How the Chancellor lost $3.5bn for the UK

Britain's central bankers sold off their gold reserves at the lowest prices in two decades. They could have done with learning a bit of financial history...

Look around Athens. Where are the descendants of Pericles and Socrates? Look at what has become of the heirs to Cato and Augustus Rome can barely manage to run the parking meters. How could they run a great empire? And in today's Britain: where is Kitchener? Rhodes? Gladstone? Disraeli? When Britain's brightest and best got together in the late 1990s to plot monetary policy, it was as if the nation had never had a bank before. As if it had no financial history. They came up with what had to be the worst trade of the decade: swapping much of the nation's remaining gold for paper currency at the bottom of a 20-year bear market in the metal! Nearly 400 tons of gold were sold between 1999 and 2002, bringing the nation $3.5bn. If they had waited until this week, they could have raised twice as much.

You can make a lot of money by watching what bankers are doing. Just remember to do the opposite. In the 1980s, Texas banks poured money into the Houston oil economy. Of course, then the price of oil collapsed and weeds grew up in the new housing developments. Who were the lenders to the Third World, just before the debt sold down to pennies on the dollar? Bankers only missed the tech bubble through no fault of their own. The young dotcom hustlers found that they could get even more money out of the gullible public and they didn't even have to pay interest. But at just the moment the tech bubble reached its zenith, Britain's Chancellor of the Exchequer found a way to make up for lost time. All over the world, economies were in the middle of the biggest explosion of money and credit of all time. And gold that antidote to financial trouble had been going down for 20 years. Was there ever a worse time to sell it?

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

So how did these people ever build and finance a great empire? In the 19th century, Britain's industry was solid; so was its money. But as the Empire softened, so did sterling. The crown's money was the world's reserve currency, as the dollar is today, for a hundred years: from the defeat of Bonaparte in 1815 to the banks of the Marne in 1914, the pound ruled the world. But what ruled the pound?

The Bank of England could exchange an ounce of gold for about 3.85 pounds. It did so with no hard feelings, until the Great War so strained Britain's finances that she was forced to turn to her erstwhile New World colony, America, for support. Thereafter, came a long string of reversals, defeats, devaluations, inflations, and swindles both for the British Empire and for its money. American and German manufacturers had already surpassed British output by 1910. By 1917, America was paying the piper and calling the tune. By the 1950s, America was indisputably the Free World's hegemon.

The Bank of England had been forced off the gold standard during World War I. After the shooting stopped, it tried to force its way back onto the gold standard, at the same level. Aiming to help our English cousins was the good intention that led US Fed chief Ben Strong to administer a little coup de whiskey' to the American market and put the US economy on the road to the hell of the 1929 crash and the Great Depression. But even with US support, Britain couldn't hold its ground. The pound was devalued in 1931, again in 1949, and again in 1969. The UK currency was still widely used in international commerce, but it was steadily slipping. By 1960, British reserves represented less than one-twentieth of the world's total and were only half of those of Germany. Ten years later, the country was nearly broke. And in 1976, the poor Brits had to beg the IMF for emergency loans in order to meet current obligations.

Through all this, you can imagine how the pound fared. Back in 1985, a pound was scarcely worth more than a dollar. But that was before Alan Greenspan came to his post at the Fed two years later. Since then, in the race to monetary hades, the dollar has spurted ahead. When we last checked, the dollar is quoted at $1.73 to the pound. But it is in terms of gold that the damage is most clearly visible. At today's price, you can buy an ounce of gold for 324 pounds. This means the pound of Queen Victoria has lost 99% of its value.

With so much recent monetary history available to them, you'd think Britain's central bankers would be among the world's most sage and the most careful to keep their feet on the ground and their hands on gold. You'd think they would jealously protect that final 1% of sterling's value. They have only to look back a quarter of a century to see what can happen to a mismanaged currency. They might even remember that gold, during that late-1970s period, was setting new price records. And they might have reminded themselves that the financial world is a treacherous place, and that things go wrong, and that when they do go wrong, it is a good idea to have a little of something solid stashed away, just in case. They might have even reflected on how history has a way of grinding down empires and paper money until there is almost nothing left of them. Alas, those who were so familiar with monetary history seemed to have nothing but contempt for it. Where is William Cotton when you need him?

Bill Bonner is editor of Dailyreckoning.com and author of US bestseller Empire of Debt

Recommended further reading:

You may also like to read Bill Bonner's views on globalisation, consumer debt and where the US economy will go next. For a full list of articles on buying and selling gold, see our section in investing in gold.