It was 100 years ago, in 1914, that the Gold Standard died. When World War I began, most countries went off the Gold Standard and attempts to return to a Gold Standard since have all failed. Some people have called for a return to the Gold Standard as a way of disciplining governments and ensuring that they do not inflate their way out of their current fiscal problems. If it were only that easy.
What many people don’t understand is that in the long run, the International Gold Standard was a very brief phenomenon, and the fact that the world moved to a Gold Standard in the late 1800s was a sign of weakness in the role of gold and silver in the economy, not of strength. The reality was that Europe was on a bimetallic standard, not a Gold Standard, from the Middle Ages until World War I, and gold triumphed in the nineteenth century because bimetallism had failed. This should have been taken as a sign that the gold standard too would inevitably fail, not that it was the result of teleological inevitability.
The first gold and silver coins were issued by Croesus in Lydia around 600 BC. Before that, both gold and silver were used as a store of for wealth, for conspicuous consumption, or to value other goods, but no coins existed. The value of gold relative to silver, the gold/silver ratio, changed over time. In 2700 BC it was around 9 to 1; under Hammurabi in 1800 BC it was 6 to 1; and by the time Croesus issued the first gold and silver coins, rather than electrum coins, it was 12 to 1.
The gold/silver ratio remained around 12 to 1 for the next 2500 years, though it could range as low as 9 to 1 or as high as 16 to 1. Athens built its empire on the silver mines of Laurium; Alexander the Great plundered the treasuries of the Persians; and the Romans seized this stolen bullion when they conquered the Mediterranean. Constantine took the gold of the Pagan temples for his needs, and whoever controlled Egypt could rely upon the mines in Nubia as a source of gold. When the Arabs spread Islam through the world, they seized the gold and silver of the lands they conquered. When they gained control over northern Africa, the Arabs also gained power over the gold coming from sub-Saharan Africa.
Europeans minted a few coins during their Dark Ages, but mainly they relied upon Arab gold coins. It wasn’t until the Europeans sacked Constantinople during the Crusades, taking its gold, and the Venetian cities developed trade surpluses with the Arabs that Europe found a need to mint gold on a regular basis, starting in 1252.
The chart below shows the gold/silver ratio over the past 750 years. In the thirteenth century, the gold to silver ratio was around 10 to 1. It was the scarcity of gold in the fifteenth century that drove the Portuguese to go south and east to seek gold and silver, and the Spaniards to go west, discovering the Americas instead of reaching China.
The discovery of America released not only the gold of the Americas which the Spaniards seized, but the silver of Potosí and Mexico which supplemented the silver mines of Germany that produced silver Thalers. Galleons filled with silver crossed the seas to Europe and China every year, causing global inflation in the seventeenth century.
The chart, which uses the gold/silver ratio for the United Kingdom through 1800 and the United States after that, shows that between 1250 and 1850, the value of gold relative to silver gradually increased, rising from around 10 to 1 in 1250 to 15 to 1 around 1850. Despite all the discoveries of gold and silver, the seizing of gold and silver by conquerors from the conquered, or the changes in the global economy during those intervening 600 years, the ratio of the price of gold to silver saw no dramatic changes.
This stability enabled the Bimetallic standard to prevail for those 600 years. As one country changed the domestic ratio of gold to silver, gold would leave one country and go to the other. If the gold/silver ratio was 12 in France and 11.5 in the Netherlands, gold would flow to France where it was more highly valued, and silver would flow to the Netherlands. If the Netherlands changed the ratio to 12.5 to 1, gold would flow from France to the Netherlands.
Anyone who thinks governments didn’t debase their currency before paper money was introduced knows nothing about history. Paper money only enabled governments to speed up the process of debasement. The English silver Shilling had 16.2 grams of silver under William I in 1066, but only 2.6 grams under Henry VIII in 1546. The French Livre Tournois had 84 grams of gold under Philip Augustus II in 1200, but 4.5 grams when the French Revolution began in 1789. The worst offender was Spain whose Maravedí had 52 grams of silver in 1200, but only 0.031 grams of silver in 1808.
What happened in the 1800s to change the gold/silver ratio forever? There were new discoveries of gold in California, Australia, South Africa and the Yukon, but what really changed things irrevocably was the huge discoveries of silver in Nevada and Colorado which caused a collapse in the price of silver, as well as its price relative to gold, as the graph below shows.
It wasn’t that countries chose to move to the Gold Standard because it was the right thing to do, but because they had no choice. The collapse in the price of silver made silver a token commodity. The relationship between gold and silver that had held for 600 years was irrevocably broken. Although almost every developed country was on the Gold Standard by 1900, few realized it was the lull before the storm. When World War I broke out in August 1914, the Gold Standard was dead.
Attempts to resurrect the Gold Standard after World War I, World War II and today were doomed to fail because the relationship between gold and silver had been changed forever. Could a country like the United States return to a Gold Standard? In theory, yes, as I have demonstrated in my paper “Returning to the Gold Standard in Five Easy Steps.” In practice, it is highly unlikely.
It wasn’t governments who destroyed the Gold Standard through their fiscal ineptitude. Governments from the Roman Empire until today have run deficits and debased the currency regularly. It was the new discoveries of gold and silver and the technology to exploit those discoveries which destroyed the price relationship between gold and silver forever.
Governments, and the people who vote for them, will have to learn to change their behavior if the debasement of currencies is to end. Whether that is possible, remains to be seen.