4. London was the dominant international financial center during the late 19th and early 20th centuries. World War I marked the end of London's dominance and the emergence of New York as the international financial center. The following paragraphs offer some explanation for why London had become the dominant international financial center and the Bank of England's role in operating the British gold standard.

"Prior to World War I, the pound sterling was the most common currency used in pricing goods and making international payments. Ordinary British merchants dealt only in pounds, leaving foreigners to transact in foreign exchange markets. Much of the world's trade was priced in sterling and financed in drafts denominated in sterling. What had made the pound sterling the international currency and London the dominant financial center? Britain held the leading position in the world as an importer, exporter, and the source of long-term and short-term capital, which made it convenient for foreign exporters and importers to hold interest-bearing, sterling balances on deposit in London. The British gold standard made gold and sterling identical, and given the unrestricted transferability of sterling deposits, nearly everyone preferred sterling balances to gold. The Bank of England operated with a gold reserve well below the reserves held by the central banks of most of the smaller gold standard countries. The continuing stability and convertibility of sterling was never a problem despite public concern in England and some other countries regarding the adequacy of the Bank of England's gold reserves.

"Rough equality between payments to and from Britain kept the world well supplied with sterling. Britain generally ran a surplus on current account in the balance of payments, with earnings from exports and on foreign investments exceeding expenditures on imports. Rather than accumulate gold reserves, British investors made this surplus available for additional overseas loans and investments. By World War I an estimated one-third of all accumulated British wealth had taken the form of private foreign investment."

(a) The above paragraphs suggest some reasons for London's dominant international financial position prior to World War I. Does this discussion ignore other important considerations relevant to London's international financial dominance? What are the crucial elements to the success of a financial intermediary and what permits a particular center to become dominant internationally? In this regard, why has there been a tendency for a single financial center to dominate during a particular historical period? Carefully explain.

(b) What factors explain why New York began to replace London as the dominant international financial center after World War I? Why would the high import-tariff policies of the U.S. during the 1920s and 30s have slowed the New York financial center's rise to dominance?

(c) Why was the fact that England's trade surplus was not converted into gold reserves important for the operation of the international gold standard? How was the fact that the Bank of England maintained an elastic money supply and did not allow a "sterling shortage" to occur important for creditor-debtor relationships? What would have happened if the Bank of England had operated its gold standard according to the "rules of the game" and the "specie-flow mechanism?" Carefully explain.