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A Retrospective on the Classical Gold Standard, 1821-1931

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A Retrospective on the Classical Gold Standard, 1821-1931
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  This PDF is a selection from an out-of-print volume from the National Bureauof Economic ResearchVolume Title: A Retrospective on the Classical Gold Standard, 1821-1931Volume Author/Editor: Michael D. Bordo and Anna J. Schwartz, editorsVolume Publisher: University of Chicago PressVolume ISBN: 0-226-06590-1Volume URL: http://www.nber.org/books/bord84-1Publication Date: 1984Chapter Title: The Gold Standard and the Bank of England in the Crisis of 1847Chapter Author: Rudiger Dornbusch, Jacob A. FrenkelChapter URL: http://www.nber.org/chapters/c11130Chapter pages in book: (p. 233 - 276)  5 The GoldStandardandthe Bank of England in the Crisis of 1847 RudigerDornbuschandJacobA.Frenkel Whenthereoccursastateof panic-a statewhichcannotbeforeseenorprovidedagainst by law-which cannotbereasonedwith,thegovernmentmustassumeapowertopreventtheconsequencewhichmayoccur.  Sir RobertPeel  1847)1 5.1Introduction Theaccelerationofworldinflationduringthe1970salongwiththeriseintherate of unemploymentandthegeneralinstability of moneyandpriceshaverenewedinterestintheoperationofthegoldstandard.Recentproposalsforareturntosomevariantofthegoldstandardstemfromthebeliefthatareturntosuchastandardwillrestoremacroeconomicstability.Thebelief is basedonacasuallookathistorywiththeconsequentinferencethatthegoldstandardcontributedtothestability of thesystem.Thatview of pricestabilitywassupportedbyKeyneswhoarguedin EssaysinPersuasion: Thecourse of eventsduringthenineteenthcenturyfavouredsuchideas   Theremarkablefeature of thislongperiodwastherelative stability of thepricelevel.Approximatelythe same level of priceruledin or abouttheyears1826,1841,1855,1862,1867,1871,and1915.Priceswerealsolevelintheyears1844,1881,and1914   No RudigerDornbusch is professor of economicsattheMassachusettsInstitute of Technologyandaresearchassociate of theNationalBureau of EconomicResearch.JacobA.Frenkel is professor of economicsattheUniversity of Chicagoandaresearchassociate of theNationalBureau of EconomicResearch.Thispaper is arevision of onepresentedattheconference  A RetrospectiveontheClassicalGoldStandard,1821-1931, atHilton Head Island,SouthCarolinainMarch1982. An earlierversionwaspresentedattheWorkshopinEconomicHistoryattheUniversity of ChicagoinOctober1971.TheauthorsareindebtedtoElianaCardoso,KarlBrunner,CharlesGoodhart,andtheconferenceparticipantsforhelpfulcommentsandtoLaurenFeinstoneandAlbertoGiovanniniforresearchassistance.Aspecialdebt is owedto Anna Schwartzfordrawingtheauthors'attentiontotheimportantrole of publicdeposits.FinancialsupportwasprovidedbygrantsfromtheNationalScienceFoundation.Thisresearch is part of the NBER PrograminInternationalStudiesandBusinessFluctuations.Theviewsexpressedarethose of theauthorsandnotnecessarilythose of the NBER, Inc. 233  234RudigerDornbuschandJacob A. Frenkel wonder that wecame to believeinthestability of moneycontractsoveralongperiod. The metal gold mightnotpossessallthetheoreticaladvantages of anartificiallyregulatedstandard, but itcouldnotbe tampered with andhad provedreliableinpractice.(Keynes1932,pp.88-89) Butanother view of thehistory of thegoldstandardduringthenineteenthcenturyrevealsasuccession of crises of varyinglengthanddepth.Asdocumentedby Hyndman [1932]1967,thenineteenthcenturyintheUnitedKingdomwitnessedatleasteightseriouscrises:in1825,1836-39,1847,1857,1866,1873,1882,and1890.Giventhisperspective of thegoldstandard era the relevantquestionshouldbenotonlyhowthegoldstandardworked but alsowhydiditfail. The srcins of thevariouscrisesduringthegoldstandard era vary.Somewere  real andsomewere financial, someautonomous(likeamassiveharvestfailure),andsomeinducedbymistakenpolicies. Of course,no proponent of thegoldstandardhassuggestedthatitwouldeliminateharvestfailures. The question,therefore, is whether and towhatextent the policies that areinducedbytherules of thegamemitigate or exacerbatetheseverity of crises. Our paper examinesthe1847crisisin Great Britain. That year,welldocumentedbyparliamentaryinquiries, is of specialinterestbecausetheorigin of thecrisiswas  real. Aharvestfailuregaverisetocommercialdistressandfinancialpanic,theextremity of whichwasremarkable. Our analysisexaminestheoperation of thegoldstandard,thepolicies of the Bank of England,aswellasthespeedandextent of internationaladjustmentintheform of goldandcapitalflows. The paper proceedsasfollows:Section5.2providesabriefaccount of themaineventsintheUnitedKingdomduring1847.Section5.3studiestheinstitutionalsetting of the goldstandardandspells out aformalmodel of thefinancialmarkets. The twocrises of April and October1847arestudiedinsection5.4. In section5.5wediscusswhethersuspension of Peel'sActwasnecessary. The paper concludeswithsomeobservations on thegoldstandardasamonetarysystem.5.2OutlineofEvents The events of 1847wereinitiatedbya major harvestfailureinIrelandandEnglandin1846. The shortage of domesticfoodsuppliesledtolargepriceincreasesand trade deficitswhichinturnbroughtaboutanexternaldrain of bullionfrom theBank of England.Thesedevelopmentsoccurredagainst the background of the railwaymania whichcommencedin1845. The railwaymaniaalongwiththefoodshortageresultedinamassivefinancialcrisis, the analysis of which is thesubject of thispaper. The characteristics of the 1847crisiswerestatedby John StuartMill:  235 TheBank of EnglandintheCrisisof1847 It is not,however,universallytruethatthecontractionofcredit,characteristic of acommercialcrisis,musthavebeenprecededbyanextraordinaryandirrationalextensionofit.Thereare other causes;andone of themorerecentcrises,thatof1847, is aninstance,havingbeenprecededbynoparticularextension of credit,andbynospeculations;exceptthoseinrailwayshares   The crisisof1847belongedtoanotherclassofmercantilephenomena.Thereoccasionallyhappensaconcurrenceofcircumstancestendingtowithdrawfromtheloanmarketaconsiderableportionofthecapitalwhichusuallysuppliesit.Thesecircumstances,inthepresentcase,weregreatforeignpayments,(occasionedbyahighprice of cottonandanunprecedentedimportationoffood,)togetherwiththecontinualdemandsonthecirculatingcapital of thecountrybyrailwaycallsandtheloantransactions of railwayscompanies....Thiscombinationofafreshdemandforloans,withacurtailmentofthecapitaldisposableforthem,raised the rate of interest,andmadeitimpossibletoborrowexceptontheverybestsecurity.Somefirms   stoppedpayment:theirfailureinvolvedmore or lessdeeplymany other firmswhichhadtrustedthem;and,asusualinsuchcases,thegeneraldistrust,commonlycalledapanic,begantosetin,andmighthaveproducedadestruction of creditequaltothatof1825,hadnotcircumstanceswhichmayalmostbecalledaccidental,giventoaverysimplemeasureofthegovernment(thesuspensionoftheBankCharterActof1844)afortunatepower of allayingpanic,towhich,whenconsideredinitself,ithadnosort ·of claim.(Mill1871,bk.3,chap.12,section3)Table5.1reportsselecteddatafortheperiod1845-48.1847wascharacterizedbyadeteriorationinthebalanceoftradeandthetermsoftradeaswellasbyasignificantriseinthepriceofwheatandthe other priceindexes. The trade-balancedeficitcausedgoldoutflowsandanaccompanyingreductioninthesupplyof Bank ofEnglandliabilitiesandcredit.While Table5.1SelectedDatafor Great Britain,1845-48 1845 184618471848 Exports 69.467.070.561.2 Imports 88.487.3112.188.2 Tradebalance -19.0-20.3-41.6-27.0 Terms of trade 119.6115.1112.5121.7 Price of wheat 50.854.770.050.5 Price of agriculturalproducts 120.0118.0125.0107.0 Price of industrialproducts 99.099.0104.092.0 Source: AlldataarefromMitchell 1962. Notes: Thebalance-of-paymentsdataaremeasuredin £ million;theterms of tradeareanindex of thenetbarterterms (1880 = 100); theprice of wheat is inshillings per imperialquarter;andthepricesofagriculturalandindustrialproductsaretheRousseauxpriceindexes (1885 = 100).  236RudigerDornbuschandJacob A. Frenkel theexternalbulliondrainwasonedirectconsequenceoftheharvestfailure,asecondonewastheextensivecommercialfailuresarisingfromspeculativeforwardpurchasesoffoodstuffsfordeliveryinmid-1847.Bythetimethesecontractscametomaturity,agoodharvestfor1847wasexpected,andthatchangeinexpectationsledtoadrasticdeclineinspotpricesanddefaultofmanytradingestablishments.Inaddition,theprecariousfinancialpositionofmanyenterprisesthathadtakenpartintherailwayspeculationsreducedconfidenceinthefinancialintegrity of thesystemandresultedinaninternaldrainofbankreserves.Figures5.1-5.3showtheweeklydataforthestockofbullionintheBankofEngland,theBank'snotereserve,thestock of notesheldoutsidetheBank,andtheprice of consols(thesourcesofthedataarelistedintheAppendix). T,wo majorcrisesoccurredduringtheyear.TheAprilcrisisarosefromthereversalofBank of Englandcreditpolicy.Havingfollowedtothatdateapolicyofsterilizationofthecrediteffectofthedeficitbyloweringitsreserve-depositratio,theBankreverseditspolicyinAprilbyraisingthediscountrateandonlysparinglyaccommodatingthediscountmarket.Thesuddennessandseverity of theactionledtoapanic as thebesthousesinthetradefounditimpossibletoobtaindomesticcredit.ThepanicinOctoberbycontrastwasduetoaninternaldrainthatresultedfromaloss of confidenceintheconvertibilityofbankdepositsintoBank of EnglandnotesandwasessentiallyduetotheoperationofPeel'sAct,which is describedinthenextsection.Thatcrisiswasovercomebythejointeffectofasuspensionoftheprohibitionoffiduciaryissueand of adiscountrateatanunprecedentedlevelof8percent.The RESERVES BULLION 10   17.5 7 5 5 2 5 \ \ , \ \ , \ , \J, \/ \,,, Bullion  \ I セ   15.0 12.5 1 Fig.5.1 o  ---  1 7  5 4 4 2 3652 16 32 48 12 184518461846 1846184618471847 18471848 Bank of Englandholdings of bullionandnotereserves(inmillion f).
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