Gold Standard payments through London look awfully like US Dollar clearing a century later...
GOLD loves nothing if not irony, writes Adrian Ash at BullionVault.
And here, 100 years to the day after the approach of World War I killed the Gold Standard stone dead, the world's monetary system risks breakdown again.
Again you could blame war in a poor corner of Europe. Again, that war could be cast as a big power demanding a small neighbor says "sorry" – then Serbia for the murder of a fat-necked Austrian prince, now Ukraine for ousting its fat-headed Moscow-backed president.
If irony suits, it only tastes richer when you think this week also marks 70 years since the Gold Standard's replacement was put together as the war that followed the war to end all wars finally slaughtered itself to a close. But that shadow system...of invisible gold and all-too visible paper...didn't quite die when the Dollar-Exchange system lost its link to bullion. US president Richard Nixon "closed the gold window" at the New York Fed in August 1971, yet the Dollar still rules today. So like world trade needed access to the City of London a century ago, clearing funds through a US bank is vital for world trade today.
Say US clearing becomes unavailable – or untrusted for credit-default or political reasons. Either trade will shut down (see the post-Lehmans' crisis of 2008), or it will find other systems to use. Comic little pops like bitcoin might suggest that's where apolitical free trade is headed, onto Silk Road and elsewhere.
Back to 1914, and "It may be," one merchant banker noted before the July Crisis hit London, "that hides and rabbit skins are being sold from Australia to New York, or coffee from Brazil to Hamburg." Either way, and whatever was being shipped to wherever, in every such cross-border deal "the buyers and sellers settle up their transaction in London."
That remains true of wholesale gold and silver today. Lacking any mine production, and with no consumer demand or refinery output to speak of, the UK still hosts the world's physical bullion market, settled in London's specialist vaults and ready for "digging out" onto a forklift truck before being shipped to the new owner should they ever want it. From Arizona to Beijing, Perth to Qatar, the world trades market-warranted London Good Delivery bars. Those same standards apply in most local non-London markets as well. Great Britain still rules in gold, an echo of the high classical Gold Standard shot dead a century ago.
Europe's second 30-year war destroyed Britain's empire, but London's role as the centre of money was already ruined. US banks moved into the rubble to settle the world's business, and the US Dollar took over from Sterling as Washington hoarded central-bank gold to win the peace as well as the war at that Bretton Woods conference of July 1944.
What had stopped the world's financial heart pumping in London? Scalded in late June 1914 by unknown Serb teenager Gavrilo Princip shooting dead the unlikable Archduke Franz Ferdinand, Austria handed its "belligerent ultimatum" to Belgrade on the evening of Thursday 23 July. Vienna's 10 outrageous demands made rejection look certain. (Serbia agreed to four, only to find Vienna dismiss its reply and start shelling regardless). Financial markets finally panicked the next morning, at last. They had been slow to take fright, as Niall Ferguson notes of the bond market, distracted by more trouble in Ireland and the coming summer vacation. But now London's bankers...creditors to half the world's cross-border transactions, according to Jamie Martin in the London Review of Books...awoke to find their debtors unable to pay. Because "it suddenly became difficult for foreign borrowers to remit payments" anywhere, London would not extend fresh credit. So the world couldn't raise the loans it needed to settle its debts, and the Sterling bill of exchange – "the world's premier financial instrument" – went entirely offline.
Sterling bills had been crucial. These bits of paper turned the Classical Gold Standard into that "period of unprecedented economic growth, with relatively free trade in goods, labor and capital" which misty-eyed gold bugs might think came thanks, between about 1880 and the rude end of July 1914, to physical metal alone. Promissory and transferable notes, typically with a 3-month maturity as Martin explains in the LRB, Sterling bills were accepted by traders on one side of the world in payment for goods sent to the other, and then sold to a local bank for cash. Merchant bankers in London then accepted and sold the bills on again, with the original debtor perhaps buying and sending another Sterling bill – rather than shipping physical gold – to settle the deal. Around it all went again. Until Austria's ultimatum to Serbia stopped it.
Yes, the Sterling standard limped on, and yes, so did something like the Classical Gold Standard after the guns of August finally fell silent in 1918. But private gold had underpinned the whole system before. You could convert cash into gold at your bank, giving them every reason to offer good rates of interest instead. A universal equivalent for all major world currencies, it was vital that the gold was mostly privately owned, rather than trapped in government or central-bank hands (although that was already changing, with fast-growing national hoards announcing the rise of the warfare- and welfare state in the decade before Princip shot the Archduke, much like the political earthquake of WWI had already struck Britain with the People's Budget five years before). But shipping bullion bars or coin remained clumsy, slow, risky, and thus expensive. So it was paper bills which released the value of the 19th century's torrent of gold, first Californian, then Australian and finally South African, to grease the first era of globalization.
By the eve of Austria's ultimatum to Serbia, the bill on London offered to some "a better currency than gold itself," as a Canadian banker put it, "more economical, more readily transmissible, more efficient." The City of London, capital of the world, stood ready to buy and sell whatever was wanted.
Nevermind. As Professor Richard Roberts explains in his excellent new Saving the City (free sample here), come 27 July – the Monday after the Serbs got Vienna's demands – London's money market was effectively shut. On Tuesday, with major shares like copper-mining giant Rio Tinto dumping 25% in a week, the London Stock Exchange suspended trade for the first time since it opened in 1801. From Wednesday 29 July, commercial banks in Britain stopped paying gold to the long queues of savers pulling out their deposits. But the banking run simply moved to the Bank of England itself, as people lined up on Threadneedle Street to swap the paper £5 notes they'd been given for Sovereign gold coins instead, sucking out £6 million of bullion in three days.
To stall the outflow, the annual Summer Bank Holiday was extended to nearly a week, from Saturday 1 to Friday 7 August. Ahead of the banks reopening, politicians desperate to lock down more gold for the national hoard "vociferously denounced the [private] hoarding of gold in speeches in the House of Commons," says Professor Roberts. But by then, Great Britain had already declared war on Germany on Tuesday the 4th. The Gold Standard would never recover, built as it was on free trade, Britain's imperial Navy and those Sterling bills of exchange on London's credit.
Yes, London's role as gold clearing house continues today (for now). But total war needed endless state spending. So the free-trade basics – and bullion limits – of the global Gold Standard could no longer apply. Private gold shipments were replaced by government-to-government transfers inside the Bank of England, the Bank for International Settlements, and the New York Fed...before French warships hauled metal to Paris, and Russian Aeroflot jets swapped Kremlin gold for Canadian wheat. London's Sterling bills have meantime long rotted as the world's key means of exchange. Which brings us to the US Dollar here in 2014.
French bank BNP Paribas now faces a $9 billion penalty "and a one-year suspension in 2015 of direct US Dollar clearing on its and gas, energy and commodity finance businesses," explains Pensions & Investments Online, after pleading guilty to $30 billion of transactions "with countries that are under US government sanction."
That's some slapdown. "Temporarily restricting its ability to handle transactions in Dollars," says Bloomberg, "would present BNP with administrative costs and could test the willingness of clients to remain with the bank."
Where else might those clients go? Forget the Yuan for the foreseeable future. The Dollar accounts for 41% of global payments by value, with the Euro at 32% and the British Pound in third place with 8%. The Chinese currency is way off the pace with just 1.5%. The Yuan accounts for only 23% of China's own direct trade with the rest of Asia!
Financing crooks or clearing their deals is a bad thing, of course. But the list of countries wearing "US goverrnment sanction" only gets longer. Parking or trading your money only gets tougher if your home-state doesn't suit what Washington thinks. Yes, a London government spokesman when asked Wednesday said there is a link – "a correlation" indeed – between the UK's new sanctions against Moscow and outflows from London of Russian oligarchs' cash. "That is certainly the case," as money scared of being frozen or seized gets out while there's still time. But London or Frankfurt today is nothing next to the United States' place in clearing global finance.
"No international bank," as the Financial Times noted last week, "can operate without access to the US money markets." And with access now restricted, claims FTfm columnist John Dizard, thanks to "dangerously stupid punitive actions and fines levied on banks using the international Dollar clearing system [means] the world is finding ways to get along without the Dollar."
Chief amongst them, according to Dizard's shadowy "sources", is gold – "the most expensive and least convenient of all monetary alternatives to the Dollar." Is he kidding? Perhaps not.
"Gold is very heavy to carry and often has to be re-assayed by the person accepting it as payment," Dizard goes on, "since there is often a lack of trust among participants in the off-the-books transactions that use it." No London Good Delivery and its chain of integrity here, in short. But where the rules roll over the trade, as India's surging gold smuggling proves, the trade will find a way if it must.
"Not many transactions or investments are actually invoiced in gold as such," says Dizard. "Instead gold is used as the settlement medium rather than for the price quotation."
So welcome to our neo-Classical Gold Standard. "Gold's popularity as a medium of international exchange," Dizard says, "has been soaring." The US might yet adapt, and accept that everyone pays who uses the Dollar, rather than inviting the world to find a replacement instead. Legal drug dealers in the United States, after all, need somewhere to bank their profits too.
Happy 100th birthday meantime to the death of gold money.