By: Nathan Lewis
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The Devaluation of the British Pound, September 21, 1931

May 22, 2016

Today, we are making use of a new weekly dataset just released by the Bank of England. It is here:

I thought I'd use it to get an idea of what was going on when the British pound was devalued on September 21, 1931.

The British pound was the leading international currency and reserve currency at the time. Its devaluation was a shock that led directly to many echo devaluations worldwide. By the end of 1931, 23 countries had left the gold standard.

The vertical line of course represents the devaluation. We see a drop in gold a little before, which is related to a big rise in government securities. I would have to look at some history to get an idea of what's going on here. It looks like either a) the BOE was fooling around with an "activist" monetary expansion, or b) there was a big gold redemption, which was intentionally "sterilized," so that the monetary base would not change. Both are pretty scary, and definitely NOT what the BOE should have been doing -- although, other central banks were doing similar things around that time, including the Federal Reserve in 1932. Definitely not confidence-inspiring. It may have been related to a desire to hold down short-term interest rates, which were already pretty high, probably reflecting fears of devaluation.

Nevertheless, the BOE certainly had plenty of gold. It was not suffering chronic "outflows" except for that one decline. However, the flatlining of gold before the devaluation suggests that gold conversion was being quietly blocked, before the official end of gold convertibility. That would probably induce a little panic among those who knew.

The rise in government securities/sudden gold outflow does not correspond with the cut in the discount rate, which was actually in May. It actually corresponds to the rise in the discount rate, in July. Oddly enough, this does not correspond with the Credit Anstalt bankruptcy, which was 11 May 1931. It might have been related to capital controls in Germany. I would have to look at the history more closely to figure out why things got so serious in July 1931.

Here we have a look at the monetary base and its composition. We see a rise in the monetary base from around the beginning of 1931. Nothing wrong with this in itself. However, if the pound's value was weak and "defense of the pound" was a priority, then there should have been some meaningful reduction in the monetary base. There certainly seems to be no attempt whatsoever to support the value of the pound via monetary base reduction before the day of the devaluation. On the contrary, base money was steadily rising. This corresponds to the historical narrative, which was that any base money contraction was avoided on the grounds that it would send the already-high short-term rates/discount rate still higher. The Keynesian "low interest rates" notion was getting the upper hand, in people's minds, over the "stable value" basis of the gold standard.

Here is the Bank's discount rate. The discount rate was rather notoriously not raised from its level of 4.5% before the devaluation. However, it was raised to 6% literally the day after. Discounts were a big part of the BOE's operation before 1913, but by this time, they were obviously overshadowed by "open market operations" in government bonds, which were then a much larger portion of total assets.

This is just a preliminary look. However, it looks pretty clear to me that the BoE didn't take any appropriate action to support the pound, via a reduction in the monetary base, probably because they were afraid that it would lead to higher short-term rates and a higher discount rate, perceived as being bad for the economy. However, the high rates (compared to the U.S. for example) themselves reflected a (justified) fear of devaluation.

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