The Gold Standard: Theory, History, and Renaissance

Master's Thesis, 2013
72 Pages, Grade: 1,7



List of Figures

List of Tables

1. Introduction
1.1. Note on quotations

2. History
2.1. The path to the classical gold standard
2.2. The classical gold standard
2.3. The gold exchange standard
2.4. Bretton Woods
2.5. The end of the gold standard

3. Theory & Renaissance
3.1. The price-specie flow mechanism and the balance of trade
3.2. The price-specie flow mechanism under the gold standard
3.3. Flows of gold and gold obligations
3.4. Commodity money supply without central banks
3.5. Costs of a return to a gold standard
3.6. Fractional reserve banking
3.7. Critique on the gold standard
3.8. Alternatives to the gold standard

4. Conclusion
A. Global gold reserve data
B. Global money supply
B.1. United States
B.2. United Kingdom
B.3. Euro zone
B.4. Japan
B.5. India
B.6. China
C. Monetary stability


List of Figures

A.1. World gold stock and gold production, 1800-1932

A.2. World gold production, 1820-1975

C.1. Wholesale price index, United Kingdom, 1880-1979

C.2. Wholesale price index, United States, 1880-1979

List of Tables

3.1. Aggregated balance of commercial banks before Rothbard’s plan

3.2. Aggregated balance of commercial banks after Rothbard’s plan

3.3. M1 and gold price for selected countries in December 2012

3.4. Gold reserves and gold target price for one hundred percent reserve

3.5. Gold reserves and required gold at the one hundred percent reserve

3.6. Fractional reserve percentage and resulting exchange rates

A.1. Global gold reserves by October 2012

A.2. Gold reserves of euro zone member countries, October 2012

B.1. US Dollar M1 and M2 for 2012

B.2. Great Britain Pounds M1 and M2 for 2012

B.3. Euro M1 for 2012

B.4. Japanese Yen M1 for 2012

B.5. Indian Rupee M3 and M1 at selected dates in 2011 and 2012

B.6. Chinese Yuan M0, M1 and M2 for 2010

1. Introduction

After the financial crisis of 2007/2008, the central banks in the United States and also in Europe strengthened their policy of cheap money that has been in force since the dotcom bubble crisis of 2001. Due to this policy, the money supply increased rapidly and endangered the low inflation rates the central banks were committed to.

The possibility of an increased inflation motivated the opponents of the current existing fiat money system to raise their voices against it. Especially libertarian economists from the United States, most of them committed to the Austrian School of Economics1, advocate for the relaunch of commodity money. According to their opinion, this commodity money can only be gold specie or at least a gold backed currency.

Since the beginning of the crisis, a number of economists worldwide sym- pathised with the idea of a gold standard2. The idea of returning to the gold standard Rothbard (2008), Skousen (2010) and others describe it, is worth thinking about.

The thesis on hand provides a historical overview of the short period when the gold standard existed. Since the advocates of the gold standard regard the years of the gold standard as a period of economical growth, prosperity, and stability, the historical part of this thesis focuses also on the crises that occurred during these years.

Besides the historical facts regarding the gold standard, the thesis on hand explains the theoretical foundation of how a gold specie or a gold backed cur- rency works. Based on works of Hume, Keynes, and others, this theoretical foundation of a commodity money, especially a monetary system based on gold, is explained. Using these theories and bringing them together with the historical facts, ideas that involve the possibility of a relaunch of the gold stan- dard are analysed. Regarding such a relaunch, many advocates of the gold standard argue with soft factors such as trust and freedom3. As these factors cannot be proven by historical data and cannot be measured on a worldwide basis, the thesis on hand takes only economical facts into account, such as the monetary supply, economical growth and gold supply.

Based on the analysis of a possible relaunch of the gold standard, the work of some opponents of the gold standard, such as Keynes, Krugman and Eichengreen are considered as well.

1.1. Note on quotations

As a number of electronical books on Amazon Kindle have been cited within the document, the following abbreviations are used to reference positions in these books:

- kp. is used to refer to a Kindle position similar to APA 6 p.
- kps. is used for Kindle positions in the meaning of APA 6 pp.

2. History

This chapter provides a historical overview of the evolution of the gold stan- dard. As there are many different views on the time line of the gold standard, G. Davies (2002) has been chosen as the main reference1 since he provides the most comprehensive and inherently consistent overview of the history of money.

The gold standard existed between 1819 and 1976 in more or less defined variants (Bordo, 2008). Most economists distinguish between three major phases of the gold standard.

The first main period was the prewar gold standard which existed before 1914. This period is mentioned by serveral authors such as Whale (1937), Ford (1960), and Bayoumi and Eichengreen (1996).

Depending on the country observed the authors of different articles chose dates between 1821 (Jarchow and R ühmann (1984, p. 30) as cited in Warnecke (2010, p. 22)) and 1890 (Husted and Melvin (2001, p. 472) as cited in Warnecke (2010, p. 22)) as the beginning of the gold standard. G. Davies (2002, p. 355) stated 1850 as the beginning year of the full gold standard.

Regarding the classical gold standard some authors use 1870 as its beginning year (e.g. Capie & Wood, 1996) while others choose an even later date up to the year 1880 (e.g. McCloskey & Zecher, 1976). The United States of Amer- ica returned to a single metallic standard in 1879 (Elwell, 2011, p. 6), being the last of the relevant economic players in the world to bind its currency to gold. Therefore, that year will be treated as the beginning of the classical gold standard in the following chapter. The years before 1879, when more and more countries followed England by replacing bimetallic or silver currencies with gold specie are discussed in chapter 2.1 while the era of the classical gold standard is discussed in chapter 2.2.

The second major period of the gold standard started in 1925, seven years after the end of World War One. To distinguish this second period from the classical gold standard, the term gold exchange standard2 is used in chapter 2.3, respecting the terminology used by Skousen (2010, p. 35), Nurkse (1944) and Bordo (2008).

The conference of Bretton Woods in 1944 was the beginning of a third period of the gold standard which is discussed in chapter 2.4.

2.1. The path to the classical gold standard

In 1821, Britain reached the full gold convertibility of its currency as the first European country. In the years before, England underwent a massive change in its monetary system.

From 1663 to 1816, the Guinea, the world’s first coin minted from gold us- ing machines, had been used as money in Great Britain (Frank, 2007). One reason to stop the minting of the Guinea in 1813 was the fixed exchange rate between the Guinea and the Pound Sterling. This exchange rate fluctuated according to the price level of silver and the value of the commonly used unit of silver, the Pound Sterling. The nominal exchange rate between the Guinea and the Pound Sterling was often adjusted during this period. In 1717, Isaac Newton finally calculated a ratio of 21 Pound Sterling for 1 gold Guinea. A mistake he made in his calculation resulted in an over-valuation of gold in Great Britain.

In 1817, a new gold coin, the Sovereign, was introduced (Frank, 2006). Two years later, England decided to restore a full gold convertibility of its cur- rency. According to the Act for the Resumption of Cash Payments, this was to be achieved by 1823. In fact, the convertibility was possible in 1821, two years earlier than planned.

From 1821 to 1844, the Bank of England strengthened its position by being the only bank allowed to emit money. The first step towards this was the decision in 1833 to make the Bank of England’s notes the only legal tender in England. Another step was the full backing of the Bank of England’s notes by gold in the Bank Charter Act in 1844 (R. Davies & Davies, 1999a). This act split the Bank of England into two parts: a commercial banking department and a central banking department. The amount of gold held by the central banking department was to be adjusted according to England’s trade balance (Ferguson, 2012, p. 51).

Although the Bank Charter Act was suspended three times during the crises of 1847, 1857, and 1866, it was the foundation of Britain’s financial system until the Currency and Bank Notes Act of 1928. The strict interpretation of the Bank Charter Act had the effect that the amount of gold, the Bank of England held, exceeded the value of the bank notes issued to the public. One sideeffect of this strict policy was the emergence of a non-secure deposit banking business in Britain (Ferguson, 2012, p. 52).

In 1954, Portugal adopted England’s system of binding its money to gold as Great Britain was its major trading partner. The majority of the other coun- tries in Europe used a bimetallic monetary system at that time. Portugal was afraid of problems arising from the increasing international trade across Eu- rope.

To solve these problems France, Belgium, Italy, and Switzerland founded the Latin Monetary Union (Union montaire latine) in 1865. The goal of this union was to ensure the convertibility of each country’s coins into the others’ using a ratio of 15,5:1 between silver and gold. Three years later, in 1868, Greece joined the Latin Monetary Union3.

After a period of fast economical growth and the victory over France in 1871, Germany used the opportunity to change its monetary foundation from silver to gold. This movement was supported by the reparations of 5 billion gold Francs, which France had to pay to Germany. Germany then used the gold to mint Goldmark and simultaneously sold its silver stock. The Scandi- navian countries Denmark, Sweden, and Norway followed in 1873 by form- ing the Scandinavian Monetary Union with gold as foundation for their cur- rency (R. Davies & Davies, 1999c). In 1874, first countries in the Latin Mon- etary Union followed, too (Lewis, 2007, p. 155). The Latin Monetary Union officially ended the bimetallic standard in 1979 (R. Davies & Davies, 1999d). The appeal of converting to gold specie instead of continuing bimetallism arose through the gold finds in the 1850s and through the dominant trading power of the British Empire in the 1870s (G. Davies, 2002, p. 356).

Another country, the United States of America, officially stopped coining silver in 1873 (Lewis, 2007, p. 155) and fully adopted the gold standard in 1879 based on the Resumption Act of 1875. From this time on, the world’s leading industrial and agricultural countries followed the idea of gold backed currencies.

Notwithstanding, Bordo (2008) argues that the United States actually al- ready switched to the gold standard in 1834 and formally in 1900 with the Gold Standard Act4. Indeed, the price for gold was fixed in 1834 at $20.67 per ounce and remained unchanged until 1933.

The path to the gold standard was not straight, but marked by a number of crises in the United States, Britain, and some other European countries. The first crisis was the banking crisis in the United States in 1837. It was caused by an expansion of the banking sector in the years before and continued until 1843. Trigger of the crisis was the rejection of New York banks to convert notes into gold or silver in May 1837.

In 1847, numerous local banks in France collapsed, forcing the Bank of France to establish branches in the whole country during the following decades (G. Davies, 2002, p. 558). In the same year the limiting of notes not backed by gold by the Bank of England was suspended to prevent an economical crisis. The same measures were taken during the crises of 1857 and 1866, when the Bank of England was forced to act as a lender of the last resort (Selgin, 2010, p. 94).

The crisis of 1857 started in the United States. It was the first global economical crisis, because European countries had made major investments in the United States and therefore were also influenced. Even though the crisis was, again, caused by banks not being able to convert notes into specie, its main trigger can be found in the excessive loans granted in the years following the gold rush that started in 1948 (G. Davies, 2002, p. 486).

2.2. The classical gold standard

During the period from 1879 to 1914, the value of silver declined. This was caused by a large amount of new mines and the amount of demonetarized sil- ver of the countries migrating from silver or bimetallic currencies to the gold standard. All of this caused an extreme decrease in value of the currencies of countries still remaining on silver, e.g. China, India, and Japan (R. Davies & Davies, 1999c).

The world’s output of gold more than doubled in the years from 1890 (5,7 million ounces) to 1900 (12,3 million ounces) (G. Davies, 2002, p. 498). This growing amount of available gold allowed the countries committed to the gold standard to increase their amount of money in a more or less balanced way in comparison to the growing economy.

The United States, one of the major producers of gold in the 1890s cancelled the laws regarding silver purchases5 in 1893 (R. Davies & Davies, 1999c) due to fear of an insufficient gold supply to back the circulating currency. This fear was justifiable as the United States had been a gold exporting country with up to $79 million a year until 1895. After that point of time, the United States turned and ”became, thanks to running a favourable balance of trade, a net- importer of $201 million of gold altogether in the next three years” (G. Davies & Davies, 1999, p. 498).

In 1882, Japan founded its own central bank, the Bank of Japan, using the Bank of Belgium as a model. Fifteen years later, Japan officially joined the gold standard. It achieved the full convertibility of the Bank of Japan’s notes into gold in 1899 (R. Davies & Davies, 1999c). One year after Japan had joined the gold standard, India decided to peg the silver rupee to the pound sterling.

At the end of the 19th century, only a small number of countries were left using silver as money. Some of them joined the gold standard in the first years of the 20th century, such as Mexico, Urugay, Peru, and Siam did in 1908.

During the whole era of the classical gold standard, the amount of the worldwide monetary gold stock continually increased, becoming more from 1895 onwards (see fig. A.1, page 49). During that time round about 5% of the produced gold was used to increase the monetary stock (Skousen, 2010, p. 74). This period may also be considered as the main foundation upon which the argument of price level stability under the gold standard is based. As O’Donoghue, Goulding, and Allen (2003) show, the price inflation was nearly zero in the UK in the years of the classical gold standard. Skousen (2010, pp. 93) shows that the wholesale price index for both, Britain and the United States, had a slight deflationary tendency.

In spite of the stability proven by the gold standard, other crises occurred during that time. The first crisis was the Great Depression6 in Britain from 1873 to 1886 (R. Davies & Davies, 1999c) which lead to first doubts on the merits of the gold standard.

The United States were plagued by a bank panic in 1893 when ...members of bank clearing houses would issue and accept among themselves ’clearing house certificates’ for settling inter-indebtedness, leaving the precious notes and gold more exclusively available for their more fearful and impatient retail and personal customers. Thus during the height of the 1893 crisis 95 per cent of all clearings in value in New York were settled with clearing house certificates.

G. Davies and Davies (1999, p. 501)

With growing economies in the United States and Germany, Britain lost its leading position in global economy and trade. Even though it had been a leading provider of money in the world, Germany closed the gap until 1914.

The first world wide suspension of the gold standard is associated with the beginning of World War One in 1914 (G. Davies, 2002, p. 372, pp. 504). Most nations committed to the gold standard required credit and therefore suspended the backing of their currencies with gold accepting the resulting increase in inflation.

2.3. The gold exchange standard

After the war, most participating countries had gathered a high amount of debt that did not allow them to continue the prewar gold standard. The gov- ernment debt of the United States rose from $1 billion in 1916 up to $25 billion in 1925 (G. Davies, 2002, p. 506), the French debt increased from 28 billion Francs to 151 billion francs (R. Davies & Davies, 1999e). Germany suffered under the inflation caused by unbacked notes and the reparations until 1923 (G. Davies, 2002, p. 574).

The German problems resulting from the reparation payments defined in the Treaty of Versailles were predicted by John Maynard Keynes in Economical Consequences of the Peace (Wapshott, 2012, kps. 100). In this book, Keynes also advocates the cancellation of debts raised during the war (G. Davies, 2002, p. 379). The cancellation of debt was refused by Montagu Norman, Governor of the Bank of England, to keep ”the City of London’s superlative reputation” (G. Davies, 2002, p. 379).

Two international conferences of the League of Nations took place in Brus- sels (1920) and Genoa (1922) to attempt the re-establishment of the gold stan- dard in Europe. Most of the nations preferred a return to the gold standard, and in fact, the nations with strong inflation reached that goal first. Austria returned to the gold standard in 1923 and Germany, after two years of hyper- inflation, replaced the Rentenmark by the Reichsmark backed by gold in 1924 (R. Davies & Davies, 1999b). Austria, as well as a number of other countries, followed the philosophy of the prewar gold standard to reach a one hun- dred percent reserve convertibility. Germany, however, decided to go for a fractional reserve of only 75% (Nurkse, 1944). France returned to a full gold standard in 1928, after a period of renewed bimetallism following World War One (R. Davies & Davies, 1999b).

In 1925, Winston Churchill decided that Britain would return to the gold standard. He did that against the advice of Keynes who argued that the rate at which the value of the pound sterling had been fixed was too high (Wapshott, 2012, kps. 782). Churchill’s decision to re-establish the gold stan- dard, together with Montagu Norman’s refusal of cancelling the allies’ debt resulting from World War One, led to economical disturbances in Britain in the second half of the 1920s. The result of the over-valued pound was a gen- eral strike in Britain, as attempts had been made to reduce prices and wages in the country (R. Davies & Davies, 1999b). The decision of the New York Federal Reserve Bank in 1927 to slightly cut down the rediscount rate, an at- tempt to support Britain with keeping the gold standard, cheapened credit in the United States and is nowadays seen as the seed of the global economic crisis of 1929 (G. Davies, 2002, p.510). Beginning with Britain’s return to the gold standard, a strong deflation occurred continuing until 1935 (see figure C.1, page 57).

The Great Crash in 1929, followed by the Great Depression of the 20th cen- tury, caused many international economic disturbances and is nowadays seen as the biggest economical crisis ever. In 1931, the United States and France held more than 75% of the global gold stock (R. Davies & Davies, 1999b). In the same year, Britain cancelled the gold standard which was followed by a massive reduction of rates on loan stock in 1932. A lot of countries followed Britain’s example, cancelling the gold standard including Japan that suffered since 1927 when a financial crisis in Taiwan spread over the whole country (R. Davies & Davies, 1999b). Both, Britain and Japan, experienced a period of substantial economic growth from 1932 onwards. In 1936, France abandoned the gold standard, too, following the example of Britain six years before. The United States still kept on with the gold standard, even after Roosevelt’s New Deal in 1933:

In a series of executive orders, legislative actions, and court deci- sions, the United States was taken off the gold standard. Convert- ibility into gold was suspended. Private holdings of gold were na- tionalized. A new parity with gold was established amounting to a devaluation of approximately 40%. This parity was only important for international transactions, however. Because Americans could not hold gold, their dollars were not convertible. The gold value of the dollar was largely meaningless. With no convertibility, the result was a quasi-gold standard. (Elwell, 2011)

Following the Gold Reserve Act, the new price of gold was fixed at $35 per ounce in January 1934. This nearly doubled price devaluated the dollar by 69 percent as well as it stabilized the banking system by stopping internal cir- culation of gold and transferring it to the reserve (G. Davies, 2002, p. 516). As private ownership of gold was still forbidden the United States continued with an only virtual gold standard (Elwell, 2011). Unlike Britain, the United States only experienced a deflationary period in the years between the Great Crash and the beginning of the New Deal (see figure C.2, page 58). The de- flation in the United States stopped with the New Deal and turned into a moderate inflation until the beginning of the Bretton Woods system.

While the classical gold standard ended more or less officially with the beginning of World War One, the gold exchange standard faded out over the years. The official end of the gold exchange standard was the conference of Bretton Woods, but the period of decay of the gold exchange standard lasted over one decade under the pressure of economical turbulences.

2.4. Bretton Woods

In July 1944, the conference of Bretton Woods took place, where participants coming from 44 nations discussed and decided on a new international mone- tary system. Two key players were John Maynard Keynes and Harry Dexter White, who both had been working on plans for a postwar monetary system since 1941. Besides establishing an international monetary system, the con- ference was meant to create results on how to re-establish Europe as a major trading partner for the United States (Ramsauer, n.d.). The United States had become the world’s dominant power during the war and had had a strong influence on the international monetary and financial politics. Even though Keynes attended the conference with a clear vision of an International Clear- ing Union, the Bretton Woods Articles of Agreement were dominated by White’s ideas who adjusted

...Keynes’ambitiousplansforanInternationalClearingUnionwith access to at least $26 billion, to what he felt he might be able to get a critical Congress to accept. . . (G. Davies, 2002, p. 519)

The Bretton Woods system was supposed to guarantee free trade world- wide which was to be realized by establishing a system of convertible curren- cies and fixed exchange rates. Since Britain as debtor and the United States as creditor had very contradicting goals in the conference, the result was an ex- pected compromise dominated by White’s plan and therefore by the United States. The US Dollar was to be the global reserve currency backed by gold at $35 per ounce (G. Davies, 2002, p. 520). To guarantee this rate, the Fed- eral Reserve Bank of New York committed itself to selling and buying gold whenever necessary. Every nation was obliged to keep the exchange rate of its nation’s currency to US Dollar at a one per cent range around the fixed exchange rate. Therefore, the national central banks were to use their fiscal possibilities. Hence, every currency that was part of Bretton Woods was convertible into US Dollar and indirectly backed by gold.


1 Neil Diamond, 1979

1 Such as White, Skousen, Selgin and others. See also Bordo (2008), Nathan (2011), Harding and Fifield (2012), and Block (1999)

2 Such as Polleit, H üslmann and others. See also Geinitz, Fehr, and Tigges (2009), (2009), Warnecke (2010), Grimmer (2012)

3 Such as Rothbard (2008), Polleit (2010), H ülsmann (2010) and others

1 An excerpt from his book is also available on a website by G. Davies and Davies (1999). Facts mentioned in the book are preferred as references in the text.

2 Other authors use the names interwar gold standard or gold bullion standard as synonyms for this period.

3 A fact, which has been criticised in 1901 by Henry Parker Willis. For the same reasons Greece’s membership in the European Monetary Union was criticised nearly 140 years later (Hartwich, 2011)

4 The Gold Standard Act of 1900 abandoned the minting of silver by law and specified the minimum capital required for founding a bank and tightened the rules for issuing notes.

5 The US Sherman Act from 1890 obliged ”the Treasury to buy 4.5 million ounces of silver each month” (R. Davies & Davies, 1999c).

6 The name Great Depression was used for this crisis until the 1930s as mentioned in (Furstenberg, 2011). It is used here as G. Davies (2002) refers to it.

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The Gold Standard: Theory, History, and Renaissance
Leipzig Graduate School of Management
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Gold Standard, Free Banking, Keynes, Rothbard, Skousen, Krugman, Eichengreen, Bordo, FIAT Money, Public Debt, Commodity Money
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Gerrit Beine (Author), 2013, The Gold Standard: Theory, History, and Renaissance, Munich, GRIN Verlag,


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