BARBAROUS RELIC!

I just finished reading Lords of Finance by Liaquat Ahamed. It is a wonderful book, but about half way through I had the same experience you have when you realize that the Star Wars movies are *really about Darth Vader*! A lot of Lords of Finance is about the resurrection and well-deserved second demise of the gold standard. Since reading the book, I've been looking for an excuse to write about the gold standard and today, China gave me an excuse!

In the early eighteenth century the world accidentally backed into the gold standard. It was Isaac Newton's idea. In eighteenth century English coins were made of gold and silver. This is called "bimetalism." The exchange rate between gold and silver was set on an exchange. A big silver strike in New Spain, for instance, would make silver less valuable relative to gold. At the time, silver bought more gold in continental Europe than in England. Enterprising Englishman began melting their silver coins exchanging them for gold in France and bringing the gold back to England to buy silver. Soon, silver coins became scarce in England. In 1717, Isaac Newton, master of the Royal Mint, proposed fixing the exchange rate as a way to maintain bimetalism. By raising and lowering the exchange rate, Newton was able to control the flow of gold into the country. Other countries in Europe soon saw how clever this was and adopted the idea. Soon after, they discovered that fixed exchange rates put a stop to cross-border currency arbitrage. When countries in Europe all went to paper currency they maintained the gold standard by making their paper convertible to gold at a fixed rate. The only thing that could shake the stability of this system was the discovery of more gold.

There were, of course, ways to cheat the system. If you want to find out what they were, read the book.