Sound Money, Unsound Men
Peace and sound money are the two necessary and sufficient requisites for prosperity. This makes Sir Robert Peel a great hero of Conservative MP Kwasi Kwarteng’s book. Sir Robert, who was instrumental in returning the United Kingdom to the gold standard in 1821, also believed in a balanced budget and introduced the Bank Charter Act of 1844. These remained the pillars of British finance until 1914, coinciding with a period of tremendous economic success and improvement in living standards and life expectancy.
Both conditions need to be fulfilled, for without peace even the greatest riches will be squandered. The Emperor Charles V, whose abdication is touchingly described, benefited from the wealth of Spain’s American conquests but the money could not be shipped fast enough to pay for his wars. This led ultimately to a series of bankruptcies and inflation as the money supply increased but productive activity was displaced by warfare, reducing the goods available. Adam Smith noted that this “diminished the value of gold and silver in Europe”.
The need for money because of war also encourages innovations which are often — but not always — catastrophic. The Bank of England was created to help fund war with France and has been a considerable boon to centuries of governments. The lower cost of British borrowing in the 18th century was an important reason for military success, although inevitably dependent on factors other than the bank. On the other hand, both the disasters of the Mississippi Scheme in France and the South Sea bubble in England came from attempts to fund government debt.
These two events are clearly described by Kwarteng in a way that explains why people thought the schemes might have worked. When bubbles have burst it is easy to laugh at those who were involved and dismiss them as fools, but given that Isaac Newton lost a fortune in the South Sea bubble, such an approach is not sufficient. It is necessary to understand what potential investors saw in the schemes and, as befits a highly intelligent man, the author describes these complex issues in an eminently digestible way.
War has often led to paper money with varying degrees of success. In France the assignats worked as long as terror enforced their value but failed afterwards. The continental dollar issued during the American rebellion became almost worthless and each effort to boost it tended to do the opposite, while the pound retained most of its value during the Napoleonic wars. This is explained by the mystic quality of fiat currency, which depends upon confidence in the state issuing it to survive, but once that is gone dissolves to nothing. The highest point of risk is naturally after a war, especially one that has been lost, as in Weimar Germany in the 1920s.
This underpins one of the major theses of the book: war destroys wealth. This could be by inflation as a paper currency or another means of devaluation robs savers and gives money to borrowers and owners of physical assets. Otherwise it is by deflation as the gold standard is restored, debtors are bankrupted and wages are forced down leading to discontent, as in the agricultural riots in Britain in the 1820s or the General Strike in 1926. Interestingly nations seem to be able to tolerate the discomfort they did not suffer last time. Hence after World War II the UK accepted inflation because after World War I it had experienced deflation; while Germany remains so conscious of the Weimar inflation that it invests its inflation-busting central bank, the Bundesbank, with an almost religious authority. Whether other eurozone states will put up with this is a question posed but not answered.
Until John Maynard Keynes came along the relationship between war and gold was fairly simple. Wars damaged the public finances and devalued the currency, but gold was restored to its throne with the peace. When Britain left the gold standard in 1931 Winston Churchill, who as Chancellor of the Exchequer had reinstated it after the war, supposedly said, “No one told me I could do that.” The financial orthodoxy of gold and balanced budgets held sway until Keynes shattered it by suggesting that in times of difficulty a government could borrow to boost the economy. This was not all he said, and Kwarteng goes a long way to save Keynes from the Keynesians, who always want to borrow regardless of the stage of the cycle.
Keynes believed in saving in boom years. When asked by my godfather, Henry Hobhouse, then a young journalist, whether governments might not borrow in times of plenty to boost their electoral chances, Keynes replied that they would not because he would make a speech in the House of Lords if they did. This may have been unduly trusting but it was not as silly as the current crop of pseudo-Keynesians.
As the book draws to a conclusion it points out how untested the current system of government financing is around the world. Money has no base and deficits are the norm. The gap between spending and taxation is only partly made up by borrowing from the market; most of it has recently come from the central banks’ printing presses. Quantitative easing is little different from clipping the coinage. The golden ages of both the UK and the US were firmly rooted in balanced budgets, which were abandoned in the Sixties and a gold-backed currency, finally dropped in the Seventies. This has left a dollar standard, especially for emerging markets such as China, whose recirculated savings paid for American consumerism in the Nineties and Noughties. Flatteringly, the book leaves it to the reader to draw out the potential conclusions from this state of affairs. Perhaps democracies are not capable of the discipline required for “sound money”, nor of saving to pay down debt. This leaves inflation or default as the ways back to equilibrium. Kwarteng quotes admirable economists such as Peter Warburton, who predicted the 2008 crash a few years before it happened. Has he foretold the next catastrophe?