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Money in the US a brief history
• 1787 – 1963
– Notes from different—state chartered banks—were
circulating
• 1863-1915
– National Banks notes issued by nationally chartered
banks, backed by deposits of treasuries with the
Treasury (Comptroller of Currency)
– Not unlike Open Market Operations with the Fed
today.
• 1915-Today
– Federal Reserve prints and issues currency.
The Gold Standard
• 1870(ish) the gold standard comes to
prominence
– US 1879.
•
•
•
•
1870(ish)-1915: Classical Gold Standard
1918-1933: Interwar Standard
1946-1971: Bretton Woods
1971-Now: No Gold
1870
1871
1872
1873
1874
1875
1876
1877
1878
1879
1880
1881
1882
1883
1884
1885
1886
1887
1888
1889
1890
1891
1892
1893
1894
1895
1896
1897
1898
1899
1900
1901
1902
1903
1904
1905
1906
1907
1908
1909
1910
1911
1912
1913
1914
1915
The Gold Standard is not about price stability.
Inflation 1870 to 1915
0.06
0.04
0.02
0
-0.02
-0.04
-0.06
-0.08
Inflation rate
It gets even worse
Inflation during the Interwar Gold Standard 1919-1933
0.2
0.15
0.1
0.05
0
1919
1920
1921
1922
1923
1924
1925
1926
-0.05
-0.1
-0.15
Inflation rate
1927
1928
1929
1930
1931
1932
1933
So what is the gold standard?
• It is an international currency standard
• If all countries are valued in gold then all
countries have bilateral exchange rates.
– This is supposed to make it easier for foreign
investment.
How the it is supposed to work
• Example: US/British Exchange rate
– EUS/EUK is determine by two things
1. The Demand for US vs British Assets
2. The Price level in the US and the UK
– These are kind of the same thing
•
•
Balance of Payments (BoP) imbalances cause gold
outflows
Gold outflows cause Ms ↓ thus PL↓
What is a BoP imbalance?
• Cross country flows.
– If the inflow of Capital (KIN) is less than the
outflow of capital (Kout) then you have an
imbalance.
– The extra $1 you want to spend in another
country (Kout) has to be in gold from the central
bank.
• Same with trade if IM>EX then you have to
export gold to make up the difference.
So BoP deficit
• KIN<KOUT or EX<IM
• Cause gold to flow out of a country.
– Monetary Base ↓ → Money Supply ↓ →
Investment↓ → Price Level Falls ↓
• When the PL falls Exports increase and this
should right the BoP.
A central bank’s Job
• According to the “rule of the game”
– CB should reinforce the decline in the money
supply by increasing the interest rate (i)
– i is the rediscount rate. The rate at which a central
bank exchanges cash for securities.
– This can also be done with open market
operations
– When i increases two things should happen
1. Y & PL ↓ → IM ↓ & EX↑
2. I attracts more KIN
Central banks didn’t follow the rules
• Central banks often “sterilized” gold inflows
– Gold↑ → MB↑
– Paper Assets↓ → MB↓
• However, the US had very large stocks of gold
relative to foreign exchange, money supply
etc.
• In part because the US banking system was so
unstable.
Why did the gold standard work
• Mostly because the British had the credibility
needed to maintain the system.
• The British had very little gold relative to its
foreign exchange liabilities.
• All foreign currency regimes essentially work
or don’t work based on the credibility of it
“anchor” country. They type of regime seems
somewhat secondary
The interwar gold standard
• During WWI all the major economies go off
the gold standard.
• After WWI the world looks totally different
politically/economically but the British fight to
keep the system the same.
• 1917-1946 is largely about the transition from
a British centered world economy to a US
centered world economy.
1919-1933
• The British refuse to acknowledge they are no
longer the “center of the world”
• The US refuse to acknowledge they are now
the “center of the world”
• Monetary stupidity ensues
1925
• Britain goes back on the Gold Standard at prewar parity $4.86 per pound (£).
– But the British economy was different (weaker)
and its price level was higher.
– So it created a persistent trade imbalance IM >EX.
– What’s more, the Bank of England kept i high to
try to fix the BoP problem.
The other side of the coin
• The US and France (who devalues the Franc
after WWI) enjoy gold inflows.
• And they sterilize those inflows.
• Free to Choose Episode 3; 18:40
• https://www.youtube.com/watch?v=z12P6Pb
K4xw
The roaring 20s
• Unemployment in the US still averages 7.6%
• While gold inflows are being sterilized, money
supply still increases.
– Real estate bubble pops in 1926
– Stock market bubble pops in 1929
• Also issues with Germany (Dawes Plan)
It is not exactly clear what started the
Great Depression
• Stock market crash?
• Agricultural price collapse?
• Banking Crises made it the Great Depression
– Banking Panics 1930-1933
Copyright © 2007 Pearson
Addison-Wesley. All rights
reserved.
23-22