Australia’s Gold Standard Blunder Has Striking Parallels With the United States

From the center of the continental United States to the middle of Australia is 9,241 miles. It’s a little further from London to Sydney—about 10,572 miles. But in economic matters—the laws of economics being both immutable and universal—the distances between the world’s cities and countries are far smaller.

I was recently reminded of this fact while researching the economic history of the Land Down Under. Curious to find out if Australia’s move away from a gold standard bore any similarities to events in the US and the UK, I discovered that the parallels are striking.

The United States and the United Kingdom (indeed, most of the world) began the 20th Century with currencies tied to the yellow metal. In the U.S., the dollar was “as good as gold”—defined as approximately 1/20 of an ounce. (The United States government steadfastly honored its commitment to redeem dollars for gold at $20.67 per ounce.)

Sir Isaac Newton, as head of the Mint, established the official ratio of gold to the British pound in 1717. An ounce of gold equated to £4.25. Except for the years of the Napoleonic Wars, that rate remained virtually unchanged until 1914. Prices of goods and services were stable, and citizens had to learn about “inflation” from history books. The Industrial Revolution of the 18th and 19th Centuries, which yielded the greatest improvement in living standards in world history, was essentially financed by sound, metallic money.

Australia became a nation on January 1, 1901, when six British colonies—New South Wales, Victoria, Queensland, Western Australia, South Australia, and Tasmania—unified to form a Commonwealth. For nearly a decade, each former colony circulated its own money (both gold coin and gold-backed paper). A remarkably stable arrangement, the different currencies traded against each other at par (one for one). Then in 1910, the Parliament created a single national currency, the Australian dollar, and pegged it to the British pound, which effectively tied Aussie money to gold.

So far, so good. Then came, in the summer of 1914, the calamity of the First World War. Government expenditures soared and while taxes and borrowing did as well, both Britain and Australia suspended the redemption of their paper currencies into gold so they could print lots of paper money. A late entrant into the conflict (in 1917), the US did not go that far but it did make gold exports nearly impossible.

Peter Yule in the International Encyclopedia of the First World War writes,

The Australian government decided in August 1914 to pay for the war primarily by printing money and borrowing rather than increasing taxation…The expenditure on the war was vastly greater than any previous object of government expenditure in Australian history, with the sole exception of railway construction.

Reflecting huge increases in the paper money supply, prices in all three nations took off during the war. In Britain, for example, the rate of price inflation in 1914 was zero. By 1917, prices were rising at an annual rate exceeding 25 percent. The government of Australia quadrupled the quantity of paper notes, yielding a 50 percent hike in the price level there by war’s end. Inflation in America jumped by 18 percent in 1918 alone.

Let’s pause to note that governments everywhere finance their spending primarily by taxing, borrowing, and printing. Toss in a few pennies here and there from asset sales and user fees and that’s pretty much it. Raising taxes is painful and sometimes politically difficult. Borrowing by issuing debt instruments such as bonds simply requires tax money later (for both principal and interest).

Printing money is a tax too—people pay for it in higher prices—but politicians can get off the hook by blaming shopkeepers for that. Bottom line: Inflation doesn’t make war any cheaper, it simply pays for it in a way that’s less direct than taxing and borrowing. And it brings with it a host of other problems, such as booms and busts and the erosion of savings.

Governments don’t like gold because they can’t print it is a truism worth canonizing in the Book of Proverbs. When a nation is on a gold standard, the adulteration or abandonment of it is an ever-present danger as governments go to war, engage in deficit spending, create central banking cartels, and otherwise scheme to debase the currency for short-term political and economic advantage.

After the inflation of World War I, Britain under Chancellor of the Exchequer Winston Churchill attempted to restore a gold standard at the pre-War rate—essentially pretending it hadn’t printed a deluge of paper pounds. Australia mimicked British policy by maintaining its currency’s peg to the pound. As I explained in detail in “Winston Churchill’s Gold Standard Folly,” this was an unsustainable blunder. Australia abandoned the gold standard just six years later (in 1929), and Britain ditched it in 1931. Franklin Roosevelt…