FEDERAL RESERVE BANK OF ST. LOUIS
Trade and Gold Reserves after the Demise of the Classical Gold Standard
Tuesday, September 1, 2020
The following post is the second in a two-part series that examines the changing relationship between trade and U.S. gold reserves throughout history.
The first post looked at the period from around 1870 to the start of World War I.
There have been significant changes to U.S. gold holdings over time.
Were the changes linked to trade flows?
In a Regional Economist article, Assistant Vice President and Economist Yi Wen and then-Research Associate Brian Reinbold explored the relationship between trade and America’s gold reserves throughout the country’s history.
They explained that, under a gold standard, one would expect the U.S. to accumulate gold when it runs trade surpluses and for gold to flow out when the U.S. runs trade deficits.
“In general, we see the U.S. accumulating gold as it ran trade surpluses from 1878 until the early 1920s, but afterward this relationship was tenuous at best as the international payments system experienced heightened uncertainty and significant change,” the authors wrote.
Trying to Save the Gold Standard
From around 1870 to the outbreak of World War I, the classical gold standard ensured that changes in a nation’s gold reserves were closely linked to changes in its trade balance, Wen and Reinbold wrote.
When World War I began, European countries suspended convertibility to gold to make financing the war effort easier.
The war left the international payments system in ruins and the gold standard struggling.
In addition, the costs of the war led to huge trade imbalances that, in turn, led to large fluctuations in countries’ gold reserves, the authors explained.
To return to the gold standard after the war, Great Britain needed to lower the price level, wait for sterling appreciation and attract gold reserves to return to the old parity, the authors wrote.
In order to accomplish this, Great Britain raised its Bank rate to as high as 7% by 1920 at the expense of the domestic economy.
This led to an economic depression due to shrinking credit.
In the U.S., the Federal Reserve Banks raised the discount rate to as high as 7% by 1920.
This was in an effort to fight inflationary pressures and defend the gold standard, which led to an economic depression, the authors noted.
This competition between the U.K. and the U.S. to attract gold by raising rates made it more difficult to realign world gold reserves and exchange rates, Wen and Reinbold wrote.
While most of the developed world had returned to the gold standard by the mid-1920s, systemic imbalances still existed, the authors pointed out.
The Shift from Gold
Unprecedented international deflation during the Great Depression destroyed any remnants of the classical gold standard, Wen and Reinbold wrote.
Great Britain abandoned the gold standard in 1931.
The U.S. suspended gold convertibility and gold exports in 1933.
The following year, the U.S. dollar was devalued and gold began to flow into the country, quadrupling its gold reserves within eight years.
By 1950, the U.S. controlled nearly two-thirds of the world’s gold reserves, up from about 40% in 1930.
The large U.S. gold stockpile created a world imbalance and prevented other nations from returning to the gold standard under the old parities, the authors noted.
The Bretton Woods System
The Bretton Woods system was created after World War II.
Under this system, the U.S. dollar was tied to gold and other currencies were tied to the value of the U.S. dollar, the authors explained.
This created a system of fixed exchange rates.
Yet, the relationship between gold and trade that was seen before World War I did not return.
“Although gold indirectly backed the international payments system during Bretton Woods, the mechanism to balance trade flows through the exchange of gold did not function as we saw under the classical gold standard,” Wen and Reinbold wrote.
They pointed out that from 1957 to 1970, the U.S. ran slight trade surpluses, yet the country saw a large outflow of gold.
U.S. gold reserves were halved by 1970, as shown by the figure below.
Eventually, fear that the U.S. couldn’t meet its gold-dollar exchange rate ended this system in the 1970s, giving rise to the current system of fiat currencies and floating exchange rates, Wen and Reinbold explained.
U.S. gold reserves have remained relatively stable despite increasing U.S. trade deficits since the end of Bretton Woods, which, the authors concluded, underscores the present weak (and possibly nonexistent) link between gold and trade flows.
Additional Resources
Regional Economist: The Changing Relationship between Trade and America’s Gold Reserves
On the Economy: Early U.S. Trade Deficits and Industrialization
https://www.stlouisfed.org/on-the-econo ... d-standard
ON THE GOLD STANDARD
Re: ON THE GOLD STANDARD
The International Gold Standard and U.S. Monetary Policy from World War I to the New Deal
Leland Crabbe, of the Division of Research and Statistics at the Board of Governors, prepared this article, which is the second in a series celebrating the seventy-fifth anniversary of the founding of the Federal Reserve System.
Before the First World War, most of the world, including the United States, Great Britain, and every country in Europe, maintained gold standard.
In the United States, the Resumption Act had restored the gold standard in 1879, and the Gold Standard Act of 1900 had established gold as the ultimate standard of value.
Internationally, the gold standard committed the United States to maintain a fixed exchange rate in relation to other countries on the gold standard, a commitment that facilitated the flow of goods and capital among countries.
Domestically, the gold standard committed the United States to limit the expansion of money and credit, and thus it restrained inflationary pressures.
The international gold standard did not function ideally, however.
Although the gold standard provided a basis for nominal stability over the long run, the U.S. and world economy suffered in the short run through periods of depression and inflation due to changes in the world's supply of and demand for gold.
Moreover, the U.S. commitment to the international gold standard had a cost: It confined, though it did not preclude, discretionary management of the domestic economy.
TO BE CONTINUED ...
Leland Crabbe, of the Division of Research and Statistics at the Board of Governors, prepared this article, which is the second in a series celebrating the seventy-fifth anniversary of the founding of the Federal Reserve System.
Before the First World War, most of the world, including the United States, Great Britain, and every country in Europe, maintained gold standard.
In the United States, the Resumption Act had restored the gold standard in 1879, and the Gold Standard Act of 1900 had established gold as the ultimate standard of value.
Internationally, the gold standard committed the United States to maintain a fixed exchange rate in relation to other countries on the gold standard, a commitment that facilitated the flow of goods and capital among countries.
Domestically, the gold standard committed the United States to limit the expansion of money and credit, and thus it restrained inflationary pressures.
The international gold standard did not function ideally, however.
Although the gold standard provided a basis for nominal stability over the long run, the U.S. and world economy suffered in the short run through periods of depression and inflation due to changes in the world's supply of and demand for gold.
Moreover, the U.S. commitment to the international gold standard had a cost: It confined, though it did not preclude, discretionary management of the domestic economy.
TO BE CONTINUED ...
Re: ON THE GOLD STANDARD
The International Gold Standard and U.S. Monetary Policy from World War I to the New Deal, continued ...
From the First World War to the New Deal, amid upheaval in international and domestic financial markets, the United States honored its commitment to redeem dollars for gold at $20.67 per ounce.
Maintenance of the gold standard, however, recurrently interfered with the Federal Reserve's broader objective of stabilizing the domestic economy.
During the First World War, the United States and other belligerents fully or partly suspended the gold standard, de jure or de facto, to prevent it from hampering the war effort.
In 1920, when the United States alone operated the gold standard without restrictions, the Federal Reserve imposed a severe monetary contraction, which defended the gold standard but contributed greatly to a depression.
Hoping to stabilize the world economy in the 1920s, the industrial nations, notably Britain and France, restored the international gold standard.
The restoration — which must be judged a failure — compelled the Federal Reserve to make choices between its international and its domestic objectives.
Indeed, throughout the 1920s and early 1930s, Federal Reserve policy alternated between management of the international gold standard and management of the domestic economy.
With the devaluation of the dollar in 1933, the United States established the principle that domestic policy objectives had primacy over the dictates of the gold standard.
(See table 1 for the major events covered in this paper and the insert on page 425 for definitions of terms regarding the gold standard.)
THE FIRST WORLD WAR
The First World War nearly demolished the international gold standard.
While none of the countries at war demonetized gold or refused to buy gold at a fixed price, none adhered strictly to the tenets of the gold standard.
When the war began, belligerent governments instituted several legal and practical changes in the gold standard, which they viewed as a temporary suspension of the rules rather than as a permanent abandonment of the international monetary system.
Previous wars had often forced suspension; peace had always brought restoration..
U.S. Response to the 1914 Crisis
Although the United States did not enter the war until 1917, the outbreak of war in Europe in 1914 immediately disrupted U.S. financial and commodity markets, the latter being heavily dependent on London for the financing of exports.
In July 1914, U.S. firms had a large amount of short-term debts payable in Europe, primarily in London; but this position was normal in the summer, as borrowers expected to use the proceeds from exports of cotton and grain to pay off their liabilities in the fall.
As Europe moved toward war, the world's financial markets became highly disorganized, especially after acceptance and discount houses in London shut down their operations.
Late in July, as foreigners began liquidating their holdings of U.S securities and as U.S. debtors scrambled to meet their obligations to pay in sterling, the dollar-pound exchange rate soared as high as $6.75, far above the parity of $4.8665.
Large quantities of gold began to flow out of the United States as the premium on sterling made exports of gold highly profitable.
Under the pressure of heavy foreign selling, stock prices fell sharply in New York.
The banking and financial systems in the United States seemed on the verge of collapse.
Relief came without the suspension of the gold standard in the United States.
TO BE CONTINUED ...
From the First World War to the New Deal, amid upheaval in international and domestic financial markets, the United States honored its commitment to redeem dollars for gold at $20.67 per ounce.
Maintenance of the gold standard, however, recurrently interfered with the Federal Reserve's broader objective of stabilizing the domestic economy.
During the First World War, the United States and other belligerents fully or partly suspended the gold standard, de jure or de facto, to prevent it from hampering the war effort.
In 1920, when the United States alone operated the gold standard without restrictions, the Federal Reserve imposed a severe monetary contraction, which defended the gold standard but contributed greatly to a depression.
Hoping to stabilize the world economy in the 1920s, the industrial nations, notably Britain and France, restored the international gold standard.
The restoration — which must be judged a failure — compelled the Federal Reserve to make choices between its international and its domestic objectives.
Indeed, throughout the 1920s and early 1930s, Federal Reserve policy alternated between management of the international gold standard and management of the domestic economy.
With the devaluation of the dollar in 1933, the United States established the principle that domestic policy objectives had primacy over the dictates of the gold standard.
(See table 1 for the major events covered in this paper and the insert on page 425 for definitions of terms regarding the gold standard.)
THE FIRST WORLD WAR
The First World War nearly demolished the international gold standard.
While none of the countries at war demonetized gold or refused to buy gold at a fixed price, none adhered strictly to the tenets of the gold standard.
When the war began, belligerent governments instituted several legal and practical changes in the gold standard, which they viewed as a temporary suspension of the rules rather than as a permanent abandonment of the international monetary system.
Previous wars had often forced suspension; peace had always brought restoration..
U.S. Response to the 1914 Crisis
Although the United States did not enter the war until 1917, the outbreak of war in Europe in 1914 immediately disrupted U.S. financial and commodity markets, the latter being heavily dependent on London for the financing of exports.
In July 1914, U.S. firms had a large amount of short-term debts payable in Europe, primarily in London; but this position was normal in the summer, as borrowers expected to use the proceeds from exports of cotton and grain to pay off their liabilities in the fall.
As Europe moved toward war, the world's financial markets became highly disorganized, especially after acceptance and discount houses in London shut down their operations.
Late in July, as foreigners began liquidating their holdings of U.S securities and as U.S. debtors scrambled to meet their obligations to pay in sterling, the dollar-pound exchange rate soared as high as $6.75, far above the parity of $4.8665.
Large quantities of gold began to flow out of the United States as the premium on sterling made exports of gold highly profitable.
Under the pressure of heavy foreign selling, stock prices fell sharply in New York.
The banking and financial systems in the United States seemed on the verge of collapse.
Relief came without the suspension of the gold standard in the United States.
TO BE CONTINUED ...
Re: ON THE GOLD STANDARD
The International Gold Standard and U.S. Monetary Policy from World War I to the New Deal, continued ...
On July 31, the New York Stock Exchange joined the world's other major exchanges in closing its doors, thus easing pressure on the gold standard by preventing the export of gold arising from foreign sales of U.S. corporate securities.
In August, unsafe shipping conditions and the unavailability of insurance further slowed gold exports.
Still, with the export sector in disarray and with $500 million in short-term debts coming due in Europe, the United States needed to implement additional actions to defend the exchange value of the dollar.
The most important relief measure came on August 3, when Secretary of the Treasury William McAdoo authorized national and state banks to issue emergency currency by invoking the Aldrich-Vreeland Act.
Because it allowed banks to use such notes to meet currency withdrawals and to safeguard reserves, this emergency measure kept panic from sweeping over the banking system.
In early September, less than a month after its first members took the oath of office, the Federal Reserve Board, in conjunction with the Secretary of the Treasury, organized a syndicate of banks that subscribed $108 million in gold to pay U.S. indebtedness in Europe.
Less than $10 million was actually exported from this gold fund, however, because the organization of the fund itself provided foreign creditors with the assurance they required.
Although the international financial machinery broke down more fundamentally in 1914 than it had in previous crises, the U.S. domestic economy fared surprisingly well.
Primarily because the issuance of emergency currency provided liquidity, the volume of loans made by banks was much higher than in past crises.
Because banks in the country actually increased their loans outstanding, in contrast to their past practices, the crisis of 1914 did not unduly burden banks in New York.
Although interest rates in the United States rose and remained high through the autumn, rates did not soar to the levels reached in past panics.
TO BE CONTINUED ...
On July 31, the New York Stock Exchange joined the world's other major exchanges in closing its doors, thus easing pressure on the gold standard by preventing the export of gold arising from foreign sales of U.S. corporate securities.
In August, unsafe shipping conditions and the unavailability of insurance further slowed gold exports.
Still, with the export sector in disarray and with $500 million in short-term debts coming due in Europe, the United States needed to implement additional actions to defend the exchange value of the dollar.
The most important relief measure came on August 3, when Secretary of the Treasury William McAdoo authorized national and state banks to issue emergency currency by invoking the Aldrich-Vreeland Act.
Because it allowed banks to use such notes to meet currency withdrawals and to safeguard reserves, this emergency measure kept panic from sweeping over the banking system.
In early September, less than a month after its first members took the oath of office, the Federal Reserve Board, in conjunction with the Secretary of the Treasury, organized a syndicate of banks that subscribed $108 million in gold to pay U.S. indebtedness in Europe.
Less than $10 million was actually exported from this gold fund, however, because the organization of the fund itself provided foreign creditors with the assurance they required.
Although the international financial machinery broke down more fundamentally in 1914 than it had in previous crises, the U.S. domestic economy fared surprisingly well.
Primarily because the issuance of emergency currency provided liquidity, the volume of loans made by banks was much higher than in past crises.
Because banks in the country actually increased their loans outstanding, in contrast to their past practices, the crisis of 1914 did not unduly burden banks in New York.
Although interest rates in the United States rose and remained high through the autumn, rates did not soar to the levels reached in past panics.
TO BE CONTINUED ...
Re: ON THE GOLD STANDARD
The International Gold Standard and U.S. Monetary Policy from World War I to the New Deal, continued ...
By the time the Federal Reserve Banks opened, on November 16, 1914, the financial crisis in the United States had nearly passed.
In November, commercial banks began to retire Aldrich-Vreeland notes.
In December, gold began to flow toward the United States, and the New York Stock Exchange reopened.
By January, with exports surging, the neutral dollar had rebounded to move past parity with the pound.
Attempts to Maintain Exchange Rate Parities during the War
The durability of the international gold standard before the First World War can be traced to a well-founded trust in the stability of the principal reserve currency, the British pound.
The preservation of confidence in the gold standard in Great Britain during the war relied on keeping the pound above the gold export point of the principal neutral currency, the U.S. dollar.
With Great Britain and all of the other warring nations hungering for commodity imports to feed their economies, gold shipments to the United States helped hold exchange rates near parity during the period of U.S. neutrality.
From August 1914 to April 1917, the United States imported a total of $1.12 billion in gold, and the monetary gold stock swelled from $1.57 billion to $2.85 billion.
While the British wanted to support the pound and to import war supplies, they realized that gold exports could not satisfy indefinitely these dual objectives without undermining confidence in the pound.
From January 13,1916, to March 19,1919, J.P. Morgan and Company, acting as agents of the British Treasury, pegged the dollar-pound rate in New York at $4,765.
Gold exports, pegging operations, and large sales of foreign securities partially shielded the fixed structure of the world's exchange rates, but Great Britain and its allies depended on international borrowing as the key weapon in their defense of exchange rate parities.
As the war stretched from months into years, an extraordinary network of international lending emerged, which fortified the strained structure of exchange rates.
In general, neutrals lent to belligerents.
Most important, the United States lent to Britain.
As the volume of debt burgeoned, the structure of the debt intertwined: Neutrals lent to neutrals; belligerents lent to their allies.
The diversion of war-financing pressures partly sheltered the world exchange rate structure at the cost of contorting the world debt structure.
When the United States entered the war in April 1917, loans by the U.S. government to its allies replenished the nearly exhausted resources of the private financial markets.
From April 1917 to November 1920, U.S. net cash advances to Britain totaled $4.20 billion; to France, $2.97 billion; and to Italy, $1.63 billion.
After the war, Britain retained its status as a central creditor nation; but by 1920, British foreign assets had fallen to one-fourth of their 1914 level, while more than $11 billion in capital exports during the war had transformed the United States from a debtor into a creditor nation.
TO BE CONTINUED ...
By the time the Federal Reserve Banks opened, on November 16, 1914, the financial crisis in the United States had nearly passed.
In November, commercial banks began to retire Aldrich-Vreeland notes.
In December, gold began to flow toward the United States, and the New York Stock Exchange reopened.
By January, with exports surging, the neutral dollar had rebounded to move past parity with the pound.
Attempts to Maintain Exchange Rate Parities during the War
The durability of the international gold standard before the First World War can be traced to a well-founded trust in the stability of the principal reserve currency, the British pound.
The preservation of confidence in the gold standard in Great Britain during the war relied on keeping the pound above the gold export point of the principal neutral currency, the U.S. dollar.
With Great Britain and all of the other warring nations hungering for commodity imports to feed their economies, gold shipments to the United States helped hold exchange rates near parity during the period of U.S. neutrality.
From August 1914 to April 1917, the United States imported a total of $1.12 billion in gold, and the monetary gold stock swelled from $1.57 billion to $2.85 billion.
While the British wanted to support the pound and to import war supplies, they realized that gold exports could not satisfy indefinitely these dual objectives without undermining confidence in the pound.
From January 13,1916, to March 19,1919, J.P. Morgan and Company, acting as agents of the British Treasury, pegged the dollar-pound rate in New York at $4,765.
Gold exports, pegging operations, and large sales of foreign securities partially shielded the fixed structure of the world's exchange rates, but Great Britain and its allies depended on international borrowing as the key weapon in their defense of exchange rate parities.
As the war stretched from months into years, an extraordinary network of international lending emerged, which fortified the strained structure of exchange rates.
In general, neutrals lent to belligerents.
Most important, the United States lent to Britain.
As the volume of debt burgeoned, the structure of the debt intertwined: Neutrals lent to neutrals; belligerents lent to their allies.
The diversion of war-financing pressures partly sheltered the world exchange rate structure at the cost of contorting the world debt structure.
When the United States entered the war in April 1917, loans by the U.S. government to its allies replenished the nearly exhausted resources of the private financial markets.
From April 1917 to November 1920, U.S. net cash advances to Britain totaled $4.20 billion; to France, $2.97 billion; and to Italy, $1.63 billion.
After the war, Britain retained its status as a central creditor nation; but by 1920, British foreign assets had fallen to one-fourth of their 1914 level, while more than $11 billion in capital exports during the war had transformed the United States from a debtor into a creditor nation.
TO BE CONTINUED ...
Re: ON THE GOLD STANDARD
The International Gold Standard and U.S. Monetary Policy from World War I to the New Deal, continued ...
Suspension of the International Gold Standard during the War
To be on the gold standard a country needed to maintain the convertibility between notes and gold and to allow gold to flow freely across its borders.
In the early days of the war, Austria-Hungary, France, Germany, and Russia all went off the gold standard as they suspended specie payments and instituted legal or de facto embargoes on the export of gold by private citizens.
Like the British Treasury, the governments of these warring countries exported gold and borrowed heavily to finance the war, but these tactics raised only a fraction of the large sums of money that the war required.
Because new taxes did not and could not make up the difference, the continental belligerents financed a large share of the war by printing money, which caused prices to soar and complicated the return of these countries to the gold standard after the war.
Unlike other belligerents, Britain did not formally suspend specie payments or institute an embargo on gold exports during the war.
Several factors, however, effectively prevented conversion of Bank of England notes into gold: Frustrating procedural obstacles at the Bank and appeals to patriotism dissuaded would-be hoarders of gold; the pegging operations and high insurance rates undercut the incentive to export; and, most important, dealers in the London gold market refused to ship gold to countries that did not reciprocate with gold exports in trade transactions.
During its period of neutrality, the United States maintained specie payments and permitted gold to flow freely to and from other countries.
Five months after the United States entered the war, President Wilson issued a proclamation that required all parties who wished to export gold from the United States to obtain permission from the Secretary of the Treasury and the Federal Reserve Board.
Because most of these applications were denied, the United States effectively embargoed the export of gold, and this embargo partially suspended the gold standard from September 1917 until June 1919.
Although unwilling to let the gold standard interfere with the war effort, the United States continued to maintain it in a limited sense, as banks did not suspend specie payments.
In practice, however, even the redemption of notes for gold became difficult until the end of the war.
The struggle to restore the international gold standard after World War I differed significantly from past experience.
In the half century before the war, the pound sterling and a growing family of gold- standard currencies provided a reliable point ofreference for non-gold currencies.
During this period, the many countries that had either adopted or restored the gold standard could depend on the Bank of England to provide predictable policy in which changes in the Bank rate carefully regulated the Bank's reserve position.
In 1919, almost every country regarded the gold standard as an essential institution; but, among the world powers, only the United States could be counted as a gold-standard country.
For other major countries, four years of inflation, price controls, exchange controls, and massive gold shipments complicated the problem of restoration.
Many governments weighed the pros and cons of returning to par versus devaluation, the latter involving the problematic selection of a new parity.
Deflation and unemployment awaited nations that aspired to reinstate prewar gold parities.
More, the general reestablishment of the international gold standard promised to precipitate large and discontinuous increases in the world demand for gold.
Rather than subjecting their economies to undue turmoil, most governments preferred to wait, at least until the pound sterling — the key currency to which others looked for leadership — had stabilized.
By default, the Federal Reserve assumed the office of manager of the gold standard.
TO BE CONTINUED ...
Suspension of the International Gold Standard during the War
To be on the gold standard a country needed to maintain the convertibility between notes and gold and to allow gold to flow freely across its borders.
In the early days of the war, Austria-Hungary, France, Germany, and Russia all went off the gold standard as they suspended specie payments and instituted legal or de facto embargoes on the export of gold by private citizens.
Like the British Treasury, the governments of these warring countries exported gold and borrowed heavily to finance the war, but these tactics raised only a fraction of the large sums of money that the war required.
Because new taxes did not and could not make up the difference, the continental belligerents financed a large share of the war by printing money, which caused prices to soar and complicated the return of these countries to the gold standard after the war.
Unlike other belligerents, Britain did not formally suspend specie payments or institute an embargo on gold exports during the war.
Several factors, however, effectively prevented conversion of Bank of England notes into gold: Frustrating procedural obstacles at the Bank and appeals to patriotism dissuaded would-be hoarders of gold; the pegging operations and high insurance rates undercut the incentive to export; and, most important, dealers in the London gold market refused to ship gold to countries that did not reciprocate with gold exports in trade transactions.
During its period of neutrality, the United States maintained specie payments and permitted gold to flow freely to and from other countries.
Five months after the United States entered the war, President Wilson issued a proclamation that required all parties who wished to export gold from the United States to obtain permission from the Secretary of the Treasury and the Federal Reserve Board.
Because most of these applications were denied, the United States effectively embargoed the export of gold, and this embargo partially suspended the gold standard from September 1917 until June 1919.
Although unwilling to let the gold standard interfere with the war effort, the United States continued to maintain it in a limited sense, as banks did not suspend specie payments.
In practice, however, even the redemption of notes for gold became difficult until the end of the war.
The struggle to restore the international gold standard after World War I differed significantly from past experience.
In the half century before the war, the pound sterling and a growing family of gold- standard currencies provided a reliable point ofreference for non-gold currencies.
During this period, the many countries that had either adopted or restored the gold standard could depend on the Bank of England to provide predictable policy in which changes in the Bank rate carefully regulated the Bank's reserve position.
In 1919, almost every country regarded the gold standard as an essential institution; but, among the world powers, only the United States could be counted as a gold-standard country.
For other major countries, four years of inflation, price controls, exchange controls, and massive gold shipments complicated the problem of restoration.
Many governments weighed the pros and cons of returning to par versus devaluation, the latter involving the problematic selection of a new parity.
Deflation and unemployment awaited nations that aspired to reinstate prewar gold parities.
More, the general reestablishment of the international gold standard promised to precipitate large and discontinuous increases in the world demand for gold.
Rather than subjecting their economies to undue turmoil, most governments preferred to wait, at least until the pound sterling — the key currency to which others looked for leadership — had stabilized.
By default, the Federal Reserve assumed the office of manager of the gold standard.
TO BE CONTINUED ...
Re: ON THE GOLD STANDARD
The International Gold Standard and U.S. Monetary Policy from World War I to the New Deal, continued ...
FEDERAL RESERVE'S POSTWAR DEFENSE OF THE GOLD STANDARD
Every Federal reserve bank shall maintain reserves in gold or lawful money of not less than thirty-five per centum against its deposits and reserves in gold of not less than forty per centum against its Federal reserve notes in actual circulation. 1
The Federal Reserve Act had legally preserved gold as the ultimate monetary standard in the United States.
The gold standard, however, did not play an active role in the implementation of policy, as the act required that Federal Reserve Banks maintain only a minimum ratio of gold reserves to currency and deposits.
(The gold standard would have played a more active role had the act stipulated the maintenance of a specific gold reserve ratio.)
Because the gold reserve requirement rarely restrained policy between 1914 and 1933, the Federal Reserve had broad discretionary powers to manage the nation's money supply in the advancement of domestic objectives. 2
However, the gold standard remained as a latent check on the Federal Reserve: The required minimum ratio limited the Federal Reserve's authority to augment the money supply, which could continue to expand only so long as gold flowed into reserves.
From the opening of the Federal Reserve Banks in November 1914 to the signing of the Armistice in November 1918, wholesale prices in the United States doubled, and the money supply (currency held by the public plus demand deposits) grew 70 percent.
Under normal conditions, a huge credit expansion and sizable inflation would have endangered the gold standard.
However, the flood of gold imports during the period of U.S. neutrality had pushed the ratio of gold reserves to deposit and Federal Reserve note liabilities to 84.1 percent in March 1917.
Although the gold reserve ratio declined fairly steadily after the United States entered the war, it stood at 48.3 percent at the end of the war, an adequate distance above the legal minimum.
After the war, two factors combined to lower the gold ratio; consequently, the gold standard in the United States encountered a challenge.
First, the Federal Reserve supported the Treasury's placing of Liberty Bonds with banks by keeping the discount rate below market interest rates and thus postponed the reversal of the wartime monetary and price expansion.
From the end of the war to January 1920, as member banks borrowed heavily from the Federal Reserve, the money supply rose 18 percent and the price level rose 16 percent.
Second, the repeal by the United States of the gold export embargo in June 1919 made the gold standard fully operative.
As a result, the United States exported gold in every month from June 1919 through March 1920, for a total for the period of $300 million.
In hindsight, Benjamin Strong, the Governor of the New York Reserve Bank, conceded that an increase in the discount rate in the first quarter of 1919 "would have been as close to an ideal 100 per cent policy of perfection as could have been adopted." 3
By December 1919, the combination of gold exports and money supply growth had reduced the gold reserve ratio to 43.5 percent.
The Federal Reserve responded to these inflationary developments by choking off the credit expansion in 1920.
Early in the year, the Federal Reserve Banks increased their discount rates 1.25 percentage points to 6 percent — the largest jump in the seventy-five-year history of the Federal Reserve — just as the economy entered a slump.
Both the wholesale price level and the money supply peaked in the spring of 1920, and, partly because of gold exports, the gold ratio continued to edge down, to 40.9 percent in May.
1. Federal Reserve Act, P.L. 63-43 (December 23, 1913), sec. 16.2.
2 "During most of their life the Federal Reserve Banks have held large amounts of reserves in excess of requirements, and the actual amount of excess reserves and reserve ratio have not been of particular significance. At times, however — especially in 1920 and during the banking holiday in 1933 — reserve ratios were close to the legal limit. In general, Federal Reserve credit policy is determined on the basis of the broad needs of the credit and business situation and not on the basis of variations in the reserve ratio." See Board of Governors of the Federal Reserve System, Banking and Monetary Statistics, 1914-1941 (Board of Governors, 1943), p. 329.
3. W. Randolph Burgess, ed., Interpretations of Federal Reserve Policy in the Speeches and Writing of Benjamin Strong (Harper & Brothers, 1930), p. 85, from a hearing before the Joint Commission of Agricultural Inquiry, August 2-11, 1921. Strong stated that the Federal Reserve resisted contracting the money supply in 1919 to prevent high interest rates from interfering with the flotation of the Victory Loan.
TO BE CONTINUED ...
FEDERAL RESERVE'S POSTWAR DEFENSE OF THE GOLD STANDARD
Every Federal reserve bank shall maintain reserves in gold or lawful money of not less than thirty-five per centum against its deposits and reserves in gold of not less than forty per centum against its Federal reserve notes in actual circulation. 1
The Federal Reserve Act had legally preserved gold as the ultimate monetary standard in the United States.
The gold standard, however, did not play an active role in the implementation of policy, as the act required that Federal Reserve Banks maintain only a minimum ratio of gold reserves to currency and deposits.
(The gold standard would have played a more active role had the act stipulated the maintenance of a specific gold reserve ratio.)
Because the gold reserve requirement rarely restrained policy between 1914 and 1933, the Federal Reserve had broad discretionary powers to manage the nation's money supply in the advancement of domestic objectives. 2
However, the gold standard remained as a latent check on the Federal Reserve: The required minimum ratio limited the Federal Reserve's authority to augment the money supply, which could continue to expand only so long as gold flowed into reserves.
From the opening of the Federal Reserve Banks in November 1914 to the signing of the Armistice in November 1918, wholesale prices in the United States doubled, and the money supply (currency held by the public plus demand deposits) grew 70 percent.
Under normal conditions, a huge credit expansion and sizable inflation would have endangered the gold standard.
However, the flood of gold imports during the period of U.S. neutrality had pushed the ratio of gold reserves to deposit and Federal Reserve note liabilities to 84.1 percent in March 1917.
Although the gold reserve ratio declined fairly steadily after the United States entered the war, it stood at 48.3 percent at the end of the war, an adequate distance above the legal minimum.
After the war, two factors combined to lower the gold ratio; consequently, the gold standard in the United States encountered a challenge.
First, the Federal Reserve supported the Treasury's placing of Liberty Bonds with banks by keeping the discount rate below market interest rates and thus postponed the reversal of the wartime monetary and price expansion.
From the end of the war to January 1920, as member banks borrowed heavily from the Federal Reserve, the money supply rose 18 percent and the price level rose 16 percent.
Second, the repeal by the United States of the gold export embargo in June 1919 made the gold standard fully operative.
As a result, the United States exported gold in every month from June 1919 through March 1920, for a total for the period of $300 million.
In hindsight, Benjamin Strong, the Governor of the New York Reserve Bank, conceded that an increase in the discount rate in the first quarter of 1919 "would have been as close to an ideal 100 per cent policy of perfection as could have been adopted." 3
By December 1919, the combination of gold exports and money supply growth had reduced the gold reserve ratio to 43.5 percent.
The Federal Reserve responded to these inflationary developments by choking off the credit expansion in 1920.
Early in the year, the Federal Reserve Banks increased their discount rates 1.25 percentage points to 6 percent — the largest jump in the seventy-five-year history of the Federal Reserve — just as the economy entered a slump.
Both the wholesale price level and the money supply peaked in the spring of 1920, and, partly because of gold exports, the gold ratio continued to edge down, to 40.9 percent in May.
1. Federal Reserve Act, P.L. 63-43 (December 23, 1913), sec. 16.2.
2 "During most of their life the Federal Reserve Banks have held large amounts of reserves in excess of requirements, and the actual amount of excess reserves and reserve ratio have not been of particular significance. At times, however — especially in 1920 and during the banking holiday in 1933 — reserve ratios were close to the legal limit. In general, Federal Reserve credit policy is determined on the basis of the broad needs of the credit and business situation and not on the basis of variations in the reserve ratio." See Board of Governors of the Federal Reserve System, Banking and Monetary Statistics, 1914-1941 (Board of Governors, 1943), p. 329.
3. W. Randolph Burgess, ed., Interpretations of Federal Reserve Policy in the Speeches and Writing of Benjamin Strong (Harper & Brothers, 1930), p. 85, from a hearing before the Joint Commission of Agricultural Inquiry, August 2-11, 1921. Strong stated that the Federal Reserve resisted contracting the money supply in 1919 to prevent high interest rates from interfering with the flotation of the Victory Loan.
TO BE CONTINUED ...
Re: ON THE GOLD STANDARD
The International Gold Standard and U.S. Monetary Policy from World War I to the New Deal, continued ...
In June 1920, the Federal Reserve Banks in New York, Chicago, Boston, and Kansas City pushed the discount rate to 7 percent, and they held it there until May 1921.
Dear money plunged the economy into a depression.
From the peak in January 1920 to the trough in July 1921, real output fell 4 percent; prices, 40 percent; and the money supply, 11 percent.
During the eighteen-month depression, high interest rates attracted gold imports of $351 million, mitigating the adjustment to the monetary stringency.
By July 1921, the gold reserve ratio had recovered to 61.7 percent.
As the economy rebounded, prices stabilized and gold continued to flow into the United States; and from the end of 1921 to the end of 1925, the gold reserve ratio remained above 70 percent.
The decisive policy actions of 1920 attest to the Federal Reserve's limited scope for discretion under the gold standard.
Had trends in monetary expansion persisted, the gold reserve ratio would have fallen below the legal minimum, a situation requiring a modification, suspension, or abandonment of the gold standard.
Playing according to the rules, the Federal Reserve tightened credit, a move that attracted gold from abroad and caused notes to reflux.
The Federal Reserve has been criticized for moving too late, for acting with too much force, and for keeping money dear too long.
Its defense of the gold standard, however, conformed broadly to the European tradition of central bank policy.
TO BE CONTINUED ...
In June 1920, the Federal Reserve Banks in New York, Chicago, Boston, and Kansas City pushed the discount rate to 7 percent, and they held it there until May 1921.
Dear money plunged the economy into a depression.
From the peak in January 1920 to the trough in July 1921, real output fell 4 percent; prices, 40 percent; and the money supply, 11 percent.
During the eighteen-month depression, high interest rates attracted gold imports of $351 million, mitigating the adjustment to the monetary stringency.
By July 1921, the gold reserve ratio had recovered to 61.7 percent.
As the economy rebounded, prices stabilized and gold continued to flow into the United States; and from the end of 1921 to the end of 1925, the gold reserve ratio remained above 70 percent.
The decisive policy actions of 1920 attest to the Federal Reserve's limited scope for discretion under the gold standard.
Had trends in monetary expansion persisted, the gold reserve ratio would have fallen below the legal minimum, a situation requiring a modification, suspension, or abandonment of the gold standard.
Playing according to the rules, the Federal Reserve tightened credit, a move that attracted gold from abroad and caused notes to reflux.
The Federal Reserve has been criticized for moving too late, for acting with too much force, and for keeping money dear too long.
Its defense of the gold standard, however, conformed broadly to the European tradition of central bank policy.
TO BE CONTINUED ...
Re: ON THE GOLD STANDARD
The International Gold Standard and U.S. Monetary Policy from World War I to the New Deal, continued ...
DELAYED RESTORATION OF THE INTERNATIONAL GOLD STANDARD
In theory, the "strict rules" of the international gold standard regulated the international price structure and anchored the international price level over the long run.
Consider a simplified description of the price-specie flow mechanism.
Following an increase in a country's monetary gold stock (arising from, say, new discoveries of gold) and an expansion of the money supply, the domestic price level would rise, and the relative price of foreign goods would fall.
This change in relative prices would induce an increase in imports and a reduction in exports, with gold exports balancing the trade deficit.
The gold out-flow would reduce pressure on the domestic price level and increase foreign prices.
Domestic and foreign prices would converge, with the international price level determined by the world's monetary gold stock.
Federal Reserve Sterilization of Gold Flows
In practice, under the gold standard central banks had the ability — within limits — to manage the effects of gold flows.
When a country imported gold, its central bank could sterilize the effect of the gold inflow on the monetary base by selling securities on the open market.
When a country exported gold, its central bank could sterilize the gold outflow with open market purchases.
For countries with gold reserve requirements, the legal ratio would limit the ability of the central bank to sterilize exports.
For all gold standard countries, continued sterilization of gold exports would reduce the ratio of gold to notes, increasing the risk of a forced suspension of the gold standard should citizens attempt to redeem central bank notes for gold.
Sterilization of gold flows shifted the burden of the adjustment of international prices to other gold standard countries.
TO BE CONTINUED ...
DELAYED RESTORATION OF THE INTERNATIONAL GOLD STANDARD
In theory, the "strict rules" of the international gold standard regulated the international price structure and anchored the international price level over the long run.
Consider a simplified description of the price-specie flow mechanism.
Following an increase in a country's monetary gold stock (arising from, say, new discoveries of gold) and an expansion of the money supply, the domestic price level would rise, and the relative price of foreign goods would fall.
This change in relative prices would induce an increase in imports and a reduction in exports, with gold exports balancing the trade deficit.
The gold out-flow would reduce pressure on the domestic price level and increase foreign prices.
Domestic and foreign prices would converge, with the international price level determined by the world's monetary gold stock.
Federal Reserve Sterilization of Gold Flows
In practice, under the gold standard central banks had the ability — within limits — to manage the effects of gold flows.
When a country imported gold, its central bank could sterilize the effect of the gold inflow on the monetary base by selling securities on the open market.
When a country exported gold, its central bank could sterilize the gold outflow with open market purchases.
For countries with gold reserve requirements, the legal ratio would limit the ability of the central bank to sterilize exports.
For all gold standard countries, continued sterilization of gold exports would reduce the ratio of gold to notes, increasing the risk of a forced suspension of the gold standard should citizens attempt to redeem central bank notes for gold.
Sterilization of gold flows shifted the burden of the adjustment of international prices to other gold standard countries.
TO BE CONTINUED ...
Re: ON THE GOLD STANDARD
The International Gold Standard and U.S. Monetary Policy from World War I to the New Deal, continued ...
Federal Reserve Sterilization of Gold Flows, concluded ...
When a country sterilized gold imports, it precluded the gold flow from increasing the domestic price level and from mitigating the deflationary tendency in the rest of the world.
Under the international gold standard, no country had absolute control over its domestic price level in the long run; but a large country could influence whether its price level converged toward the world price level or world prices converged toward the domestic price level.
In the early 1920s, the United States bid a higher price for monetary gold than any other country did.
As a result, gold flowed toward the United States and afforded considerable slack to the manager of the gold standard, the Federal Reserve.
Instead of letting gold imports expand the money supply and raise the domestic price level, the Federal Reserve sterilized gold inflows and stabilized the domestic price level.
Chart 1, which presents evidence of the sterilization, shows that changes in Federal Reserve Bank credit outstanding offset changes in the monetary gold stock in the 1920s. 4
Chart 1 also displays the success of the sterilization operations: After January 1921, the wholesale price level fluctuated within a narrow 6 percent band.
Traditionally, economists and politicians have criticized the Federal Reserve for not playing by the strict rules of the gold standard during the 1920s.
For example, William A. Brown stated the following about the Federal Reserve policy of sterilization: From 1914 to 1925 it was true that the influence of American policy alone on American prices and therefore on the world value of gold was so dominant as to deprive the expression "maintaining the dollar at parity with gold" of the significance properly attributed to it when an international gold standard system is in force. . . .
Though this large measure of control over the traditional standard was freely recognized and taken advantage of under the exigencies of war and post-war finance, this was not enough to alter by a hair's breadth the deep underlying conviction that the United States was anchored to a sound monetary base and that therefore her currency was safe.
The United States was dragging her golden anchor.
Indeed, she was carrying it on deck, but as long as she was still attached to it, she felt safe even though it was no longer fast to the ocean bed. 5
This traditional judgment may have been too harsh: What were the "rules" of the international gold standard in a period when no major country other than the United States maintained a commitment to buy and sell gold at a fixed price without export restrictions?
The gold standard could "anchor" the price level only if the world demand for gold were stable.
In consideration of the international uncertainty, Federal Reserve sterilization in the early 1920s probably served the best interests of the United States.
4. Federal Reserve Bank credit was the sum of the earning assets of the Federal Reserve Banks. The principal assets were bills discounted, bills bought, and government securities.
5. William Adams Brown, Jr., The International Gold Standard Reinterpreted, 1914-1934, vol. 1 (National Bureau of Economic Research, 1940), p. 286.
TO BE CONTINUED ...
Federal Reserve Sterilization of Gold Flows, concluded ...
When a country sterilized gold imports, it precluded the gold flow from increasing the domestic price level and from mitigating the deflationary tendency in the rest of the world.
Under the international gold standard, no country had absolute control over its domestic price level in the long run; but a large country could influence whether its price level converged toward the world price level or world prices converged toward the domestic price level.
In the early 1920s, the United States bid a higher price for monetary gold than any other country did.
As a result, gold flowed toward the United States and afforded considerable slack to the manager of the gold standard, the Federal Reserve.
Instead of letting gold imports expand the money supply and raise the domestic price level, the Federal Reserve sterilized gold inflows and stabilized the domestic price level.
Chart 1, which presents evidence of the sterilization, shows that changes in Federal Reserve Bank credit outstanding offset changes in the monetary gold stock in the 1920s. 4
Chart 1 also displays the success of the sterilization operations: After January 1921, the wholesale price level fluctuated within a narrow 6 percent band.
Traditionally, economists and politicians have criticized the Federal Reserve for not playing by the strict rules of the gold standard during the 1920s.
For example, William A. Brown stated the following about the Federal Reserve policy of sterilization: From 1914 to 1925 it was true that the influence of American policy alone on American prices and therefore on the world value of gold was so dominant as to deprive the expression "maintaining the dollar at parity with gold" of the significance properly attributed to it when an international gold standard system is in force. . . .
Though this large measure of control over the traditional standard was freely recognized and taken advantage of under the exigencies of war and post-war finance, this was not enough to alter by a hair's breadth the deep underlying conviction that the United States was anchored to a sound monetary base and that therefore her currency was safe.
The United States was dragging her golden anchor.
Indeed, she was carrying it on deck, but as long as she was still attached to it, she felt safe even though it was no longer fast to the ocean bed. 5
This traditional judgment may have been too harsh: What were the "rules" of the international gold standard in a period when no major country other than the United States maintained a commitment to buy and sell gold at a fixed price without export restrictions?
The gold standard could "anchor" the price level only if the world demand for gold were stable.
In consideration of the international uncertainty, Federal Reserve sterilization in the early 1920s probably served the best interests of the United States.
4. Federal Reserve Bank credit was the sum of the earning assets of the Federal Reserve Banks. The principal assets were bills discounted, bills bought, and government securities.
5. William Adams Brown, Jr., The International Gold Standard Reinterpreted, 1914-1934, vol. 1 (National Bureau of Economic Research, 1940), p. 286.
TO BE CONTINUED ...