lockout began on 1 May, and the Trades Union Congress called out its members from midnight on 3 May. Something between one and a half and one and three-quarter million workers stopped for nine days. The TUC called the General Strike off on 12 May without securing terms; the miners stayed out until November and went back on worse pay and longer hours than they had refused.

Insured unemployment is the Ministry of Labour series covering workers inside the national insurance scheme, which excluded much of agriculture and domestic service; it runs above the whole-economy rate but it is the figure ministers read. It did not fall below 9.7 per cent in any year between 1921 and 1939.

The Cost of the Defence

Defending $4.86 meant keeping British interest rates high enough to hold funds in London whatever was happening elsewhere. Bank Rate spent the second half of the decade well above where domestic conditions alone would have put it, and the constraint tightened as Wall Street's boom pulled gold and short-term money to New York. In February 1929 Bank Rate went to 5.5 per cent; on 26 September 1929, with the Hatry fraud unravelling and reserves leaving, the Bank raised it to 6.5 per cent. Strong, who had spent the decade cutting American rates partly to relieve pressure on London, had died in October 1928.

Britain therefore entered the world depression with an economy that had never recovered from the last one, tied to a parity it could only hold by importing every shock through the money market. R. S. Sayers, writing the Bank's official history, concluded that the authorities had committed themselves to a rate that left them with no room and then spent six years discovering how little room they had (Sayers, 1976). The comparison with the country that had destroyed its currency instead is uncomfortable: Germany, having written off its debts in the hyperinflation of 1921 to 1923, returned to gold in 1924 at a fresh parity with no legacy of overvalued costs, and grew faster than Britain for the rest of the decade.

21 September 1931

The end came from Austria and Germany. Creditanstalt's failure in May 1931 froze Central European assets, and the London houses that had lent there could not be paid. Foreign holders of sterling balances started asking for gold. The May Committee report of 31 July, forecasting a budget deficit of £120 million and recommending cuts including a 20 per cent reduction in unemployment benefit, turned a banking problem into a political one. Ramsay MacDonald's Labour cabinet split over the cuts and was replaced on 24 August by a National Government formed to defend the pound.

It lasted under a month. Sailors at Invergordon refused duty on 15 September over pay reductions, the news reached the exchanges, and the drain accelerated beyond what the Bank's remaining credits could meet. On Sunday 20 September the decision was taken; the Gold Standard (Amendment) Act passed through both Houses the following day and suspended the Bank's obligation to sell gold. Sterling fell to about $3.75 within a fortnight and to roughly $3.40 by December.

What followed was the discovery that the ceiling had been the floor. Bank Rate came down to 2 per cent by June 1932 and stayed there for most of the decade. Cheap money financed a housing boom, industrial production recovered faster than in France or the United States, and Britain's departure from gold in 1931 turns out to predict the start of its recovery exactly as Eichengreen's comparative work says it should. Sidney Webb, who had sat in the cabinet that fell defending the parity, is supposed to have said on hearing the news that nobody had told them they could do that.

The men who made the decision did not defend it afterwards. Norman stayed at the Bank until 1944 and never explained. Churchill, according to Grigg, referred to the return to gold for the rest of his life as the biggest blunder he ever made — and he had made it, as his own February memorandum shows, with his eyes open, having written down the objection to the policy more clearly than any of the experts who talked him out of it. He signed the Act anyway, and the international monetary order rebuilt at Bretton Woods in 1944 was designed by a delegation whose senior British member was the man who had lost the argument at dinner in 1925.