I.
The Classical Gold Standard
Gold is the money of kings, silver is the money of gentlemen, barter is the money of peasants, and debt is the money of slaves.
To understand the economic history of the twentieth century, we must first examine the monetary system that dominated at its inception. The classical gold standard era, from 1873 to 1914, represented the first time since antiquity that Western civilization was using the same monetary standard. And given European industrial and economic advancement over the rest of the world, by the end of the nineteenth century, the classical gold standard had arguably extended to the whole planet, as most of the world was now using gold as money, or gold-backed currencies, while only a few governments still clung to the silver standard and became increasingly marginalized economically, with the largest capital holders in their territories shifting to gold.
Why Gold?
But why did money concentrate in gold and silver, and then gold alone? The answer can be best understood with reference to these metals having the lowest growth rate of their stockpiles. A detailed study of monetary history shows that, at any time and place, whatever is used as money is whatever fungible, divisible, groupable, and transportable good happens to have the lowest stockpile growth rates. For instance, pre-industrial societies used seashells that were very hard to find. Societies that had not invented glass production used imported glass beads as money. Islands that had no limestone used limestone as money, because limestone could only be obtained at great risk and cost from other faraway islands, making their supply difficult to increase. Prisoners use cigarettes as money because they usually cannot be manufactured in prison, and getting new ones is difficult. As metallurgy began to spread, metals proved remarkably suited for serving as money, as they were fungible, divisible, groupable, and transportable. Iron, copper, silver, and gold had all been used as money, but over time, the first three metals gradually lost their monetary role to gold, the hardest-to-make monetary metal, because their supplies could be increased at rates faster than that of gold's supply.
It is remarkable that the rise of the gold standard did not occur through the efforts of any conscious designer or government mandate. The majority of the world had dealt with gold, silver, and copper as money for centuries. There was no international treaty between governments that would give gold monetary primacy and mandate the demonetization of silver. Individual governments had usually sought to maintain the monetary role of silver alongside gold, but they were powerless to do so in the face of overwhelming monetary incentives shaped by technological reality. Gold kept growing in prominence, and governments' regulations either facilitated its wider adoption to the benefit of their people, or impotently attempted to stymie its growth at the expense of their people's economic well-being.
Whether it was through rational consideration leading people to abandon alternative moneys for gold or through the holders of these moneys bleeding wealth to supply inflation far faster than gold holders, the end result has been the same everywhere in the world: the vast majority of wealth was concentrated in the hands of the holders of the monetary good that was the hardest to produce and had the lowest liquid stockpile growth rate.
Gold is distinct from the three other monetary metals in that it is chemically stable and practically impossible to destroy. It is the only one of these metals that does not corrode, disintegrate, rust, or tarnish. This means that all the gold humanity has produced over thousands of years remains available today, used as gold. Whereas the other metals' stockpiles are constantly disintegrating, gold's stockpiles just continue to grow. This means that, at any given time, the liquid stockpiles of gold held by people worldwide are orders of magnitude larger than any year's production. Data from the past century indicates the annual production of gold is usually in the range of 1.5%-2% of total stockpiles. Even if production were to increase through large discoveries of gold or increases in the productivity of mining processes, the increased supply growth rate will be transitory and self-defeating, as it is added to the existing stockpiles, making the denominator in the supply growth rate larger, bringing the supply growth rate down. Since silver, copper, and iron are constantly being consumed and ruined, their fungible liquid stockpiles are constantly declining, resulting in new production constituting a larger fraction of existing stockpiles as production becomes more efficient and as industrial uses increase.1
From the most primitive seashell to the most sophisticated modern gold bank, the choice of monetary medium has always been one determined by the market and subject to the iron forces of economic incentives. Governments enforced the market's choice, benefitting from obeying it and suffering when opposing it. By the start of the nineteenth century, money was gold and silver virtually everywhere, iron had lost its monetary role long ago, and copper's monetary role was confined to increasingly inconsequential small change. For millennia, under what came to be known as bimetallism, governments would mint gold and silver into fixed-weight coins and put their imprint on these coins to make them fungible and easy to trade, obviating the need for weighing and measuring irregular chunks of gold and thus making trade easier and less costly. However, the variations in the price of gold in relation to silver created a problem for monetary authorities, who would have liked to fix the price between their silver and gold denominations to facilitate trade, but the vagaries of supply and demand constantly shifted the price away from the desired fixed ratio.
Bimetallism and Its Discontents
The classical gold standard emerged from the increasingly unworkable nature of the bimetallic monetary system that had dominated the world for millennia. Both gold and silver were used as money. Gold's higher value per unit of weight gave it the leading role for larger transactions, whereas silver's lower value made it the dominant choice for lower-value transactions. The gold-silver ratio, which measures how many ounces of silver one needs to purchase an ounce of gold, has changed significantly throughout history, but nothing like its changes in the last century. Before 550 BC, we have records of the ratio varying between as little as 2 and as high as 21. Around 1000 BC the price was 3 in ancient Egypt thanks to the abundance of gold in the Nubian mines. In Phoenicia around 800-600 BC, the ratio was around 8 to 12. In the Levant, it was around 6 to 7; and in Mesopotamia and Anatolia, around 8 to 10. In the 7th century BC, the price in Persia was at 13 to 1. In Ancient Greece, the price was around 10 in the 4th Century BC. In the Roman Empire, Emperor Augustus fixed the price at 12 to 1 in the year 23 BC.2 The debasement of the silver denarius led to the rise in desirability of gold and the rise of the GSR to 14 to 18, but the restoration of the Roman Empire in Constantinople led to the decline of the ratio to the range of 12 to 14. In the Islamic world, the ratio was closer to 10 to 15 from the 7th century AD, and under the Ottomans, from 1500 onward, the ratio was around 12 to 15. Medieval Europe saw silver appreciate to as little as a 9 to 4 GSR after the Black Death, but the ratio returned to the 12 to 15 range. The influx of silver from the new world to Europe around 1500-1800 stabilized the ratio around 15.3
As global trade became more advanced, cheaper, and widespread, the price harmonized globally. By the 17th century a global steady price of approximately 15 prevailed in the majority of the world's major markets and economies. But then, in the nineteenth century, modern banking, banknotes, checkbooks, the telegraph and train, making trade more efficient, all conspired to undermine silver's monetary role. But the market rate had remained fixed around 15 because of many governments imposing that rate.
The intractable problem of bimetallism was that, being market goods, silver and gold would fluctuate in value as a result of variations in supply and demand conditions, causing them to diverge from any fixed exchange rate monetary authorities would set between their two denominations. If the exchange rate was set between the two and then the price of silver rose, the government's monetary standard presented an opportunity for arbitrage: any citizen could acquire gold coins and exchange them at the mint for silver coins at the fixed rate set by the government. In effect, the citizen was getting cheap silver from the government, which he could then export abroad and sell for gold at the prevailing foreign market rate, thus obtaining a larger quantity of gold than he had started with. By fixing the exchange rate, governments would necessarily undervalue one of the metals as soon as the market exchange rate between them moved slightly, which would drive the undervalued metal out of its borders and flood its markets with the overvalued metal.
It was through the process of bimetallic arbitrage that the classical gold standard emerged, thanks to the genius of the great English physicist Isaac Newton. Having dedicated his life to alchemy and developing a deep understanding of the processing of precious metals, Newton was appointed the warden of The Royal Mint. He set...
