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Monthly Kmcw j v ID A H O A LA SK A FEDERAL RESERVE TWELFTH B A N K FEDERAL O F RESERVE S A N F R A N C I S C O DISTRICT m i *3n D ili* JJ ue Review of Business Conditions................page 78 The Search For Certainty In An Uncertain World PART I: The Rise of Gold as a Domestic Standard . page 84 A R IZO N A N EV A D A Review of Business Conditions w ere g ro u n d h o g s, they would have emerged from their burrows on February 2, seen their own shadows and, as in the legend, returned underground convinced that winter would last six more weeks. The shadows, not of economists, but of declining business activity were still to be seen all about the econom ic landscape in F eb ruary, but there was also widespread anticipation that business would turn up in the spring. N a tional business activity did improve on many fronts in March, and further gains in April and early May revealed that the economy had swung into the recovery phase of the business cycle. Industrial production rose 2Vi percent in A p ril, follow ing a very slight gain in March. The April index was 105 percent of the 1957 base, compared with the recession low of 102 percent in February. Output gains were widespread in April and included in creased production in the auto and steel in dustries, where much of the recent decline was concentrated. New car sales rose about 19 percent from February to March, on a daily average basis, and this level was main tained in April, reducing new car stocks. As a result, auto makers stepped up production schedules and boosted their steel orders. F ur th er gains in steel and au to p ro d u c tio n o ccurred in May. The value of new c o n struction p u t in place rose both in M arch and April, with the larger gain occurring in April. New construction in that month was valued at $55.8 billion, at a seasonally ad justed annual rate. Private residential con struction, which had been one of the major weak spots during the recession, increased 4 percent in April, reflecting in part the 8 per cent rise in private housing starts in March. E m plo y m ent in nonfarm establishments rose m oderately both in M arch and April, aided by the expansion in construction ac tivity. In the latter month, employment began to pick up in most manufacturing industries. I f e c o n o m i s t s The average factory workweek continued to lengthen in April as it had throughout the first quarter. The April increase was of special significance because there is usually a sea sonal decline in manufacturing hours in April. Average hourly and weekly earnings also in creased somewhat and were 2 percent above a year ago. Despite these gains, a high proportion of the work force remained jobless. The season ally adjusted unemployment rate of 6.8 per cent was the same in April as in December, when industrial production and construction activity were at lower levels. The capacity of the economy to provide em plo ym ent for many of those now out of work and to ex pand employment as the labor force con tinues to grow will be a major test of the vigor of the present recovery. In the Twelfth District, overall business activity did not pick up in March and scat tered data for April and early May indicate a continued weakness in residential construc tion and retail trade; however, steel produc tion did rise sharply in April. In the absence of a strong demand for business loans, Dis trict banks added substantially to investments in United States Government securities dur ing March and April. District nonfarm employment edged downward; unemployment rises Employment developments in March in the District were mixed but continued to pre sent a picture of weakness. Total civilian em ployment increased by 35,000 on the Pacific Coast, on a seasonally adjusted basis, but additions to the labor force raised the sea sonally adjusted unemployment rate to 6.3 percent from 6.1 percent in February. Unem ployment was widespread in the District, with 1 1 of the 15 major labor markets classified as areas of substantial labor surplus (6 per cent or more unemployed). Among the small labor market areas, Centralia, Washington M ay 1961 MONTHLY REVIEW and Klamath Falls, Oregon were classified in April as having a substantial labor surplus, raising the District total of small areas so classified to a record 14. Six of the 14 are also designated as “chronic” labor surplus areas.1 Pacific C oast total nonagricultural em ployment declined in March by about 0.1 percent, making the District nonfarm em ployment level of 7.1 million workers a shade lower than in February when there was a de cline of the same relative magnitude. The only sizable employment decline in March was in construction, which had a drop from February of 16,400 workers, or 3.6 percent, on a seasonally adjusted basis. Much of this decline was accounted for by California and was associated with the continued slump in residential building activity there, and some of it occurred in the Pacific Northwest, where bad weather seriously interfered with build ing activity. Transportation employment also declined slightly, and mining and trade were virtually unchanged. Gains were recorded in government, services, and finance. District m anu factu rin g em ploym ent in March, seasonally adjusted, showed a slight gain and returned to the January level. Pa cific Coast manufacturing jobs increased by 2 ,6 00 to 1,669,000. Gains in nondurable goods were concentrated in food processing. Durable goods employment dropped slightly in March, but the decline was much smaller than in January and February. Most of the decline in March stemmed from a cutback in auto assembly and continued declines in lum ber. Aircraft and metals employment were unchanged; electrical machinery showed a little gain but remained below the January level. The recent abatement of heavy layoffs in aircraft may be temporary. The California State D ep artm en t of E m ploym ent reports that nearly all of the major aircraft firms in 'A n area in w h ich the u n em p lo y m en t rate has been 50 percent o r m ore above th e n a tio n a l average for a prolo n g ed perio d . southern California forecast substantial lay offs for April through July. Pacific Coast plants did not participate in the recent $1 billion Air Force contract awards for military jet cargo planes. It is reported to be uncertain whether the present B-70 bomber program will be continued. Aside from recent Boeing orders, there has been little strength in the market for commercial aircraft. Lumber prices rise but plyw ood prices reduced Fir and pine lumber prices continued to rise during April, both absolutely and rela tive to a year ago. Much of the increase was concentrated in green fir items. By mid-April, the average price for fir and pine items was only 6 percent below a year ago, according to Crow’s industry average. Prices rose by over $5 per thousand board feet from the beginning of March, when they averaged 13 percent below the year-ago average. Green fir prices alone increased $8 per thousand board feet, to a level only 2 percent below 1960. Preliminary data indicate that Douglas fir output and shipments are beginning to re spond to the recent increases in prices and the N ew orders for Douglas fir rose s h a r p ly in M a r c h M i ll io n s o f B o a rd Feet Source: W est C oast L u m b e rm en ’s Association F E DE RAL RESERVE BANK March rise in new orders. The market impact of any substantial production boost will de pend on how well demand holds up. New orders in April were 17 percent below the March level. The industry is focusing most of its attention on developments in the hous ing market. Plywood producers had raised prices to $72 per thousand square feet by mid-April, but consumer demand proved insufficient to maintain prices at this level. Demand did not appear to exceed normal inventory replace ment buying, and early in May many pro ducers cut prices back to $68. District construction declines slightly from last year The value of District construction con tracts in March dipped I percent below the same month last year because of a further decline in single family residential contracts and a d ro p in n o n re s id e n tia l c o n tra c ts . Awards for other types of construction con tin u e d above 1960 levels. T o ta l c o n tra c t awards, however, did show a gain from Feb ruary to March. District contracts did not share in the na tional increase over last March largely be cause reduced single family unit construction led to an 11 percent decline in total residen tial awards, whereas residential construction rose nationally. Contracts for multiple family units continued to show signs of strength. The anomalous situation of increasing levels of rental unit construction in the face of rising rental vacancy rates changed in the first quar ter. The United States Census Bureau indi cates that first quarter rental housing vacancy rates levelled off in the West, with the rate being about 11 percent in both the fourth quarter of last year and the first quarter of 1961. Nonresidential awards in the District fol lowed the national pattern and fell 9 percent below last March; contracts for manufactur OF SAN FRANCISCO ing and education and science buildings declined. H eavy engineering construction contracts were 43 percent above a year ago, reflecting a continued rise in awards for street and highway construction and increased con tracts for electric light and power systems. A recent survey by the Federal Housing Admin istration indicates that mortgage rates have been easing in the District. The F H A re ported that average interest rates on conven tional first mortgages on new-home loans in the West declined to 6.40 percent on April 1 from 6.55 percent on January 1 of this year. The average rate on existing-home loans was reported to have fallen from 6.65 percent to 6.45 percent over the same period. On April 1, the secondary market price of the typical FHA-insured 5 lA percent mortgages aver aged 97.6 per $100 amount of the outstand ing mortgage, almost equal to the 97.7 price that was reported for the 5% percent mort gages on February 1, 1961. The spread be tween these two was wider in other regions, suggesting that there have been heavier up ward pressures on F H A -insured mortgage prices in the Twelfth District compared with other parts of the country. The market has been reported to be at a standstill during the past several weeks. Con ventional rates have apparently steadied and the secondary market prices of F H A and VA mortgages have remained approximately the same. The latter is attributed to the fact that the mortgage demands of Eastern savings banks have softened in recent weeks. The net flow of savings into District sav ings and lo an asso c iatio n s in c re ase d in March, and for the first three months of this year was 2 percent above the same period last year. The dollar rise in their loans out standing during the first quarter was approxi mately equal to that for the comparable pe riod of last year. Time deposits of District weekly reporting member banks rose $568 million in the first 4 months of this year, with MONTHLY REVIEW May 1961 C H A N G E S IN S E L E C T E D B A L A N C E S H E E T I T E M S OF W E E K L Y R E P O R T I N G M E M B E R B A N K S IN L E A D IN G C I T I E S (d oll ar a m o u n t s in m il li o n s) T w e lft h D is tric t From Mar. 15, 1961 to Apr. 26, 1961 Dolla rs Percent ASSETS: Total loans and investments Loans and investments adjusted' Loans adjusted1 Commercial and industrial loans Real estate loans Agricultural loans Loans for purchasing and carrying securities Loans to nonbank financial institutions Loans to domestic commercial banks Loans to foreign banks Other loans U. S. Government securities Other securities + 53 + 17 — 19 + 374 — 35 LIABILITIES: Demand deposits adjusted Time deposits Savings accounts + 101 + 307 + 160 + + + + 382 + 329 — to + 20 + 8 + 18 United States From Apr. 27, 1960 to Apr. 26, 1961 D olla rs Percent From Mar. 15, 1961 t o Apr. 26, 1961 Dollars Percent + 1,534 + 1,475 + 158 + 126 — 175 70 + 6,93 6.75 + 1.06 + 2.42 — 3.32 + 12.43 — + + + 1.64 1.43 0.07 0.38 0.16 2.92 + + 471 483 370 506 40 40 + + — + + — — — — — — — + + 0.42 0.44 0.53 1.58 0.32 3.66 From Apr, 27, I 9 6 0 to Apr. 26, 1961 Dollars Percent + 6,629 + 6,684 + 1,468 + 552 — 113 + 231 + + 6.33 6.49 + 2.18 + 1.78 — 0,90 + 25,63 + 2 + 0.99 + 34 + 20.00 + 447 + 13.56 + 681 + 22.23 — 54 — 7.17 — 81 — 10.38 — 378 — 7.21 — 1,010 — 17.18 + 19.49 + 9.24 — 0.60 + 6.40 — 1.66 59 + — 31 + 228 + 1,167 + 150 + 22.18 — 13.36 + 7.88 + 23.10 + 7.78 + + — — + 12 18 26 250 137 + + — — + 0.78 2.57 0.16 0.83 1.29 — 55 — 67 + 1,287 + 3,995 + 1,221 — 3.41 — 8.75 + 8.69 + 15.37 + 12.76 0.91 2.61 1.68 + 127 + 1,429 + 677 + 1.15 + 13.43 + 7.50 + 604 + 1,017 n.a. + + 0.99 2.79 n.a. + 710 + 5,736 n.a. + 1.17 + 18.05 n.a. n .a . N o t available. 'E x clu siv e of loans to doniestic com m ercial b anks and a fte r ded u ctio n of v alu atio n reserves; individual loan item s are shown gross. S ource: Board of G overnors of the F ederal R eserve System an d F ederal R eserve B ank of San F rancisco. more than half of the gain occurring after mid-March. This is in sharp contrast to the loss of nearly $400 million in the first third of last year when funds were withdrawn for investment in higher yielding G overnm ent securities and savings and loan shares. Steel production revived quickly in April Western steel production rose rapidly in April, following a small increase in March. The Western1 steel production index rose to 124 (1957-59 = 100) in the first week of May from 108 at the beginning of April, closely paralleling the gain in production nationally. While the national increase was partly a reflection of new orders from the auto industry, District outp ut is sold p ri marily for construction, canning, and ship building. 'T w e lf th D istrict states an d C o lo rad o . Copper prices strengthened by developments in world market Several c o p p e r p ro d u c e rs raised th e ir prices 1 cent to 30 cents a pound on May 1. Rising demand for copper in foreign markets during recent months lifted the London price about 2 cents above the United States domes tic price, after allowing for United States im port duty. In addition, heavy demand for domestic scrap, especially for export, pushed up scrap prices to a point where custom smelters’ raw material prices exceeded the equivalent refined value. Domestic fabrica tors also reported a continuing increase in business. Stocks of copper remained large, however, and a general price increase may reflect unwillingness to permit substantial in ventory reduction in the face of a possible domestic labor dispute this summer and fur ther disruption of the Congo supply. FEDERAL RESERVE BANK Retail trade s lu g g is h C aliforn ia new c ar registrations declined 4 .6 p e rc e n t fro m F e b ru a ry to M a rc h , o n a daily average basis. D e p a rtm e n t sto re sales failed to show signs of revival in M a rc h , after seaso n al ad ju stm en t. T h e T w elfth D istrict index declined 3 p e rc en t fro m F e b ru a ry al th o u g h the level was 1 p e rc e n t above a year ago. U n a d ju s te d figures th a t include the p re E a s te r w eek fo r b o th years show sales do w n 3 p e rc e n t fro m a year ago d u rin g the six w eeks e n d e d M ay 6. C u m u la tiv e d e p a rtm e n t store sales for the year th ro u g h M a y 6 w ere 1 p e rc e n t below the c o rre sp o n d in g perio d in 1960, for b o th the District a nd the nation. E s tim a te s of c o n su m e r in stalm en t credit o u ts ta n d in g at m a jo r C aliforn ia c o n su m e r fi n a n c e i n s t i t u t i o n s c o n t i n u e d to d e c li n e th r o u g h M a r c h , b rin g in g th e v o lu m e o u t s t a n d i n g c l o s e r to 1 9 6 0 l e v e l s . C r e d i t o u ts ta n d in g in M arch was 2.2 p e rc e n t above a year ago, w h ereas it was 3.8 p e rc e n t g reater in F e b ru a ry . Farm incom e rises in early 1961 D istrict fa rm e rs ’ cash receipts in J a n u a ry a n d F e b ru a ry w ere a b o u t 3 p e rc en t above the sam e m o n th s in 1960 a nd c o n tin u e d above y e ar-ag o levels in M arch , acc o rd in g to p re lim inary estim ates. T h e gain was relatively sm aller th a n the 10 p e rc en t rise in fa rm re ceipts natio n ally in this period. F a r m incom e in o th e r areas w as b o o sted by higher re tu rn s OF SAN FRANCISCO the sale was n o te w o rth y b ecause it o c c u rre d at a time w hen un sold inventories of m u n ic i pal bonds were large, a nd institutional inves tors h ad not been very active in the m a rk e t for some weeks. R eoffering prices w ere set to yield fro m 1.70 p e rc e n t in 1962 to 4 p e r cent for the longest m aturities. N et interest cost to the state was 3 .8 6 6 percent. B a n k investm ents rise; no e x p a n sio n in b u sin e ss lo a n s L e n d in g a n d inv estm en t b e h a v io r of D is trict weekly re po rting m e m b e r b a n k s has c o n tin ued to reflect recession influences, a n d the sh arp seasonal increase in lo an d e m a n d th a t often occurs in the spring h a d not em erg ed by th e e n d o f A p r il. F r o m m id - M a r c h th ro u g h A pril, to tal loans o u ts ta n d in g ( e x cluding loans to d om estic b a n k s a n d v a lu a tion reserv es) fluctuated becau se of tax b o r row ings a nd rep ay m ents. W h a t small gain did o c c u r in business loans w as c o n c e n tra te d in one w eek a nd reflected mostly loans to public u tility firm s. R e a l e s ta te a n d a g ric u ltu ra l loans m oved up slightly. Sales finance c o m - M a jo r ty p e s of lo a n s h a v e s h o w n lit t le c h a n g e a t D i s t r i c t b a n k s in 1 9 6 1 fro m so y b ean s a n d hogs, c o m m o d ities which are n o t p ro d u c e d in large quantities in this D istrict. C a lifo r n ia ’s h u g e b o n d issue successful in a con gested m arket T h e m o st im p o rta n t d e v elo p m en t in D is trict m u nicipal bon d s d u rin g A pril w as the sale of a $ 1 9 0 million C alifornia issue on A p ril 5. It w as the largest single issue ever sold by the State a n d w as re p o rte d to have to final investors. T h e success of sold quickly N o te : T w e lf th D is tr ic t w e e k ly r e p o rtin g m e m b e r b a n k s . T h e s h a r p rise in “ O t h e r ” lo a n s in la te J a n u a r y 1961 re fle c ts a la rg e p u r c h a s e of in s ta lm e n t p a p e r fro m a n a tio n a l r e ta ile r. May 1961 M O N T H LY REVIEW In v e s tm e n ts of District b a n k s rise w h ile lo a n v o lu m e rem ains sta ble B illio n s of D o llo ts C o nsisten t with the lack of p ressu re on reserves from loan d e m a n d , D istrict w eekly re p o rtin g m e m b e r b a n k s have tu rn e d to in vestm ents a n d a d d e d m o re th a n $ 3 0 0 million to their holdings of U n ited States G o v e rn m e n t securities d u rin g the first fou r m o n th s of 1961. T h ey m ad e a ne t re d u c tio n of $ 6 0 0 million in the sam e p e rio d a year ago w hen loan d e m a n d was strong, a n d b a n k reserves w ere re la tiv e ly tig h t. F r o m m id -M a rc h th ro u g h A pril, these b an k s a d d e d $ 3 7 4 m il lion to their holdings of G o v e rn m e n ts. A preferen ce for liquidity w as p ro n o u n c e d as tw o-th irds of the increase was in sh o rt-term holdings, mostly T re a s u ry bills. B ank s also a d d e d to their holdings o f G o v e rn m e n t se curities m a tu rin g in over 5 years, p artly r e flecting in vestm ent in the T re a s u ry b o n d s offered in the M a rc h refunding. N o t e : D a t a a r e fo r T w e lf th D is tr ic t w e e k ly r e p o rtin g m e m b e r banks. p anies m a d e net re p a y m en ts of d e b t in this period. A lth o u g h D istrict b an k s have am ple funds with w hich to ex ten d loans, the d e m a n d for loans has n o t been strong en o u g h to result in a net ex p an sio n in their loan portfolios so far this year. D e m a n d deposits follow ed a seasonal p a t tern d u rin g this re p o rtin g p eriod ; the increase of $3 6 5 million from m id -M a rc h th ro u g h the first three weeks of A p ril was so m ew h at less th a n in the y ear-ag o period. D e m a n d deposits d eclined seasonally in the last w eek of A pril as fu nd s w ere w ith d ra w n for tax paym ents. 83 The Search For Certainty in An Uncertain World P A R T I: T H E R IS E O F G O L D A S A D O M E S T I C S T A N D A R D apparent in the thinking of the American public during the past decade and, to some extent, in economically advanced countries throughout the world, is a desire for stability of relationships, whether economic, political, or social. In part this may reflect a delayed reaction to the marked dis ruptions occasioned by World W ar II, by postwar inflation, the cold war, nationalist movements, and “popular” revolutions; and, in part, it represents a return to the search for stability of earlier generations but with some accentuation in recent years in the face of particularly rapid scientific and technolog ical change. It is not surprising in such a world to find a similar search for a domestic and international standard of payments which promises stability. Monetary stability not only provides a firm basis for trade but also promotes the saving and investment processes so necessary for economic growth and, perhaps equally im portant, contributes to the preservation of the middle classes of western societies and, thus, is conducive to political stability. It is also of some moment that a stable medium of exchange fulfills a moral commitment to pay back debts in the coin in which they were contracted and prevents well-earned retire ments from becoming not so genteel poverty. If wishing could make it so, such a system would have long been established. At present the desires for such a system are manifest in two generally opposing programs. One rep resents an attempt to return to the golden I n c r e a s in g ly days of youth and takes the form of fuller reliance upon gold production and move ments to induce stablity in our economy. A contrasting approach presumes the extension to the international sphere of a system of credit similar to that developed domestically in many countries which relies upon the in genuity of man to substitute properly the ease of writing numbers in ledgers for the diffi culty of scraping gold out of the ground. As between these two views there are a myriad of compromises both possible and proposed. The recent threat posed to confidence in the dollar, which may now have shifted to other currencies, the mounting liabilities to foreign ers by the United States, the low level of re serves in underdeveloped countries, and a continued flow of reserves into western E u rope generally have caused the problem of an international payments mechanism to assume the status of one of the major economic prob lems of our time. In the interest of public information, a series of articles on this subject have been prepared and will be published in this R eview over the coming months. The first article here presented traces the rise of money and of gold as a medium of exchange. Articles will follow on the rise of other payments mechanisms, a survey of the production and movement of gold around the world, and a concluding piece on the problems before us. M oney and gold Man is acquisitive— for himself, his family, his tribe, his town and country. He displays A F ** May 1961 MONTHLY REVIEW amazing ingenuity in devising means by which he can more easily possess those goods and services that he wants. When barter proved unsatisfactory and cumbersome, various means of exchange were developed and re fined. gradually evolving into the monetary mechanisms that exist in modern market economies. Sometimes man attempted to gain unfair advantage in effecting an exchange by giving in trade an old cow or a lazy slave, by chipping off a small amount from a coin before passing it along, or by handing over worthless currency or a check written on a nonexistent bank account. But more com monly he tried to obtain through fair ex change those goods and services which he desired. As a result, during all periods of his tory, men and governments have continuously sought a monetary standard not subject to wide fluctuations in value, either domestically or in relation to monetary units of other coun tries, and a medium of exchange which would contribute most to the effective functioning of the market. The fact that all mechanisms of exchange are man-made has led man both to irresponsible manipulation on occasion and to the establishment of monetary mechanisms to protect the exchange medium from such manipulation. Archeologists have discovered that some primitive societies had fairly complex systems of exchange which involved elements of mod ern money economies, and recent history re veals that some highly industrialized countries under certain circumstances, such as severe financial crises or war, have reverted tempo rarily to direct barter arrangements. In gen eral, however, with increasing industrializa tion and specialization, economic activity has become more complex and interrelated, with trade more essential and restricted less and less within narrow geographic or national boundaries. The development, therefore, of a means of exchanging the products of one area or country for those of another and of measuring their relative values is of para mount importance. It is obvious that modern economies would grind to a halt if they had to return to direct barter or even to the use of certain types of commodity money, such as wives, cattle, slaves, salt, wampum, or cowry shells. Although the functions per formed by money today are basically much the same as in early civilized societies, a brief historical review of the development of mone tary standards and exchange media may help us to understand some of the forces under lying the establishment and abandonment of the domestic gold standard, the rise of cur rency standards, the growth of international financial agencies, and the significance of, and problems posed by, the recent gold losses of the United States. The attributes of money Money is anything, regardless of physical or legal characteristics, which serves as a means of payment for goods and services in the market place and for the discharge of debt. Its most essential property is that it be generally acceptable. Early moneys were often commodities, such as cattle, grain, salt, or tobacco, which were useful and widely de sired in the community, although some soci eties adopted commodity moneys of solely ornamental value. The monetary standard or measure of value, however, does not always serve as the actual medium of exchange. In Borneo, for example, human skulls were the unit of account or standard of value, with pigs and palm huts “circulating” as the med ium of exchange, each having a prescribed value in terms of human skulls. Similarly, in the United States gold is the standard of value, with silver, nickel, and copper coins and paper money circulating as the medium of exchange. Many of the early forms of money were unwieldy because they were not divisible into smaller units of value and could not be easily carried around. Many of them were not of FEDERAL RE S E R V E B A N K OF S A N consistent quality— one ox was not as young or as strong as another. Consequently, it was not long before a number of countries began to use precious metals, particularly gold and silver, as money.1 Gold and silver best com bined those characteristics desired in a med ium of exchange and standard of value. They were relatively scarce and their value re mained relatively high, assuring that small amounts could command relatively large quantities of goods and services in exchange. They could be divided into homogeneous units that were identical in value. Their small size and durability made them easy to use in everyday transactions, and they could not be readily imitated. In addition, the supply of the two precious metals remained compara tively stable, at least over historically short periods of time. G old coins appear on the scene Throughout history, gold appears to have been particularly favored as an international currency. Perhaps its luster enhanced its ac ceptability, but more practical reasons, such as its occurrence in the natural state without the necessity of refining and other desirable metallurgical properties, were more impor tant. It was first used as money in the form of rings or bars of fixed weight. In exchange transactions it was customary to weigh the gold offered in payment as well as the goods being bought. Its fineness was also checked 1 G old w as used by th e E g y p tian s as m oney as early as 3400 B.C . FRANCISCO when possible, if only by biting. The difficul ties in trading caused by wide variations in the weight and fineness of the gold rings and bars were partly responsible for the develop ment of coinage— the placing of a seal or stamp upon a piece of metal attesting that the metal was of stated quality and weight. Coin age not only expanded the use of metallic sub stances as money but led eventually to the differentiation of money from its component material. When coins constituted the prin cipal means of payment and were limited in relation to the volume of transactions, the value of the coins as money rose above the market value of its metallic content and com manded more goods in trade. When coins were issued in large quantity, on the other hand, their metallic value was greater than their face value and they tended to be melted down. The shift in gold coinage from the East to the West Some of the earliest known coins of the western world were those of the famous king and merchant of Lydia, Croesus, who issued both gold and silver coins bearing his seal. Gold coins were also widely used by the Greeks and the Romans. Throughout the Middle Ages, however, Byzantine and A rab gold coins were more important for interna tional trade and for hoarding purposes. This was in large part due to the fact that the By zantine Empire was the leading trading coun try of that period. Its principal coin, the soli dus (called bezant by westerners and nomisma by the G reeks), retained its weight and fineness from the late 6th century until the early 13th century. The progressive decline in economic activity in western Europe in the Middle Ages following the decay of the Roman Empire reduced trade, specialization, and exchange to such an extent that for part of the period western Europe’s economy closely resembled a barter economy and the May 1961 MONTHLY REVIEW need for money was accordingly reduced. At the same time, the lack of sizable gold-bearing deposits and the greater prevalence of silver in northern and western Europe, the domi nance of the Byzantine and Moslem empires which attracted most of the gold, and the movement of the remaining gold into hoards and church decorations—-all militated against the maintenance of gold coinage in western Europe. Consequently, Charlemagne sanc tioned the abandonment of gold coinage in the latter part of the 8th century, and silver be came the standard coin. Foreign gold coins, however, continued to circulate. The recovery of trade in Mediterranean Europe by the 13th century led to a resump tion of gold coinage, with the first gold coins issued by the Holy Roman Em peror F red erick II in 1231. This was followed by the revival of gold coinage in Italy (the fiorino of Florence and the ducato of Venice), which gradually displaced the Byzantine solidus and the Moslem dinar. The emergence of the eco nomically powerful Italian city-states was in strumental in the decline in prestige of the Byzantine and Arab coins although debase ment of these coins also played a part. The re turn to gold coinage in the West led to the establishment of a bimetallic standard by the end of the 13th century. Monetary problems of the M id dle A ge s The Middle Ages was a period of economic stagnation and monetary instability, accom panied by a chaotic coinage system. Problems were posed by the excessive number of en tities with the right of coinage, such as the Italian cities and, at one time, more than 600 coiners of money in Germany, and by num erous changes in the metal content of coins. The French king, John the Good (13501364), reduced the amount of metal in his coins 18 times in one year to finance his costs in the Hundred Years’ War. The existence of bimetallism and the absence of a generally accepted ratio of gold to silver further com plicated the monetary situation as the under valued metal tended to move out of the coun try. Coins were also easy to counterfeit or alter; penalties such as the loss of a hand or boiling in oil did not prove to be effective deterrents. Because of the bewildering number of coins of varying issues, weight, and quality in cir culation, merchants came to rely more and more upon the services of money changers, who were skilled in determining the true value of circulating coins and were, in general, trust worthy. Because of this and because of the dangers of traveling with large sums of money, merchants developed the practice of depositing coin with a money changer in one town and arranging through a written order to receive the equivalent sum from a money changer in another town where business was to be transacted. These pieces of paper con stituted bills of exchange and greatly facili tated trade between distant locations.1 Later, formalized merchant banks — municipal banks of deposit— were established which is sued receipts ( “bank money” ) to the mer chant as evidence of deposits of coin.2 These receipts were in turn used by the merchant to carry on business transactions. Accounts were also settled during this period at inter national fairs, with bills sometimes drawn and payable at a subsequent fair, but no deposits of funds were involved. Greater discipline in coinage and the emergence of modern deposit banking When economic activity revived after the end of the Middle Ages, the currency situa tion improved and banking institutions de veloped further. The large inflow of precious metal from the New World facilitated this process, the increased money supply feeding •B ills of exchange were in u se in I ta ly as early a s 1200 A .D . Bills of exchange am ong m erch an ts them selves had been used even earlier, d ating back a t least to G reece an d possibly to th e tim e of H am m urabi in B abylon. 2O ne of the first ban k s of th is ty p e w as established in B arcelona in 1401 A .D . T w o cen tu ries la te r fam ous b an k s of the sam e k in d were established in V enice, M ilan , an d H am burg. FEDERAL RE S E R V E B A N K OF S A N the increase in activity. One of the most im portant events occurred in 1561 when Queen Elizabeth I of England, in a carefully planned surprise move, recalled immediately from cir culation all debased coins issued by her predecessors. In their place were issued coins of uniform quality and weight. From that point on, there was virtually no tampering with the English silver coins, and the only changes in the value of the coins were due to variations in the relative market prices of gold and silver. By 1650 the coinage had im proved markedly, and, in the latter half of the 17th century, England (in 1666) and France (in 1679) abolished the seigniorage charge for minting, thus establishing the prin ciple of free minting that became a feature of the gold standard. England, however, tend ed to undervalue silver in relation to gold throughout this period, causing silver to drop out of circulation and leaving what amounted to a gold coin standard.1 After the Middle Ages, a variety of stand ards existed. Some countries, such as Bel gium, Holland, Switzerland, and Italy, re mained on a silver standard, while England was essentially on a gold standard from 1821 onwards. A number of other countries, such as France, adopted a bimetallic standard. U n der bimetallism, all types of money are de fined in terms of both gold and silver. One advantage of this standard was that it pro vided full-bodied coins for both large and small transactions and thus satisfied the strong preference for coins which stemmed from the questionable value of some of the paper money of this period. Another presumed ad vantage was that if the value of the monetary unit was determined by demand and supply conditions for two metals instead of one, the standard would be stronger and fluctuations in one metal might offset the other. Actually, the constantly changing market values of the 1 U n d er a gold coin (o r specie) sta n d ard , th e m onetary u n it is defined in term s of gold, an d full-bodied coins are issued, th a t is, coins whose v alu e in gold w hen m elted down is as g reat as its value as m oney. FRANCISCO two metals caused by variations in supply a n d /o r demand made maintenance of a bi metallic standard difficult, if not impossible. Supplementing coins at this time were com mercial paper, which was more easily negoti able and discountable than its medieval coun terpart, and various banking facilities. By 1500 there were public and private banks in southern Europe, but the private banks were prone to invest their funds unwisely, and the public banks were permitted to lend only to public authorities and not to the general public. In view of the ambiguous position of the Church on the propriety of money lending and interest, the extent to which bank ing did develop testifies to the urgency of the needs served. In England, there were no municipal banks because merchants had per mission to deposit their gold in the Tower of London for safekeeping. This was eminently satisfactory until 1640 when Charles I seized the merchants’ gold for his own use. The merchants thereafter turned to the goldsmiths as more trustworthy custodians for their gold. With these additional resources, the gold smiths expanded their functions. They lent the money left on deposit with them both to individuals and to the Crow n,1 issued written promises to pay (which were the forerunner of bank notes), and issued orders at the re quest of depositors to deliver money to third persons, foreshadowing the bank check of to day. The goldsmiths’ written promises to pay were accepted as money and became part of the medium of exchange, marking the begin ning of debt money— promises to pay or redeem in standard money upon demand. The goldsmiths thus became the first to em body all the functions of a private bank—• deposit, transfer, note issue, and loans. 1 T here had been m oney lenders since early periods of h isto ry , b u t m oney len t in m ost in stan c es was th a t of the lender, n o t m oney held on deposit belonging to others. T h ere were exceptions, such as the B abylonian Igibi b an k , a p riv a te firm founded in 575 B.C. w hich m ade loans an d received deposits, an d public bodies, p riv ate firm s and tem ples in G reece w hich tested and changed coins, accepted deposits, made loans, an d arranged cred it tra n s actio n s betw een cities in the 4 th c e n tu ry , B.C . May 1961 MONTHLY REVIEW The role of the goldsmiths was shortly eclipsed by the establishment of the Bank of England in 1694 in order to finance the war with France. The Bank of England became the principal lender to the Government. It also gradually became a bankers’ bank as most banks in England opened drawing ac counts with it and stopped issuing their own notes, using those of the Bank of England instead which enjoyed an excellent reputa tion. In times of crisis when banks needed gold, they drew upon their accounts with the Bank of England. To meet these obliga tions, the Bank accumulated large gold reserves, and most of the gold in the country not in actual circulation as coin found its way into its vaults. Banking spread rapidly throughout western Europe in the 17th and 18th centuries, but bank notes were often issued so irresponsibly that exchange transactions, both domestic and international, were as difficult as in earlier periods when much of the circulating medium was of doubtful value.1 Governments gradu ally intervened to control and regulate banks, particularly the issuance of bank notes. Gov ernments also issued paper currency2 and other forms of credit instruments— written promises to pay which were redeemable in gold or silver or whatever the legal monetary standard was— to finance their debts, espe cially in times of war. Thus, the monetary importance of gold gradually shifted from that of being the actual medium of exchange to serving as the legal backing for currency, both government issue and bank notes. As more and more paper currency, bank notes, and checks written on bank deposit accounts made their appearance, money no longer con sisted mainly of metallic coin or occasional 3 In F ran ce, th e b an k note issue collapse resu ltin g from John L aw ’s land sp eculation in L ouisiana had such disastrous financial and econom ic effects th a t note issuing in F rance w as discredited for years. - I n C h in a, rulers had issued paper cu rre n cy m any centuries earlier; by 800 A .I), th ey had already gone through two p ap er m oney inflations. P ap er cu rre n cy issue ceased in C hina ab o u t 1400 A .D . and w as n o t resum ed until a fte r w estern countries had tu rn ed to its use. bills of exchange. Except to the extent that governments imposed legal restrictions on the amount of bank notes which could be issued against gold or silver held by banks, the circulating medium of exchange was no longer limited to the available supply of gold or silver. By the end of the 19th century, central banks — government-owned or con trolled in varying degrees— had been estab lished by most industrialized nations, and many were given exclusive rights of note issue. The internal circulation of foreign coins and bank notes was prohibited. It was the first time that most countries had purely national currencies, giving them greater con trol over their own money supply. The development of the United States monetary system It was in the late 18th century that the United States became an independent nation and added even more colorful and turbulent chapters to the history of money and bank ing. The legal provisions in our Constitution pertaining to a monetary standard reflect the reaction against the chaotic situation that ex isted under the Articles of Confederation when each state issued its own coin and cur rency, augmenting the already wide range of bank notes, foreign coin, and paper currency in circulation. The Constitution reserved to Congress the “ power to coin money, regulate the value thereof, and of foreign coin . . and specified that “ No State shall . . . coin money, emit bills of credit, make anything but gold and silver coin a tender in payment of debt . . The Coinage Act of 1792 pro vided for the establishment of a mint and a bimetallic standard with the mint ratio of 15 fine grains of silver to 1 of gold. The United States monetary unit became the dol lar because the Spanish milled dollar (the fabled “pieces of eight” ) was the coin most widely used and most uniform in value in comparison with the great variety of shillings which had been issued by the individual F EDE RAL R E S E R V E B A N K OF S A N states. All coins were full-bodied because of continued distrust of credit money, but foreign coins remained in circulation and as legal tender until 1856 because of the scarcity of domestic coins. Although the United States was officially on a bimetallic standard, its operation was not entirely successful. Until 1834 gold tend ed to leave the country, partly because gold was valued at a 15.5 to 1 ratio in France and partly because England was on a gold stand ard after 1821. In an attempt to arrest the outflow of gold, the mint ratio was changed in 1834 to 16 to 1, which overvalued gold and caused a return flow to the United States. Silver in turn tended to drop out of circula tion. During periods of crisis, moreover, bank notes were often not kept redeemable in specie. The disappearance of silver coins, especially the fractional coins, also handi capped business, and “shinplasters” (frac tional paper issued by banks) and other pri vate token money were poor substitutes. Fi nally, in 1853, Congress converted fractional silver into token coins (coins with metal con tent less than the face value of the coin), but the reduction in metal content was not large enough so that these coins also disap peared from circulation during the Civil War inflation. As a result, bank notes eventually 90 FRANCISCO formed the major part of the circulating medium of the period. During the Civil War, the United States was on an inconvertible paper standard be cause of the heavy requirements of war fi nancing. State and national bank notes, Treas ury greenbacks, and bank-created checking deposits in favor of the Treasury constituted the principal circulating media in place of gold, silver, and fractional coins, the value of which as metal rose above their mint prices. For fourteen years after the end of the Civil War, the United States remained on an incon vertible paper standard, primarily because of inability to agree on the metallic content of the dollar since United States prices had doubled over prewar levels. Finally, in 1878 , Congress restored the prewar gold content of the dollar, necessitating a sharp deflation which adversely affected the economy and severely penalized debtors. The return to the prewar standard was accomplished in a series of steps taken over a number of years. In 1873 , free and unlimited coinage of silver was discontinued— the so-called “Crime of ’7 3 .” In 1875 , the Gold Resumption Act pro vided for the return to a gold-based dollar. In 1879 , the dollar was actually made con vertible into gold, and greenbacks became redeemable in gold. Thereafter, the role of silver in the United States monetary system deteriorated rapidly. Under legislation passed in 1878 and 1890 the Treasury was author ized to purchase silver for monetary use but not for use as standard money. There is clearly apparent in the history of the United States a division between the creditor and the debtor. As long as they remained readily identifiable groups— such as the Eastern sea board and the frontier, the city dweller and the farmer— the “money issue” was in the forefront of American politics, with one group or area favoring “sound money” while the other opposed limitations on the money sup ply which were attributed to Wall Street con- May 1961 M O N T H LY REVIEW trol. The defeat of W illiam Jennings Bryan in 1896 effectively ended the agitation in favor o f silver although it certainly did not settle the more basic issue involved. The A ct of March 14, 1900 officially placed the U nited States on a single gold standard. The rise of the U nited States b a n k in g system Paralleling the developm ent o f the U nited States m onetary system was the rise of the banking system . The first m odern bank— Bank o f N orth A m erica— was incorporated in Philadelphia in 1782 to aid in financing the R evolutionary War. Similar institutions were founded in M assachusetts and N ew York. T he only other banks were unincorporated private banks. In 1791 the first federally chartered bank— The First Bank o f the U nited States— was set up. Its conservative policies, especially in regard to redemption of state bank notes, were attacked as hinder ing the developm ent o f the nation, and ques tions about the constitutionality o f Congress action in awarding federal bank charters led to its dem ise in 1811. The ensuing five years were characterized by rapid proliferation of state bank notes, m any o f w hich soon becam e worthless. C onsequently, The Second Bank o f the U nited States was chartered by C on gress in 1816 to counteract the abuses o f state banking, but it encountered many o f the same problem s faced by its predecessor. In addi tion, its central banking functions— such as control of currency issues— did not accord with its private ow nership and com m ercial banking business. Frontier philosophy con tributed to the refusal by C ongress to extend the charter o f the bank in 1836. Incorporated and unincorporated state banks then took over m ost o f the banking business; their record was checkered— som e were good but many were bad. By 1863, it becam e evident that a national banking sys tem was necessary to replace the unsound and unsafe state system and to help finance the Civil War. T he N ational B anking A ct requifed national banks to m aintain reserves against their outstanding notes (until 1 8 7 4 ) and against their deposits. N oteholders were further protected by various provisions regu lating note issues. A dditional legislation in 1865 placed a 1 0 percent tax on the circula ting notes o f state banks as a m eans o f en couraging them to apply for federal charters. In the first few years after the tax was put into effect, the number o f state banks dropped sharply. State banking revived thereafter as notes becam e a relatively unimportant part o f a bank’s business, and also because state banking regulations were generally less re strictive than those o f the Federal govern ment. The national banking system , how ever, had its share o f shortcom ings. T he supply o f na tional bank notes tended to be inflexible and unresponsive to seasonal needs and em ergen cies since their volum e depended primarily on the supply o f G overnm ent bonds which con stituted the collateral behind the notes. The pyramiding o f reserves through concentra tion of interbank balances in the leading cities and the rigidity o f the reserve requirements were other sources o f w eakness. T he defects o f the system were mirrored in the frequency FEDERAL RESERVE BANK o f banking panics— in 1 8 73, 1884, 1 893, and 1907— and more num erous periods of serious credit stringencies. In 1 907, the N a tional M onetary C om m ission was created to study the U nited States banking system , and its recom m endations served as the basis for the legislation setting up the Federal R eserve System. T he Federal R eserve A ct was designed to correct the deficiencies o f the national bank ing system and the m onetary structure. It provided for a more flexible supply of credit and for greater control by the monetary authorities. A gold requirement o f 4 0 per cent against notes and 35 percent against d e posits o f the Federal R eserve Banks was set up primarily to ensure the convertibility o f notes and deposits. E ligible paper and later G overnm ent securities constituted the rem ainder o f the collateral behind Federal R eserve notes. The gold requirement, which has taken the form of gold certificates since 1934, was unchanged until 1945 w hen it was reduced by C ongress to its present level of 25 percent against both Federal R eserve note and deposit liabilities. A bill has recently been introduced into C ongress which w ould abolish the present 25 percent gold require ment. W id e s p r e a d a d o p tio n of the g o ld sta n d a rd In adopting a de facto gold standard in 1 879, the U nited States was in step with the major countries of western E urope, alm ost all o f w hich had adopted gold as their m one tary standard o f value by the second half o f the 19th century. There were a number of factors w hich were responsible for this gen OF S A N FRANCISCO eral return to gold. T he disastrous inflation ary effects of overissue o f bank notes led an increasing number o f countries to restrict by law the issuance o f currency to the am ount of gold coin or bullion held by the bank. In E ng land, the Peel A ct of 1844 drastically lim ited the note issue of the Bank o f England to a fiduciary issue o f £ 1 4 m illion, backed by governm ent securities, with any am ount in excess to be fully backed by gold. In G er m any, the R eichsbank w as also required to keep a gold cover for its notes. Thus gold assum ed increased im portance as a backing or cover for the issuance o f paper currency since the gold requirem ents tended to lim it the m oney supply. One o f the principal reasons inducing cou n tries to join England on the gold standard bandwagon was their equating o f E ngland’s prosperity and econ om ic strength with the gold standard system . It was not realized that the successful operation of the gold standard in England rested on E ngland’s resources and not the other way around. The extensive use o f sterling drafts in international trade and the indebtedness o f m any countries to E ng land also encouraged expansion o f the list o f gold standard countries. A further push toward gold occurred in 1871 w hen the G er man Em pire switched from a silver to a gold standard. Prior to this tim e, countries on a bim etallic standard were able to m aintain bim etallism and stable exchange rates with May 1961 M O N T H LY REVIEW sterling because o f large, new supplies o f gold from California and Australia in the 1 8 4 0 ’s, which replenished gold drains to England. A fter 1870, how ever, the flood o f silver from Germ any, from A sia (especially In d ia ), and from new deposits in N evada led to a co n certed shift towards the gold standard. Table 1 gives the dates on which the major na tions went on the gold standard during the latter part o f the 19th century and the first few years o f the 20th century. In the U nited States, silver producers, debtors, and those who feared the gold standard would lim it the supply o f credit needed for econom ic expan sion continued to protest the abandonm ent o f silver as a monetary standard. The g o ld sta n d a rd in the 20th century From 1870 to W orld War I alm ost all major countries of the world were on a gold specie (or coin ) standard. Their currencies were convertible into gold, in either large or small am ounts, at the initiative o f any holder, and exports and imports o f gold were unre stricted. This was the period known as the “golden age of the gold standard” and is dis cussed in more detail in connection with the functioning o f the international gold standard in the next article in this series. In the United States, the com plaints o f the silver advocates were lost in the general prosperity which pre vailed. In addition, the m oney supply tripled as the supply of gold was increased by use o f the newly developed cyanide process and by new gold discoveries in the Y ukon region o f A laska and in the Rand district o f the Trans vaal in South Africa, and as the rapid growth of banks expanded demand deposits. The outbreak of W orld War I resulted in the suspension o f the gold standard by m ost western nations, and gold coin and bullion were further concentrated in the hands o f governm ents and central banks as these coun tries refused to redeem their m oney in gold or permit gold exports. A t the conclusion o f Digitized FRASER the forwar in 1919, the United States terminated T able 1 DATES OF ADOPTING GOLD STANDARDS Great Britain Germany Sweden ► Norway Denmark > France Belgium Switzerland Italy Greece 1816 1871 1873 1874 Holland Uruguay United States Austria Chile Japan Russia Dominican Republic Panama Mexico 1875 1876 1879 1892 1895 1897 1898 1901 1904 1905 S o u rc e : C h a n d le r, L e s te r V ., T h e E c o n o m ic s of M o n e y a n d B a n k in g ( 1 9 5 3 , re v . e d . ) , p . 1 2 2 . restrictions on gold exports and on converti bility o f currency into gold, thereby fully restoring the gold coin standard without alter ing the dollar’s prewar gold content. Other countries recovered more slow ly from the in flationary effects o f war financing and did not return to a gold standard until later— Britain in 1925 and France in 1928. M ost western European countries which did reestablish a gold standard adopted a gold bullion stand ard, under which coinage o f gold was dis continued and other types o f m oney were not necessarily convertible into gold. Under a bullion standard, gold is bought and sold by the governm ent or central bank at a fixed price and in unlim ited quantities and serves as a m onetary reserve and medium for foreign paym ents. A number of countries at this tim e went on a gold exchange standard, under which the m onetary unit is defined not in gold but in the currency o f som e country which is on the gold standard. Both the gold bullion and gold exchange standards eco n om ized the use o f gold. Since m ost countries were no longer on a gold coin standard, gold lost its form er im portance as a dom estic medium o f exchange; its m onetary signifi cance was as a reserve backing the m oney supply in the form o f currency and dem and deposits and as a m eans o f settling interna tional paym ents balances. This concentration o f gold in the hands of governm ents and cen tral banks gave them increased discretionary FEDERAL RESERVE BANK p o w e r s in m o n eta ry m a n a g e m e n t, b o th dom estically and internationally. T he international gold standard that was restored after W orld War I differed in im por tant respects from the prewar m odel. The en vironm ent in w hich it operated and its insti tutions had changed significantly. T he prewar exchange relationships and the highly efficient and centralized international banking system had been disturbed, and international capital and gold flows were often disruptive. The collapse o f the stock market in the U nited States in 1929, coupled with bank failures there and elsew here in the world, was enough to upset the highly precarious international m onetary balance that had been achieved. A s th e d e p r e ss io n sp r e a d , v a r io u s c o u n tr ie s abandoned gold as a m onetary standard in an effort to insulate them selves from external deflationary pressures. The next article in this series will explore in greater detail the developm ents o f this period and their signifi cance to the international m onetary system . T he U nited States legally abandoned the gold coin standard in M arch 1933 and in January 1 9 3 4 established a gold bullion standard and reduced the gold value o f the dollar. G old coinage was ended and existing coins were m elted down into bars, and gold bullion was held dom estically only under license for industry or the arts and sold for export only under Treasury regulations. T he gold clauses existing in debt contracts were abrogated, and all coins and currencies o f the U nited States were declared to be legal tender for paym ent o f debt. A t the outbreak o f W orld War II, only the U nited States and a few other countries were on a lim ited form o f gold standard. M ost nations were on in convertible paper standards under w hich the various types o f m oney within a country were kept at a parity with each other but not at a constant value in terms of any metal. During the war, practically the w hole world went off including the U nited States 94 the gold standard, OF S A N FRANCISCO in the sense that it placed restrictions o n the use of gold in international paym ents. Since W orld War II, only the U nited States and a few other countries have adhered to a m on e tary standard based on gold. G old, nevertheless, is still o f significance on both the dom estic and international scene. U nder the rules o f the International M onetary Fund, which will be exam ined m ore closely in a subsequent article, the par value o f m em ber country currencies must be expressed in terms o f gold or U nited States dollars o f the weight and fineness in effect in 1944. R elatively few countries today, on the other hand, have in effect legal requirem ents for the holding o f gold against notes or other sight liabilities issued by their central banks. In w estern E urope, for instance, only five countries have gold cover requirem ents against notes a n d /o r certain other liabilities, four others perm it gold or foreign exchange to be held as cover, while nine countries have no prescribed m inim um legal requirem ents or the requirem ents have been suspended. T he trend in the past several years has been towards the liberalization o f required m ini mum holdings. This does not m ean, o f course, that central banks do not continue to hold gold a n d /o r foreign exchange, either against their note and deposit liabilities or as interna tional reserves. A great deal o f variation also exists in the degree to w hich individuals may hold, transfer, and buy and sell gold. M ajor areas today where private gold ow nership is prohibited are the U nited States, the U nited K ingdom and certain sterling area countries, and Scandinavia. There are m any countries, including B elgium , Canada, G erm any, and Switzerland, which allow their nationals to hold, transfer, buy and sell gold dom estically and generally export or im port gold freely. A nother group o f countries permits their citizens to carry on the sam e types o f gold transactions except for export and im port; the outstanding exam ple in this category is May 1961 M O N T H L Y REVIEW pansion o f m oney and as a protection against inflation. The necessity o f relying on changes in the gold stock for changes in the m oney supply, how ever, often resulted in a shortage o f m oney during seasonal peaks o f activity or for longer run econ om ic developm ent. Fur ther, the deflationary im pact o f lim ited gold supplies was liable to occur at inopportune m om ents o f history. Finally, gold discoveries and im provem ent in mining techniques or changes in the industrial dem and for gold bear no clear relation to the need for funds. France. In the overall total o f gold transac tions, private transactions are generally not very substantial although at tim es their influ ence on gold prices is discernible. The pri mary function o f gold at the present tim e is in the settlem ent o f international paym ents. The dom estic im portance o f gold has de clined, and m anaged paper currencies are more the rule than the exception. The dom estic virtues o f g o ld W hat were the reasons for the popularity o f gold as a dom estic monetary standard? In the first place, it was felt that under a gold specie standard the m oney supply w ould be relatively stable since the m onetary authori ties could not increase the m oney supply unless gold supplies increased. T his restraint was also view ed as a direct check upon the ability o f central governm ents to engage in excessive expenditure. U nder a system of fractional gold reserve requirem ents, these constraints were w eakened som ew hat but would still tend to operate along similar lines. A nother advantage claim ed for the dom es tic gold standard was that gold production tended to increase when the general price level was low and to decrease w hen prices rose, providing a more or less autom atic re sponse to econom ic conditions. W hen the econ om y needed an injection o f m oney, gold output expanded; when prices rose unduly, output fell. Thus the gold standard was view ed as serving as an autom atic check on the ex S u m m a ry The basic function o f m oney as a m edium o f exchange and measure o f value for the purchase of goods and services and paym ent o f debt has rem ained constant over history. The forms o f m oney, how ever, have changed radically over tim e and will undoubtedly c o n tinue to evolve. The direction o f m onetary developm ent will vary from country to coun try and will be dependent upon the prefer ences o f individuals and governm ents, the state o f econom ic and financial advancem ent, the type o f governm ent, and the degree o f national and international control over m oney and econ om ic activity. A s exchange o f goods and services contributed to specialization and thereby to m ore efficient production and higher living standards, the m eans o f e x change also becam e m ore specialized as e f forts were directed towards increasing the efficiency o f the exchange m echanism . This evolution has been expressed in the m ove m ent from com m odity m oney to representa tive coinage, from coins to paper currency, and from paper currency to deposits. The preceding brief historical survey of gold in the m onetary system has stressed several points. One is that gold shared the dom estic stage with silver through much of history and only em erged supreme in the relatively recent past although it always was preferred as an international means o f pay ment. Second, it was not until the second half FEDERAL RESERVE BANK o f the 19th century that m ost countries at tained m onetary sovereignty w ith national currencies o f their ow n. Prior to that tim e, dom estic m onetary conditions were often in fluenced by the internal circulation o f foreign coins. T he experience o f individual nations w ith their ow n national m onetary system s therefore covers a relatively short span of tim e. Sim ilarly, the use o f gold as a currency standard has been a com paratively recent developm ent. Third, the gold standard has been associated throughout history with eco nom ically strong countries w ith large stakes in international trade, for exam ple, the B yzan tine and M oslem em pires, the Italian cities, and England. A s a consequence, there devel oped a strong tendency to attribute econom ic strength to the existence o f the gold standard. http://fraser.stlouisfed.org/ 96 Federal Reserve Bank of St. Louis OF SAN FRANCISCO Last, although the gold standard was lauded for its contributions to stability and econ om ic growth, it generally was abandoned in favor o f an inconvertible paper standard w henever a crisis— such as war or financial panics— occurred because the governm ents or m on e tary authorities w anted greater flexibility in m onetary m anagem ent at such tim es. G old thus has lost its form er im portance as a dom estic m edium o f exchange, and m anaged currencies represent the prevailing m onetary system . G old, how ever, rem ains as a part o f the m onetary reserves o f govern ments and central banks. A s a standard o f value for international paym ents, gold has lost little o f its luster. Its significance in the international m onetary area w ill be discussed in the succeeding article.
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