Global Monetary Systems: Then and Now; Last Month We Talked about How the Evolution of the Gold Standard Led to Global Growth. This Month We Will Discuss How the Conflicts of the 20th Century Altered the World's Monetary Systems and Look at What May Come Next

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World War I--the war to end all wars--changed the map of humankind forever. Battle and famine claimed 15 million lives. Empires and dynasties imploded into multiple states throughout eastern and central Europe. A pact between France and Britain carved up the last unclaimed dominion of the crumbled Ottoman Empire, creating the mandates of Syria, Lebanon, Iraq and Palestine.

But the peace that ensued after the Treaty of Versailles in 1919 could not mend the world's monetary system--the gold standard. Evolving organically through three centuries, by 1890 it shouldered the whole of European and American commerce. When European nations suspended gold convertibility at war's outbreak to finance their massive military campaigns, it collapsed.

At war's end, Great Britain, previously the world's largest overseas investor, was one of its biggest debtors with interest payments devouring 40% of all government spending. Tsarist Russia, formerly a magnet for foreign investment, experienced a flight of capital as the Bolsheviks seized control of industry, agriculture, banking and foreign trade. France and Belgium, devastated from the German land invasion, became hoarders of bullion. Forced to pay reparations, Germany saw its coffers drained of gold and its land emptied of coal and steel. Hyperinflation, unknown on the continent in the preceding century, ravaged the economies of Russia, Austria, Hungary, Poland, Bulgaria and Germany.

Against this backdrop, the restoration of the gold standard and the fixed-rate currency system was a tenet common to political and social doctrines of the new Europe. Lenin's communist Russia was the first country to stabilize to gold in 1923. Mussolini waged a nationalistic battle--Quota Novanta--vowing to restore the weakened Italian lira to the prewar level of 90 against the British pound, which was itself fixed to gold in 1924. In an opposite move, France devalued its currency by 80% to gain an export advantage. Reasserting its supremacy, Britain fixed the pound at the pre-war level and quickly saw a 12% surge in unemployment, which had held steady at 3% for 70 years.

Previously considered a purely economic institution, an unstable world discovered that a single money standard was also a social mechanism, underpinning the welfare of swaths of agriculturalists and workers.

Once currencies were refixed to gold, they came under speculative attacks and government intervention. Also common were bank panics: a bank failure in Austria in 1931 ignited a wave of bank runs across the financial world in which depositors demanded gold. That same year, Britain left gold and devalued the pound, creating a de facto sterling currency zone for nearly half the world. Eight years earlier the British economist John Maynard Keynes had damned the gold standard for its stringency.

In a review of the interwar period, Fed Chairman Ben Bernanke describes the impossibility of reconciling the two opposing trends that eventually tore the gold standard apart: "central banks could do little in the face of combined banking and exchange-rate crises, as the former seemed to demand easy money policies while the latter required monetary tightening."

In the late 1920s, when the U.S. Federal Reserve countered inflation with monetary contraction, it triggered a worldwide depression. Concurrently, surging nationalism and protectionism strangled trade and prevented a coherent monetary system from revitalizing, leaving each country to defend its currency on a managed or "dirty float" scheme. Much to American and European consternation, Germany conducted trade through bi-lateral barter arrangements with the nearby Balkan states and across the Atlantic with Brazil and Argentina, noted Murray Rothbard in, The History of Money and Banking in the United States. The opaque transactions bypassed the banking system altogether and effectively blocked American goods from reaching Germany and its trading partners. …