The Power of Gold: The History of an Obsession

by Peter L. Bernstein

  One other measure conveys the dramatic process of economic growth in the nineteenth century. In 1800, the United States consumed a total of three trillion BTU of energy-coal, wood, hydropower, and petroleum. In 1850, at the time of the gold discoveries in California and Australia, energy consumption was up to 219 trillion BTU. It tripled in the next fifteen years and then rose twelvefold over the next 35 years. At the end of the century, energy consumption was at 7322 trillion BTU, a growth rate of 7.3 percent a year from the day that James Marshall stumbled onto gold at Sutter's Mill.ss

  At a time such as the present, when technological change and leaps in productivity are accepted as a matter of course, we have difficulty conceiving of what technological innovation was like in an age when discontinuities were both immense and abrupt. Here, for example, is a letter from a nobleman who had gone from Manchester to Liverpool in 1833 to visit the grave of his old friend, William Huskisson, the poor co-author of the Bullion Committee Report who had been killed by Stephenson's famous Rocket at the opening ceremonies of the Liverpool and Manchester Railway in 1830:

  I arrived at Manchester last night at 11 o'c. This morning at 7 I rose, and at 8 had the carriage mounted on the Ry ... and at %z past 9 was at Liverpool-32 miles in 90 minutes!!!.... You would have laughed to have seen Thompson and James on the box of the carriage, while we were sometimes flying on the rly. a mile in 2 minutes. Thompson trying to grin with his tongue out and his fingers all on end, and James quite as usual, only losing his hat now and then.56

  In reading these lines, we must recall that through all of human history up to that time people had never been able to travel faster than a horse could carry them, and even a horse could sustain its highest speed for only brief periods of time. My own maternal grandmother, who was born in 1860, always referred to the family automobile as "the machine," an expression she continued to use right up to her death at the age of 86 in 1946.

  There was a modest degree of correlation between gold production and price inflation, especially after 1870, but nobody took notice. Yearto-year price changes were in any case so irregular and erratic that no underlying inflationary trend was able to rise to the surface until the full impact of the South African discoveries made themselves felt in the world economic system after 1900-and even then the perception of inflation was delayed or muted.* The most striking evidence of the public's relaxed view of the probability of inflation is in the behavior of interest rates, which moved up and down without any systematic linkage to what was happening in the price level for commodities and services."

  Chevalier's inability to comprehend what would happen to the productivity of the economic system was enough to make mincemeat of his gloomy predictions. This aspect of the matter, however, was not the only development that doomed his forecast to failure.

  He devotes two pages to the practice of hoarding, which he describes as "to hide money in secret places." He denigrates this habit as "belonging to an uncivilised state of society, in which riches take refuge under ground to escape spoliation.' 58 As a faithful and enthusiastic participant of an age of great physical improvement in the way of life and the democratization of the political system, Chevalier minimizes the likelihood that hoarding as he defines it would amount to very much. He even goes so far as to suggest that "In the Europe of our day, the quantity of the precious metals which issue from their hidingplaces is, in all likelihood, greater than that which seeks refuge there."sv

  Although we have no good data to test Chevalier's hypotheses about hoarding, we do know that he failed to recognize a demand for hoarding in a civilized state of society that would turn out to be untold magnitudes greater than any amount of gold that individuals might hide to escape spoliation. The growing acceptance of the gold standard, following Britain's first steps in that direction in the early 1800s, created an enormous demand for gold for hoarding-not by individuals but by the central banks of the nations, such as the Bank of England and the Bank of France, or the U.S. Treasury. A hoard of gold was the major line of defense against an unexpected surge in imports or outflow of investment capital to other financial centers. With the huge expansion in economic activity and international trade and investment, those gold hoards were essential to give nations freedom of action and to attract new capital to their shores. "Sound money" and "sound banks" were defined by the accessibility of gold to be paid out on demand to anyone who came to the windows and asked for it. Countries gaining gold were held in high repute; countries on the losing side were viewed as in deep trouble.

  As a consequence, little of the "vast production" of gold that troubled Chevalier moved around from hand-to-hand. The largest part of it was transferred into idle hoards in monumental buildings that looked like Greek temples, where the heaps of gold enjoyed the more polite name of "reserves." Let us turn now to see how all that worked and what kinds of trouble erupted in the wake of the international gold standard.

  he international gold standard shimmers from the past like the memory of a lost paradise, embodying all the nostalgia of the Victorian and Edwardian eras-stability, harmony, respectability. The glow attached to this nostalgia is not based in myth but stems from a vivid reality. From the end of the American Civil War to the outbreak of World War I-a brief period of only fifty years-the international gold standard acquired a mystique that radiated far beyond the simple discipline that it imposed on its members. The control of gold over the affairs of human beings has never been so absolute, nor the worship of gold by hard-headed financiers and statesmen so humble.

  As we shall see, the gold standard developed all the trappings of a full-fledged religion: shared beliefs, high priests, strict codes of behavior, creed, and faith. The gospel had been drafted by the Bullion Committee of 1810, inspired by Ricardo. The altars at which the members of this religion worshipped were the meticulously mounted stacks of gleaming gold bricks in the vaults of the banks. The high priests were the monetary authorities, in most cases the managers of the central banks such as the Bank of England or the Bank of France, in less frequent cases the finance ministers or secretaries of the Treasury; controversy exists over whether there was a pope or the equivalent. Like many great religions, the gold standard compelled dreaded punishments for those who dared to stray from the straight-and-narrow, but it also promised absolution to those who pledged to reject apostasy by vowing to return to the fold as soon as possible. The gold standard provided its believers with comfort, community, pride, and a sense of immortality.

  The group of nations that adopted the gold standard developed into a kind of fraternity-an enviable and exclusive group whose members protected one another from the hazards and uncertainties imposed on them by the world beyond their borders. The great economist and historian Joseph Schumpeter described the attraction of the gold standard as a search for national prestige, "a symbol of sound practice and badge of honor and decency," with a value that was independent of purely economic advantages.' A contemporary member of the Austrian parliament warned his colleagues about the loss of "esteem" that their nation suffered by being "a scrap-of-paper economy."2 A Russian economist asserted that "Membership in worldwide civilization is unthinkable without membership in the worldwide monetary economy."3 John Sherman, a prominent member of the U.S. Congress and of presidential cabinets, declared that a currency without redeemability into gold was a "national dishonor."4

  Britain was the charter member of the club, even its inventor. The United States, though on a bimetallic silver/gold standard at the time, was one of the first to follow in Britain's footsteps by rejiggering the price relationship between the two metals in 1834 to establish a defacto gold standard; a gold standard de jure would wait for another 66 years, after the struggle between the silver advocates and the supporters of gold had been finally resolved in favor of gold. The Germans came aboard in 1871, financing their gold reserves with part of the indemnity paid by the French after their defeat in the Franco-Prussian War-an indemnity equal to five billion francs, which was about one-third
of France's total output of goods and services.*' The French went with gold afterward, not in a full, immediate step but by limiting the permitted volume of silver coinage. As we shall see, the move was considered "precautionary and revocable" and was motivated by a desire to complicate the German effort to dispose of their silver stocks.'' By 1876, Italy, Belgium, Switzerland, the Scandinavian countries, the Netherlands, and Belgium had all signed on. At the end of the decade, only India and China among major countries were still on a silver standard.

  The reverence for gold in the nineteenth century was so steadfast that it led to a persistent decline in the prestige and, ultimately, the acceptability of silver as money. This view was summed up best by English Prime Minister Lord Liverpool when he pointed out that "Coins should be made of metals more or less valuable ... in proportion to the wealth and commerce of the country in which they are to be the measure of property."' It was not just silver that was downgraded in this fashion. Once the gold standard was in place, paper notes and bank deposits as well as holdings of foreign exchange were considered as little more than convenient substitutes for the "real thing," assets that enjoyed acceptability purely by virtue of being convertible into gold.8

  The most compelling feature of the gold-standard system was the ingenious manner in which it combined primitive trust in a shiny metal, reaching back to the earliest times, with a highly sophisticated dynamic that served gold's purposes so well in the years of vigorous industrial and financial development before the First World War. The primitive and sophisticated properties reinforced each other in a manner that was unique in history and that the world since 1914 has never been able to replicate.

  So potent was this image after the Armistice in 1918 that few people dared to suggest-or even notice-that the gold standard had been rendered obsolete by the social, economic, and political earthquakes unleashed by the bloody struggle of the First World War. Andrew Boyle, biographer of Montagu Norman, the man who served as Governor of the Bank of England from 1920 to 1944, put it this way: "Anyone rash enough then to have advocated a different course might well have been locked up and certified as insane. No alternative plan was conceivable."9

  Almost every country took extraordinary political risks to restore the gold standard, even if compromises in format and structure were unavoidable. For more than fifty years after the guns of World War I had fallen silent, the deferential respect for the autopilot of gold lingered on, in one form or another, while gold continued to manage-or mismanage-large areas of the world economy.

  If the gold standard finally turned out to be an anachronism amid the international and economic turbulence of the twentieth century, might the twenty-first century offer a different set of circumstances? The possible answer to that question must wait until the end of our story.

  The primitive notions supporting the gold standard traced their origins back to the prestige and international acceptability of Croesus's staters, when gold first started to perform as money in a systematic fashion. From this root, the religion of the international gold standard had just one absolute commandment: gold, and gold alone, is the ultimate form of money, the standard. A country on the gold standard defined its money-pound, franc, lira, dollar-in terms of a specified and immutable quantity of gold. Its own citizens, and the world around them, expected the authorities to maintain full and free convertibility of its banknotes and bank deposits (private money, as we saw in Chapter 10) into gold at that fixed ratio, come what may.

  The numbers are fussy, and the convention of measuring weights in grains is annoying, but the ratios are important for they define how many units of one currency such as pounds sterling will exchange for units of another currency such as dollars or francs. For example, Britain's sovereign coin, which was the equivalent of one pound sterling, was defined in 1870 as 113.0016 grains of gold, a setting that reached all the way back to a parliamentary resolution of 1717, a familiar date. This was equal to about a quarter of an ounce, the same weight as a modern 25¢ piece. The dollar's weight in gold was set at 23.22 grains or $20.67 per ounce in 1837, after having fluctuated between 24.68 grains and 22.85 grains from 1791 to 1837.*10

  The result of the definitive settings of 113.0016 grains to the pound and 23.22 grains to the dollar was an automatic and invariable rate of exchange between the two currencies, an act of faith that £1 would equal $4.86 (the result of dividing 113.0016 by 23.22) forever and ever. Under those conditions, fluctuations over time around this rate would be minimal and determined primarily by the costs incurred in shipping gold across the Atlantic between London and New York.

  These publicly announced relationships to gold were inviolate. The international gold standard amounted to nothing more than that. As long as the gold parities were intact, dollars or krone were as welcome as pounds in London and marks or rubles were as welcome as francs in Paris, in an era in which globalization of capital and trade was as forceful a process as it has been over the past 25 years. Nobel Laureate Robert Mundell has succinctly described this system: "Currencies were just names for particular weights of gold.""

  The sophisticated dynamic of the system arose from the robust tension between the good news and the bad news in the gold standard. The good news was in the many advantages of having a currency that was universally acceptable because it was backed by stuff before which humanity had been genuflecting since the beginning of time. This meant that holders of your currency would not desert you at the first sign of trouble. In rare cases such as Britain's sterling, foreigners were willing, or often even more willing, to hold sterling and make their payments in sterling in preference to their own currency, just as people around the world use dollars today. The British derived major benefits from these arrangements, because the Bank of England could function with low levels of gold reserves, which produce no income, unlike the hoards carried by the other central banks and Treasuries. Thus, in 1913, the Bank held only $165 million in gold, compared with $678 million at the Bank of France and $1.3 billion at the U.S. Treasury.12 The Bank of England did come in for criticism from some conservative circles, who held that the low level of gold reserves showed that the management of the Bank was putting the interests of the shareholders above the needs of the British banking system as a whole.13

  The bad news was the shattering loss of acceptability that would afflict a nation that mismanaged its affairs or was caught in the whirlwind of a global economic crisis. Then investors, traders, and speculators would rush to redeem their paper and bank deposits for gold, depleting the country's precious stockpile. This cataclysmic outcome was frequent among the smaller but aspiring nations, most of which were dependent on the volatile markets for raw materials. The senior members of the gold standard club went to the brink more often than the nostalgia about the gold standard might suggest, but none of them ever succumbed to apostasy despite frequent narrow escapes.

  Nobody invented this remarkable system, no grand plan was ever devised, no one ever wrote a rule book on the necessary codes of behavior. The closest thing to an official guide to the gold standard was in the words of the Bullion Committee in 1810: "Gold is itself the measure of all exchangeable value, the scale to which all money prices are referred. ... Bullion is the true regulator both of the value of a local currency and the rate of the Foreign Exchange." 4

  Luck, politics, geography, and the laws of physics had as much to do with the spread of the gold standard as any of the monetary theories then in vogue; most of the imposing theory that later supported the gold standard came along after the fact. It was 1875 before Stanley Jevons set forth the dominant philosophy underlying the gold standard that we quoted in Chapter 13: "So unaccountable are the prejudices of men on the subject of currency that it is not well to leave anything to discretionary management."''

  Isaac Newton, traditionally stuck with the honor-or blame-for launching the gold standard, had no such idea in 1717. Rather, he made a faulty estimate of the appropriate ratio between gold prices and silver prices, leaving Britain unin
tentionally on the gold standard. Despite Newton's miscalculation, the British did not officially abandon a bimetallic standard of gold plus silver until 1816, when silver coins were converted to small change with limited legal tender. The British defenders of silver remained vocal for another thirty years.16

  Until the 1870s, every movement toward a European gold standard was as unplanned as Newton's. Two metals were necessary, because gold coins are so valuable that the system could not function without a widely accepted subsidiary coinage. In most countries, convertibility of paper currency and bank deposits into gold was perceived as nothing more than a variation on the theme of a bimetallic standard that consisted of both gold and silver; elsewhere, silver was the sole standard. The only constant was that specie-metallic-based money-was imperative all the way. The world would not outlive that primitive notion for many decades to come.

  Despite gold's glitter, glamour, and prominence in many aspects of life, silver was the primary form of money right up to the middle of the nineteenth century. Angela Redish, a British economist, has argued that the main reason the gold standard succeeded during the nineteenth century was that "New technology employed by the Mint was able to make [silver] coins that counterfeiters could not copy cheaply and because the Mint accepted the responsibility of guaranteeing the convertibility of [these] tokens."" The plentiful supply of good silver coins, in contrast to the pathetic clipped coins of the late seventeenth century, provided for payments in small transactions, while gold lorded over the system of large transactions and liquidity reserves.