HISTORY OF GLOBALIZATION Spring 2011 LECTURE 7 March 22, 2011 The “First Globalization”: the international gold standard Readings: Lecture notes; Eichengreen B (1996), Chapter 2.

International Monetary System A “ free money ” (market-based) system. Issues, how best to achieve: - efficiency - stability Exchange rates between national currencies: - fixed - flexible

Flexible Exchange Rates The price of each currency (in terms of other currencies) is left to the market. Advantage: governments don ’ t have to worry about xchange rates (monetary policy is free to pursue other goals). Disadvantages: a) higher transaction cost, b) transmission of international inflation/deflation “ Dirty float ” rather than “ free float ” the rule

Fixed Exchange Rates Governments peg domestic currency to other means of payment (gold, another currency, a basket of currencies). Disadvantage: monetary policy tied to pegging Advantages: a) predictability (lower transaction costs), b) lower inflation (and deflation?)

“ Traditional ” monetary systems If payments are made entirely or predominately in metal coins, international transactions are on a fixed exchange rate basis (the metal content determines the exchange rate between currencies) Problem: a) floating rates between metals (eg gold vs. sliver), b) high transaction costs.

The gold standard Mon. Authorities declare gold content (official parity) of their currency Central banks stand ready to buy (redeem) paper money against gold at par Central banks are required to hold a given amount of gold reserves (as % of outstanding circulation)

The gold standard in theory If: a) there is no restriction to international gold movements, b) prices are flexible, c) authorities do not interfere with market (or act according to “ rules of the game ” ) Then: Gold Standard should assure balance of payments and price stability. Why?

The rules of the game A net outflow of gold (due to BP deficit) must be met by an increase in interest rates to maintain the fixed exchange rate (thereby creating unemployment) A net inflow of gold (due to BP surplus) must be met by a decrease in interest rates to maintain the fixed exchange rate (thereby creating price inflation)

A free lunch? If markets (including labor markets) were perfectly competitive and prices (including wages) were perfectly (and instantaneously) flexible, then the gold standard would be compatible with full employment. If NOT, then a degree of unemployment is required to redress balance of payments deficits and a degree of price inflation to redress surpluses.

Asymmetric incentives A country with BP deficit has a major incentive to raise interests rates, to avoid “ going off gold ” ( major blow to reputation and therefore to international capital inflows). A country with BP surplus has little or no incentive to increase domestic prices THE COST OF ADJUSTMENT FALLS ENTIRELY ON DEFICIT COUNTRIES

England: gold or silver standard? Silver standard dominates in Medieval times Bimetallism adopted by England (Newton) Outflow of silver (to East) Bank of England (1694) De facto gold standard Convertibility suspended ( ) Gold standard

The diffusion of the gold standard In the early 1870s most of the world still on silver or bimetallic standard Germany moves to gold after 1871 Discoveries of silver dump its price US note convertibility (1879) de facto gold Italy (1883), Austria (1892), Russia and Japan (1897)

International cooperation Questions:  Why cooperate?  When (daily or emergency only)?  How?  Was cooperation successful?

Gold standard and “ globalization ” Just a symbol? Did it matter to the integration of international: commodity markets? capital markets? labor markets?