The World Gold Standard of 1870-1914: the Most Perfect Monetary System Ever Created
January 3, 2013
(This item originally appeared at Forbes.com on January 3, 2013.)
http://www.forbes.com/sites/nathanlewis/2013/01/03/the-1870-1914-gold-standard-the-most-perfect-one-ever-created/
The most perfect monetary system humans have yet created was the world gold standard system of the late 19th century, roughly 1870-1914. We don’t have to hypothesize too much about what a new world gold standard system could look like. We can just look at what has already been done.
Contrary to popular belief, people generally did not conduct commerce with gold coins. Yes, gold coins existed, but people mostly used paper banknotes and bank transfers, just as they do today. In 1910, gold coins comprised $591 million out of total currency (base money) of $3,149 million in the United States, or 18.7%. These gold coins were probably not used actively, and served more as a savings device, in a coffee can for example.
Silver coins were also used, but by then they had become token coins, just like our token coins today. By 1910, most countries in the world officially had “monometallic” monetary systems, with gold alone as the standard of currency value. This eliminated many of the difficulties of bimetallic systems, which had caused minor but chronic problems in the earlier 19th century.
Also contrary to popular belief, there was no “100% bullion reserve” system, in which each banknote was “backed” by an equivalent amount of gold bullion in a vault. In the United States in 1910, gold bullion reserve coverage was 42% of banknotes in circulation.
For other countries, we can refer to Monetary Policy Under the International Gold Standard: 1880-1914, by Arthur Bloomfield. It was published in 1959. Bloomfield provides references to major central bank balance sheets around the world. He summarizes various “reserve ratios,” but includes not only gold bullion but also foreign exchange reserves (i.e., bonds denominated in foreign gold-linked currencies). The “reserve ratios,” on this basis for 1910, were 46% in Britain, 54% in Germany, 60% in France, 41% in Belgium, 73% for the Netherlands, 68% for Denmark, 80% for Finland, 75% for Norway, 75% for Switzerland, 55% for Russia, and 62% for Austro-Hungary. Reserve ratios for gold bullion alone would be, naturally, less than these numbers.
A number of countries had variations on a “gold exchange standard,” which is to say, a currency board-like system linked to a gold-linked reserve currency (usually the British pound). This became more common in the 1920s, and especially during the Bretton Woods period, but it was in regular use pre-1914 as well. Bloomfield lists countries on some form of a “gold exchange standard,” including: Russia, Japan, Austria-Hungary, the Netherlands, most Scandinavian countries, Canada, South Africa, Australia, New Zealand, India, the Philippines, and “a number of other Asiatic and Latin American countries, whose currency systems operated analogously to modern currency boards.” The pre-1914 era was the age of empire, and many of these countries were formally or informally within one or another European empire. Their currency systems also ended up being subsidiary to the currency of the imperial seat.
Most of the leading European countries had some sort of central bank, upon the model of the Bank of England. The U.S. did not, opting for a “free-banking” system (although one dominated by U.S. Treasury-issued banknotes). The countries with central banks also mimicked the Bank of England’s typical operating procedures, which included continuous involvement in credit markets by way of “discount” lending (short-term collateralized lending). This was not at all necessary, but was an outgrowth of the Bank of England’s history as a profit-making commercial bank. Thus, central banks also, in the fashion of the Bank of England, often managed base money supply by way of its lending policy, which included its “discount rate.”
The world gold standard did not produce some sort of “balance” in the “balance of payments” – in other words, no current account deficit or surplus. There was no “price-specie-flow mechanism.” These so-called “balance of payments imbalances” are another word for “international capital flows,” and capital flowed freely in those days. With all countries basically using the same currency – gold as the standard of value – and also with legal and regulatory foundations normalized by European imperial governance, international trade and investment was easy.
It was the first great age of globalization. Net foreign investment (“current account surplus”) was regularly above 6% of GDP for Britain, and climbed to an incredible 9% of GDP before World War I. From 1880 to 1914, British exports of goods and services averaged around 30% of GDP. (In 2011, it was 19.3%.) In 1914, 44% of global net foreign investment was coming from Britain. France accounted for 20%, Germany 13%.
This river of capital flowed mostly to emerging markets. The United States, which was something of an emerging market in those days although one that was already surpassing its European forebears (much like China today), was a consistent capital-importer (“current account deficit”). Most British foreign capital went to Latin America; Africa accounted for much of the remainder.
Gross global foreign investment rose from an estimated 7% of GDP in 1870 to 18% in 1914. In 1938, it had fallen back to 5%, and stayed at low levels until the 1970s.
In 1870, the ratio of world trade to GDP was 10%, and rose to 21% in 1914. In 1938, it had fallen back to 9%.
This explosion of European capital translated into tremendous investment around the world. British-governed India had no railways in 1849. In 1880, India had 9,000 miles of track. In 1929, there were 41,000 miles of railroad in India, build by British engineers, British capital, and Indian labor. British-governed South Africa opened its first railroad in 1860. This grew to 12,000 miles of track, not including extensions into today’s Zimbabwe and elsewhere in Africa.
The arrangement was largely voluntary. There were no fiscal limitations or centralized governing bodies, such as the eurozone has today. The Bank of England served mostly as an example to imitate. Countries could opt out if they wished, and several did from time to time, although they usually tried to rejoin later. The countries that had rather loose allegiance to gold standard principles should be no surprise: Argentina, Brazil, Spain, Italy, Chile, and Greece, among others.
With monetary stability assured by the gold standard system, bond yields fell everywhere to very low levels. Yields on long-term government bonds were 3.00% in France in 1902; 3.26% in the Netherlands in 1900; 2.92% in Belgium in 1900; 3.46% in Germany in 1900. Corporate bonds followed along: the yield on long-term high-grade railroad bonds in the United States was 3.18% in 1900. Unlike today, these rock-bottom yields were not obtained by every sort of central bank manipulation imaginable, but reflected the long history and expectation for monetary and macroeconomic stability that the gold standard system provided. They could continue at these low levels for decades, and often did: from 1821, when Britain returned to a gold standard after a floating-currency period during the Napoleonic Wars, to 1914, the average yield on government bonds of infinite (!) maturity in Britain was 3.14%.
During the 20th century, and now into the 21st, no central bank in the world has been able to match this performance. They are not even in the same galaxy. No world monetary arrangement has provided even a pale shadow of that era’s incredible successes.
We could create an updated version of the world gold standard system of the pre-1914 era. However, there isn’t really much need to change things very much. It worked fine, and would still be working today if not for World War I, and soon after, the rise of Keynesian notions that governments could manage their economies by jiggering the currency. This requires a floating currency, which is why we have floating currencies today.
Once we finally abandon these funny-money notions – probably because of their catastrophic failure – it will be very easy to create, once again, a superlative world gold standard system.
