Following the Yellow Brick Road: How the United States Adopted the Gold Standard
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View metadata, citation and similar papers at core.ac.uk brought to you by CORE provided by Research Papers in Economics Following the yellow brick road: How the United States adopted the gold standard François R. Velde Introduction and summary why it disappeared so suddenly, and whether the In 1900 L. Frank Baum published a childrens tale, United States could have taken another road. The Wonderful Wizard of Oz. In it, a little girl from Definitions the Midwest plains is transported by a tornado to the Land of Oz and accidentally kills the Wicked Witch I begin with some definitions. A commodity money of the East, setting the Munchkins free. Yearning to system is a monetary system in which a commodity return home, she takes the witchs silver shoes1 and (usually a metal) is also money; that is, the objects follows the Yellow Brick Road to the Emerald City, that serve as medium of exchange are made of that in search of the Wizard who will help her. She and the commodity. The essential feature of such a system is companions she meets on her way ultimately discov- that the commodity be easily turned into money and er that the wizard is a sham, and that the silver shoes back. This requires: 1) unrestricted minting, in the alone could have returned her to Aunt Em. Littlefield sense that the public mint always be ready to convert (1964) and Rockoff (1990) have decoded Baums tale any desired amount of metal into coin; and 2) unre- as an allegory on the monetary politics of late nine- stricted melting and exporting, allowing money to be teenth century America. The silver shoes are the silver converted into the commodity, or into other goods at standard, the witch of the East represents the mon- world prices. ied interest of the East Coast, the scarecrow and the A commodity money system based on gold or sil- tin man are the farmers and workers of the Midwest, ver is also described as a gold or silver standard. In while the cowardly lion is their unsuccessful champi- such a standard, the medium of exchange may not be on, William Jennings Bryan. The yellow brick road is limited strictly to coins, but may include notes (private- the gold standard, whose fallacy is exposed by Dorothys ly or publicly issued), as long as the notes are convert- triumphant return home borne by the silver shoes. ible on demand and at sight into coin. William Jennings Bryan, as nominee of the Dem- The double standard is one where both gold and ocratic Party in the presidential election of 1896, cam- silver are money. This is also called a bimetallic stan- paigned on a platform to reverse the so-called crime dard, or bimetallism. The characteristics of bimetallism of 1873. The phrase referred to the change in the include: United States monetary system from bimetallism, in 1. Concurrent use of gold and silver as money, which gold and silver are used concurrently, to the gold 2. Free minting and melting of both metals, standard. Bryan lost, and in 1900 a law was passed and firmly committing the United States to the gold stan- 3. A constant exchange rate between gold and dard. The bimetallic controversy soon died away. The silver coins. United States had taken the yellow brick road. Condition 1 usually means that both gold and In this article, I recount the historical background silver coins are unlimited legal tender. Any limitation to the bimetallic controversy, replacing it in its inter- national context. Bimetallism, which until 1873 had been the system in a number of other countries, dis- François R. Velde is a senior economist in the Economic Research Department at the Federal Reserve Bank of appeared abruptly. I use a model to understand how Chicago. bimetallism could have been viable in the first place, 42 2Q/2002, Economic Perspectives on the size of debts that can be paid in coins of either with limited success. The way this was done was by metal is therefore a departure from condition 1. assigning a legal tender or face value to each coin. All three characteristics should be present to The government assigns a number N to coin i, such i have a proper bimetallic system. For example, condi- that coin i is legal tender for a debt of N units of ac- i tions 1 and 2 alone define a regime where one metal count. Often, N = 1 for some particular coin j, and that j is the standard (say, silver) and the price of the gold coin was by definition the unit of account. For a long coin is not fixed, but varies according to the market. time, governments had difficulties enforcing these laws, The fluctuating coin is called trade money. Conditions and market rates between two coins often diverged far 1 and 3 alone, but with only one metal freely minted, from the ratio of their legal tender values. Neverthe- result in a limping standard. It is similar to a single less, governments kept trying, and by the eighteenth standard based on the metal freely minted, except that century it was commonly seen as a desirable goal to some portion of the money stock is made up of the achieve stability in the relative price between the ob- other metal. The government regulates the size of that jects that served as money, so that it might not matter portion. A number of countries moved from a bime- which ones were used in payment of an obligation. By tallic to a limping standard, as we shall see later. 1800, enough stability had been achieved that denomi- Bimetallism used coins of silver and coins of gold nations could be inscribed on the coins with increasing with a fixed exchange rate between the two. For ex- frequency. But the stability had not necessarily been ex- ample, the gold eagle and the silver dollar were ex- tended to the whole range of coins, including silver and pected to circulate at a rate of 10:1 (10 silver dollars gold. In practice, a variety of monetary systems exist- for one gold eagle), and the values $10 and $1 were ed in Europe by the middle of the nineteenth century: inscribed on the coins themselves. Moreover, anyone I Gold in Great Britain, Portugal, and some could take any amount of silver to the mint in exchange colonies; for $1 coins and any amount of gold in exchange for I Silver in Central and Eastern Europe and the $10 coins.2 East (India, China), with gold as trade money Let X be the amount of gold in a gold eagle, and in some countries (Netherlands, Germany); and Y the amount of silver in a silver dollar. If both coins circulate, then, as money, X ounces of gold are worth I Bimetallism in France, Latin America (with a 10Y ounces of silver. The ratio (10Y/X) is called the 15.5 legal ratio), and U.S. (with a 16 legal ratio). (goldsilver) legal ratio. In the United States, after 1834, an eagle contained 232 grains3 of pure gold, while The controversy a dollar contained 371.25 grains of pure silver, so the Bimetallism became controversial in the mid- legal ratio was 16. The relative price of gold and sil- nineteenth century and remained so until around 1900. ver as metals in the market is called the market ratio. I first describe the nature of the controversy and then sketch its history. The history The controversy around bimetallism ultimately We are so used to our current system of fiat money, stems from the fact that it is a system that appears to where the only thing that matters about a coin or a defy economic logic. One of the textbook functions of note is the number inscribed on it, that it takes a slight money is to provide a unit of account and a standard effort to think of money in earlier times.4 of deferred payment. Accounts are kept in dollars, and In the Middle Ages, various objects were used as debt contracts promise payment of a known quantity money: round disks made of gold, silver, and copper of dollars. Thus, money serves as numeraire. The (or silver alloyed with copper). These disks had designs gold standard is a straightforward example, because on them by which one could determine where they a dollar is simply defined to be X ounces of gold. came from and how much metal they contained. But In reality, then, it is gold that is used as a numeraire. they did not have any numbers or other quantitative This poses no particular problem in economic theory. indication of value. And, in fact, the exchange rates In equilibrium, prices are determined as a vector, or between these objects were not necessarily constant. list of numbers, that sets the sum of excess demands One should think of such a system as one in which for each good to zero (or clears markets). Since noth- various goods are simultaneously used as means of ing changes when all units are consistently changed exchange, because some are more suited to certain by a given number, the price vector is indeterminate transactions than others. up to a constant rescaling. Any good (gold, say) can For a long time, governments endeavored to stabi- be chosen to be the unit of measurement of value, by lize the relation between the various monetary objects, setting the price of X ounces conventionally to one. All Federal Reserve Bank of Chicago 43 prices in the economy are thus expressed in ounces The bimetallic camp argued that the system, far of gold or gold dollars.5 from degenerating into an alternation between stan- But bimetallism is something else: It defines the dards, could successfully maintain gold and silver in dollar to be X ounces of gold or Y ounces of silver.