Money Mischief_ Episodes in Monetary History - Milton Friedman [48]
Beginning in the early 1870s, most advanced countries, including the United States in 1879, shifted to a monometallic gold standard, that is, a standard under which only the price of gold was legally fixed. This left India and China as the only two populous countries relying primarily on silver. Silver was still used elsewhere, but just for minor coinage. After World War I the link between money and gold was progressively loosened, with a gold-exchange standard—a commitment by governments to redeem their money either in gold or in a foreign currency that was redeemable in gold—replacing a strict gold standard as the norm. After World War II, the Bretton Woods agreement setting up the International Monetary Fund gave gold an even smaller role, requiring convertibility into gold only for the United States and only for external purposes. This final link was ended by President Richard Nixon on August 15, 1971, when, in monetary jargon, he "closed the gold window" by refusing to honor the U.S. commitment under the International Monetary Fund agreement to sell gold to foreign central banks at $35 an ounce. Since then, every major country has adopted an inconvertible paper or fiat standard, not as a temporary emergency measure but as a system intended to be permanent. Such a worldwide fiat monetary system has no historical precedent.
Up to the present, the fiat monetary system has been characterized by wide fluctuations in price levels, interest rates, and exchange rates, as the major nations have tried to learn how to navigate in these uncharted waters, have tried to find some anchor for the price level other than conversion into a commodity. Whether the fiat system will lead to acceptable results—and, if so, when—remains an open question, which is examined in chapter 10. Hence, a discussion of perhaps the most common earlier world system, bimetallism, may be of more than historical interest.
In a 1936 article entitled "Bimetallism Reconsidered," Lewis Froman wrote: "Economists in general are almost unanimously in agreement that bimetallism does not provide a satisfactory monetary system" (p. 55). Until recently I shared that view, which I believe remains the conventional view of monetary economists: namely, that bimetallism is an unstable and unsatisfactory monetary system involving frequent shifts between alternative monometallic systems; that monometallism is preferable, with gold monometallism preferable to silver monometallism.*
In the course of doing research on the U.S. monetary history of the nineteenth century for chapters 3, 4, and 5, I discovered, much to my surprise, that the conventional view is dubious, if not outright wrong, with respect to both the superiority of monometallism over bimetallism and the superiority of gold monometallism over silver monometallism.
Historical Experience
In his 1791 Treasury Report on the Establishment of the Mint, in which he recommended the adoption of a bimetallic standard, Alexander Hamilton ([1791] 1969, [>]) wrote: "Gold may, perhaps, in certain senses, be said to have greater stability than silver: as, being of superior value, less liberties have been taken with it, in the regulation of different countries. Its standard has remained more uniform, and it has, in other respects, undergone fewer changes; as being not so much an article of merchandise,...it is less liable to be influenced by circumstances of commercial demand."
Hamilton nonetheless chose bimetallism, on the purely pragmatic grounds that silver was the metal in more common use, that most specie in the original thirteen states was silver, in the form of foreign coins, and that gold was rare. He chose a ratio of 15 to 1 because that was the market ratio at the time, while also recognizing that the ratio was subject to variation and urging that "care