Unlike the pure and simple gold standard, bimetallism was based on both gold and silver. Gold and silver coins were freely minted and had unlimited legal tender power. In both systems there was a fixed legal relationship between the monetary value of the two metals. These features characterized the French monetary system from the Law of 7 Germinal, Year XI (March 28, 1803) until the Law of June 25, 1928. The Germinal franc was defined as a coin containing 5 grams of 9/10 fine silver. The law also specified that 155 coins of 20 francs could be minted from 1 kilogram of 9/10 fine gold. The legal ratio between the monetary value of gold and silver was therefore 15.5, since one kilogram of 9/10 fine gold was worth 3,100 francs (155 × 20), while the same amount represented the legal value of 15.5 kilograms of silver.
From the second half of the nineteenth century onward, bimetallism functioned poorly because the commercial value of silver continuously depreciated relative to gold. As a result, gold tended to leave bimetallic countries, since it was more advantageous to settle foreign accounts in gold: countries operating under a pure gold standard accepted payments in silver only at its commercial value, that is, at its depreciated price. According to Gresham’s Law, bad money drives out good. This movement was reinforced by speculative operations, which became more profitable as the gap between the legal ratio and the market ratio widened.
Protective measures had to be introduced. On February 28, 1878, a U.S. law known as the Bland Bill required the government to mint silver coins amounting to two million dollars and provided for the monthly purchase of five million dollars’ worth of silver at the legal price, a volume that lay between domestic silver production and roughly one third of world output.
Automatic equilibrium
The most complete theoretical presentation of the mechanisms of the gold standard is attributed to the authors of the Cunliffe Report, drafted in 1918 at the request of the British government (The Interim Report of the Committee on Currency and the Foreign Exchanges). Eleven years later, the Macmillan Report revisited the Cunliffe Committee’s conclusions. It is noteworthy that these two analyses appeared at moments when the system was already being questioned (1918) or was functioning poorly and on the eve of a major collapse (1929). In such situations, there is often a tendency to realize that one is about to lose a vast set of perceived advantages.
The characteristics of the gold standard were as follows:
- The national monetary unit was defined by a specific weight of gold, and the central bank bought and sold gold at a fixed price (or within very narrow limits).
- Banknotes were convertible into gold, and the minting of coins was free.
- Exchange rates were determined by the gold content of each currency and were maintained within the limits set by the gold points.
- The import and export of gold were completely free; as a result, each country’s money supply was directly linked to international movements of the metal. Internal equilibrium depended on external equilibrium, and automatic mechanisms were supposed to ensure harmony in costs and prices through the rapid absorption of any tendency toward imbalance.
This was the fundamental virtue that many authors believed they had identified in the gold standard since the writings of Ricardo and the Bullion Report. When a large number of countries adopted this regime, gold functioned simultaneously as a national and international currency. Because currencies were exchanged at fixed rates, the international monetary system was homogeneous and unified. The authors of the Cunliffe Report therefore considered that nineteenth-century experience had confirmed the Ricardian theory of the automatic adjustment of balance-of-payments disequilibria, according to which any external deficit or surplus would be eliminated by market mechanisms.
This is the core of the theoretical functioning of the gold standard. When foreign trade was in deficit and the exchange rate reached the gold export point, it became profitable to export gold. In cases of surplus, inflationary pressure could lead to rising prices that slowed exports and encouraged imports, eventually eliminating the surplus. In cases of deficit, gold outflows generated deflationary pressure by reducing the domestic money supply; falling prices then stimulated exports and discouraged imports. In this way, the deficit was gradually reabsorbed.