Lecture 8: gold standard
Instructor: Ling Zhu
Fall, 2013
(ECON 442)
Lecture 8: gold standard
Fall, 2013
1 / 17
Goal of the Lecture
How did the world end up with gold standard (GS) in 19th century? Accident + Network Externality How did GS work as a global exchange rate system? Stability mechanism of GS.
(ECON 442)
Lecture 8: gold standard
Fall, 2013
2 / 17
Currency Standards in early 19th Century
Gold standard: UK Silver Standard: Germany, Austro-Hungarian Empire, Scandinavia, Russia, and Far East Bimetallism: US, France
(ECON 442)
Lecture 8: gold standard
Fall, 2013
3 / 17
Challenge of Bimetallism
Fluctuations in relative price of gold to silver
(ECON 442)
Lecture 8: gold standard
Fall, 2013
4 / 17
Fig 1. Relative Price of Gold to Silver, 1830-1902
(ECON 442)
Lecture 8: gold standard
Fall, 2013
5 / 17
Lure of Bimetallism over GS
Gold is not good for daily transaction Token coins were easy to counterfeit Political lobby by farmers Question: Both bimetallism and gold
standard have their issues, then why not silver standard?
(ECON 442)
Lecture 8: gold standard
Fall, 2013
6 / 17
Advent of GS
Invention of steam-powered presses in 1816 Portugal: 1854 Rise of UK as the world lender Germany: 1871 Network externalities Falling silver price
(ECON 442)
Lecture 8: gold standard
Fall, 2013
7 / 17
Problem with GS: Deflation Fig 2. British Whole Sale Price, 1873-1913
(ECON 442)
Lecture 8: gold standard
Fall, 2013
8 / 17
Fig 3: Structure of the Post-1880 International GS
(ECON 442)
Lecture 8: gold standard
Fall, 2013
9 / 17
Fig 4: 1000 pound bank note from 1918
(ECON 442)
Lecture 8: gold standard
Fall, 2013
10 / 17
Fig 4: 100 dollar bank note from 1900
(ECON 442)
Lecture 8: gold standard
Fall, 2013
11 / 17
Stability of GS
Gold standard would have to be abandoned if a country runs out of gold. So the success of GS depends on the stabilization of golf flows. Then how does Gold standard stabilize flow of gold across boarders? There are four stabilization channels under GS: Automatic Adjustment Mechanism– Price Specie Flow Central Bank Intervention: Discount Rates Central Bank Credibility: “Good” Speculative Capital Flow International Cooperation
(ECON 442)
Lecture 8: gold standard
Fall, 2013
12 / 17
Price Specie Flow
David Hume 1752 Trade Deficit→ Gold Outflow→ Reduce Money Supply at Home (Increase Money Supply Abroad)→Price Deflation at Home (Price Inflation Abroad)→ Export Price falls relative to Import Price, i.e. Terms of Trade Improvement→ Trade Surplus→Gold Inflow→ Gold Reserve Restored. This mechanism takes time.
(ECON 442)
Lecture 8: gold standard
Fall, 2013
13 / 17
Discount Rate
What is discount rate? Discount rate affect domestic credit, hence money supply Higher discount rate also attracts foreign capital What should CB do when it anticipates a trade deficit?
(ECON 442)
Lecture 8: gold standard
Fall, 2013
14 / 17
“Good” Speculative Capital Flow
Central Banks was committed to maintain gold standard. Gold outflow→ Gold convertibility under pressure→Market exchange rate depreciates→Speculators anticipate the central bank to intervene to restore the market exchange rate→ Speculators buy domestic currency using gold →Gold inflow
(ECON 442)
Lecture 8: gold standard
Fall, 2013
15 / 17
International Cooperation
Baring Crisis in 1890 : Elements of the crisis : Sovereign default; bank runs; too big to fail; lender of last resort. What did not work: to lend to Baring Brothers, Bank of England needed more gold reserve. Hence it raised discount rate, but failed to attract gold inflow. In fact there was a run on pound. What worked in the end: The Bank of England borrowed 4 million pound of gold from Bank of France and obtained a pledge of 1.5 million pound of gold coin from Russia. How come price specie flow mechanism was unable to attract gold to resolve Baring Crisis?
(ECON 442)
Lecture 8: gold standard
Fall, 2013
16 / 17
Conflicting Objectives of Central Bank
Defending GS or being the Lender of Last Resort. -Modern Finance Defending GS or stimulating domestic economy during recessions. -Policy Trilemma Would you recommend U.S. or any country to adopt to GS today? What are the pros and cons?
(ECON 442)
Lecture 8: gold standard
Fall, 2013
17 / 17
