4. Phase IV: Fluctuating Fiat Currencies, 1931-1945

The world was now back to the monetary chaos of World War I, except that now there seemed to be little hope for a restoration of gold. The international economic order had disintegrated into the chaos clean and dirty floating exchange rates, competing devaluations, exchange controls, and trade barriers; international economic and monetary warfare raged between currencies and currency blocs. International trade and investment came to a virtual standstill; and trade was conducted through barter agreements conducted by governments competing and conflicting with one another. Secretary of State Cordell Hull repeatedly pointed out that these monetary and economic conflicts of the 1930s were the major cause of World War II.3

The United States remained on the gold standard for two years, and then, in 1933-34, went off the classical gold standard in a vain attempt to get out of the depression. American citizens could no longer redeem dollars in gold, and were even prohibited from owning any gold, either here or abroad. But the United States remained, after 1934, on a peculiar new form of gold standard, in which the dollar, now redefined to 1/35 of a gold ounce, was redeemable in gold to foreign governments and central banks. A lingering tie to gold remained. Furthermore, the monetary chaos in Europe led to gold flowing into the only relatively safe monetary haven, the United States.

The chaos and the unbridled economic warfare of the 1930s points up an important lesson: the grievous political flaw (apart from the economic problems) in the Milton Friedman-Chicago School monetary scheme for freely-fluctuating fiat currencies. For what the Friedmanites would do—in the name of the free market—is to cut all ties to gold completely, leave the absolute control of each national currency in the hands of its central government issuing fiat paper as legal tender—and then advise each government to allow its currency to fluctuate freely with respect to all other fiat currencies, as well as to refrain from inflating its currency too outrageously. The grave political flaw is to hand total control of the money supply to the nation-state, and then to hope and expect that the state will refrain from using that power. And since power always tends to be used, including the power to counterfeit legally, the naivete, as well as the statist nature, of this type of program should be starkly evident. And so, the disastrous experience of Phase IV, the 1930s world of fiat paper and economic warfare, led the U.S. authorities to adopt as their major economic war aim of World War II the restoration of a viable international monetary order, an order on which could be built a renaissance of world trade and the fruits of the international division of labor.

• 3Cordell Hull, Memoirs (New York, 1948) p. 81. Also see Richard N. Gardner, Sterling-Dollar Conspiracy (Oxford: Clarendon Press, 1956) p. 141.