WEBVTT NOTE 51. The Classical Gold Standard 1 00:00:00.000 --> 00:00:03.000 The Classical Gold Standard 2 00:00:03.000 --> 00:00:10.000 The 19th century monetary system has been referred to as the quote, classical gold standard. 3 00:00:10.000 --> 00:00:18.000 It has become fashionable among economists to denigrate that system as only existent in the last decades of the 19th century 4 00:00:18.000 --> 00:00:25.000 and as simply a form of pound sterling standard since London was the great financial center during this period. 5 00:00:25.000 --> 00:00:26.360 period. 6 00:00:26.360 --> 00:00:31.360 This disparagement of gold, however, is faulty and misleading. 7 00:00:31.360 --> 00:00:36.600 It is true that London was the major financial center in that period, but the world was scarcely 8 00:00:36.600 --> 00:00:38.840 on a pound standard. 9 00:00:38.840 --> 00:00:46.960 Active competition from other financial centers—Berlin, Paris, Amsterdam, Brussels, New York—insured 10 00:00:46.960 --> 00:00:51.000 that gold was truly the only standard money throughout the world. 11 00:00:51.000 --> 00:00:57.800 Furthermore, to stress only the few decades before 1914 as the age of the gold standard 12 00:00:57.800 --> 00:01:02.800 ignores the fact that gold and silver have been the world's two monetary metals from 13 00:01:02.800 --> 00:01:05.320 time immemorial. 14 00:01:05.320 --> 00:01:12.400 Countries shifted to and from freely fluctuating parallel gold and silver standards in attempts, 15 00:01:12.400 --> 00:01:18.080 self-defeating in the long run, to fix the rate of exchange between the two metals, quote 16 00:01:18.080 --> 00:01:22.520 Biometallism The fact that countries stampeded from silver 17 00:01:22.520 --> 00:01:28.260 and toward gold monometallism in the late 19th century should not obscure the fact that 18 00:01:28.260 --> 00:01:35.640 gold and silver, for centuries, were the world's moneys and that previous paper money experiments, 19 00:01:35.640 --> 00:01:41.560 the longest during the Napoleonic wars, were considered to be both ephemeral and disastrously 20 00:01:41.560 --> 00:01:43.640 inflationary. 21 00:01:43.640 --> 00:01:48.880 Specie standards, whether gold or silver, have been virtually coextensive with the history 22 00:01:48.880 --> 00:01:50.920 of civilization. 23 00:01:50.920 --> 00:01:56.400 Apart from a few calamitous experiments, such as John Law's Mississippi Bubble and the 24 00:01:56.400 --> 00:02:02.480 South Sea Bubble in the 1710s, and apart from the generation-long experience in Britain 25 00:02:02.480 --> 00:02:08.720 during the Napoleonic War, until the 20th century, specie rather than paper had always 26 00:02:08.720 --> 00:02:10.940 been the standard money. 27 00:02:10.940 --> 00:02:16.180 In the classical gold standard, every nation's currency was defined as a unit of weight of 28 00:02:16.180 --> 00:02:22.400 gold and therefore the paper currency was redeemable by its issuer, the government or 29 00:02:22.400 --> 00:02:27.220 its central bank, in the defined weight of gold coin. 30 00:02:27.220 --> 00:02:33.680 While gold bullion, in the form of large bars, was used for international payment, gold coin 31 00:02:33.680 --> 00:02:37.940 was used in everyday transactions by the general public. 32 00:02:37.940 --> 00:02:43.540 For obvious reasons, it is the inherent tendency of every money issuer to create as much money 33 00:02:43.540 --> 00:02:45.780 as it can get away with. 34 00:02:45.780 --> 00:02:51.140 But governments or central banks were, on the gold standard, restricted in their issue 35 00:02:51.140 --> 00:02:57.820 of paper or bank deposits by the iron necessity of immediate redemption in gold, and particularly 36 00:02:57.820 --> 00:03:00.980 in gold coin, on demand. 37 00:03:00.980 --> 00:03:07.020 As in the familiar Hume-Cantillon international price specie flow mechanism, an increase of 38 00:03:07.020 --> 00:03:22.520 The increase of the supply of francs and incomes in francs leads to A. an increase in both domestic and foreign spending, hence raising imports. 39 00:03:22.520 --> 00:03:32.520 and B. a rise in domestic French prices, in turn making domestic goods less competitive abroad and lowering exports 40 00:03:32.520 --> 00:03:38.960 less competitive abroad and lowering exports, and making foreign goods more attractive and 41 00:03:38.960 --> 00:03:41.120 raising imports. 42 00:03:41.120 --> 00:03:46.480 The result is an inexorable deficit in the balance of payments, putting pressure upon 43 00:03:46.480 --> 00:03:52.640 French banks to supply gold to English, American or Dutch exporters. 44 00:03:52.640 --> 00:03:58.920 In short, since in fractional reserve banking, paper and banknotes pyramid as a multiple 45 00:03:58.920 --> 00:04:05.880 of Gold Reserves, this expansion of the already engorged top of the inverted pyramid must 46 00:04:05.880 --> 00:04:12.280 inexorably be followed by a loss in the bottom, supporting the swollen liabilities. 47 00:04:12.280 --> 00:04:18.920 In addition, clients who are holders of French banknotes or deposits are apt to become increasingly 48 00:04:18.920 --> 00:04:24.520 concerned, lose confidence in the viability of the French banks, and hence call on those 49 00:04:24.520 --> 00:04:49.520 The result will be an often panicky and sudden contraction of banknotes, generating a recession to replace the previous inflationary boom, and leading to a contraction in notes and deposits, a drop in the French money supply, and a consequent fall in domestic French prices. 50 00:04:49.520 --> 00:04:56.920 The balance of payments deficit is reversed, and gold flows back into French coffers. 51 00:04:56.920 --> 00:05:02.560 In short, the classical gold standard put a severe limit upon the inherent tendency of 52 00:05:02.560 --> 00:05:07.480 monopoly money issuers to issue money without check. 53 00:05:07.480 --> 00:05:14.960 As Ludwig von Mises pointed out, this international species flow mechanism also described a correct, 54 00:05:14.960 --> 00:05:18.400 if primitive, model of the business cycle. 55 00:05:18.400 --> 00:05:24.080 While central banking and fractional reserve banking allowed play for a boom-bust cycle, 56 00:05:24.080 --> 00:05:30.800 the inflationary boom and its compensating bust was kept in strict bounds. 57 00:05:30.800 --> 00:05:35.920 While scarcely perfect or lacking problems, the classical gold standard worked well enough 58 00:05:35.920 --> 00:05:41.920 for the World, after World War I, to look back upon it with understandable nostalgia.