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• Titles In the Liberty Fund Library of the Works of Ludwig Von Mises
• Acknowledgments
• Preface
• Introduction
• Monetary and Economic Policy Problems Before, During, and After the Great War
• Part 1: Austro-hungarian Monetary and Fiscal Policy Issues Before the First World War
• Chapter 1: The Political-economic Motives of the Austrian Currency Reform 1
• Chapter 2: The Problem of Legal Resumption of Specie Payments In Austria-hungary 1
• Chapter 3: The Foreign Exchange Policy of the Austro-hungarian Bank 1
• Chapter 4: On the Problem of Legal Resumption of Specie Payments In Austria-hungary
• Chapter 5: The Fourth Issuing Right of the Austro-hungarian Bank 1
• Chapter 6: Financial Reform In Austria 1
• Chapter 7: The General Rise In Prices In the Light of Economic Theory 1
• Chapter 8: On Rising Prices and Purchasing Power Policies 1
• Chapter 9: Disturbances In the Economic Life of the Austro-hungarian Monarchy During the Years 1912-1913 1
• Part 2: Economic Policy Issues In the Midst of the Great War
• Chapter 10: On the Goals of Trade Policy 1
• Chapter 11: Inflation 1
• Chapter 12: On Paying For the Costs of War and War Loans 1
• Chapter 13: Remarks Concerning the Problem of Emigration 1
• Part 3: Austrian Fiscal and Monetary Problems In the Postwar Period
• Chapter 14: Monetary Devaluation and the National Budget 1
• Chapter 15: For the Reintroduction of Normal Stock Market Practices In Foreign Exchange Dealings 1
• Chapter 16: On Carl Menger’s Eightieth Birthday 1
• Chapter 17: How Can Austria Be Saved?
• Chapter 18: The Claims of Note Holders Upon Liquidation of the Bank 1
• Chapter 19: The Austrian Currency Problem Thirty Years Ago and Today 1
• Chapter 20: The Restoration of Austria’s Economic Situation 1
• Chapter 21: The Austrian Problem 1
• Chapter 22: The Gold-exchange Standard 1
• Chapter 23: The Social Democratic Agrarian Program 1
• Chapter 24: America and the Reconstruction of the European Economy 1
• Chapter 25: The Currency and Finances of the Federal State of Austria 1
• Chapter 26: The Economic Crisis and Lessons For Banking Policy 1
• Part 4: Interventionism, Collectivism, and Their Ideological Roots
• Chapter 27: The Economic System of Interventionism 1
• Chapter 28: Economic Order and the Political System 1
• Chapter 29: Remarks Concerning the Ideological Roots of the Monetary Catastrophe of 1923 1
• Appendixes
• Appendix A: Maxims For the Discussion of Methodological Problems In the Social Sciences: Paper Delivered At the Private Seminar 1
• Appendix B: Short Curriculum Vitae of Mayer Rachmiel Mises of Lemberg 1

CHAPTER 22

The Gold-Exchange Standard1

The Bismarck-Bamberger coinage reform of 1871-73 put an end to the fragmentation of the German currency and at the same time shifted the German currency system from one based on silver to one based on gold. The idea behind it was the view that in everyday commercial transactions wider scope needed to be assigned to the use of gold coins.

The practice in England served as a model. In Germany things were never carried as far as in England, where all banknote denominations under five pounds were suppressed. Nevertheless, all regulations concerning banknote denominations and German Imperial Treasury certificates were clearly based on the idea that paper-money substitutes did not belong in the hands of the farmer, the worker, the craftsman, and the subordinate. It was considered an important task of the new German imperial monetary policy to “satisfy” the demand for gold, for which a not inconsiderable material sacrifice was made.

German sales of silver [to buy the gold needed to back the currency under the reform] were the impetus if not the primary cause for the decline in the price of silver. This, and the fact that the action of Imperial Germany decided the controversy over the currency question in favor of gold, compelled India also to shift from the silver standard to the gold standard in the last decade of the nineteenth century.

The Indian government was not inclined to follow the German example in the technical details of carrying out the currency reform. Neither did the Indian government want to bear the great financial sacrifice that supplying the economy with a large stock of gold would entail, including the selling off of a large amount of silver at what likely would be a falling price. It did not want to force the Indian population to give up the ancient, inherited use of silver money and accept unaccustomed gold money.

But above all else, it feared the reaction that such policy measures would have on the movement of international gold prices. Such large purchases of gold to cover Indian financial requirements would have driven the price of gold significantly higher and exacerbated the general decline in the prices of goods. In the first half of the 1890s, this decline in prices was still, at this time, the leading concern of statesmen in all the countries of the world.

Instead, India seized upon the expedient of having a gold standard without creating a circulation of gold in domestic transactions. The free coinage of silver was suspended; and after the accumulation of a currency reserve fund, the silver rupee was converted into a sort of silver banknote. Rupees were exchanged for gold and gold for rupees at a fixed rate. Thus the rupee was brought into a fixed relation to gold; if previously it had been the unit of a silver currency system, it now became a money substitute for a gold standard. The monetary policy goal behind the Indian currency reform was achieved.2

In the last decades before the war, the currency question was resolved in a whole series of Asian and American silver- and paper-currency countries in a way similar to the reform in India. This new system also found its way into Europe. For example, Austria-Hungary began to create a gold standard following the German model without the actual circulation of gold. What was finally achieved—from around 1900—was a gold standard without gold in circulation.

David Ricardo3 was the intellectual father of this new system, which bears the name “the gold-exchange standard,” or the gold-“core” currency. In a paper that was published in 1816 under the title “Proposals for an Economical and Secure Currency,” he recommended a metallic currency as the best and least costly currency system—a currency based on a noble metal (gold or silver)—but without the noble metal in actual circulation.4 In a conscious imitation of Ricardo’s forgotten proposals, Lindsey and Probyn recommended the gold-core standard as the best way out of India’s currency difficulty.

The advantage offered by the gold-core standard, and what has made it attractive to finance ministers, is to be exclusively found in the fact that it reduces the higher costs connected with the actual use of gold in daily monetary transactions. Since this reduces the need for gold, the gold-core currency must be considered responsible for the fall in the price of gold, that is, for the general increase in the prices of goods.

As was mentioned earlier, the economizing on the use of gold was considered a singular advantage to the system. Perhaps if this causal connection between the lower demand for gold and the general rise in prices was clearly recognized, people would be more inclined to see it as a disadvantage.

The gold-core currency, however, is now practiced in such a way that a part of the currency reserve, and in many countries the entire reserve, is held as claims to gold in a gold-standard country in the form of gold-backed foreign exchange—and not in the form of actual gold (ingot or coins) in the domestic economy. The benefit from investing the reserve currency in this way is clear: the gold-backed foreign exchange earns interest, while the stock of gold lies “unproductively” in the vaults of the national central bank.

The gold-core standard, however, has reached a critical turning point with this arrangement. It is clear, of course, that the investment of currency reserve funds in gold-backed foreign exchange cannot become the general norm for all the countries of the world. At least one country must remain on an actual gold standard of the old type, or at least retain a gold-core standard with real metal, otherwise there would remain no place in the world where gold was used as a monetary metal.

After the great inflationary episode of the last several years, all the countries of the world have or are trying to put their monetary systems back in order on the basis of a gold-core standard with currency reserves invested in gold-backed foreign exchange. This can happen only for as long as a few countries are willing to absorb all this gold, especially the United States of America. It is doubtful, however, that in the long run the United States will be willing to bear this heavy burden.

It is highly unlikely that the United States will seriously give a hearing to the proposals recommending that country “break away” from gold and shift to an Indian-type currency. The serious drawbacks that speak against the occasional proposals of Irving Fisher and John Maynard Keynes are too great.5 However, the demand might be made that at least the richer and economically more powerful states of the world should either move back from the gold-core standard to the gold standard with actual gold in circulation, or at least commit themselves to the holding of a certain actual gold reserve.

The problems brought about by the recent development of the gold-core standard so far have been treated in a stepmother-like fashion in the economics literature. Up to now, and especially in Germany and Austria, the gold-core standard has not been given the attention which it deserves; probably there are many for whom it is not clear that Germany’s new currency is also a gold-core currency. There still prevail in public opinion many misunderstandings about the gold-core standard that have been spread through the writings of Heyn and Knapp.6

For this reason, we welcome with particular satisfaction the fact that Dr. Fritz Machlup7 has undertaken to explain the gold-core standard in a monograph.8 Especially to be appreciated is an appendix with Ricardo’s currency proposal of 1816 translated and made available for the first time in the German language. In various particulars and even in many fundamental questions one may be of a different opinion than those of the thoroughly expert and well-read author of this monograph.

One cannot contest, however, that we have here a sound work that deals with the whole sphere of problems in a comprehensive way, which covers the core questions with great skill, and seeks intelligently to prepare the way for their solution. Until now, a book of this kind has been lacking from our monetary literature. Everyone who proposes to deal in a serious way with the question of monetary systems—especially the German system-should not merely look over this work but study it thoroughly. It offers the best foundation for the discussion of the further development of the German and the European monetary system.

[1. ][This article was originally published in German in the Deutsche allgemeine Zeitung. Ausgabe Grosse (February 24, 1925).—Ed.]

[2. ][On the history of Indian monetary reform in the late nineteenth and early twentieth centuries, see Edwin W. Kemmerer, Modern Currency Reforms: A History and Discussion of Recent Currency Reforms in India, Porto Rico, Philippine Islands, Straits Settlements, and Mexico (New York: Macmillan, 1916), pp. 3-154.—Ed.]

[3. ][David Ricardo (1772-1823) spent his formative years in his family’s brokerage business, until he retired at the age of forty-two after accumulating a large fortune. He devoted his time to the study of political economy, writing several influential essays on inflation, gold, and monetary reform in the early nineteenth century during Britain’s wars with France. In 1817, he published his most famous work, The Principles of Political Economy and Taxation, which became a cornerstone of the Classical system. Among his contributions was the development of the theory of comparative advantage. He served as a Member of Parliament in the House of Commons from 1819 until his death.—Ed.]

[4. ][David Ricardo, “Proposals for an Economical and Secure Currency,” (1816) in Piero Sraffa, ed., The Works and Correspondence of David Ricardo, vol. 4, Pamphlets and Papers, 1815-1823 (Cambridge: Cambridge University Press, 1951), pp. 41-141.—Ed.]

[5. ][See Ludwig von Mises, “The Return to the Gold Standard,” (1924) in Richard M. Ebeling, ed., Selected Writings of Ludwig von Mises, vol. 2, Between the Two World Wars: Monetary Disorder, Intervention, Socialism, and the Great Depression (Indianapolis: Liberty Fund, 2002), pp. 136-53, for Mises’s analysis and criticisms of Irving Fisher’s and John Maynard Keynes’s proposals.—Ed.]

[6. ][See Chapter 2, “The Problem of Legal Resumption of Specie Payments in Austria-Hungary,” footnote 10.—Ed.]

[7. ][Fritz Machlup (1902-83) was an internationally recognized economist for his writings on international trade, finance, and currency; methodology of the social sciences; and market structures in his two major works, The Political Economy of Monopoly (1952) and The Economics of Sellers’ Competition (1952). He is also considered a pioneer in the development of the theory of the economics of knowledge in the three-volume work he completed before his death, Knowledge: Its Creation, Distribution, and Economic Significance (1980, 1982, 1984). He studied at the University of Vienna under Friedrich von Wieser, and Ludwig von Mises was his dissertation advisor for the book reviewed in this chapter. In Mises’s copy of the book, Fritz Machlup wrote the inscription “To my spiritual father.” Machlup also contributed to literature on the Austrian monetary and business cycle in The Stock Market, Credit, and Capital Formation (1940) and defended the Austrian theory of capital in his article “Professor Knight and the ‘Period of Production,’” Journal of Political Economy (October 1935).—Ed.]

[8. ]Die Goldkernwährung. Eine währungsgeschichtliche und währungstheoretische Untersuchung [The Gold-Core Standard: A Historical and Theoretical Monetary Investigation] by Dr. Fritz Machlup. With an appendix: translation of Ricardo’s currency plans from the year 1816 by Dr. Wilhelm Frontowitz and Dr. Fritz Machlup (Halberstadt: H. Meyers Publisher, Abteilung Verlag, 1925).