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.