Proposal preview

Monetary standards in the long-run: financial issues and trade opportunities

The literature on international monetary standards emphasises the link between the adherence of countries to a given regime and the combined impact on trade and financial integration. So, for instance, the international gold standard (1870-1913) is supposed to have fostered both trade and financial integration, contributing to the wave of globalisation and growth taking place before the WWI.
By melting these two aspects into one, however, this well-established approach to the functioning of international monetary regimes hides some relevant questions and some still-unsolved puzzles. For instance, did countries join these standards (or did not abandon them) in the attempt to foster (protect) their position in the international trade, or to attract financial flows (or to stabilise them), or both? In doing so, which were the options (gold; bimetallism; silver) available under different regimes and why did countries choose one solution? Did peripheral and core countries behave differently, and why? What is the role played by interest groups and political forces?
The aim of this section is to shed light on some of these issues by analysing various aspects of the functioning of monetary regimes in the long-run. The session looks at the long period starting with the mid-19th century international monetary and financial integration, followed by an analysis of what standards were available under the “classic gold standard” and why and how different countries opted for different solutions, to finish with the issue of devaluation and international debts in the 1930.

Organizer(s)

  • Paolo PDM Di Martino University of Birmingham p.dimartino@bham.ac.uk UK

Session members

  • Christopher Meissner, University of California Davis
  • Rita Martins de Sousa, Universidade de Lisboa
  • Marcela Sabaté , University of Zaragoza
  • Carmen Fillat, University of Zaragoza
  • Bert Kramer, Rijksuniversiteit Groningen
  • Stefano Ugolini, University of Toulouse
  • Vincent Bignon, Banque de France
  • Paolo Di Martino, University of Birmingham
  • Michael Bordo, Rutgers University and NBER
  • Jinzhao Chen , ESSCA School of Management

Discussant(s)

Papers

Panel abstract

This section focuses on various aspects of the functioning of monetary regimes between 1840s and 1930s, in particular the relative role of finance, trade and political economy factors in shaping monetary arrangements, their functioning, and their impact on the real economy. The session is divided in two parts. The first one covers 19th century international monetary and financial integration, why Portugal joined the gold standard in this period, and how this monetary regime evolved in the following decades. The second part of the section focuses more specifically on the political economy of the international gold standard, to finish with the issue of devaluation and international debts in the 1930.

1st half

Beneath the Gold Points

Vincent Bignon, Jinzhao Chen,Stefano Ugolini

We measure the degree of financial integration among the top five financial centers of mid-19th-century Europe by applying threshold-regression analysis to a new database of exchange rates and bullion prices. We find that, instead of London, Hamburg, Frankfurt or Amsterdam, it was Paris that played the role of hub of European foreign exchange markets. We also document a high level of financial integration before the gold standard period, with estimated transaction costs far lower than historically-observed “gold” and “silver points” (i.e., the costs to bullion arbitrage). We review the assumptions of the classical gold-point arbitrage model and conclude that TAR-computed thresholds cannot be interpreted as transaction costs in the bullion trade. High integration may be explained not by low transaction costs in bilateral bullion arbitrage, but by the availability of multilateral financial arbitrage techniques

We measure the degree of financial integration among the top five financial centers of mid-19th-century Europe by applying threshold-regression analysis to a new database of exchange rates and bullion prices. We find that, instead of London, Hamburg, Frankfurt or Amsterdam, it was Paris that played the role of hub of European foreign exchange markets. We also document a high level of financial integration before the gold standard period, with estimated transaction costs far lower than historically-observed “gold” and “silver points” (i.e., the costs to bullion arbitrage). We review the assumptions of the classical gold-point arbitrage model and conclude that TAR-computed thresholds cannot be interpreted as transaction costs in the bullion trade. High integration may be explained not by low transaction costs in bilateral bullion arbitrage, but by the availability of multilateral financial arbitrage techniques

Portugal adoption of the gold standard

Rita Martins de Sousa

The transition from bimetallism to the gold standard constitutes the subject of this research. Several studies have emphasised different explanations for this transition. We do not reject the theses discussed until now and we do consider that, to a greater or lesser extent, they all account for causes of the shift in the monetary regime. However, no explanations have yet been found either for the appreciation of gold in the Portuguese market in 1847 or the reasons behind maintaining British gold sovereigns in circulation in 1851, year when all other foreign coins were withdrawn. We argue that the adoption of the gold standard should be explain by a political decision, and would not impact too negatively on the private sector. This episode, which took place in a southern European country over 150 years ago, once again demonstrates the importance of political concerns in monetary decision-making.

The transition from bimetallism to the gold standard constitutes the subject of this research. Several studies have emphasised different explanations for this transition. We do not reject the theses discussed until now and we do consider that, to a greater or lesser extent, they all account for causes of the shift in the monetary regime. However, no explanations have yet been found either for the appreciation of gold in the Portuguese market in 1847 or the reasons behind maintaining British gold sovereigns in circulation in 1851, year when all other foreign coins were withdrawn. We argue that the adoption of the gold standard should be explain by a political decision, and would not impact too negatively on the private sector. This episode, which took place in a southern European country over 150 years ago, once again demonstrates the importance of political concerns in monetary decision-making.

Rethinking the geography of the gold standard

Paolo Di Martino

Conventional analysis of the international Gold Standard insists on the existence of a structural difference between core and peripheral countries in terms of successful adherence to gold convertibility. Using ideas originally developed in the 1990s, this papers analyses how and why a set of peripheral economies (Austria-Hungary; Italy; Norway, Spain, Sweden) managed to fix their currencies against gold-based ones since the run of the century. The paper shows a variety of strategies adopted by each country and how issues of international trade and international finance shaped such strategies.

Conventional analysis of the international Gold Standard insists on the existence of a structural difference between core and peripheral countries in terms of successful adherence to gold convertibility. Using ideas originally developed in the 1990s, this papers analyses how and why a set of peripheral economies (Austria-Hungary; Italy; Norway, Spain, Sweden) managed to fix their currencies against gold-based ones since the run of the century. The paper shows a variety of strategies adopted by each country and how issues of international trade and international finance shaped such strategies.

2nd half

Democratic Constraints

Bert S. Kramer, Petros Milionis

We study how domestic politics a¤ected the decisions of countries to adhere to the classical gold standard. Using a variety of econometric techniques and controlling for a wide range of economic factors, we demonstrate that political constraints were important in the decision of countries to adopt the gold standard as well as in the decision to suspend it. Speci…cally we …nd that the probability of adherence to the gold standard was ceteris paribus lower for countries in which domestic politics were organized in a more open and democratic fashion. This e¤ect appears to be driven largely by the extent of domestic political competition and was particularly relevant for peripheral countries.

We study how domestic politics a¤ected the decisions of countries to adhere to the classical gold standard. Using a variety of econometric techniques and controlling for a wide range of economic factors, we demonstrate that political constraints were important in the decision of countries to adopt the gold standard as well as in the decision to suspend it. Speci…cally we …nd that the probability of adherence to the gold standard was ceteris paribus lower for countries in which domestic politics were organized in a more open and democratic fashion. This e¤ect appears to be driven largely by the extent of domestic political competition and was particularly relevant for peripheral countries.

Exchange rates and groups of interest in Spain

Carmen Fillet, Marcela Sabaté

The Spanish peseta never belonged to the classical gold standard. The idea that the monetary financing of deficits led Spanish prices to diverge from international prices, provoking gold depletion and forcing the suspension of convertibility, is central to the narrative on why this country prioritized floating over fixed exchange rates. We want to explore the possibility that there were other forces at work, namely, groups of interest, influencing policy-makers decisions on exchange rates. Our goal is to identify how these groups channeled their pressures, if indeed they did, by voting in the Spanish congress on issues related to proposals to move to gold convertibility, external debt conversions and limits on monetary circulation. By taking the approach in Frieden (1997), we look for a link between proxies for Spanish vested economic interests and roll-call votes in favor of pro-gold measures or not. Finally, we want to use the Spanish case to...

The Spanish peseta never belonged to the classical gold standard. The idea that the monetary financing of deficits led Spanish prices to diverge from international prices, provoking gold depletion and forcing the suspension of convertibility, is central to the narrative on why this country prioritized floating over fixed exchange rates. We want to explore the possibility that there were other forces at work, namely, groups of interest, influencing policy-makers decisions on exchange rates. Our goal is to identify how these groups channeled their pressures, if indeed they did, by voting in the Spanish congress on issues related to proposals to move to gold convertibility, external debt conversions and limits on monetary circulation. By taking the approach in Frieden (1997), we look for a link between proxies for Spanish vested economic interests and roll-call votes in favor of pro-gold measures or not. Finally, we want to use the Spanish case to explore the possible trade-off between currency and commercial policies, which is an area with still scant evidence, by pooling all voting data on exchange rate issues for the whole period 1874-1913 and controlling for changes in customs barriers.

Foreign currency

Michael D. Bordo, Christopher M. Meissner

We investigate the linkage between the presence of foreign currency debt and the decision to devalue and/or default facing peripheral countries during the Great Depression. Our empirical results have considerable resonance for the plight of a number of peripheral countries in the Eurozone today such as Cyprus, Greece, Ireland, Italy, Portugal and Spain The best historical precedent for the EMU predicament is the Great Depression. When it started, nations were tethered together by the gold standard and most of them did not engage in active countercyclical fiscal policy. A leading view of the Great Depression holds that devaluation stimulated the recovery (Eichengreen, 1992). A series of statistical tests by Eichengreen and Sachs (1985), and later Campa (1990) mainly using univariate cross-sectional regressions, showed that nations’ recoveries depended upon devaluation between 1931 and 1935. Countries that delayed going off gold, had the weakest growth, the slowest rise in exports and the...

We investigate the linkage between the presence of foreign currency debt and the decision to devalue and/or default facing peripheral countries during the Great Depression. Our empirical results have considerable resonance for the plight of a number of peripheral countries in the Eurozone today such as Cyprus, Greece, Ireland, Italy, Portugal and Spain The best historical precedent for the EMU predicament is the Great Depression. When it started, nations were tethered together by the gold standard and most of them did not engage in active countercyclical fiscal policy. A leading view of the Great Depression holds that devaluation stimulated the recovery (Eichengreen, 1992). A series of statistical tests by Eichengreen and Sachs (1985), and later Campa (1990) mainly using univariate cross-sectional regressions, showed that nations’ recoveries depended upon devaluation between 1931 and 1935. Countries that delayed going off gold, had the weakest growth, the slowest rise in exports and the lowest investment. If this view is at all applicable, it suggests that the costs of remaining in a hard peg during a significant economic downturn are higher than the costs of exit. Contemporary observers mainly frowned on the instability that devaluation created. Today, the salutary effects of depreciation have been much discussed in the case of the Depression. Still, the negative effects of depreciation have recently been emphasized in light of the East Asian financial crisis and recent events in Europe. As it turns out, hard currency debt and financial instability were also in play during the Depression much as they were in the 1990s and even now. External debt denominated in foreign currency was a significant constraint for many countries in the 1930s. League of Nations and United Nations data on domestic and foreign debt, which we rely on in this study, reports that the average ratio of foreign debt to total debt for a large set of countries was close to 60% in 1930. Recent theoretical work by Céspedes, Chang, and Velasco (2004) suggests that devaluation can have negative effects when foreign currency debt makes up a significant fraction of the total, when leverage is high, and when the responsiveness of exports to depreciation is low. Consistent with this, our preliminary examination of 1930s data suggests that the higher the ratio of foreign to total debt the longer nations waited to devalue. We test this hypothesis more rigorously in a set of multivariate duration regressions where the timing of the departure from gold in the 1930s is a function of the level of debt, reserves and foreign currency exposure as well as other important macroeconomic controls. Policy makers in the 1930s were well aware of the fact that depreciation could have a fatal impact on their ability to service external debt. Officials in Australia noted the benefit of lower interest payments for the deficit when sterling was devalued in September 1931 (Yearbook of Australia, 1939). They also argued in August 1931, prior to sterling’s devaluation, that a devaluation of the Australian pound would have aggravated the government deficit. The latter observations suggest that the choice of devaluing in the 1930s depended on monetary policy in the key creditor nations as well as the currency composition and amount of debt. Sterling’s devaluation of 1931 and the US devaluation of 1933 may have helped aid recovery indirectly by limiting the rise in debt repayments accompanying any potential devaluation. If this is true, then for the debtor nations, devaluation to generate recovery was not the only objective. The testable implication is that nations would have also focused on their debt position and foreign monetary policy when making their own decisions regarding economic recovery and exchange rate policy. Our conclusion is that foreign currency debt was a major constraint on exchange rate policy in the 1930s. Only once the major nations had devalued, or debt had been eliminated via repayment or default, could emerging markets free themselves from the constraints of the gold exchange standard. In the meantime, nations maintained exchange rate stability against the currencies in which their debt was denominated. We also carry out a number of event studies on bond yields to show how foreign shocks to the exchange rate mattered for sovereign risk. Nominal appreciation is significantly associated with lower bond yields and lower risk premia. This historical episode is of great importance for an understanding of the evolution of exchange rate policy, international capital flows and the dynamics of public debt. It can also shed light on the benefits and costs of devaluation as a means to recovery in a highly integrated global economy. It also highlights the potential benefits to a coordinated response within institutional frameworks like the European Monetary Union or a potential European fiscal union. Such institutions were in part designed to avoid the default and instability of the 1930s