Economics: Monetary History


Figure 1.-- Historians rank the Great Depression as one of the most serious crisis in American history, second only to the Civil War. Most economists believe that it was a catastrophe that did not need to have happened. The damage done to Americans and people around the world are incalculable. The still not widely understood matter concerning the Depression is that a normal down turn in the economy was turned into the Great Depression not by businessmen but by Government officials, politicians, and the Federal Reserve. This Dorthea Lange photograph shows Dust Bowl Depression Era kids from Oklahoma in a 1936 California migratory refugee camp. You can almost feel their pain.

A monetary system is the mechanisms by which a government provides a means of exchange (money) to facilitate economic activity. In addition to exchange mony can also serve as a store of value and a standard for measuring value. Normal istitutions, are a mint/printing office (bureau of engraving), central bank, and commercial banks. In the modern age new intitutions and exchang mechanisms are seveloping such as bit-coin and fintech. Over time a wide range of items have been used, inclueding skulls, salt, pigs, palm nuts, wapum, shells and much mokre. Different socirties have evaluated various items differently. The Aztecs and other Native Americans greatly valued a green stone (turquoise) which the Spanish were not impressed with. Over time two metals known as bullion (gold and silver) were seen by most sophisticaed cultures as of great value and thus provided a useful mode of exchange--the most common type of commodity money. The first monetary coins were appeared independently during th Iron Age in Anatolia and Archaic Greece, India and China (7th and 6th centuries BC). The use of monetary coins then spread rapidly. Paper bills were first adopted by the Chinese during the important Tang Dynasty (7th-10th century AD). Usage did not become widesread until modern times (late-19th century). Modern systems have used bullion (gold and or silver) and in the 20th century primarily paper bills. Paper money was at first not commoly accepted unless convertavle into gold and silver. Paper currency was, howevet, after the Depression of the 1930s and the end of the gold system was not normally convertable into bullion becoming fiat mony. he money of especially important economies with responsible finncial systems becme accepted as reserve currncies, the British pound stirling in the 19th century abd the American dollar in the 20th century. The Europeans created a common currency which now competes with the dollar, but reckless fiscal policies in both he United States and Europe are destablizing financial markets. China with its growing economy is interested in making its Yuan a reserve currency.

Ancient Monetary Systems

Over time a wide range of items have been used, inclueding skulls, salt, pigs, palm nuts, wapum, shells and much more. Different societies have evaluated various items differently. The Aztecs and other Native Americans greatly valued a green stone (turquoise) which the Spanish were not impressed with. Over time two metals known as bullion (gold and silver) were seen by most sophisticaed cultures as of great value and thus provided a useful mode of exchange--the most common type of commodity money. The first monetary coins were appeared independently during th Iron Age in Anatolia and Archaic Greece, India and China (7th and 6th centuries BC). The use of monetary coins then spread rapidly. Paper bills were first adopted by the Chinese during the important Tang Dynasty (7th-10th century AD). <

Mercantilism

Europe experienced significant ecomomic growth spread by internation trade (17th and 18th century). The common view at the time was exports and the accumulation of bulliomn increased national wealth. Imports were seen as a negative ctivity reducing ntional wealth. These economic views are known as mercantilism. As a result, the rising nations of the day adopted protective and other economic policies to promote exports and discouage imports with the goal of a favorable trade balance. Adam Smith wrote is classic Wealth of Nations to discredit mercantilism and promote free trade. Smith posited against equating wealth with money, writing 'the real wealth or poverty of a country ... would depend altogether upon the abundance or scarcity of these consumable goods'. His asertion was that the import of cheap, useful goods for consumption and productive capital assets may increase the wealth of a nation more than monetary metals. "A country that has wherewithal to buy wine will always get the wine which it has occasion for; and a country that has wherewithal to buy gold and silver will never be in want of these metals". It is possible to regard exports as a cost, draining domestically produced goods from the country, while the gain of trade stems from imports — but this view is just the converse fallacy to mercantilism. [Smith] Smith published his book in the same year that the United States declared its indeoebdence (1776). No country would adopt his ideas on free trade and capitalism more fully than the United Sates.

American Bimetalism

The United States Congress as one of its first actions passed the Coinage Act of 1792. Congress in the act defined the '"dollar' very exactly as 371.25 grains of pure silver or 24.75 grains (roughly 1/20th a troy ounce) of pure gold. At the time the coins in circulation were foreign coins, espcially the Spanish real piece of eight. The Spanish had discovered enormous silver deposits in Bolivia and their coins were a major share of the American and European money supply. The first coin minted by the United states was the half-disme (dime) struck at the new Philidelphia mint (July 1792). For years foreign couns, especially Spanish silver coins were the primary coins used in America. The American government determined for Congress that the average Spanish real (dollar) in circulation weighed 371.25 grains rather than the official weight of 377 grains claimed by Spain. A grain at the time was rather inprecisely defined as the weight of a plump grain of wheat, slightly more than a 16th of a gram. in modern terms.

International Gold Standard

Britain adopted a gold national standard (1844). The Bank of England fully backed its notes with gold. Subsequently lmost every country in Western Europe adopted a gold standard. A gold standard international monetary system, was most complete from the mid-1890s. This was a period of growing economic activity and international trade. Britin had begun to industrialize a century earlier. American nd a unted Germany (1870) became industrial giants. Using gold as a universal currency of international trade has been described by economists as a kind of universal economic language. A universal language eliminted 'translation costs'. The gold standard eliminated economic 'transaction costs'.

Gold Standard

The gold standard developed in ancint times. It was not designed, but simply developed as aesult of the universal llure of the precious metal. It resulted from the pschological and not fully understood appeal of gold even before the developmnt of civilization itself. Across culture, gold has been admired fr its beauty. Its indstruability and rarity were all factors. Various commodities over time have been used as money in different cultures. As civilization rogressed, the commodity that loses the least value over time tends to becomes the most accepted as a monetary unit. Gold wasseen as valuable throughout the ancient world. The first documented use of gold as money began in Asia Minor (Anatolia). Gold was used as currency in the Rman wrld, although silver was more common for everydy commerce. After the fall of the Wstern Empire, the Byzantine gold solidus (the bezant) was used widely throughout Europe and the Mediterranean furing the early and mid-medival period. As the Byzantine Empire and economy declined so did its ability to mint gold coins's economic influence declined, so too did its suppy of gold and ability to mint gold coins. As the European economy grew and natin states formed, the new coutries began to mint their own coins. Most focused on silver which was available in greater quantities. Silver standards developed in part because there were silver mines in Europe, but few sources of gold. Here the monetary history varies from country to country. In Mercia (an British Anglo-Saxon kindom, King Offa (c757–796 AD) minted silver pennies based on the Roman denarius. Other silver coins included the Italian denari, French deniers, and Spanish dineros circulated throughout Europe and not just in the countrie here they were minted. As the pace of European commerce quickened and the economy began emerging from the medieval period, economic activity was impaired by the lack of an adequate monetary base. This began to change with Columbus' discovery of the America's. Spanish Conquistadores launched expeditions onquering Ntive American empires because theypossessed gold and silver. And the Spanish subsequently discovered vast silver deposits in Mexico (1522) and Bolivia (1545). Potosi in Bolivia was esentially a silver mountain. Spanish galleons brought vast shioments of silver to Europe which dramaically affected the Europran economy. International trade came to depend on coins based on Spanish bullion especially silver. It financed trade with Chinas the Europeans had little the Chinese wanted. Coins such as the Spanish real de a ocho (pidces of eight) and Maria Theresa's thaler (the origine of the term dollar) became essential in international trade. Gradually because of the enormous sums involved in international trade shifted to a gold system. This began a period of bimetalism. The British along with the Dutch were becoming the centers of European finance. This shift to gold appears to have begun in the British West Indies in asociation with the emensely profitable sugar trade. This began with Queen Anne's proclamation as part of a money bill (1704). The resulting British West Indies gold standard was a de facto gold standard based interestingly enough on Spanish gold doubloon coins. The next move was made by none other than Sir Isaac Newton, the master of the Royal Mint. Newton established a new mint ratio between silver and gold (1717). This had the effect of driving silver out of circulation and essentially put Britain on a gold standard. The Royal Mint at Tower Hill following the Napoleonic Wars introduced a new gold sovereign (1816). The British Government then adopted a formal gold specie standard (1821). A shortage of specie impaired the development of the U.S. econmy and was involved in a serious depression (1830s). This was in part alieviated by the discovery of gold in Califirnia (1848). The United Province of Canada adopted aold standard (1853) and Newfoundland (1865). Two new industrial powerhouses, the United States and the new German Empire--de jure) adopted the gold srandard (1873). The United States used the double eagle coin as its unit. Germany introduced the new gold mark. Canada adopted a dual system based on both the American gold eagle and the British gold sovereign. Australia and New Zealand followed by adopting the British gold standard as did the British West Indies which by this time was no longer of economic importance. Newfoundland whichbwas not yet part of Canada was the only British Empire territory to introduce its own gold coin. Britain itself did not have gold mines. Australia did. The Royal Mint opened branches in Sydney, Melbourne and Perth to mint gold sovereigns. A major political issue developed in America where Democratic political candidate wanted to increase siolver coining meaning inflation and labeled the gold standard a 'cross of gold'. The gold specie standard came to an abrupt end in Britain and the British Empire with the outbreak of World War I.

World War I (1914-18)

Countries varied in theur ability to finance imports. As a result, countries periodically suspended convertibility during the 19th century. This was not uncommon. The gold standard was at its all time peak at the time War broke out. Financing imports because of the need to supply vast armies and maintain industrial production became a major issue with the outbreak of World War I. Most of the beligerant nations at the onset of World War I went off the gold standard. Most indicated they were suspending convertibility. They adopted policies to hold their gold resources for the best use in their war efforts. As a result of financing the war effort and and abandoning the gold standard, the belligerent countries experieced various degrees of inflation. Prices in some cases doubled (the United States and Britain). It was worse in other countries. French prices tripled and Italian ptrices quadrupled. Fixed exchange rates were slow to afjust. As the United states held prices under control better than the Europeans. The Allies at first waged the war with gold reserves and foregign assetts, both within the Empire as well as in other countries like the United States. The Anglo-French Financial Commission arranged a $0.5 billion loan from private American banks (1915). Britain by 1916 was funding most of the Empire's war expenditures, all of Italy's and two thirds of the war costs of France and Russia, plus smaller nations as well. Their gold reserves, overseas investments and private credit then ran out forcing Britain to borrow $4 billion from the U.S. Treasury (1917–18). [Lobell] Shipments of raw materials from the Empire, America, and other countries enabled Britain to feed itself and its Army while maintaining industrial productivity. Overrall Britain' war financing was generally successful, if financially depleting. [Daunton] London at the onset of the War was the world financial center which was a great assett. And careful financial management as well as gold reserves and overseas assetts helped to deal with problems like inflation. The French government floated four war bond issues on the London market after the outbreak of the War. They raised 55 million pounds--a staggering amount at the time. The bonds were denominated in francs instead of pounds or gold. And the bonds were not guaranteed against exchange rate fluctuations. As a result of the War and post-War economic problems, the franc lost much of its value. British bondholders attempted but failed, to get restitution. [Turner] While Germany was militarily prepared for war, it was not in as strong a poition as the Allies. It did not have Britain's gold reserves nor did it adopt such sound policies. And the Allied naval embargo made imports impossible even if Germany could have afforded them. Of course a strong factor was thatvGrmany was unable to borrow money in America to finance its war effort. One major impct of the war was that the world financial center shifted from London to New York.

Post-World War I Era (1920s)


Depression and Retreat from the Gold Standard (1930s)

There is an ongoing debate as to what caused the Great Depression. Varied explanations have ben offered. This is a little complicated, because whatvcaused the initial recession and Wall Street Crash is not necessarily what caused the devestating dislocations that developed into the Great Depressiion. What developed into the Great Depression began with the Wall Street Crash (September 1929) and in America persisted until the onset of World War II (1939). It became the worst economic dislocatiomn ever experienced by the industrialized Western economies. The American Wall Street Crash quickly not only affected America, but European and other economies around the world. The consequnces were severe: sharp declines in output, high unemployment, and serious deflation in one country after another. Historians rank the Great Depression as one of the most serious crisis in American history, second only to the Civil War. And the consequenes extend to the rise of the NAZIs and Japanese militarism which led to World War II. The Depression began as an ordinary downturn in the business cycle. There had been many recessions not only in America and Britain and Europe. Most were mild and the economy quickly recovered. Many economists believe that what caused the ordinary 1929 recession to become the Great Depression was the chatertophic monetary policy of the Federal reserve. [Friedman and Schwartz] Ironically, the Federal Reserve System was only 16 years old and inexpeiencd. The Fed had been established in 1913 as a progressive reporm to prevent just such a economic crisis from developing. A major goal was to prevent a banking crisis. Instead it presided over the most serious banking vrisis in Amerian history. Fed policies caused a serious contraction in the money supply--something like a third. this was a direct cause of the banking crisis. About a third of American banks failed ands as the banks were uninsured at the time, this meant that millions of Americans lost their savings. It according to two imprrtant sinentists was all unnecessary. [Friedman and Schwartz] Many more banks were failing when President Roosevelt assumed office (March 1933). He immediately tool two actions which prevented the crisis from spiraling further dowm. He instituted a bank holiday to prevcent a run on the banks still open. And he took Anerica off the gold standard. Recovering from the Depression would be difficult, but largely as a result of these two 1933 actions the downard spiral was ended.

World War II

Economics played a central role in World War II. Hitler's rearament program was bankrupting NAZI Germany. It involved massive borrowing which wa hid from the German public and financial markets. It is questionable how long Hitler could have continued his rearament program if he had not taken Germany to war in September 1939. Germany proceeded to loot the national banks of the conquered nations. Britain after the fall of France moved much of its gold reserve to Canada as part of Iperation Fish. The persecuution of the Jews and the Holcaust was also used in part to finance the War. The NAZIs very effectively integrated the economiy of Czecheslovakia into the German arms industry. Germany did not go to a full war footing until late in the War. Not did Germany effectively cooperate in war production with its Axis allies. Germany also did not effectively used the economies and industries of the captive nations, especially the countries occupied in Western Europe. The Germans did use te conquered countries as a source of slave labor. German ineffiency in coordinating with Allies stands in sharp contrast to the close copperation between Britain and America. Financing the War was a major problem for Britain which was not in the same position of strength as it benefited from in World War I. President Roosevelt began mobilizing the Arsenal of democracy, the vast American economy well before America went to war. Part of the American effort was financing the war. Very extensive cooperation in weapons development and production also began between Britain and American before American entered the War. American Lend Lease essentially wrote Britain a blank check, solving Britains war finance problem. Hitler avoided putting Germany on a full war footing, because he thought the War had been won and he did not want shortages and rationing to deminish domestic support for the War. Only after the setbacks in Russia, especially Stalingrad, did Hitler turn to Speer and give him the authority to fully convert the German economy for war. Fortunally for the world, by then it was to late to stop the expanding force of the Soviet Union in the East and the Western allies in the West.

Breton Woods (1944)

A World War II was being fought o a conclusion, the United States hosted an international confernce to plan for the post-War monetary system and economic actvity. This was the United Nations Monetary and Financial Conference. Some 730 delegates from all 44 Allied nations met at the Mount Washington Hotel, situated in Bretton Woods, New Hampshire. And is today usually referred to as the Breton Woods Confrence. The delegates withe NAZIs now obviously defeated and the end of the War in sight set out to create a system that would regulate the international monetary and financial order. [Markwell] The Confence was held (July 1-22, 1944). Agreements were reached that later established the International Bank for Reconstruction and Development (IBRD). (The IBRD is today part of the World Bank Group.) The International Monetary Fund (IMF)is another product of Breton Woods. The results of the the Conference were unpresedented. Breton Woods was the first international agreement was creating a common monetary policy among inependent nations. The delegates sought to create a stable international currency regime that would permanently ensure monetary stability. It was a lofty, perhaps impossible goal. And it was asignificant turing point in monetary policy. The delegates did set up a system that would allow the global economy to recover grom the War--at least the Free Word. Stalin and the new Eastern Europen empire he had already begun to construct did not participate. The cre of the Breton Woods international monetary system was that individual nations would agree to adhere to a global gold standard. It was a fixed rate currency regime with the dollar as the global reserve currency. The United States was the only major country emerging from the War with its economy still in tact. To ensure stability and financial discipline, the major currencies were fixed to the dollar and the dollar was fixed to gold at the rate of US$35 an ounce. Each signatory nation committed to maintain its currency at values within a narrow margin to the value of gold. The Conference created a series of currency stabilization programs as well as providing for infrastructure loans to aid the war-batterd nations. The Breton Woods system was fully oerational soon after the War, inckung the IRD nd IMF (1946). The IMF facilitated payment imbalances on a temporary basis. The Breton Woods system functioned reasonably for 25 years. It was, hwever, fatally flawed in its basic assumptions. Gold was actually wrth much more than $35 an ounze. This had been an value set in internatinal negotiond during the Depression (1934). The U.S. dollar was still astring currency, but had lost substantial purchasing power during the War and this continued after the War. As the European and Japanese economies recovered, the growing drain on U.S. gold reserves meant that the Bretton Woods Agreement would not be a permanent, global working monetary system. The Bretton Woods system set up an arrangement that because of the dollar's reserve currency status, the United States unlike other countries could run large deficits. The deficits could essentially be covered simply by issuing dollars. The excess dollars began showing up in global central banks. The central banks began converting their dollars into gold. This acted to refuce the value of the U.S. dollar in relation to gold. Central bankers attempted to manage the growing problem. The set up the 'London Gold Pool' in an attempt to maintain the dollar price of gold to $35 an ounce (1961). This effort worked for a while but was disrupted when France withdrew from the Pool (1968). Central babkers than tried another approach in an effort to save the Bretton Woods system. The set up a two-tiered gold market. The first operated at the official $35 an ounce price while the second traded gold at a market price, which was significantly above $35. This like similar regimes was unsustainable and also eventully failed as well.

Post-World War II Economic Development

Modern industrial ecomomies emerged in Europe beginning with Britain where the Industrial Revolution began about 1740 and gradually spread to the Continent. Economic development also occurred in the United States and some English colonies (Australia, Canada, and New Zealand). A comcomitant of industrial development has been varying degrees of political democracy. Except for Japan, other countries did not attempt or failed to succeed with the Western economic model--actually the keys to economic deveopment that have since proven as effective in other areas as well as the West. Russia which until World War I was rapidly developing, but the Revolution shifted the economic model to state planning and socialism. This was also attempted by China after World War II. Many newly independent countries like India, Indonesia, and countries througout Africa pursued socialist ideas and big government economic planning. Te new leaders ignored the florishing West European ecnomics and embraced the economic policies of the Soviet Union and its Easern European empire. The results astonished many, none more so than the Soviets. The fundamental inefficenies of socialism led to the deimse of the Soviet behemoth. The results in China were even more shocking. China experienced disasters in which millions perished. The Great Leap Forward resultedin the worst famine in hinese history--even worse that the World war II crisis. The results in other areas was generally less draconian, but the bright hope of independence were dashed on the ideological commitent to socialism. The results despite billions of dollars of Western aid was a range of unfavorable results. The countries unless they had oil virytualkly without exception eprienced either economic stagnation or actul declines in living standards. Diverging from the established pattern, several Asian countries (Singapore, South Korea, and Taiwan) after the War achieved considerable success. And China of all countries went from radical Maoist Communism to free market reforms, albeit without political democracy. The market refors in obly a few short years transformed China crarting a prosperous middle-class India after independence embraced a socialist system with state planning and a stifeling beaircracy. The economy languished. Free market reforms have in recent years jump-started the economy and aso created a large middle-class. Socialism and big-government continue to have appeal and has India eld back from many needed reforms. A new Government elected with a substanial mandate is considering major reforms(2014). he countries of the Middle East, Africa, and Latin America have had great difficulty in developing productive modern ecomonomies.

Ending the Gold Standard

President Nixon, as the Bretton Woods system could no longer be sustained, finally put an end to it (August 1971). He suspended the convertibility of the U.S. dollar into gold. The U.S. dollar was left without a semblance of an ancor. The global monetary system was thus tranformed from the Breton Woods fixed system to a floating regime. American pliticians benefitted because the UnitedStates could pay for impots with essentially 'costless' dollars. This mean that needed, but unpopular economic reforms and budget cuts could be avoided. The result was, however, a decade of monetary instability and abnormally high inflation. Surprisingly, the U.S. dollar despite its declining purchasing power managed to maintained its world reserve currency status. This occurred for several reasons. First was the size and strength of the undrlying U.S. economy. Second was the imprtance of american financial markets, providing a loquidity not oyher cnational currency could offer. Third was the power of the U.S. military, ensuring the indepence of the Western world and Asian allies. Fourth, there was no real alternative to the dollar. As a result, despite the declining value of the U.S. dollar, the reserve currency status of the dollar actually increased around the world for the next few decades. Central bankers were aware of the underlying weakness, bit no one wanted to touch the issue. And many on both sides of the transfers benefitted from the U.S. dollars reserve sratus. Americn consumers benefitted because they could pay for imported goods with 'costless', ovrvalued dollars. And America's trading partners benfitted from the strong demand for their products, creating jobs and expanding the local economies. The United States experienced huge balance of payments deficits As a result of excessive U.S. consumption and declining domestic oil production. This produced massive liquidity throughout the world economy. Text book economic theory would have predicted a collapse of the dollar because of the mssive glut of dollars flooding the system. This dud not, however, actually ocur. Central bankers and world economic policy makers simply dis not want the system to end. So instead of refusing to accept bad paper (U.S. dollzrs), they just reinvested their excess dollars back into the U.S. asset markets, [rimarilu U.S. Government debt. This acted to supported the U.S. dollar, kept interest rates low, and allowed the the imbalances to grow in size and potential danger.

Sources

Daunton, M.J. "How to pay for the War: State, society and taxation in Britain, 1917–24," English Historical Review (1996) Vo. 111, No. 443. pp. 882–919.

Diamond. Jared. Guns, Germs, and Steel: The Fates of Human Societies (Norton: New York, 1997), 494p.

Ferguson, Niall. Civilization: The West and the Rest.

Friedman, Milton and Anna J. Schwartz. A Monetary History of the United States.

Lobell, Steven. "The political economy of war mobilization: From Britain's limited liability to a continental commitment," International Politics (2006) Vol. 43, No. 3, pp. 283–304.

Madrick, Jeff. "Why the experts missed the recessiuin," New York Review of Books Vol. LXI, No. 14 (September 25, 2014), pp. 66-68.

Markwell, Donald. John Maynard Keynes and International Relations: Economic Paths to War and Peace (Oxford: Oxford University Press, 2006).

Smith, Adam. The Wealth of Nations (1776).

Turner, Arthur. "British holdings of French war bonds: An aspect of Anglo-French relations during the 1920s," Financial History Review (1996) Vol. 3, No. 2, pp 153–74.







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Created: 6:37 AM 1/8/2017
Last updated: 6:37 AM 1/8/2017