Monetary Hegemony - British Monetary Hegemony

British Monetary Hegemony

Great Britain rose to the status of monetary hegemon in 1871 with widespread adoption of the gold standard. During the gold standard of the late nineteenth century, Britain became the greatest exporter of financial capital. Its capital city, London, also became center of the world gold, money, and financial markets. This was a major reason for states adopting the gold standard. In order for Paris, Berlin, and other financial centers to attract the lucrative financial business from London, it was necessary to emulate Britain’s gold standard, for it reduced transaction costs, represented creditworthiness, and sound financial policy from government (Schwartz, 1996). The city of London was the leading supplier of both short term and long term credit, which was channeled abroad. Its extensive financial facilities provided cheap credit, which enhanced the strength of the pound through deepening its use for international payments. According to Walter (1991), during the decades of 1870-1913, “sterling bills and short-term credits financed perhaps 60 percent of world trade” (p. 88).

Britain’s foreign investment cultivated foreign economies for the use of sterling. In 1850, Britain’s net overseas assets grew from 7 percent of the stock of net national wealth to 14 percent in 1870, and to around 32 percent in 1913 (Edelstein, 1994). The world had never before seen one nation committing so much of its national income and savings to foreign investment. Britain’s foreign lending practices possessed two technical aspects that gave greater credence to the prominence of sterling as a unit of storage and medium of exchange: first, British loans to foreigners were made in sterling, which allowed the borrowing country to service the debt more conveniently with its sterling reserves, and second, Britain’s use of written instructions to pay or bill exchanges were drawn in London to finance international trade

More importantly, its unrivalled ability to run current account deficits through the issuance of its unquestioned currency and its discount rate endowed Britain with a special privilege. The effects of the discount rate had a “controlling influence on Britain’s balance of payments regardless of what other central banks were doing” (Cleveland, 1976, p. 17). When other central banks engaged in a tug of war over international capital flows, “the Bank of England could tug the hardest” (Eichengreen, 1985, p. 6). In this regard, British monetary hegemony was seldom threatened by crises of convertibility for its gold reserves were insulated by the discount rate and all foreign rates followed the British rate. The prominence of London’s credit drains led Keynes (1930) to write that the sway 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” (p. 306-307). Karl Polanyi in his renowned work the Great Transformation states “Pax Britannica held its sway sometimes by the ominous poise of heavy ship’s cannon, but more frequently it prevailed by the timely pull of a thread in the international monetary network” (Polanyi, 1944, p. 24).

Britain’s position waned due to inter-state competition, insufficient domestic investment, and World War I. Despite its economic weaknesses, British political sway continued after World War I, which led to the gold-exchange standard created under the Genoa Conference of 1922. This system failed, however, not only due to Britain’s incapability, but to the growing decentralization of the international monetary system with the rise of New York and Paris as financial centers that resulted in the collapse of the gold exchange standard in 1931. The Gold Exchange standard of the interwar period, as Kindleberger cogently stated, collapsed because "Britain couldn't and America wouldn't." In fact, Kindleberger provides a slightly different variation of monetary hegemony that possesses five functions rather than three defined here.