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April 09, 2008


Gabriel Chodorow-Reich

Gold Standard
According to a survey conducted by Robert Shiller, forty-six percent of Americans “fully agree” with the statement: “If the government were to make a mistake next year, such as printing too much money, and creates prices that are 20% higher than they are today, I think that they should try to reverse their mistake, and bring prices back down where they are today” (Shiller 1996). In his lecture notes on this paper George Akerlof, as forgiving of behavioral quirks as economists come, stated that “he did not even have a guess what is on peoples’ minds when they give this answer” (Akelof 2007). Of course, the statement precisely describes the policy of the Bank of England and the other gold standard adherents as they sought to return to their pre-war par values following World War I.

The policy of returning the deflated currencies to their pre-war par values had disastrous effects. As Keynes argued throughout the 1920s, successful simultaneous deflation of both prices and wages required in impossible amount of coordination in wage bargaining in an economy as decentralized as England’s. The result instead was persistent inflation. Furthermore, when depression conditions developed at the end of the decade, adherence to the gold standard prevented central banks from having the flexibility to inject extra liquidity into the financial system to prevent banking crises (Eichengreen). Monetary authorities in 1930 may not have had Ben Bernanke’s expertise, but even if the fed chairman were transplanted back eighty years he could not have executed the full range of options seen over the past eight months without compromising the United States’ commitment to gold convertability.
Why did the world pursue these policies? Whatever benefits the gold standard had, its efficacy rested on its credibility in the eyes of the financial community. According to Bordo and Rockoff, restoring par value following crises and absorbing economic pain increased the credibility of the system by demonstrating the resolve of the central players. Sufficient credibility, moreover, could actually make the system self-reinforcing by encouraging speculative flows into any area suffering an attack because of investor’s belief that the attack would fail.

And the gold standard did appear to create a positive international environment from 1870 to 1914. Trade and foreign investment boomed, and world growth reached an unprecedented level. Of these factors, the gold standard probably had its largest direct effect on investment flows, and a secondary effect on trade due to the associated currency stability. Yet, in a debate echoed in the 1990s, it is not clear that the capital flows had so large an effect on growth. Fishlow cites the U.S. railroads as an example where foreign investment appeared to have a positive effect, but he also points out that the railroads succeeded partly because foreign capital constituted such a small part of the total financing. As at the end of the twentieth century, foreign investment also precipitated a series of payments and debt crises, in such familiar countries as Argentina, Brazil, Peru and Turkey.

A system of fixed exchange rates probably made sense at the turn of the century if for no other reason than that era lacked the communication and information technology necessary to have a market of freely floating currencies. Without such markets international traders would have faced possibly prohibitive amounts of currency risk, thereby inhibiting the flow of goods and services across borders. The world would have done well, however, to adopt a less restrictive regime than the immutable gold standard. With proper international coordination, world-wide devaluation following World War I could have prevented the recessionary environment in much of Europe. And if Depression still came, policy-makers might have shown greater willingness to adjust or abandon a more flexible system than the iron-clad, set-in-stone gold standard.

Other Sources Cited
Akerlof, George (2007). Lecture notes for 202a. Lecture VI.
Shiller, Robert (1996). “Why Do People Dislike Inflation?” Yale University. Mimeo.

K. Powers

Several components and consequences of the gold standard system suggest that another international monetary system might be a better choice. A primary feature of the gold standard system, according to Michael Bordo in The Concise Encyclopedia of Economics, is that it relies on the price-specie-flow mechanism in order to ensure balanced prices among countries. However, John Dutton cites studies by Nurkse (1944), Bloomfield (1959), and Pippenger (1974) that belie the dependence of the gold standard on this mechanism, since a majority of central banks in the pre-war period took short-term actions that hampered market-based balance of payments adjustments. For instance, many central banks participation in sterilization, the trading of domestic securities in order to protect the domestic money supply from disequilibria abroad (Bordo 4). The medium- and long-term actions of the Bank of England, at least, did not violate the “rules of the gold standard game,” and central banks also rarely toyed with the value of their currency in order to promote growth in the domestic economy (Dutton 174-175; Bordo 5). But even if central banks in the late nineteenth century had completely followed the “rules,” the lack of discount rate stability implicit in the “game” put business at a disadvantage. Being a period of “relatively free trade in goods, labor, and capital,” the tying of both monetary and real shocks abroad to the domestic economy also made it difficult for business (Bordo 1, 3; Dutton 175-176).

In addition to the discount rate, short-term prices were very unstable during the gold standard regime. In particular, Australian and Californian gold discoveries around 1850 led to a surge in the money supply and, therefore, the price level (Bordo 2). Monetary and real shocks, therefore, would not only affect business; frequent changes in price levels also affect the stability of real income for the country of discovery as well as its trading partners (Bordo 3). The coefficient of variation for short-term prices was 17 between 1879 and 1913, compared to 0.8 between 1946 and 1990. Real output, according to Bordo, also suffered from more instability in the earlier period, earning a coefficient of variation of 3.5, which decreased in the later period to 1.5 (5). On the other hand, Andrew Young and Shaoyin Du found that, “if there was a structural break in the volatility of real GNP it was considerably later than the 1933 departure from the gold standard” [1].

In contrast to short-term price instability and individual countries’ money supply manipulation, the late nineteenth century saw an annual inflation rate near 0.1 percent. This contrasts with a 4.2 percent annual inflation rate between 1946 and 1990 (Bordo 5). Additionally, the largest central banks maintained their ability to convert their currencies into gold in the late nineteenth century, thus warranting John Dutton’s labeling of the period as a “halcyon period of international monetary relations” (Dutton 173).

In conclusion, given that, in the late nineteenth century, “the achievement and maintenance of reasonable stability in the level of economic activity and of prices” was not a primary policy objective of central bankers, it would be difficult to assert that a standard besides that of gold would have been more acceptable at the time (Dutton 175). However, Young and Du also found that “abandonment of the gold standard ushered in longer expansions absolutely and relative to adjacent recessions” (13). So what are the alternatives? Architects of the Bretton Woods system believed that floating exchange rates caused economies to suffer from “destabilizing speculation and competitive depreciations,” and indeed, many domestic economies have suffered currency crises since the Smithsonian Agreement in 1971 [2]. However, the Bretton Woods system also rested on the assumption that U.S. monetary policy would be stabilizing; increased U.S. government spending after 1965 illuminated the inability of pegged rates to deal with increasing payments imbalances, as well as the persistence of speculators in destabilizing currency. The U.S. also held an incredible amount of political power over the whole system (Cohen 8). Although free-floating currencies can slip relatively easily into financial crisis, the modified free-floating system that includes international regimes—especially considering evidence that this system leads to longer economic expansions—is probably the system I would recommend for the late nineteenth century.

[1] Andrew Young and Shaoyin Du, “Did Leaving the Gold Standard Tame the Business Cycle? Evidence from NBER Reference Dates and Real GNP,” Working paper, March 2007: 21. Accessible at http://ssrn.com/abstract=985152.
[2] Benjamin Cohen, “Bretton Woods System,” Prepared for the Routledge Encyclopedia of International Political Economy: 2 http://www.polisci.ucsb.edu/faculty/cohen/impress/bretton.html.


Rules of the game.
Bordo argues that the gold standard rested on countries playing “by the ‘rules of the game,’” which Britain did and France and Belgium and others did not as much, but they still did for the most part. Because the standard determined the rules, countries could continue to play by the rules, and rely on the cooperation and thus credibility discussed by Eichengreen, and thus the system could be successful. Yet, as Eichengreen relates, after World War I, the game was changed and the system could no longer function as before.

In answer to the question, I did not find evidence in these articles that a system that was preferable to the gold system as it was functioning at the end of the 19th century was available. There may have been no plausible superior alternatives because while the international monetary arrangements implied by the gold standard became impractical or suboptimal later on, at the time, they were effective.

Eichengreen’s argument that the stability of international monetary systems was due to credibility and cooperation implies that the system was already reasonably insecure. These factors may have been very easy to lose. Bordo points out that many countries already “broke the rules” and that even England and the United States occasionally pulled out of the system, even though they returned after emergencies. Thus the first World War was an instability too much to handle. Eichengreen cites those who believe that “the collapse of the gold standard destroyed confidence in financial stability, prompting capital flight which undermined the solvency of financial institutions.” While he disagrees, arguing that the Gold Standard was itself the problem, he specifies that it is the gold standard after WWI that was at odds with long-term international monetary stability and acknowledges a – possibly precarious – pre-war stability.

Speculation: The rules of the game are what matter. Perhaps the rules set out by the gold standard did not provide a perfectly equitable distribution of international power and perhaps the more complex system today does not either. The rules aren’t perfect now and they were not then. For example, previously, countries may not have risked the disastrous effects of hyper-inflation occasionally seen in the last century and presently in Zimbabwe, and currently central banks may have too much discretionary power. Still, it’s unclear that a perfect set of rules exists and thus having an agreed upon set of rules with limited incentives to deviate in a way that is harmful to others at least gives governments the information needed to play the game and make decisions about involvement in the international monetary system. The gold standard did may have done this at the end of the 19th century, but this week’s readings effectively imply that it cannot be reinstated.

Mitchell Hoffman

Although it is extremely difficult to argue with much certainty, I would argue that the world economy would have been better off in the late 19th and early 20th century if the world has used the current fiat money system in place today instead of the gold standard.

The main advantage of the gold standard, as discussed by Bordo, is price stability. Mean inflation under the gold standard was much less than mean inflation after its usage was discontinued. However, as discussed by Bordo, use of the gold standard may limit the capacities of central banks and/or governments. While the gold standard helped avert inflation, it also likely contributed to large-scale deflation.

This discussion is connected to the size and costs of business cycles in the late 19th century. In US History class, we were taught that the crashes in the late 19th century were some of the worst in American history, for example, the Crash/Crisis of 1893. These business cycles were significantly larger than business cycles in the mid to late 20th century. Although Christina Romer has argued that apparent differences in magnitude between 20th century and late 19th century business cycles may simply reflect measurement error in late 19th century aggregate variables, it is still likely that 19th century business cycles were significant in size. And it is likely that even if the gold standard brought price stability that its usage was a constraint in dealing such financial crises.

Eichengreen argues broadly that the use of the gold standard helped contribute to the financial and economic crises of the early 1930s, including the Great Depression. He argues that effective use of the gold standard required political cooperation between countries. Post World War I, as there seemed to be a decline in political cooperation, it is likely that effective international usage of the gold standard became more difficult. Although my background knowledge of this subject is limited, Eichengreen’s arguments appear persuasive to me, and seem to apply not only for the interwar period, but also for the late 19th century. While it is true that the present day system of fiat international currency also requires some political cooperation (for example, in dealing with issues of currency pegging, as the US currently has with China), if political cooperation was present in the late 19th century and so allowed the gold standard to function fairly well, it would have also facilitated usage of the fiat currency system.

Irwin’s article on the US tinplate industry does not related directly to the question of the gold standard, but is rather concerned with whether tariffs helped promote the US tinplate industry. Irwin argues that tariffs, even if they may have helped the industry develop quicker, are not justified in a cost-benefit analysis, as the industry would’ve developed though a little slower. If a virtue of the gold standard is that it provides price stability so that tariffs can be implemented by governments to allow growth of new domestic industries, Irwin’s article signifies that this is not much of a benefit to count in the gold standard’s favor, as industry growth would’ve occurred without the tariff protection.

Ernie Tedeschi

The United States withdrew from the gold standard in 1971, signaling the demise of a financial system in place on a de facto basis since as early as the 18th century. For years, many thought of the gold standard as the bedrock of global capital, a symbol of stability. But several of the readings this week cast doubt on that very assumption, both in terms of implementation and empirical results. The question arises, then, whether the world could have experienced more robust growth with an alternative monetary system in place. I believe the answer is that given the level of economic sophistication present in the 19th century, the gold standard, flawed though it turned out to be, was the best of the choices available to central bankers.
The gold standard undoubtedly had its advantages. When working correctly, the system self-corrected global account imbalances. Michael Bordo also points out that long term inflation during periods of pre-World War I gold standard adherence – the “classical” gold standard – was an almost non-existent one-tenth of one percent, a record that exceeds modern central bank performance. Low long term inflation, however, came at the expense of employment and short-term price stability. Under the current fiat money system, unemployment has been lower and inflation more predictable. Institutionally, the gold standard was prone to poor implementation. John Dutton finds that, even in times of peace, the Bank of England did not adhere to the “rules” of gold standard monetary policy well at all: it acted counter-cyclically when it should have adjusted rates to encourage market-driven adjustments in national gold reserves. The gold standard also proved to be a lumbering mastodon in the face of financial and national crises. This explains why most “core” gold standard countries left it in times of war, and why they all eventually dropped the standard in the fact of the Depression. Barry Eichengreen argues that those who did so recovered more quickly.
Given what 19th century central bankers knew about economics in general and monetary policy in particular, however, and given the lack of supportive financial institutions such as deposit insurance, the gold standard was probably the least of all evils. Several countries had attempted a bimetallic monetary system, only to misprice silver and gold relative to one another, often leading to a de facto gold standard. The bigger question would be the success of a fiat money system with more active central banks in the 19th century. Central banks were likely not up to the task. The Bank of England was still private and for-profit. The United States did not even have a central bank until 1913. And coordinating a set of rules amongst central bankers proved difficult enough under the gold standard, when the “proper” responses were relatively straight-forward. The one counterargument is that in the absence of large social programs prior to the Great Depression, fiscal policy would not have interfered with central bank actions, and so a fiat monetary system with independent central banks might have proven more effective than even now.

Edson R Severnini

As defined by Bordo, “the gold standard was a commitment by participating countries to fix the prices of their domestic currencies in terms of a specified amount of gold”. The period from 1880 to 1914 is known as the classical gold standard: the majority of countries had adhered during that period and it was a interregnum of unprecedented economic growth with relatively free trade in goods, labor, and capital. Despite of the fact that fluctuations in the amount of gold that was mined could cause inflation/deflation, that the gold standard system could lower the options for central banks to respond to economic crises, and that the system could be susceptible to speculative attacks when a government financial position appeared weak, I think that the world economy could not be better off if it had adopted some other form of international monetary arrangements late in the nineteenth century, because the gold standard protected countries from hyperinflation and other abuses of monetary policy, as were seen in several moments in the economic history after 1914, and then allowed the world economy to grow with relatively long-run price stability in a period that the policymakers did not know so much how to manage monetary policy in a dynamically consistent way.

Bordo explains that the gold standard was a domestic standard, regulating the quantity and growth rate of a country's money supply, and also an international standard, determining the value of a country's currency in terms of other countries' currencies. Although periodic surges in the world's gold stock, such as the gold discoveries in Australia and California around 1850, caused price levels to be very unstable in the short-run, this monetary system caused price levels around the world to move together (since exchange rates were fixed) and to be stable in the long-run. In fact, Bordo affirms that the great virtue of the gold standard was the long-term price stability (the average annual inflation rate was of 0.1 percent between 1880 and 1914 and of 4.2 percent between 1946 and 1990).

Furthermore, although economies on the gold standard were less able to avoid or offset either monetary or real shocks because that system gave government very little discretion to use monetary policy, that monetary system protected the citizens from abusive inflationary policies and provided the government with a simple rule to do monetary policy. Indeed, that simplicity was so helpful: the policymakers of that time probably did not know how to manage dynamically consistent monetary policies, for instance, so even if the governments wanted to do monetary policy in a responsible way, they could end up in a Prisoner's Dilemma game and, consequently, nominal interest rates would rise to high levels, swelling the government's expenses and inflicting welfare losses. As a result, the variability of the real output and the economic losses could be even higher that they in fact was during the classical gold standard period.

Alexandre Poirier

Gold standard as an international monetary agreement seemed to be a very good system during the time considered (1870-1914). On the other hand, the gold standard between the two World Wars is arguably a cause of the Great Depression. Let's examine the pros and cons of the gold standard during the 1870-1914 period, and consider the alternative arrangements. The gold standard fixes the price of a currency to an amount of gold: this causes stability of exchange rates across countries on the gold standard. But, according to Fishlow, the overall arrangement encouraged foreign investment, especially towards peripheral developing countries. Also, exchange rate stability may have had an effect on international trade, as constant terms of trade greatly diminishes export and import variability. There may have been a positive effect on trade from this stability, but it is debated. Also, by tying money supply to a relatively constant gold reserve, there was little price variation in the long run. In fact, average inflation during the 1880-1914 period was of 0.1%.

The gold standard prevented countries from having independent monetary policies, because if the central banks were playing by " the rules of the game ", then an increase in the domestic price was supposed to be counterbalanced by a change of the bank rate, facilitating the outflow of gold until the ratio of the domestic to foreign price was restored. This is a strong disadvantage of the standard. Also, adherence to the standard meant very little domestic monetary policy power, as they cannot inject lots of liquidity on the market without correspondingly increasing their bank reserves. This inability to use discretionary monetary policy may have helped the spread of the of the Great Depression from the United States to the rest of the world (see Eichengreen).

Another caveat of adhering to the gold standard is the volatility cost it imposes on key economic variables. The money supply, so closely tied to the quantity of gold reserves, was very sensitive to changes to the amount of gold in reserve, and other real shocks. Since discretionary monetary policy was very weak, the central banks could not smooth these real and gold shocks, and reduce the volatility of output and the price level. As Bordo shows, the inflation rate and real output were more volatile during the gold standard years than afterwards. Also, the unemployment rate was much higher during these years.

One can ask what other monetary arrangements would have been possible at the time. A fully floating exchange rate seems to rely too heavily on communication technology to be an efficient way to organize world trade and finance. Maybe the gold standard was the best way to organize the system, as it promoted high growth and high foreign investment.


This is a question quite difficult to answer, as we need to rely on counterfactual evidence to argue if other alternate monetary agreements is better than the gold standard.

The most important distinction of monetary systems is whether a particular system depends on fiat money or on representative money, such as the gold standard. The main advantage of having a fiat currency is that the central bank can use its power to fight against recession. This can be significant as we see from what happened during the great depression. There remains some doubt on if the central banks at the time can utilize the fiat currency to mitigate the recession, but, as Eichengreen argues, the gold standard was not effectively used due to the lack of cooperation among countries, either. Deflation can be much more harmful than inflation.

The advantage of representative currency system is recognized as the price stability it provides, as stated in Bordo. However, this argument is quite hard to defend ex ante. As the monetary supply in the gold standard system is effectively dependent on the supply of gold as chemical substance, the stability it seems to have provided may well be illusionary. It just might be the case that no major gold production site was found during the era by pure chance.

Among the readings, Irwin claims that the protectionism for infant industry was partly effective, but not beneficial for a country as a whole. Tariff is more efficiently introduced with the gold standard, or any other representative currency schemes, than the fiat counterpart. Hence, his argument also works against the gold standard system.

As seen easily, I'm leaning towards the fiat money system, but then I need to answer why the gold standard had been maintained for a long time. If it is advantageous, then it should have been introduced earlier. This can be explained by coordination failure and the lack of knowledge. As the representative money is so easy to understand and had been used for eons, the new fiat money system must be first discovered and recognized as useful by many countries. It's easy to imagine this is a tough task without a horde of macroeconomists like what we have now.

As a matter of comprehensiveness, other form of representative money systems should be discussed, too. However, this is not very difficult. As the fiat money scheme took so much time to be implemented, persuading people that a new money system is a daunting task. It would be harder if there's no factual evidence like one the fiat money has.

Insook Lee

For settlement of trade, the criterion for the exchange and convertibility of currencies must have of huge and unprecedented importance at the era of rise in international trade around 18th century. It might be natural to think that gold as the pivot since there apparently was no political conflict over whose currency worked as anchor for transnational payment. In addition, as Bordo pointed out, gold standard could assure the long-term price stability. This was also supported by the empirical analysis of the tariff on the infant industry by Douglas Irwin (1998), which shows that protective measure of tariff turned out not to be that helpful for the industry, since in the inertia of price convergence, the industry could have developed without it. However, it was just case of tinplate industry which probably does not apply for the economy wide concern. It is because sharing standard or ratio of currency with different countries and, in a certain sense, fixing a price level, which was not based on the real goods market clearing conditions, cannot avoid certain side effects. Since nominal terms of economy should follow the real terms, putting artificial fix point in one part is highly likely to make some problems, especially confronting short fluctuations of real economy.
However, the problems also arouse from financial markets, not only from goods markets. As Albert Fishlow (1985) argued, before 1914 capital market under the gold standard system did NOT operate smoothly. In fixing the value of currency with a certain ratio of gold was troubling and risky source of cyclical swings. Nevertheless, the volume of international trade of goods and capital grew in the gold standard system, since capital importers had to expand export in order to pay loans. And at the center of international capital flow lay England who was benefited from the trade. But whether gold standard was good housekeeper of this growing global economy begs some skeptics and critiques. Since as Albert Fishlow(1985) showed that there was not decent measure for default crisis in gold standard system, and in fact Baring Crisis of 1890 and Russia’s revenue default damaged the other economies a lot. In short, gold standard system was not effective in responding some fluctuations or events.
Indeed, gold standard system does not imply that the monetary policy was as inflexible as gold. Even though in principle, latitude of monetary policy of central banks was supposed to stick to the exchange ratio to gold, this was not always the case even for the England who was the leader of that system. John Dutton (1983) finds that Bank of England violated a sort of “rules of game” that is monetary prescription designed in gold standard system and provided some manual of prescription. However, John Dutton (1983) showed that Bank of England took counter cyclical monetary policies, which were not obeying “rules of game” Nevertheless, apparent principle was to stick to gold standard. As pointed out above, this loss of freedom or flexibility was doomed to raise unnecessary loss due to drop the ability of adjustment in the process of market clearing. Thus, if more flexible convertibility could have been feasible in that period, world economy would flourish more than otherwise. Since only based on reading for this week, it is hardly possible to verify the possibility of alternative system, although they gave me a broad and rough picture how it worked. Therefore, the extent of development of credit market is not sure at the moment, but if it were widely used at that time, it would work better than stiff gold. Since it can decrease the side effects of sticking to each other and losing a certain degree of flexibility, which was detrimental to the stabilization of economy and stable growth in the long run.

Tijl Vanneste

To answer this question, one would have to define 'the world economy' and a way of evaluating its condition. It is a complicated matter. Can the late nineteenth century indeed be labeled as already containing one world economy, wherein as far as international monetary arrangements is concerned, the gold standard did not have competition?
The late nineteenth century has been labeled an era of globalization, aided by technological improvements in transportation and communication. It seems that the adoption of the gold standard could be seen as either a consolidation of a process of (partial) globalization or one of its causing factors, in causing the price levels around the gold-standard world to move together. It caused a long-term price stability, but as different readings agree, the short-run stability was not guaranteed (see for instance the case of the California gold rush). The gold standard tied the world closer together, and it seems that this could succeed because the countries on the gold standard did have an international way of thinking (Eichengreen, p. 6). The workability of the system depended on credibility and cooperation. It created a ‘safe’ environment wherein international investors and traders could know what to expect since the exchange rates of currencies remained fixed. It created a certain predictability as well that was a good incentive for trade. It seems then that the gold standard, in having countries adopting external financial policies and cooperating, thus creating an international frame of mind rather than a domestic one, and in creating a system that minimized the risk of major falls in exchange rate, indeed greatly benefited a globalised world of commerce. It was a time wherein foreign investments were very popular, just think of the railroad. As some of the readings point out (Bordo, Eichengreen) this evolution could only take place in the absence of a stronger domestic focus. The gold standard did create problems at home, unemployment was a major issue. Since it was at the time not always perceived as such, or since the people who did see it as a major issue did not yet possess the necessary powers to change things, it seems that the flipside of a successful world economy was a social domestic problem that only became larger rather than being solved. It were also domestic forces, economically as well as politically, that threatened later the gold standard. The world was not politically unified, and it seems that economic global agreements at some point became doubted, this was the case then as well as it is today. The adherence to the gold standard did not make domestic interests disappear, as can be seen in for instance Irwin’s paper. The U.S. government did for instance adopt tariff policies to benefit home production. According to Eichengreen, at the time import duties were the most important revenue incomes for governments (Eichengreen, p. 7). Irwin argued that in the tinplate industry, the tariff adopted caused home production to start somewhat earlier, but that it would have taken off at some point. Furthermore, tariff protection did not survive a cost-benefit analysis. Import duties did not seem to be a fantastic thing when it came to stimulating home production in a world economy that became more globalised. Alternatives for the gold standard perhaps would have worked better on a domestic level, but then perhaps flows of trade and finance could not have taken the same dimension. Already in 1867, Napoleon III of France argued for a single world coinage. It seemed however, if it could be theoretically beneficial, a historical impossible option.

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