The Bimetallic Era (until 1870) of Currency - dummies

The Bimetallic Era (until 1870) of Currency

By Ayse Evrensel

Although the gold standard dates back to 1821 in the United Kingdom as a legal institution, until the early 1870s, many countries had a bimetallic standard by pegging their currency to both silver and gold. In this case, countries had to maintain parity between gold and silver money as well. Not surprisingly, gold was generally worth several times more per ounce than silver.

Here are advantages and disadvantages of the bimetallic system:

  • Advantage: When the relative market price of gold and silver changed, the use of gold and silver dollar coins was adjusted. Whichever metal’s price was rising, coins made of this metal were disappearing from circulation.

    For example, when the gold price rose relative to that of silver, gold coins were used to buy silver coins and gold coins went out of circulation. The fact that coins made of scarce (therefore more expensive) metal disappeared from circulation may have reduced the inflation rate and acted like insurance for price stability.

  • Disadvantage: What was described as an advantage may turn out to be a disadvantage. The flexibility in the use of gold or silver coins can lead to instability, especially when the relative price of these metals change frequently and substantially. Frequent wars, revolutions, and so on may have magnified this particular disadvantage of the bimetallic standard.

The U.S. and the bimetallic standard

After the American War for Independence, the U.S. introduced the bimetallic standard in 1792 and continued to be on it until the Civil War. The bimetallic system required adequate amounts of gold and silver to back paper currency. It also required establishing parity between gold and silver. In the 18th century, for example, parity was 1 ounce of gold for 15 ounces of silver.

The bimetallic standard in the U.S. went through various changes. The Independent Treasury Act of 1840 allowed the Treasury to do business only in gold or silver coins, in an attempt to take the fiscal authority out of the banking system. The government’s attempt to use specie (gold or silver coins) in its transactions reduced the increase in credit using paper money.

However, specie payments to and from the government affected the amount of specie in circulation and therefore the money market.

In the late 1840s, silver became overvalued relative to gold. Hoarding of silver led to a reduction of gold in circulation and caused a search for gold, which led to the California Gold Rush of 1849. Later in 1853, in an attempt to keep silver coins in circulation, the U.S. reduced the silver weight of coins.

The later part of the bimetallic era coincides with the Free Banking Era (1837–1862). During the Free Banking Era, the U.S. had no central bank. In fact, until 1863, only state banks existed. These banks issued money backed by specie (gold and silver coins). However, they were short-lived, and about one third of banks went out of business because of losses on their assets.

During the final crisis of the Free Banking Era in 1857, the U.S. suspended payments in silver. Nevertheless, the bimetallic standard was used until the Civil War (1861–1865). As in the case of every armed conflict, the bimetallic standard was abolished in 1861 to print money and finance the war.

Greenbacks introduced during the Civil War were fiat currency, which led to higher inflation rates during the war years. After a decade following the Civil War, the U.S. introduced the gold standard in 1875.

The bimetallic standard around the world

Britain was one of the first countries to leave the bimetallic standard, and it introduced the gold standard in 1844. In addition to the fact that the Napoleonic Wars had left Britain in serious silver shortage, Britain’s wars with China reduced the amount of silver-based money.

As in the case of Britain, one of the problems of the bimetallic era was that it coincided with a period of world history filled with wars and revolutions. Especially in Europe, frequent armed conflicts reflected the pain of getting out of the empire setting and establishing nation states.

The following example looks at Austria, a country that was involved in many military conflicts during the bimetallic era. The example shows that it’s no wonder countries sacrificed the metallic standard and fixed exchange rates to finance wars.

Between the late 18th century and the late 19th century, Austria’s monetary history was one of printing money and then promising to exercise budgetary discipline. For example, the government announced its intention in 1811 to stop printing money and issue a new currency, to decrease the amount of paper money in circulation.

However, the renewal of the Napoleonic war in 1812 prompted Austria to again print too much of the new currency. At the end of the Napoleonic wars, France made reparations payments to Austria, and the Austrian government promised to use those payments to retire some of the money in circulation.

However, when the Hungarian revolt against the Austrian rule began in 1848, the government suspended silver redemption and banned the export of gold and silver. Then the Crimean War (1853–1856), wars against the Italian nationalists in northern Italy, and a devastating war with Prussia (1866) followed.

Only after the Prussian War in 1866 did Austrian governments exercise discipline on their budget and stop printing money. Eventually, the then-Austrian currency (florin) had a premium against silver. Even though Austria had been on a silver standard since 1816, armed conflicts didn’t allow the country to effectively implement the metallic standard for half a century.

The later parts of the bimetallic era coincided with important developments in financial markets. During the 19th century, developed countries started introducing their central banks. Additionally, the connection between financial markets of developed countries was strengthening, which led to various monetary unions between countries.