Was Bretton Woods a real gold standard?

John Maynard Keynes and Harry Dexter White, who contributed to the design of the Bretton Woods system

David Glasner's piece on the gold standard got me thinking about the Bretton Woods system, the monetary system that prevailed after WWII up until the early 1970s.

There are many differences between Bretton Woods and the classical gold standard of the 1800s. My claim is that despite these differences, for a short period of time the Bretton Woods system did everything that the classical gold standard did. I'm using David's definition of a gold standard whereby the monetary unit, the dollar, is tied to a set amount of gold. This linkage ensures that there can never be an excess quantity of monetary liabilities in circulation—unwanted notes will simply reflux back to the issuer in return for gold. When most people criticize Bretton Woods, they say that it lacked such a linkage.

A narrowing redemption mechanism

For a gold standard to be in effect, a central bank's notes and deposits have typically been tied down to gold via some sort of redemption mechanism. In the days of the classical gold standard, central banks didn't discriminate; the right to redeem was universal. Whether black or white, big or small, male or female, you could bring your notes or deposits to a central bank teller and have them be converted into an equivalent quantity of gold coin. Any unwanted notes and deposits quickly found their way back to the issuer.

After 1925, the world adopted a narrower redemption mechanism; a gold bullion standard. Economist and trader David Ricardo had recommended this system a century before as a way to reduce the resource costs of running a gold standard. Gold coins were withdrawn from circulation, and rather than offering to redeem notes and deposits in coin, the monetary authorities would only offer bulky gold bars. This excluded most of the population from redemption since only a tiny minority would ever be wealthy enough to own a bar's worth of notes.

It might seem that this narrowing of the redemption mechanism compromised the gold standard. After all, if too many dollars were created by a central bank, and these fell into the hands of those too poor to redeem for bullion bars, than the excess might remain outstanding rather than refluxing back to the issuer.

But consider what happens if a free secondary market in gold is allowed to operate. Unable to send excess notes to the central bank, less wealthy gold owners can sell them in the free market. This would drive notes to a discount relative to their official price, at which point large dealers will buy them and bring them back to the central bank for redemption in bars, earning arbitrage profits. The free market price is thus kept in line with the central bank's redemption price. So as long as the wealthy and not-so wealthy are joined by a market in which they can exchange together, then a narrower redemption mechanism needn't impinge on the proper functioning of a gold standard.

Anyone who has toyed around with ETFs will know what I'm talking about. Despite the fact that a gold ETF limits direct redemption to a tiny population of investors (so called authorized participants), the price of the ETF will stay locked in line with the market price of gold. Authorized participants earn profits by arbitraging differences between the ETF and the underlying, thus maintaining the peg on behalf of all ETF owners. You don't need many of them; just a few well-heeled ones.

When authorized participants don't do their job

The U.S. narrowed the gold redemption mechanism even further when, in 1934, Roosevelt limited redemption to foreign governments. As long as foreign governments and the public were joined by a market, then excess notes could be sold to these governments and returned to the U.S. for gold at the official price. The free market price and the U.S.'s official price would converge and a gold standard would still be in effect.

Things didn't work that way. After it entered WWII, the U.S. continued to buy and sell gold to governments at $35, but gold traded far above that level in so-called free gold or premium markets in Zurich (see chart below), Paris, Beirut, Macau, Tangiers, Hong Kong, and elsewhere. The existence of premium markets continued through the 1940s and well into the 1950s.

While private dealers have incentives to engage in arbitrage, national governments are driven by political motives. Governments no doubt could have earned large profits by buying gold from the U.S. at $35, shipping it home, and selling it in their domestic free gold markets at $45 or $50, but they chose not to, most likely to avoid raising the ire of American officials.

The monetary system in the 1940s and 1950s was a malfunctioning ETF. For various reason the authorized participants (ie. foreign governments) were not arbitraging differences between the price of the ETF and the underlying, and the ETF was therefore wandering from its appropriate price.

With the redemption mechanism compromised, the supply of U.S. monetary liabilities in circulation could exceed the demand, the result being that the market price of dollars sagged to a discount to their official price. Bretton Woods, with its multiple prices for gold, was not a gold standard, at least not yet.

The London gold market

It was only in 1954 that the so-called "free gold" price in Zurich and elsewhere finally converged with the official price of $35. This happened more by accident than purposeful arbitrage conducted via the redemption mechanism. On the supply side, the Soviets were bringing large supplies of "red gold"  to sell on free markets while the South Africans were diverting more gold away from official buyers in order to earn wider margins. At the same time, the end of the Korean War was reducing safe haven demand.

Source: The Economist

Once parity between free gold prices and the U.S. official price was established, the London gold market reopened for business. London had always been the largest gold market in the world, far eclipsing Paris, Zurich, and the rest. Its re-opening had probably been delayed for face-saving reasons. Given that the Brits and the Americans effectively ran the world's monetary system, they could safely ignore premium markets in Zurich and Paris. But the existence of a British gold price in excess of the official price would have been embarrassing. Upon the market's reopening, British authorities limited the ability of locals to buy on the market (they could freely sell) but put no restrictions on the ability of foreigners to participate in the London gold market.

From the time it opened in 1954 to 1960 the London price was well-behaved, staying locked in line with the official price. In October 1960, however, speculators took over control of the London gold market and sent the price of gold to an intraday high of $40, well above its official price of $35. Rather than arbitraging the market by buying from the U.S. Treasury at $35 and selling in London at $40, foreign central banks stepped aside.

The London gold pool

The authorities' response to the 1960 gold crisis is what finally turned Bretton Woods into a real gold standard, at least in my opinion. While the U.S. had ignored premium markets in the 1940s and early 50s, they couldn't ignore a premium market in their own backyard. At the behest of the U.S., the London gold pool was formed. Under the management of the Bank of England, the pool assembled a gold war chest with contributions from the U.S., U.K., Germany, Holland, France, Italy, Belgium, and Switzerland. Whenever gold rose above $35.20, the pool sold gold on the London market in order to keep the price steady. When it fell to $34.80, it bought in order to support the price. The existence of the pool was never officially declared, but everyone knew it was in operation and had the task of setting the London gold price.

This effectively created a functioning gold standard. Before, the only mechanism connecting the public's excess dollars with the U.S.'s gold was the somewhat unpredictable predilection of foreign governments to buy that excess and exercise the right to return it for redemption. Now the public could deal directly with the U.S. government by selling on the London gold exchange to the U.S.-led London gold pool, which guaranteed a price of at least $35.20.

And as the chart below shows, the pool worked pretty well for the next few years, keeping the price of gold in a narrow range. However, the devaluation of the British pound in 1967 and the departure of the French from the gold pool shook confidence in the $35 peg. The system imploded in March 1968 when a steady jog into gold accelerated into an all out run. Rather than continue to bleed gold to speculators, the London gold pool disbanded and the price of gold in London shot up to over $40, well above the official price of $35.20.

But from 1961 to 1968, the world pretty much had a gold standard. Or, put differently, thanks to the opening of the London gold market and the arming of the London gold pool, the world's monetary system between 1961 and 1968 did pretty much everything that the  gold standard of the 1800s did. After 1968, the U.S. dollar slid back into its earlier Bretton Woods pattern of having more than one price in terms of gold; the $35 official price and the "free" London price. This was no gold standard. When Nixon famously dismantled the already-narrow redemption mechanism in 1971, most of the damage had already been done.

Freshwater macro, China's silver standard, and the yuan peg

1934 Chinese silver dollar with Sun Yat-sen on the obverse side. The ship may be in freshwater.

I have been hitting my head against the wall these last few weeks trying to understand Chinese monetary policy, a project that I've probably made harder than necessary by starting in the distant past, specifically with the nation's experience during the Great Depression. Taking a reading break, I was surprised to see that Paul Krugman's recent post on the topic of freshwater macro had surprising parallels to my own admittedly esoteric readings on Chinese monetary history.

Unlike most nations, China was on a silver standard during the Great Depression. The consensus view, at least up until it was challenged by the freshwater economists that people Krugman's post, had always been that the silver standard protected China from the first stage of the Great Depression, only to betray the nation by imposing on it a terrible internal devaluation as silver prices rose. This would eventually lead China to forsake the silver standard. This consensus view has been championed by the likes of Milton Friedman and Anna Schwartz in their monumental Monetary History of the United States.

This consensus view is a decidedly non-freshwater take on things as it it depends on features like sticky prices and money illusion to generate its conclusions. After all, given the huge rise in the value of silver, as long as Chinese prices and wages—the reciprocal of the silver price—could adjust smoothly downwards, then the internal devaluation forced on China would be relatively painless. If, however, the necessary adjustment was impeded by rigidities then prices would have been locked at artificially high levels, the result being unsold inventories, unemployment, and a recession.

Just to add some more colour, China's internal devaluation was imposed on it by American President Franklin D. Roosevelt in two fell swoops, first by de-linking the U.S. from gold in 1933 and then by buying up mass quantities of silver starting in 1934. The first step ignited an economic rebound in the U.S. and around the world that helped push up all prices including that of silver. As for the second, Roosevelt was fulfilling a campaign promise to those who supported him in the western states where a strong silver lobby resided thanks to the abundance of silver mines. The price of silver, which had fallen from 60 cents in 1928 to below 30 cents in 1932, quickly rose back above its 1928 levels, as illustrated in the chart below. According to one contemporary account, that of Arthur N. Young, an American financial adviser to the Nationalist government, "China passed from moderate prosperity to deep depression."

As I mentioned at the outset, this consensus view was challenged by the freshwater economists, no less than the freshest of them all, Thomas Sargent (who was once referred to as "distilled water"), in a 1988 paper coauthored with Loren Brandt (RePEc link). New data showed that Chinese GDP rose in 1933 and only declined modestly in 1934, this due to a harvest failure, not a monetary disturbance. So much for a brutal internal devaluation.

According to Sargent and Brandt, it appeared that "that there was little or no Phillips curve tradeoff between inflation and output growth in China." In non econo-speak, deflation.not.bad. They put forth several reasons for this, including a short duration of nominal contracts and village level mechanisms for "haggling and adjusting loan payments in the event of a crop failure." In essence, Chinese prices were very quick to adjust to silver's incredible rise.

Four years later, Friedman responded (without Schwartz) to what he referred to as the freshwater economists' "highly imaginative and theoretically attractive interpretation." (Here's the RePEc link). His point was that foreign trade data, which apparently has a firmer statistical basis than the output data on which Sargent and Brandt depended, revealed that imports had fallen on a real basis from 1931 to 1935, and particularly sharply from 1933 to 1935. So we are back to a story in which, it would seem, the rise in silver did place a significant drag on the Chinese economy, although Friedman grudgingly allowed for the fact that perhaps he may have "overestimated" the real effects of the silver deflation.

So this battle of economic titans leads to a watered-down story in which Roosevelt's silver purchases probably had *some* deleterious effects on China. China would go on to leave the silver standard, although what probably provided the final nudge was a bank run that kicked off in the financial centre of Shanghai in 1934. Depositors steadily withdrew the white metal from their accounts in anticipation of some combination of a devaluation of the currency, exchange controls, and an all-out exit from the silver standard, a process outlined in a 1988 paper by Kevin Chang (and referenced by Friedman). This self-fulfilling mechanism, very similar in nature to the recent run on Greece, may have encouraged the authorities to sever the currency's linkage to silver and put it on a managed fiat standard. The Chinese economy went on to perform very well in 1935 and 1936, although that all ended with the Japanese invasion in 1937.

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As I mentioned at the outset, these events and the way they were perceived by freshwater and non-freshwater economists seem to me to have some relevance to modern Chinese monetary policy. As in 1934, China is to some extent importing made-in-US monetary policy. The yuan is effectively pegged to the U.S. dollar, so any change in the purchasing power of the dollar leads to a concurrent change in the purchasing power of the yuan.

There's an asterisk to this. In 1934, China was a relatively open economy whereas today China makes use of capital controls. By immobilizing wealth, these controls make cross-border arbitrage more difficult, thus providing Chinese monetary authorities with a certain degree of latitude in establishing a made-in-China monetary policy.  But capital controls have become increasingly porous over the years, especially as the effort to internationalize the yuan—which requires more open capital markets—gains momentum. By maintaining the peg and becoming more open, China's monetary policy is getting ever more like it was in 1934.

As best I can tell, the monetary policy that Fed Chair Janet Yellen is exporting to China is getting tighter. One measure of this, albeit an imperfect one, is the incredible rise of the U.S. dollar over the last year. Given its peg, the yuan has gone along for the ride. Another indication of tightness in the U.S. is Scott Sumner's nominal GDP betting market which shows nominal growth expectations for 2015 falling from around 5% to 3.2%. That's quite a decline. On a longer time scale, consider that the Fed has been consistently missing its core PCE price target of 2% since 2009, or that the employment cost index just printed its lowest monthly increase on record.

If Chinese prices are as flexible as Brandt and Sargent claimed they were in 1934, then the tightening of U.S. dollar, like the rise in silver, is no cause for concern for China. But if Chinese prices are to some extent rigid, then we've got a Friedman & Schwartz explanation whereby the importation of Yellen's tight monetary policy could have very real repercussions for the Chinese economy, and for the rest of the world given China's size.

Interestingly, since 2014 Chinese monetary authorities have been widening the band in which the yuan is allowed to trade against the U.S. dollar. And the peg, which authorities had been gently pushing higher since 2005, has been brought to a standstill. The last time the Chinese allowed the peg to stop crawling higher was in 2008 during the credit crisis, a halt that Scott Sumner once went so far as to say saved the world from a depression.

Chinese GDP [edit: GDP growth] continues to fall to multi-decade lows while the monetary authorities consistently undershoot their stated inflation objectives. In pausing the yuan's appreciation, the Chinese authorities could very well be executing something like a Friedman & Schwartz-style exit from the silver standard in order to save their economy from tight U.S. monetary policy. This time it isn't an insane silver buying program that is at fault, but the Fed's odd reticence to reduce rates to anything below 0.25%. Further tightening from Yellen may only provoke more offsetting from the Chinese... unless, of course, the sort of thinking underlying Wallace and Brandt takes hold and Chinese authorities decide to allow domestic prices to take the full brunt of adjustment.

Gilded cage

This blog wouldn't be around if it wasn't for gold bugs.

Many moons ago my former-employer (and friend), the truest gold bug you'd ever meet, would lecture everyone in the office for hours about imminent hyperinflation, the wonders of the gold standard, and why gold should be worth $10,000. Fascinated, but unsure what to make of his diatribes, I started to read about the history of monetary systems, all of which would eventually provide grist for this blog.

A gold bug will typically have the following characteristics. 1) An abnormally-sized portion of their investing portfolio will be allocated to the yellow metal; 2) they believe in an eventual 'day of reckoning' when gold's price rises into the stratosphere, the mirror image of which is hyperinflation; 3) their investing case for gold is twinned with strong moral view on the decrepitude of the current monetary system and/or society in general; and 4) they are 100% sure that the monetary system's collapse will lead to the flowering of a new and virtuous system, a gold standard.

One thing I discovered fairly early on from my interactions with the gold bug community is that there's no point in debating a gold bug. In any debate, you should be able to ask your opponent what evidence they'd accept as proving their idea to be wrong. Gold bugs are loathe to submit such a list. After all, to do so would open up the possibility that they might have to precommitt themselves to changing their mind, which is the last thing they want to do. A gold bug's ideas are comforting to them. They've structured their entire mental landscape around these ideas, not to mention their entire life's savings and often careers around them.

Gold bugs have a powerful set of defense mechanisms to protect their ideas from outside threat. These mechanism, I'll call them 'mental bodyguards', will kill on sight any idea or bit of evidence that runs contrary to the gold bug schema, thus saving the gold bug from the discomfort, and potential danger, of having to weigh each new bit of data on its own merit.

For instance, consider the fact that central bank money was unmoored from the gold peg in 1968 (almost 50 years ago!). The monkeys behind the wheel should have caused hyperinflation by now and all those financial Noahs who were smart enough to jump into the gold boat before the fiat flood should be fabulously wealthy. But gold trades at just $1200 or so, not far above $850 levels set in 1980. Except for a few exceptions like Zimbabwe, hyperinflation hasn't happened.

Gold bugs can rationalize this contradiction because they possess a 'mental bodyguard' that absolves them of any responsibility for the timing of their predictions. Like the Millerite movement—which predicted the second coming of Jesus Christ on March 21, 1884, only to have to push the date to April 18 when nothing happened, and when that day passed uneventfully, bumped the event to October 22—gold bugs can keep pushing the day-of-reckoning further into the future without suffering any mental dissonance. Using an even more impressive bit of mental-Aikido they turn disconfirmation into a positive. The longer gold's meteoric rise is forestalled, say gold bugs, the more time it provides true believers with an opportunity to accumulate a larger stash of the stuff.

Another powerful mental body guard is the invocation of "them". Gold bugs invariably blame vague external and impersonal forces for wreaking havoc on the noble intentions of gold bugs and the upwards trajectory of the metal's price. They  may be the Federal Reserve, the plunge protection team, or a cabal of Jewish bankers (politically-correct gold bugs just blame Goldman Sachs). When gold falls in price it's always because of the the machinations of these oppressors, without which the metal would be worth $12,000 or $13,000 by now. (Yes, gold bugs like to refer to gold as "the" metal, presumably to differentiate it from all the plebeian metals)

Thanks to the them mental body guard, the inability of gold bug predictions to be borne out in reality is never due to any inherent weakness in the ideas themselves, but to outside interference. Doubts are conveniently refocused on something external like Ben Bernanke and the Fed, upon which gold bugs regularly bestow two minute hates.

Other mental bodyguards that prove useful in protecting the core gold bug ideology include the knee jerk discredit that gold bugs level at both the economics profession and economic data. Gold bugs screen out economists by deriding them as mainstream and therefore (obviously!) puppets of the system. The shoot-first assumption of guilt spares gold bugs from having to engage with these economists' potentially contradictory ideas on a level playing field. The same goes for inflation data, which they dismiss out of hand as being 'cooked'. And if you try mentioning the MIT Billion Prices Index to them, they hum loudly and put their fingers in their ears. (Although when there's any sort of divergence between the BPI and CPI, they suddenly start to make noise).

The awful returns that gold and especially gold shares have provided over the decades have impoverished many gold bugs as well as those unlucky enough to listen to them. Yep, I've seen the year-end statements. Yet somehow the gold bug meme continues to limp on. That's because gold bugs are less concerned about making money than upholding "the cause", as they like to refer to it. The cause is a vague combination of the promotion of a gold standard and a +$10,000 gold price, where simply holding gold through all downturns is an expression of support for that cause. Mere financial losses cannot keep them down.

Now I've been tough on the gold bugs in this post, but the fact is that gold bugs would probably say that both myself and any of their many accusers harbour mental body guards of our own. And the gold bugs probably wouldn't be entirely wrong. With so much time and energy having been invested in the various things we know and believe, a bit of cognitive dissonance is only natural. I'd argue that the gold bugs having walked much further out along that plank than their critics.

This post won't change the minds of any gold bugs—as I already pointed out, they've made up their minds long ago. But if you're a busy individual with some money to invest, and you're considering a gold bug advisor, remember that the fate of your investment may take second seat to the gold bug's devotion to the cause. Be wary.

A brief history of the Guinea

1685 Guinea with the bust of James II (link)

The guinea makes a fascinating story because its evolution reveals so many different monetary phenomena. It began its life in 1663 in the Kingdom of England as a mere coin, one medium of exchange in a whole sea of competing exchange media that included crowns, bobs, halfpennies, farthings, not to mention all the foreign coins that circulated in England, Bank of England paper notes, as well as the full range of portable property—like jewelery and art—and property-not-so-portable, say houses and land and such. If things had stayed that way, the guinea's life would be a boring one and I wouldn't be writing about it.

But in the late 1600s the guinea crossed a line and became a very different thing. Rather than functioning as just one exchange medium among many, the guinea suddenly emerged as one of Britain's two media of account, the items used to define a nation's unit of account, in this case the £. Within a few decades it had wrested the medium of account function for itself, holding this pre-eminent spot until 1816, at which point the guinea was decommissioned.

Interestingly, while the guinea ceased to exist in 1816, its memory was sufficiently strong that it continued to function as a unit of account, albeit a relatively unimportant one, well into the 1900s. More on that later.

Just a regular coin

Whereas most of England's coinage at the time was silver,  the guinea was a gold coin. Introduced in 1663 during the reign of Charles II, it was initially rated at 20 shillings, or one pound (£), by the monetary authorities (the mint and the king). Pounds, shillings, and pence, or £sd, comprised the English unit of account—the set of signs that merchants affixed to their wares to indicate prices. The pound unit had been defined in terms of silver coins for centuries, but the the decision by the mint to give a 1 pound (or 20 shilling) rating to the guinea meant that the pound would now be dually defined in terms of both gold and silver coins.

However, according to Lord Liverpool, both the public and the authorities ignored this 20 shilling rating so that a market-determined price emerged for the guinea. In this way the guinea was no different from any other item of merchandise; its price floated independently according to the whims of buyers and sellers.

This stands in contrast to England's silver coinage. Silver pennies, halfpennies, and farthings had an extra function; they served as the nation's medium of account. The pound unit, the £, the symbol with which merchants set prices or denominated debts, was defined by the nation's silver coinage. Put differently, by setting a farm's price at £10, a seller was stipulating that the farm was worth the amount of silver residing in a collection of pennies and farthings.

When something serves as the medium of account, it's price doesn't float independently. Rather, the whole universe of other prices shifts to accommodate changes in the value of the medium of account. For example, if the value of silver were to have risen in the 1670s due to increased demand for silver jewelery, then the entire English price level would have had to fall. Alternatively, if the amount of silver in the nation's coinage was debauched, then the English price level would have risen. A change in the demand for gold in the 1670s, however, would have produced an entirely different result; the relative price of the guinea would have shifted, but little else. That's why a medium of account is so special. Unlike all other items, the price of everything pivots around it.

The fact that the guinea's initial 1663 rating had been ignored was very important. Imagine that the authorities had been stern about enforcing it. Returning to our farm example, in setting the farm's price at £10, our seller would have been stipulating that the farm was worth either the amount of sliver residing in a collection of pennies and farthings, or the amount of gold residing in the guinea. A very different monetary system would have emerged; bimetallism. But more on that later.

Liverpool tells us that the guinea fluctuated between 21 and 22 shillings in its first decades, but in 1695 its price rose rapidly to 30 shillings. This wasn't because of an increase in the demand for gold but a function of the quickening pace of clipping and sweating of pennies, which reduced the quantity of silver in the coinage. Guineas weren't the only commodity to rise in 1695; the entire array of English prices had to pivot around the diminishing value of the silver penny. Once the silver coinage was reformed (its silver content being restored) in the Great Recoinage of 1696, the price of guineas quickly returned to 22 shillings.

The switch to bimetallism

Things all changed in 1697 when the Exchequer, the department responsible for receiving taxes, announced that all guineas were to be accepted by the Exchequer's tellers at 22 shillings. Prior to then, the Exchequer had accepted guineas at the going market rate. As Sykes points out, after 36 years of floating this was tantamount to fixing the price of the guinea relative to silver. Guinea couldn't circulate for less than this stipulated amount, say 21 shillings, because an arbitrageur would mop up those guineas at 21 shillings and use them to pay 22 shillings worth of taxes, earning him or herself a 1 shilling gain. (The next year, the Exchequer would reduce this rate to 21 shillings 6 pence.)

Britain, which had been on a silver standard up to 1697, was now on a bimetallic standard, with the £ unit defined as the amount of silver residing in the English penny, and simultaneously the amount of gold residing in the guinea.

The guinea takes over

The problem with the new standard was that in setting the guinea at 21s 6p, the Exchequer had overvalued gold relative to the market price, more specifically the silver-to-gold ratio prevalent in the rest of the world. By how much? In 1702 Sir Isaac Newton, Master of the Mint since 1699, concluded that 'Gold is therefore at too high a rate in England by about 10 pence or 12 pence in the Guinea.' In other words, the Exchequer should have announced it would only accept guineas at around 20s 6p, or 4.6% less than it had.

What were the consequences of this over-valuation? All of the silver pennies began to leave Britain, gold coins filling the void. Given the choice between paying a debt or a tax in either an overvalued or undervalued instrument, people will always select to use the overvalued one. After all, buying 20 shillings 6 pence's worth of gold in France and using it to discharge a 21s 6p shilling tax liability in England resulted in a 4.6% profit (less transportation and minting costs). The undervalued instrument, in this case silver, is best used in other parts of the world where it is capable of purchasing a larger real amount of goods (or discharging a larger real quantity of taxes) than in the country in which it is artificially undervalued. This is, of course, Gresham's law; the bad drives out the good.

So our guinea, which had started its young life as a mere medium of exchange, had not only graduated to becoming one of only two English media of account, but was responsible for the mass flushing out of silver from England.

By 1717, the silver outflow was getting significantly bad that the authorities decided to do something about it. Newton, still Master of the Mint, noted that the market price for the guinea was around 20s 8d, given the exchange rate between silver and gold in other European markets, and suggested an initial rate reduction from 21s 6d to 21 shillings.

But even at this lower price the English authorities were still overvaluing the yellow metal. They had now fixed the silver to gold ratio at 15.069 to 1, but because the rate was 14.8 to 1 in Holland and France, a profit still remained on exporting silver and importing gold. This silver outflow would continue over the decades until most silver was gone. England had gone from a bimetallic standard to a monometallic standard. Though it was still de jure bimetallic, de facto it had become a gold standard. And the guinea, which was now the controlling element in English prices, was to blame (or at least the decision to misprice it was).(1)

The end of the guinea

For the next century, the English price level pivoted around the value of the gold guinea, until the Great Recoinage of 1816, at which point the guinea's life suddenly came to an end. Since the days of Isaac Newton, the guinea had been awkwardly rated at 21 shillings, or one pound one shilling. This must have made payments somewhat arduous since there was no coin that could satisfy an even 1 pound bill or debt, and people like round numbers. The decision was made to introduce a less awkward gold coin, the sovereign, with slightly less gold. The sovereign was conveniently rated at exactly 1 pound, or 20 shillings, the upshot being that the pound unit of account still contained just as much physical gold as before, but now a coin existed that corresponded with the exact pound unit. The guinea was dead.

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Well, not entirely. Though is was no longer being minted, the guinea continued to be used as a way to price items. According to Willem Buiter (pdf), auction houses and "expensive and pretentious shops" continued to set prices in terms of guineas through the 1800s and 1900s. Bespoke tailoring and furniture, for instance, was quoted in the legacy gold coin. The unit used was g, or gn, with the plural being gs or gns, although payments were made in sovereign coins or Bank of England notes.

Gillette advertisement (link)

Doctor's and lawyer's fees, often known as "Guinea fees" we're advertised in terms of the legacy gold coin. Whereas common laborers were paid in pounds, payments in guineas was considered more gentlemanly. You can see it pop up in the literature of the time. In Arthur Conan Doyle's Sherlock Holmes tale the Adventure of the Engineer's Thumb a stranger offers Mr Hatherly, a hydraulic engineer who is down on his luck, a unique proposal. "How would fifty guineas for a night's work suit you?"

An ad from 1929 (link)

The standard rate paid by Charles Dickens for contributions to his weekly periodicals Household Words and All The Year Round was half a guinea a column or a guinea a page. In his novels, the guinea pops up often. In Oliver Twist (set in the 1840s), a 5 guinea reward for information on Oliver is posted by the kind Mr. Brownlow.

In more modern times, horses continue to be auctioned in terms of guineas.

Dancing Rain sold for 4 million guineas (link)

Now of course this is a bit of a come-down for the once almighty guinea. Serving as the unit at Tattersalls isn't the same as underpinning the entire price level. But at least its better than the sovereign, the coin that replaced the guinea, which has gone silent, or most other medieval coins for that matter, which neither circulate nor serve as legacy units.

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(1) The 1717 reduction of the guinea to 21 shillings was accompanied by the requirement that those guineas be accepted as legal tender at that price. Prior to then, only silver had functioned as legal tender, meaning that a debtor could only discharge a debt with silver coins. After the change, a debtor could choose to use either guineas or silver coins to pay off their debt, a decision made easier given gold's overvaluation.

Some References:

Lord Liverpool, A Treatise on the Coin of the Realm, 1805.
Sargent & Velde, The Big Problem Of Small Change, 2001.
Selgin, Good Money, 2008.
Sykes, Banking and Currency, 1905. 
Macleod, Bimetallism, 1894.

From intimate to distant: the relationship between Her Majesty's Treasury and the Bank of England

James Gillray, a popular caricaturist, drew the above cartoon in 1797. In it, England's Prime Minister William Pitt the Younger is fishing through the pockets of the Old Lady on Threadneedle Street -- the Bank of England -- for gold. At the time, England was in the middle of fighting the Napoleonic wars and its bills were piling up.

According to its original 1694 charter, the Bank of England was prohibited from lending directly to the Treasury without the express authority of Parliament. Over the years, the Bank had adopted a compromise of sorts in which it provided the government with limited advances without Parliamentary approval, as long as those amounts did not exceed £50,000. In 1793 Pitt had this prohibition removed and in formalizing the Bank's lending policies, imposed no limit on the amounts that could be advanced by the Bank.

Thenceforth Pitt made large and continuous appeals to the Bank for loans. Without the traditional Parliamentary check, there was little the Bank could do except satisfy Pitt's demands. As Pitt liberally spent these borrowed funds in Europe, gold began to flow out of England in earnest, a pattern that was compounded by an internal gold drain set off when a small French force invaded Ireland in early February 1797, causing a crisis of confidence in banks. Pitt suspended convertibility of Bank of England notes into gold on February 26. England would not go back onto the gold standard until 1821, some twenty-four years after Pitt had taken it off.

Having removed both Parliament and the gold standard as checks, Pitt had effectively turned the Bank of England into the government's piggy bank. Thus the inspiration for Gillray's caricature of a groping William Pitt. To some extent, Gillray's worries were borne out as a steady inflation began after 1797. However, the Pound's inflation over that period came far short of the terrible assignat hyperinflation that had plagued France only a few years before. The fears so aptly captured in Gillray's caricature were never fully realized.[1]

Back to the future: Ways and Means advances

Pitt's robbing of the old Lady on Threadneedle street illustrates an episode in which the traditional English divide between Bank and State was removed. Both the Treasury and the Bank of England were effectively consolidated into one entity with the Treasury calling the shots.

The last decade or two illustrate the opposite -- the re-erection of walls between Bank and State. If you browse the asset side of the Bank of England's balance sheet, for instance, you'll notice an entry called Ways and Means advances to HM Treasury ("Her Majesty's Treasury"). Ways and means advances are direct loans to the government. They are generally short term, designed to provide the government with temporary financing to plug gaps between expected tax receipts.

Ways and means advances provide the government with an extra degree of freedom because they offer an alternative avenue for funding. Rather than relying on the bond market or the taxpayer for loans, the government can tap its central bank for money. Ways and means advances are very much like banking overdraft facilities. Unlike a regular loan, the borrower needn't provide a detailed account of what the overdraft will be spent on, nor do overdrafts require specific collateral. They are provided automatically and without fuss.

While overdrafts typically come with specified limits and must be paid back on schedule, they don't always turn out that way. William Pitt's machinations secured for himself what was effectively an unlimited overdraft facility to fund the war against Napoleon. A chunk of the British government's WWI expenses were funded by Bank of England Ways and Means advances and though supposedly of a short term nature, these advances took years to pay down. [2]

While any sovereign would welcome the opportunity to directly borrow from a central bank, from the perspective of the lending bank, overdrafts are risky. First, they are illiquid. Other central banking operations, say open market operations, bring a marketable asset onto the central bank's balance sheet, giving the bank the flexibility to rid itself of that asset whenever it sees fit. Secondly, overdrafts are uncollateralized. Should the borrower go bankrupt, the central bank lacks a counterbalancing asset to compensate itself for its loss.

While the Ways and Means overdraft amount to a piddling £370 million, or 0.1% of the Bank's portfolio of assets, in times past it was very large. See the chart below, cribbed from this Bank of England publication.

At various points in the late 1990s, The Bank's Ways and Means overdrafts amounted to as much as £20 billion. Given the fact that the Bank's note issue then stood at around £25 to £30 billion, Ways and Means advances provided as much as 80% of the backing for paper pounds! Insofar as the value of currency is set by the assets that back the issue, the purchasing power of the pound during the 1990s depended very much on the quality of these Ways and Means advances.

Why did Ways and Means advances contract?

In 1997, the government decided that it would cease using the Bank of England as its source for short term financing and instead would turn to money markets. The final changeover occurred in 2000, at which point the Ways and Means balance was fixed at £13.4 billion, and eventually paid down to £370 million in 2008. Thus ended the Treasury's ability to turn to the Bank of England for financing. As for the Bank, it had earned for itself a larger degree of flexibility -- a large and illiquid asset no longer existed on its balance sheet.

There seem to be a few reasons for ending Ways and Means advances. To begin with, the Treasury was already in the process of handing over its control of monetary policy to the Bank of England. Prior to 1998, the Treasury had been responsible for setting rates. Subsequent to 1998, the Bank of England's Monetary Policy Committee has set rates. The decision to freeze and eventually pay down Ways and Means advances went hand in hand with the Bank's increased independence in setting monetary policy.

Secondly, the third stage of European and Monetary Union (EMU) requires that all member nations cease to lend directly to their government. While the United Kingdom is a signatory to EMU, it never proceeded to the third stage, so it was not required to end Ways and Means advances. Nevertheless, given the possibility that it might proceed to the third stage at some future point in time, it probably made sense to plan ahead by ensuring that the government had already established a viable short term financing alternative to the Bank of England.

Dormant, but not dead

While Ways and Means advances are no longer used, the mechanism isn't dead. The interactive chart below illustrates the Bank of England's balance sheet since 2006. Let's remove all component assets except for ways and means advances, the purple series, and see what we get.

As the chart illustrates, after being paid down in early 2008, Ways and Means advances spiked briefly in late December 2008 to £20 billion only to fall back by April 2009 to £370 million. According to this Bank of England report, the explanation for this spike is that the Treasury briefly borrowed from the Bank to refinance loans that the Bank had earlier made to the Financial Services Compensation Scheme and to Bradford & Bingley.

Bradford & Bingley was a failing bank that was nationalized by the UK government in September 2008. The Bank of England had lent around £4 billion in emergency "Special Liquidity Scheme" funds to Bradford & Bingley as it coped with withdrawals. The SLS had been established earlier that year to improve liquidity of the UK banking system. All Bank of England funding via the SLS was indemnified by the Treasury, so any loss that resulted from supporting Bradford and Bingley up until nationalization would have been absorbed by the Treasury, first by taking on the loan itself and funding that loan via ways and means advances from the Bank of England, and then paying the Bank back by April.

The FSCS, the UK's deposit insurance authority, was able to make good on B&B's deposits through a short term loan from the Bank of England, which was quickly replaced by a government loan financed by Ways and Means advances, which in turn was paid down by the government by April.

Just as Ways and Means mechanism provides the government with the ability to meet sudden spending requirements during war, it provided the same during a period of financial crisis.

Where does the Bank of England stand relative to other central banks?

Although the Bank of England has secured itself a significant degree of financial independence relative to the 1990s and Pitt's era, compared to the Federal Reserve/US Treasury relationship the Bank of England/HM Treasury is much tighter. The Fed has been legally prohibited from granting overdrafts to the government since 1980, as I've outlined here. While Bank of England Ways and Means advances are no longer the modus operandi, they haven't been legally struck out of central bank law as they have in the US. Direct advances to the government could be back one day, with a vengeance.

Compared to the Bank of Canada/Department of Finance relationship, the interface between the Bank of England and HM Treasury is fairly tight. As I've outlined here, the Bank of Canada has the ability to directly lend significant amounts to the government over long periods of time. Indeed, the Bank of Canada is currently purchasing record amounts of bonds in government debt auctions, providing the Finance Department with a continuous overdraft of sorts. Few governments in the western world have the ability to harness their central bank in such a manner.

In general I think it's healthy to establish well defined boundaries between a nation's central bank and its executive branch. Ever since John Law's Banque Royale was nationalized in 1718 and then looted by King Louis XV, scholars have been attuned to the dangers of excessive state control over the issuing power of a nation's monopoly monetary body.

That being said, central bank overdrafts needn't necessarily lead to the sorts of hyperinflation seen in Law's day. The Bank of England provided overdrafts to the Treasury for centuries without igniting prices. The gold standard acted to discipline excess use of the overdraft facility, but in modern days a well-publicized inflation target should be sufficient to reign in any silliness. Absent the discipline imposed by inflation targets, the ability to enjoy central bank financing may be too tempting for a sovereign to forgo. Strict limits or all-out bans on overdraft facilities may provide a needed degree of redundancy.

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[1] Most of the information concerning the Pitt era comes from Eugene White and Michael Bordo's British and French Finance During the Napoleonic Wars, as well as Henry Dunning Macleod's excellent Theory and Practice of Banking, Volume I.
[2] I get this from Sayers's The Bank of England, 1891-1944.

QE-zero

Bob Murphy asks if central bank actions taken during the early 1930s might be considered "unprecedented". In the comments I pointed out that during that era an early form of QE was tried. I'm not referring here to the famous 1933 Roosevelt purchases of gold that market monetarists often point to. For instance, see David Glasner here, David Beckworth here, and Scott Sumner here. Scott also has a very interesting paper on the 1933 gold purchasing program (pdf). No, I was referring to the 1932 treasury purchasing program.

I'm going to replicate the simple graphical analysis that market monetarists use in order to look at the 1932 episode. See this post by Lars Christensen, for example, who overlays important monetary events (QE1, QE2, LTRO) over the S&P500.

Here is the context. Prior to 1932, the Federal Reserve system was significantly limited in its ability to embark on large purchases of government securities. This was because of strict backing laws in the Federal Reserve Act that limited eligible backing assets to gold and assets accepted as collateral for Fed discount loans, primarily commercial paper. In effect, the Reserve banks could only purchase government debt to the extent that there was already excess gold and discounted assets on the Reserve bank balance sheets.

This limitation was removed with the passage of the Glass Steagall Act of February 1932, which allowed the Fed to include government debt as backing for notes and deposits. Almost immediately the Federal Reserve began a large scale asset purchasing program that increased the system's government debt portfolio from $743 million at the end of February 1932 to $1413m by May. The program, which I'll call QE0, continued at a slower rate after May, eventually hitting a peak just above $1800m by the end of July 1932. I overlay this on the Dow Jones Industrial Average.

The second chart extends the time frame to include 1933, putting QE0 on a scale with the Roosevelt devaluation.

Gavyn Davies, who has treaded this path before, notes that Milton Friedman and Anna Schwartz declared QE0 to be a success. In their Monetary History of the United States, the two drew attention to the conjunction of QE0 with a lull in bank failures and a "tapering off of the in the decline in the stock of money". They point to the bottoming of industrial production in August, five months after QE0 started, as a sign of its success. In his History of the Federal Reserve, Allan Meltzer also strikes a note of optimism when he discusses QE0, noting many of the same improvements in data that Friedman and Schwartz point to. Meltzer writes that "it seems likely that had purchases continued, the collapse of the monetary system during the winter of 1933 might have been avoided" and notes the rise in stock prices beginning in July as evidence.

But no market monetarist would agree with Friedman and Schwartz's analysis, since the new breed of monetarists take asset prices as the best indication of monetary stance. Scott Sumner points out here, for instance, that US equity markets had one of their fastest two day rallies in history as President Hoover met with Congressional leaders to begin work on Glass Steagall. All good, then, for the market monetarist stance, who like to see rising market prices coincide with easy monetary policy at the zero lower bound. Unfortunately for them that was the end of the rally. Markets continued falling to new lows even as QE0 accelerated. Scott Sumner indeed notes that "In many respects, the period from April to July 1932 was the worst three months of the entire Depression. Commodity prices continued to fall, and both stock prices and industrial production reached their Depression lows in July." Oddly enough, only with the end of the QE0 did stock prices begin to rise again, as the first chart shows, which runs contra to market monetarist thinking.

No wonder then that market monetarists prefer to look at the second chart. In 1933, the conjunction of increases in stock prices with various monetary events, including the departure of the dollar from gold convertibility and Roosevelt's gold purchase plan, is quite striking. This cozy relationship is no doubt the main reason that market monetarists prefer to point to 1933 rather than QE0 for evidence of monetary policy effectiveness at the zero lower bound.

QE0's seeming failure might seem to confirm Murray Rothbard's view that the huge increase in the money supply engendered by QE0 "endangered public confidence in the government's ability to maintain the dollar on the gold standard," leading to a loss of confidence on the part of foreigners who drew out gold, and on the part of Americans who converted deposits into notes. This turned an intended inflation into an unintended deflation. The aboves is also Peter Temin's view, who points out that the purchases reduced confidence, the resulting gold outflow nullifying QE0's potential for expansion.

My reading of Scott Sumner is that the 1932 purchasing program was rendered ineffective because of growing expectations that the dollar would float, leading to gold ouflows and an ensuing general panic in equity markets. In meting out blame for this panic, Sumner emphasizes the role of Congress in engendering uncertainty rather than the Fed's QE0 program. Once the dollar panic was alleviated and the hoarding instinct of foreign central banks and the private sector satiated, markets began their rise in the latter half of 1932.

Hsieh and Romer (pdf), on the other hand, use data on dollar forward rates to show that traders were not particularly worried about a dollar devaluation. If H&R are right, then one can only conclude that there was no dollar crisis, leaving market monetarists with no corresponding event to blame for counterbalancing the inflationary effects of QE0. So QE0, it would seem, was irrelevant -- a non-event. Scott talks about Hsieh and Romer's paper here. It all seems rather tortured to me, and leads me to (somewhat dismally) conclude that one can probably get a set of historical events to say almost anything one wants it to say. This is not a criticism of Scott, but one of economics in general.

All of this leads to current discussion of QE3. The New Keynesians point to the ineffectiveness of QE itself at the zero lower bound. For instance, see Simon Wren Lewis. This view is inherited from John Maynard Keynes who, it would seem, got it from his observations of the failure of QE0 in 1932. Here is Keynes in Chapter 15 of the General Theory:

There is the possibility, for the reasons discussed above, that, after the rate of interest has fallen to a certain level, liquidity-preference may become virtually absolute in the sense that almost everyone prefers cash to holding a debt which yields so low a rate of interest. In this event the monetary authority would have lost effective control over the rate of interest. But whilst this limiting case might become practically important in future, I know of no example of it hitherto. Indeed, owing to the unwillingness of most monetary authorities to deal boldly in debts of long term, there has not been much opportunity for a test. Moreover, if such a situation were to arise, it would mean that the public authority itself could borrow through the banking system on an unlimited scale at a nominal rate of interest.

The most striking examples of a complete breakdown of stability in the rate of interest, due to the liquidity function flattening out in one direction or the other, have occurred in very abnormal circumstances. In Russia and Central Europe after the war a currency crisis or flight from the currency was experienced, when no one could be induced to retain holdings either of money or of debts on any terms whatever, and even a high and rising rate of interest was unable to keep pace with the marginal efficiency of capital (especially of stocks of liquid goods) under the influence of the expectation of an ever greater fall in the value of money; whilst in the United States at certain dates in 1932 there was a crisis of the opposite kind — a financial crisis or crisis of liquidation, when scarcely anyone could be induced to part with holdings of money on any reasonable terms.

The market monetarists, of course, believe in the effectiveness of QE, although announcing a nominal target would greatly improve a purchase program's effectiveness.

This is what Nick Rowe means when he says that there are two types of economists (HT Bob Murphy). There are those who think monetary policy is useless at the zero lower bound, and those who don't. I wonder how much of the divergence between these two traditions has its origins in the data generated by the separate 1932 and 1933 monetary events. If you focused on the latter, you became a monetary policy believer, if you focused on the former you stopped believing.

Other posts on the efficacy of QE or lack thereof:

Stephen Williamson (here and here), Bruegel blog, Richard Serlin, Miles Kimball (here and here), Paul Krugman (here and here), James Hamilton, John Taylor, John Cochrane, Michael Woodford (pdf), and Simon Wren Lewis.

Gold conspiracies

James Hamilton and Stephen Williamson recently commented on the Republican Party platform (pdf) which calls for a commission to investigate possible ways to set a fixed value for the dollar. Here is a fragment from the platform:

Determined to crush the double-digit inflation that was part of the Carter Administration’s economic legacy, President Reagan, shortly after his inauguration, established a commission to consider the feasibility of a metallic basis for U.S. currency. The commission advised against such a move. Now, three decades later, as we face the task of cleaning up the wreckage of the current Administration’s policies, we propose a similar commission to investigate possible ways to set a fixed value for the dollar.

JDH was puzzled about the odd timing of an appeal to the gold standard, given a decade of low (sometimes negative) inflation. I left my thoughts on JDH's blog. Gold bugs tend to be conspiracy theorists... but here I think I've one-upped them by placing them within their own conspiracy theory box:

One theory here is that politics are driven by that class that has enjoyed the most recent financial success. Hard core gold bugs have surely enjoyed plenty of success over the last ten years, and are therefore capable of using their financial clout to get their favored policies onto the radar screen.

Note that the last Gold Commission was brought into law by Jessie Helms in October 1980. Gold had run up from $35 to $850. According to Anna Schwartz, that was the third bit of pro-gold legislation enacted by Helms:

"On his initiative, the right to include gold clauses in private contracts entered into on or after October 28, 1977, was enacted (P.L. 95-147). The program of Treasury medallion sales, in accordance with the American Arts Gold Medallion Act of November 10, 1978, was a second legislative initiative of the senator (P.L. 95-630). He was unsuccessful in subsequent efforts in 1980 to suspend Treasury gold sales and to provide for restitution of IMF gold."

Rumour has it that that Helms was friendly with the gold lobby.

So like the late 70s, the gold lobby's commodity of choice has risen in value, therefore their political agenda benefits from a large financial tailwind.

Just a theory, of course.

On a side note, Hamilton linked to an old paper he wrote called The Role of the International Gold Standard in Propagating the Great Depression (or here). The thrust of his paper is that in a gold standard, speculators are continuously evaluating the probability of changes in a currency's peg to gold. New conditions might cause a speculative run, with both that run and the government's response being potentially destabilizing. Hamilton points out that the run on the dollar in fall of 1931, and the Fed's response to this run - a dramatic increase in discount rates - helped propagate the Great Depression. Here is a paragraph, my emphasis in bold:

It sometimes is asserted that a gold standard introduces “discipline” into the conduct of monetary and fiscal policy where none existed before. Indeed, this was the primary reason that the world returned to an international gold standard during the 1920s. I cannot think of a more naive and more dangerous notion. A government lacking discipline in monetary and fiscal policy in the absence of a gold standard likely also lacks the discipline and credibility necessary for successfully adhering to a gold standard. Substantial uncertainty about the future inevitably will result as speculators anticipate changes in the terms of gold convertibility. This institutionalizes a system susceptible to large and sudden inflows or outflows of capital and to destabilizing monetary policy if authorities must resort to great extremes to reestablish credibility.

To bring Hamilton's point into its modern context, just substitute the word "gold" with the ECB's Target2 settlement system. If gold convertibility can be doubted, so can Greek Euro convertibility into German Euro and vice versa, the parities of which are enforced by Target2. The uncertainty about the alleged fixity of rates has spawned a 1931-type panic out of those euro-currencies most likely to suffer from an adjustment in their conversion ratio. That's why the huge Target2 imbalances are there... more or less for the same reasons the US experienced huge gold outflows in 1931.

The evolving nature of central bank liabilities - from gold convertibility to bond convertibility

In his tradition of imagining alternative monetary systems, Nick Rowe asks if there is any fundamental theoretical difference between how monetary policy worked under the gold standard and how monetary policy works today for a modern inflation-targeting central bank. Nick uses a progression-style of reasoning in which he incrementally adds/subtracts elements to the original gold standard system to arrive at a modern inflation-targeting regime, or what he calls the CPI standard.

His point, and I agree with it, is that the two standards are not fundamentally different - rather, the same core mechanism underlies each system, with only a few modifications here and there. This runs counter to most people's intuition that the gold standard is a totally different beast from our modern system.

Although I criticized some of his points in the comments section, these disagreements stemmed from the fact that what interests me is not so much the evolution of monetary policy, but the evolution of the nature of a central bank liabilities. But this is really just the flip side of Nick's argument, since monetary policy is carried out via central bank liabilities, and updates to central bank monetary policy occur by tinkering with the structure of the liabilities issued by central banks. In essence, mine is the store of value approach to money, in which money is analyzed as a security. That's also why Nick didn't quite understand what I was saying, even though our final meeting place was the same.

Invoking Nick's method, the evolution of central bank liabilities goes something like this. Under a gold standard, the convertibility feature provided by central bank money - when it was exercised - was to be settled in gold by the central bank. The convertibility rate was some fixed quantity of gold. Everyone could directly go to the central bank and enjoy money's gold convertibility feature. Convertibility meant that in the secondary market, the public market for already-issued money, central bank money could purchase the same amount of gold for which it could be converted at the central bank.

Nowadays, the convertibility feature is still there, but it's been updated. Upon exercising central bank money's convertibility feature, the redemption medium is bonds, not gold. You can redeem notes for bonds via open market operations. The redemption rate is no longer fixed. Rather, it is adjusted to ensure that, in the secondary market for central bank money, that money's value relative to goods-in-general falls by 1-3% a year. Only a select few institutions can enjoy this redemption feature, but their participation is enough to ensure that central bank money falls at a 1-3% rate. The exclusivity of the modern redemption option is not entirely unique to our modern system, since even in the waning days of the gold standard central banks began to limit gold conversion to a few select institutions, usually other central banks.