part-1 (only history)
Gold Standard
The
gold standard is a monetary system in which the standard economic unit of account is a fixed mass of gold. There are distinct kinds of gold standard. First, the
gold specie standard
is a system in which the monetary unit is associated with circulating
gold coins, or with the unit of value defined in terms of one particular
circulating gold coin in conjunction with subsidiary coinage made from a
lesser valuable metal.
Similarly, the
gold exchange standard typically involves the
circulation of only coins made of silver or other metals, but where the
authorities guarantee a fixed exchange rate with another country that is
on the gold standard. This creates a
de facto
gold standard, in that the value of the silver coins has a fixed
external value in terms of gold that is independent of the inherent
silver value. Finally, the
gold bullion standard
is a system in which gold coins do not circulate, but in which the
authorities have agreed to sell gold bullion on demand at a fixed price
in exchange for the circulating currency.
History:
The gold specie standard was not designed, but rather arose out of a
general acceptance that gold was useful as a universal currency.
When commodities compete for the role of money, the one that over time loses the least value, takes on the role.
The use of gold as money dates back many thousands of years and the
first known gold coins were minted in the Greek city state of Lydia in
Asia Minor around 610 BC. The first coins minted in China are thought to
date around 600 BC.
During the Middle Ages, the Byzantine gold Solidus, commonly known as the
Bezant,
circulated throughout Europe and the Mediterranean. But as the
Byzantine Empire's economic influence declined, the European world
tended to see silver, rather than gold, as the currency of choice,
leading to the development of a silver standard. Silver pennies, based on the Roman Denarius, became the staple coin of Britain around the time of King Offa,
circa AD 796, and similar coins, including Italian
denari, French
deniers, and Spanish
dineros circulated throughout Europe. Following the Spanish discovery of great silver deposits at Potosà and in Mexico during the 16th century, international trade came to depend on coins such as the Spanish dollar, Maria Theresa thaler, and, in the 1870s, the United States Trade dollar.
In modern times the British West Indies
was one of the first regions to adopt a gold specie standard. Following
Queen Anne's proclamation of 1704, the British West Indies gold
standard was a
de facto gold standard based on the Spanish gold doubloon coin. In the year 1717, master of the Royal Mint Sir Isaac Newton
established a new mint ratio between silver and gold that had the
effect of driving silver out of circulation and putting Britain on a
gold standard. However, only in 1821, following the introduction of the gold sovereign coin by the new Royal Mint at Tower Hill
in the year 1816, was the United Kingdom formally put on a gold specie
standard, the first of the great industrial powers. Soon to follow was Canada in 1853, Newfoundland in 1865, and the USA and Germany
de jure in 1873. The USA used the Eagle as their unit, and Germany introduced the new gold mark, while Canada adopted a dual system based on both the American Gold Eagle and the British Gold Sovereign.
Australia and New Zealand adopted the British gold standard, as did the British West Indies,
while Newfoundland was the only British Empire territory to introduce
its own gold coin as a standard. Royal Mint branches were established in
Sydney, New South Wales, Melbourne, Victoria, and Perth, Western Australia for the purpose of minting gold sovereigns from Australia's rich gold deposits.
The crisis of silver currency and bank notes (1750–1870) :
In the late 18th century, wars and trade with China, which sold to
Europe but had little use for European goods, drained silver from the
economies of Western Europe and the United States. Coins were struck in
smaller and smaller numbers, and there was a proliferation of bank and
stock notes used as money.
In the 1790s, England, suffering a massive shortage of silver
coinage, ceased to mint larger silver coins and issued "token" silver
coins and overstruck foreign coins. With the end of the Napoleonic Wars,
England began a massive recoinage programme
that created standard gold sovereigns and circulating crowns and
half-crowns, and eventually copper farthings in 1821. The recoinage of
silver in England after a long drought produced a burst of coins:
England struck nearly 40 million shillings between 1816 and 1820, 17
million half crowns and 1.3 million silver crowns. The 1819 Act for the
Resumption of Cash Payments set 1823 as the date for resumption of
convertibility, reached instead by 1821. Throughout the 1820s, small
notes were issued by regional banks, which were finally restricted in
1826, while the Bank of England was allowed to set up regional branches.
In 1833, however, the Bank of England notes were made legal tender, and
redemption by other banks was discouraged. In 1844 the Bank Charter Act
established that Bank of England Notes, fully backed by gold, were the
legal standard. According to the strict interpretation of the gold
standard, this 1844 act marks the establishment of a full gold standard
for British money.
The US adopted a silver standard based on the Spanish milled dollar
in 1785. This was codified in the 1792 Mint and Coinage Act, and by the
Federal Government's use of the "Bank of the United States" to hold its
reserves, as well as establishing a fixed ratio of gold to the US
dollar. This was, in effect, a derivative silver standard, since the
bank was not required to keep silver to back all of its currency. This
began a long series of attempts for America to create a bi-metallic
standard for the US Dollar, which would continue until the 1920s. Gold
and silver coins were legal tender, including the Spanish real, a silver
coin struck in the Western Hemisphere. Because of the huge debt taken
on by the US Federal Government to finance the Revolutionary War, silver
coins struck by the government left circulation, and in 1806 President
Jefferson suspended the minting of silver coins.
The US Treasury was put on a strict hard-money standard, doing
business only in gold or silver coin as part of the Independent Treasury
Act of 1848, which legally separated the accounts of the Federal
Government from the banking system. However the fixed rate of gold to
silver overvalued silver in relation to the demand for gold to trade or
borrow from England. The drain of gold in favor of silver led to the
search for gold, including the California Gold Rush of 1849. Following Gresham's law,
silver poured into the US, which traded with other silver nations, and
gold moved out. In 1853, the US reduced the silver weight of coins, to
keep them in circulation, and in 1857 removed legal tender status from
foreign coinage.
In 1857 the final crisis of the free banking era of international
finance began, as American banks suspended payment in silver, rippling
through the very young international financial system of central banks.
In the United States this collapse was a contributory factor in the
American Civil War, and in 1861 the US government suspended payment in
gold and silver, effectively ending the attempts to form a silver
standard basis for the dollar. Through the 1860–1871 period, various
attempts to resurrect bi-metallic standards were made, including one
based on the gold and silver franc; however, with the rapid influx of
silver from new deposits, the expectation of scarcity of silver ended.
The interaction between central banking and currency basis formed the
primary source of monetary instability during this period. The
combination that produced economic stability was a restriction of supply
of new notes, a government monopoly on the issuance of notes directly
and, indirectly, a central bank and a single unit of value. Attempts to
avoid these conditions produced periodic monetary crises: as notes
devalued; or silver ceased to circulate as a store of value; or there
was a depression as governments, demanding specie as payment, drained
the circulating medium out of the economy. At the same time, there was a
dramatically expanded need for credit, and large banks were being
chartered in various states, including, by 1872, Japan. The need for a
solid basis in monetary affairs would produce a rapid acceptance of the
gold standard in the period that followed.
By way of example, and following Germany's decision after the Franco-Prussian War
to extract reparations to facilitate a move to the gold standard, Japan
gained the needed reserves after the Sino-Japanese War of 1894–1895.
Whether the gold standard provided a government sufficient bona fides
when it sought to borrow abroad is debated. For Japan, moving to gold
was considered vital to gain access to Western capital markets.
The gold exchange standard (1870–1914):
Towards the end of the 19th century, some of the remaining silver
standard countries began to peg their silver coin units to the gold
standards of the United Kingdom or the USA. In 1898, British India pegged the silver rupee to the pound sterling at a fixed rate of 1s 4d, while in 1906, the Straits Settlements adopted a gold exchange standard against the pound sterling with the silver Straits dollar being fixed at 2s 4d.
At the turn of the century, the Philippines pegged the silver
Peso/dollar to the US dollar at 50 cents. A similar pegging at 50 cents
occurred at around the same time with the silver Peso of Mexico and the
silver Yen of Japan. When Siam adopted a gold exchange standard in 1908,
this left only China and Hong Kong on the silver standard.
Impact of World War I (1914–25):
Governments faced with the need to fund high levels of expenditure,
but with limited sources of tax revenue, suspended convertibility of
currency into gold on a number of occasions in the 19th century. The
British government suspended convertibility (that is to say, it went off
the gold standard) during the Napoleonic wars and the US government during the US Civil War. In both cases, convertibility was resumed after the war.
The real test, however, came in the form of World War I, a test "it failed utterly" according to economist Richard Lipsey.
In order to finance the costs of war, most belligerent countries went
off the gold standard during the war, and suffered significant inflation.
Because inflation levels varied between states, when they returned to
the standard after the war at price determined by themselves (some, for
example, chose to enter at pre-war prices), some countries' goods were
undervalued and some overvalued.
Ultimately, the system as it stood could not deal quickly enough with the large deficits and surpluses created in the balance of payments;
this has previously been attributed to increasing rigidity of wages
(particularly in terms of wage cuts) brought about by the advent of unionized labor,
but is now more likely to be thought of as an inherent fault with the
system which came to light under the pressures of war and rapid
technological change. In any case, prices had not reached equilibrium by
the time of the Great Depression, which served only to kill it off
completely.
For example, Germany
had gone off the gold standard in 1914, and could not effectively
return to it as Germany had lost much of its remaining gold reserves in
reparations. The German central bank issued unbacked marks virtually without limit to buy foreign currency for further reparations and to support workers during the Occupation of the Ruhr finally leading to hyperinflation in the 1920s.
The gold bullion standard and the decline of the gold standard (1925–31):
The gold specie standard ended in the United Kingdom and the rest of
the British Empire at the outbreak of World War I. Treasury notes
replaced the circulation of the gold sovereigns and gold half
sovereigns. However, legally, the gold specie standard was not repealed.
The end of the gold standard was successfully effected by appeals to
patriotism when somebody would request the Bank of England to redeem
their paper money for gold specie. It was only in the year 1925 when
Britain returned to the gold standard in conjunction with Australia and
South Africa that the gold specie standard was officially ended.
The British Gold Standard Act 1925 both introduced the gold bullion
standard and simultaneously repealed the gold specie standard. The new
gold bullion standard did not envisage any return to the circulation of
gold specie coins. Instead, the law compelled the authorities to sell
gold bullion on demand at a fixed price. This gold bullion standard
lasted until 1931.
On September 19, 1931, the United Kingdom left the revised gold standard,
forced to suspend the gold billion standard due to large outflows of
gold across the Atlantic Ocean. The British benefited from the
departure. They could now use monetary policy to stimulate the economy
through the lowering of interest rates. Australia and New Zealand had
already been forced off the gold standard by the same pressures
connected with the Great Depression, and Canada quickly followed suit
with the United Kingdom.
 |
| [William McKinley ran for president on the basis of the gold standard.] |
Depression and World War II (1932–46):
Prolongation of the Great Depression
Some economic historians, such as American professor Barry
Eichengreen, blame the gold standard of the 1920s for prolonging the
Great Depression.
Others including Federal Reserve Chairman Ben Bernanke and Nobel Prize winning economist Milton Friedman lay the blame at the feet of the Federal Reserve.
The gold standard limited the flexibility of central banks' monetary policy
by limiting their ability to expand the money supply, and thus their
ability to lower interest rates. In the US, the Federal Reserve was
required by law to have 40% gold backing of its Federal Reserve demand
notes, and thus, could not expand the money supply beyond what was
allowed by the gold reserves held in their vaults.
In the early 1930s, the Federal Reserve defended the fixed price of
dollars in respect to the gold standard by raising interest rates,
trying to increase the demand for dollars. Its commitment and adherence
to the gold standard explain why the U.S. did not engage in expansionary
monetary policy. To compete in the international economy, the U.S.
maintained high interest rates. This helped attract international
investors who bought foreign assets with gold. Higher interest rates
intensified the deflationary pressure on the dollar and reduced
investment in U.S. banks. Commercial banks also converted Federal
Reserve Notes to gold in 1931, reducing the Federal Reserve's gold
reserves, and forcing a corresponding reduction in the amount of Federal
Reserve Notes in circulation.
This speculative attack on the dollar created a panic in the U.S.
banking system. Fearing imminent devaluation of the dollar, many foreign
and domestic depositors withdrew funds from U.S. banks to convert them
into gold or other assets.
The forced contraction of the money supply caused by people removing
funds from the banking system during the bank panics resulted in
deflation; and even as nominal interest rates dropped,
inflation-adjusted real interest rates remained high, rewarding those
that held onto money instead of spending it, causing a further slowdown
in the economy.
Recovery in the United States was slower than in Britain, in part due
to Congressional reluctance to abandon the gold standard and float the
U.S. currency as Britain had done.
Congress passed the Gold Reserve Act
on 30 January 1934; the measure nationalized all gold by ordering the
Federal Reserve banks to turn over their supply to the U.S. Treasury. In
return the banks received gold certificates to be used as reserves
against deposits and Federal Reserve notes. The act also authorized the
president to devalue the gold dollar so that it would have no more than
60 percent of its existing weight. Under this authority the president,
on 31 January 1934, fixed the value of the gold dollar at 59.06 cents.
British hesitate to return to gold standard:
During the 1939–1942 period, the UK depleted much of its gold stock in purchases of munitions and weaponry on a "cash-and-carry" basis from the U.S. and other nations.
This depletion of the UK's reserve convinced Winston Churchill of the
impracticality of returning to a pre-war style gold standard. To put it
simply, the war had bankrupted Britain.
John Maynard Keynes,
who had argued against such a gold standard, proposed to put the power
to print money in the hands of the privately owned Bank of England.
Keynes, in warning about the menaces of inflation, said "By a continuous
process of inflation, governments can confiscate, secretly and
unobserved, an important part of the wealth of their citizens. By this
method, they not only confiscate, but they confiscate arbitrarily; and
while the process impoverishes many, it actually enriches some".
Quite possibly because of this, the 1944 Bretton Woods Agreement established the International Monetary Fund
and an international monetary system based on convertibility of the
various national currencies into a U.S. dollar that was in turn
convertible into gold.
Post-war international gold-dollar standard (1946–1971):
After the Second World War,
a system similar to a Gold Standard and sometimes described as a "gold
exchange standard" was established by the Bretton Woods Agreements.
Under this system, many countries fixed their exchange rates relative to
the U.S. dollar. The U.S. promised to fix the price of gold at
approximately $35 per ounce. Implicitly, then, all currencies pegged to
the dollar also had a fixed value in terms of gold. Under the administration of the French President Charles de Gaulle
up to 1970, France reduced its dollar reserves, trading them for gold
from the U.S. government, thereby reducing U.S. economic influence
abroad. This, along with the fiscal strain of federal expenditures for
the Vietnam War and persistent balance of payments deficits, led President Richard Nixon to end the direct convertibility of the dollar to gold on August 15th 1971, resulting in the system's breakdown (the "Nixon Shock").
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