by Philip Pilkington

I note that there is oftentimes confusion today when the gold standard era is brought up. The reason for the confusion when discussing this era is because the monetary system functioned in an entirely different way.

The confusion goes two ways; both from the past to the present and from the present to the past. Austrian-style economists and gold bugs tend to project the manner in which the 18th and 19th century monetary system functioned onto today’s world. While more modern theorists tend to project the way that the monetary system of today’s world works back onto the system of the 18th and 19th century.

I’m not going to lay out how the contemporary monetary system functions here. Sorry, Austrians, but you’re going to have to do your own work in this regard (try the Bank of England here). So, I will assume that readers are familiar with what might broadly be termed the theory of endogenous money creation and/or interest-rate targeting through Open Market Operations (OMOs) in a flexible exchange-rate system (or even, to some extent, in a pegged system). I will draw on a rather nice account that is laid out in Roy Harrod’s book Money. (Note that some of the discussion in this book is otherwise rather confused).

Under the gold (and silver) standard systems, as everyone knows, money was convertible into precious metal. The central authority set the official rate of conversion and the market adjusted to this. When the gold price, for example, fell in relation to money, gold would flood the public mint to be converted into money. The opposite happened when the gold price went above the value of money; i.e. money would return to the mint to be converted into gold.

In a gold standard system the effects of new money issuance will be primarily on the value of the currency vis-a-vis the value of other currencies. In a floating system, however, the issuance of new money has its effects, in the main, on the rate of interest. All other effects that it has are purely secondary.