Thomas Tooke

Archive for the ‘Gold vs monetary base’ Category

How to cheat the Gold: The failure of the Gold exchange standard was highly predictible in 1920.

In Gold vs monetary base on May 19, 2012 at 9:28 pm

Kemmerer argues that the inflation forces since 1896 resulted in a 3% annual inflation until 1913, which according to Milton Friedman has to do with the cyanide process.


Even without the war, therefore, we might reasonably have expected, as the result of a continuation of pre-war forces, an increase in prices from 1913 to 1920 of something like 20 per cent.  But much more important that this is the fact that the war period has probably wrought important permanent changes in our currency and banking systems — changes which will greatly improve the efficiency of these systems and thereby enable a given amount of gold to carry on its shoulders a larger load of exchange work than in pre-war days. This is a large subject and only a few phases of it can be suggested here.

It appears likely that in the future the world´s supply of monetary gold will be found to an increasing extent in the vaults of central banks and will be used to a decreasing extent for purposes of hand to hand circulation. This will greatly increase the monetary efficiency of the average ounce of monetary gold. Furthermore the establishment and development of our federal reserve system, the increasing movement for bank consolidation in Europe and America, the reduction of gold shipments both national and international through the creation of such devices as our gold settlement fund, and the increasing use of funds located abroad for making international payments through debits and credits without the necessity of shipping gold – these changes and others of a similar character are resulting to an ever increasing degree in economizing the use of gold and in thereby reducing the ratio of the gold base to the credit superstructure it supports. We can do a given amount of money work with less gold because gold is being made to work harder and more efficiently.


Here we should add that indeed the objective of the super structure is to make creation of money easier and credit easier. The continuous build up of the super structure and the elimination of the Gold constraint since 1971 has further increased the build up of this structure to truly unprecedented level (the total leverage of 2007 surpassed the one of 1929.

Later Kemmerer brings the counter argument to an excessive quantity of paper currency against the monetary gold quantities and reflects upon the necessity to change the Bullion- currency parities. Evidently from his writings the failure of the Gold exchange standard seems quite visible, there is no free convertibility so that market participant can not force the contraction of the paper by redeeming the paper currency and therefore regulating its quantities, there is no Gold flow, the Gold is impounded in the central bank vaults. The money is nationalized and the gold to paper quantities are excessive.

Here is what Kemmerer writes in 1920.


A factor which may possibly reduce the structure of circulating credit in proportion to the gold base is the debasement of hte gold units of value in certain foreign countries. When on notes the tremendous depreciation today in gold values of the paper money units of many belligerent countries, at a time when the value of gold itself in terms of commodities has been more than cut in half in six years, and when he notes the staggering burdens of debt these countries are carrying he need not be surprised to hear increasing demands among their peoples for debasing the legal gold unit of value.


My comment here is that clearly the Gold is artificially tied to an artificially low amount of currency units. There is no floating of Gold against paper money like there was during the greenback period.

Kemmerer continues.


Advocates of debasement will point out that the government in floating its domestic debt received its pay largely in greatly depreciated paper money. They will show that even if it were possible for the government ultimately to pay these domestic debts in the old monetary units, at a parity with gold, such payment would involve an oppressive burden of taxation that would be grossly unjust in that it would give to the bondholder a much more valuable money than he originally loaned to the Government. They will stress the depressing influences on all kinds of business of a currency contraction that would bring the value of the present paper monetary unit back to par, a contraction in some countries as, for example, in Germany, Austria and Russia, of thousands per cent. It appears probable that we shall witness in the near future widespread and vigorous movement in many countries in favor of the adoption of new gold units of value somewhere in the neighborhood of their de facto paper money unit of today, or at least much lower than their pre-war gold units.

Monetary history is full of examples of such debasement. If the existing paper money unit should appear to be an inconveniently small value, its name might be continued and also its legal power in settlement of domestic debt, while a new unit might be superimposed upon it of which the old unit would become merely a division. Suppose, for example, the mark should be stabilized at a gold value of 2.5 cents United States currency, retaining its name and its present domestic debt-paying powers, and suppose this mark should  be made the “dime” of a new German unit worth, say 25 cents, United States currency, and called perhaps a “Hindenburg”. Obviously by such a process such a process a given weight of gold in Germany would have its efficiency for reserve purposes multiplied approximately ten times, and the return to gold basis would be greatly expedited. That this would be a form of domestic debt repudiation and be open to many serious objections is of course obvious.

Here we are neither arguing for or against such a proposition, but merely pointing out that to a large number of people in the most debt-burdened and paper money-ridden countries of Europe such a course is likely to appear, with all its difficulties, to be the least objectionable road to day-light. The adoption of such a program by some counties would obviously reduce the amount of deflation necessary in other countries to bring the structure of circulating credit down to a reasonable safe multiple of the gold base.


A personal comment here. It is abundantly clear that the British were very stubborn in thinking they could pull a 1816-1821 return to gold-paper parity after the Napoleonic wars and necessary gold-paper conversion “bank restriction”. Despite very high level of debt in the 1816-1821 it was feasible, so Britain probably thought they could do it again. The bankers and the government were wrong this time. Had the parity of been changed and gold flow re-established, the artificial monetary system than ensued might not have happened, nor the need to do a devaluation of the dollar in 1932, nor the need to confiscate people´s gold. Short term political expediency did cost massively down the road. Kemmerer was probably not the only one to call for a more balance gold-paper ratio after the war, yet the right course of action was not followed.

Gold Backing of the Currency before and After the first world war in the United States

In Gold vs monetary base on May 19, 2012 at 6:22 pm

As Kemmerer wrote in 1920 there were some difficulties in computing accurately the change is Gold backing between 1913 and 1919.


Let us now turn to the Untied States, the country that is supposed to have absorbed the larger part of the gold lost by the belligerent countries of Europe. Unfortunately a change made some time ago in the form of compiling the bank figures published by the Comptroller of the currency makes it no longer possible to tell how much gold is held by reporting banks in their own vaults. This fact together with  complete reorganization of our legal reserve requirements, brought about by the establishment and development of the federal reserve system, renders a comparison of the exact percentages of gold reserve held in the United States before the war and now, impracticable. Some idea of our changed position since June, 1914, however, may be found by comparing for that date and the present the ratios of our stock of monetary gold to the total amount of money in circulation and to total individual deposits in national banks. These figures have been previously given, and need only be summarized here.

Our stock of monetary gold on July 1st, 1914, was equivalent to 55.3 per cent of our total monetary circulation, and on June 1st, 1920, it was equivalent to 43.6 per cent. On the  former date it was equivalent to 29.7 per cent of our national bank deposits (exclusive of bankers´balance), and on December 31st, 1919, the stock of monetary gold, less that held by the federal reserve system as reserve against federal reserve notes, was equivalent to only 14.1 per cent of the national bank deposits. Ultimate cash reserves, against deposits in commercial banks, declined from an average of 11.7 per cent in 1914 to 6.6 per cent in 1919.

Our Gold position is thus far below that of pre-war times and we have been losing gold on a net balance almost continually since May, 1919 our net loss for the period January 1st, 1919, to June 10th, 1920, having been in round numbers $386 millions. To us however more than to any other country, belligerent Europe ultimately will look for the replenishment of her gold in order to return to a specie basis.


Gold Backing Levels of Currencies before and after 1913.

In Gold vs monetary base on May 12, 2012 at 1:56 am

In 1913 Kemmerer wrote.


Why the is deflation necessary? The strong reason for deflation is that our present gold base is altogether inadequate safely to support the present paper money and deposit currency circulation. While this is true of the United Sates it is true to a much higher degree of most other advanced countries of importance.  The safety and security of our economic organization demand that there be a reasonable relationship between the size of the metallic base and the size of the superstructure of circulating media it supports. Long experience gave each country a rough idea of what that proportion should be under the conditions existing prior to the great war. Of course there were variations in this proportion from season to season but there was in each country a fairly recognized norm about which these seasonal movements fluctuated. A suggestion of how far some of the leading countries have departed from that ratio of mettalic reserve to note and deposit currency circulation that pre-war experience had shown to be the wise one will be found in figures given in the following paragraphs. Unfortunately the metallic reserve ratios of many countries of prewar days and those of today as officially published are not strictly comparable because of changes wrought by the war in currency and banking organization, in methods of computing reserves, and in the character of published statistics.

The figures given below therefore should be considered only rough approximations. Where they err, they are more likely to err on the side of understating the decline in the metallic ratio since pre-war days than in overstating it, for in belligerent countries the war strain encouraged making of as good as a showing as practicable.

The bank notes outstanding from the issue department of the Bank of England on May 20th, 1914, were P52.6 millions against which the issue department held a gold coin and bullion reserve of P 34.2 millions or 65 per cent, which was fairly normal percentage. On March 3rd, 1920, the outstanding bank notes of the issue department were P 131.4 millions, and there was outstanding in addition (March 4) government currency notes to the amount of P 327.5 millions. The combined outstanding note circulation was therefore P458.9 millions. Against these notes there was a combined gold coin and bullion reserve on March 3 and 4, 1920, of P 141.4 millions or 31 per cent. On May 20th, 1914, the Bank of England was carrying a reserve of 43.6 per cent against its deposits, which was a fairly normal percentage, and on March 3rd, 1920, this reserve had fallen to 19.6 per cent.

On December 26th, 1913, the Bank of France was carrying in its vaults a metallic reserve of 62.1 per cent against its notes and deposit liabilities combined, which was about a normal reserve; and on March 4th, 1920, this reserve had declined to 9.3 per cent. The metallic reserve against notes and deposits of the Bank of Italy declined from 71.2 per cent on May 20th, 1914 to 11.2 per cent on October 31st, 1919. That of the National Bank of Belgium decreased from 31.7 per cent on June 11th, 1914, to 5.1% per cent on February 26th, 1920. The Bank of Japan held a metallic reserve of 43.2 per cent on June 30th, 1914, and one of 38.0 per cent on March 6th, 1920.

The metallic reserve of the German Reichsbank was 43.73 per cent on December 31st, 1913, and 2.17 per cent on February 23rd, 1920. For the Austro-Hungarian Bank the metallic reserve declined from 73.6 per cent on June 25th, 1914, to 0.53 per cent December 31st, 1919. In Russia the condition is much worse, where the situation is aggravated, as it is in Germany, by huge issues of paper money in addition to ordinary bank notes.

The neutral countries of Europe are generally supposed to have their banking positions strengthened by the war. These countries are mostly countries of comparatively small populations (Spain being the largest with less than 21,000,000), and of secondary importance as factors in the world´s market for gold.

For the Bank of Spain the ratio of the metallic reserve to circulation and deposits increased from 46.76 per cent on December 27th, 1913 to 62.4 per cent on February 28th, 1920. For the Netherlands Bank there was an increase from 52.4 per cent on March 31st, 1914, to 55.79 per cent on February 28th, 1920. For the National Bank of Switzerland there was a decline from 62.9 % per cent on June 11th, 1914 to 60.5% per cent on February 23rd, 1920. The Bank of Norway showed a decline from 39.7 per cent on June 15, 1914, to 31 per cent on February 23rd, 1920; and the Bank of Sweden a decline from 36.8 per cent on June 13th, 1914, to 31.9 per cent on February 21st, 1920. Every one of these neutral countries has experienced a great increase in the volume of metallic reseve in its national bank, but three out of the five national banks have expanded their bank notes and deposits more than proportionately with a consequent reduction in the percentage of reserve; and one of the other two has not improved its reserve position very much.


Decrease in Gold backing of the currency and deposits in 1920 in different countries.

In Gold vs monetary base on April 29, 2012 at 4:12 pm

Kemmerer writes


The proportion of gold in our total circulation has likewise materially declined. On July 1, 1914, our stock of monetary gold (namely, gold coin, plus gold bullion in the treasury) was equivalent to 55.3 per cent of our total monetary circulation (as computed by the Treasury Department); and on June 1st, 1920, it was equivalent to 43.6 per cent. On June 30th, 1914, the stock of monetary gold was equivalent to 29.7 per cent of our national banks deposits bank deposits (exclusive of bankers´balances), and on December 31st, 1919 (the date of the last Comptroller´s call for which figures are available), the stock of monetary gold, less than held by the federal reserve notes, was equivalent to only 14.1 per cent of the national bank deposits.


Replacement of 100% Gold to 40% of the Gold by the Fed in 1913-1919. Withdrawal of Gold from circulation by the Fed.

In Gold vs monetary base, Inflationary Period of 1913-1920 on April 25, 2012 at 1:52 am

In the previous post we discussed the monetary expansion in the US during the 1913-1919.

As Kemmener wrote:


Two important items in this great increase in the monetary circulation were:

(1) the heavy net imports of Gold from Europe resulting from our large exports of war materials to the belligerent countries, and (2) the policy of the federal reserve authorities of withdrawing gold certificates and gold coin from active circulation, and substituting  therefor so far as possible federal reserve notes, thereby substituting for money representing 100 gold as form of money which required only a legal gold reserve of 40% per cent. The period studied witnessed a very large expansion of federal reserve notes. In 1913 there were no federal reserve notes, and on November 7th, 1919 there were $2.8 billions of federal reserve notes in circulation against which a reserve of 45.3 per cent was held, giving a net circulation of uncovered by gold of $.15 billions. At the present writing (March 26th, 1920) the circulation of federal reserve notes is $3,048 millions against which a reserve of 40.1 per cent is held, giving a circulation uncovered by gold of $1,826. […]

What was the level of Gold backing of the currency at the Bank of England in 1833?

In Gold vs monetary base on April 23, 2012 at 2:56 am

In an old piece of archives dating from 1833 about the pressure on the money markets I found the following data:

Evidently the balance sheet is presented in reverse order compared to today with Liabilities on the left side and assets on the right side. If Circulation is M0 and Deposit sort of M1 component and there is not much more beyond those basic forms of money, we have 10,900,000 / (19,800,000 + 13,000) = 33.23% backing of the deposits and circulation. We will see in some other posts how this evolved over time.