I’ve been making my way through one of Ralph
Hawtrey’s classic works, The Gold
Standard in Theory and Practice. The book is both highly readable and
insightful. Of interest today is Hawtrey’s narrative of the classical gold
standard.
Gold and silver were both used for exchange in
commerce throughout much of recorded history. It was not until the 1870s that
the western world moved to a uniform gold standard. The foundations for this
move were laid as a result of large gold discoveries in Australia and
California during the middle of the 19th century. Gold had been the
more highly valued money, which under bimetallism meant that it was hoarded and silver
was used for exchange as official par overvalued it. After the gold discoveries, the
reverse was true. The increase in the monetary gold stock brought down its
value so that now silver traded at a premium under bimetal standards. Hawtrey notes that this was
not without consequence:
The French franc from a silver unit became a gold unit. The two great financial centres of the world, London and Paris, were both gold centres.
At the time Germany employed a silver standard, and
conditions were not favorable for such a position:
Germany no longer derived any advantage from the silver standard in her trade with Eastern Europe, because silver had there made way for inconvertible paper. The bimetallic currencies of Western Europe had passed from a state of fixity in terms of silver [i.e., a de facto silver standard under a bimetal regime], with a slight fluctuating premium on gold, to fixity in terms of gold, with a slight fluctuating premium on silver… Even if the ratio of gold to silver continued to be stabilized by the bimetallism of the Latin Union, the silver standard might be expected to be a disadvantage to the German financial centres.
After its war in 1871 Germany adopted the gold
standard and suspended the free coinage of silver. With new demand for gold,
this shifted the price ratio in favor of a de
facto silver standard for bimetal regimes. [See my brief discussion of
Gresham’s law from last post.] That is, had bimetal regimes operated as they
had beforehand, silver would have been employed under those regimes. But at
this time, “Russia Austria-Hungary, Italy and the United States were using
depreciated paper” and France made her money inconvertible. With the suspension
of redemption in traditionally bimetal regimes:
There was nothing to relieve the sudden scarcity of gold, and the price of silver in gold began to fall. But that meant that the currencies of silver-using countries began to depreciate… The only remedy was the suspension of coinage of silver.
Given the above described political situation, the
general adoption of the gold standard appears to be an accident of history. What were the precise impacts of this "accident"?
An interesting, yet not broadly acknowledged, aspect
of the adoption of the gold standard concerns its promotion of a relatively unstable
price level. After the gold standard was adopted, the impact on the price level
from a change in the monetary gold stock or in production appears to increase. Notice the change that occurs in 1873:
Notice that prices had stabilized from about 1856 to 1873. The gold standard era can be divided into an era of price deflation, 1873-1896, and of price inflation, 1896-1914. During 1914 most nations on the gold standard suspended redemption, but since gold was implicitly the only metallic standard - the return of redemption was anticipated after the war - price rose steeply as demand for gold fell. Precisely what one would expect given a lack of metallic money substitutes.
I ran a series of regressions to investigate:
Years
|
VARIABLES
|
British GDP
|
Monetary Gold Stock
|
Constant
|
|
1839
|
Sauerbeck-Statist Index
|
-0.608*
|
0.469**
|
9.583***
|
|
to
|
(0.32)
|
(0.19)
|
(2.78)
|
||
1873
|
SIGMA2
|
0.00701***
|
|||
1839
|
Sauerbeck-Statist Index
|
-1.433***
|
0.878***
|
17.04***
|
|
to
|
(0.17)
|
(0.12)
|
(1.40)
|
||
1896
|
SIGMA2
|
0.00800***
|
|||
1839
|
Sauerbeck-Statist Index
|
-1.404***
|
0.868***
|
16.76***
|
|
to
|
(0.14)
|
(0.10)
|
(1.16)
|
||
1913
|
SIGMA2
|
0.00718***
|
|||
Standard errors in parentheses
|
|||||
*** p<0.01, ** p<0.05, * p<0.1
|
I used an ARCH model to account for the clustering
of price level volatility as changes in direction tend to occur for more than
one year at a time. The coefficients (those numbers with *s next to them) estimate
the percent impact of a one percent increase in the independent variables – GDP
and Monetary Gold – on the Sauerbeck-Statist Index, a measure of the British wholesale prices. The effect of both about
doubles across the entire time period after
the gold standard is established. The effects decrease slightly when the time period
is extended to 1913, likely due to the increase in production of gold that
began to occur in the 1890s after the discovery of the cyanide process for
extraction. This alleviated the impacts of an increase in demand for gold.
Bottom line, a monometallic standard is bad for
price stability. Was this bad for production? It is hard to tell because the industrial revolution was in full bloom at the time of the change. Clearly the world economy was able to handle a less flexible monetary standard as the growth associated with the period was before unthinkable. And perhaps the move to a common standard decreased transactions costs enough to compensate for the inflexibility. The interesting question is: on net, did the gold standard hurt or help economic growth?
Late note: The use of ARCH does not seem to matter as I receive the same output with a simple regression with Newey-West HAC errors.
Late note: The use of ARCH does not seem to matter as I receive the same output with a simple regression with Newey-West HAC errors.
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