Following the Great Depression, the world witnessed for the second time the interaction between the international monetary regime and trading system, which occurred between 1869 and 1913. This previous interaction was a very positive one, portrayed by the gold standard system, which linked nations for decades through a the agreement of certain exchange rates. This pre-World War I system allowed the free movement of capital and goods, but also facilitated and promoted the growth of trade. Lopez-Cordova and Meissner (2003) argue that about 1/5 of the growth in trade between 1880 and 1910 is due to the security provided by the gold standard, as well as the low trade barriers that were in place over this period. (Estevadeordal, Frantz, and Taylor (2003))The gold standard system was put to the side during World War I, as all the nations taking part into the war, started placing barriers to slow gold exports as much as possible. By 1915, all but the United States, had shortened the link between gold and their central bank currency. By the end of the end of the war, the gold standard was reintroduced as the gold-exchange standard, it relied mainly on the use of foreign exchange reserves; at a time where the sterling was no longer the economic leader it was before the war, and where the dollar was not ready to become the leader it will become. The Gold convertibility was resumed bit-by-bit, with countries restoring it from the middle to the end of the 1920s; it is Austria and Germany who restored the system the fastest, only months after the end of the hyperinflation which lasted until 1923. By the end of the decade, the fundamentals of this prewar monetary system where back in use.With the restoration of the monetary system, many thought it would go back to the stability they had known before. As a result of this, trade policies were liberalized, with tariffs resembling the ones before World War I; The 1920s also saw a proliferation of bilateral commercial agreements. No one could predict the Great Depression, no even the League of Nations who met during the World Economic Conference of 1927 in order to prepare the end of war time trade restrictions. The gold exchange system was unfortunately quite weak to the prewar system, this was due to the fact gold was not reevaluated from the prewar levels, as well as an uneven distribution, where nations like France and the United States owned over 60% of the gold reserves. To face this issue, nations were encouraged to use foreign exchange reserves, which made the system more fragile then ever. Finally this system was is trouble as it had integrated countries in crisis to be part of gold parities, bringing with them crippled economies, war debts and reparations.For all of these reasons, the gold standard was violently destroyed, as soon as the recession began in 1928-29. The reasons for this sudden destruction are still uncertain, but some debate it was mainly due to the French. Indeed, France took two major decisions in the year 1928: they de jure reevaluated their currency at depreciated rates, and decided to convert their foreign exchange reserves all at once into gold (since the 2008 crisis, this dumping method is illegal). (Hamilton 1987, Eichengreen 1992, Johnson 1997)
These decisions added to an unstable system, drained the world’s reserves in gold, destroying the liberal economic world, forcing countries into protectionist systems. There were three reactions to this crisis: a few countries decided to stick to the gold standard, hoping that price deflation combined with readjusted wages would be enough to recreate an economic balance. The second reaction some countries had, was to put up barriers to control capital outflows, putting a leach on their gold and foreign exchange reserves. Finally countries with the most fragile economies, simply got out of the gold standard system, letting their currencies devaluate in order to pursue more expansionary financial policies. In comparison to the 2008 crisis, no interstate coordination was seen, pushing the idea of a resolution further than ever. It took up to 1936 for nations to quit one after the other the gold standard, finally allowing their gold reserves ratio to readjust. During this slow process, the lack of coordination created difficulties for both groups of countries, which later led to a long period where trade and finance was approached in an ‘orthodox’ manner; with restriction on imports, regulations of foreign transactions and a proliferation of trade tariffs and interest rates. The Great Depression of 1929, not only was the biggest financial crisis our modern society lived, it also destroyed a system which took years to rise through liberal policies in monetary, commercial and political spheres. By the end of the 1930s, a majority of the prewar leading economies became protectionist economies, getting rid of the expansionist system that had been in place for decades.