World War II


Hitler at the Reichstag


The gold standard had been destroyed in World War I.  The world political authorities replaced it with a “grotesque caricature” — the gold-exchange standard.  This tragically spiraled into the great depression, devolving to the rise of Hitler and world war.

Had the price of gold been raised in the late 1920's, or, alternatively, had the major central banks pursued policies of price stability instead of adhering to the gold standard, there would have been no Great Depression, no Nazi revolution and no World War II.  …

World War II brought a repetition of the monetary imbalances of World War I. The devaluation of the dollar and gathering war clouds in Europe made the dollar a safe haven and the recipient of gold to pay for war goods. The United States sterilized the gold imports and imposed price controls. It was therefore able to run deficits without going off gold. Because gold was still "overvalued" in this era of "dollar shortage," interest rates remained incredibly low. By 1945, the public debt had soared to 125 percent of GDP.”


In Robert Skidelsky’s definitive three volume biography of Keynes, Volume 3 Fighting for Freedom 1937-1946 (Viking, 2000, p. 67) observes:

“No appraisal of Keynes’s political legacy can leave out How to Pay for the War.  (For its economic legacy, see pp. 87-90, below.)  After the war ended, Lionel Robbins wrote that there were two views about how to run a war economy—the fiscal theory and the planning theory.  According to the fiscal theory the government should withdraw as much purchasing power as was necessary to avoid inflation, and allow the price system to allocate resources.  By contrast, the planning theory fixes wages and prices, with the government commanding resources and allocating them between the armed forces, productive instruments and final goods according to the strategic plan.   Both theories agree that in war civilian consumption should be residual; the crucial disagreement is over the role that the price system may play in allocating resources.  Robbins, a Hayekian in peacetime, argued that “for the conduct of small wars” the fiscal recipe might be adequate, but for modern “total” war, where rapidity of response to war demands was of the essence, there was no alternative to “totalitarianism”.

“Since Keynes is so often unthinkingly placed in the dirigiste camp, it is important to insist that he favored the fiscal theory of war control.  More importantly, he invented the fiscal theory, precisely in order to avoid “totalitarian” planning.  He did not see demand management as a useful adjunct to planning, price fixing, rationing, bureaucratic controls and so on, but as an alternative to them, in war as in peace.  In the first World War he had quipped: “If we put prices low enough and wages high enough, we could achieve the most magnificent queues even in peacetime; there never has been anything like enough caviar to go around.”  This position proved increasingly difficult to maintain after the fall of France in June 1940.  “As the war developed the need for central allocation of resources increased progressively.”  Nor did Keynes’s approach necessarily fit the popular mood.  The issue here is not whether he was right or wrong, but the spirit in which he approached wartime problems.  Harrod and Moggridge failed to bring out the liberal presuppositions underlying his plan, especially his belief that prices were the essential element of freedom in the economic system, however restricted their scope might have to be.  After a long search Keynes had found his own point of equilibrium between individualism and collectivism and he held fast to it.

“Keynes fiscal theory was an alternative to inflation as well as to physical planning.  Indeed, he believed that the first would inevitably lead to the second.  What he called “totalitarianism” was an inevitable outcome of failing to control inflation in a modern economy—a conclusion strikingly similar to that of Hayek in his Road to Serfdom published in 1944.

“A case can be made out for How to Pay for the War as the quintessence of Keynes’s achievement.”

The liberal democracies triumphed over National Socialism, fascism, and military dictatorship. The American-led victory in World War II set the stage for another confrontation between liberal democracies and totalitarians, now presenting as international socialism: the Cold War. It also led to a fateful international monetary conference at a New Hampshire resort in July 1944 adopting the unstable gold-exchange standard: Bretton Woods.

Next: Bretton Woods

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