194 Money and Finance
standard; the British pound sterling, backed by a strong government and the world’s
leading financial center, was “as good as gold,” and most international trade and
payments were carried out in sterling.
The world financial system in the century before World War I was indeed
dominated by British banks, which financed much of world trade and channeled
enormous amounts of investment capital to such rapidly developing countries as
the United States, Australia, Argentina, and South Africa. As time wore on, the
financial institutions of other European powers, especially France and Germany,
also began to expand abroad. The result was a highly integrated system of
international monetary and financial interactions under the Pax Britannica. In
Reading 13, Lawrence Broz argues that this relatively smoothly functioning system
was due largely to the concerns of the dominant private interests in the world’s
monetary and financial leaders.
Even before World War I, however, strains and rivalries were beginning to test
the system. Once the war started, in 1914, international trade and payments
collapsed: of all the world’s major financial markets, only New York stayed open
for the duration of the conflict. Indeed, by the time World War I ended, the center
of international finance had shifted from London to New York, and Wall Street
remained the world’s principal lender until the Great Depression of the 1930s.
As might be expected, given the reduced economic might of Great Britain,
the prewar gold sterling standard could not be rebuilt. Yet neither was the United
States, which was beset by the isolationist-internationalist conflict at home, willing
to simply replace Great Britain at the apex of the world monetary system. What
emerged was the so-called gold exchange standard, whereby most countries went
back to tying their currencies to gold but no single national currency came to
dominate the others. Dollars, sterling, and French francs were all widely used
in world trade and payments, yet, given the lack of lasting international monetary
cooperation in the period, the arrangement was quite unstable and short-lived.
Normal international economic conditions were not restored until 1924, and
within a few years the Depression had brought the system crashing down. With
the collapse of the gold exchange standard and the onset of the Depression and
World War II, the international monetary and financial systems remained in
disarray until after 1945.
As World War II came to an end, the Allied powers, led by the United States,
began reconstructing an international monetary system under the Bretton Woods
agreement. This system was based, in the monetary sphere, on an American dollar
tied to gold at the rate of thirty-five dollars an ounce; other Western currencies
were, in turn, tied to the dollar. This was a modified version of the pre-1914 gold
standard, with the dollar at its center rather than sterling. As in the Pax Britannica,
massive flows of capital from the leading nation—Great Britain, in the first instance;
the United States, in the second—were crucial to the proper functioning of the
mechanism. Whereas in the British case these capital flows were primarily private
loans, from 1945 to 1965 they were essentially government or multilateral loans
and foreign direct investment. After 1965, private international finance once again
become significant, rapidly reaching historically unprecedented proportions and
developing new characteristics.