The Pre-1913 World Gold Standard — Something All Classical Thinkers Can Agree On
May 23, 2013
(This item originally appeared in Forbes.com on May 23, 2013.)
http://www.forbes.com/sites/nathanlewis/2013/05/23/what-all-classical-economic-thinkers-agree-about/
There are a lot of Classical-flavored economists in the U.S., and they all have their quirks. However, they can all agree on a few things.
First: that a Classical stable-value monetary policy is superior to a Mercantilist funny-money policy.
Second: that the best practical, real-life way of achieving the Classical goal of stable money (which is really an extension of standardized weights and measures) is a gold standard system.
You can actually devise a lot of different kinds of gold standard systems. But, one thing that I think virtually all the serious Classical thinkers agree on today is that the pre-1913 world gold standard system worked exceptionally well. I call it the Most Perfect Monetary System the World Has Ever Seen. Some contemporary variant of that would also work – very well, in fact.
In the pre-1913 period, every country had its own sort of gold standard system. Probably no two were exactly alike. But, they shared certain characteristics.
First: they were gold standard systems. This means that the policy goal was to maintain the value of the currency at a specified gold parity. In the U.S., the parity was $20.67 per ounce of gold. In other words, the value of the dollar was to be managed such that it was exactly equivalent to 1/20.67 of an ounce of gold, or 23.2 troy grains.
In Britain, the parity was three pounds, seventeen shillings and ten pence per ounce of gold.
Second: there was a fully-functional operating mechanism designed to achieve this policy goal. This involved managing the monetary base, on a daily basis. When the supply of currency was in excess of demand, causing the value of the currency to sag beneath its gold parity value, the base money supply would be contracted in some way. When the supply of currency was in relative shortage, compared to demand, causing the value of the currency to rise above its parity value, the base money supply of currency would be expanded in some way.
There were a great many methods in use for expanding or contracting the base money supply. These included: transactions in gold bullion (known as “redemption” and “monetization”), transactions in government debt, corporate debt, or debt in foreign gold-based currencies; transactions in foreign currencies directly; changes in the quantity of direct lending; allowing base money supply to contract as a result of interest payments on assets; and allowing base money supply to contract as a result of the maturation of either bond holdings or direct lending.
I know this sounds complicated. But, these were all ways of achieving the same goal — to adjust the supply of base money, as a way to keep the value of the currency at its gold parity.
The great classical economists, such as David Ricardo and John Stuart Mill, understood that it was not strictly necessary to have gold bullion redemption (or “convertibility”) to manage a gold standard system. However, it was a political necessity: without this element, currency managers would soon start to play games with the currency, and the gold standard system would be abandoned.
Thus, the most prominent of the pre-1913 gold standard currencies, such as the British pound, U.S. dollar, and German mark, had direct gold bullion convertibility. Some countries had direct convertibility, not into gold bullion but rather into another major gold-based currency.
In the pre-1913 period, a number of countries – mostly colonial holdings of European empires – used a currency-board type system linked to a major European “reserve currency” like the British pound and German mark. However, this was not as prominent then as it was in the 1920s, and certainly not as prominent as the 1950s, when virtually all the world’s currencies were linked to the U.S. dollar.
The major currencies were independent. They had their own direct link to gold bullion, not an indirect link via some other “reserve currency.”
Currency managers did not hold a “100% bullion reserve” against base money in circulation. The Bank of England maintained roughly a 30% bullion reserve during the 1844-1913 period. The United States had quite a lot of variation, swinging between a 15% bullion reserve and about 40%. Other countries had even more variability than this. Italy’s bullion reserve varied from 6% to 42%.
The major central banks did not hold enormous quantities of gold, as a percentage of total aboveground gold supply. The Bank of England, the premier central bank of the era, held an average of only about 1.5% of all aboveground gold in its vaults.
Gold coins were in regular use, although they had already been mostly supplanted by paper banknotes, which were much more convenient. In 1910, only about 25% of the currency of the United States was in the form of gold and silver coins. The other 75% was paper banknotes, of one sort or another. Probably, these gold coins were not even used much, but might have served as a savings device.
However, everyone could own and use gold coins in commerce if they wanted to. This was very different than the 1950s and 1960s, when it was illegal to own gold coins in the United States. If you ever were in doubt regarding the proper management of banknotes at their gold parity, you could redeem the banknotes for gold coins on demand.
Each country could join the world gold standard on its own schedule and on its own terms. It was a voluntary club that did not need any great agreements or treaties. There was no coordinated fiscal policy, or any other sort of imposition on each country’s sovereignity. Sometimes countries left the gold standard, and devalued their currencies. (Greece was one – some things never change.) They usually regretted this, and rejoined soon after, once again on their own schedule and on their own terms.
Unlike the 1950s and 1960s, there were no capital controls. Capital flowed freely around the world. In 1913, foreign investment, as a percentage of world GDP, hit 18%. Foreign investment then collapsed as a result of World War I. In 1950, it was 5%. The 18% level was not reached again until 1999.
Globalization and international trade blossomed everywhere. In 1913, the ratio of world trade to GDP was 21%. This level was not reached again until 1996.
All of these elements worked wonderfully at the time. They should be elements of our new world gold standard system. On these points, I believe that all serious Classical economists can agree.
