Last time we saw how the utopian project championed by economic liberals–the global “One Big Market” –was created by the forced commodification of land, labor and capital into factors of production, and the institutional separation of society into a totally separate economic sphere and political sphere. The economy was now “disembedded” — something wholly separate from the wider society and subject to its own “economic” laws, to be kept free from outside “interference.” A new class of professional economists came into being at this time, dedicated to uncovering the deterministic “laws” of the self-regulating marketplace that were as regular and predictable as the laws of physics.
In order to construct the global self-regulating market, economic liberals championed three core concepts after 1820. These were that:
- Labor should find its price on the market.
- The creation of money should be subject to an automatic mechanism.
- Goods should be free to flow from country to country without hindrance or preference.
These led to the following institutions:
- A competitive labor market
- The automatic gold standard
- International free trade.
Polanyi says that after 1830, the concept of market liberalism went from “academic interest” to “boundless activism.” One of these activities was the repeal of the Speenhamland system in England, a sort of Universal Basic Income scheme, and its replacement with the New Poor Law, which was expressly designed to force people into the labor market, designating horrible “workhouses” for those who could not find paid work. Now everyone would have to compete against one another in the labor market to survive.
Although the Poor Law Amendment Act did not ban all forms of outdoor relief, it stated that no able-bodied person was to receive money or other help from the Poor Law authorities except in a workhouse. Conditions in workhouses were to be made harsh to discourage people from claiming…The Poor Law Commissioners were to be responsible for overseeing the implementation of the Act…Despite the aspirations of the reformers, the New Poor Law was unable to make the Workhouse as bad as life outside. The primary problem was that in order to make the diet of the Workhouse inmates “less eligible” than what they could expect outside, it would be necessary to starve the inmates beyond an acceptable level. It was for this reason that other ways were found to deter entrance to the Workhouses. These measures ranged from the introduction of prison style uniforms to the segregation of ‘inmates’ into yards – there were normally male, female, boys’ and girls’ yards.
New Poor Law (Wikipedia)
Polanyi explains that the gold standard was an innovation expressly designed to put the theory of self-regulating markets in place and make it appear as if it were a natural development. That is, it was an institution specifically designed to drive the necessity of global trade. How did it work?
Market liberals wanted to create a world with maximal opportunities to extend the scope of markets internationally, but they had to find a way that people in different countries with different currencies could freely engage in transactions with each other. They reasoned that if every country conformed to three simple rules, the global economy would have the perfect mechanism for global self-regulation.
- First, each country would set the value of its currency in relation to a fixed amount of gold and would commit to buying and selling gold at that price.
- Second, each country would base its domestic money supply on the quantity of gold that it held in its reserves, its circulating currency would be backed by gold.
- Third, each country would endeavor to give its residents maximal freedom to engage in international economic transactions.
The gold standard put a fantastic machinery of global self-regulation into place. Firms in England were able to export goods and invest in all parts of the world, confident that the currencies they earned would be as “good as gold.” In theory, if a country is in a deficit position in a given year because its citizens spent more abroad than they earned, gold flows out of that country’s reserves to clear payments due to foreigners. The domestic supply of money and credit automatically shrinks, interest rates rise, prices and wages fall, demand for imports declines, and exports become more competitive. The country’s deficit would therefore be self-liquidating.
Without the heavy hand of government, each nation’s international accounts would reach a balance. The globe would be unified into a single market place without the need for some kind of world government or global financial authority; sovereignty would remain divided among many nation-states whose self-interest would lead them to adopt the gold standard rules voluntarily.
By the 1800’s the idea that money’s value derived from gold was treated as received wisdom and was generally accepted by people of different political persuasions in all major industrialized countries:
Belief in the gold standard was the faith of the age…namely, that banknotes have value because they represent gold.Whether the gold itself has value for the reason that it embodies labor, as the socialists held, or for the reason that it is useful and scarce, as the orthodox doctrine ran, made for once no difference. The war between heaven and hell ignored the money issue, leaving capitalists and socialists miraculously united… It would be hard to find any divergence between utterances of Hoover and Lenin, Churchill and Mussolini, on this point. Indeed, the essentiality of the gold standard to the functioning of the international economic system of the time was the one and only tenet common to men of all nations and all classes, religious denominations, and social philosophies 
The three mechanisms above were all interlocking: they formed a tripod, with the removal of any single leg causing the whole thing to collapse. Polanyi tells us “The sacrifices involved in achieving any one of them were useless, if not worse, unless the other two were equally secured. It was everything or nothing.” That’s why even if one of those things ran into a problem–such as the gold standard– they had to remain in place, because each interlocking piece was needed to reinforce the other.
All Western countries followed the same trend, irrespective of national mentality and history With the international gold standard the most ambitious market scheme of all was put into effect, implying absolute independence of markets from national authorities. World trade now meant the organizing of life on the planet under a self-regulating market, comprising labor, land, and money, with the gold standard as the guardian of this gargantuan automaton. Nations and peoples were mere puppets in a show utterly beyond their control. They shielded themselves from unemployment and instability with the help of central banks and customs tariffs, supplemented by migration laws. These devices were designed to counteract the destructive effects of free trade plus fixed currencies, and to the degree in which they achieved this purpose they interfered with the play of those mechanisms.
The international gold standard and fixed rates meant that a trade imbalance would lead to devastating deflations in the domestic economy. Exports were cheaper for manufacturers, but the rest of the domestic economy would have to cope with falling prices and falling wages. This caused the credit system to frieze up which damaged the domestic economy. To cope with falling wages, grain would have to be as cheap as possible, which necessitated a global grain market free from any price supports for domestic producers. The only way to rectify the imbalance was to increase foreign exports, which meant an elimination of all tariffs and trade barriers. All these parts were interlocking, and the removal of one would cause the system to fail:
Anybody could see that the gold standard, for instance, meant danger of deadly deflation and, maybe, of fatal monetary stringency in a panic.The manufacturer could, therefore, hope to hold his own only if he was assured of an increasing scale of production at remunerative prices (in other words, only if wages fell at least in proportion to the general fall in prices, so as to allow the exploitation of an everexpanding world market)…Nothing less than a self-regulating market on a world scale could ensure the functioning of this stupendous mechanism. Unless the price of labor was dependent upon the cheapest grain available, there was no guarantee that the unprotected industries would not succumb in the grip of the voluntarily accepted taskmaster, gold.
The expansion of the market system in the nineteenth century was synonymous with the simultaneous spreading of international free trade, competitive labor market, and gold standard; they belonged together. No wonder that economic liberalism turned almost into a religion once the great perils of this venture were evident.
What Polanyi calls “token money” was created and regulated by the state to cope with the needs for credit and stable purchasing power in the domestic economy:
But for domestic purposes…specie is an inadequate money just because it is a commodity and its amount cannot be increased at will. The amount of gold available may be increased by a small percentage over a year, but not by as many dozen within a few weeks, as might be required to carry a sudden expansion of transactions.
Token money was developed at an early date to shelter trade from the enforced deflations that accompanied the use of specie when the volume of business swelled. No market economy was possible without the medium of artificial money.
In the absence of token money business would have to be either curtailed or carried on at very much lower prices, thus inducing a slump and creating unemployment.
In its simplest form the problem was this: commodity money was vital to the existence of foreign trade; token money, to the existence of domestic trade. How far did they agree with each other?
To spread the risks around to the widest extent, token money needed to be centrally managed. This led to the establishment of various central banks. This means that: central banks were first created to cope with the effects of the gold standard! This shows the ignorance of the Libertarian/Austrian insistence on the gold standard with the simultaneous efforts to dismantle central banking. The use of token money once again meant that the “free” market required government management (Bitcoin advocates, please note):
Under nineteenth-century conditions foreign trade and the gold standard had undisputed priority over the needs of domestic business. The working of the gold standard required the lowering of domestic prices whenever the exchange was threatened by depreciation. Since deflation happens through credit restrictions, it follows that the working of commodity money interfered with the working of the credit system. This was a standing danger to business. Yet to discard token money altogether and restrict currency to commodity money was entirely out of the question, since such a remedy would have been worse than the disease.
Central banking mitigated this defect of credit money greatly. By centralizing the supply of credit in a country, it was possible to avoid the wholesale dislocation of business and employment involved in deflation and to organize deflation in such a way as to absorb the shock and spread its burden over the whole country. The bank in its normal function was cushioning the immediate effects of gold withdrawals on the circulation of notes as well as of the diminished circulation of notes on business.
The case of money showed a very real analogy to that of labor and land. The application of the commodity fiction to each of them led to its effective inclusion into the market system, while at the same time grave dangers to society developed. With money, the threat was to productive enterprise, the existence of which was imperiled by any fall in the price level caused by use of commodity money. Here also protective measures had to be taken, with the result that the self steering mechanism of the market was put out of action.
Now the institutional separation of the political and economic spheres had never been complete, and it was precisely in the matter of currency that it was necessarily incomplete; the state…was in fact the guarantor of the value of token money, which it accepted in payment for taxes and otherwise. This money was not a means of exchange, it was a means of payment; it was not a commodity, it was purchasing power; far from having utility itself, it was merely a counter embodying a quantified claim to things that would be purchased. Clearly, a society in which distribution depended upon the possession of such tokens of purchasing power was a construction entirely different from market economy.
Libertarians often point to the United States during this period as the exemplar of a self-regulating market delivering prosperity free from government interference. This is their ideal “golden age.” But Polanyi points out that this was only possible due to an endless supply of the “fictitious commodities” of land and labor. Once those failed to grow, the system broke down:
America has been adduced by economic liberals as conclusive proof of the ability of a market economy to function. For a century, labor, land, and money were traded in the States with complete freedom, yet allegedly no measures of social protection were needed, and apart from customs tariffs, industrial life continued unhampered by government interference.
The explanation, of course, was simply free labor, land, and money. Up to the 1890s the frontier was open and free land lasted; up to the Great War the supply of low standard labor flowed freely; and up to the turn of the century there was no commitment to keep foreign exchanges stable. A free supply of land, labor, and money continued to be available; consequently no self-regulating market system was in existence. As long as these conditions prevailed, neither man, nor nature, nor business organization needed protection of the kind that only intervention can provide.
As the lower ranges of labor could not any more be freely replaced from an inexhaustible reservoir of immigrants, while its higher ranges were unable to settle freely on the land; as soil and natural resources became scarce and had to be husbanded; as the gold standard was introduced in order to remove the currency from politics and to link domestic trade with that of the world, the United States caught up with a century of European development: protection of the soil and its cultivators, social security for labor through unionism and legislation, and central banking—all on the largest scale—made their appearance…Thus America offered striking proof, both positive and negative, of our thesis that social protection was the accompaniment of a supposedly self-regulating market.
In fact, the gold standard led to all sort of problems for domestic businesses, which sought ways to limit the damage, something omitted in the happy tales and sunny depictions of yeoman farmers, cattle ranchers, general store owners, and other “rugged individualists” of this time period spun by libertarians:
This aggressive push to wean the economy off of paper currency—and onto hard money—strained the banking system. Demand for specie by customers in New York City exceeded supply, and, on May 9, 1837, banks there responded by refusing specie withdrawal. The suspension of convertibility in the nation’s financial center caused panic that quickly spread to the rest of the country. Banks, looking to replenish the specie in their vaults, refused to make new loans and called in existing loans, triggering a collapse of credit and a severe and prolonged decline in production and employment across the country.
The Man on the Twenty-Dollar Bill and the Panic of 1837 (Liberty Street)
The [1849 California] gold rush constituted a positive monetary supply shock because the United States was on the gold standard at the time. The nation had switched from a bimetallic (gold and silver) standard to a de facto gold standard in 1834. Under the latter, the U.S. government stood ready to buy gold for $20.67 per ounce, a parity that prevailed until 1933. That commitment anchored prices, but the large gold discovery functioned like a monetary easing by a central bank, with more gold chasing the same amount of goods and services. The increase in spending ultimately led to higher prices because nothing real had changed except the availability of a shiny yellow metal.
In his excellent essay on gold standards, the economic historian Michael Bordo documents that the average annual U.S. inflation rate was many times lower under the gold standard (between 1880 and 1914) than in the subsequent 1946-2003 period. However, he shows that the gold standard led to more volatile short-term prices (including bouts of pernicious deflation) and more volatile real economic activity (because a gold standard limits the government’s discretion to offset aggregate demand shock). Bordo documents that short-run prices and real output were many times less volatile after the United States left the gold standard than before. Apart from their macroeconomic disadvantages, gold standards are also expensive; Milton Friedman estimated the cost of mining the gold to maintain a gold standard for the United States in 1960 at 2.5 percent of GDP ($442 billion in today’s terms).
The California Gold Rush and the Gold Standard (Liberty Street)
In the late 1800s, a surge in silver production made a shift toward a monetary standard based on gold and silver rather than gold alone increasingly attractive to debtors seeking relief through higher prices.The U.S. government made a tentative step in this direction with the Sherman Silver Purchase Act, an 1890 law requiring the Treasury to significantly increase its purchases of silver. Concern about the United States abandoning the gold standard, however, drove up the demand for gold, which drained the Treasury’s holdings and created strains on the financial system’s liquidity. News in April 1893 that the government was running low on gold was followed by the Panic in May and a severe depression involving widespread commercial and bank failures.
Gold, Deflation, and the Panic of 1893 (Liberty Street)
Polanyi also argues that colonialism was another response to these problems. In theory the global marketplace was anti-colonial, since everyone had access and any country could enter it and trade on equal terms with everyone else. In practice, however, the world organized into trade blocks behind barriers to protect themselves. By colonizing large parts of the globe, nation-states ensured a reliable source of raw materials (rubber in the Belgian Congo, for example) and reliable export markets for domestic producers. This drove the rush for colonies in Africa and Asia:
The import tariffs of one country hampered the exports of another and forced it to seek for markets in politically unprotected regions. Economic imperialism was mainly a struggle between the Powers for the privilege of extending their trade into politically unprotected markets. Export pressure was reinforced by a scramble for raw material supplies caused by the manufacturing fever. Governments lent support to their nationals engaged in business in backward countries. Trade and flag were racing in one another’s wake. Imperialism and half-conscious preparation for autarchy were the bent of Powers which found themselves more and more dependent upon an increasingly unreliable system of world economy. And yet rigid maintenance of the integrity of the international gold standard was imperative. This was one institutional source of disruption.
At this same time, to cope with the effects of trade and industrialism, you also saw the trend of nation-states becoming larger and more centralized. This was to seek ever-bigger internal markets to secure a competitive advantage. Get big or get out. The large, centralized states we take for granted today, such as Germany and Italy, came into being in the 1870’s. The two great terrestrial empires – the United States and Russia, expanded ocean to ocean while gobbling up territory from their neighbors.
This leads to one of the “paradoxes” of the market—It created an enormous expansion–not contraction–in centralized state power and the reach of the nation-state. Even today we see that the largest capitalist economies always have the largest governments, because they are required to ensure that the system functions as designed:
There was nothing natural about laissez-faire; free markets could never have come into being merely by allowing things to take their course. Just as cotton manufactures—the leading free trade industry—were created by the help of protective tariffs, export bounties, and indirect wage subsidies, laissez-faire itself was enforced by the state. The [eighteen] thirties and forties saw not only an outburst of legislation repealing restrictive regulations, but also an enormous increase in the administrative functions of the state, which was now being endowed with a central bureaucracy able to fulfil the tasks set by the adherents of liberalism…
The road to the free market was opened and kept open by an enormous increase in continuous, centrally organized and controlled interventionism. To make Adam Smith’s “simple and natural liberty” compatible with the needs of a human society was a most complicated affair. Witness the complexity of the provisions in the innumerable enclosure laws; the amount of bureaucratic control involved in the administration of the New Poor Laws which for the first time since Queen Elizabeth’s reign were effectively supervised by central authority; or the increase in governmental administration entailed in the meritorious task of municipal reform. And yet all these strongholds of governmental interference were erected with a view to the organizing of some simple freedom—such as that of land, labor, or municipal administration.
Just as, contrary to expectation, the invention of laborsaving machinery had not diminished but actually increased the uses of human labor, the introduction of free markets, far from doing away with the need for control, regulation, and intervention, enormously increased their range. Administrators had to be constantly on the watch to ensure the free working of the system. Thus even those who wished most ardently to free the state from all unnecessary duties, and whose whole philosophy demanded the restriction of state activities, could not but entrust the self-same state with the new powers, organs, and instruments required for the establishment of laissez-faire. [146-147]
Consider, for example, the vast bureaucracy involved in credit scores – numbers that track every individual’s behavior to assess their “credit risk.” Or bond ratings agencies. Or the public school and university system. Or the vast bureaucracy which is dedicated to policing people on public assistance to make sure they are spending the money properly and are looking for jobs. Or the vast prison gulags which house the unemployed (modern workhouses). Or the vast system of state-owned and supported roads, ports, and other infrastructure. Or the regulatory apparatus designed to ensure trust and fair-dealing which is necessary for exchange. It takes a lot of bureaucrats–government and otherwise–to make “free and open” markets work properly.
While the drive to create the laissez-faire economy was planned from the top-down and put into place by legislation (or its repeal), the drive to protect society from its ill-effects through some sort of collective protection was spontaneous and unplanned. this leads to one of Polanyi’s most often cited quotes: “laissez faire was planned; planning was not.” While establishing the global market was top-down unified intellectual movement advanced by market liberals, the drive to protect workers and communities from devastation emerged spontaneously and piecemeal in multiple countries via grass-roots efforts, only later coalescing into broad-based popular movements. Thus, the market project is more accurately described as “collectivist,’ while the drive to rein it in was individualistic:
The countermove against economic liberalism and laissez-faire possessed all the unmistakable characteristics of a spontaneous reaction. At innumerable disconnected points it set in without any traceable links between the interests directly affected or any ideological conformity between them.
The great variety of forms in which the “collectivist” countermovement appeared was not due to any preference for socialism or nationalism on the part of concerted interests, but exclusively to the broad range of the vital social interests affected by the expanding market mechanism.
For if market economy was a threat to the human and natural components of the social fabric, as we insisted, what else would one expect than an urge on the part of a great variety of people to press for some sort of protection?…Also, one would expect this to happen without any theoretical or intellectual preconceptions on their part, and irrespective of their attitudes toward the principles underlying a market economy. Again, this was the case…[156-157]
As he points out, social protection legislation emerges at about the same time in Victorian England and Bismarck’s Prussia, two radically different societies with no ideological connection or coordination between them. By contrast, market institutions such as the dismantling of tariffs and the gold standard were planned, executed and coordinated simultaneously by global elites and bureaucrats as part of a top-down project; indeed they could only emerge this way. An automatically-adjusting global trading mechanism does not just “happen” despite what libertarians claim.
“Collectivist” social movements were constantly scapegoated by market liberals for the system’s failures. According to them it was the “greedy” businessmen, monopolists, leftist intellectuals, and trade unions whose “lack of faith” was responsible for not adhering to the letter of the program, giving them a built-in excuse:
While in our view the concept of a self-regulating market was Utopian, and its progress was stopped by the realistic self-protection of society, in their view all protectionism was a mistake due to impatience, greed, and shortsightedness, but for which the market would have resolved its difficulties…
When around the 1870s a general protectionist movement—social and national—started in Europe, who can doubt that it hampered and restricted trade? Who can doubt that factory laws, social insurance, municipal trading, health services, public utilities, tariffs, bounties and subsidies, cartels and trusts, embargoes on immigration, on capital movements, on imports—not to speak of less-open restrictions on the movements of men, goods, and payments—must have acted as so many hindrances to the functioning of the competitive system, protracting business depressions, aggravating unemployment, deepening financial slumps, diminishing trade, and damaging severely the self-regulating mechanism of the market?
The root of all evil, the liberal insists, was precisely this interference with the freedom of employment, trade and currencies practiced by the various schools of social, national, and monopolistic protectionism since the third quarter of the nineteenth century; but for the unholy alliance of trade unions and labor parties with monopolistic manufacturers and agrarian interests, which in their shortsighted greed joined forces to frustrate economic liberty, the world would be enjoying today the fruits of an almost automatic system of creating material welfare. Liberal leaders never weary of repeating that the tragedy of the nineteenth century sprang from the incapacity of man to remain faithful to the inspiration of the early liberals; that the generous initiative of our ancestors was frustrated by the passions of nationalism and class war, vested interests, and monopolists, and above all, by the blindness of the working people to the ultimate beneficence of unrestricted economic freedom to all human interests, including their own. A great intellectual and moral advance was thus, it is claimed; frustrated by the intellectual and moral weaknesses of the mass of the people…
This, indeed, is the last remaining argument of economic liberalism today. Its apologists are repeating in endless variations that but for the policies advocated by its critics, liberalism would have delivered the goods; that not the competitive system and the self-regulating market, but interference with that system and interventions with that market are responsible for our ills.
The shorthand used by libertarians today is “capitalism would be a great system if it were ever tried,” or their constant carping about “crony capitalism.”
Polanyi says that neither the spread of the market, nor the counterreaction to it, breaks down simply along class divisions. This is probably in response to Marx’s analysis. Concerning the Market, he says, “The spread of the market was thus both advanced and obstructed by the action of class forces. ” Similarly, the response to it was not as simple as the working classes in opposition to the wealthier classes; for example, many small businessmen and landowners wanted protection from the vagaries of the market too: “Briefly, not single groups or classes were the source of the so-called collectivist movement, though the outcome was decisively influenced by the character of the class interests involved.”
One of the side-effects of this interlocking trade mechanism was what Polanyi called “The Hundred Years’ Peace” in Europe from the end of the Napoleonic Wars to the outbreak of World War One. Conflicts at this time were mainly sporadic colonial conflicts (e.g. Boer War, Crimean War, war in the Congo, etc.). What caused this extraordinary historical circumstance? Polanyi attributes it to what he calls haute finance:
For an explanation of this amazing feat, we must seek for some undisclosed powerful social instrumentality at work in the new setting, which could play the role of dynasties and episcopacies under the old, and make the peace interest effective. This anonymous factor, we submit, was haute finance.
Haute finance an institution sui generis, peculiar to the last third of the nineteenth and the first third of the twentieth century, functioned as the main link between the political and the economic organization of the world. It supplied the instruments for an international peace system, which was worked with the help of the Powers, but which the Powers themselves could neither have established nor maintained… Organizationally, haute finance was the nucleus of one of the most complex institutions the history of man has produced.
Polanyi calls this new international system comprised of the gold standard, haute finance and constitutionalism the “balance of power system.” The balance of power system meant that nations gained more from peace than by war.
The influence that haute finance exerted on the Powers was consistently favorable to European peace. And this influence was effective to the degree to which the governments themselves depended upon its cooperation in more than one direction. Consequently, there was never a time when the peace interest was unrepresented in the councils of the Concert of Europe. If we add to this the growing peace interest inside the nations where the investment habit had taken root, we shall begin to see why the awful innovation of an armed peace of dozens of practically mobilized states could hover over Europe from 1871 to 1914 without bursting forth in a shattering conflagration. 
The vast majority of the holders of government securities, as well as other investors and traders, were bound to be the first losers in such wars, especially if currencies were affected. …Finance…acted as a powerful moderator…Loans, and the renewal of loans, hinged upon credit, and credit upon good behavior…behavior is reflected in the budget and the external value of the currency cannot be detached from the appreciation of the budget, debtor governments were well advised to watch their exchanges carefully and to avoid policies which might reflect upon the soundness of the budgetary position… 
Trade had become linked with peace. In the past the organization of trade had been military and warlike… Trade was now dependent upon an international monetary system which could not function in a general war. It demanded peace, and the Great Powers were striving to maintain it. But the balance-of-power system, as we have seen, could not by itself ensure peace. This was done by international finance, the very existence of which embodied the principle of the new dependence of trade upon peace. [15-16]
Polanyi sees the breakdown of the market system and conflicts over colonialism as the fundamental cause of the First World War. This article gives some detail of the economic origins of the war:
The Economic Causes of the First World War (Socialist Standard)
Following that conflagration, Polanyi says that the nations failed to learn the lessons of the War and sought to reactivate the market society as it had been before, complete with open global trade and the gold standard. This simply set the stage for the Second World War.
In 1924 and after, Europe and the United States were the scene of a boisterous boom and drowned all concern for the soundness of the market system. Capitalism was proclaimed restored. Both Bolshevism and fascism were liquidated except in peripheric regions. The Comintern declared the consolidation of capitalism as a fact; Mussolini eulogized liberal capitalism; all important countries except Great Britain were on the upgrade. The United States enjoyed a legendary prosperity, and the Continent was doing almost as well. Hitler’s putsch had been quashed; France had evacuated the Ruhr; the Reichsmark was restored as by miracle; the Dawes Plan had taken politics out of reparations; Locarno was in the offing; and Germany was staring out on seven fat years. Before the end of 1926 the gold standard ruled again from Moscow to Lisbon.
It was in the third period–after 1929–that the true significant of fascism became apparent. The deadlock of the market system was evident. Until then fascism had hardly been more than a trait in Italy’s authoritarian government, which otherwise differed but little from those of a more traditional type. It now emerged as an alternative solution of the problem of an industrial society. Germany took the lead in a revolution of European scope and the fascist alignment provided her struggle for power with a dynamics which soon embraced five continents. History was in the gear for social change.
An adventitious but by no means accidental event started the destruction of the international system. A Wall Street slump grew to huge dimensions and was followed by Great Britain’s decision to go off gold and, another two years later, by a similar move on the part of the United States. Concurrently, the Disarmament Conference ceased to meet, and, in 1934, Germany left the League of Nations.
These symbolic events ushered in an epoch of spectacular change in the organization of the world. Three powers, Japan, Germany, and Italy, rebelled against the status quo and sabotaged the crumbling institutions of peace. At the same time the factual organization of the world economy refused to function. The gold standard was at least temporarily put out of action by its Anglo-Saxon creators; under the guise of default, foreign debts were repudiated; capital markets and world trade dwindled away. The political and economic system of the planet disintegrated conjointly.[243-244]
Eventually, the world fell into the biggest bust of them all–the global Great Depression. Polanyi argues that one again, the crisis was caused by the adherence to the gold standard and fixed exchange rates that market liberals championed to facilitate free trade. The 1930’s saw the second major breakdown of the international market system. Once again, unemployment soared and countries passed tariffs to try and limit the damage. Polanyi sees the rise of fascism and communism as an inevitable response to the failure of market society: “In reality, the part played by fascism was determined by one factor: the condition of the market system.”
These articles describe the role gold played in the economic disintegration of the world’s major industrial powers which led to the rise of fascism and the Second World War:
What was [the] gold standard and why was it under pressure in 1931?
The idea was that gold reserves represented a foundation for a nation’s currency and securities, allowing government notes to be exchanged for gold at any time at fixed rates. Exchange rates were stable among nations maintaining the gold standard. If a state began spending beyond its means and running deficits, those holding its notes would start converting them to gold, worrying that inflation would devalue the dollar, pound or franc. Conversions could exhaust a country’s gold reserves, punishing the government and the economy. Reserve levels determined how much currency nations could issue, and hence the money supply.
During the Depression, as revenues fell, governments trying to provide services ran growing budget deficits. This unnerved banks and wealthy investors, domestic and foreign, spurring waves of cash-outs (“Here’s your paper money; give me my gold!”). Banks and individuals then hoarded the gold, rather than using it for making loans or new investments.
The result was a continuing spiral of contraction. Credit was throttled, prices and wages fell (there wasn’t enough money moving to sustain them), debtors were hammered (their payments were fixed as their incomes shrank), and ultimately there were widespread defaults on economic commitments (bankruptcies, inability to pay interest due, abandonment of loans, expanding layoffs).
Gold withdrawals gutted the German financial system in the summer of 1931. When the state stopped shipments through exchange controls, the virus spread to Britain. As money evaporated from the banking system, economic activity floundered. Governments had two main options: Defend the exchange value of their currency to prevent inflation, at the price of further slowing the economy, or let the currency devalue to whatever level markets would determine, undermining exchange rates and purchasing power, in the hope that money “rightly priced” would begin circulating more fluidly.
Germany held the mark at a fixed rate, which turned out to be the wrong strategy. Britain let the pound float, at the mercy of the market. Initially the pound fell from $4.85 to less than $4.00. Then it rose to $4.22 before dropping again to $3.91 in early 1932. Bonds denominated in pounds had lost between 15 and 20 percent of their exchange value, but British products suddenly were 15 to 20 percent cheaper to sell abroad. Such tradeoffs punished investors but advantaged exporters. More than a dozen other nations soon followed Britain in abandoning the gold standard.
But France and the U.S. didn’t — with harsh implications before long.
The Gold Standard and the Great Depression: Echoes (BloombergView)
Under a pure gold standard, the government would stand ready to trade dollars for gold at a fixed rate. Under such a monetary rule, it seems the dollar is “as good as gold.”
Except that it really isn’t– the dollar is only as good as the government’s credibility to stick with the standard. If a government can go on a gold standard, it can go off, and historically countries have done exactly that all the time. The fact that speculators know this means that any currency adhering to a gold standard (or, in more modern times, a fixed exchange rate) may be subject to a speculative attack.
A gold standard only works when everybody believes in the overall fiscal and monetary responsibility of the major world governments and the relative price of gold is fairly stable. And yet a lack of such faith was the precise reason the world returned to gold in the late 1920’s and the reason many argue for a return to gold today. Saying you’re on a gold standard does not suddenly make you credible. But it does set you up for some ferocious problems if people still doubt whether you’ve set your house in order.
After suspending gold convertibility in World War I, many countries stayed off gold and experienced chaotic fiscal and monetary policies in the early 1920’s. Many observers reasoned then, just as many observers reason today, that the only way to restore fiscal and monetary responsibility would be to go back on gold, and by the end of the 1920’s, most countries had returned to the gold standard.
…The longer a country stayed on the gold standard, the more overall deflation it experienced. Many of us are persuaded that this deflation greatly added to the economic difficulties of those countries that insisted on sticking with a fixed value of their currency in terms of gold.
13 other countries besides the U.K. had decided to abandon their currencies’ gold parity in 1931…the average growth rate of industrial production for these countries…was positive in every year from 1932 on. Countries that stayed on gold, by contrast, experienced an average output decline of 15% in 1932. The U.S. abandoned gold in 1933, after which its dramatic recovery immediately began. The same happened after Italy dropped the gold standard in 1934, and for Belgium when it went off in 1935. On the other hand, the three countries that stuck with gold through 1936 (France, Netherlands, and Poland) saw a 6% drop in industrial production in 1935, while the rest of the world was experiencing solid growth.
The gold standard and the Great Depression (Econbrowser)
Polanyi published the book as World War Two was raging around the globe. His conclusion was that these events were ultimately caused by the failure of market society. He concluded that that the ideal market society championed by market liberals, where everything (including land, labor and capital) was a mere factor of economic production, and where society was just an accessory to the One Big Market was not only utopian, but ran contrary to fundamental human nature, which is why attempts to construct it would always be doomed to fail (emphasis in the original):
If industrialism is not to extinguish the race, it must be subordinated to the requirements of man’s nature…Nineteenth century society assumed that in his economic activity man strove for profit, that his materialistic propensities would induce him to choose the lesser instead of the greater effort and to expect payment for his labor; in short, that in his economic activity he would tend to abide by what they described as economic rationality, and that all contrary behavior was the result of outside interference.
It followed that markets were natural institutions, that they would spontaneously arise if only men were let alone. Thus, nothing could be more normal than an economic system consisting of markets under the sole control of market prices, and a human society based on such markets appeared, therefore, as the goal of all progress. Whatever the desirability or undesirability of such a society on moral grounds, it practicability–this was axiomatic–was grounded in the immutable characteristic of the race.
Actually, as we now know, the behavior of man both in his primitive state and right through the course of history has been almost the opposite of that implied in this view…The tendency to barter, on which Adam Smith so confidently relied for his picture of primitive man, is not a common tendency of the human being in his economic activities, but a most infrequent one. Not only does the evidence of modern anthropology give the lie to these rationalistic constructs, but the history of trade and markets has also been completely different from that assumed in the harmonistic teachings of nineteenth century sociologists.
Economic history reveals that the emergence of national markets was in no way the result of the gradual and spontaneous emancipation of the economic sphere from governmental control. On the contrary, the market has been the outcome of a conscious and often violent intervention on the part of government which imposed the market organization on society for noneconomic ends. And the self-regulating market of the nineteenth century turns out on closer inspection to be radically different from even its immediate predecessor in that it relied for its regulation on economic self-interest. The congenital weakness of nineteenth century society was not that it was industrial but that it was a market society. Industrial civilization will continue to exist when the utopian experiment of a self-regulating market will be no more than a memory
Polanyi was confident that we could only be saved by pulling back from “pure” market society and re-embedding our economic life in social institutions. In his time, he believed that this was finally starting to happen through things like the abandonment of the gold standard during the war, and political movements like the New Deal and its “Four Freedoms,” including a guarantee of housing and work for everyone. He thought we might finally be learning our lesson.
Sadly, we now know that’s not what happened. After the oil crisis of the 1970’s, Keynsianism, designed to manage the recurring crises of the market and smooth out its excesses, was replaced by a global movement to create a “pure” market society based solely on unremitting competition. Citizens would be replaced with “consumers” transacting in the Market. Government would shrink,at least in theory.
Polanyi would be quick to point out how much Neoliberalism—just as much as its nineteenth-century predecessor—was an artificial creation of central state power rather than its absence. He would point to transnational institutions such as the World Bank, the International Monetary Fund, the Maastricht Treaty, the European Union, NAFTA, and the World Trade Organization, and other organizations/agreements. He would point to the role of the United States military in maintaining this system, as the British Empire did in years prior. He would note the dollar’s role as the world’s reserve currency. He would point to the artificial recasting of the natural world as “natural capital,” a fictitious commodity if there ever was one. He would point to the privatization of essential public services sustained by taxpayer dollars. He would point to what has happened in China over the past several decades as proof that the Market is a creation of strong central governments. He would say it is almost a reenactment of what took place in Britain, with its displaced rural proletariat heading into urban factories, its state supported industries, its trade protections and export-led model, its public infrastructure, it’s police state, its infrastructure development, and so forth. He would point to copyright protections and intellectual property laws. He would point to “welfare to work” schemes as the new poor law. He would point to the fact that the creators of Neoliberalism openly admit that it is imposed from above after some sort of crisis (the Shock Doctrine). And he would point to things like TPP/TTIP/TISA as not a lack of rules, but as a rewriting of them to benefit the needs of stakeholders like international corporations and the investor class over those of the citizenry. Finally, he would point out that the Euro works exactly like the gold standard did, with exactly the same catastrophic results. Rather than dismantle or limit the market society, we have instead put it on steroids.
And now once again the world is on the brink of collapse…
BONUS: Barter in the modern world.