After the crash of the New York Stock Exchange in 1929, the depression spread rapidly and Great Britain was unable to escape its advance. Wholesale prices fell by 25 percent between 1929 and 1931, while unemployment, which represented 10.3 percent in October 1929, rose to 18.5 percent in October 1930 and reached 22.4 percent in September 1931.
The current account of the balance of payments showed a surplus of 103 million pounds in 1929, 28 million pounds in 1930, and a deficit of 104 million pounds in 1931. Within only a few years, from 1929 to 1931, exports declined by 46 percent in value and by 33 percent in volume. The trade balance deficit increased by 27 million pounds. Nevertheless, the terms of trade improved because the prices of imported goods fell more sharply than the prices of exports.
At the same time, the British government experienced a decline in fiscal revenues while its expenditures increased due to unemployment benefits, which aggravated the imbalance of public finances. The Bank of England reduced its discount rate to 2½ percent in May 1931, even though gold reserves had fallen to only 148 million pounds. This situation represented another example of the incompatibility between internal equilibrium and external equilibrium. The lack of confidence in the pound and the resulting flight from the currency were largely the consequence of these difficulties generated by the depression.
Austria and Germany also failed to escape the depression, and several spectacular bankruptcies further increased London’s financial difficulties. The Austrian Credit-Anstalt announced its financial problems in March 1931 and received a loan of five million pounds from the Bank of England. Despite this assistance, the bank collapsed in May 1931.
On June 19 a financial panic erupted in Berlin. The following day President Hoover proposed a one-year moratorium on all intergovernmental debts and reparations, which produced some dissatisfaction in France. Nevertheless, the agreement was signed on July 4 and a credit of 100 million dollars for fifteen days was granted to the Reichsbank through the Bank for International Settlements.
This measure did not prevent further financial catastrophes. The bankruptcy of several industrial companies, including Nordwolle, one of the major German textile enterprises, increased the difficulties faced by German banks. On July 15, 1931, all German banks closed their counters, blocking British short-term assets valued at 70 million pounds.
This situation did little to restore confidence among holders of pounds, who increasingly wished to convert their assets into gold. In periods of monetary uncertainty, gold becomes a safe-haven asset. Nevertheless, France and the United States granted a loan of 130 million pounds to the Bank of England. Conflicts did not entirely exclude cooperation.
Certain houses in the City of London were severely affected by the German collapse, and a chain reaction of bankruptcies was avoided only thanks to the solidarity of banks supported by the Bank of England. This situation hardly strengthened confidence. Between July 15 and July 29 the Bank of England lost 32 million pounds in gold reserves. The discount rate was raised from 2½ percent to 3½ percent and then to 4½ percent on July 30.
Despite new loans granted by France and the United States, Great Britain abandoned the gold standard in September 1931. In this way the gold exchange standard came to an end. A floating exchange rate was established for the pound, which immediately depreciated. The lowest point was reached at the end of 1932 when the pound was valued at 3.2765 dollars.
This exchange rate instability became a new reason for abandoning foreign currencies as international reserves, since the depreciation of the key currency implied a loss. During 1931 and 1932 the United Kingdom’s gold reserves for monetary purposes declined by 135 million dollars, falling from 718 million to 583 million. The gold reserves of the United States also declined by 180 million dollars, from 4.225 billion to 4.045 billion dollars.
The two key-currency countries therefore lost a total of 315 million dollars in gold, while six “creditor” countries—France, Belgium, Italy, the Netherlands, Sweden and Switzerland—experienced an increase of 1.929 billion dollars in gold reserves. These creditor countries were those that had accumulated convertible foreign currencies.
Other “debtor” countries—Nurkse identifies eighteen—lost both foreign exchange and gold reserves. It should be recalled that between 1920 and 1930 New York and London had granted short-term credits to a large number of countries. The dollar and pound reserves held by these countries therefore represented debts toward the gold centers, which demanded repayment after 1930, even though not all countries had collapsed like Germany.