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Goods ranging from cowrie shells (in ancient societies) to cigarettes (in World War II prisonerof- war camps) have circulated as generally accepted means of payment throughout history, but gold and silver predominated from the eighth century BCE. In the modern world, efforts to peg international currencies against a gold standard were thwarted by balance-of-payment deficits that caused exchange-rate instabilities.
- Colonial Era through the Nineteenth Century
- Twentieth Century and Beyond
Although the use of goods as a form of payment was accepted throughout history at certain times, ancient societies had already found that coins made from specified amounts of precious metals were more viable and convenient. Authors from Aristotle to Adam Smith noted that gold and silver had the advantages of being divisible, homogenous, and storable (not rusting or decaying through reaction with other elements). In addition, being scarce and costly to produce, gold and silver were highly valuable per unit of weight, so that only small quantities needed to be transported to make payments.
While merchants may have made the first coins, discs containing a specified amount of precious metal, states and cities in Anatolia (modern-day Turkey) and the Aegean coined silver and electrum (a mixture of gold and silver) from the eighth century BCE, with the earliest known gold coins issued in the sixth century by Croesus, king of Lydia in Asia Minor. Solon, in sixth-century Athens, introduced seigniorage, a margin of profit on coinage, by ordering 6,300 drachmae to be minted from each talent of silver, even though the accepted standard of weights and measures equated 6,000 drachmae (60 minae) to a talent. For centuries, gold, silver, bronze, and copper coins of many rulers and cities circulated, trading externally at rates reflecting their varying metallic content and the changing relative values of the monetary metals. The seigniorage from minting coins with less than full bullion content repeatedly tempted rulers to profit from debasing the coinage, reducing the market value of their coins. In China, copper “cash” was coined, with silver ingots used for large transactions, and Marco Polo was startled to discover paper currency issued by the Chinese state in the thirteenth century CE.
Colonial Era through the Nineteenth Century
The inflow of silver from the newly conquered Spanish colonies of Mexico and Upper Peru (Bolivia) raised price levels and lowered the purchasing power of silver in Europe during the “Price Revolution” of the sixteenth century, but the outflow of silver from Europe to Asia to pay for spices and textiles in the late seventeenth century raised the value of silver. In 1717, Isaac Newton, as master of Britain’s Royal Mint, set the value of the gold guinea at twenty-one silver shillings, a mint price of 3 pounds, 17 shillings, 10.5 pence per ounce of gold (fifteen-sixteenths fine) that was maintained until 1939. Newton overvalued gold and undervalued silver, so, in keeping with Gresham’s Law that bad money drives out good, only gold coins circulated, while silver coins were melted down into bullion. In 1752, David Hume expounded the theory of the specie-flow mechanism underlying the gold standard: if international trade and payments were unbalanced, gold bullion would flow from the country with a trade deficit to the one with a trade surplus, reducing the money supply and price level in the deficit country and increasing the money supply and price level in the surplus country. The changing relative price levels would reduce the net exports of the surplus country and raise those of the deficit country until the balance of payments surpluses and deficits were restored to zero. Bank notes were convertible into coin on demand, and coin or bullion was used for international settlements, with a bank raising its discount rate when a gold outflow threatened the adequacy of its reserves. By the nineteenth century, London was established as the world center of finance and commerce, and the Bank of England as the key institution of the gold standard.
The conversion of Bank of England notes was suspended from 1797 to 1821, and the British government paid for its role in the Napoleonic Wars through inflationary finance, with large increases in national debt stock in the hands of the public and of the Bank of England, depreciation of inconvertible Bank of England notes against gold, and a higher price level. Restoration of convertibility at the old parity required a sharp deflation, but was followed by nearly a century of growing world trade and largely stable exchange rates (although the United States was on an inconvertible “greenback” paper standard from the Civil War until the start of 1879). The Latin Monetary Union, a pioneering French-led effort at European monetary unification begun in 1865, linked the French, Italian, Belgian, Swiss, Spanish, and Greek currencies to a bimetallic standard, but foundered in the face of British and German opposition and the shifting relative price of gold and silver.
Twentieth Century and Beyond
World War I disrupted the gold standard, and was followed by spectacular hyperinflations and exchange depreciations in Central and Eastern Europe, with the German mark stabilized in 1924 at one trillionth of its prewar gold value. John Maynard Keynes presciently criticized Britain’s return to the gold standard at the prewar parity in 1925, warning that the deflation of prices and wages required to remain internationally competitive at a higher exchange rate would exacerbate unemployment. Following the Wall Street crash of 1929, the fixed exchange rates of the gold standard transmitted deflation and depression from country to country, with Britain forced off the gold standard in 1931 and the United States devaluing and ending gold conversion of the dollar in 1933. The Great Depression of the 1930s was a period of fluctuating exchange rates, protectionist tariffs, restrictions on capital flows, and shrinking world trade, a retreat from globalization.
At the end of World War II, the international monetary conference at Bretton Woods, New Hampshire, guided by Lord Keynes and Harry Dexter White, devised a system of fixed exchange rates, adjustable in case of fundamental payment imbalances, with an International Monetary Fund (IMF) to lend foreign exchange, and with the U.S. dollar as the key reserve currency. The dollar was pegged to gold at $35 per ounce, but only other central banks could present dollars to the Federal Reserve for redemption in gold. IMF lending, being conditional on following policy advice designed to end payment deficits, caused friction between borrowing governments and the IMF. Although a few nations floated their currencies (notably Canada from 1950 to 1962), the pound sterling was devalued in 1949 and 1967, and centrally planned economies such as the USSR and China stood apart, the Bretton Woods system provided a stable framework for expanding global trade and investment flows from 1945 to 1973. Persistent U.S. balance of payments deficits undermined the Bretton Woods system, which was followed by a period of exchange rate instability. The Exchange Rate Mechanism, designed to stabilize exchange rates among European currencies, collapsed under speculative attacks such as that against the pound sterling in September 1992. The adoption of the euro as a common currency, initially by eleven European countries at the start of 1999 and growing to twenty-two by early 2010, with a single monetary policy conducted by the European Central Bank, was intended to eliminate the possibility of such speculative attacks, while leaving the euro floating against the U.S. dollar, Japanese yen, and other currencies.
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