The Power of Gold: The History of an Obsession

by Peter L. Bernstein

  Silver was always more plentiful than gold, as Offa's pennies remind us. It is no coincidence that the French word for money, argent, translates as silver, or that "sterling" has defined English money for centuries, even when the pound was defined only by gold.' Even during the disputes over gold during the days of the Bullion Committee and its immediate aftermath, silver was a major focus of attention. Both Ricardo and Locke favored one metal over two as the standard, but in 1816 Ricardo opted for silver rather than gold for this purpose. He based his argument on silver's "greater regularity of supply and demand," and its use by all foreign countries, arguing that the inconvenience of its bulk could be entirely offset by substituting paper money as the "general circulation medium."*l9

  Silver might have been number one forever, but it has two disadvantages. First, silver lacks gold's glamour because it tarnishes so much faster than gold; silver has never driven men and women to the extremes of greed that have been motivated by gold. Second, silver's bulk is much greater than gold's. In the days of Locke and Newton, one thousand guineas at £3 17s 10%d weighed about 18% pounds, while the same amount of money-,C1050-in silver coins would have come to nearly 280 pounds. The cost of transporting a given amount of money in gold coin was therefore much lower than the cost of moving the same value in silver. With commerce, industry, and international trade and finance growing with unparalleled vigor in the course of the nineteenth century, this simple physical difference against silver operated as a tax on international movements and in the end may have been as important as "honor and decency" in tipping the scales in favor of gold.2' Another factor in favor of gold was that a given physical volume of each metal at the Mint could produce a much higher value of gold coins than silver coins.

  The bimetallic system did have its advantages, although any arrangement based on metal was destined to be vulnerable to shocks such as new discoveries or new mining technologies, wars, the changing tastes of the Asians, and the fruits of plunder. A convincing justification for bimetallism was made in 1791 by Alexander Hamilton in a remarkable document in which he invented the American monetary system, including its metallic standards, the decimal system, coin denominations, and many smaller details. The coins were to include three gold coins-$10, $5, and $2.50-then a dollar, half-dollar, quarters, dimes, and half-dimes in silver, plus a copper penny and a half-penny. The decimal structure of denominations was a radical break with the long tradition of Offa's pennies, with 240 to the pound, and the use of the multiple of twelve in so many other monetary systems that developed in Europe.

  Although Hamilton set the pattern for economists in times to come by offering innumerable arguments "on the one hand" and then "on the other hand," he concludes after great deliberation that "The Secretary is upon the whole strongly inclined to the Opinion that a preference ought to be given to neither of the Metals for the monetary unit."21 His document emphasizes the importance of having a money that would be acceptable in the varied systems of all countries and therefore warns against the consequences of converting one of the metals into "mere merchandize [sic]. "222 He goes on to make an even more important point that reveals his extraordinary foresight: "To annul the use of either of the metals, as money, is to abridge the quantity of circulating medium; and is liable to all the objections, which arise from a comparison of the benefits of a full, with the evils of a scanty circulation."23 An insufficient supply of gold-except briefly in the 1850s-would turn out to be a recurring concern for the world economy during the entire nineteenth century.

  There is a case that the great international gold standard was by no means an inevitable development. Marc Flandreau, a contemporary economist, has declared that the elimination of silver and its replacement by gold as the sole standard in the 1870s was "a blatant failure of international cooperation"-nothing more than a narrow-minded decision by the French to depress the price of silver in order to make life difficult for the Germans, who were trying to unload their stock of sil ver and establish a gold standard.24 In 1911, the most prominent economist in the United States, Professor Irving Fisher of Yale, went even further, contending that the growing shortage of gold in the first half of the nineteenth century would have driven the world to desert bimetallism and transfer its allegiance to a silver standard, if gold had not been discovered in California and Australia "as though to save the day."25

  The sequence of events leading to the final triumph of gold in Europe was indeed dramatic. As in the sixteenth and seventeenth centuries, North America and Asia continued to swing monetary developments in Europe and were the source of most of the severely protracted disturbances.

  The story begins in the fledgling United States of America, which in 1791 followed Alexander Hamilton's advice to set the mint price of gold equal to $19.3939 and the mint price of silver at $1.2929, which works out to a ratio of 15:1. This happened to be the moment when supplies of gold from Brazil began to decline, to be followed soon afterward by the Latin American revolutions and a precipitous drop in precious metal shipments from the Western Hemisphere. Then Napoleon insisted on a specie-backed money system in France, followed by England's attempt to return to convertibility of sterling into gold. With supply falling and demand rising, the price of gold in the markets around the world soon climbed to more than fifteen times the mint price of silver. One could now bring fifteen ounces of silver to the U.S. Mint and receive one ounce of gold in return, then go into the market and use that ounce to buy more than fifteen ounces of silver, and then repeat the process.

  The process was so irresistible that the United States found itself with only silver circulating and gold gradually disappearing from the monetary system. As a practical matter, the country was on a silver standard. This disparity between gold and silver persisted for over forty years. By 1834, the gold-silver price ratio in world markets had changed from 15:1 to about 15.625:1. A growing shortage of gold coin was now interfering with commercial and financial transactions. Michel Chevalier, the French economist who would be so concerned about the flood of gold from the California gold rush, spent over a year in the United States during 1833-1834 and wrote back home that "Since I have been in the United States, I have not seen there one piece of gold money, except on the scales at the Mint. Once minted, gold is embarked for Europe and remelted. "26

  In 1834, Congress finally recognized that 15:1 was no longer the appropriate ratio of the mint price of gold to the mint price of silver and that an adjustment closer to the reality of world markets could be postponed no longer. But Congress did not set the new ratio of mint prices at 15.625. Instead, it went all the way to 16:1, which worked out to the gold price of $20.67 an ounce that prevailed for another 99 years.

  This step threw the prevailing flows of metal into reverse. Now it was profitable to bring an ounce of gold to the mint, obtain sixteen ounces of silver, go into the marketplace and repurchase the ounce of gold for the equivalent of only 15.625 ounces of silver, and repeat the process. The members of Congress were fully aware that they were stimulating the demand for gold in their choice of 16:1. Two factors, both strongly political, determined the decision. The first was a desire to "do something for gold," because modest amounts had been discovered in Virginia, the Carolinas, and Georgia. Second, these decisions coincided with Andrew Jackson's war against the Second Bank of the United States-known as Biddle's Bank-whose banknotes were a favored medium of exchange at the time. The politicians hoped that a rising supply of gold coins would be a ready substitute for the banknotes and would weaken Biddle's position.

  The United States was now effectively on a gold standard, even though official legislation establishing the gold standard would not be enacted until 1900. Silver continued to function as subsidiary coinage, but gold was the major holding into which currency and bank deposits could be converted.27

  These shifts were the inevitable consequence of using a commodity as a standard of value for the monetary system. The demand for gold and silver depends on more than monetary factors, for these metals h
ave additional uses such as adornment or as hoards against uncertain futures. At the same time, nobody knows when new discoveries will occur. Thus, a variety of forces played upon world prices for gold and silver in the nineteenth century, creating constant disturbances within the monetary system as divergences developed between prices set in the market place and prices set at the mints. The experience of 1834 was just the first act in the drama. More violent upheavals were yet to come.

  The discoveries at Sutter's Mill in California in 1848 and Hargrove's discovery in Australia in 1852 shook the world. The supply of gold coming into the markets ballooned and pushed the price of gold in the marketplace downward. Now silver appeared relatively expensive. People ceased to bring silver to the mints for coining and hoarded it by cashing in their paper money or bank deposits and even giving up gold in exchange for it. In 1850, about three times as much money circulated in silver coin as in gold coin; by 1860, the amounts were roughly even.28

  Silver was the primary factor that kept gold from turning into a glut on the market after the discoveries in California and Australia. As it had for a long time, silver traveled to Asia during the 1850s in high volume, especially to India. Chevalier pointed out that the exports of silver acted like a "parachute" to cushion the fall in the price of gold and the expansion in the supply of money, thereby postponing the terrible inflation that he feared was inevitable. Shipments of silver into India quadrupled from the 1840s to the 1850s; French exports alone rose steadily from 82 million francs in 1850 to 458 trillion francs in 1857. Then came the American Civil War, which shut down American exports of cotton and led to an abrupt surge in the demand for Indian cotton; India obliged by importing even more silver in exchange."

  Just as suddenly, everything went into reverse after the Civil War came to an end. The demand for gold showed no signs of diminishing while the Indian demand for silver had a precipitous drop. During 1870-1875, total Indian imports of silver were smaller than in the year 1865 alone. When a huge silver deposit known as the Comstock Lode was discovered in Nevada in 1859, the glut had clearly switched over to silver.

  For silver, the timing could not have been worse. In view of Britain's economic leadership in foreign trade, other countries began to give serious consideration to shifting to a pure gold standard like Britain'sbut the difficulty of disposing of their stocks of silver in an oversupplied market was a major deterrent. Germany was especially eager to make the changeover to gold, for the Germans wanted to be perceived by the world as a great power. Germany also wanted to be on the same standard as Britain in order to meet the growing need for sterling to pay for raw material imports from the outposts of the British Empire. Ludwig Bamberger, a politician who played a major role in putting Germany on the gold standard, admitted as much when he declared, "We chose gold, not because gold is gold, but because Britain is Britain.""'

  Germany seized on the opportunity provided by its victory over France in 1871. The indemnity paid by the French relieved the Germans of the necessity of liquidating silver in order to finance its purchases of gold. They waited until 1873 to begin their silver sales, even expecting some to be bought by the French. The French not only refused to cooperate but took a more drastic step. On September 5, 1873, the day after the last payment on the indemnity, France limited its silver coinage to 280,000 francs a day and cut it again in November to 150,000.3' The result was another sharp drop in the demand for silver.

  The French ended up outdoing themselves. Too many other countries joined in the selling wave in an effort to avoid being caught with a stock of silver money that was worth less almost by the hour. The game became a self-fulfilling prophecy. A decision that the French perceived as a tactical rather than a strategic step provoked a steady fall in the price of silver from over sixty pence per ounce in the 1860s to only 523/4 pence in 1876 and 51 pence by the end of the 1870s.32 By that time, an ounce of gold in the marketplace was bringing eighteen times as much as an ounce of silver; by the end of the century, the amount was up to thirty times as much as an ounce of silver. As the glut of silver drove the ratio of market prices further and further away from the ratio of prices at the mints, anyone who used gold to buy silver at such depressed prices in the market and then brought the silver into the paint for coinage enjoyed a profitable, riskless, and irresistible activity. The process rocked the gold standard to its very foundations and threatened to bring down the whole structure. The only defense was to eliminate silver as a monetary metal except for small coins.

  That is precisely what happened during the course of the 1870s, beginning in 1873 in France, and also in the United States, as we shall see in the next chapter. That sequence of events explains why so many countries hastened to follow Germany into a pure gold-standard system.

  Thus, the fabled international gold standard was built from the dust of the disaster to silver-by 1893, even the mints in India were closed to the coinage of silver. The gold discoveries in California and Australia and the Comstock Lode in Nevada, the appetite of Indians for silver, the American Civil War, and Germany's overwhelming ambition to be a great power in effect backed the world into a system that no one had anticipated and that many people were reluctant to accept. Once in place, however, the system displayed remarkable durability for the next half-century.

  The establishment of the international gold standard during the 1870s was no guarantee of smooth sailing for the world economy, but the system did tend to limit the magnitude of the inevitable crises that developed from speculation, overinvestment, and excessive competition in a system in which governments offered no safety nets even when all hell appeared to be breaking loose. An outflow of gold served as a danger signal that soon gave rise to defensive actions by the central banks in the form of rising interest rates. If those efforts failed to stem the tide, the central banks tended to step in and come to one another's aid, frequently in partnership with the larger private banking institutions.

  The very idea that a major nation would allow itself to run out of gold was unthinkable-credibility, in other words, was beyond question-which meant that these kinds of credits were forthcoming before matters flew out of control. The easing in the crisis that resulted then made possible repayment of the credits, and the repayments renewed the credibility that kept the whole system functioning. These facilities, it should be emphasized, were available among the major powers. Countries on the periphery-including the United States-often had to fend for themselves and did run out of gold or silver reserves.

  Devotion to the system was so complete that countries could even take the drastic step of suspending convertibility of their currency into gold under special circumstances and continue to do business almost as though nothing had happened. On the rare occasion when a member country was forced to suspend convertibility, everyone understood that the step was taken to protect its gold hoard so that it would be able to avoid deserting the system when the crisis was past. Most of these special cases arose in times of war. We have already seen how Britain set the precedent during the Napoleonic Wars. Convertibility was suspended in the United States from 1862 until 1879. In both cases, convertibility was ultimately reestablished at the old parity. These precedents had a profound influence on Britain's decision in 1925 to return to gold convertibility at the old parity after going off in World War I. The French, however, took a less orthodox course in the 1920s by resetting the relation between the franc and gold at a rate that gave full recognition to the enormous rise in French prices over the years since 1915. The French lived more happily than the British for a while, but not forever after. In the case of both France and Britain, however, any course other than a return to the gold standard would have been unthinkable.

  One of the most spectacular-but by no means atypical-crises in the age of the gold standard occurred in 1890, largely as a result of illadvised and mismanaged investments in Argentina by the respected London house of Baring Brothers. Barings came perilously close to bringing the Bank of England itself to its knees.

/>   Along with their devotion to the gold standard, the British had long led the way among the European nations in the development of financial markets and institutions. As the resources of the City expanded, the British capital market became the leading source of funds for economic growth all around the world. Britain was the largest supplier of capital for the development of the railroad system in the United States, but British capital also poured into many developing economies in Latin America and in Asia. Argentina was a special favorite. Henry Dana Noyes, one of the best informed and most articulate of American commentators on the financial scene of the late nineteenth century, observed that "Into no foreign state had English capital rushed with such reckless eagerness as into the Argentine Republic."33 Noyes took a dim view, arguing that the Argentine climate "was precarious for production, its currency depreciated, and its government untrustworthy."34

  Noyes's observations have the advantage of hindsight. The enthusiasm for Argentina from 1870 to 1890 was well justified by the impres sive growth achieved by this nation. Immigration to Argentina in those years doubled the population, with Europeans who were very different from the "flotsam and jetsam" that headed to the United States. Many brought capital with them to acquire and develop the vast territories of land available for ranching and for agriculture. The result was a surging demand for roads, railways, waterworks, and industrial enterprises. Just during the brief period of 1882-1889, European investors poured $1 billion into Argentina.3S As one knowledgeable observer has pointed out, there was "no well-governed country in Europe which could get so large a credit in relation to its people."36