204 The Domestic Politics of International Monetary Order: The Gold Standard
THE CLASSICAL GOLD STANDARD
Like other international monetary orders, an international gold standard is supposed
to consist of a group of sovereign countries bound together by a common
commitment to certain fundamental principles of monetary organization and rules
of monetary behavior. In a true gold standard, there are two basic principles.
First, a country must commit its monetary authorities to freely exchange (buy and
sell) the domestic currency for gold at a fixed rate without limitation or condition.
Second, monetary officials must pledge to allow residents and nonresidents the
absolute freedom to export and import gold in whatever quantities they desire.
When a group of countries bind themselves to the first principle, fixed exchange
rates are established; when they commit to respect the free flow of gold, a pure
fixed-exchange-rate mechanism of balance-of-payments adjustment comes into
being. Thus a stylized international gold standard is a system of states linked
together by two general monetary principles (to uphold the gold convertibility of
their national currencies at par; to allow gold to cross national borders unimpeded)
and two basic rules of behavior governing international monetary policy (to deflate
in the event of a gold drain; to inflate in the event of an inflow). As an economic
model, this describes an efficient, self-sustaining system for reducing the transactions
costs of international exchange and investment and providing a nearly automatic
mechanism for reconciling international imbalances. As an approximation of late
nineteenth- and early twentieth-century reality, however, the model is quite
inappropriate.
As the following comparison will illustrate, there were sharp national differences
in the degree to which countries maintained a commitment to the underlying
principles and operational rules of the gold standard. Among the European countries,
England stayed most consistently on the gold standard, meaning both that the
pound sterling was convertible into gold on demand at the legally defined rate
and that individuals had complete freedom to export or import gold. On the continent,
in contrast, free and unlimited convertibility was by no means guaranteed, especially
if gold was sought for export purposes, and monetary officials often placed
administrative barriers on the free flow of gold. As for the rules of the game, the
received wisdom today is that all gold-standard countries engaged at times in
practices that were in “violation” of the regime’s rules. Although this conclusion
is certainly valid in general, it masks significant national differences.
Great Britain paid only occasional attention to internal conditions while on the
continent internal targets loomed much larger. In England, discount-rate policy
was the main instrument of international monetary policy, and the Bank of England
looked to the size of its gold reserve in setting its discount rate. Because its reserve
ratio was affected primarily by movements of gold, the Bank’s operating principle
was that a reduction in its reserve due to a foreign drain was to be met with a hike
in “Bank Rate”—a policy that implied acceptance to at least half of the gold
standard’s rules. At no time did the Bank of England hold its discount rate steady
in the face of a serious foreign drain. The same cannot be said of the continental
central banks, which relied far less extensively on discount-rate policy as the
basis for their international monetary policies. To avoid the internal consequences