And it is very easy to prove that it was a myth. By “myth” of course, what I mean is that it is a myth that the real world Classical Gold Standard (from 1880 to 1914) was
(1) a system with a pure metallic standard, orIn reality, credit money (mostly unbacked by metal) was the predominant form of money through the entire period of the Classical Gold Standard.
(2) one where most money was gold, and where all credit money was backed up by gold.
Of course, I am not denying that gold was the inelastic monetary base in this period, that monetary units were defined in terms of grains of gold, and that the real world system could impose a contractionary and deflationary bias on the nations that used it.
The Classical Gold Standard era is usually dated from 1880 to 1914. Some economists and historians prefer a broader time period from 1821 to 1914, but this seems quite misleading for a number of reasons. During the early 19th century, silver was more important than gold as a commodity money base (Triffin 1985: 153). Right down to the early 19th century most nations were on a bimetallic standard that was based not on gold but on silver (Bordo 1999: 158).
Although the gold standard was adopted by different nations at different times, it was not until 1880 that the majority of nations were on some form of gold standard (Bordo 1999: 159).
But what was the actual composition of the broad money supply in various nations on the gold standard in the 1880 to 1914 era? What percentage of the total money stock was actually gold?
Let us look at the data. Many might be surprised.
Below are pie charts showing the composition of the broad money supply in the following 11 nations for 1885 and 1913: the United States, Canada, the United Kingdom, France, Germany, Italy, Netherlands, Belgium, Sweden, Switzerland, and Japan.
In other words, we have data here on most of the Western world in the 19th century with the emerging industrial economy of Japan. The data are taken from Triffin (1985: 154, Table 8.2).
First, the year 1885. The chart below shows total money supply with component percentages of
(1) gold,Note that the “currency” component includes non-silver, fiduciary coinage (and, though it is not clear to me, perhaps also central bank notes). Total credit money consists of both (a) currency and (b) demand deposits, including paper currency.
(3) currency, and
(4) demand deposits.
Notice anything? Only years after the emergence of the international gold standard (around 1880), by 1885 67% of broad money – that is, most of it – was already credit money. Demand deposits were already the largest component of the money supply.
What happened by 1913 at the end of the Classical Gold Standard? Let us look at the second chart for 1913, which again shows the total money supply composition in 11 nations.
Actual gold declined to just 10% of the money supply, and credit money accounted for the overwhelming 85% of the money stock. Demand deposit money (bank money) stood at 63% of total money supply – again the largest component and much larger than in 1885.
What happened is that fractional reserve banking was meeting most of the demand for credit money: money was mostly in the form of demand deposits and banknotes.
Money supply was elastic, and total money supply was partly endogenous and partly exogenous. The exogenous component was the base money (or monetary base) of gold and silver, and the credit money component was endogenous.
The inelastic nature of the commodity base imposed constraints on how much credit money could be created of course (which libertarians and Austrians no doubt applaud), but one wonders how much private investment was prevented and stifled because of the need to maintain gold reserves for final clearing of credit money transactions. To what extent was economic growth in the late 19th century reduced by the “barbarous relic”? Probably to some important degree, if there was significant demand for credit from businesses that was unmet by banks. (Today, as a matter of interest, many Post Keynesians would consider even base money endogenous, so that our monetary system is freed from the straitjacket of gold.)
Eventually, the gold standard system itself required new sources of base money, and banknotes of central banks came to be effectively a form of base money in many nations. Within other nations, the banknotes of the most powerful or trusted private banks no doubt also came to be used as if they were base money.
As another interesting datum, it was not just gold that was the international reserve currency: the UK pound sterling – often just banknotes of the Bank of England – was also a fundamental reserve currency in the international payments system of the 19th century.
Robert Triffin’s verdict on the 19th-century gold standard is significant:
“[the] reconciliation of high rates of economic growth with exchange-rate and gold-price stability [in the 19th century] was made possible … by the rapid growth and proper management of bank money, and could hardly have been achieved under the purely, or predominantly, metallic systems of money creation characteristic of the previous centuries. Finally, the term ‘gold standard’ could hardly be applied to the period as a whole, in view of the overwhelming dominance of silver during its first decades, and of bank money during the latter ones. All in all, the nineteenth century could be far more accurately described as the century of an emerging and growing credit-money standard, and of the euthanasia of gold and silver moneys, rather than as the century of the gold standard.” (Triffin 1985: 153).Triffin (1985: 152) estimates that in 1800 bank money or credit money probably constituted less than 33% of the money supply. By 1913, paper currency and bank deposits accounted for 83% of overall currency circulation in the world, and actual gold itself for not much more than 10%.
The final collapse of the gold standard in the 1930s – after the disastrous attempt to restore it via the gold exchange standard – was the understandable culmination of a process already well underway in the late 19th century: the increasing irrelevance of gold and its shrinking role as a form of money.
Finally, the graph below shows the rise in the money supply from 1885 to 1913.
As we can see, the gold standard did not stop the continuous, annual expansion in the money supply.
Nor did it stop the remarkable expansion of the credit money component of national money stocks, which came to dominate national money supplies by 1913.
In short, the gold standard was a myth.
Bordo, Michael D. 1999. The Gold Standard and Related Regimes. Cambridge University Press, Cambridge.
Triffin, R. 1985. “Myth and Realities of the Gold Standard,” in B. Eichengreen and M. Flandreau (eds.), The Gold Standard in Theory and History. Routledge, London and New York. 140–161.