The beginning of World War I marked the end of the classical age of the gold standard. All major countries suspended the convertibility of domestic bank notes into gold and the free movement of gold between countries. This was often done unofficially. For example, in the United Kingdom, private exports and imports of gold remained legal in theory. However, in addition to a number of government-imposed regulations that discouraged the buying and selling of gold, bullion dealers refused to permit gold exports on patriotic grounds.
In Canada, convertibility was officially suspended. As tensions mounted in the days immediately prior to the declaration of war on 4 August 1914, there were heavy withdrawals of gold from banks. In an "atmosphere of incipient financial panic” , there were concerns about the possibility of bank runs. In the absence of a lender of last resort, this was potentially very serious, since banks were legally required to close if they were not able to meet depositor demand for gold or Dominion notes. On 3 August 1914, an emergency meeting was held in Ottawa between the government and the Canadian Bankers Association to discuss the crisis. Later that day, an Order-in-Council was issued that provided protection for banks that were threatened by insolvency by making notes issued by the banks legal tender. This allowed the banks to meet their depositor demands with their own bank notes rather than with Dominion notes or gold. The government also increased the amount of notes that banks were legally permitted to issue. The government was also empowered to make advances to banks by issuing Dominion notes against securities deposited with the minister of finance. This provision enabled banks to increase the amount of their bank notes in circulation.
(Home Bank, $10, 1917
The Home Bank was one of several chartered banks established in Canada during a period of economic expansion early in the twentieth century. Its operations were suspended in 1923, owing to poor management. Following a Royal Commission into its operations, the Office of the Inspector General of Banks (the forerunner of the Office of the Superintendent of Financial Institutions) was established in 1925.)
A second Order-in-Council, issued on 10 August 1914, suspended the redemption of Dominion notes into gold. This and the previous Order-in-Council were subsequently converted into legislation as "An Act to Conserve the Commercial and Financial Interests of Canada” (the Finance Act), which received royal assent on 22 August 1914.
The Finance Act gave the government the power to act as a lender of last resort to the banking system—one of the powers of a modern central bank. It also provided a means for the government (Treasury Board) to set the Advance Rate, the rate at which it would make loans to the chartered banks. Advances under the Finance Act were made at the request of banks. The government did not actively manage interest rates, nor was there any board overseeing the conduct of monetary policy.
Canadian Dollar in Terms of the U.S. Dollar
Monthly averages (1914–26)
1. August 1914: Outbreak of World War 1
2. November 1918: End of World War 1
3. July 1926: Return to gold standard
Source: U.S. Board of Governors of the Federal Reserve System (1943)
(Dominion of Canada, $2, 1914
The portraits of Canada’s Governors General and their wives were commonly featured on Canadian government notes in the late nineteenth and early twentieth centuries. The Duke of Connaught, Governor General from 1911 to 1916, and his wife are shown here.)
Throughout the war, the Advance Rate remained at 5 per cent, although a special 3.5 per cent rate was established in 1917 under which the government discounted British treasury bills held by the chartered banks. This facility was designed to assist the British government’s war effort. It was complemented by a special $50 million issue of Dominion notes backed by British treasury bills to help finance British purchases of war materials in Canada. The government also increased the fiduciary issue of Dominion notes (i.e., notes not backed by gold) in 1915 under an amendment to the Dominion Notes Act.
(Dominion of Canada, $1, 1917
This note features Princess Patricia, daughter of the Duke and Duchess of Connaught and patron of the famous Princess Patricia’s Canadian Light Infantry.)
Despite the suspension of gold convertibility in August 1914, the Canadian dollar traded in a very narrow range close to parity with its U.S. counterpart throughout the war years (Chart 2). In 1918, however, the Canadian dollar began to weaken, and its decline accelerated during the two-year period following the end of hostilities, until it reached a low of roughly US$0.84 in 1920. The weakness of the currency reflected a significant monetary expansion, high inflation, and a deterioration in Canada’s balance of payments associated with financing the war effort and the ensuing cost of troop demobilization.