I’ve been thinking a lot lately about the classical gold standard. This was an international monetary standard that lasted from roughly 1870 to 1914. Not perhaps coincidentally, this was a time of a vast expansion in trade (the first modern wave of globalization) and a general surge in global prosperity.
Without getting into the details, I wanted to react to what requirements the classical gold standard imposed on countries. Each country on the standard had to relinquish direct control of its domestic money supply (imagine the Fed for example saying that, “we’ll leave it up to gold flows to determine prices in our country”). It did this by fixing the price of gold in relation to its domestic currency unit, and standing ready to redeem its notes and obligations for gold upon demand. If each c0untry did this, then it follows that this is a system of fixed exchange rates. To illustrate one of the many fixed bilateral rates, the dollar price of gold was $20.67 per ounce and the pound price of gold was £4.25 (I think) per ounce. Hence the $/£ exchange rate was fixed at $4.86. Americans with dollars could, whenever they wished, present them to issuing banks in exchange for specie, and this specie could then be used to purchase foreign currencies at the specified rates.
For the system to work (perhaps I’ll diagram some mechanics in a future post) it required that many (all?) countries participated. It also required that each participant rigidly stick to the rules. If for some reason your banks or central bank were being careless with their note issuance (and hence domestic prices would rise) they had to permit customers to convert their notes into specie and use those funds outside the country. This action would result in gold outflows in the inflationary country (which forces banks to contract and hence prices to fall back down) while it would result in gold inflows to the other countries. So, for this system to work, the “other” countries had to allow the gold inflows to come in and allow domestic prices to rise as a result.
Similarly, there could very well be an outflow of gold from a country that was behaving quite well, if for example, there was an improvement in productivity driving prices lower in other countries (or if they were experiencing true deflations). This latter requirement is particularly painful, as there are a variety of mechanisms through which allowing deflation in your country could lead to serious problems in the real economy. One such possibility is debt-deflation induced bankruptcies putting serious pressure on the solvency of underlying financial institutions, leading to serious credit tightening, and a downward spiral of reduced aggregate demand and prices (let’s discuss that another day). My point is that countries had to swallow hard and bite the bullet as these sorts of events were staring them down.
Yet, the classical gold standard seemed to work remarkably well for that 40+ year period. And such a standard could only have worked well with incredible amounts of global cooperation AND discipline in the face of some potentially unpleasant circumstances that were perhaps no fault of your own, and with interest group pressures breathing down policymakers necks. That it worked as long and as well tells me two things. First, that is simply a remarkable achievement, and it showed a remarkable faith in allowing market forces to determine the “right” amount of money across countries. Second, this seems to demonstrate that massive global coordination to deal with hard problems is possible.
Let me repeat that – nearly 150 years ago we lived in a world where extremely disparate countries that could not communicate well with one another given the technologies of the day were able to commit to a challenging, sometimes painful, global monetary arrangement that ended up contributing to an enormous flourishing of global trade and prosperity. My take on this is that when there is a good idea out there, sometimes it is possible to defeat nationalistic tendencies.
What’s the deal with Gaia? Well, if one subscribes to the view that the only way to save the Earth from destruction is to massively reduce global carbon emissions, then such a plan would require a global commitment not unlike what we saw a century and a half ago. For some countries the commitment would be less of a burden than for others. But every country would face the temptation to shirk on their agreement, much like countries during the classical gold standard had the regular temptation to devalue their own currency (for example, if London had devalued the pound, say by allowing the domestic price of gold to rise to say £6 per ounce that would have led to a surge in exports as citizens from other countries would be able to secure more British currency for any particular amount of domestic currency they started with – this would lead to the UK piling up gold while selling lots of stuff to foreigners for low prices … sound familiar?). Such shirking could easily lead to beggar-thy-neighbor responses and a large global inflation to follow. But it did not happen. World War I changed things.
The nations of the world at the time overwhelmingly saw the benefits of adhering to such a program and they committed to it. In order to get global cooperation on global warming action, my sense is that the benefits are going to have to be even more apparent than offering up a stable monetary system that prevented global inflations from causing problems. Even for the most hard-core “alarmist” I think the writing should be on the wall. It’s very unlikely that this will happen in any foreseeable future especially considering that the best course of action is not a massive global tax on carbon, but instead something else, something that we are perhaps unaware of.
I am not much interested in policy complications and what is really “needed” to get global cooperation, but I am very interested in understanding what our choices reveal about our values and expectations – and this applies to “countries” as much as individuals.
Gold was accepted as a standard because it had a long history as a store of value — it does not corrode, it is easily transportable, relatively easily divisible, and used by many as a medium of exchange. It also had limited industrial uses, and therefore was not subject to fluctuations in demand. I’m sure there are several other reasons I’ve missed here.
Gold did have its drawbacks, but fewer drawbacks than, say, silver or copper. It was therefore possible to come to an agreement, because it was widely accepted.
On the other hand, the notion that man-made CO2 is going to lead us to catastrophe is not widely accepted, nor is the idea that we all would be better off if Americans in particular should live like the Unabomber and we should let all hydrocarbons sit buried forever.
Sorry, wintercow, if I scared off the Sierra Club and the easy money crowd. I would have hoped for at least some of your learned colleagues to take the time to defend or promote their position.
This in no way is to diminish the comments of your regular contributors.