Page 2 of 5 CHINA'S DOLLAR MILLSTONE, Part 3 History of monetary imperialism
By Henry C K Liu
controversy broke out over whether the "Currency Principle" of making existing
mixed gold-paper currency expand and contract in direct proportion to gold
reserves was sufficient to safeguard against note over-issuance, or whether
additional regulation was necessary. This controversy grew out of the
expansionist pressure put on the supply of pound sterling by the rapid
expansion of the British Empire. Or rather, the increase in the supply of pound
sterling allowed Britain to finance the considerable expenses of creating and
maintaining a global empire.
Members of the CS argued that even a fully, legally convertible currency could
be issued in excess with undesirable consequences, such as rising domestic
prices relative to foreign prices, balance-of-payments deficits, falling
foreign-exchange
rates, gold outflow resulting in depletion of gold reserves and ultimately
forced suspension of convertibility. The rate of reserves drain often
accelerated when the external gold drain coincided with internal domestic panic
conversion of paper into gold in fear of pending depreciation. Thus the CS
promoted full convertibility plus strict regulation of the volume of banknotes
to prevent the recurrence of gold drains, exchange depreciation and domestic
liquidity crises.
The apprehension of the CS was fully justified by past actions of the Bank of
England, which had been perverse and destabilizing by international finance
standards. The destabilizing argument stressed the time lag on the Bank's
policy response to gold outflow and to exchange-rate movements. The inevitably
too little, too late measures taken by the national bank, instead of protecting
gold reserves, merely exacerbated financial panics and liquidity crises that
inevitably followed periods of currency-credit excess. The famous Bank Charter
Act of 1844, in modern parlance, imposed a 100% reserve requirement, with an
unabashed bias toward wealth preservation over wealth creation. The CS also
asserts that money substitutes cannot impair the effectiveness of monetary
regulation. Thus if banknotes could be controlled, there would be no need to
control deposits explicitly, on the ground that money substitutes have low
velocity and are of declining substitutional value in times of crisis.
By the end of the 19th century, bimetallism had become a political issue in the
US. Newly discovered silver mines in the West caused an effective decrease in
the value of money. In 1873, the US Congress passed the Fourth Coinage Act,
which demonetized silver, shrinking the money supply and causing severe
deflation. Silverites called this "the crime of '73" as deflation caused
farmers to default on their fixed rate mortgages while prices of farm produce
fell. There similarity between the crime of 1873 and that of 2007 when the
subprime mortgage crises broke out is striking in many respects.
French monetary regime
The French livre was established by Charlemagne (747-841) as a unit of account
equal to one pound of silver. From the crusades, Louis IX (1214-1270) brought
back the idea of a royal monopoly on the minting of coinage to France. He
minted the first gold ecu d'or and silver gros d'argent, whose weights (and
thus monetary divisions) were roughly equivalent to the livre tournois, a
standard used in Tours, one of the richest town in France at the time. Argent
still means both silver and money in modern French. Between 1360 and 1641,
coins worth one livre tournois were minted and known as francs. The first
French paper money was issued by Louis XIV in 1701 and was denominated in
livres tournois.
France, then with the largest economy in Europe, had been the powerhouse anchor
of silver/gold bimetallism since the time of Louis XIV (1643-1715). The
silver/gold ratio of 15/1 was maintained because France always stood ready to
exchange gold into silver and back at that ratio. Monetarily, French money was
neutral, never good or bad in the Gresham Law sense because the French state
kept the commercial price of silver to gold also at the fixed monetary ratio of
15:1.
The French franc was the national currency of France from 1360 until 1641 and
again from 1795 until 1999 (franc coins and notes were legal tender until
2002). The franc was also minted for many of the former French colonies, such
as Morocco, Algeria, French West Africa, and others. Today, after independence,
many of these countries continue to use the franc as their standard
denomination.
The National Constituent Assembly during the French Revolution issued a paper
currency in 1790 known as Assignats, based on the value of confiscated church
properties. Assignats were used successfully to retire a significant portion of
the public debt as they were accepted as legal tender by domestic and
international creditors. Lack of control over the amount to be printed soon
pushed the face value of the assignats to exceed the market value of
confiscated church properties, causing hyperinflation by 1792. Napoleon I
reintroduced the franc to replace assignats in 1803 to the new currency, by
which time assignats had become worthless. On December 31, 1998, transitioning
to the European Monetary Union, the value of the French franc was locked to the
euro at 1 euro to 6.55957 francs.
Napoleon I, in reviving the franc, made the mistake of allowing Britain to
continue to overvalue gold against silver monetarily, an error of monetary
policy that eventually cost France her financial preeminence. This was despite
Napoleon's Continental System, declared on November 21, 1806, by the Berlin
Decrees, to blockade British trade with the continent so as to deny Britain the
ability to fund the wars waged against France by British allies on the
continent. The French effort to enforce the Continental System was a key reason
for the Peninsular War, which drove Spain into alliance with Britain despite
French liberation of Spain from the unpopular reign of Charles IV. It was also
a key factor behind Napoleon's disastrous invasion of Russia.
British financial prowess played a significant role in her ability to form the
Sixth Coalition with Austria, Russia, Sweden and the Germanic states to defeat
Napoleon I in the Battle of Nations at Leipzig in 1814 and again to support
Austria to defeat Napoleon III in the Franco-Prussian War in 1870. British
monetary hegemony could have been prevented by France if only Napoleon had
matched the monetary silver-gold ratio of 15.5 to 1 to stop the flow of gold
into Britain.
The Spanish monetary regime
Spanish dollars, know popularly as Pieces of Eight, were silver coins minted
for use in the Spanish Empire after a Spanish currency reform in 1497. The coin
was legal tender in the US until congress discontinued the practice in 1857 and
was the first world currency - accepted in Europe, the Americas and Asia in the
late 18th century. Many currencies in use today, such as the US and Canadian
dollars, and most Latin American currencies, the Chinese yuan, the Japanese yen
and the Phillipine peso, were initially based on the Spanish dollar and
8-reales coins. Spain's adoption of the peseta and her joining the Latin
Monetary Union meant the effective end for the last vestiges of the Spanish
dollar in Spain itself.
The Austrian monetary regime
Austria introduced the Guldengroschen in 1486, a large silver specie coin with
high purity that eventually spread throughout the rest of Europe.
Wilhelm von Schr๖der (1640-1688) advocated a monetary strategy to
stimulate the Austrian economy in his 1886 book Furstliche Schatz- und
Rentkammer, nebst einem notwendigen Unterrichte zum Goldmachen (The
Royal Treasury and How to Make Money), calling for the introduction of paper
banknotes to provide the sovereign with "an unlimited and perpetual source of
gold and finance."
It is one of the three major works of Germanic cameralism, in the company of Politische
Discurs of 1668 by Johan Joachim Becher (1635-1682) and Philipp von
Hoernigk's Oesterreich uber alles of 1684. Cameralism is a Germanic
version of mercantilism particularly concerned with the political and economic
phenomena of the territorial states. Its aim was an efficient and just
administration, via a fiscal policy and similar financial measures designed to
fill the state's treasury, marked by an active and paternalizing interference
in society. Like the other mercantilist writers, the cameralists have been
accused of the error of confusing money and wealth. Money is not wealth, only a
measuring devise of wealth. One can have a lot of money and be poor, a state
known as hyperinflation. Schroder held that "it is not the import and export of
money, but the equilibrium of the different trades which causes the wealth or
poverty of a country." He was wrong, which explained why Austria was left
behind by a rising Britain.
In fact, Schroder was among the first of the German mercantilists who
distinctly supported the balance-of-trade theory. He supported free trade,
which he regarded as "the principal and the best means whereby a country may
become rich". Keynes praised Schroder for his arguments against other
mercantilists who advocated the accumulation of state treasury as a means for
the enhancing of the power of the state. Schroder however "employed the usual
mercantilist arguments in drawing a lurid picture of how the circulation in the
country would be robbed of all its money through a greatly increasing state
treasury" (Keynes General Theory, p344). Schroder was influenced by the
view of Thomas Hobbes (1588-1679) on social contract and civil society, the
theories of William Petty (1623-1687) on fiscal contributions, national wealth,
money supply, circulation and velocity, value, interest rate, international
trade, government investment and above all, the importance of full employment.
He was also influenced by the scientific views of British chemist Robert Boyle
(1627-1691) as well as the views of Thomas Mun (1571-1642) on the merits of
mercantilist colonialism in empire building.
Unfortunately, Austria did not implement Schroder's proposal. She resorted
instead to the conventional path of raising taxes and to borrowing. During the
regency of Charles VI (1711-1740), Austria borrowed from her allies and sold
sovereign debt to anyone who would buy it.
The mercantilist reforms towards statist activism in economic policies in the
first half of the 18th century required the standardization of currency against
increasing defacement of coinage. Empress Maria Theresa (1740-1780) introduced
a new bi-metal coinage standard that all German lands joined except Prussia.
The Austrian coinage standard was extended to become Convention Standard, and
remained in effect for more than a century to facilitate international payments
until 1858. The Austrian standard, by fixing the monetary ration of silver/gold
at 15/1, contributed to the flow of gold to Britain where the ratio was 15.5/1.
The pretext for the War of the Austrian Succession (1740-1748) was the
eligibility of Maria Teresa of Austria to succeed to the Habsburg throne, as
Salic law precluded royal inheritance by a woman. Continuous war costs
presented Austria with a persistent financial problem. Foreign credit bridged
budget deficits temporarily but interest costs exacerbated the state's
unsustainable financial deterioration. During the regency of Charles VI, the
national debt ballooned by two-thirds to a total of over 54 million Austrian
gulden.
The high premium on silver in the wake of the gold rushes in California and
Australia triggered heavy outflows of European silver coins to the Americas and
to East Asia, particularly China, while gold flowed into Britain. For many
European countries, the switch to a gold standard appeared attractive because
it provided borrowers of gold-back currency loans with lower interest rates.
To finance war debts, Maria Theresa in 1762 issued paper money for the first
time in Austrian history while keeping the coinage standard.
Wiener-Stadt-Banco, a bank that had handled the national debt, was selected as
the issuer of paper notes. State revenue was reserved as backing for 12 million
gulden worth of non-interest-bearing bank notes, known as Banco-Zettel,
declared as legal tender for any type of payment. Banco-Zettel worth 200 gulden
or more were also exchangeable for imperial bonds at 5% interest.
However, the banknotes were not tied to the coinage standard. The notes had a
slight premium over coins at the beginning, but in later years they fell in
value relative to the coins until their value was fixed in 1811 at one fifth of
their face value in coins. That year, the Priviligirte Vereinigte
Einl๖sungs und Tilgungs Deputation (Privileged United Redemption
and Repayment Deputation) began issuing paper money valued at par with the
coinage, followed by the "Austrian National Note Bank" in 1816 and the
"Privileged Austrian National Bank" between 1825 and 1863.
In
essence, Austria moved away from specie money to
adopt a regime of sovereign credit with a fiat
currency based on the State Theory of Money, or
Chartalism, later spelled out by Georg Friedrich
Knapp (1842-1926) in his 1918 book The State
Theory of Money.
While there was no obligation to accept Banco-Zettel as legal tender outside of
Austria, there was no doubt that they would be redeemed for silver coin on
presentation, so that the Banco-Zettel at times even commanded a premium of 1%
to 2.5% on silver coins. Banco-Zettel were issued again in 1771 and 1785.
After the wars against the Ottoman Empire in 1788 and Revolutionary France in
1792, Austria was left in dire financial difficulties. Public expenditure,
which had come to approximately 90 million gulden before the Ottoman war,
skyrocketed to 572 million gulden in 1798. Emperor Francis II (1792-1835) opted
to print more paper money. As the volume of paper money mushroomed, gold and
silver coins grew scarce, following Gresham's Law of bad money driving out
good.
Inflation resulting from the quantity theory of money reached dangerous highs
between 1800 and 1806, after which more paper money was repeatedly issued. The
reparation payments imposed on Austria by the Peace of Schonbrunn of 1809
fueled inflation further. In 1810, the volume of Banco-Zettel in circulation
exceeded 1 billion gulden. In December 1810, the government imposed a
moratorium on all payment obligations in coin. Just three months later, on
February 20, 1811, Austria had to declare national bankruptcy. The Banco-Zettel
and the Banco-Zettel divisional coins were to be exchanged for exchange coupons
also referred to as "Vienna currency" at a rate of one coupon to five
Banco-Settel notes.
The state coffers were severely strained by wars and the Congress of Vienna in
1814-15, making it necessary to issue paper money once again soon after the
Banco-Zettel had been exchanged for Vienna currency. The volume of Vienna
currency exchange coupons made it necessary to call the new paper money issues
"anticipation coupons" (Antizipationsscheine), as they were covered by
tax revenue not yet collected.
The consequence of war
Inflation was an inevitable consequence of war. The public lost 90% of their
cash wealth from paper currency devaluation, the redistribution of incomes, the
outflow of assets abroad, and the monetary reconstruction which followed.
In May 1815, Austria began to put her monetary system back on a sounder
footing. The Privilegirte Oesterreichische National-Bank was founded June 1,
1816, modeled on the French and English national banks, as an independent stock
company vested with the right to issue banknotes to stabilize the monetary
system, to finance the chronic budget deficit and to manage the expansion of
the money supply. By 1847, the Vienna currency exchange coupons had been almost
wholly exchanged for Convention coins, and after a 25-year pause, it became
possible to mint gold and silver coins again.
Austria, however, decided to keep its silver currency and sought to join the
German Zollverein, a customs union established in 1834 among the majority of
the states of the German Confederation during the Industrial Revolution to
remove internal customs barriers, although upholding a protectionist tariff
system with foreign trade partners. The main ideological contributor behind the
customs union was Friedrich List, an advocate of economic nationalism. The
Zollverein had excluded Austria because of its highly protected industry. The
exclusion exacerbated the Austro-Prussian rivalry for dominance in central
Europe during the late 19th century.
The member states of the Zollverein had already embarked on a unification of
currency systems with the Agreement of Munich in 1837. Twenty years later,
Austria relinquished its Convention monetary standard in the Vienna Monetary
Agreement of 1857 and adjusted the Austrian gulden to the North German thaler,
a silver coin used throughout Europe for almost four hundred years. One and a
half Austrian gulden were equal to a Convention thaler. The coin weight unit
was the "pound" of 500 grams, with 30 Convention thalers (45 Austrian gulden)
being struck from one pound of fine silver. Under the decimal system that was
obligatory for the Zollverein currency, the Austrian gulden was subdivided into
100 kreuzer. The Zollverein was effectively ended in 1866 with outbreak of the
Austro-Prussian War. A new organization with the same name was formed in 1867
when peace was restored.
After Prussia defeated Austria at the Battle of K๖niggrไtz in 1866,
Austria pulled out of the Zollverein and in 1867 oriented its coinage on the
bimetallic standard of the Latin Monetary Union (LMU) founded by France,
Belgium, Switzerland and Italy in 1865. In a nod to the LMU, Austria minted
gold coins of a value of eight and four gulden, which were the equivalent of 20
and 10 francs. However, Austria never actually joined the LMU, a step it had
planned for 1870, because its monetary system remained in disarray.
Monetary impacts of the 1848
revolutions After the successful
consolidation of the monetary system of Austria, the revolutions of 1848
represented a renewed disruption. The money supply shot up. In May, the
redemption of banknotes in silver was suspended, making paper money legal
tender, that is, acceptance of paper money was declared a legal obligation (it
was declared fiat, or fiduciary, money).
Whereas the state resorted to issuing banknotes to cover the cost of quelling
the revolution and of the wars with Hungary and Italy, the municipalities and
citizens issued notgeld (emergency money) to cope with the lack of
change. Tokens of brass, lead, tin, copper and even glass, leather, wood and
cardboard were
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