Monetary Standards: An Introduction



A monetary standard is a set of institutions and rules governing the supply of money in an economy. These rules and institutions collectively constrain the production of money. Through its constraints on money creation, the standard indirectly acts on prices. A monetary standard may also affect the rate of growth of real economic output, but that depends on expectations. Monetary institutions may also affect other economic institutions, which themselves influence economic growth.

Some authors talk about a monetary regime, and still others a monetary constitution. For purposes of this discussion, the same underlying issues are being discussed.

The banking and financial system interacts with the monetary standard and differences in the one may affect how the other operates. Though very important, the banking and financial system is not my main focus.

Modern authors often talk of the “choice” of a monetary standard, but historically monetary standards evolved over time. Gold and silver evolved as the money of choice by an historical process first enunciated by the Austrian economist Carl Menger in 1892.[1]

Sovereigns often tried to choose a monetary standard, as by decreeing either gold or silver to be money. Sometimes their choices were effective and sometimes market forces upended their choices. That was especially likely to occur when a sovereign choose two standards (bimetallism), most often a gold and a silver standard.

If the sovereign chose wisely, he adopted an exchange rate between the two metals reflecting their market prices. Inevitably, over time, the market exchange rate between the two metals changed due to demand and supply factors. Each metal had nonmonetary uses, and demand conditions tended to change over time. So, too, did supply conditions for the two metals.

Once market and official exchange rates diverged, bimetallism became unstable. The metal undervalued in monetary use would tend to disappear into nonmonetary uses. The bimetallic standard evolved into a monometallic standard.

There is an important lesson here. In monetary matters (as in others), a sovereign proposes and the market disposes.

We now live in a fiat money world. That is, we have a fiat monetary standard, which has its own institutions and rules. The standard critique of such a standard is that it does not sufficiently constrain inflation. The value of a U.S. dollar today is a small fraction of what it was in 1913, the year the Federal Reserve System was enacted into law.[2] Differences in the inflation performance of different standards are very important. But they may not be the most important issue.

Consider the case for the gold standard made by one of its most prominent exponents. “The gold standard was the world standard of the age of capitalism, increasing welfare, liberty, and democracy, both political and economic. In the eyes of free traders its main eminence was precisely the fact that it was an international standard as required by international trade and the transactions of the international money and capital market.”[3] The linkage between the gold standard, free trade, free capital markets, and global prosperity is the strong argument for a gold standard. It has recently been reprised by Benn Steil and Manuel Hinds.[4]

Mises also made an essentially political argument for the gold standard, or what he termed sound money. “Ideologically it belongs in the same class with political constitutions and bills of rights. The demand for constitutional guarantees and for bills of rights was a reaction against arbitrary rule and the non-observance of old customs by kings.”[5]

The argument is that the gold standard, free trade and free capital flows are interlinked. It exemplifies how the selection or evolution of a monetary standard also affects other economic institutions. Along with the rule of law, they were the source of strong economic growth in both the West, especially in the United Kingdom and the United States in the 19th century.[6]

My main point in this introductory comment is that the selection of a monetary standard is not merely a technical issue. It is also an embodiment of political values, and one’s view of the relationship between the citizen and the state.

[1] Menger, C. (1892) “On the Origin of Money.” Trans.C. A. Foley. Economic Journal2: 238-55.

[2] The United States was on the gold standard when the Federal Reserve was created. The movement from gold to fiat money occurred in stages.

[3] Mises, L. von (1966) Human Action: A Treatise on Economics. 3rd ed. Chicago: Henry Regnery, p. 472.

[4] Steill, B. and M. Hinds (2009) Money, Markets and Sovereignty. New Haven and London: Yale University Press.

[5] Mises, L. von (1971) The Theory of Money and Credit. Trans. H. E. Batson. Irvington-on-Hudson, The Foundation for Economic Education, p. 414.

[6] The United States was legally on a bimetallic standard in the 19th century (except during suspension in the Civil War). It was not formally on the gold standard until the Gold Standard Act of 1900.

  • Ron Helwig

    The very idea that there should be a standard is itself a political statement. I believe it is a bad choice to have a standard.

    • vikingvista

      But the idea that a free market will tend to produce a single standard over time (as exemplified here with the description of monometallism from bimetallism) is an economic, not political, statement.

      It is also not political to explain how a single standard is economically preferable and so why free markets tend to produce one.

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  • Mike Sproul

    "Through its constraints on money creation, the standard indirectly acts on prices."

    The other possibility is that the gold standard acts on prices, not by constraining the amount of money created, but by constraining the RATIO of money to backing assets. Whether we have $350 backed by assets worth 10 oz of gold, or $700 backed by 20 oz. of gold, $1=1/35 oz either way.

  • martinbrock

    If a bimetallic standard evolves into a monometallic standard as the undervalued metal disappears into non-monetary uses, why did a monometallic gold standard replace the bimetallic gold/silver standard in the U.S. in the nineteenth century? Gold was the undervalued metal or was expected to be become the undervalued metal by proponents of the statute that effectively imposed this "evolution".

    • George Selgin

      Gold became overvalued after the California gold discoveries, but relative values started to shift in its favor during the mid-1870s. By then silver dollars had not been coined for some time, and had indeed been stricken from the list of coins to be supplied by the U.S. mint–the so-called "Crime of '73." So yes, a statutory change–though one not considered important when it was made–contributed inadvertently to the U.S. remaining on a gold standard rather than switching to a silver one.

      I discuss this history and other details in my Cato Policy Analysis "The Rise and Fall of the Gold Standard in the United States."

  • 789

    >>>> [2] The United States was on the gold standard when the Federal Reserve was created

    Not exactly true; since February 25, 1863, –the passing of the National currency Bank Act– the United States was on __bond standard__: bank capital and the basis of bank-note circulation being federal bonds and United States notes (greenbacks)

    Please read section 15-18 and section 41 of the act

    The FedResAct merely adjusted and reorganized the national currency bank system, and, once again, made bonds the basis of banking and note issuing;
    as stated on some of the early FedRes notes: "secured by US certificates of indebtedness"

    • George Selgin

      It is true that at the time of the passage of the FRA national bank notes were backed by U.S. bonds. Federal Reserve Notes, however, were not. Indeed, until the 1930s government securities were not an important FRS asset, the Fed;s founders having sought to rule out direct Fed financing of government deficits. And the Fed was obliged both to maintain substantial gold reserve backing for its notes and to redeem them on demand. According to all received expert opinion, my own included, those stipulations imply a gold standard.

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