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Monetary Central Planning and the State, Part 29: The Gold Standard in the 19th Century


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The history of paper money is an account of abuse, mismanagement, and financial disaster. Generally, the classical economists of the 19th century understood that and warned of the dangers of paper money. In France, the lesson had been learned during the French Revolution, when a flood of paper money, known as the assignats, resulted in economic catastrophe. In Great Britain, the lesson had been learned as a result of the British government’s financing of the war against Napoleon.

The Bank of England, a private corporation, had been born in 1694 out of the British government’s need for cheap loans to finance its expenses. Three years later, the bank was given extensive monopoly rights covering banking and note-issuing activities within England, with its monopoly power reinforced by an act of Parliament in 1742.

Once the war with France began in the 1790s, the British government saw its military expenses rise dramatically. The government had what would be called today a “line of credit” that enabled it to pay its expenses with bills that the Bank of England was expected to redeem on demand in gold. But by 1797, the bank was faced with such heavy demands for gold redemption from claimants, both domestic and foreign, that its gold reserves were reaching dangerously low levels. The British government passed the Bank Restriction Act, which freed the Bank of England from having to redeem its bank notes and other financial claims in gold.

When the Restriction Act was passed, the Bank’s notes in circulation had a face value of £9.7 million on gold reserves of £1.1 million. When the war was approaching its end in 1814, bank notes outstanding had a face value of £28.4 million on gold reserves of £2.2 million. Between 1797 and 1814, commodity prices in general in Britain had about doubled and the value of the British paper pound had depreciated by about 30 percent on the Hamburg foreign-exchange market.

In 1809, David Ricardo, one of the leading figures of British classical economics, published a monograph entitled The High Price of Bullion. He argued that the depreciation of the British pound was due solely to the excessive expansion of the Bank of England’s notes that had been made possible by the removal of redemption on demand in gold by the Restriction Act. Ricardo reasoned that the close connection between the Bank of England and the British government, due to the latter’s heavy borrowing and the former’s large amount of lending irredeemable paper money to the government, had resulted in the Bank’s losing any independence it had in its money-creation powers. It had become a financial arm of the government. Only one thing could return Britain to a stable currency: gold redemption on demand. Said Ricardo:

“It is said … that the Bank of England is independent of Government…. But it may be questioned whether a bank lending many millions more to government than its capital and savings, can be called independent of that Government…. It was then owing to the too intimate connection between the Bank and the Government, that the restriction [act] became necessary; it is to that cause, too, that we owe its continuance. To prevent the evil consequences which may attend perseverance of this system, we must keep our eyes steadily fixed on the repeal of the restriction bill. The only legitimate security which the public can possess against the indiscretion of the Bank is to oblige them to pay their notes on demand in specie [i.e., in gold or silver].”

In 1810, the House of Commons appointed a Select Committee on the High Price of Gold Bullion. Its report reached the same conclusions as Ricardo and argued for a return to gold redemption at the earliest possible time. Between 1814 and 1821, Bank of England notes in circulation were reduced by almost one-third, while gold reserves were increased tenfold. Finally in 1823, the Bank of England was required to begin redeeming on demand its notes for gold. Except for some brief bank panic periods later in the 19th century, Bank of England notes and bank-deposit accounts were redeemable on demand for gold until 1914, when Britain suspended gold payments during World War I.

Throughout the 19th century, the mark of a sound economist and policymaker was an appreciation of the need to prevent governments from directly or indirectly manipulating the monetary system for political or economic reasons. John Stuart Mill, in his 1848 Principles of Political Economy, expressed the widely shared view that if no check was placed on the power of issuers of paper money,

“the issuers may add to it indefinitely, lowering its value and raising prices in proportion; they may, in other words depreciate the currency without limit. Such a power, in whomsoever vested, is an intolerable evil…. To be able to pay off the national debt, defray the expenses of government without taxation, and in fine, to make the fortunes of the entire community, is a brilliant prospect, when once a man is capable of believing that printing a few characters on bits of paper will do it…. There is therefore a preponderance of reasons in favor of a convertible, in preference to even the best regulated inconvertible currency. The temptation to over-issue, in certain financial emergencies is so strong, that nothing is admissible which can tend, in however slight a degree, to weaken the barriers that restrain it.”

By the 1890s, practically every major Western industrial country had put its monetary system on the gold standard. What did being on the gold standard mean? T.G. Gregory explained it concisely in his book The Gold Standard and Its Future (1935):

“If bank deposits are convertible into Bank of England notes and Bank of England notes are effectively convertible into gold [at a fixed rate of exchange], the mass of British purchasing power in Great Britain is linked to gold and Great Britain is upon the gold standard.”

By the fact that such a large number of countries had each linked their respective currencies to gold at some fixed rate of redemption in this manner, there emerged an international gold standard. A person in any one of those countries could enter any number of established, authorized banks and trade in a certain quantity of bank notes for a stipulated sum of gold, in the form of either coin or bullion. He could transport that sum of gold to any of the other gold-based countries and readily convert it at a fixed rate of exchange into the currency of the country to which he had traveled. As Murray Rothbard expressed it in What Has Government Done to Our Money? that meant,

“The world was on a gold standard, which meant that each national currency (the dollar, pound, franc, etc.) was merely a name for a certain definite weight of gold. The ‘dollar,’ for example, was defined as 1/20 of a gold ounce, the pound sterling as slightly less than 1/4 of a gold ounce…. This meant that the ‘exchange rates’ between various national currencies were fixed, not because they were arbitrarily controlled by government, but in the same way that one pound of weight is defined as being equal to sixteen ounces.”

Why did governments recognize and (with occasional exceptions) follow the rules of the gold standard through most of the 19th century? Because the gold standard was considered an integral element in the reigning political philosophy of the time, classical liberalism. As the German free-market economist Wilhelm Roepke explained in International Order and Economic Integration:

“The international ‘open society’ of the 19th century was the creation of the “liberal spirit” in the widest sense, [guided by] the liberal principle that economic affairs should be free from political direction, the principle of a thorough separation between the spheres of government and of economy…. The economic process was thereby removed from the sphere of officialdom, of public and penal law, in short from the sphere of the ‘state’ to that of the ‘market,’ of private law, of property, in short to the sphere of ‘society.’”

At the same time, said Roepke,

“This [liberal] principle also solved an extremely important special problem of international integration … i.e., the problem of an international monetary system … in the form of a gold standard…. It was a monetary system which rested upon the structural similarity of the national systems, and which made currency dependent, not upon political decisions of national governments and their direction, but upon the objective economic laws, which applied once a national currency was linked to gold…. But it was at the same time a phenomenon with a moral foundation…. The obligations, namely, which a conscientious conformity with the rules of the gold standard imposed upon all participating countries formed at the same time a part of that system of written and unwritten standards which … comprised the [international] liberal order.”

In the 19th century, the ruling idea had been liberty. The wealth of nations was seen as arising from individual freedom in a social order respecting private property in the means of production. The relationships among men, it was believed, should be based on voluntary exchange for mutual benefit. Just as there were no inherent antagonisms among men in a free market within the same nation, there were no inherent antagonisms among men living in different nations. The mutual gains from trade could be expanded by extending the principle of division of labor to a global scale. If men were to benefit from those possibilities, a stable, sound, and trustworthy monetary order had to assist in the internationalization of trade. Gold was considered the commodity most proven through the ages to serve that function. And preservation of the gold standard, therefore, was given a prominent place among the limited duties assigned to the classical-liberal state of the 19th century.

There was only one fundamental problem and inconsistency in this conception of and role for the gold standard in the free society. It left control over the value and supply of money in government hands. In an age that believed in the superiority of free markets and private enterprise, it practiced the theory of monetary central planning. The gold standard, after all, was a government-managed monetary system.

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    Richard M. Ebeling is a professor of economics at Northwood University. He was formerly president of The Foundation for Economic Education (2003–2008), was the Ludwig von Mises Professor of Economics at Hillsdale College (1988–2003) in Hillsdale, Michigan, and served as vice president of academic affairs for The Future of Freedom Foundation (1989–2003).