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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.
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