Tarnished Gold

Globalizing Capital: A History of the International Monetary System, Barry Eichengreen, 2018.

Umberto Boccioni, Dynamic Decomposition, 1913.

For an international monetary system which collapsed over a century ago, it is remarkable that the gold standard is today a shorthand for perfection — a commonplace idiom near synonymous with best practice. This is all the more striking considering how the gold standard was far from the paragon of stable prosperity that crude anglocentric monetary history might suggest. But there is some historical truth to its idiomatic power; a testament not to the stability of the gold standard, so much as to the instability of the interwar system that came after it. However, our love of invoking the gold standard might diminish if we remember that this interwar instability came about from the attempt to recreate that system lost in the First World War, an attempt which had almost succeeded before it was quashed by the Great Depression. What explains this failure? And why is the classical gold standard no longer the ‘gold standard’ of the international monetary system today?

Answers can be found in Barry Eichengreen’s Globalizing Capital: A History of the International Monetary System; the gold standard of historical narratives on monetary history.¹ A sprawling-if-succinct walk through the international monetary system from its early nineteenth century origins until the eurozone crisis of the 2010’s, Globalizing Capital helps us realise that there is a logic to the development of the international monetary system. Over the next couple reviews, I will look at the key episodes of this story, through different books, in more detail. But, for now, Eichengreen provides us a clear lens for framing international monetary history at the most abstract level; and, in the process, answers the questions I posed above.

What are the key forces that have driven international monetary history? This is the question which underlies the book’s entire project. Eichengreen takes a consciously Polanyian view towards answering this, arguing that international monetary history is essentially determined by a conflict between markets and democracy. On the one hand, there is capital’s will to be mobile; to exploit the most profitable investment opportunities — and importantly, escape from the least profitable ones — unencumbered by geography. Modern communication and transport technologies have made this easier to fulfil, contributing to the unprecedented mobility of capital today. But international monetary history is not the history of inexorably globalising capital. Capital mobility has varied widely this last century, despite technological pressures — as has the size of the financial sector.

This is because there is a countervailing force: democracy. Eichengreen sees this in a quintessentially Polanyian way: that the expansion of the market (in this case, the capital market) destabilises society, and thus generates forces which seek to insulate society from its consequences. Within the context of monetary history, capital mobility can produce these pressures in a number of ways: by jeopardising a stable rate of exchange between currencies (and thus a stable trading system); by the deflation or inflation required to make adjustments to keep a stable rate of exchange; or by restricting the policy autonomy of governments via limiting their fiscal space. Under a fixed-rate exchange regime, as has existed, in some form, for most of modern history, these Polanyian pressures are felt because of the requirements of holding a particular exchange rate. In a floating-rate system, as exists between most countries today, this pressure comes from the fiscal consequences of rapid currency fluctuations, and their implications for financial stability.

Leaving the present aside, however, these forces give us the essential analytic to understand international monetary history and the rise and fall of the gold standard. The gold standard arose, almost organically, in the mid-nineteenth century; as Britain — which had adopted a purely gold-based currency before anyone else, largely by accident — became the world’s economic centre. Most other countries had a metallic peg for the value of their currency then, but it was either bimetallic (both a silver and gold peg), as in France, or silver based, as in Sweden. Over the course of the late-nineteenth century most countries adopted the pure gold peg, first Portugal in 1854, and many others — of which Germany was the most important — joining in the 1870’s. By the beginning of the twentieth century, silver was part of the monetary standard only in China and some Central American states. But why did this happen? Bimetallism had problems, but not fatal ones. Eichengreen argues that while it is traditionally thought that a silver glut in the 1850’s sent countries to gold (because falling silver prices destabilising silver-backed currencies), this could be solved just by changing the silver/gold ration of a bimetallic standard. Milton Friedman, in fact, believed international bimetallism would have been more stable than gold. At the end of the day, Eichengreen says, it was network externalities — the benefit of being part of a system with many actors — and the momentum of British growth which propelled the gold standard forwards.

As I mentioned at the beginning, while the gold standard is synonymous with stability and prosperity, this is not quite true. It was, as Eichengreen writes, a “historically specific institution”; dependent upon a political economy within which governments could give priority to maintaining convertibility without fearing democratic backlash. This has everything to do with a concept that is familiar to monetary policy today: credibility. In essence, credibility refers to the extent to which a central bank (or government’s) commitment to a policy can be believed, especially by financial markets. If we cast our minds back to Éric Monnet’s Balance of Power, you will remember that credibility is the key justification of central bank independence — precisely because it is believed that elected governments cannot make credible commitments to monetary policies, given their incentives to break promises come election time. In the context of the nineteenth century, however, credibility was assured, simply because the investor classes were the government and maintaining the gold peg was in the interest of the investor classes. This had a stabilising impact on the system, reducing the likelihood of destabilising capital flows and the need for drastic monetary actions. Furthermore, when monetary tightening was needed to keep gold reserves from draining, the near-complete absence of labour unions and labour parties meant wages were flexible, and the voice of those cast into unemployment was silent. It can be said that with the gold standard, fixed exchange rates solved one Polanyian instability problem, and a lack of democracy solved the others.

It should now be clear why the gold standard depended on the circumstances of its historical moment. There is a long-standing debate on the nature of the interwar monetary instability. While the traditional view (which informed the monetary policy of post-WW2 ‘embedded liberalism’, as I will return to in the next post) is that the instability was a product of how floating exchange rates created destabilising speculation), Friedman (and other pro-float neoliberals) argue that the exchange volatility was an accurate reflection of the volatility of fiscal and monetary polices in the period. But what is undoubtedly clear is that the prospects of recreating the prewar gold standard were narrow. The gold-exchange standard which sought to do exactly this lasted five years on any reasonable reckoning, from 1926 to 1931. The capital flows of the period deeply scarred policymakers, setting the stage for the move towards capital controls after the Second World War. If we take Polanyi-Eichengreen as our guide, this is unsurprising: with the franchise extended, unions empowered, and labour parties entering government around the world, the credibility of the convertibility commitments of governments and inchoate central banks was rapidly evaporating. Without this, international capital mobility quickly generated the Polanyian forces which would mobilise against it.

If I were forced to criticise Globalizing Capital, it would be that Eichengreen’s description is relatively thin. For a Polanyian narrative which puts the conflict between democracy and the market at the fore, the substance of this conflict is left abstract: there are no bankers, politicians, labour activists, and so forth. The reader is left largely to assume these conflicts, without much description of the history — in the names, dates, and decisions sense — which constitutes it. But this is a half-hearted critique at best: as Eichengreen is tackling a wide question with brevity, which inevitably — and justifiably — comes at the cost of some detail.

Returning once again to the broadest possible perspective, the most essential insight of Globalizing Capital is that the history of the international monetary system is an active process. Eichengreen’s book itself is a testament to this: a living document, new chapters are added in with each edition, as history has continued to unfold. But most importantly, it is the book’s core analytic which lends the narrative this open-endedness; since Eichengreen makes clear that the political economy of monetary policy, Polanyian forces, and technological and economic development interact in an unrelentingly surprising fashion. It is worth remembering the (well-circulated) recent paper by the BIS’s Claudio Borio, which gently called into question the future of inflation targeting — the monetary paradigm that we live under today — for reasons doubtless familiar to the reader of Eichengreen (and, for that matter, of Éric Monnet). All orders, political and monetary, are ‘historically specific’, including our own. If there is any reason to read to revisit Globalizing Capital, it is as a reminder of this.

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Supplemental: Tarnished Gold

1. This is also, to a large extent, derivative of Eichengreen’s 1992 Golden Fetters — but Globalizing Capital is much more recent and covers much of the same ground.