When Winston Churchill was appointed Chancellor in November 1924, he reportedly mistook his role for the largely ceremonial position of Chancellor of the Duchy of Lancaster. His astonishment was palpable—not just at the title but at the reality of his new job, which was, in fact, Chancellor of the Exchequer, the second most significant position in the British government. “I was surprised,” Churchill noted, “and the Conservative Party was dumbfounded.”
The ensuing controversy during Churchill’s tenure has significant implications for contemporary policy discussions. Central to these debates are macroeconomics and exchange rates: their influence on trade and development, the merits of fixed versus floating rates, and the dilemmas these choices pose for policymakers. The immediate fallout from Churchill’s decisions culminated in the General Strike of 1926, a conflict whose reverberations still resonate today.
Churchill inherited a daunting challenge: reinstating Britain to the gold standard at pre-World War I levels. In 1914, the British pound was pegged to gold at £4.25 per ounce, which translated to an exchange rate of £1 for $4.87. With the onset of war, Britain, like many nations, suspended convertibility to protect its gold reserves and financed its efforts by issuing currency. This led to a decline in metallic reserves as a proportion of banknotes and deposits—from 40% in 1914 to 33% by 1918.
The Cunliffe Committee’s 1918 recommendation to restore convertibility highlighted a mismatch between currency and reserves, raising fears of a run on the pound as holders sought to exchange it for gold. In an effort to stabilize the situation, Britain’s postwar governments aimed for balance of payments surpluses and implemented tight monetary policies with elevated interest rates, which also reduced the amount of currency in circulation. This strategy lifted the pound from a low of £1 for $3.38 in February 1920 to £1 for $4.78 by March 1925.
Despite his reservations about returning to the gold standard at pre-war rates, Churchill felt outmatched by Montagu Norman, the assertive Governor of the Bank of England, who championed the policy to uphold London’s status as a financial hub. “If [economists] were soldiers or generals, I would understand them,” Churchill lamented. “As it is, they all talk Persian.”
Churchill hoped that John Maynard Keynes, a prominent public intellectual since the publication of The Economic Consequences of the Peace in 1919, would offer a solution. In 1925, Keynes released a pamphlet titled The Economic Consequences of Mr. Churchill, arguing that Britain’s high unemployment rate stemmed from inflated export prices in international markets. He pointed out that “the value of sterling money abroad has been raised by 10 percent, whilst its purchasing power over British labor remains unchanged.”
Keynes illustrated that an American purchasing a product priced at £1 would need to pay $4.33 before the pound’s value was raised to $4.78, effectively putting British goods out of reach for foreign buyers. He argued that the country would have to accept “10 percent less in our money” ($4.33 or 90 pence), which squeezed profits into losses and contributed to the ensuing economic downturn.
“About this there is no difference of opinion,” Keynes asserted, and he was right. The consensus was clear: excessive wages in exporting industries, particularly coal, were the primary issue. The divergence emerged in the proposed solutions; while Norman and others advocated for nominal wage cuts and a decrease in the domestic price level—essentially an internal devaluation—Keynes believed that such an approach was impractical and would lead to widespread suffering.
Keynes maintained that internal devaluation would necessitate a “struggle with each group in turn,” resulting in hardship for those targeted first. He posited that “those who are attacked first are faced with a depression of their standard of living… and therefore they are justified in defending themselves.” His remedy was an external devaluation, suggesting a drop in the value of sterling or the exchange rate to restore competitiveness, ideally back to £1 for $4.33.
Norman, who famously described Keynes as “always absolutely charming, always absolutely wrong,” ultimately prevailed. In April 1925, Churchill, in a defensive address, announced Britain’s return to the gold standard at the pre-war parity.
Yet, in this instance, Keynes’ insights proved prescient. As British prices soared in foreign currency terms, coal exports plummeted, profits evaporated, and mine owners resorted to wage cuts, prompting fierce union opposition. Keynes observed that the miners were being asked to make sacrifices to remedy a situation beyond their control. The government deferred action by establishing a commission and enacting a temporary subsidy, but when the commission reported in March 1926, it recommended wage cuts, triggering the historic General Strike in May, which remains the most significant industrial unrest in British history.
The debates surrounding the gold standard under Churchill would resurface in later years. Milton Friedman advocated for floating exchange rates for reasons akin to those of Keynes, which also aligned with Margaret Thatcher’s resistance to Britain’s adoption of the European single currency. The arguments of Keynes and Friedman echoed again during the eurozone’s debt crisis from 2010 to 2013, where the preference for external adjustments of exchange rates over internal price corrections became increasingly evident.
An exchange rate essentially reflects the price of one currency in terms of another, and attempts to fix this price have proven just as ineffective as trying to set the price of any other commodity.
In his memoirs, Churchill’s private secretary, Sir James Grigg, remarked that “Winston has almost come to believe it, that the decision to go back to gold was the greatest mistake of his life.” While Churchill certainly faced stiff competition for the title of history’s greatest blunder, he may have been onto something after all.
