51. The Classical Gold Standard

0:00The Classical Gold Standard The 19th century monetary system has been referred to as the quote, classical gold standard. It has become fashionable among economists to denigrate that system as only existent in the last decades of the 19th century and as simply a form of pound sterling standard since London was the great financial center during this period. period. This disparagement of gold, however, is faulty and misleading. It is true that London was the major financial center in that period, but the world was scarcely on a pound standard. Active competition from other financial centers—Berlin, Paris, Amsterdam, Brussels, New York—insured that gold was truly the only standard money throughout the world.

0:51Furthermore, to stress only the few decades before 1914 as the age of the gold standard ignores the fact that gold and silver have been the world's two monetary metals from time immemorial. Countries shifted to and from freely fluctuating parallel gold and silver standards in attempts, self-defeating in the long run, to fix the rate of exchange between the two metals, quote Biometallism The fact that countries stampeded from silver and toward gold monometallism in the late 19th century should not obscure the fact that gold and silver, for centuries, were the world's moneys and that previous paper money experiments, the longest during the Napoleonic wars, were considered to be both ephemeral and disastrously inflationary.

1:43Specie standards, whether gold or silver, have been virtually coextensive with the history of civilization. Apart from a few calamitous experiments, such as John Law's Mississippi Bubble and the South Sea Bubble in the 1710s, and apart from the generation-long experience in Britain during the Napoleonic War, until the 20th century, specie rather than paper had always been the standard money. In the classical gold standard, every nation's currency was defined as a unit of weight of gold and therefore the paper currency was redeemable by its issuer, the government or its central bank, in the defined weight of gold coin. While gold bullion, in the form of large bars, was used for international payment, gold coin was used in everyday transactions by the general public.

2:37For obvious reasons, it is the inherent tendency of every money issuer to create as much money as it can get away with. But governments or central banks were, on the gold standard, restricted in their issue of paper or bank deposits by the iron necessity of immediate redemption in gold, and particularly in gold coin, on demand. As in the familiar Hume-Cantillon international price specie flow mechanism, an increase of The increase of the supply of francs and incomes in francs leads to A. an increase in both domestic and foreign spending, hence raising imports. and B. a rise in domestic French prices, in turn making domestic goods less competitive abroad and lowering exports less competitive abroad and lowering exports, and making foreign goods more attractive and raising imports.

3:41The result is an inexorable deficit in the balance of payments, putting pressure upon French banks to supply gold to English, American or Dutch exporters. In short, since in fractional reserve banking, paper and banknotes pyramid as a multiple of Gold Reserves, this expansion of the already engorged top of the inverted pyramid must inexorably be followed by a loss in the bottom, supporting the swollen liabilities. In addition, clients who are holders of French banknotes or deposits are apt to become increasingly concerned, lose confidence in the viability of the French banks, and hence call on those The result will be an often panicky and sudden contraction of banknotes, generating a recession to replace the previous inflationary boom, and leading to a contraction in notes and deposits, a drop in the French money supply, and a consequent fall in domestic French prices.

4:49The balance of payments deficit is reversed, and gold flows back into French coffers. In short, the classical gold standard put a severe limit upon the inherent tendency of monopoly money issuers to issue money without check. As Ludwig von Mises pointed out, this international species flow mechanism also described a correct, if primitive, model of the business cycle. While central banking and fractional reserve banking allowed play for a boom-bust cycle, the inflationary boom and its compensating bust was kept in strict bounds. While scarcely perfect or lacking problems, the classical gold standard worked well enough for the World, after World War I, to look back upon it with understandable nostalgia.