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href="#ulink_81e03868-ed41-59e0-869a-2c7ed3546dc0">¹⁴ Understandably, the Americans were reluctant to take a write-down on their loans to the Allies and Woodrow Wilson dismissed Keynes’ proposal, insisting that reparations and war debts be treated as two separate matters.

      Reparations and war debt, however, were not the greatest villains in the cast that Keynes held responsible for the global economic ills of the interwar period. The leading role, as his thinking developed through the 1920s, was reserved for gold.

The expansion of global trade during the 19^th century had been underpinned by the fixing of the value of currencies against gold. Issuers of currency on the so-called gold standard committed themselves to holding reserves of physical gold against the paper money that they issued. This provided an assurance that the issuer would not erode the value of its currency by simply printing more notes. Expansion of the money supply, therefore, was restricted by the pace of new gold discoveries, which were relatively infrequent.¹⁵

Of course, in periods of distress such as times of war, governments can be tempted to expand the money supply by way of the printing presses in order to meet their obligations. Britain had last done this during the French Revolutionary War in 1797, when the threat of invasion had led to mass withdrawals of gold from the Bank of England. However, in the years 1815–1821, following Napoleon's defeat at Waterloo, the Bank had withdrawn around half the paper money in circulation, driving prices down by 50 percent, and restored the gold standard. Though those six years had witnessed riots and economic distress, Britain's monetary discipline was seen as having set sterling apart from all other currencies in Europe. This in turn was credited for the country's emergence as the world's leading economic power over the half-century that followed.¹⁶ As trade surpluses from Britain's lead in manufacturing exports generated excess capital searching for investments, London emerged from the 19^th century as the banker to the world and sterling the pre-eminent global currency.

During the four years of WW1, European governments had incurred total war spending of around $200 billion, or roughly half of their aggregate GDP. In addition to borrowing from their own citizens and from overseas, they had raised taxes and printed more money. By the end of the war, the money supply in Britain had doubled, in France it had tripled, and in Germany it had quadrupled.¹⁷ In the early 1920s, in the face of social and fiscal pressures, Germany resorted to uncontrolled money printing, leading to massive hyperinflation that decimated the value of middle-class savings. Britain, still vested with the pride of a great imperial power, chose the opposite route and sought to restore the value of sterling to the pre-war level.

Before WW1, the British pound's exchange rate to the US dollar, fixed by the gold standard, had been $4.86. Having untethered itself from gold during the war, sterling's exchange rate had fallen to as low as $3.20. In 1920–1921, the Bank of England, led by its conservative governor Montagu Norman, chose to deflate the economy via high interest rates in order to reverse wartime inflation. Prices fell by 50 percent from their wartime highs and the pound recovered to $4.35 by the autumn of 1924. However, while the country rebounded from a recession in 1921, growth remained muted and the exchange rate struggled to recover to the 1914 level.¹⁸

Keynes, back in Cambridge after the war and having acquired celebrity status on account of the success of The Economic Consequences, became a prolific columnist writing on economic issues. He also dabbled in speculation on currencies and commodity prices. While the rest of the country was struggling with unemployment rates of around 10 percent in 1923, these pursuits provided him with a handsome living. The main target of his writings was the Bank of England and its stubborn quest to restore the old dollar parity. He argued eloquently and with acerbic wit that the Bank was mistaken in its belief that wages were sufficiently flexible to adjust as rapidly as prices, and that the short-term pain caused by its policies was bringing Britain to the ‘verge of revolution’.¹⁹

      Notwithstanding Maynard Keynes’ impassioned assault on gold, the Conservative Party's victory in the 1924 general election heightened expectations of a return to the gold standard. Winston Churchill, who had roamed the political wilderness since spearheading the Gallipoli debacle in 1915, was surprised to find himself appointed Chancellor of the Exchequer in Stanley Baldwin's government. This meant that the decision about sterling's link to gold fell to him. While no intellectual laggard, Churchill never mastered the details of monetary policy and relied on advice from experts in the field. Although Keynes was among those whom he consulted, the establishment orthodoxy prevailed. In his budget of April 1925, Churchill announced Britain's return to the gold standard at the pre-war rate. This soon proved to be a mistake that he came to regret.

At the level at which it was fixed to gold, sterling was significantly overvalued, making Britain's exports uncompetitive. France, on the other hand, returned to the gold standard in 1928 at one-fifth of the 1914 parity, significantly undervaluing the franc and thereby making French exports far more attractive.²⁰ As a consequence, capital flooded into France with its undervalued currency and into the US, which was experiencing a stock market boom, while uncompetitive British industry was starved of investment.

In a series of articles, pamphlets and books written and published between 1923 and 1936, Keynes launched an intellectual attack on the classical economic orthodoxy and its reliance on gold, which he called a ‘barbarous relic’. These works addressed not just monetary policy, but its relationship with employment, prices and trade. His theories were to form an intellectual basis for economic policies that predominated in the West in the post-war years up until the 1970s.

      He argued that gold as a foundation for the monetary system had only worked during the 19^th century because new mining discoveries had fortuitously kept pace with economic growth. The operation of monetary policy to avoid the loss of gold reserves, as was the prevailing practice, entailed raising interest rates at times of economic weakness, which served to raise savings and exacerbate falling consumer demand, further compounding falling profits. Given the fluctuating pace of economic growth and variances between different trading partners, he believed that central banks were much better positioned to manage a country's monetary affairs without gold as a reference. This is, in fact, the system commonly followed today with floating fiat currencies, but was a revolutionary concept at the time.

      Keynes also explained that inflation and deflation, more than just a rise and fall in prices, were a means of wealth transfer between different groups and social classes within society. Classical economic theory held that, in a free market, wages would naturally adjust to a level at which there would be full employment. Keynes debunked this theory and showed that there was no natural tendency for full employment. For structural and even psychological reasons, wages do not necessarily adjust in line with falls in prices and profits. Further, since falling wages themselves removed economic demand, deflation could actually worsen unemployment. This meant that high unemployment could persist indefinitely unless governments intervened to boost consumption demand. Crucially, he argued that such government spending would have a ‘multiplier’ effect, since it would stimulate other economic activity. This therefore justified governments’ use of deficit spending at times of rising unemployment as a means of ‘pump priming’ the economy to induce a return to growth.

Citing his famous remark that ‘In the long run, we are all dead’,²¹ critics of Keynesian economic theory have often accused him of advocating policy short-termism and irresponsible government spending that would lead to ever rising deficits. This is inaccurate, as Keynes actually believed strongly in balanced budgets over an economic cycle. However, governments have tended to lack the political will or discipline to rein in their budgets in the good times.

There

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