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November/December 1981 Perspectives O n: Gold I n f l a t i o n h a s b e e n a c h r o n i c a f f l i c t i o n o f m o s t e c o n o m i e s o f t h e w o r l d s i n c e W o r l d W a r II a n d h a s b e c o m e a c u t e s i n c e t h e m i d 1960s. R e p e a t e d d e c l a r a t i o n s b y g o v e r n m e n t s o f t h e i r d e t e r m i n a t i o n to d e a l w ith t h e p r o b l e m b y a d o p t i n g c o n s e r v a t i v e m o n e t a r y a n d fiscal p o l i c i e s h a v e b e e n b e l i e d b y c o n t i n u e d large b u d g e t d eficits a n d e x c e s s iv e ly r a p id a n d e rra tic m o n e y g r o w t h . In t h e U n i t e d States, d i s i l lu s io n m e n t w ith d i s c r e t i o n a r y e c o n o m i c p o l i c i e s has l e d to a v a riety o f s u g g e s t i o n s fo r p l a c in g c o n s tra in ts o n s u c h p o lic ie s . O n e o f t h e m o s t f r e q u e n t l y h e a r d s u g g e s t i o n s is t o l im it m o n e y c r e a t i o n b y r e q u i r i n g th a t m o n e y b e c o n v e r t i b l e i n t o , o r o t h e r w i s e l i n k e d t o , g o l d . T h e t w o a r t i c l e s in th is i s s u e o f Economic Perspectives discuss tw o i s s u e s o f g r e a t i m p o r t a n c e in j u d g i n g r e c e n t p r o p o s a l s t o a d o p t a g o l d s t a n d a r d : t h e a l l e g e d a u to m a ticity o f in te rn a tio n a l a d ju s tm e n t u n d e r a g o ld s ta n d a rd a n d th e d ifficu lty — a n d q u e s tio n a b le w i s d o m — o f g e t t i n g 'g o v e r n m e n t s to s u b o r d in a t e d o m e s t i c e c o n o m i c o b je c t i v e s to th e s u c c e s s fu l o p e ra tio n o f su c h a standard. Gold in the international arena: how automatic is international adjustment? 3 T h e r e a re s e v e r a l v a rieties o f g o l d sta n d a rd , e a c h w ith w id e ly d iffe rin g im p lica tio n s fo r th e d e g r e e o f a u t o m a ticity o f in te rn a tio n a l a d ju s tm e n t . The demise of the gold standard H i s t o r i c a l e x p e r i e n c e o f f e r s litt le r e a s o n to b e l i e v e that g o v e r n m e n t s w o u l d b e w illin g to m a k e t h e s a c rific e s n e c e s s a r y to a b id e b y th e " r u le s o f the g o ld sta n d a rd g a m e ." ECONOM IC PERSPECTIVES November/December 1981, Volum e V, Issue 6 Economic Perspectives is published bimonthly by the Research Department of the Federal Reserve Bank of Chicago. The publication is produced under the direction of Harvey Rosenblum, Vice President, and is edited by Larry R. Mote, Vice President, with the assistance of Gloria Hull (editorial), Roger Thryselius (artwork and graphics), and Nancy Ahlstrom (typeset ting). The views expressed in Economic Perspectives are the authors' and do not necessarily reflect the views of the management of the Federal Reserve Bank of Chicago or the Federal Reserve System. Single-copy subscriptions of Economic Perspectives are available free of charge. Please send requests for single- and multiple-copy subscriptions, back issues, and address changes to Public Information Center, Federal Reserve Bank of Chicago, P.O. Box 834, Chicago, Illinois 60690, or telephone (312) 322-5112. Articles may be reprinted provided source is credited and Public Information Center is provided with a copy of the published material. Controlled circulation postage paid at Chicago, Illinois. 13 Gold in the international arena: how automatic is international adjustment? W i l l i a m L. W i l b y W h ile to the layman the idea of a modern day “ gold standard" conjures up images of gold coins and bullion hidden in the crypts of Fort Knox “ b ackin g " the value of the A m e ri can cu rre n cy, to students of international eco nom ics, the connotation of a gold stan dard is quite d ifferen t. To the latter, the gold standard is m erely one of several alternative systems of international m onetary adjust m ent— a system for settling, and ultim ately co rrectin g , paym ents im balances in a co u n try's international accounts. H ow ever, given the key role of the dollar in international trade (dollars are used in over 70 percent of all in te rn a tio n a l tran sa ctio n s), it should be obvious to anyone, w h eth er layman or inter national fin a n cie r, that any unilateral move by the U nited States towards a gold standard w ould have dram atic im plications for the international m onetary system. This suggests that any jud g m ent on the merits of such a move must take into consideration its inter national im pact. This article focuses on one small aspect of the gold standard: the supposed autom aticity of the international gold standard in restoring eq u ilib riu m in a co u n try’s balance of pay ments. Although there are num erous other issues p ertinent to the evaluation of the gold standard as a system of international adjust m ent, many of these issues revolve around the responses of national econom ies to dis tu rb a n ce s o rig in a tin g a b ro ad . These re sponses depend upon the speeds of adjust ment of a plethora of eco nom ic variables— questions that w ere considered beyond the scope of this article. Rather, we w ill focus here on the narrow q uestion: To what extent does the international gold standard rem ove the d iscretio nary ability of governm ents to Federal Reserve Bank o f Chicago control their national monetary supplies, there by forcing the adjustm ents necessary to re store eq u ilib riu m in the balance of payments? To answ er this question, we w ill first exam ine the intellectual roots of the ideal ized gold standard, the so-called price-specie flow m echanism , with a view towards u nder standing both the origins of the concept of international adjustm ent and the merits of the gold standard w hen it is left to operate freely. Second, we w ill exam ine the theoreti cal operation of the gold standard when we move from the realm of com m odity money to the existence of fractio n ally backed or credit m oney. Fin ally, w e w ill look briefly at the actual functioning of the gold standard d u r ing the period considered to be most repre s e n ta tiv e o f its o p e r a tio n in a p u re fo r m — th e period 1879-1913. It w ill be argued below that w hile the pure international gold standard should, in p rin cip le, function well as a system of interna tional adjustm ent, its operation in practice leaves considerable room for governm ent m anipulation. M oreover, the historical record indicates that it was the threat of reserve flows (which could exist under any system of fixed exchange rates) and a specific governm ent focus on the balance of payments that ensured a general w o rld w id e coordination of m one tary policy rather than gold flows p e r se. The price-specie flow mechanism The earliest analyses of the role of gold (and other precious metals as w ell) in the system of international trade and payments gave rise to the d octrine of m ercantilism , and the system of protective trade regulations that was inspired by it. Simply stated, the d oc 3 trine of m ercantilism em phasized the im por tance of having an excess of exports over imports in order to accum ulate “ treasure” through a favorable balance of trade. N um er ous protectionist m easures (the British Corn Laws w ere one such exam ple) were designed to achieve this end by prom oting exports and taxing imports at prohibitive levels. This d octrine cam e to be criticized on several g rou n d s (m u ch of Adam Sm ith's W ealth o f Nations is an attack on m ercan til ism), but some of the strongest criticism s of m ercantilism came from British w riters in the late 17th and early 18th centuries who argued that a policy of accum ulating treasure, or “ sp ecie,” 1 was self-defeating because of the econom ic repercussions triggered by the build up of specie itself. The clearest articulation of these ideas is found in the w ritings of David H um e, an 18th century Scottish philosopher. Hume argued that the national stock of money (or sp ecie, since the two w ere synonym ous in Hume's time) would take care of itself, regard less of the degree of m ercantilistic interven tion designed to produce a favorable balance of trade. Hum e made his case by postulating that four-fifths of all the m oney in Great Britain had been destroyed overnig ht, and then p ro ceeding to show the consequences. Prices of British com m odities and wages would fall p ro p ortio nally to the d eclin e in m oney. Brit ish exports w ould thus becom e less expensive relative to foreign goods, and the resultant excess of exports over im ports would cause Britain to exp erien ce an inflo w of specie (a balance-of-paym ents surplus) until the in com ing m oney paym ents restored the British money supply to its “ natural le ve l.” 2 C o n versely, if the British m oney supply w ere increased fivefo ld , prices and wages in England w ould rise so high that no country could purchase British com m odities, w hile British subjects w ould desire to purchase only the cheaper foreign goods. The outflow of m oney to purchase foreign goods (a balanceof-paym ents deficit) w ould shrink the British m oney supply until the “ level of m oney” in Great Britain w ere equal to that in neighbor ing countries. The forces that caused m oney to seek its “ natural le ve l” w e re , according to H um e, self-equilibrating and sym m etrical between co untries, and w ould thus operate to m ain tain a fairly even balance of trade between nations. This m echanism of adjustm ent is know n as the price-specie flow mechanism and is the classical prototype of what modern econom ists mean when they speak of an “ international adjustment m echanism .” M ore over, the m echanism also defines in a very prim itive way the idealized operation of the international gold standard. As one can see from the preceding exam ples, the effective functioning of the price-specie flow m echanism requires ad herence to certain “ rules of the game” — rules that also govern the operation of the ideal ized international gold standard. First, each m onetary authority must take steps to fix the value of its cu rren cy in terms of gold. Second, there must be no restrictions on the flow of gold between co untries. T h ird , each m one tary authority must ensure that the issuance of notes or the creation of checking deposits is in some fixed relationship to its gold holdings. If gold is the only acceptable money v ‘Specie” generally refers to money in coin. In Hume's time specie consisted of other precious metals besides gold. However, because of its physical attributes, gold eventually evolved as the preferred store of value. relationship, presumably flows of money and goods would result until these natural levels were reestab lished. This proposition first appeared in print with the works of Isaac Gervaise over 250 years ago. See Gervaise, "The System or Theory of the Trade of the World, 1720,” in Economic Tracts (Baltimore: The Johns Hopkins Press, 1956). The theory has much in common with the modern monetary approach to the balance of payments. See Jacob A. Frenkel and Harry G. Johnson, eds., The Mone tary Approach to the Balance of Payments (London: Allen & Unwin, 1975). 2 The concept of the "natural level” of money is a primitive concept of monetary equilibrium. Given the worldwide quantity of specie and the worldwide quan tity of goods, there was presumably a "natural” price level based on the relative amounts of both. If the rela tionship between the quantity of goods and the quantity of money for one country were to deviate from the world 4 Econom ic Perspectives w o rld -w id e, these rules are autom atically en fo rced . To g ether, they ensure that deficits and surpluses in a country's international transactions translate into gold flow s, w hich in turn are translated into m ovem ents in a country's dom estic money supply. H ow ever, the degree to w hich this mechanism is in fact self-equilibrating and self-correcting, as Hume argued, depends on the predictability and precision of the relationship between the “ level of m oney'' and p rices— an issue hotly debated by econom ists. M o rever, as should becom e clear in the follow ing section, when notes or paper cu rren cy are allowed to exist in addition to, and as a substitute for gold, the operation of the price-specie flow m echa n is m b e c o m e s o p e n to g o v e r n m e n t “ tin k e rin g ." The theoretical operation of a gold standard There is no such thing, even in theory, as “ th e " gold standard. O ne may define three d ifferen t levels of operation of a gold stan dard d epending on the degree to w hich the creation of credit m oney is wedded to its gold base: (1) a gold-specie standard, (2) a goldb ullion standard, and (3) a gold-exchange standard. Each of these three types of stan dards has d iffering im plications for the opera tion of the international adjustm ent m echa nism ,and will be discussed in turn. To illustrate the operation of each of these standards, it is assumed that there are only two (fictitious) co u n tries, Am erica and Europa, each with a single bank w hich is also the m onetary au th o rity. All coin and cu rren cy are minted or exchanged by, and all deposits are held w ith, their respective central banks. U nder a g o ld -sp ecie standard, gold is the only form of m oney, and the nation's c u r rency is sim ply a unit of account for a sp eci fied w eight of gold. For exam ple, the country of A m erica might define its cu rren cy, the d o l lar, as being o ne-half ounce of gold of a speci fied degree of purity. The Am erican mint is always w illin g to coin one-half ounce of gold of the specified purity into a one dollar coin. Federal Reserve Bank o f Chicago Thus, the price of one-half ounce of gold can never fall below one dollar or rise above one d o llar, since the two are synonym ous. M ore o ver, if a Europan mark is defined as onequarter o unce of gold of sim ilar purity, the exchange rate betw een the mark and the dol lar is fixed at two m arks/dollar. U nder this system, if Am erica sold Europa 100 bushels of wheat and received 200 gold marks in paym ent, the Am erican exporters could take the 200 marks (50 ounces of gold) to the Am erican mint and receive 100 gold dollars in return. The Am erican money supply increases by 100 dollars, and H um e’s pricespecie flow m echanism begins to generate forces raising Am erican prices and making Am erican wheat m ore expensive to the Euro pans. Sim ultaneously, Europan exports be com e cheaper to citizens of Am erica, since the Europan m oney supply declines by the am ount of the gold outflow . The im portant consideration under a gold-specie standard is that gold and money are synonym ous. To the extent that several countries are on a gold-specie standard, the exchange rates betw een their dom estic cu r rencies are autom atically fixed , and a selfequilibrating international monetary system comes as part of the package— but only if one accepts the existence of a fairly rigid link between the quantity of money and prices. U nder a g old -b u llion standard, a national cu rren cy exists side by side with gold (which may or may not be co in ed ), and the value of the cu rren cy is specified in terms of a fixed am ount of gold. An individual may always sell gold at a price at least as high as that offered by the m onetary autho rity, and a buyer may always purchase gold at least as cheaply as the governm ent’s p rice—w hich effectively fixes the price of gold and the value of national cu rren cy in terms of gold. If two countries are on a gold-bullion standard, the exchange rate between their currencies is fixed within the bounds set by the costs associated with gold shipm ent (see box). The effects of gold flows and purchases and sales of gold by the m onetary authority w ill have vastly differen t effects on the supply 5 of money depending on the extent to w hich the m onetary authority is required to m ain tain gold “ backing ” for the national currency. If 100 percent gold “ backing” is req u ired — that is, the m onetary authority must hold one d o llar’s worth of gold in its coffers for each Gold export and import points A lthough the exchange rate betw een two curren cies can be fixed by setting a fixed price for each of them in term s of gold, it is in fact the process of gold arbitrage* that actually m ain tains the exchange rate w ith in relatively fixed lim its. Since gold arbitrage has certain costs associated w ith it, inclu din g the cost of ship ping, in su ra n ce , and interest foregone during the period of transit, the cu rren cy exchange rate can actually fluctuate betw een boundaries established by these costs. These boundaries are called the g o ld -e x p o rt p o in t and the goldim port point. Let us d e rive the gold exp o rt and im port points for the exam ple in the text. If the A m e ri can do llar equals o ne-h alf oun ce of gold (or e q u iv ale n tly , if the p rice of gold is $2 per o u n ce), and if the Europan m ark equals onequarter oun ce of gold, then the m int exch an g e rate equals two m arks per do llar. If w e further assum e that it costs .04 dollars (= .08 m arks) to ship one ounce of gold from A m erica to Europa, the gold exp o rt point from A m erica equals $.51/m ark and the gold im port point equals $.49/m ark. (R em em b er that one m ark equals only o ne-quarter oun ce of gold so that the transport cost for one m ark equals $.01 or .02 m arks.) The gold-export point from Europa equals 2.04 m arks/do llar and the gold-im port point equals 1.96 m arks/d o llar. Sim ply stated, at the gold export point, the local cu rren cy is so expensive in term s of foreign cu rren cy that it pays traders to obtain foreign cu rren cy by exchanging local cu rren cy for gold at the local mint price and then gold for foreign cu rren cy at the foreign m int p rice, rather than exchanging local curren cy for foreign cu rren cy directly. In terms of e co n o m ic analysis the foreign exchange dem and and supply functions becom e “ infinitely elastic” at the gold export and im port points. That is, outside the boundaries of the gold points, m arket adjustm ents consist totally of quantity changes (i.e ., gold flow s) rather than of both price and quantity changes. To u n d e r stand this po int, co nsid er the diagram below w hich depicts the m arket for Europan marks. Price of m arks, R The quantity of m arks is on the horizo ntal axis, and the price of m arks (in term s of d o llars) is on the vertical axis. The m int exchange rate, Rm , is the price of m arks established by the ratio of mint gold prices (= $.50/m ark). If transport costs w ere as given p revio usly and if the price of m a rk s w e r e fo r so m e re a s o n to e q u a l $.515/m ark, it w ould pay som eone w ho wanted to exchange dollars for marks to purchase gold at $2 per o u n ce, ship it to Europa at $.04 per o u n ce , and then sell the gold to the Europan m int for fo ur m arks. He thereb y w ould have obtained an exchange rate of $2.04/4.00 = $.51, the same as the gold-export point. The savings of $.005/m ark w ould equal $1,000 on a $100,000 transaction. Thus, the m arket for direct exchange of dollars for m arks w ould “ dry u p ” outside the gold points. W ithin the gold points, how ever, the exchange rate adjusts in such a w ay as to establish e q u ilib riu m betw een the supply and dem and for the cu rre n cie s (as at Re on the diagram ). In fact, the m int rate (Rm ) essentially becom es m eaningless, and the exchange rate fluctuates freely betw een the gold points. •Arbitrage is the process of simultaneously buying and selling in different markets to take advantage of price differentials. 6 Econom ic Perspectives paper dollar it issues— then it can issue new paper dollars only by acquiring additional gold, usually exchanging them one for one with the p ub lic. In this type of system, paper m oney takes the form simply of receipts for the gold deposited by the public with the central bank. H ow ever, outside the realm of 100 percent gold backing for a cu rren cy lies the fourth dim ension of "c re d it" money. Again using Am erica and Europa for illus tr a tiv e p u rp o s e s , a ssu m e in it ia lly th at A m erica has gold dollars and paper dollars existing side by side with 100 percent gold backing of the paper currency. If an A m eri can citizen loses co nfid ence in the paper d ol lar, he can always exchange it for a gold dollar and the actions of the m onetary authority in doing so have no effect on the Am erican m oney sup p ly; only the relative com position of that m oney supply between gold and paper dollars changes. O n the other hand, if Am erican law requires only that the m onetary authority retain 50 percent gold backing behind each paper d o llar, th en — assuming that paper d ol lars had been expanded to the legal lim it— an exchange of paper for gold dollars with the m onetary authority forces it to contract the m oney supply. Suppose, for exam ple, that an A m erican citizen takes 50 paper dollars to the m onetary authority to exchange for 50 gold dollars. Because gold holdings of the m one tary autho rity are reduced by 50, the out standing level of paper dollars must fall by an additional 50 (for a total of 100, including the 50 paper dollars exchanged for gold) if the m onetary autho rity is to m aintain the proper ratio to its gold "b a se ." Sim ilarly, if the A m er ican citizen in the exam ple is an im porter who exchanges the paper dollars for gold in order to pay a Europan exp o rter, there is a net co n traction of 100 in the A m erican m oney supply and, if Europa also m aintains 50 percent gold backing of the paper m ark, an increase of 100 dollars (= 200 m arks) in the Europan money supply. This o ccurs even though the balanceof-paym ents transaction was only 50 dollars (= 100 m arks). Stated d ifferen tly, the legal gold backing ratio requires the Am erican Federal Reserve Bank o f Chicago m onetary authority to re in fo rce the m one tary contraction w rought by the gold outflow and the Europan m onetary authority to re in fo rce the m onetary expansion wrought by the gold inflo w by retracting or issuing paper m oney.3 Fractional backing to a nation's currency in the form of gold or any other com m odity puts an effective ceiling on the amount of new m oney that can be created by the mere issuance of lO U s. Thus, by "callin g in " loans to the governm ent or selling governm ent securities to the p u b lic, Am erica's monetary authority can reduce its m oney supply by the additional 50 dollars needed to maintain its gold ratio. Sim ilarly, by purchasing securities from the governm ent or the p u b lic, the cen tral bank of Europa can expand its money supply to m aintain a 50 percent level of gold backing. These types of transactions are called open market operations. To sum m arize, under a gold-bullion stan dard, the price of gold, the gold value of the cu rre n cy, and the exchange rate (if the other country is on either a gold-specie or goldbullion standard) are fixed. H ow ever, the operation of the H um ean price-specie flow m echanism may be slightly different if only fractional gold backing of the national cu r rency is req u ired . Specifically, a fractional gold-bullion standard w ill result in a m ulti plied response of the national money supply to trade surpluses or deficits or to conversions of the dom estic fiat cu rren cy into gold if the national m onetary authority attempts to main tain a fixed fractional ratio of gold to its other m onetary liabilities. The successful operation of the p rice-specie flow m echanism under a fractional gold-bullion standard thus requires that governm ent decisions determ ine two specific rules and, in tu rn , that governm ents adhere to the rules they have established. These rules co ver: the m inim um level of frac 3 The normal procedure is for the government to auction securities to the public (borrow money) to make up any gap between its expenditures and receipts. When the monetary authority increases the money supply it does so by purchasing these securities from their holders (many of whom are banks) through government security dealers and paying for them by a check written on itself. 7 tional gold backing of the cu rren cy and w hether or not the central bank should allow gold flows to have a m u ltip lie d effect on national m oney supplies by engaging in rein forcing open m arket operations to keep the ratio fixed . (As a polar case of the latter, the governm ent m ight pursue a policy of “ ste rili zatio n ," offsetting the gold flows com pletely.) Although sim ilar in concept to both the gold-specie and gold-bullion standards, the g old -excha n g e standard allows even more scope for discretionary governm ent decisions to interfere with the “ autom atic" nature of the price-specie flow m echanism . U nder this system, gold coins are not put into circu la tion, nor does the m onetary authority buy or sell its cu rren cy in exchange for gold. Rather, it buys and sells its own cu rren cy in exchange for the cu rren cy of another country that is itself on a gold-specie or gold-bullion stan dard. Continuing with our exam ple, if the d o l lar is fixed in p rice in term s of gold such that Am erica is on a gold-bullion standard, and if the m onetary authority of Europa always stands ready to exchange one dollar for two marks or one m ark for one-half d o llar, then the mark is effectively valued in terms of gold even though it cannot be exchanged directly for gold. In this case, if the dollar is worth one-half ounce of gold, the mark is necessar ily worth one-quarter ounce of gold. This is sim ilar to the system w hich was in effect from 1944 to 1971 under the terms of the Bretton W oods agreem ent. The U.S. d o l lar was fixed in term s of gold and was the only cu rren cy directly exchangeable for gold. The exchange rates of most other currencies were fixed in term s of dollars by the w illingness of their national m onetary authorities to buy or sell dollars at the fixed exchange rate. H ow ever, the gold exchange standard has even m ore “ slippages" than the bullion standard to prevent its operation as e n vi sioned by H um e. C o n sid er what happens if Am erica is on a fractional gold-bullion stan d ard ,Eu ro p a ison a gold-exchange standard, and Am erica exp erien ces a 50 dollar deficit (as in the previous exam ple). Because its cu r rency is an international reserve, Am erica 8 uses dollars to pay for its excess im ports. The Europan exporters who receive paym ent are likely to exchange the 50 dollars with Europa's m o netary a u th o rity fo r 100 m arks (again assuming an exchange rate fixed at two marks per dollar), increasing Europa’s m oney supply by that am ount. U nder these circum stances, the degree of m onetary adjustm ent in both countries again depends entirely on the poli cies and actions of their central banks. If Europa considers the dollar an official reserve that is as “ good as g o ld " and if it also maintains a ratio of 50 percent between o ffi cial reserves and its national m oney supply, it must rein force the m oney supply expansion by an additional 100 marks (for a total of 200, as in the previous case) to maintain that fixed ratio. O f co urse, if the Europan m onetary authority so chooses, it can accum ulate the dollar reserves w ithout any further actions, thereby lim iting the increase in its dom estic m oney supply to the 100 marks it previously exchanged for dollars. Still another option open to the Europan m onetary authority is to “ ste rilize " the 100 m ark increase by selling 100 marks worth of governm ent securities, thus negating the entire m onetary effect of its earlier foreign exchange transaction. The portfolio decisions of the Europan monetary authority also determ ine the effect of these international transactions on A m e ri ca's m oney supply. If the Europan m onetary authority decides to hold the dollar balances it receives from the exporter in the form of demand deposits with the Am erican central bank, the Am erican m oney supply remains the same or falls by 50 dollars depending on w hether it is defined to include other central bank balances. O n the other hand, if Europa uses the 50 dollars to purchase governm ent securities from the Am erican central bank, the A m erican m oney supply falls by that am ount.4 If Europa exchanges the dollars for 4On the other hand, if Europa purchased the securi ties from the American public, the money supply would remain unchanged. In the U.S. today the Federal Reserve purchases securities from the public for its central bank customers so that there is no net effect on the U.S. money supply. Econom ic Perspectives gold instead of secu rities, the gold drain causes a m ultiplied contraction in the A m eri can m oney su p p ly— but only if Am erica is w illin g to rein fo rce the gold drain by co n tracting its m oney supply sufficiently to m ain tain a fixed gold ratio. O th erw ise, Am erica can renounce (or relax) the gold standard and o ffset the gold d rain by open m arket operations. To su m m arize, even under an interna tional banking system consisting only of ce n tral banks and no com m ercial banking sys tem , with all deposit m oney held in the form of deposits or other liabilities of these central banks, a gold exchange standard allows co n siderable discretion to governm ents and ce n tral banks. Not only is there leeway in govern mental decision-making for the "cen ter” coun try w hose cu rre n cy is used as an international reserve (the same leeway as under the goldbullion standard), but there are additional choices open to every "sa te llite ” country. These choices are: first, w hether or not to treat holdings of the center co un try’s cu r rency as reserves on an equal footing with gold; second, how to divide the com position of its portfolio between gold and the cu r rency of the center co u n try; and th ird , w h eth er to hold the cu rren cy of the center country in interest-bearing or noninterest bearing fo rm , or both, and in what p ro portion. Although it should be easy enough to legislate rules with respect to these matters that w ould enable a fractio n ally based gold standard to operate in a m anner sim ilar to H u m e’s price-specie flow m echanism , the actions req uired of the m onetary authority in adhering to these rules often impose a heavy price in term s of adjustm ent on the real eco nom ies invo lved . If changes in the money supply affected only prices, the problem w ould not be so com plicated. But, in the short run , changes in the money supply affect a w hole host of variables such as em ploym ent and interest rates in addition to just the price level. It is changes in these real variables that governm ents generally resist most fo rcefu lly, p articularly if the prevailing world trend in Federal Reserve Bank o f Chicago these variables runs counter to the policy goals of the governm ent. W hen the monetary system is com plicated to include a com m er cial banking system, the pressures on a govern ment to offset the effects of changes in gold on the reserves of the banking system become particularly acute. Theory versus practice In actual p ractice, the operation of the international adjustm ent mechanism under a gold standard is even less straightforward than th ep recedin gsim p lified examples would suggest. The structures of most financial sys tems leave considerably more room for slip page in the linkages of a gold-centered pay ments system. First, contrary to the assumptions of the exam ples, most deposits of the non-bank public are not held with central banks, but instead are held with private banks, which in turn hold their deposits with th ecen tral bank. Thus, the gold base becom es two steps re moved from deposit-m oney liabilities, and the m ultiplied effect on national money sup plies of a change in gold depends on the size and fixity of the ratios maintained between gold and central bank liabilities and between the latter and m oney. For exam p le, if the U.S. governm ent required the Federal Reserve to hold gold equal to 10 percent of its reservedeposit liabilities and, in turn , required com m ercial banks to maintain reserves at the Fed equal to 10 percent of their own deposit liabil ities, a 10 m illion dollar gold outflow would force the Fed to engage in reinforcing open market sales culm inating in a 100 m illion dol lar change in Federal Reserve deposits. This would force the banking system to contract deposits by 1 b illion dollars—a m ultiplier of one hundred! The pressures on the Fed to resist such drastic changes in the nation’s money supply in response to international disequilibria would be great indeed. To the extent that banks hold reserves in excess of those required by the Fed, the m ultiplier is somewhat smaller, but an additional elem ent of discretion on 9 the part of the com m ercial banking system is added to the supposed “ autom aticity” of the price-specie flow m echanism .5 Sim ilarly, the existence of near-m oney deposits in m oney market funds and in U.S. nonbank financial interm ediaries makes the relationship betw een changes in the U.S. monetary base and the various monetary aggregates even m ore un p red ictab le. D e posit interest rate ceilings in com bination with volatile m arket interest rates induce shifts from one type of deposit m oney to another, such that the precise effect on any single measure of m oney is often d ifficult to predict.6 Finally, the possibility of short-term capi tal movem ents in response to expectations and interest rate differentials can seriously com plicate the idealized working of the pricespecie flow m echanism .7 But what about the em pirical evidence? Did the gold standard during its historical heyday actually operate as envisioned by Hume? O r did governm ents intervene and “ tin k e r" with its actual operation? To answer these questions, let us briefly exam ine the 5ln actual fact most banking systems have some form of “ lagged” reserve accounting which reduces the useful ness of the concept of a multiplier. What we would likely see, in the absence of a change in this type of reserve accounting, would be drastic movements of the federal funds rate in response to gold flows. Alternatively, were the Federal Reserve to use interest rates as an operating target of monetary policy (as it did prior to October, 1979), the rules of the gold standard would force the Fed to "sterilize” , or offset, the reserve effects of gold flows by increasing or decreasing reserves to maintain the target interest rate. Thus, the question of a return to a gold standard cannot be considered without also consid ering the whole range of technical instruments of mone tary control. ‘ Different types of deposit liabilities have different levels of reserve requirements and different interest rate ceilings. As interest rates change these various ceilings may become binding constraints on the returns to hold ing particular types of deposits. As people shift funds from one type of deposit to another to avoid the effect of these ceilings, the average ratio of reserves to deposits also changes, and with it the effects of a given change in reserves on the various monetary aggregates. 7Even under the gold bullion standard (see box), there is room for exchange rate movements between the gold points and short-term capital flows to take advan tage of interest differentials between countries. 70 operation of the price-specie flow m echa nism under the international gold-bullion standard just before and after the turn of the century. The historical record The halcyon days of the gold standard w ere between 1879 and 1914. This period was unusual in that it was characterized by rapid real econom ic growth, a relative absence of restrictions on trade and movem ents of capi tal and labor, and, in general, an absence of wars or revolutions. In terms of the conduct of m onetary policy, how ever, there are other characteristics of this period that stand ou t.8 First and most im portantly, the central banks of most trading nations did not gener ally engineer m ultiplied expansions or co n tractions of their m oney supplies in response to balance-of-paym ents flows. Instead, they allowed considerable flexib ility in the gold “ co ve r" ratios behind the issuance of their national currencies. A study by A rthur I. Bloom field in 1959 com pared year-to-year changes in central bank holdings of securities with changes in central bank holdings of gold over the 1880-1913 period. He found that movements in these two classes of assets were in the opposite direction 60 percent of the tim e, rather than in the same direction as would be predicted if m onetary authorities w ere indeed engaging in reinforcing open m arket operations to maintain their money supplies in some fixed relationship to gold.9 Bloom field's study also found that some ce n tral banks deliberately introduced flexib ility in the gold ratio by varying reserve re q u ire ments during the period, either by changing the reserve ratios or by changing the d e fin i tions of what constituted reserves.1 0 A second observation on the conduct of 8 See Robert M. Stern, The Balance of Payments (New York: Aldine, 1973), p. 112. 9Arthur I. Bloomfield, Monetary Policy Under the International Cold Standard, Federal Reserve Bank of New York, 1959, pp. 47-51. 10lbid. p. 18. Econom ic Perspectives m onetary policies during this period co n cerns the key role of the discount rate as an instrum ent of m onetary policy. Discount rate m ovem ents to induce or reverse short-term capital flow s w ere the prim ary tool used by central banks to m aintain stability in their exchange rates and equilibrium in their pay ments balances; open market operations were rarely e m p lo yed .1 In many cases discount 1 rate changes w ere used to counteract the threat of gold losses or short-term capital flig ht, and in alm ost all cases they w orked in a direction opposite that of central bank gold reserve changes, as would be expected. Finally, Bloom field's study notes that price and discount rate m ovem ents in the co u n tries he studied w ere generally p arallel, ind i cating fairly synchronous movements in ind i vidual business cycles, and in the application of m onetary p olicy. The study further ind i cates that the sim ilarity of m ovem ents in national discount rates reflected not only the broadly synchronous pattern of cyclical busi ness activity but, in the case of many of the central banks, com petitive or defensive dis co unt rate changes. In other w ords, when one bank increased its discount rate, there was a ten d en cy for others to follow suit to guard against the possibility of outflows of short-term capital or gold. Thus, there was evid en ce of co ord inatio n in the im plem enta tion of m onetary p o licy, albeit not always as the result of voluntary cooperation. W hat co nclusio ns can be drawn from the findings of Bloom field's study? Bloom field him self co nclud es that the operation of the p re -1 9 1 4 g o ld s ta n d a rd w as less th an autom atic: Far from responding invariably in a m echan ical w ay, and in accord with some sim ple or unique ru le, to m ovem ents of gold and other external reserves, central banks were constantly called upon to exercise, and did exercise, discretion and judgem ent in a "Bloomfield cities only two documented instances of open market operations during the entire period. Ibid, pp. 45-46. Federal Reserve Bank o f Chicago w ide variety of ways. C lea rly, the pre-1914 gold standard was a managed and not a quasi-autom atic one from the view point of the leading individual countries. Nor did that system always w o rk as "sm o o th ly" as is believed. Critical situations arose from time to tim e in various countries necessitating "e m e rg e n cy" measures by central banks and governm ents to safeguard the co ntin uing co nvertib ility of the currency. In all respects, th en , the differences between central bank policies under the pre-1914 gold standard and after W orld W ar I were essentially differences of degree rather than of kin d .1 2 Bloom field fu rth er concludes that the osten sible "h a rm o n y " of m onetary policy during the pre-1914 perio d, as manifested by the synchronous discount rate movem ents, was brought about not so m uch by the operation of the gold standard as by a lack of conflict between dom estic policy goals and balanceof-payments eq u ilib riu m . W ith a bit m ore hindsight, these co n clu sions may be extended considerably. A l though price stability, generally thought of in terms of "d efen d ing the cu rre n cy ", was cer tainly a co ncern of central b an kersd u rin g th e pre-1914 perio d, the ability of m onetary pol icy to influ en ce real variables such as the rate of output or em ploym ent was not generally appreciated. M o reo ver, the com bined use of m onetary and fiscal policy to pursue such dom estic objectives as full em ploym ent and price stability was also largely u n kno w n. John M aynard Keynes' w ell-know n treatise, T h e G e n e r a l T h e o r y o f E m p lo y m e n t, Interest, a n d M o n e y , w hich won w ide acceptance for such policies, was not published until 1936. Also, reliable inform ation on price-level m ove ments was not im m ediately available for use as a m onetary indicator. O n the other hand, data on reserve flow s w e r e an im m ediate, tangible indicator of the state of econom ic activity and, as a co nseq u en ce, helped to reinforce the single-m inded focus on the bal 12lbid. p. 60. 11 ance of paym ents as the target of m onetary policy. This preoccupation with external balance exacted a high price in term s of the perfor mance of the dom estic econom ies. National prices and output fluctuated considerably more during the gold standard period than they have in recent years, although the gold standard period was free of the pronounced inflationary bias that has characterized many non-gold standard periods. In the United States, for exam p le, the co efficient of varia tion (that is, the ratio of the standard devia tion to the mean) of annual percentage changes in the price level was 17.0 for the gold standard period and 1.3 for the period 1946-1979. Likew ise, the co efficient of varia tion of changes in real per capita incom e was 3.5 under the gold standard and 1.6 in the post-war p erio d .1 Sim ilar results hold for the 3 United Kingdom . Although this variation re flected dow nw ard as w ell as upward price m ovem ents, so that prices w ere stable over the long run , it rem ains highly doubtful w hether countries today would be w illing to allow such drastic fluctuations in econom ic activity. As for the w idespread reliance on the discount rate as the prim ary tool of monetary policy during the era of the gold standard, it must be rem em bered that the use of open market operations as a day-to-day instrum ent of m onetary control was u n kn o w n. M o re over, governm ent security markets in most countries were not sufficiently well-developed and integrated to enable open m arket op era tions to have the speedy, p recise, and w id e spread im pact that they have in the United States today. It thus seems reasonable to conclude that the harm ony in the im plem entation of m one tary policy during the years of the gold stan dard was d ue, at least in part, to the prim itive 13Michael David Bordo, "The Classical Gold Stan dard: Some Lessons for Today,” Review, Federal Reserve Bank of St. Louis, vol. 63 (May 1981), p. 14. 12 state of the art. The absence of any effective alternative to the discount m echanism as the prim ary instrum ent of m onetary policy and the single-m inded focus on b alance-ofpayments eq u ilib riu m as the target of that policy go a long way towards explaining the em pirical evidence on the behavior of central banks under the pre-1914 gold standard. Conclusion The so -called au to m atic adju stm ent m echanism often attributed to the intern a tional gold standard leaves considerable room for slippage and, under a fractio nally backed gold-bullion standard, even re q u ire s the assistance of governm ental policy to re in force its effects. In practice, the successful operation of the international gold standard was due not so much to the autom atic eq u ili brating effects of gold flows as to a (histori cally unique) general harm ony in the practice of m onetary policy and the policy priority given to balance-of-payments considerations. Although the priority given to balance-ofpayments considerations was certainly a result of the threat of gold reserve losses, it was also due in no small part to the fact that dom estic stabilization policies w ere largely unknow n. From the perspective of the current inter national m onetary system, the one lesson to be drawn from exp erien ce under the classical gold standard seems to be that the threat of reserve losses can provide pressure to har m onize m onetary policies if governm ents are w illin g to abide by the rules necessary to the operation of such a standard. Recent e x perience also seems to indicate that the threat of exchange rate depreciation can provide similar pressure. But the w illingness of nations to abide by the international gold standard presupposes a w illingness to place balanceof-payments and foreign exchange consider ations above dom estic policy goals. W hether it is realistic to expect such a drastic reo rd er ing of priorities on the part of the w o rld ’s sovereign governm ents is doubtful at best. Econom ic Perspectives The demise of the gold standard John H. W o od It is iro n ic that most of the recent agita tion for a return to some form of gold stan dard has com e from the United States, whose o fficial p olicies played a leading role in the destruction of that standard. After describing the co nd u ct of governm ents necessary for the successful operation of a gold standard, this article tells the story of the failure of the post-W orld W ar I attempt by the British to restore the pre-1914 m onetary system— an attem pt doom ed to failure by the refusal of the U nited States and France to play by the rules of the gold standard game. Governments and the gold standard W e begin with a system in w hich the m edium of exchang e— i.e ., m oney— consists only of som e useful com m odity and paper claim s on specified am ounts of that com m od ity. M any com m odities have served the dual function of m oney and the m onetary base and the theory portions of our story are app li cable to any of them . H o w ever, gold w ill be the only com m odity considered because of its almost universal acceptance as m oney, to the exclusion of other com m odities, by west ern societies in the 19th and 20th centuries. G o vernm ents are not necessary to the gold standard. If there are free markets in gold and w heat, their relative prices— i.e ., the rate of exchange of gold for w heat—w ill depend upon private supplies and dem ands for the two com m odities. Suppose one ounce of gold (of a particular degree of fineness) is w orth seven bushels of w heat in the m arket place. Also suppose that business is trans acted partly w ith gold coins that weigh 1/35 of an o unce and are called “ dollars.” The dollar is the unit of account and other coins and goods are valued in terms of the dollar. For exam p le, one bushel of w heat, w hich is worth 1/7 of an ounce of gold, is quoted at a price of $5. Gold coins w eighing 10/35 of an ounce Federal Reserve Bank o f Chicago carry the stamp “ Ten D o llars” on one side and the likeness of A lexander Hamilton on the other side. H o w ever, people find it convenient to transact most of their business not with gold coins but with pieces of paper— bank notes and ch ecks—that are convertible into gold. W hen you deposit 100 ounces of gold in a bank, the bank either credits your checking account w ith $3500 or presents you with bank notes of various denom inations totaling $3500. Banks hold reserves of gold in order to carry out their p rom ise, under threat of bank ruptcy, to convert their paper liabilities into gold upon d em an d . G iven the public's m oney-holding p references for gold relative to bank liabilities and the proportions of gold held by banks as reserves against those liab ili ties, the quantity of m oney (i.e ., bank liabili ties plus gold coins held by the nonbank pub lic) in an econom y is determ ined by the m onetary gold stock. The m onetary gold stock is in turn determ ined by the domestic production of gold, the acquisition or loss of gold through international transactions, and fluctuations in the dem and for gold for non monetary uses. All of these factors w ere from time to time sources of fluctuation in the money supply under the gold standard. But an upper lim it was placed on the rate of increase of the m oney supply by the rate at w hich an econo my's m onetary gold stock could be aug mented and by the m inim um reserve ratio w hich banks could hold without provoking fears for their failu re on the part of creditors. Th ere is no such upper lim it under our pres ent “ paper standard” in w hich the greater part of the m onetary base is not the monetary gold stock but central bank liabilities that are limited by neither legal nor prudential consid erations. G o vern m en t may play a part in the o p er ation of the “ p u re ” gold standard described 13 above, for exam ple, by verifying the weights of coins and by im posing reserve req u ire ments on banks. These activities may (or may not) contribute to the smooth operation of the system, but they play no essential part. The only essential pattern of behavior that the system requires of governm ent is that it allow itself to be lim ited by the same constraints to w hich private actors are subject. Specifically, when the governm ent issues paper currency of its o w n, that cu rre n cy, like bank liabilities, must be co nvertib le into gold. This limits its paper issues in the same way that prudential reserve considerations lim it the deposits of banks. Although governm ents n e e d not play an active part in the operation of the gold stand ard, they have in fact done so. The rem ainder of this paper is largely a story of the support ive and destructive interventions of govern ments in the fu n ctio n in g of the gold standard preceding and im m ediately follow ing W orld War I. Automatic adjustment under the gold standard The theory (and, to a large extent, the practice) of the gold standard provided for an autom atic m echanism that corrected balance-of-paym ents disequilibria and prevent ed unlim ited inflations or deflations. First, consider a dom estic m onetary disturbance in the form of an expansion of bank credit and the m oney supply. Suppose banks respond to increases in credit dem ands and interest rates by reducing their reserve ratios. The conse quences are inflation and a balance-of-payments deficit as dom estic goods rise in price relative to foreign goods. Am ericans are buy ing m ore from foreigners than they areselling to foreigners. If the international means of payment is gold, as it was in the 19th century, instead of dollars, as has been the case since about 1940, the dollar claim s accum ulated by foreigners w ill be converted into gold. The loss of reserves by Am erican banks, even given their new and low er desired reserve ratios, forces a contraction of m oney and 74 credit. A m erican prices stop rising and p er haps even d e clin e , and the balance-of-payments deficit is corrected as the Am erican inflation is exp orted—for foreign banks e x pand their lending as they acquire gold from the United States. In addition to the external drain of gold discussed above, there w ill also probably be an internal drain as m ore m oney of all kinds, including gold co in , is needed to carry out tra n sa ctio n s at th e h ig h e r p ric e s . R. G . Hawtrey argued that the internal drain was norm ally a larger and sw ifter force than the external drain in 19th-century gold standard adjustm ent.1 Now consider a second, non-m onetary disturbance: a balance-of-paym ents deficit due to a bad harvest. The m echanism of adjustm ent is identical to that in the first case: a loss of bank reserves, m onetary contraction, deflation, and restoration of the balance of payments. Harvest fluctuations w ere proba bly the most im portant source of monetary and price instability in the United States between its return to the gold standard in 1879 and the form ation of the Federal Reserve System in 1913.1 2 As a third and final exam ple, consider the effects of a “ Keyn esian ” depression in W est ern Europe, characterized by a drastic fall in incom e but w ithout a significant fall in prices, on m oney and prices in the United States. U nem ployed Europeans reduce their pur chases of Am erican goods, causing an out flow of gold from the United States and resul tant declines in m oney and credit. In sum m ary, autom atic adjustment under the gold standard is neither more nor less than the international transm ission of eco nom ic disturbances. U nder the gold stan dard, inflations, deflations, high incom es, and unem ploym ent are exported to and imported from other co untries. O u r own inflations and 1R. G. Hawtrey, A Century of Bank Rate (London: Longman, Green, and Co., 1938), ch.3. 2Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867-1960 (Princeton: Princeton University Press, 1963), ch. 3. Econom ic Perspectives deflations are lim ited in extent by the gold standard— at the price of accepting the infla tions and deflations of others. Discretionary m onetary policy is severely lim ited. Am erican m oney and prices are controlled to an im por tant extent by fo reigners; and foreign money and prices are subject to fluctuations in the United States. The operation of this autom atic adjust ment m echanism requires at least passive acceptance by governm ents, including non in te rfe re n ce with the free flow of gold and other goods. Dom estic inflations may be pro longed by restrictions on the export of gold, subsidies for exports, and tariffs and quotas on im ports. Free trade is necessary to the full realization of the co rrective effects of the gold standard m entioned at the beginning of this section. But governm ents can do more than re frain from in te rferen ce with the gold stan dard. The adjustm ents described above are probably indeed "au to m atic'’ in the sense of being inevitab le, under the conditions as sum ed, given enough tim e to w o rk. H ow eve r, those adjustm ents may be too slow for those co ncern ed with the solvency of banks and the preservation of a country's gold reserves. W hen this is the case, governm ents can play an active role in speeding up the adjustm ent process, som etim es called the "ru le s of the gold standard g a m e."3The play ers designated by governm ents to play this game are central banks. In order to under stand how the game should be played, it is necessary to exam ine the conduct of the Bank of England, w hich was the only major central bank w illing to play by the rules. The Bank of England (Bank) was until 1945 a private firm . But from its inception in 1694 the Bank had im portant, w ell-defined p ub lic responsibilities. No harm is done by th in kin g of the Bank as an o fficia l, or at least a q u asi-o fficial, agency. It enjoyed special m onopoly privileges regarding note issue in London, operated under a series of short term charters renew able by parliam ent, and served as the Treasury's main depository and an im portant source of credit to the govern ment. H ow ever, the Bank was not at first a "cen tral b an k" in the sense in w hich that term cam e to be used in the 19th and 20th cen tu r ies; i.e ., it was not conceived as a regulator of the m onetary base or a lender of last resort to the financial system. N evertheless, by a com bination of its m onopoly privileges, its special roles as governm ent depository and creditor, and, most im portant, its conservative lending b eh avio r, the Bank had by the end of the 18th century acquired the substance of the central banking powers and responsibilities later con ferred by law on the Bank, the Federal Reserve System, and other official central banks. Because of the Bank's well-deserved rep utation for soundness, its note and deposit liabilities w ere considered "as good as gold." As a co nsequ en ce, the reserves of other banks w ere held predom inantly in the form of the note and deposit liabilities of the Bank of England. Claim s on banks by the nonbank public and by other banks were routinely settled by the exchange of claim s on the Bank of England because people w ere satisfied that the latter w ere alw ays, with certainty, co n vertible into gold. The Bank had become the holder of "th e ultim ate cash reserve of the co u n try ."4 The effect of this arrangem ent was that the Bank's liab ilities, with the gold held out side the Bank as cu rren cy or as reserves in banks, constituted the monetary base. W hen gold came into the Bank, due either to a favorable balance of payments or to a reduc tion in the dom estic dem and for cu rren cy, the Bank was in a position to expand its lend ing. This meant an increase in the reserves of other banks and therefore a m ultiple expan sion of total bank credit and the money 3 John Maynard Keynes, A Treatise on Money, vol. II (London: Macmillan, 1930), p. 306. 4Walter Bagehot, Lombard Street (New York: Scribner, Armstrong, and Co., 1873), p. 315. Central banks and the rules of the gold standard game Federal Reserve Bank o f Chicago 15 supply— precisely in the m anner of a Federal Reserve open market purchase in the 1980s. By behaving in this m anner, by doing what comes naturally to any profit-seeking bank, the Bank of England— long before the d e velo p m e n t of the term or even the theory— was by the end of the 18th century playing according to the rules of the gold standard game. C o n sid er, for exam ple, a flow of gold to Britain resulting from inflation on the C o ntinent. M uch of this gold found its way to the Bank of England. U nder these conditions, the Bank often expanded its lend ing by a m ultiple of the increase in its gold reserve. O th er banks, w hich tended to hold the additional note and deposit liabilities of the Bank as their own reserves, also expanded their own credit. British financial institutions had developed in such a way that the central bank, the Bank of England, accentuated the effects of gold flows. A gain or loss of gold had a twice m ultiple effect on m oney and prices— first on the m onetary base through central bank lending, and then on the lending of other banks due to changes in the m onetary base. The operation of the pre-1914 gold standard In order to understand the Bank's behav ior between 1844 and 1914, we must begin with the Restriction Period of 1797-1821, when Britain was not on the gold standard. O fficial policy between that tim e and 1931 was d om i nated by a reaction to what was generally thought to be the Bank's m isconduct w hile free of gold standard constraints.5 M aintenance of co nvertib ility between the nation's m oney and gold at a fixed rate of exchange was only the Bank of England's second most im portant objective. First was support of the state. During the 1790s, the Bank purchased substantial quantities of 5For an extensive discussion of the events and the controversies arising from those events between 1797 and 1865, see Jacob Viner, Studies in the Theory o f Inter national Trade (London: George Allen and Unwin, 1937), ch. 3-5. 76 governm ent securities issued to finance the war with Napoleon. The consequences were expansions of the m onetary base and the m oney supply, inflatio n , and a loss of gold. The Bank was very close to being unable to make good on its prom ise to convert its liab il ities into gold at the historic rate of exchange. The choices faced by the Bank and the governm ent were either a restriction of credit, thereby forcing the governm ent to finance the war w ithout resorting to the Bank (i.e ., to rely upon taxes and private len din g), or a legal suspension of the Bank's obligation to redeem its liabilities in gold. The latter course was chosen in 1797 and again during W orld War I, as was the case for A m erican banks during and for several years after the Civil War. Present-day A m ericans w ill not be sur prised to learn that the Bank of England's behavior under these co nd itio n s— i.e ., its response to (1) a release from the necessity of keeping a prudent gold reserve and (2) pres sure from a g o vern m en t ru n n in g large d eficits—was expansionary. The Bank only did what has com e to be expected of central banks during w artim e. But it was severely crit icized and held responsible by politicians and econom ists for the rapid increase in prices, averaging nearly 4 percent per year, between 1797 and 1813. Th en , when it was assigned the task of reversing the w artim e inflation so that the cu rren cy might increase in value sufficiently to restore the gold standard at the prewar rate, the Bank came under even m ore w id e spread attack—this time joined by unem ployed w o rkers, failed bankers, and bankrupt businessm en—for causing a 50 percent fall in prices (nearly 7.5 percent per year) between 1813 and 1822. Even after the resum ption of co nvertib ility in 1821, the Bank's behavior was highly erratic and continuously a source of controversy in and out of parliam ent. U n re strained central banks have considerable dis cretion even under the gold standard, at least in the short run , until their policies force the suspension of the system. This had occurred in 1797 and fears of a repetition of that exp e Econom ic Perspectives rien ce w ere w idespread. The co untry had had enough of discre tionary m onetary policy and attempted to rectify matters in the Bank Charter Act of 1844 by tying the Bank to a rule. The Bank was divided into two departm ents. Gold was held in the Issue D epartm ent, w hich had no fu n c tion except to exchange bank notes for gold. This was the m onetary ru le : changes in the B an k’s note liabilities w ere tied , pound for p o u n d , to its gains and losses of gold. The Banking D epartm ent, on the other hand, was designed to be free to behave " lik e any other b an k .” 6 The Banking Departm ent was expect ed to pursue profits, with no thought of any larger p u b lic re sp o n sib ility, by extending credit on the basis of its reserve, w hich took the form of its holdings of the Issue Depart m ent's notes.7 But the Act of 1844 was badly designed. It took no account of the Ban k’s deposit liab ili ties. Th en , as now , most business purchases w ere paid for by ch eck , and the money supply consisted p rincipally of demand d e posits. C o n seq u en tly, a rule for the Bank's notes left the main portion of the monetary base untouched . For the Bank's deposit liab il ities w ere now the special preserve of the Banking D epartm ent, w hich had in effect been told to pretend that its lending policies did not dom inate the reserves of other banks or the co u n try’s m oney supply.8 A co nseq u en ce of the Act of 1844 was th atth e Bank began to play by the ru le so f the game w ith , if possible, even m ore zeal than b efo re. It im m ediately em barked on an e x pansion that, in com bination with other c ir cum stances, including a poor harvest in 1846, 6Bagehot, p. 41. 7See John H. Wood, “ Two Notes on the Uniqueness of Commercial B a n k s Journal o f Finance, vol. 25 (March 1970), pp. 99-108 for a formal description of the Bank’s structure and its role in the monetary system under the Act of 1844. 8AII of this was recognized at the time by Tooke and other critics of the Act of 1844. See Thomas Tooke, An Inquiry Into The C urrency Principle; the C onnection of the C urrency with Prices and the Expediency o f a Separa tion o f Issue from Banking (London: Longman, Brown, led to an adverse balance of payments and a loss of gold. The Bank accordingly sharply reversed its liberal p olicy, causing the panic of 1847. U n dau n ted, the Bank persisted in its destabilizing policies, precipitating further financial crises in 1857 and 1866. The Bank changed its behavior after 1866 as it apparently becam e m ore conscious of its role as the co u n try’s central bank— i.e ., as the regulator of the m onetary base and the lender of last resort. Some people attributed this change to W alter Bagehot's articles in The Econom ist and his book Lom bard Street (1873), w hich rem ains unsurpassed as a de scription of the responsibilities of a central bank under the gold standard. W hatever the reason, the Bank now began to play the gold standard game with a little less enthusiasm. It adopted a m iddle way between the rules of the game and co ncern for dom estic stability. The years betw een 1880 and 1914 have been called the heyday of the gold standard. The gold standard had been adopted by most m ajor western countries by 1880 but never fully recovered from the changes arising out of W orld W ar I. O n e of the most interesting and inform ative studies of the conduct of the Bank of England, as w ell as other central banks, during this period was published by A rthur Bloom field in 1959.9 Bloom field p re sented two sets of data bearing on the degrees to w hich 11 central banks played by the rules of the gold standard game. First, Bloom field found that for most co un tries, including the United Kingdom , central bank discount rates and reserve ratios tended to be inversely co rrelated . For exam p le, central banks usu ally low ered their lending rates when they acquired gold and usually raised their rates when they lost g o ld .1 This is consistent with 0 the rules of the gam e, although the co rrela tions w ere not sufficiently high to persuade 9Arthur I. Bloomfield, M onetary Policy Under The International C old Standard: 1880-1914 (New York: Fed eral Reserve Bank of New York, 1959). Green, and Longmans, 1844), pp. 101-24. 1 See ibid. pp. 30-35. The countries were the United 0 Kingdom, Germany, France, Belgium, the Netherlands, Denmark, Finland, Norway, Switzerland, Russia, and Austria-Flungary. Federal Reserve Bank o f Chicago 17 Bloom field that the game had been played with as much enthusiasm as he had expected to find. But changes in discount rates are im por tant only to the extent that they induce changes in central bank cred it. The evidence presented by Bloom field on the response of central bank credit to changes in gold hold ings strongly suggests that the rules of the game w ere violated m ore often than obeyed. In nine of the eleven co untries, annual changes in central bank credit tended to offset the effects of gold on the m onetary base far more than half the tim e. O n ly the Bank of England and the Bank of Finland accentuated the effects of gold inflows almost as often as they neutralized those flow s.1 1 The choice By adopting the gold standard and playing by the rules, Britain purchased long-run price stability at the cost of short-run instability.*2 1 O ther countries joined the gam e, but only half-heartedly, and Britain's own enthusiasm waned with tim e. The choice that had been made and the p rice that had been paid w ere well understood by econom ists, the general, p ub lic, and central bank o fficials. The Bank of England, the Act of 1844, and the gold stan dard w ere subjected to almost continuous attack from most sectors of society, especially businessmen. Cham bers of Com m erce passed resolutions condem ning the gold standard "Ibid., pp. 47-51. "See Benjamin Klein, "The Impact of Inflation on the Term Structure of Corporate Financial Instruments: 1900-1972,’’ in William L. Silber, ed., Financial Innovation (Lexington, Mass.: D.C. Heath, 1975), pp. 125-49 and Michael D. Bordo, "The Classical Gold Standard: Some Lessons for Today,” Review , Federal Reserve Bank of St. Louis, vol. 63 (May 1981), pp. 2-17 for evidence that yearto-year fluctuations in prices and output were greater under the gold standard than since 1945 but that longerrun changes in prices have been greater in the latter period. "See "The Petition of the Merchants, Bankers, and Traders of London Against the Bank Charter Act; July 1847” in T. E. Gregory, ed., Select Statutes, Docum ents and Reports Relating to British Banking, 1832-1928, vol. II (London: Oxford University Press, 1929), pp. 3-7. 18 and petitioned parliam ent to com pel the Bank to alter its b eh avio r.1 Following the crises of 3 1847 and 1857, parliam ent form ed com m ittees to inqu ire into the w orkings of the financial system. Horsley Palm er, a directo r and form er G o vernor of the Bank, testified in 1848thatan increase in Bank Rate "presses upon all branches of com m erce in a way that is most prejudicial to th em ; the raising of the rate of interest, I am given to understand, stopped very largely the m ercantiletransactions of the co un try—exports as well as im p o rts."1 The 4 fall in prices resulting from a restriction of the Ban k’s credit "destroys the labor of the co u n try; at the present m om ent in the neighbor hood of London and in the m anufacturing districts you can hardly move in any direction w ithout hearing universal com plaints of the want of em ploym ent of the labourers of the co un try." James Spooner, Birm ingham banker and m em ber of parliam ent, continued the q u estioning: “ That you ascribe to the m ea sures w hich it was necessary to adopt in order to preserve the co nvertib ility of the note?” Palmer re p lied : " I think that the present depressed state of labour is en tirely ow ing to that circu m stan ce." The then G o vern or and Deputy G o vern or of the Bank agreed with Palm er. A colleague of Spooner's, Edward C ayley, suggested to the G o vernor in a hostile leading question that " the price of the co n vertibility of the note under that state of things is the disem ploym ent of labour and the ruin of the m erchants of the co u n try ." After squirm ing a bit, the G o vern o r adm itted that an increase in Bank Rate w ould "Prob ab ly for a tim e . . . lead toa disem ploym ent of lab o u r.” A half century later leading econom ists were still deploring the "evils of our present monetary system ."1 Knut W icksell predicted 5 that “ the danger of basing the w h o le of our eco nom ic system on som ething so capricious "The quotations in this paragraph are from Hawtrey, pp. 27-29. "Alfred Marshall, "Remedies for Fluctuations of General Prices,” Contem porary Review (March 1887), reprinted in A. Pigou, ed., M em orial o f A lfred Marshall (London: MacMillan, 1925), p. 188. Econom ic Perspectives as the o ccu rren ce of a certain precious metal must sooner or later com e to lig h t.” 1 *W ick6 sell,^ A lfred M arsh all,1 and John Stuart M ill1 8 9 in England and Irving Fisher2 in the United 0 States gave lengthy accounts of gold's sins and how they w ere aggravated by central banks. But econom ists w ere confronted by a dilem m a that still has not been solved. The ch o ice of m onetary systems lay between “ the cross of gold” 2 and a discretionary monetary 1 authority under the thum b of a profligate governm ent. Except for the overseas section of the C ity of London, w hich believed that London's financial suprem acy depended on the m aintenance of a fixed rate of exchange betw een the pound and gold, no one seemed fond of the prevailing system. H ow ever, based on th eir bitter exp erien ce of unrestrained paper standards, especially the 1791-1821 Re striction Period in Britain and the colonial paper issues and C ivil W ar greenbacks in A m erica, they liked the alternative even less. A third possibility— a discretionary system managed in an intelligent, non-political, noninflationary w ay— appeared so outlandish that it was rejected out of hand.2 2 The necessities of war finance forced the 16Knut Wicksell, Lectures on Political Economy, vol. II, translated by E. Classen (London: Routledge and Kegan Paul, 1935), pp. 125-26. “ Wicksell, Interest and Prices, translated by R. F. Kahn (London: Macmillan, 1936) pp. 165-96. 18Marshall, pp. 188-211. 1 John Stuart Mill, Principles o f Political Economy 9 (London: Longmans, Green and Co., 1848), pp. 651-77. 20lrving Fisher, The Purchasing Power o f M oney (New York: Macmillan, 1911), pp. 234-348. 21William Jennings Bryan, Speech closing the plat form debate at the Democratic Convention, July 8,1896. Published in Bryan’s Speeches, vol. I (New York: Funk and Wagnalls, 1913), pp. 238-49. “ Published proposals for solving this dilemma would fill a good-sized library. Several of the better known schemes may be found in M ill, Bk. Ill; Marshall, pp. 192-211; Knut Wicksell, Interest and Prices, ch. 12, and Fisher, ch. 13. Most were designed to alleviate the rigidity of the gold standard without accepting the flexibility of a discretionary monetary authority. For a discussion of our continued failure to find a satisfactory solution, see John R. Hicks, “ Monetary Theory and History—An Attempt at Perspective,” in Critical Essays in M onetary Theory (Ox ford: Clarendon Press, 1967). Federal Reserve Bank o f Chicago effective suspension of convertibility during W orld W ar I, as the governm ent again bor rowed heavily from the Bank. Inflation during and im m ediately after the war was much m ore severe in the U nited Kingdom than in the United States. W holesale prices increased approxim ately 175 percent between mid1914 and the end of 1920 in Britain, compared with 100 percent in the United States. The adverse in flu en ce of these price changes on the dollar value of the pound was exacer bated by Britain's loss of im portant export markets during the w ar. The value of the pound was m aintained by exchange controls and other expedients w h ile the war lasted. But the lifting of controls allow ed the pound to fall from its prew ar value of $4.86 to a low of $3.44 in N ovem ber 1920.2 3 The return to gold These events did not alter the govern ment's determ ination, expressed in 1918, “ that after the war the conditions necessary to the m aintenance of an effective gold standard should be restored w ithout d elay.” 2 This 4 meant a restoration of the prew ar parity with gold, and therefo re with the dollar. The Bank of England sought to achieve this objective by means of a severely contractionary monetary policy. Its credit was reduced 20 percent dur ing the next two years and w holesale prices fell 34 percent. The United States was sub2 Converting shillings and pence to decimals, the 3 pound had been defined early in the 18th century such that one fine ounce of gold was worth approximately £4.2479 (although the rate of £3.89375 per standard ounce was quoted more frequently.) The dollar had been defined by law in 1792 such that one ounce of fine gold was worth $20.67. The dollar/pound exchange rate was therefore 4.2479 Our use of $4.86 is slightly inaccurate but follows custom. 24First Interim Report of the Committee on Currency and Foreign Exchanges After the War, 1918, Summary and Conclusions,” reported in Gregory, vol. II, p. 361. This Committee was called the Cunliffe Commission after its Chairman, Lord Cunliffe, who was Governor of the Bank of England from 1913 to 1918. 19 jected to sim ilar, but less extrem e shocks and Am erican w holesale prices fell 16 percent. By the end of 1922, the pound had risen to $4.61 and “ the Authorities w ere in a position to begin serious consideration of the tactics for a return to p a r."2 5 W hat tactics? C entral bankers knew neither m ore nor less in the 1920s than in the 1980s about how to reduce inflation o r, in the case at hand, how to cause d eflation. What other course is there but a restriction of cre d it? F u rth e rm o re , th ey had learn ed nothing since 1848, as w e have learned nothing since 1922, about how to do this w ithout severe eco nom ic disruption. U nem ploym ent was 14 percent of the labor force when the Bank perceived itself to be closing in on the goal of $4.86. Economists and busi nessmen, w h ile not quite rejecting the gold standard co m p le te ly , reco iled from the governm ent’s program .2 But the perm anent 6 staffs of the Bank and the Treasury were determ ined to return to gold as soon as pos sible regardless of the “ d isco m fo rts"2 in 7 vo lve d and p ersu ad ed p o litic ia n s to go along.2 W ith some exceptions due to dom es 8 tic pressures, restrictive m onetary and fiscal policies w ere co ntinued u ntil, after a fall to 25D. E. Moggridge, The Return to C o ld 1925: The Formulation of Econom ic Policy and its Critics, (Cam bridge: Cambridge University Press, 1969), p. 16. 26Nearly all economists who wrote or testified on the subject opposed a return to gold at the prewar parity at the real costs that they argued were implied by the government’s policies. For examples, see John Maynard Keynes, A Tract on M onetary Reform (London: Macmil lan, 1923) and A. C. Pigou, “ Memorandum on Credit, Currency, and Exchange Fluctuations,” submitted to the Brussels Conference, 1920. Partially reproduced in W. A. Brown, The International G old Standard Reinterpreted, 7974 -34 , vol. I (New York: National Bureau of Economic Research, 1940), pp. 222-23. For a discussion of the oppo sition of other groups, see W. A. Brown, England and the New C old Standard, 1919-1926 (New FHaven: Yale Univer sity Press, 1929), ch. 10. $4.26 in January 1924, the pound was gotten up to $4.86 in June 1925 and the Gold Stand ard Act officially restored the country to the sum m er of 1914.2 9 The United States, France, and the collapse of the gold standard The question of w hether the pound was overvalued at $4.86 during and after 1925 is still controversial. In any case, external co n siderations continued to dom inate British monetary and fiscal policy. Deflation and unem ploym ent continued through 1929, and after that matters got w orse. Although the authorities w ere prepared to bear the costs (and in the event did bear the costs) of defla tion sufficient to return to and then to m ain tain the gold standard at the prewar parity, they had hoped that deflation w ould not be necessary. To a large exten t, British policies w ere based on the expectation that the large accum ulations of gold in the United States during and after the war would eventually be allowed to affect Am erican m oney and prices. The British waited in vain for the United States to begin to play the gold standard game as the Bank of England had played it before 1914. But they cannot com plain that they w ere deceived. Benjam in Strong, President of the Federal Reserve Bank of New York and the most influential official in the Federal Reserve System until his death in 1928, made clear that his goal was price stability and that the rules of the game w ere som ething d e voutly to be avoided rather than fo llow ed. In 1923, Strong w rote to M ontagu Norm an, G o vern or of the Bank of England, that with A m erica’s “ excessive gold stock we must entirely ignore any statutory or traditional percentage of reserve and give greater weight to what is taking place in prices, business activity, em ploym ent, and credit volum e and 2 This was the euphemism applied by Montagu 7 Norman, Governor of the Bank of England from 1920 to 1944, to the costs of the gold standard. 2 For a detailed account of official thinking during 8 this period see D. E. Moggridge, British M onetary Policy, 1924-1931: The Norman Conquest of $4.86 (Cambridge: Cambridge University Press, 1972). 20 29Except that domestic gold circulation was abol ished and the complete, pure gold standard was suc ceeded by an international gold standard in which gold would be paid only to foreigners. Econom ic Perspectives tu rn o ve r.30 Th en , perhaps thinking that his message was a bit harsh in view of what the British w ere trying to accom plish, Strong added : " O f course we must not close our eyes to the bearing this may have upon Eu ro p e ____” As w e shall see below , Am erican officials in fact took little account of the effects of their policies on others. Strong opposed legislation that would have required the Federal Reserve to stabilize the price level because, among other reasons, he felt that factors outside the System's co n trol also affect prices. N evertheless, he ac cepted price stability as the Fed's prim ary goal, w hich he proposed to achieve by a m onetary base ru le : “ If I w ere C zar of the Federal Reserve System I'd see that the total of our earning assets did not go much above or b elow th eir last year's average, after deducting an am ount equalling from time to tim e our total new gold im ports.'' Such a gold n eutralization policy is, of course, the exact antithesis of the gold standard game. In 1944 Ragnar Nurkse presented evi dence on the w illingness of central banks to play by the rules of the game during the interw ar p erio d .3 W ith one small and one 1 large excep tio n , his results w ere sim ilar to B lo o m field ’s for the prewar period. The cen tral banks w hose behavior was reported by both Bloom field and Nurkse at least partially neutralized gold flows 64 percent of the time between 1880 and 1914, com pared with 67 percent of the tim e between 1922 and 1931.3 2 The small exception w asthat the Bank of Eng land co nform ed to the rules 60 percent of the tim e during the 1922-31 period com pared w ith 48 p ercent of the tim e between 1880 and 1914— a d ifferen ce that may not be statisti cally significant in view of the small number of observations in the later period. Th e m ajo r d iffe re n c e b etw een the m onetary systems observed by Bloom field and Nurkse was the em ergence of a new and dom inant actor in the form of an Am erican central bank that had discretionary powers and was determ ined to prevent the gold standard from u nderm ining dom estic stabil ity. Nurkse reported that the Federal Reserve at least partially neutralized gold flows during nine of the ten years 1922-31. His results are shown in the ch art, w hich covers a som e what longer perio d, 1921-33. During 12 of these 13 years, changes in Federal Reserve credit (A F ) w ere the opposite of changes in the governm ent's gold holdings (A G ), which until W orld II made up the largest part of the m onetary base.3 The A m erican governm ent’s 3 stock of gold grew from $1,290 m illion in D ecem ber 1913 to $2,451 m illion in 1920, $3,985 m illion in 1925, and $4,225 m illion in 3 The exception to this neutralization policy in 3 Nurkse’s data, which were March-to-March changes, was 1931. The exception in the end-of-year changes shown in the chart is 1924. Changes in Federal Reserve credit (A F) and U.S. official gold holdings* (A G ) billion dollars 3 This and other statements by Strong are quoted 0 from Lester V. Chandler, Benjamin Strong, Central Banker (Washington, D.C.: The Brookings Institution, 1958), ch. 6, which is appropriately titled “ New Goals, New Methods.” 3 Ragnar Nurkse, International Currency Experience: 1 Lessons o f the Inter-W ar Period (Princeton, N.J., Prince ton University Press, 1944), pp. 237-39. *G is the monetary gold stock less gold coin in circulation. 32Nurkse presented no data for Belgium or the Soviet Union and reported both Austria and Hungary. SO U RCE: B a n k in g a n d M o n e t a r y S ta tistic s, 1914-1941 (Washington, D .C .: Board of Governors of the Federal Reserve System, 1943), pp. 369-71. Federal Reserve Bank of Chicago 21 1930— from 27 percent of the w orld's gold reserves in 1913 to 38 percent in 1930. This accum ulation of gold was due not only to the Federal Reserve's conservative m onetary pol icy (Am erican m oney and prices in 1929 were virtually unchanged from their 1925 levels) but to successively higher protective tariffs culm inating in the Sm oot-Hawley Act of 1930. Am erican policies w ere reinforced be ginning in D ecem ber 1926 by France, w hich returned to the gold standard at a rate of exchange considerably below that prevailing during most of the preceding several years and w hich is w id ely thought to have u nd er valued the fran c. It now becam e a race between the U nited States and France to see who could accum ulate the most gold. French gold reserves rose from $711 m illion in Decem ber 1926 to $2,699 m illion in 1931. At the end of 1931, the United States and France owned 60 percent of the w orld's gold reserves, com pared with 39 percent in 1913 and 43 p er cent in 1920. M oney, p rices, and incom e fell rapidly in Britain between the fall of 1929 and the fall of 1931, but not as rapidly as in the U nited States and France. The British balance of payments w orsened, gold drains becam e more severe, and, fin ally, in Septem ber 1931, the Bank of England was no longer able to maintain the co nvertib ility of the cu rren cy. The pound was allow ed to float and by the end of the year had fallen to $3.37. Postscript The British must accept a large part of the blame for the tim ing of the collapse of the gold standard. In retrospect, it appears that they returned to gold too soon or at the wrong rate or both— although their argu ment that a return to gold at a d ifferent rate would have been inconsistent with the essen tial idea of a gold standard is unansw erable. A 34For evidence that official French policy was to return to gold at a rate that would give its export indus tries an advantage in world markets, see R. S. Sayers, “ The Return to Gold, 1925,” in L. S. Pressnell, ed., Studies in the Industrial Revolution (London: Athlane, 1960). 35Moggridge, British M onetary Policy, p. 7. 22 gold standard under w hich rates are adjusted w henever cu rren cies com e under pressure is not worth its nam e. C e rtain ly, it performs none of its intended fu n ctio n s— in particular, the elim ination of m onetary discretion. H ow ever, the stated objectives and behavior of France3 and especially the United States sug 4 gest that the gold standard w ould not have had much of a fu tu re regardless of the c o n d i tions under w hich it was restarted. It is in co n ceivable that a gold standard can w ork when the dom inant trading country treats dom estic objectives as param ount. Britain has been called variously the um pire and the conductor of the pre-1914 gold standard. But these terms understate Brit ain's im portance, for she was also the major player. She played as w ell as called the tune. An understanding of the role of London in the operation of the system requires a grasp of “ the im m ensely strong underlying position of Britain in the international econom y. In the cen tu ry before 1913, in every year but tw o, Britain had been in surplus on cu rren t a cco u n t.''3 London was also, as the world's 5 b anker, the depository for large amounts of foreign funds. These factors meant that Lon don exerted a large and continuing pull on the w orld's gold—w hich was allowed to flow out again because Britain was also the w orld's largest overseas investor. She lost this posi tion after the war to a co untry that showed a strong inclination to accum ulate gold. The Bank of England treated gold as an instrum ent, som ething to be used to expand credit when it flowed in and som ething to be paid out, w ithout regret, upon dem and. In com m on with others, the British loved easy m oney and good tim es, w hich the Bank sup plied w henever it was able. The Bank's appar ent eagerness to see how close it could trim its reserves w ithout quite falling off the gold standard was a source of am azem ent and co n ce rn .3 This pattern of behavior, probably 6 3 The admonition to keep a larger reserve was prob 6 ably the most urgent advice of both Tooke, An Inquiry Into the C urrency Principle, and Bagehot, Lombard Street. Econom ic Perspectives essential to a successful gold standard, was diam etrically opposed to that of France and the U nited States not only during the 1920s but also in the 1960s, w hen the form er co u n try again evinced a strong desire to accum u late gold and the latter w orried that gold was actually being called upon to perform its function as a reserve. The decision of the U nited States in August 1971 to renege on its prom ise to foreign central banks to redeem dollars in gold— i.e ., to apply its gold reserve to the use for w hich it was presum ably in tended37— raises serious doubts about this country's ability to succeed Britain as man ager of an internatio nal gold standard. Per haps more im portantly, the high domestic costs of adhering to the rules of the gold standard game raise serious doubts aboutany co untry's ability and w illingness to take on such a responsibility. 3 What possible function can America’s gold reserve 7 now perform except as a continuing reminder to for eigners of our unreliability as an international banker? ECO N O M IC PERSPECTIVES— Index for 1981 Agriculture and farm finance 1980 developments in rural credit markets................................. A new role for federal crop insu ran ce......................................... Issue Pages January/February September/October 18-23 18-23 Banking, credit, and finance The significance and measurement of concentration .......... District trends in banking concentration .................................... Structural change in Wisconsin in the 1970s............................... Interest rates and inflation.................................................................. Improving housing finance in an inflationary environment: alternative residential mortgage instruments.......................... March/April March/April March/April May/June 3-5 6-12 13-21 3-12 July/August 3-23 Economic conditions The Midwest and the recession........................................................ Economic events in 1980—a chronology...................................... January/February January/February 3-7 12-13 Government finance Federal tax and spending reform ................................................... 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