An Essay on the Emergence of the Classical Gold Standard

Marc Flandreau, CNRS and OFCE

The decade 1870-1880 was one of dramatic changes in the organization of the international monetary system. While before 1870 nations were either on a gold, or on a silver, or on a dual standard, the post-1870 period witnessed a general trend - especially in the industrialized world - towards the adoption of the gold standard. Indeed by 1880, Germany, France, Belgium, Italy, Switzerland, the United States, Holland and the Scandinavian nations had moved to gold: the monetary role of silver declined. Its price (which had been virtually fixed until the early 1870s) began a secular fall. Central Banks started to peg the value of their notes in terms of gold. The so-called `Classical Gold Standard' was born.

The causes of these phenomena have been variously assessed: almost everyone has a `theory' of the emergence of the gold standard. So far, four main arguments have dominated the literature. The first type of explanation emphasizes the importance of rising silver production in the late 1860s and 1870s. This would have led to silver depreciation and resulted in a flight away from that metal. I suggest to call this argument the `structural theory'. The second type of interpretation stresses the role of micro-motives: silver, it is said, was bulkier than gold and hence more costly for international payments. The emergence of the gold standard would then be consistent with the development of economic efficiency. I will label this explanation the `metal specific transaction costs theory'. A third variety of argument insists upon the actions of the different interest groups struggling to promote a certain monetary organization. According to this `political economy of the gold standard' the changes of the 1870s would have supposedly reflected the victory of the `gold party' identified with ascending bourgeoisie. Finally, the fourth and most popular interpretation analyzes the making of the international gold standard as a self-fulfilling prophecy. In this view, every nation rushed away from silver to escape from its depreciation hereby causing the depreciation itself. This view will be named the `free rider theory'.

Although analytically distinct, those four main arguments usually come together in historical accounts of the emergence of the classical gold standard (see in particular Mertens' [1944] authoritative account, which probably remains the best source for the period). What differentiates the various descriptions is mainly the weight they attach to each `cause', and the way the different explanations are combined. This research started as an attempt to disentangle these `theories' in order to provide a clearer understanding of their relative explicative power. We became growingly convinced however, that none of these analyses (neither separately nor jointly) could really account for the radical transformations of the 1870s: many of the elements they involved were found inaccurate, incomplete, or insufficient. Instead, it appeared to us that the emergence of the gold standard was the product of a crisis resulting from inconsistent policy moves which themselves derived from `beggar-thy-neighbour' strategies between France and Germany. These actions created a series of difficulties which rendered necessary the emergence of gold standard institutions.

The paper is organized in a staightforward manner: Section I documents the operation of the international monetary system prior to 1870 and offers a framework in which the conventional theories of the making of the gold standard will be conveniently discussed. Section II reviews and criticizes the traditional explanations. Section III offers an alternative interpretation. We argue that the making of the classical gold standard was very much the solution of a crisis ignited by Germany and France rivalry, and later amplified by the endogenous emergence of gold standard policies.

In a nutshell, our critique of the traditional interpretations of the `collapse' of international bimetallism after 1873 may be stated as follows: first, it is not clear how rising silver production in the late 1860s could really threaten the system, since this rise was proportionately much smaller than the one that had affected gold after 1848 without collapsing the bimetallic regime. Second, in order to switch from silver to gold Germany had to exchange about two billions (French Francs) of silver: but in the early 1870s France was holding at least 5 billions in gold. Third, contrary to popular beliefs, it is not true that gold strongly dominated silver as an instrument for international transactions, nor that the `bourgeoisie' unequivocally supported gold.

In fact, our analysis of the emergence of the gold standard suggests that in the early 1870s, bimetallism was not doomed. Until 1870, the perceived high costs associated with deviating from the bimetallic equilibrium stabilized the international monetary system. In particular, both Germany and France felt that moving to gold was impractical. These perceptions, however, were deeply altered by the Franco-Prussian war. Germany incorrectly assumed that France would not be able to oppose its move to gold. This triggered an immediate reaction in France not because the French government felt that the German reform would force France on a floating silver standard, but because it thought that it could `have it both ways', i.e. preserve bimetallism and impede German reform. However, the limitation of the free coinage of silver left that metal without the `backing' of the market. This forced central banks to `step in' and peg the value of circulating silver coins in terms of gold. This intervention - which limited in the short run the drastic monetary contraction that would have resulted from a sudden dismissal of silver - spread the deflation over a number of years, because monetary policies had eventually to adjust to the gradual erosion of the market value of silver reserves.

There is a number of theoretical implications to be drawn from this episode. First of all, it suggests that the political moves that produce regime changes are better described as resulting from a bounded rationality framework. In a sense, it must be said that Germany's decision was not rational because it overlooked that France could assume that it could stick to bimetallism and impede German reform - a conception which in itself was `irrational'. Politics have always to incorporate an element of `trembling hand' which is probably why cooperative outcomes are usually Pareto superior: indeed, they insure players against unpredictable or incoherent behavior.

While standard theories of the emergence of Central Banks emphasize their role as lender of last resort as a way to prevent market failures, the increased importance of the Bank of France was more accurately the outcome of a governement engeneered `panic'. It was not the market that had failed, it was the government that had failed to rely on the market, and this required an institutional solution. Interestingly enough, the crisis was solved by adjusting monetary policy to what the market would have done had the Banks not existed. Finally, the emergence of the gold standard was a compromise between markets and governments.

This connects to our final point. Discussions of the international gold standard usually oppose its golden age (1880-1914) to its gloomy age (1920-1930s): during the latter period, it is said, failure of international cooperation had amplified - if not caused - the economic crisis (see e.g. Eichengreen [1993]). By symmetry, it is suggested that international cooperation was an essential element of the 1880-1914 period. Our interpretation of the emergence of the gold standard casts some doubts on this view. Indeed, we found that most of the `evils' at work during the interwar years (competition among nations, strict adherence to the convertibility rule, inability to enforce a coordinated outcome, misconceptions about the effects of monetary policies, and the Franco-German rivalry) were already operating during the 1870s. Not only did those forces presided to the emergence of the international gold standard, but moreover, as we have argued, they were probably responsible for the long deflation initiated in the 1870s and which used to be known as the Great Depression - before it got displaced in vocabulary and memories by a more recent one. In our view, it was in 1873 that the `Golden Fetters' were tied.