Last week, we
were looking at how gold standard systems work. We used the example of the
United States, which, from 1789 to 1860, had a libertarian "free
banking" system. Anyone could issue currency, but it had to be pegged to
gold. This "gold peg" was a value peg. It had nothing to do
with gold mining, or the gold reserves of banks, or imports and exports of
gold. Does gold mining alter the value of gold? Essentially no, because
annual gold mining production is a small fraction -- about 2% -- of existing
world gold supply. Does importing and exporting gold change the value of
gold? Not unless there are some sort of restrictions on importing and
exporting, which is rare, and hard to enforce even if it
exists. Gold is the same value everywhere. Does the fact that a bank
owns or does not own gold change the value of gold? Nope. It's the same value
no matter who owns it. So you see, none of these factors have much effect on
the value of gold. And if a banknote's value is pegged to gold -- via
the adjustment of supply -- then obviously these factors have little effect
on the value of banknotes.
The fact of the matter is, during the "free banking" period, nobody
actually knew what the "money supply" was. In 1859, the Hodges
Genuine Bank Notes of America listed 9,916 notes issued by 1,356 banks.
Yes, there were 1,356 banks all issuing their own homegrown currency in those
days, all of it linked to gold. Actually, there were more than 1,356 banks,
because Hodges missed dozens if not hundreds of banks! Banks were opening and
closing all the time. Do you see? Not only did nobody know the total amount
of banknotes in issuance (except for some vague statistics), nobody even
knew how many banks there were issuing currency. Think about that. So how
was the money supply determined in those days? All of these 1,356+ banks had
the same operating mechanism, which was a gold value peg maintained
via the adjustment of supply. When the value of banknotes was a little
low compared to its gold peg, the supply of banknotes was reduced. When
people were happy to accept larger issuance of banknotes, without redeeming
them for gold, in other words when the value of banknotes was higher than the
gold peg, then the supply of banknotes increased.
January 2, 2011: The "Money
Supply" With a Gold Standard
August 26, 2007: How To Operate a
August 19, 2007:
Gold Standard Fallacies
Unfortunately, today we have all sorts of the stupidest imaginable ideas
floating around, whereby a "gold standard" is a system by which the
amount of money in circulation is determined by gold mining, or the
"current account balance," or that a gold standard means a
"100% gold reserve ratio" or absolutely no change in the
"money supply" whatsoever, some such thing. Anyone with the
briefest understanding of historical monetary statistics -- this includes you
if you read last week's item -- can see immediately that this is complete
baloney. The next thing you should realize is that 99% of academic
economists including Ben Bernanke and also 95% of gold standard
advocates including Murray Rothbard -- also
have no idea whatsoever how real gold standard systems operated, in real life
during the period 1789-1971. What this means is that, after spending 20
minutes to read last week's item, you now know more about this than 95%+ of
the so-called "experts." Do you see now why I say that today's
understanding of these matters is appalling? On the other hand, you can now
be a World Expert with about 45 minutes of work. Which is sort of fun, in a
Let's continue our story in 1880. In 1863, the National Bank Notes system was
introduced in the United States. Banks that wanted to issue currency had to
register with the Office of the Comptroller of the Currency, an agency of the
U.S. Treasury. There were still thousands of these National Banks -- 3,438
National Banks in May 1890 -- so it was still a libertarian sort of system.
However, now we have system-wide statistics on the total banknotes outstanding.
The dollar floated vs. gold from 1861 to 1879, so 1880 is a good place to
restart our tale of how the gold standard system operated in the United
States. The National Banks themselves didn't hold gold reserves for the most
part, but rather U.S. Treasury obligations. The gold reserve of the National
Bank system was the U.S. Treasury itself.
Here is some information on the National Bank system from the annual reports
of the OCC:
The St. Louis Fed has all kinds of wonderful historical stuff. You used to
have to go to the library for this sort of thing. I did a lot from microfilm!
Unfortunately, I don't have good statistics on U.S. Treasury gold holdings
from 1900 to 1913. I only have 1905 and 1910. So, the intervening years are
linearly extrapolated. If you have these numbers, let me know.
Let's review first the history of the dollar.
"dollar" was originally a European silver coin called the "thaler." It originated in 1518. This became the
Spanish silver "dollar," which became the template for the U.S.
dollar when the dollar was defined in 1792. So, the idea of the "dollar/thaler" goes waaaay back.
Except for a minor adjustment in 1834, the dollar's value was unchanged until
the Roosevelt devalutation in 1933. We can consider
the entirety of the 1789-1932 period as having a dollar
pegged to gold at $20.67/oz. There was a lapse during the Civil War, and also
some business around the War of 1812. After the Roosevelt devaluation, the
dollar was pegged at $35/oz., until 1971. However, there were some lapses
during this time too, especially during World War II.
Here you can see the Civil War devaluation and return to the gold standard,
the 1933 devaluation, and the floating currency period after 1971.
This shows the WWII "lapse" in the gold standard -- the U.S. wasn't
quite off gold, but not quite on it either, it was all a little fuzzy, hey,
there was a war going on -- and the return to the $35/oz. peg around 1952,
after the "Fed Accord" of 1951. The dollar sank to about $43.25/oz.
at its lowest point in 1948, which is to say that it took 43.25/35=23.5% more
dollars to buy an ounce of gold, or in other words the dollar's value fell by
19%. Not really that big a deal, as long as it didn't get out of hand.
There you go. The pink bars are base money (not including gold coin),
basically banknotes and bank reserves. The green bars are the total amount of
gold held by the U.S. Treasury, in terms of dollars. You can see a big jump
in gold reserves in 1934, because that's when they were revalued at $35/oz.
instead of $20.67/oz. The data comes from Milton Friedman A Monetary
History of the United States, "high powered money" minus gold
coin, which comes from the Federal Reserve's Banking and Monetary
Statistics. The base money figues after 1918
come from the St. Louis Fed.
During this period, base money expanded by 90x. If
you adjust for the 1933 devaluation, the expansion in the "gold value of
the money supply" is 53x. Does that sound to
you like "no expansion in the money supply"? During this period,
1880-1970, the total amount of gold in the world rose by 6.51x.
So you see, the money supply with a gold standard has nothing to do with gold
mining, imports or exports of gold, the current account balance, "no expansion
in the money supply," "100% reserves" or some other stable
reserve ratio, or all the other stupid things you hear about all the time.