EC120 week 18, topic 13, slide 1

The International Gold StandardTopics:

• Monetary standards

• International money: a brief chronology

• Adoption of the Gold Standard from mid-19th century

• Complications: 1. Bimetallism; 2. capital flows & interest rates

• The Gold Standard in practice, 1880−1914

• Financial crises and monetary policy

• `Lender of Last Resort’ & the Bagehot principle

• The mechanism of international adjustment

• Summing up: interpretation and assessment

EC120 week 18, topic 13, slide 2

Monetary standards

• A spectrum of standards between the extremes of:

– Adopt another currency altogether

– Peg currency to a precious metal (“fixed parity”)

– Floating exchange rates with other currencies

• Some currencies were pegged to two (or more) metals

EC120 week 18, topic 13, slide 3

International money: a brief chronology

• Prior to mid/late 19C: various, based on precious metals

• International Gold Standard, c1870−1914

• Interwar period, 1918−39: `Gold Exchange Standard’

• Bretton Woods, 1945−71: Adjustable pegged exch. rates

• Since 1971: mixed `system’, mostly quasi-floating

EC120 week 18, topic 13, slide 4

Adoption of the Gold Standard from mid-19C

• Move to gold was piecemeal

• How the Gold Standard worked, perhaps:

– Exports>Imports: inflow of gold

– Imports>Exports: outflow of gold

– Hume’s `specie flow’ model:exports <> imports changes in money (gold) stock goods’ prices exports = imports `external balance’

EC120 week 18, topic 13, slide 5

Complications, 1: Bimetallism

• What is `bimetallism’?

– Currency pegged to two metals, e.g. gold and silver

• Often attractive when precious metals are used as money

• In practice one metal, gold, became dominant

• But the silver lobby did not die easily: “... You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold.” William Jennings Bryan, 1896

EC120 week 18, topic 13, slide 6

Complications, 2: capital flows & interest rates

• Δ(money stock) = (exports − imports) + net capital inflow

• Capital flows include borrowing/lending as well as gold

• `International Trilemma’: allows only two of −

a. Fixed exchange rates (e.g. gold standard)

b. Capital mobility

c. Independent monetary policy

• To uphold the gold standard, (c) was abandoned

EC120 week 18, topic 13, slide 7

The Gold Standard in practice, 1880−1914

• Varieties of `Gold Standard’:

– Only a core group issued gold coins (specie standard)

– Some countries issued a mixture (inc. token currency)

– Many countries held foreign exchange as reserves

• Worldwide deflation: c1873 to c1896 declining price levels

Financial Crises & Monetary Policy

• More sophisticated finance supported trade and industry– But recurring crises had widespread impact

• Expanding international trade links increased the need for stable monetary standards: unsystematic adoption of gold or silver

• Twin goals of state monetary policies:

– Internal balance: stable price level and prosperity

– External balance: to maintain the currency’s convertibility

• Inadequate financial supervision of banking systems to achieve policy objectives

EC120 week 18, topic 13, slide 8

The Bagehot Principle

• Policy problem: to maintain both internal & external balance

• External balance was threatened if gold flowed abroad

• Internal balance was threatened if banks fail (or in distress)

• Bagehot principles: a lender of last resort that– Lends freely – On good collateral, but– At penal (high) interest rates

• Bagehot problem: moral hazard

EC120 week 18, topic 13, slide 9

EC120 week 18, topic 13, slide 10

The mechanism of international adjustment

• Very little gold was shipped from one country to another

• Were the “rules of the game” obeyed?

– Central banks manipulated interest rates

– Central banks co-ordinated their policies

– In times of `stress’ convertibility was suspended

EC120 week 18, topic 13, slide 11

Stability of the international Gold Standard

• Adherence to the Gold Standard: was seen as a

– “Good Housekeeping Seal of Approval”

• Stability/instability at the periphery: mixed experience

• Stability among the core nations seemed robust

EC120 week 18, topic 13, slide 12

Summing up: interpretation and assessment

• Why the international gold standard worked:

– Kindleberger’s `theory of hegemonic stability’

– Eichengreen emphasises credibility and co-operation

• International stability a cause or an effect of the G.S.?

• How long could it have survived?