The "Money Supply" and the Gold
Standard 2: 1880-1970
January 9, 2010
Last week, we were looking at how gold standard systems work. We used
the example of the United States, which, from 1789 to 1860, had a
libertarian "free banking" system. Anyone could issue currency, but it
had to be pegged to gold. This "gold peg" was a value peg. It had nothing to do
with gold mining, or the gold reserves of banks, or imports and exports
of gold. Does gold mining alter the value of gold? Essentially no,
because annual gold mining production is a small fraction -- about 2%
-- of existing world gold supply. Does importing and exporting gold
change the value of gold? Not unless there are some sort of
restrictions on importing and exporting, which is rare, and hard to
enforce even if it exists. Gold is the same value everywhere. Does the
fact that a bank owns or does not own gold change the value of gold?
Nope. It's the same value no matter who owns it. So you see, none of
these factors have much effect on the value
gold. And if a banknote's value is pegged to gold -- via the
adjustment of supply -- then obviously these factors have little effect
on the value of banknotes.
The fact of the matter is, during the "free banking" period, nobody actually knew what the "money
supply" was. In 1859, the Hodges
of America listed 9,916 notes issued by 1,356
banks. Yes, there were 1,356 banks all issuing their own homegrown
currency in those days, all of it linked to gold. Actually, there were
more than 1,356 banks, because Hodges missed dozens if not hundreds of
banks! Banks were opening and closing all the time. Do you see? Not
only did nobody know the total amount of banknotes in issuance (except
for some vague statistics), nobody
even knew how many banks there were issuing currency. Think
about that. So how was the money supply determined in those days? All
of these 1,356+ banks had the same operating mechanism, which was a gold value peg maintained via the adjustment of supply. When the
value of banknotes was a little low compared to its gold peg, the
supply of banknotes was reduced. When people were happy to accept
larger issuance of banknotes, without redeeming them for gold, in other
words when the value of banknotes was higher than the gold peg, then
the supply of banknotes increased.
Supply" With a Gold Standard
To Operate a Gold Standard
August 19, 2007: Gold Standard Fallacies
Unfortunately, today we have all sorts of the stupidest imaginable
ideas floating around, whereby a "gold standard" is a system by which
the amount of money in circulation is determined by gold mining, or the
"current account balance," or that a gold standard means a "100% gold
reserve ratio" or absolutely no change in the "money supply"
whatsoever, some such thing. Anyone with the briefest
understanding of historical monetary statistics -- this includes you if
you read last week's item -- can see immediately that this is complete
baloney. The next thing you should realize is that 99% of academic economists including Ben
Bernanke and also 95% of gold
standard advocates including Murray Rothbard -- also have no
idea whatsoever how real gold standard systems operated, in real life
during the period 1789-1971. What this means is that, after spending 20
minutes to read last week's item, you now know more about this than
95%+ of the so-called "experts." Do you see now why I say that today's
understanding of these matters is appalling? On the other hand, you can
now be a World Expert with about 45 minutes of work. Which is sort of
fun, in a way.
Let's continue our story in 1880. In 1863, the National Bank Notes
system was introduced in the United States. Banks that wanted to issue
currency had to register with the Office of the Comptroller of the
Currency, an agency of the U.S. Treasury. There were still thousands of
these National Banks -- 3,438 National Banks in May 1890 -- so it was
still a libertarian sort of system. However, now we have system-wide
statistics on the total banknotes outstanding. The dollar floated vs.
gold from 1861 to 1879, so 1880 is a good place to restart our tale of
how the gold standard system operated in the United States. The
National Banks themselves didn't hold gold reserves for the most part,
but rather U.S. Treasury obligations. The gold reserve of the National
Bank system was the U.S. Treasury itself.
Here is some information on the National Bank system from the annual
reports of the OCC:
The St. Louis Fed has all kinds of wonderful historical stuff. You used
to have to go to the library for this sort of thing. I did a lot from
Unfortunately, I don't have good statistics on U.S. Treasury gold
holdings from 1900 to 1913. I only have 1905 and 1910. So, the
intervening years are linearly extrapolated. If you have these numbers,
let me know.
Let's review first the history of the dollar.
The "dollar" was originally a European silver coin called the "thaler."
It originated in 1518. This became the Spanish silver "dollar," which
became the template for the U.S. dollar when the dollar was defined in
1792. So, the idea of the "dollar/thaler" goes waaaay back.
Except for a minor adjustment in 1834, the dollar's value was unchanged
until the Roosevelt devalutation in 1933. We can consider the entirety
of the 1789-1932 period as having a dollar pegged to gold at $20.67/oz.
There was a lapse during the Civil War, and also some business around
the War of 1812. After the Roosevelt devaluation, the dollar was pegged
at $35/oz., until 1971. However, there were some lapses during this
time too, especially during World War II.
Here you can see the Civil War devaluation and return to the gold
standard, the 1933 devaluation, and the floating currency period after
This shows the WWII "lapse" in the gold standard -- the U.S. wasn't
quite off gold, but not quite on it either, it was all a little fuzzy,
hey, there was a war going on -- and the return to the $35/oz. peg
around 1952, after the "Fed Accord" of 1951. The dollar sank to about
$43.25/oz. at its lowest point in 1948, which is to say that it took
43.25/35=23.5% more dollars to buy an ounce of gold, or in other words
the dollar's value fell by 19%. Not really that big a deal, as long as
it didn't get out of hand.
There you go. The pink bars are base money (not including gold coin),
basically banknotes and bank reserves. The green bars are the total
amount of gold held by the U.S. Treasury, in terms of dollars. You can
see a big jump in gold reserves in 1934, because that's when they were
revalued at $35/oz. instead of $20.67/oz. The data comes from Milton
Friedman A Monetary History of the
United States, "high powered money" minus gold coin, which comes
from the Federal Reserve's Banking
and Monetary Statistics. The base money figues after 1918 come
from the St. Louis Fed.
During this period, base money (including coins) expanded
by 69x. If you adjust for the 1933 devaluation, the expansion in the
"gold value of the money supply" is 41x. Does that sound to you like
"no expansion in the money supply"? During this period, 1880-1970, the
total amount of gold in the world rose by 6.51x. So you see, the money
supply with a gold standard has nothing to do with gold mining, imports
or exports of gold, the current account balance, "no expansion in the
money supply," "100% reserves" or some other stable reserve ratio, or
all the other stupid things you hear about all the time.