230 Hegemonic Stability Theories of the International Monetary System
Adjustment
Adjustment under the classical gold standard has frequently been characterized in
terms compatible with hegemonic stability theory. The gold standard is portrayed
as a managed system whose preservation and smooth operation were ensured through
its regulation by a hegemonic power, Great Britain, and its agent, the Bank of
England....
Before 1914, London was indisputably the world’s leading financial center. A
large proportion of world trade—60 percent by one estimate—was settled through
payment in sterling bills, with London functioning as a clearinghouse for importers
and exporters of other nations. British discount houses bought bills from abroad,
either directly or through the London agencies of foreign banks. Foreigners
maintained balances in London to meet commitments on bills outstanding and to
service British portfolio investments overseas. Foreign governments and central
banks held deposits in London as interest-earning alternatives to gold reserves.
Although the pound was not the only reserve currency of the pre 1914 era, sterling
reserves matched the combined value of reserves denominated in other currencies.
At the same time, Britain possessed perhaps £350 million of short-term capital
overseas. Though it is unclear whether Britain was a net short-term debtor or
creditor before the war, it is certain that a large volume of short-term funds was
responsive to changes in domestic interest rates.
Such changes in interest rates might be instigated by the Bank of England. By
altering the rates at which it discounted for its customers and rediscounted for the
discount houses, the bank could affect rates prevailing in the discount market.
But the effect of Bank rate was not limited to the bill market. While in part this
reflected the exceptional integration characteristic of British financial markets, it
was reinforced by institutionalization. In London, banks automatically fixed their
deposit rates half a percentage point above Bank rate. Loan rates were similarly
indexed to Bank rate but at a higher level. Though there were exceptions to these
rules, changes in Bank rate were immediately reflected in a broad range of British
interest rates.
An increase in Bank rate, by raising the general level of British interest rates,
induced foreign investors to accumulate additional funds in London and to delay
the repatriation or transfer of existing balances to other centers. British balances
abroad were repatriated to earn the higher rate of return. Drawings of finance bills,
which represented half of total bills in 1913, were similarly sensitive to changes in
interest rates. Higher interest rates spread to the security market and delayed the
flotation of new issues for overseas borrowers. In this way the Bank of England
was able to insulate its gold reserve from disturbances in the external accounts....
But why did the Bank of England’s exceptional leverage not threaten
convertibility abroad? The answer commonly offered is that Britain’s unrivaled
market power led to a de facto harmonization of national policies.... As Keynes
wrote in the Treatise on Money, “During the latter half of the nineteenth century
the influence of London on credit conditions throughout the world was so
predominant that the Bank of England could almost have claimed to be the conductor
of the international orchestra.”