GK Chesterton delivered a wise warning to reformers, David Frum reminds us:
Never tear down a wall until you understand why it was put up. He might have balanced his advice with an equal warning to nostalgics: Never attempt to rebuild a structure until you understand why it was ripped down.
Frum’s case in point: the gold standard, discussed at length in Barry Eichengreen’s Golden Fetters: The Gold Standard and the Great Depression, published by Oxford University Press in 1992:
Although human beings have used gold as a store of value for hundreds if not thousands of years, the “gold standard” — meaning the use of gold as money — was a relatively modern development. Until comparatively recently, not enough gold existed above ground. The coins that liquefied commerce in ancient Rome and pre-Civil War America were silver, not gold.The shift to gold began in Britain, and it began by accident, in the course of a 1695 currency reform intended to improve the state of Britain’s silver-coinage. The reform slightly under-priced silver and slightly over-priced gold. The result was an ironic working of Gresham’s law, whereby the bad (gold) money drove out the good (silver) money. Intended to improve silver coinage, Britain found itself with only gold. To cope, the Mint began to use copper for lower-value coins, especially the money of the poor, the penny. The rich used paper money backed by the gold backs accumulated in lieu of the silver they could no longer get. Britain stumbled along through the 18th century on this informal gold standard. The role of gold was at last formalized with the return of peace after the Napoleonic wars: the Coinage Act of 1816 fixed the pound’s value in terms of gold. (Nicholas Mayhew’s Sterling: The Rise and Fall of a Currency is a lively and entertaining history of British monetary developments.)
From 1816 until 1914, the Bank of England stood ready to redeem paper money for the equivalent in gold coin.
But through the larger part of the period, no other bank on earth would do the same. Gold coins existed of course everywhere. But if you took paper money to the bank in the America of the 1830s, you’d expect it to be redeemed in silver dollars. In Berlin, you’d get silver marks from the Prussian authorities. Not until the 1870s did the world’s leading economic powers join Britain in defining their money as a certain weight of gold: The United States did not formally do so until 1900, although the demonetization of silver in 1873 made the US a gold standard country in all but time.
This “classical” gold standard lasted barely more than a generation. Eichengreen’s book opens by debunking some of the myths surrounding gold’s operations.
Theoretically, the gold standard was self-balancing — this is much of its appeal to modern libertarians. If business accelerated in any gold-standard country to a point that seemed to threaten inflation, gold would begin to withdraw from circulation. If any country ran a persistent trade deficit, gold would have to be exported to rectify the balance. The country would go into recession or slump until monetary values were restored and gold returned.
In practice, it did not work that way. The gold standard was maintained by a system of international cooperation, coordinated by a Bank of England that held surprisingly little gold in its own vaults but that could mobilize resources from other banks — especially France’s and Germany’s — who shared the British commitment to the stability of the system. This coordination succeeded in large part because of the weakness of democratic processes in the three countries: Everybody understood that the central bankers would accept very high levels of unemployment to protect the gold value of money — and there was not much short of revolution that voters could do to change their minds.
The United States did not fully participate in this system. Before 1913, the U.S. lacked a central bank. It was private American bankers, and most famously J.P. Morgan, who worked with the European central banks. Being the most democratic country, America’s commitment to gold was also least credible. The result was that the U.S. financial system was uniquely susceptible to panics and the risk of being forced off gold, as nearly happened in 1893 and again in 1907.
Frum editorializes:
It’s super hilariously ironic that modern monetary cranks of the Ron Paul variety now combine enthusiasm for gold with opposition both to an American central bank and hatred of international monetary cooperation — the two ingredients absolutely essential to sustaining the ancient currency regime for which they claim to yearn.