Since the successful first edition of The Gold Standard in Theory and History was published in 1985, much new research has been completed. This updated version contains five new essays including: * post 1990 literature on exchange rate target zones * a discussion of the light shed by the gold standard on the European Monetary Union debate * a new introduction by Eichengreen with Marc Flandreau This will be an invaluable resource for students of macroeconomics, international economics and economic history at all levels.
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The financial globalization that followed the collapse of the Bretton Woods System opened a new chapter in the history of international monetary relations. The founding fathers of Bretton Woodsâthe eminent British economist John Maynard Keynes and US Treasury official Harry Dexter White prominent among themâ sought to create a more perfect international monetary order conducive to financial stability and economic growth. Their system was crafted to contain destabilizing flows of âhot moneyâ and to allow governments to adjust policy to domestic conditions. For a few years it seemed to work. But by the 1970s international financial markets had regained the upper hand. International capital flows seemingly unprecedented in scope first undermined fixed currency pegs. Following the transition to floating exchange rates, financial markets threatened officials seeking to avail themselves of their newfound freedom with capital flight, the collapse of the currency, and inflation. When US President Bill Clintonâs advisor James Carville famously remarked that if reincarnated he wanted to come back as the bond market, he was only articulating many officialsâ sense of helplessness when confronted by a world of global finance.
Critics of the current system contend that the generalized float now prevailing provides neither the stability needed for effective international specialization nor the flexibility required for independent action. Turbulence and volatility in international financial markets disrupt firmsâ production and investment decisions. Misaligned currencies confer arbitrary competitive advantages, evoking complaints from those who produce in competition with imports. The âtemporaryâ trade restraints adopted in response are not easily removed once the exchange-rate fluctuation is reversed.
Dissatisfaction with current arrangements naturally prompts proposals for reform. Virtually all such proposals seek to limit exchange-rate variability by establishing a system of multilateral currency bands (or their variants: crawling pegs and target zones).1 The member states of the European Union, among whom economic integration is particularly close, have established the European Monetary System (EMS), a multilateral exchange-rate grid, to limit the variability of their currencies. Countries as diverse as Finland, Sweden, Mexico, Argentina, and Estonia have pegged their exchange rates to the currencies of major trading partners for various periods of time.
But the decision to peg the exchange rate is easier to issue than to enforce. In 1992â3, the European Monetary System erupted in a crisis that expelled two major participants, Italy and the United Kingdom, from its Exchange Rate Mechanism and forced the remaining countries to widen their fluctuation bands from
to 15 per cent. The Mexican policy of pegging the peso to the dollar came asunder in 1994, when an attempt to realign led to a full-blown panic and financial collapse.
The implication is that pegging the exchange rate has become exceedingly difficultâsome would say impossible for any length of timeâin todayâs world of liquid financial markets and quicksilver capital flows. The resources commanded by currency traders far exceed the reserves of central banks. By forcing governments seeking to defend the currency to raise interest rates to politically insupportable levels, the markets have the capacity to demolish the peg at any time.
Things may have been different under the Bretton Woods System of pegged-but-adjustable exchange rates, but this was because controls limited international capital movements, sheltering currencies from market pressures. In todayâs globalized capital markets, where capital controls have become exceedingly expensive to enforce, countries will inevitably gravitate toward greater exchange-rate flexibility.
The gold standard is the obvious challenge to this conventional wisdom. When it prevailed, currencies were successfully pegged against one another despite the presence of open capital markets.2 International financial transactions were unrestricted, and foreign lending and borrowing, as a share of global GNP, reached even higher levels than today.3 Yet exchange rates were stabilized within 1 per cent bands for extended periods, a record of stability that remains unparalleled even today.
Popular images of the gold standard reflect present problems as much as past realities. When the first edition of this book appeared a dozen years ago, the appeal of the gold standard was its association with price stability. Countries were just emerging from the high inflation of the 1970s. The fact that prices had been little different in 1870 and 1913 recommended the system to those who valued price stability. In the course of the last ten years, inflation was brought under better control, and its threat was superseded in the eyes of many by the problem of exchange-rate instability. Correspondingly, the appeal of the gold standard today is as a mechanism for stabilizing exchange rates and smoothing the balance-of-payments adjustment process.
In the textbook story, the gold standard worked smoothly because it was automatic. Each countryâs money supply was linked to its gold reserves, and balance-of-payments adjustment was accomplished by international shipments of precious metal. Each country being subject to the same gold standard discipline, the system brought about a de facto harmonization of policies and an admirable degree of exchange-rate stability.
Unfortunately, this vision of the gold standard, like the unicorn in James Thurberâs garden, is a mythical beast. Far from the normal state of affairs prior to the twentieth century, the gold standard prevailed on a global scale for barely a third of a century. The experience of the industrial economies was more satisfactory than that of countries specializing in the production of primary products; international creditors had happier experiences than debtors. The gold standard did not prevent the international transmission of financial crises, nor did it preclude suspensions of convertibility. Discretionary actions by national authorities featured prominently in the gold standardâs operation in both normal periods and times of crisis.
If we reject the gold standard myth, we must then come to terms with the reality. This is an enterprise to which scholars from a number of different disciplines can contribute. In the work of economists we find models of the gold standard as a self-equilibrating system of markets. One class of models focuses on the mechanisms by which balance-of-payments equilibrium and exchange-rate stability were maintained. Another analyzes how deflation stimulated mining activity and augmented the supply of monetary gold, stabilizing the price level. Such models are useful for checking the internal consistency of accounts of the operation of the monetary system, but by their stylized nature they abstract from important aspects of its structure.
In the work of historians we find detailed studies of particular aspects of that structure. Some consider the gold standardâs impact on individual countries or on relations between them. Others focus on the role of central banks and even of particular central bankers. These studies have little in common with the gold standard myth. But while providing a wealth of institutional and historical detail on particular episodes and markets, they discourage efforts to generalize by virtue of the detailed and idiosyncratic nature of their accounts.
In work by political scientists, finally, we find attempts to explain the emergence and operation of the gold standard in terms of interest-group pressures, institutions, and international political interactions.4 These are factors that make no appearance in the models of economists and play at best a subsidiary role in most historiansâ accounts of international monetary relations: for example, the extent of the electoral franchise, conflicts between landed and industrial interests, and management of the gold standard system by the leading commercial and financial powers.
The existence of three distinct literatures is frequently taken to indicate that our knowledge of the gold standard is incomplete. In fact, most of the elements needed to paint a complete picture are at hand. Completing it requires only that we blend the contributions of economic theorists, historians, and political scientists. Like the blind man with the elephant, students of the gold standard have gained their impressions from an awareness confined to parts of the beast. Theorists have sought to model the gold standardâs operation, but only occasionally have they drawn guidance from the work of historical scholars. Historians have concentrated on particular instances of the gold standardâs operation. Political scientists have downplayed the role of markets and historical happenstance in order to highlight political dynamics.
Interaction between these three sets of scholars and integration of these literatures are needed to provide fresh insights. This volume therefore brings together selections on the international gold standard from the literatures of economics, history, and political science. It is directed at students of all three disciplines in the hope that their understanding of the gold standard will be enriched and that they will acquire a new appreciation of the gains from intellectual trade.
The emergence of the international gold standard
The gold standard is frequently portrayed as the normal state of affairs prior to 1913. But in fact, it prevailed on a global scale only for a third of a century, from 1880 to 1914. Prior to that, currencies were generally based on silver instead of gold or on a combination of the two metals. Britain was the principal exception, having been on a full legal gold standard from 1821 and on a de facto gold standard from 1717, when Sir Isaac Newton, then Master of the Mint, set too high a silver price for the gold guinea. With the Mint price of silver lower than its international market price, Britainâs newly reminted full-bodied silver coins were quickly driven from circulation.
During the Napoleonic Wars, the imperatives of war finance led to inflation and suspension of convertibility. Parliament brought this episode to a close by passing a law in 1819 that required the Bank of England to make its notes redeemable in gold at the market price prevailing in 1821. This placed the Bank of England in a peculiar position, since it was still a private institution, albeit one with special privileges and obligations, including the obligation to redeem its notes for specified quantities of gold. Its position was further complicated by the Bank Charter Act of 1844, which divided the Bank into an Issue Department responsible for backing the note circulation with gold, and a Banking Department to undertake commercial activities and market intervention.
All the while, the United States and France operated bimetallic standards. Their Mints stood ready to transform specified quantities of gold or silver into coins of comparable value. In effect, these countries ran two simultaneous commodity price stabilization schemes, pegging their currencies to those of countries on both gold and silver standards, and thus implicitly pegging the gold-silver price ratio. Although the US had to adjust Mint prices of the two metals from time to time to keep both metals in circulation, this arrangement was remarkably successful at stabilizing the gold-silver price ratio at
to 1 for more than three-quarters of a century (Flandreau 1995).
In the United States, the Coinage Act of 1792 established a Mint ratio of 15 ounces of silver to an ounce of gold, approximating the market price. But increases in Mexican and South American silver production soon caused the price of silver to fall to
to 1. With gold undervalued at the Mint, silver was brought there to be coined, and gold was shipped abroad where its price was higher (the opposite of the effect of Isaac Newtonâs undervaluation of silverâcf. p. 4 above). As a result, through the first half of the 1830s the United States was effectively on a silver standard. The Coinage Act of 1834 raised the Mint ratio to 16 to 1 in an attempt to restore gold coins to circulation. Gold discoveries in California and Australia and the steady output of Russiaâs mines then depressed the price of gold, causing silver to be exported and gold to be coined.5 The US was effectively placed on the gold standard until convertibility was suspended with the outbreak of the Civil War.
While Franceâs experience was similar in many respects, its larger internal circulation of both gold and silver insulated it from disturbances to the availability of the two metals. The Mint ratio of
to 1 was below the market ratio for many years after 1803, and gold was exported (in exchange for silver) until the 1840s. Once mid-century gold discoveries augmented supplies of the yellow metal, gold came to dominate the French monetary circulation. But, even at the height of the California gold rush, both gold and silver coin continued to circulate (Flandreau, 1995).
While Britain was first to adopt the gold standard, her example was not followed until the second half of the nineteenth century. Fears of inflation due to gold discoveries deterred other nations (Sayers, 1933),6 and until the 1870s there did not exist a critical mass of gold standard countries to attract others to the system. Indeed, at mid-century the dominant direction of movement was away from the gold standard, not toward it. The possibility of inflation due to newly mined gold flowing into the coffers of central banks led governments to suspend gold coinage. This was the response of Belgium, Switzerland, and the Netherlands, although larger countries like France and England hesitated to take this step for fear of further destabilizing the international system.7
In the end, the anticipated inflation never materialized, due in part to the operation of the bimetallic system itself. As gold flowed toward the bimetallic countries, their silver flowed toward countries on silver standards. Thus the impact of the gold rushes in California and elsewhere on the money stocks of the bimetallic countries was minimized by the operation of this âparachute effectâ .8
By 1860 it had become clear that the gold-silver exchange rate would not be significantly displaced by discoveries in California and elsewhere; in response, Belgium and Switzerland resumed coining gold. Their resumption of bimetallism turned out to be the first step toward the creation of a global gold standard.
The expansion of Europeâs trade in the 1860s heightened the attractions of exchange-rate stability. Although Franceâs bimetallic system helped to stabilize the exchange rates linking the gold and silver blocs, a common basis for Europeâs currencies would have been even better for weaving together the continentâs trade. In 1867 an international conference was held in Paris for the purpose of establishing a common standard. With gold now comprising the majority of the French monetary circulation and England on the gold standard, the yellow metal was the natural focus of negotiations. The bimetallic lobby remained powerful, however, and the 1867 conference failed to overcome its opposition and agree on international action.
The outcome hoped for by many delegates, namely the establishment of an international gold standard, eventually resulted anyway from the unilateral actions of individual governments. Germany initiated the process in 1871. Although the country had previously derived some advantage from its silver standard in trade with Eastern Europe, by 1870 most of that region had suspended convertibility. The indemnity received in 1871â3 as victor in the Franco-Prussian War provided the resources needed to carry out a currency reform. Germany established a gold-based currency unit, the mark, and used her indemnity to purchase about half of the gold needed for circulation.
The Germans sought to complete the process by selling their silver on world markets, taking advantage of bimetallic Franceâs commitment to purchase it (and sell gold). Concerned not to aid its German rival, Paris responded by limiting silver coinage. Without France to peg the gold-silver exchange rate, the solidity of the bimetallic bloc was shattered. The members of the Latin Monetary Union (Belgium, Switzerland, Italy, and Greece, along with France), as well as smaller silver standard countries (the Netherlands, Denmark, Norway, and Sweden), followed by limiting or suspending silver coinage and shifting to gold (Flandreau, 1996b).
The more countries adopted the gold standard, the more attractive it became for the others. Gold soon became the monetary standard in virtually every European country.9 The international gold standard rea...
