Shifting China’s Export towards the Domestic Market

Henry C. K. Liu

Part I: Breaking Free from Dollar Hegemony
Part II: Developing China with Sovereign Credit

Part III: History of Monetary Imperialism

This article appeared in AToL on  September 26, 2008

Over the course of the 19th century, enough gold was known to have been accumulated by Britain to make it credible for the British Treasury to introduce paper currency backed by its gold to force the demonetization of silver in Europe to advance British monetary imperialism. Many historians inaccurately ascribe to 19th century mercantilism as the policy of accumulating gold for a country through export of merchandise. The fact is that gold accumulation can only be achieved by a purposeful policy of monetary imperialism. Mercantilism under bimetallism gave a trade surplus country both silver and gold. Only monetary imperialism could cause an inflow of gold with an outflow of silver.
Demonetization of Silver turned Gold into a Fiat Currency
In reality, Britain earned gold in the 19th century not from export of merchandise because buyers of British goods had a choice of paying in silver or gold under bimetallism. In reality, Britain accumulated gold by overvaluing gold monetarily all through the 19th century.  This allowed Britain to force the world to demonetized silver and to replace bimetallism with the gold standard after enough of the world’s gold had flowed into Britain to enable the pound sterling, a paper currency back by gold, but essentially a fiat current without bimetallism, to act as a reserve currency for world trade with which to finance Britain’s role of sole superpower after the fall of Napoleon.
With the pound sterling as reserve currency, British banks, operating on a fractional reserve system backed by the Bank of England, the central bank, as lender of last resort, could practice predatory lending all over the world, sucking up wealth with boom and bust business cycles instigated by her predatory monetary policy of fiat paper currency. The strategy worked for more than a century until the end of World War I. Between 1800 and 1914, the main British export was financial capital denominated in fiat pound sterling disguised by the gold standard to be as good as gold. The factor income from banking profits derived from pound sterling hegemony paid for the wealth and luxury that Britain enjoyed as the world’s preeminent power in the century between the fall of Napoleon in 1815 and the start of First World War in 1914, for a whole century.
The demonetization of silver stealthily turned the gold standard into a fiat paper money regime through the officially gold-backed pound sterling because the gold backing it was no longer priced in silver at a fixed rate, or any other metal of intrinsic value for that matter. Gold and only gold became a fiat unit of account set by the British Mint, a fact that made Britain monetary hegemon of the age
An asset that is priced by or in itself has no transactional meaning, even if it is gold. This is because a transaction must involve at least two assets of different value, expressed with different prices in exchangeable currencies. And there must be an agreed upon exchange ratio at the time of the transaction to effectuate a transactional outcome. Even in barter, an exchange ratio between the two assets to be exchanged needs to be agreed upon. For example, an ounce of gold can be exchanged for 15 ounces of silver. An ounce of gold that can be exchanged for another ounce of gold carries no information of transactional value.
Thus the pound sterling, even when backed by gold, was in fact a fiat paper currency because the monetary value of gold is set by fiat devoid of any relationship to any other thing of intrinsic value beside gold itself. Without bimetallism, specie money cannot have any meaning of transactional worth. Currency backed by gold turns into a fiat currency if it can be redeemed at its face value only in gold. The monetary value of gold is not separate from the commercial value of gold. Gold then can fluctuate in purchasing power due to any number of factors, including government policy, but is not fixed to any other metal of intrinsic value at an universally agreed upon ratio.
That a pound sterling is worth another pound sterling is no different than an ounce of gold is worth another ounce of gold. And the market price of gold can be manipulated by the government who is in possession of more gold than any other market participant. This means that any unwelcome speculator can be quickly ruined by the government. This is of course how central banks nowadays intervene in the foreign exchange market for fiat currencies. Central banks with sufficient dollar reserves, a fiat currency, can drive speculators against their national currencies toward bankruptcy.
Before silver was demonetized, the silver/gold ratio was set monetarily at 15.5/1 in England and 15/1 in France, motivating speculators to buy silver with gold in England and buy gold with silver in France for an arbitrage profit of half an ounce of silver for each ounce of gold so transacted in the two countries. This caused a continuous flow of gold to England independent of international trade flows in other commodities. Even when Britain incurred a trade deficit, gold continues to flow into Britain because of the monetary hegemony of the pound sterling.


After silver was demonetized, gold could be exchanged at the British Treasury only for pound sterling notes at the rate of 21 shillings or £1-1s per ounce of gold fixed in 1717. The commercial price of gold in England was set by the British Treasury on par with its monetary value because gold price was denominated in pound sterling. The commercial price of silver or any other commodity in England was also denominated in pound sterling which had a monetary value in gold set by the British Treasury by fiat.
After the demonetization of silver,  no one knew how much silver was worth as money because it was no longer used as money anywhere. Thus there could not be any discrepancy between the commercial price of silver and its monetary value because silver ceased to have a monetary value. Silver then became a commercial commodity like any other commercial commodity, while only gold remained a monetary unit of account accepted in the British Treasury and in other treasuries of countries which observed the gold standard. Countries that refused to join the gold standard saw their currency kept out of international trade and had to pay a penalty of higher interest rates on loans denominated in their non-gold-backed currency.
Further, the Bank of England could issue more pound sterling notes by fiat based on the fractional reserve principle in banking. She only needs to keep enough gold to prevent a run on pound sterling notes for gold at the Bank of England. And since England was in possession of more gold than any other country at the time, Britain under the gold standard became the monetary hegemon, with more money at her disposal than justified by the amount of gold she actually held.  Other gold standard country had to maintain a much higher fractional reserve in gold than Britain and therefore had less money with which to participate in international capital markets. The monetary hegemon could sustain a trade deficit with an inflow of gold cause by monetary policy.
Without a fixed exchange rate regime, each nation could adopt a gold standard unrelated to other nations’ gold standard. For example, the US at $20.67 dollars per ounce of gold and Britain at £3-17s-10.5d per ounce of gold would let the exchange rate between the dollar and the pound sterling work itself out mathematically. This is what a fiat currency regime does, except instead of being valued by a gold standard based on the amount of gold held by the issuing government, the exchange rate of the currency is valued by each country’s monetary policy implications and financial conditions, such as interest rates, balance of payments, domestic inflation rate, fiscal budgets, trade deficits, etc.
The United States, though formally on a bimetallic (gold and silver) standard, switched to gold de facto in 1834 and de jure in 1900. In 1834, the United States fixed the price of gold at $20.67 per ounce, where it remained for a century until 1933, when President Roosevelt devalued the dollar to $35 per ounce of gold, but made it illegal for US citizens to own gold in amount more than $100. Before World War I, Britain had fixed the per ounce price of gold at £3-17s-10.5d, three times the original price of gold set in 1717 which was at one Guinea or 21 shillings. The exchange rate between dollars and pounds sterling, the “par exchange rate”, mathematically came to $4.867 per pound during the period between 1834 and 1914. Between 1914 and 1933, the dollar/pound exchange rate mathematically rose to $2.214 per pound sterling.
On August 25, 2008, a relatively uneventful trading day, the per-ounce market price for silver was $13.45 and that of gold was $829, yielding a silver/gold ratio of 61.6/1. This was 4 times the historical British Mint ratio of 15.5/1. On that same day, the exchange rate between the dollar and the pound sterling, both free floating fiat currencies, was $1.853 per pound sterling, determined by monetary policies of their respective central banks. The exchange rate between the dollar and the pound sterling on that day was less than one third of the “par exchange rate” from 1834 through 1914. The British pound had lost more than a third of its exchange value against the dollar in 94 years while the dollar itself had also fallen against gold by 4,000%, from $20.67 to $829. The dollar had not become stronger, only the pound had become weaker against the dollar. This is because the pound, like all other fiat currencies in the world, has become a derivative currency of the dollar.
John Locke (1632-1704) and David Hume (1711-76) provided considerable refinement, elaboration and extension to the Quantity Theory of Money (QTM), allowing it to be integrated into the mainstream of orthodox monetarist tradition. Locke developed the right of private property based on the labor theory of value and the mechanics of political checks and balances that were incorporated in the US Constitution. Locke, in 1661, asserted the proportionality postulate: that a doubling of the quantity of money (M) would double the level of prices (P) and half the value of the monetary unit.

Hume, in 1752, introduced the notion of causation by stating that variation in M (money quantity) will cause proportionate changes in P (price level). Concurrently with Irish banker Richard Cantillon (1680-1734), Hume applied to the QTM two crucial distinctions: 1) between static (long-run stationary equilibrium) and dynamic (short-run movement toward equilibrium); and 2) between the long-run neutrality and the short-run non-neutrality of money. Hume and Cantillon provided the first dynamic process analysis of how the impact of a monetary change spread from one sector of the economy to another, altering relative price and quantity in the process.
They pointed out that most monetary injection would involve non-neutral distribution effects. New money would not be distributed among individuals in proportion to their pre-existing share of money holdings. Those who receive more will benefit at the expense of those receiving less than their proportionate share, and they will exert more influence in determining the composition of new output. Initial distribution effects temporarily alter the pattern of expenditure and thus the structure of production and the allocation of resources. This is how inflation causes income disparity.
Thus it is understandable that conservatives would be sympathetic to the QTM to maintain the wealth distribution status quo, or if the QTM is skirted, to ensure that the mal-distribution tilts toward those who are more likely to engage in capital formation, namely the rich. This is precisely what happened in the past two decades and caused sharp rises in income disparity. Thus developing economies in need of capital formation would find logic in first enriching the financial elite while advanced economies with production overcapacity would need to increase aggregate demand by restricting income disparity, which free market fundamentalism has failed to do. This is the problem of central banking in market capitalism: it delivers money to those who need it least. This excess money is called capital.

Hume describes how different degrees of money illusion among income recipients, coupled with time natural and artificial delays in the adjustment process, could cause costs to lag behind prices, thus creating abnormal profits and stimulating optimistic profit expectations that would spur business overexpansion and employment during the transition period. These non-neutral effects are not denied by the adherents of QTM, who nevertheless assert that they are bound to dissipate in the long run, albeit often with great damage if the optimism was unjustified. The latest evidence of the non-neutral effects of money is observable in expansion of the so-called New Economy from easy money in the past decades and the recurring collapse of its serial bubbles.

The QTM formed the central core of 19th-century classical monetary analysis, provided the dominant conceptual framework for interpreting contemporary financial events and formed the intellectual foundation of orthodox policy prescription designed to preserve the gold standard. The economic structure in 19th-century Europe led analysts to acknowledge additional non-neutral effects, such as the lag of money wages behind the rise of prices, which temporarily reduces real wages; the stimulus to output occasioned by inflation-induced reduction in real debt burdens, which shifts real income from productive debtor-entrepreneurs to unproductive creditor-rentiers; the so-called “forced saving” effect occasioned by price-induced redistribution of income among socio-economic classes having structurally different propensity to save and invest; and the stimulus to investment imparted by a temporary reduction in the rate of interest below the anticipated rate of return on new capital.

Yet classical quantity theorists tended persistently to minimize the importance of non-neutral effects as merely transitional. Whereas Hume tended to stress lengthy dynamic disequilibrium periods in which money matters much, classical analysts focused on long-run equilibrium in which money is merely a veil. Ricardo, the most influential of the classical economists, thought such disequilibrium effects ephemeral and unimportant in long-run equilibrium analysis. Gods, of course, enjoy longer perspectives than most mortals, as do the rich over the poor. As John Maynard Keynes famously said: “In the long run, we will all be dead.”
As leader of the Bullionists who advocated immediate and full-par resumption of convertibility of notes in gold, Ricardo charged that inflation in Britain was solely the result of the Bank of England’s irresponsible over-issue of money, when in 1797, under financial stress from the Napoleonic Wars, Britain left the gold standard for inconvertible paper. At that time, the Bank of England was still operating as a national bank, not a central bank in the modern sense of the term. In other words, it operated to improve the English economy rather than to strengthen the sanctity of international finance by protecting the value of money against inflation. Ricardo, by focusing on long-term equilibrium, discouraged discussions on the possible beneficial output and employment effects of monetary injection on the national level. Like modern-day monetarists, Bullionists laid the source of inflation, considered a decidedly evil force in international finance, squarely at the door of the national bank.
Milton Friedman declared some two centuries after Richardo: “inflation is everywhere a monetary phenomenon.” Friedman’s concept of “money matters” is the diametrical opposite of Hume’s view of money that most monetary injection would involve non-neutral distribution effects. This has been the result of Greenspan’s abusive use of liquidity to moderate the business cycle by creating price bubbles.

The historical evolution in 18th-century Europe from a predominantly full-metal money to a mixed metal-paper money forced advances in the understanding of the monetary transmission mechanism. After gold coins had given way to banknotes, Hume’s direct mechanism of price adjustment was found lacking in explaining how banknotes are injected into the system.

Henry Thornton (1760-1815), in his classic The Paper Credit of Great Britain (1802), provided the first description of the indirect mechanism by observing that new money created by banks enters financial markets initially via an expansion of bank loans, by increasing the supply of lend-able funds, temporarily reducing the interest rate below the rate of return on new capital, thus stimulating additional investment and loan demand. This in turn pushes prices up, including capital good prices, drives up loan demands and eventually interest rates, bringing the system back into equilibrium indirectly.

The central issue of the doctrines of the British classical school that dominated the first half of the 19th century was focused around the application of the QTM to government policy, which manifested itself in the maintenance of external equilibrium and the restoration and defense of the gold standard. Consequently, the QTM tended to be directed toward the analysis of international price levels, gold flow, exchange-rate fluctuations and trade balance. It formed the foundation of mercantilism, which underpinned the economic structure of the British Empire via colonialism, which reached institutional maturity in the same period.  But it was the British who discovered that gold flow was guided by Gresham’s Law of bad money driving out good, and caused gold to flow into Britain by purposefully overvaluing its monetary ratio to silver.

Bullionists developed the idea that the stock of money, or its currency component, could be effectively regulated by controlling a narrowly defined monetary base, that the control of “high-power money” (bank reserves) in a fractional reserve banking regime implies virtual control of the money supply. High-power money is the totality of bank reserves that would be multiplied many times through the money-creation power of commercial bank lending, depending on the velocity of circulation. Under the gold standard, bank reserve can take of form of gold or bank notes.
In the three decades after Britain returned to the gold standard in 1821, the policy objective focused on the maintenance of fixed exchange rates and the automatic gold convertibility of the pound. But the Currency School (CS) versus Banking School (BS) controversy broke out over whether the “Currency Principle” of making existing mixed gold-paper currency expands and contracts 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 that demonetized silver, shrinking the money supply and caused severe deflation, which Silverites called “The Crime of ’73” as deflation caused farmers to default on their fixed rate mortgages while prices of farm produce fell. The 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 brought back to France the idea of a royal monopoly on the minting of coinage. He minted the first gold écu 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 toretire a significant portion of the public debt as they were accepted as legal tenderby 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 FRF.
Napoleon I in reviving the franc made the mistake of allowing Britain to continue to overvalue gold against silver monetarily. This mistake in monetary policy eventually cost France her financial preeminence 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. 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
The Spanish dollar, know popularly as Pieces of Eight, was a silver coin 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. It 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 Japanes 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
Following Spain, Austria introduced the Guldengroschen in 1486, a large silver specie coin with high purity. The Austrian coin eventually spread throughout the rest of Europe.

Wilhelm von Schröder (1640-1688) advocated a monetary strategy to stimulate the Austrian economy in his 1886 book “Fürstliche 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 Hoernigk’s Oesterreich über 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, p.344). 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 slso 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 the proposal of Schröder. She resorted instead to the conventional path of raising taxes and to borrowing. During the regency of Charles VI’s (1711-1740), Austria borrowed from her allies and sold sovereign debts to anyone who would buy them. 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 which 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 to 1, contributed to the flow of gold to Britain where the ratio was 15.5 to 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, the notes 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 Einlösungs 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 1/2% on silver coins. Banco-Zettel were issued again in 1771 and 1785.
After the war against the Ottoman Empire in 1788 and the war against 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 more paper money were repeatedly issued. The reparation payments imposed on Austria by the Peace of Schönbrunn 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 1 coupon to 5 Banco-Settel notes.

The Consequence of War

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. 

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.

, 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 1 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.

Prussia defeated Austria at the Battle of Königgrätz 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 8 and 4 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 Revolutions of 1848

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, i.e. 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 circulated. By prohibiting the acceptance of such privately-issued token coinages and by issuing sufficient amounts of official divisional coins, the imperial treasurer managed to regain control of the monetary system before the end of 1848.

Latin Monetary
The US Civil War ((1861–65) led to demonetization of silver in the US and the rise of the Republican Party of big finance. After blocking the Silver Republicans from control of the party, the Grand Old Party established the gold standard and became closely linked to British banking interests and shifted the preserved union further from its founding focus of popular democracy.
As the US Civil War began to exercise upward pressure on the market price of silver, Second Empire France (1852-70) under Napoleon III launched a broad initiative to create monetary union in Europe based on standardized silver coinage. It came to be called the Latin Monetary Union (LMU), a forerunner of today’s euro which was established by the 1992 Maastricht Treaty on European Economic and Monetary Union. The LMU came into being in 1865 between France, Italy, Belgium and Switzerland, setting the silver/gold monetary ratio at 15.5/1. To conform to union standard, the alloy/silver content in the French franc was increased from 1/10 to 1/6. Thereafter silver and gold coins of LMU member countries were accepted as legal tender in the whole union but token coins were legal only within countries of origin. Greece joined the LMU in 1868, but Scandinavian countries withdrew in 1870 as a result of Franco-Prussian War. Other countries fixed their coinage to LMU standard without formal membership.
By 1873, the relatively high market value of silver in relation to gold in Europe engineered by Britain’s overvalue of the monetary value of gold in England caused a wave of conversion from silver to gold at the LMU monetary rate of 15.5 ounces of silver to 1 of gold for easy profit by shipping the gold to England for silver to return to Europe to buy more gold to ship to England. In 1873, 154 million francs were exchanged for gold for export to England, over 5 times the amount exchanged in the previous year. Fearing that a massive influx of silver coinage to Europe coupled with a massive outflow of gold to Britain would destroy bimetallism, the LMU member nations agreed in Paris on January 30, 1874 to limit the free conversion of silver temporarily.
By 1878, with no stabilization in the commercial price of silver in sight, minting of silver coinage was suspended entirely. From 1873 onwards, the LMU was on a de facto gold standard under British monetary pressure. The LMU was finally disbanded in 1927 since the gold standard had made it superfluous. Two years later, the gold standard caused the crash of 1929 and brought on the Great Depression and eventually World War I. Switzerland, a neutral nation still with honest banking, continued to mint Swiss silver and gold coins set to LMU bimetal standard until 1967. 
The silver/gold bimetal standard adopted by the LMU at first required little government intervention in foreign exchange markets beyond setting commonly agreed upon monetary standards among member states. This created a direct conflict with British strategy to demonetize silver through the overvaluing of the monetary ratio of gold to silver. After enough gold had flowed into England, she began, as planned, to use the gold standard to financing the expansion of the British Empire by expanding pound sterling money supply without destabilizing international exchange rates. The LMU was standing in the way of this strategy by keeping bimetallism operating. England needed to destroy the LMU by causing the commercial price of silver in Europe to rise against gold and above the monetary silver/gold ratio set by the LMU bimetal regime, making seignoriage costly to LMU member governments.
French Second Empire
The French economy modernized during the Second Empire (1852-70) under Napoleon III (1808-73), the bourgeois emperor who fashioned himself as a reformer and social engineer. The industrialization of France during this period was supported at first by both big business and workers. Yet Napoleon III mongered fear of social radicalism where his heroic uncle promised the vision of a new world order. Architecturally, he resurrected the baroque style of the counter-reformation and infested it with the cultural obesity of vulgarity and ostentatious exhibitionism of the Second Empire. Bonapartism, militarism, clericalism, conservatism and liberalism were incorporated superficially in the new bourgeois political culture. Napoleon III faced a delicate balancing act between the legitimacy conferred by parliamentary liberalism and the need to maintain a police state to control opposition. Napoleon III’s populist authoritarian style of empty substance, both political and esthetical, would since be imitated by every subsequent pint-size dictator.
Some of the supporters of the Second Empire were Saint-Simonians who described Napoleon III as the “socialist emperor.” Saint-Simonians founded a new type of banking institution, in the form of Crédit Mobilier, which sold stock to the public and then used the money raised to invest in industrial enterprises in France. This sparked a period of rapid economic development. It became the model for investment banking in modern times. The discovery of gold in California in 1849 and in Australia soon after greatly increased money supply in Europe which fitted in with the rise of new credit institutions. The new investment banks built large scale projects, such as the Suez Canal at first through state-owned enterprises. With the appearance of private banking, large corporations followed to mobilize capital to build rail roads, the new transportation system that allowed development of landed interior, breaking the trade monopoly of coastal cities.
In 1863, a new law of limited liability was proclaimed by which a stockholder would risk only the par value of his stock regardless of the scale of insolvency and outstanding debt carried by the company. The public, even those with no skill in business and finance, could now invest in enterprises that could operate at a scale beyond what individual shareowners could otherwise do separately. Financiers who were skilled in handling money, credit and securities assumed a new prominence in society. Some became super rich to rival dukes and princes of the feudal age. Industrial growth was accompanied by a decline in deep-rooted morals. The purpose of life transformed into a single-minded quest for easy money through speculation. 
French capital went overseas to develop colonies. In the US, it took the form of Credit Mobilier of America, the builder of the Union Pacific Railroad, which was later engulfed in a major scandal involving the bribing of members of congress with company stocks. The investment company charge $94 million for construction that cost less than $50 million to pay dividends of 348%, a hundred times more than convention.  Four merchants with names that history would immortalize: Leland Stanford (Stanford University), Collins P Huntington, Charles Crocker (Crocker National Bank) and Mark Hopkins (Mark Hopkins Hotel in San Francisco) were part of Credit Mobilier of America. 
High baroque was a style of vulgar exhibitionism preferred by the Second Empire under Napoleon III. George-Eugene Haussmann (1809-91), the influential but insensitive city planner under the imperial dictator, with his wholesale clearance of historical Paris, indiscriminately wiping out ancient picturesque quartiers of uniquely individual character and colorful past, destroyed much of the city’s old charm, not to mention historical landmarks, and replaced them with sterile and brassy monumental white elephants, linked by drab and mediocre avenues devoid of human scale. Armed with the blind zeal of a sanitation engineer, with as much sensitivity for architecture as a circus producer, Haussmann's baroque city planning was also dominated by the political purpose of clearing the rebel-infested urban quartiers in the old city, of the ease of effectively deploying troops on the new, broad boulevards against much-feared popular uprisings, and of preventing the easy erection of revolutionary barricades on narrow streets that had once frustrated government authority in the "Bloody June Days" of the democratic uprisings of 1848.

Unfortunately, Haussmann has since been much imitated by many egomaniac city planners worldwide in modern times, just as his patron, Napoleon III, has been imitated by every pint-size dictator. Washington DC is a classic example of Haussmann urban design. The City beautiful Movement in US city planning is strongly influenced by Haussmann. Victor Hugo (1802-85), the towering figure of French literature, poetry and drama, son of a general under Napoleon Bonaparte, opposed the regime of Napoleon III's Second Empire and lived in exile in protest until after its downfall in 1870. Emile Zola (1840-1902) documented in his series of social-realism novels the abuses suffered by the poor in France during the Second Empire, as Charles Dickens (1812-70) did with the Industrial Revolution in England. The sensational novels of Alexandre Dumas the younger, son of Dumas pere, the best-known of which being Camille, mirrored the pitiless emptiness of Parisian life, while the operettas of Jacques Levy Offenbach, though popularly acclaimed by society during the Second Empire, satirized the mundane values of their naive, applauding audiences.

The Paris Opera (begun in 1861 and opened in 1875), the crown jewel of the Second Empire, the piece de resistance de la Belle Epoque of the bourgeois emperor, was designed by Charles Garnier (1825-98), star student of the state-sponsored Ecole des Beaux-Arts, winner of the Grand Prix de Rome. The building, which would become the model for architecturally mundane opera houses all over the world, failed to herald any worthwhile movement of architecture. With its unabashed flaunting of banal stylistic ostentation, devoid of originality, mindlessly confusing conspicuous consumption with sophisticated elegance, oozing with the vulgarity of the nouveau riche, it was a bourgeois caricature of the much-admired style of the exquisite east facade of the Louvre designed by Claude Perrault (1613-88). Functionally, the horseshoe plan of the Paris Opera House condemned a disproportionately large portion of the audience to obstructed sight lines and inferior acoustics while affording a few boisterous celebrities in the side parterres to compete with the stage for attention. The New York Metropolitian Opera House adopt a horseshoe plan, modified to accommodate 3,700 seats, more that twice the capacity of the Paris Opera, magnified the faults of the Paris Opera while diluting the intimate spatial quality of the horseshoe plan by its oversize.
Conditions in the second half of the 19th century were favorable for industrial expansion due to a confluence of factors. Technology took a big leap forward from a sharp increase of the money supply to turn an eruption of scientific discoveries into new industrial enterprises. The gold rush in California, and later Australia, increased the global money supply operating under the gold standard. The steady rise of prices caused by the increase of the money supply encouraged the forming of joint stock companies that provided respectable returns and prospered from domestic and overseas investments. In France, the mileage of railways in France increased from 3,000 to 16,000 kilometers during the 1850s, and this growth of a new form of land transportation allowed inland mines and factories to operate at higher rates of productivity benefiting continental powers. The 55 smaller rail lines of France were merged into 6 major lines, while new iron steamships fueled by coal replaced wooden sail ships. Between 1859 and 1869, a French joint stock company with the government as the major share owner built the Suez Canal, opening a new chapter in global transportation and trade with Asia.
French Capitalism and Imperialism
The connection of global finance with imperialistic expansion made Britain into a superpower even before the railway age because of the long coast line of the island nation. Following Britain’s example, France under Napoleon III adopted free trade in 1860 and took steps to establish a French colonial empire in Indochina.
In 1680, the French East India Company, which had been chartered by Louis XIV in 1664 to compete with its British and Dutch counterparts, opened a trading post in Pho Hien. In 1858, Napoleon III launched a punitive naval expedition against the Vietnam kingdom with the pretext of punishing Buddhist Vietnamese for their resistance to French Catholic missionaries and forced the Vietnam king to accept a French presence in the country. An important factor in his decision was the belief that France risked becoming a second-rate power by not expanding its influence in East Asia. Also, the idea that France had a civilizing mission was spreading beyond Europe was in the France psyche. This eventually led to a full-out invasion in 1861. By 1862, victory in war created the French Empire in Indochina with a federation of four protectorates (Tonkin, Annam, Cambodia and Laos) and one directly-ruled colony (Cochin-China) with Nanoi as capital. Three ports were opened exclusively to French trade, with free passage of French warships up river, freedom of action for French missionaries. France received a large war indemnity.
In China, France took part in the Second Opium War in support of Britain, and in 1860 French troops entered Peking along side British troops. China was forced to concede more trading rights, allow freedom of navigation of the Yangtze River, permit Christian missionaries to operate on Chinese soil, and give France and Britain huge war indemnity. This combined with the intervention in Vietnam set the stage for further French influence in China leading up to a sphere of influence over parts of Southern China.
In 1866, French naval troops launched a failed attack on Korea in response to the execution of French missionaries, which resulted in the eclipse of French influence in the region. In 1867, a French Military Mission to Japan was sent, which played a key role in modernizing the troops of the Shogun Tokugawa Yoshinobu, and even participated on his side against Imperial troops during the Boshin war.
In Europe, the Franco-Prussian War (1870-71) broke out over the issue of a German Hohenzollern prince for the vacant Spanish throne, a vestige of the Holly Roman Empire, following the deposition of Isabella II in 1868 against a background of historic hostility dating back to the defeat of Napoleon I at Waterloo by a British-Prussian coalition. The war gave Britain an opening to force the demonetization of silver in Europe via its support of Prussia whose Crown Prince was married to a princess daughter of Queen Victoria. The liberal democratic attempt to unify Germany had failed along with the 1848 democratic revolutions. Prussian victory over France of Napoleon III paved the way for German unification on January 23, 1871 through conservative politics of blood and iron engineered by Otto von Bismarck, the welfare statesman who gladly paid the price of demonetizing silver to buy British acquiescence. A unified Germany would rise to challenge British hegemony, resulting in the First World War in 1914.
The Paris Commune of 1871, its Suppression and Political Implications
The Second Empire political culture was a mixed bag of Bonapartism, adventurism, militarism, expansionism, colonialism, clericalism, conservatism and liberalism, particularly in trade and finance. It could only be sustained by victory in foreign wars. The Franco-Prussian War was France’s response to rising Germen challenge against French hegemony in continental Europe. The fate of the Second Empire
depended on a continuing train of victories in foreign war which unfortunately was derailed by the better-led Prussian army.
On September 4, 1870, two days after Emperor Napoleon III surrendered to the Prussian army at the disastrous Battle of Sedan and allowed himself to be taken prisoner, the French emperor was deposed by republican forces in Paris. The end to the Second Empire was proclaimed along with the creation of the Third Republic of France headed by Louis-Adolphe Thiers. 
On March 3, one month after the signing of the armistice with Germany by the new Third Republic, and seventy days before the official end to the war, German troops marched into a Paris of empty streets and shuttered windows, shut down in silent protest by the indignant people of Paris. The Parisians elected a municipal council - the Paris Commune - consisting of moderate republicans, Proudhon anarchists, Blanqui putschists and Marxist worker association members.
On March 18, , to regain control of Paris from Communards, Thiers attempted to seize the cannons of the National Guard, an armed militia of some 260 battalions organized earlier by the fallen government of the Second Empire to help defend Paris against the Prussian siege in the last days of the disastrous Franco-Prussian War, and to use them against the Communards. But the attempt was foiled by the Women of Montmartre who appealed to government soldiers, many of whom refused to fire on the people of Paris and turned their muskets against Third Republic government forces in a gesture of solidarity with the Commune. Within hours Paris was in a state of insurrection, and the Mairies of many arrondisements in the capital came under the control of the National Guard. During these feverish hours, an angry mob seized two commanding government generals, one of whom having been involved in trying to capture the cannons against the people summarily executed them against the wall of a garden in Montmartre. The firing squad included members of the National Guard as well as disgruntled government troops.
Thiers and his provincial government fled to Versailles to join the National Assembly under a majority of Monarchists from previous elections. The Central Committee of the National Guard occupied the abandoned Hôtel de Ville and announced preparations for new municipal elections. On March 26, the left coalition gained enough votes to establish a socialist-oriented ‘Commune’ - which will last until May 28. On March 28, the Commune installed itself at the Hôtel de Ville, and for the next two months ran Paris to implement a program of social reform, while fending off a growing siege from the Versaillais, who advance closer and closer in a singularly brutal war fought on the western edges of the capital.
During its short reign, the Paris Commune proclaimed the separation of church and state and the nationalization of Church property. On April 8, 1871, it removed all representations of religion from the schools of Paris. The Communards tried to introduce a series of radical social measures, e.g., separation of Church and State, establishing a lay education system, opening professional education for women, provision of pensions to unmarried women workers, abolition of night-work for bakers, etc.
On April 11, government troops sent by Thiers began a new siege of Paris. Intense fighting continued into May. After the official end to the war with Prussia on May 10, government troops, free from confronting a victorious enemy that their former emperor had surrendered to, broke through the people’s defense and entered Paris on May 21, and for eight days they overwhelmed Communard resistance street by street. This period was known in history as la semaine sanglante - ‘the bloody week’. In a series of bloody attacks against street barricades across Paris, before finally eliminating the last blocks of Communard resistance in the working class 11th, 19th and 20th arrondisements.  In an orgy of reprisals, up to 20,000 workers and peasants, including children, were killed by a French army under the direction of its most senior generals that had not shown similar élant against foreign enemy soldiers in a foreign war.
Many have since viewed the Paris Commune as a monument of struggle for liberation that provided a symbolic model for a political system based on grass-root participatory democracy. Several Chinese revolutionaries, such as Zhou Enlai and Deng Xiaoping, as young students in France in 1920 inspired by the Paris Commune, formed the nuclear of what later became the Communist Party of China.
The collapse of the Paris Commune was another disappointment on top of the failed Revolutions of 1848 for revolutionaries worldwide, including Marx and Engels. Reactionary hostility to revolution helped elect to the new National Assembly delegates close to the Church and in favor of restoring the monarchy, and in 1873 a monarchist majority forced Thiers to resign. However, with monarchists weakened by internal factional division, moderate Republicans won enough support in France’s parliament to frustrate monarchist aims, and the Third French Republic was born in 1879 to survive until 1940.
Marx and Class Struggle
After the failures of the democratic revolutions of 1848, socialist movements went into abeyance for two decades, until Karl Marx published his “Das Kapital” in 1867  (first English trans. in 1887, 4 years after his death, with Volume II and III, ed. by Engels 1884-94, Eng. trans 1907-9). The manuscript for the fourth volume was edited by Karl Kautsky and published in German as Theroien uber den Mehrwert (3 parts, 1905-10). The full English translation of the 1st part, A History of Economic Theories, was not published until 1952.  Selected translations were published as Theories of Surplus Value in 1951. Yet the spirit of 1848 echoed around the world among the oppressed.
Marx rejected utopian socialism and introduced scientific socialism. Louis Blanc (1811-82), in his Organization du Trvail, published 1840, from which sprung the famous “from each according to his ability, to each according to his needs”, advocated workers cooperatives supported by the state, provided a link between utopian and scientific socialism. Breaking with the tradition of natural rights as a basis for reform, Marx invoked “inevitable” laws of historical premises. Through dialectic materialism, which presumes the primacy of economic determinants in history, the premise of class struggle holds that a specific class can rule only as long as it represents the productive forces of society, and from this historical process, a classless society would eventually emerge.
Class struggle has nothing to do with promoting hatred between classes, as capitalist propaganda fear-mongering would have the world believe. Class struggle leads to the demise of capitalism out of a scientific historical process by the nature of economic concepts such as the labor theory of value and the idea of surplus value. These concepts argue that the value of a commodity is determined by the amount of labor required for its manufacture, not by its exchange value in a market manipulated by capitalists. The value of the commodities meant for purchased by worker wages is set higher than the value of the commodities workers produce with their labor. The difference, called surplus value, is the profit for capitalists who own the capital. When surplus value becomes excessive, overcapacity and insufficient demand will result because workers who produce the products cannot afford to buy them with their low wages. Globalization of trade under dollar hegemony in the 21st century via cross-border wage arbitrage to deny the labor theory of value will lead to the collapse of neo-liberal free market capitalism. It is a scientific phenomenon, unrelated to ideology or morality.
As productivity improves through industrialization, the fruits of production are increasingly kept from the workers who contribute most to its production, through the exploitation of labor by capital via the capitalistic structure in the economy. The workings of this artificial structure are presented as economic laws of the market. If and when these exploitative features of market economy are removed, capitalism will be replaced by socialism as feudalism, having lost its economic function, had once been replaced by capitalism.
It is when the capitalist class employs armed suppression of this evolutionary development that makes revolution by the working class necessary. Socialist revolutionaries seek to destroy only the political structure that insists on foiling the organic evolutionary process from capitalism toward socialism. Capitalism by itself has already exhausted its socio-economic function in history and its demise needs no further coaxing.
The collapse of the Paris Commune of 1871, suppressed with bloody ferocity by the French bourgeoisie, consolidated a reactionary backlash that dissipated the First International, an international socialist organization founded in 1864 which aimed at uniting a variety of different progressive political groups and trade union organizations that were based on advancing the cause of the working class through the theory of class struggle. Marx praised the Paris Commune and introduced the concept of the dictatorship of the proletariat as a defensive countermeasure against anticipated capitalist reactionary barbarism.
By 1880, a popular movement to restore protective tariffs against British commercial dominance emerged, but tariffs were impediments rather than effective barriers, which were finally brought on by the start of the First World War in 1914.  As with the US today, Britain, the finance hegemon in the 19th century, despite the export of manufactured goods of the industrial revolution, consume more goods from abroad than its sent out, with import increasing by eight folds while import increased by ten folds between 1800 and 1900. In the decades before 1914 when the war started, Britain enjoyed an annual import surplus of more than $750 million on average. She was able to do this because of pound sterling hegemony as the US is able to do the same today because of dollar hegemony.
Trade Surplus Denominated in Foreign Currency not a Plus
What many trade economists fail to understand is that a trade surplus is not a plus for an economy when trade is denominated in a foreign currency even if that currency is backed by gold. When trade is denominated in a fiat paper currency backed by military power, a trade deficit by that currency issuing country is pure monetary imperialism against its trade surplus partners. For the monetary hegemon, such as the US after the Cold War, factor income from overseas investment more than out weights loss of domestic factor income from wages.
Council of Economic Advisers chairman Martin Feldstein, a highly respected conservative economist from Harvard with a reputation for intellectual honesty, was not only among the first to understand the obscure relationship between trade deficits and the reserve currency for trade. He was also the first to propose it as US national policy. He pointed out the benefits of a strong dollar in President Reagan’s first term, arguing that the loss suffered by US manufacturing for export was a fair cost for national financial strength derived from a strong currency that had the advantage of being the reserve currency for trade. But such sophisticated views were not music to the ears of the uninformed chauvinistic Reagan White House, nor the Treasury under Donald Reagan, former head of Merrill Lynch, whose roster of clients included all major manufacturing giants which had yet to catch on to the escape valve of outsourcing labor-intensive manufacturing to low-wage countries and that it was more profitable to import low price-goods from overseas than to export non-competitive over-priced goods overseas. Feldstein, given the brush-off by a White House run by astrology, went back to Harvard to continue his quest for truth in theoretical global geo-economics after serving two years in the Reagan White House, where voodoo economics reigned.

Feldstein went on to train many influential economists who later would hold key positions in government, including Larry Summers, treasury secretary under president Bill Clinton and later a failed president of Harvard University; Lawrence Lindsey, dismissed Presidential Economic Advisor to President George W. Bush; and Gregory Mankiew, Chairman of the Bush White House Council of Economic Advisers, who sparked an uproar by saying, in the same intellectual tradition: “Outsourcing is a growing phenomenon, but it’s something that we should realize is probably a plus for the [US] economy in the long run.” Whether that is true depends of course on which part of the US economy one is housed.
The Classical Gold Standard Era
The gold standard was an international standard that determined the value of a country’s currency in terms of other countries’ currencies through the monetary value of gold as expressed in each currency. Because adherents to the gold standard maintained a fixed price for gold, rates of exchange between currencies tied to gold were necessarily fixed. For example, the United States fixed the price of gold at $20.67 per ounce from 1834 until 1933; Britain fixed the price at £3 17s 10.5d per ounce until WWI and restore it in 1925. The exchange rate between dollars and pounds—the “par exchange rate”—necessarily came to $4.867 per pound sterling during these periods.
Other major trading countries joined the gold standard in the 1870s. The period from 1880 to 1914 is known as the classical gold standard era in monetary history. During that time, a majority of trading nations adhered in varying degrees to the gold standard. It was also a period of unprecedented economic growth with relatively free trade in goods, labor, and capital without being hampered by government or market exchange rate manipulation. Between 1880 and 1914, the period when the United States was on the gold standard, inflation averaged only 0.1 percent per year.  This was because the physical supply of gold was in sync with the rate of economic expansion, but because of the endogenous effect of the gold standard. But the demonetization of silver gradually destroyed the myth that the gold standard could keep the value of money stable without the anchor of bimetallism.
Also, stable currency was generally associated with the gold standard partly because international trade during the classical gold standard era was a relatively small portion of all national economies. Trade for Britain was largely an intra-empire affair dominated by the pound sterling. Today, for nations that fall into the trap of excessively high foreign trade dependency, generally viewed as above 35% of GDP in total two-way trade, exchange rate issues related to a reserve currency denominated in foreign fiat currency, such as the dollar, can and will do great damage to their national economies in cyclical financial crises.
Gold Standard Restoration Problems
As noted before, the commercial value ratio between silver and gold was 61.6/1 on August 25, 2008 with the market price for silver at $13.45 and that of gold at $829. The commercial value of gold was four times higher than the monetary value of gold set by bimetallism.  A return to the historical gold standard now would drive any government bankrupt unless gold is set at a monetary value higher than its highest recorded commercial value, which is about $1,000 so far.
The US Treasury now owns 261 million ounces of gold. At its peak in December 1941 it owned 650 million ounces. As of August 30, 2008, the US National Debt was $9.65 trillion. Price of gold required to pay back the national debt with gold held by the US would have to be US$36,983 per ounce. The rise in the price of gold necessary to keep up with the rise in US national debt at current rate is US$8.15 per ounce per day. There is no free market for gold. The price of gold is the most manipulated item of government intervention of the market. When there is no free market for gold, there is no free market for anything else. Free markets have never existed in civilization for that matter. Free market fundamentalism is merely a fantasy.
To restore the gold standard, gold price would have to increase constantly even if there is no inflation because the rate of physical production of new gold is far below the accepted rate of economic expansion in modern time. The monetary inelasticity of gold is the strongest obstacle to a restoration of the gold standard.
World War I and the Decline of Britain
Prior to World War I, Britain’s economy was the world’s strongest, controlling 40% of the world’s investments and 80% of world trade, mostly due to its vast network of colonies. However, by the end of the war, Britain owed £850 million, mostly to the United States, with interest payment taking up 40% of the government’s budget. Attempting to protect her financial advantage against rising German challenge was a fundamental cause of the war. British, spoiled by pound sterling hegemony that had reduced industrial productivity in the British Isles in favor of financial manipulation, having to reply heavily on exploiting the wealth of her colonies, fell into debtor nation status from war spending, allowing the US to become the world’s strong financial power. Even though the British Isles were also exempted from war destruction in WWI, British productivity suffered from the disruption of her network of far-flung colonies. The Federal Reserve under Benjamin Strong after World War I tried to help Britain maintain the gold standard as a way to rebuilt Europe’s war-torn economy under British leadership, a move that contributed significantly to the 1929 crash on Wall Street.
The export of capital meant that an older and wealthier country, instead of using its entire national income to raise the standard of living of its own people by raising wages and investing in better houses and more efficient factories, diverted increasing large portion of the national income for overseas investment to increase trade. Banks of rich countries lend money to banks of less developed countries not to improve the living standard of the borrowing countries, which in turn lent money to support foreign trade in those countries. Capital then came from profit from keeping both domestic and foreign wages low, creating a structural widening of income and wealth disparity both among nations and within nations. Workers of the world over forewent better income to support capitalist of the world.
In the US, economic expansion from the 1850s on was largely finance by French capital and by British capital after the fall of Napoleon III.
By 1914, Britain controlled $30 billion in foreign investment, about one quarter of her national wealth. France controlled $8.7 billion, about one sixth of her national wealth, and Germany controlled $6 billion of overseas investment, at a faster rising pace than the two leaders. It was this German threat to British/French overseas investment supremacy that led to the First World War by the end of which Britain lost about one quarter of her overseas investment, France about one third and Germany the entire amount, all to the US.
Before 1914, world trade was denominated in currencies that adhered to the gold standard anchored by the pound sterling, with London as the preeminent financial center. Trade surpluses and deficits at fixed exchange rates caused inflow and outflow of gold across national borders. Exchange rates could not be manipulated by government or through market forces to correct imbalance of payments. After World War I, with massive gold drained from the British Treasury, Britain was forced to replace the gold standard with a new “gold exchange standard”, basing the pound sterling on the gold-back dollar instead of directly on gold held by Britain. The US, being the world largest creditor nation as a result of war finance, saw her central bank becoming the world’s lender of last resort.
Historical data showed that when New York Fed President Benjamin Strong leaned on the regional Feds to ease the discount rate on an already overheated economy in 1927, the Fed lost its last window of opportunity to prevent the 1929 crash. Some historians claimed that Strong did so to fulfill his internationalist vision at the risk of endangering the US national interest.
While British restoration of the gold standard did not occur officially until April 1925, the decision to re-join the gold standard had effectively been taken some seven years earlier. In the final months of the WWI in 1918, the Treasury and the Ministry for Reconstruction set up the Cunliffe Committee, headed by Lord Cunliffe, former Governor of Bank of England. Committee members included Cambridge neoclassical economist Arthur Cecil Pigou (1877-1959), star student of Alfred Marshall (1824-1924) and intellectual heir to Marshallian orthodoxy of supply/demand and marginal utility. The Committee was to consider the problems of currency and foreign exchange during the reconstruction and “report upon the steps required to bring about the restoration of normal conditions in due course.” It was the forerunner of the post-WWII Bretton Woods Conference.
The Cunliffe interim report in August 1918 concluded that sterling should re-join the pre-war parity of £3 17s 10.5d per ounce of gold, equivalent to $4.86 at $20.67 per ounce of gold, saying “it is imperative that the conditions necessary to the maintenance of an effective gold standard should be restored without delay.”
But before the gold standard restoration decision was implemented, wartime decontrols and pent-up post-war demand released a happy boom in England and the US which history referred to as the Roaring Twenties. British trade deficit widened to cause the exchange value of sterling to fall substantially. Fiscal policy was then tightened and interest rates were raised by the Bank of England to slow demand and support the pound sterling, turning the boom into the 1921 slump in England, creating the steepest recorded recession in British economic history to that date, as unemployment climbed from 1.4% to 16.7% within a year and wholesale prices fell sharply with deflation. Britain, adebtor nation by then, was in no position to go along with the US on a liquidity joy ride.

The deflationary policy stance of the Bank of England brought British prices down towards US levels and put upwards pressure on sterling exchange rate. And the Bank of England felt comfortable enough with the strength the pound sterling to lower interest rates in the summer of 1922 to below US levels. But by the following summer, with sterling again under downward pressure and monetary policy focused on restoring the parity exchange rate to $4.86, interest rates had to be raised again. By 1924, UK interest rates were above US levels.
This monetary policy squeeze achieved its dubious objective of a strong pound sterling. Sterling rose steadily from a low of $3.20 in February 1920 to $4.32 and then up to the pre-war parity of $4.86 in the ten months before the April 1925 decision to re-fix, a 32% currency appreciation to restore the gold standard that had been demolished by the war. After adjusting for what was, despite the post-slump deflation, the relative inflation of wholesale prices, which rose by 60% in the UK between 1914 and 1925 compared to 40% in the US, this translated to a real exchange rate appreciation of well over 10% since 1914.
Historian Robert Skidelsky records that there was general consensus among monetary economists at the time that the gold standard would anchor the value of domestic money and prevent inflation. Bank of England Governor Montagu Norman argued in his Evidence to Parliament that a return to the gold standard would prevent a “great borrowing by public authorities.” Also, the return to gold was seen as necessary to revive world trade and restore Britain’s trading advantage by restoring the pound sterling as a reserve currency. Finally, opinion in the City, the financial heart in London, was near unanimous in the view that a return to gold was necessary to restore it to its former position as the world’s leading banker, and sterling to its former position as the world’s leading currency. In hindsight, many now suspect that the British ruling circle knew that the gold standard without bimetallism was merely a fancy fiat currency regime, and that the gold standard was a fraud.
Winston Churchill, as Chancellor of the Exchequer, said in his April 1925 Budget statement: “If we had not taken this action [restoring the gold standard] the whole of the rest of the British Empire would have taken it without us, and it would have come to a gold standard, not on the basis of the pound sterling. But a gold standard of the dollar.”
For Britain, the 1925 gold standard attempt was a final battle of sterling versus dollar for supremacy. It was Britain’s monetary Waterloo. The then young John Maynard Keynes, later a key framer of the Bretton Woods regime based on a gold-backed dollar, was not against fixing the pound sterling at its pre-war parity with the dollar if circumstances had justified; but he argued that it should not be an object of policy and was especially opposed to a deliberate policy of deflation to bring it about. But Keynes at that time was only a young economist with a lone voice waiting for events to make his views creditable four years later when he was introduced to President Roosevelt by Felix Frankfurter, then a Harvard law professor and later Supreme Court Justice.
The 1925 return to the Gold Standard ended in failure with sterling devaluation because Britain suffered from the delusion of dealing from a position of strength but in fact was dealing from a position of hopeless strategic weakness. International monetary leadership was passing from London to New York by larger trends.
The Post-war Gold Exchange Standard
Britain’s post-war gold exchange standard called for Britain to keep its monetary reserves not in gold, as it had before 1914, but mainly in gold-backed dollars, while the countries of continental Europe, still in the depths of war-torn depression, would keep their reserves in sterling backed by dollars. The US was persuaded by Britain, her victorious but greatly wounded ally, to fund the recovery of war-torn Europe through the British pound sterling, because the US was not interest in having too many dollars go overseas except to London.
After 1925, British pound sterling became a derivative currency of the dollar and European currencies became derivative currencies of the pound sterling. The Federal Reserve lowered the Fed Funds rate target to encourage US banks to lend profitably to British banks backed by the Bank of England at rates lower than rates prevalent in Europe so that British banks could in turn lend to European borrowers at higher interest rates for “carry trade” profit.  The Bank of England in effect became a monetary agent of the US dollar after WWI which was the reason why post-war reconstruction of Europe never benefited the British economy and failed to restore Britain, a victor in the war, to her pre-war glory. Most of the profit went to Wall Street.
The Finance Committee of the League of Nations and the International Monetary Fund
The Finance Committee of the League of Nations, dominated by British bankers, pressured European member states to establish central bank collaboration with the Bank of England, around the new gold exchange standard in which claims on gold were merely theoretical, difficult to exercise by non-government market participants.
European currencies holders could lay claim on the pound sterling, after which they become pound sterling holders. But because cross-border flow of funds was strictly controlled, they could not lay claim on the dollar because they did not hold British nationality. British holders of pound sterling had no claim on dollars or gold because Britain was a debtor to the US.
Only central banks were able to transact foreign exchange deals. This allowed all currencies to deface together without creating volatility in exchange rates, providing the world economy with massive liquidity without destabilizing the fixed exchange rate regime all through the 1920s.  The League of Nations Finance Committee provided a model for the International Monetary Fund after World War II to allow issuer of the world’s reserve currency, namely the US, to dominate global finance with dollar hegemony.
Finance Internationalism verses Economic Nationalism 
The return to the gold standard via the new gold exchange standard in war-torn Europe in the 1920s was engineered by a coalition of internationalist central bankers on both sides of the Atlantic as a prerequisite for postwar economic reconstruction. Benjamin Strong, president of the New York Fed, and his former partners at the House of Morgan were closely associated with the Bank of England, the Banque de France, the Reichsbank, and the central banks of Austria, the Netherlands, Italy, and Belgium, as well as with leading internationalist private bankers in those countries. The supranational institution supervising the international arrangement was the Finance Committee of the League of Nations.
Montagu Norman, governor of the Bank of England from 1920-44, enjoyed a long and close personal friendship with Benjamin Strong of the New York Fed as well as being ideological allies. Their joint commitment to restore the gold standard in Europe and so to bring about a return to “international financial normalcy” of the prewar years has been well documented. Norman recognized that the impairment of Britain’s financial hegemony by war meant that, to accomplish postwar economic reconstruction that would preserve residual British monetary advantage, Europe would “need the active cooperation of our friends in the United States.” Not the distinction between “our friends in the United States”, and not “our friend the United States”.
Like other New York bankers, Strong perceived World War I as an opportunity to expand US participation in international finance, allowing New York to move toward coveted international-finance-center status to rival London’s historical preeminence, through the development of a commercial paper market, known as bankers’ acceptances in England, breaking London’s long monopoly. The Federal Reserve Act of 1913 permitted the Federal Reserve Banks to buy, or rediscount, such paper and the NY Fed has since become the national agent for all six regional Reserve Banks. This allowed large US money center banks in New York to play an increasingly central role in international finance in competition with the London money market.
Herbert Hoover, after losing his second-term US presidential election to Franklin D Roosevelt as a result of the 1929 crash, criticized Strong as “a mental annex to Europe”, and blamed Strong’s internationalist commitment to facilitating Europe’s postwar economic recovery for the US stock-market crash of 1929 and the subsequent Great Depression that robbed Hoover of a second term. Europe’s return to the gold standard, with Britain’s insistence on what Hoover termed a “fictitious rate” of US$4.86 to the pound sterling, required Strong to expand US credit by keeping the discount rate unrealistically low and to manipulate the Fed’s open market operations to keep US interest rate low to ease market pressures on the overvalued pound sterling. Hoover, with justification, ascribed Strong’s internationalist policies to what he viewed as the malign persuasions of Norman and other European central bankers, especially Hjalmar Schacht of the Reichsbank and Charles Rist of the Bank of France. From the mid-1920s onward, the US experienced credit-pushed inflation, which fueled the stock-market bubble that finally collapsed in 1929.
Within the Federal Reserve System, Strong’s low-rate policies of the mid-1920s also provoked substantial regional opposition, particularly from Midwestern and agricultural elements, who generally endorsed Hoover’s subsequent critical analysis. Throughout the 1920s, two of the Federal Reserve Board's directors, Adolph C Miller, a professional economist, and Charles S Hamlin, perennially disapproved of the degree to which they believed Strong subordinated domestic interest to international considerations.
The fairness of Hoover’s allegation is subject to debate, but the fact that there was a divergence of priority between the White House and the Fed is beyond dispute, as is the fact that what is good for the international financial system may not always be good for a national economy. This is evidenced today by the collapse of one economy after another under the current international finance architecture that all central banks support instinctively out of a sense of institutional solidarity.
The issue of government control over foreign loans also brought the Fed, dominated by Strong, into direct conflict with Hoover when the latter was Secretary of Commerce. HooverUS government should have right of approval on foreign loans based on national-interest considerations and that the proceeds of US loans should be spent on US goods and services. Strong opposed all such restrictions as undesirable government intervention in free trade and international finance.
In July and August 1927, Strong, despite ominous data on mounting market speculation and inflation, pushed the Fed to lower the discount rate from 4 to 3% to relieve market pressures again on the overvalued British pound. In July 1927, the central bankers of Great Britain, the United States, France, and Weimar Germany met on Long Island in the US to discuss means of increasing Britain’s gold reserves and stabilizing the European currency situation. Strong’s reduction of the discount rate and purchase of £12 million, for which he paid the Bank of England in gold, not dollars, appeared to come directly from that meeting. French central banker Charles Rist reported that Strong said that US authorities would reduce the discount rate as “un petit coup de whisky for the stock exchange.” Strong pushed this reduction through the Fed despite strong opposition from Miller and fellow board member James McDougal of the Chicago Fed, who represented Midwestern bankers, who generally did not share New York’s internationalist preoccupation.  See my November 27, 2002 AToL article: Critique  of Central Banking
Gold Exchange Standard ended by the Great Depression
The gold standard broke down during World War I as major belligerents resorted to inflationary war finance. Classical gold standard was causing deflation around that world that translated into a worldwide depression while mercantilism, the quest by nations for gold through exporting, was causing protectionist reaction in all countries. It was briefly reinstated from 1925 to 1931 as the gold exchange standard. The idea of the need for international cooperation in trade and for a new “gold exchange standard” which would make wider use of gold by supplementing it with an anchor currency that would be readily convertible into gold had been developed in the 1920 international conference in Genoa, Italy, but the participating governments failed to reach agreement on account not all were ready to accept British sterling hegemony. This idea was incorporated two and a half decades later into the Bretton Woods regime with a gold-backed dollar replacing the British pound. The challenge was to devise an operative international finance architecture out of fiat currencies anchored to a gold-backed dollar to accommodate post-war international trade.
The gold exchange standard version broke down in 1931 following Britain’s forced departure from gold in the face of massive gold and capital outflows. In 1933, President Roosevelt nationalized gold owned by private citizens and abrogated all contracts in which payment was specified in gold. On April 5, Roosevelt issued Executive Order No. 6102 requiring all US citizens to exchange their gold and gold certificates to a Federal Reserve Bank for dollars at $35 per ounce, a currency devaluation of 69.3%, from $20.28 per ounce of gold. The public did not object as they were getting $35 for the gold that they only paid $20.28 to acquired, not realizing that they only gained dollars that were worth 69.3% less that they were worth a day earlier. Possession of gold beyond $100’s worth after April 5, 1931 was punishable by a fine of up to $10,000 and imprisonment for up to 10 years.
Birth and Death of the Bretton Woods Monetary Regime
As WWII came to a close, Anglo-US economists came together and devised a monetary system for the post-war era. The Bretton Woods conference was attended by more than 700 delegates from 44 victorious allied nations. But the scheme that emerged was designed by the economists from Western countries led by the US, for the benefit of their advanced economies which were expected to hold up the world economy as indispensable leaders and structural pillars, a financial version of the White Man Burden. The Bretton Woods twins of the IMF and the World Bank were given the roles of fire brigade and ambulance respectively, the former to police bankrupt poor nations to prevent credit abuse and the latter to keep systemic poverty from turning into political instability. 
The Bretton Woods system operated for three decades by getting member nations to deny their citizens the right to buy and own gold. Many Third World finance ministers were on the US payroll directly or indirectly to keep the world network of central banks working smoothly under the banner of coordination. The key devices were always to not allow ordinary citizens to buy and own gold and ban the import and export of gold, under the high sounding name of a gold control policy.
Economic data were structured to show that the Bretton Woods monetary regime as facilitating economic development and eradicated poverty. Yet a case can be made that such meager advances were made by technological progress and Cold War competition between the two superpowers. For the West where Bretton Woods regime governed, a more equitable monetary regime might have produced far superior results. After the demise of the Bretton Woods regime, neoliberalism obliterated even the meager progress under the Bretton Woods regime. The world economy is currently faced with crises more serious than any in history.
The Marshall Plan: a Trojan Horse
The Marshall Plan, officially announce on June 5, 1947 as the European Recovery Program, grew out of the Truman Doctrine, proclaimed three months earlier on March 12, 1947, stressing US moralistic duty to resist by force the establishment of communist governments worldwide. The Marshall Plan spent US$13 billion (out of a 1947 GDP of $244 billion or 5.4%, equivalent to $777 billion in 2008) to help Europe recover economically from World War II to keep it from communism. The amount is about one fifth of the Treasury’s 2008 plan of nationalizing the liability of $4.5 trillion of Fannie Mae and Freddie Mac.
The Marshall Plan money actually did not come out of US government budget, but out of US sovereign credit. The most significant aspect of the Marshall Plan was the US government guarantee to US investors in Europe to exchange their profits denominated in weak European currencies back into dollars at guaranteed fixed rates, backed by gold at $35 an ounce. The key component of the Plan’s success rested on its monetary prowess based on the dollar. At the same time, the Marshall Plan marked the monetary conquest of Europe by the US.

At a time when the monetary regimes of Europe laid in ruin, the Marshall Plan helped establish the US dollar as the world’s reserved currency that anchored a fixed exchange rate regime established by the IMF, which had been created by the Bretton Woods Conference in July 1944. The Marshall Plan enabled international trade denominated in dollars to resume after the war, and laid the foundation for dollar hegemony for three quarters of a century, even after the dollar was taken off gold by President Richard Nixon in 1971. While the Marshall Plan did help the German economy recover, it was not entirely a selfless gift from the victor to the vanquished. It was more a Trojan horse for monetary conquest. It condemned Germany’s economy to the status of a dependent satellite of the US economy from which it has yet to free itself fully. For that matter, all the world’s trading economies have unwittingly become monetary satellites of the US because of dollar hegemony.

The Marshall Plan lent Europe the equivalent of $777 billion in 2008 dollars. China’ foreign-exchange reserves were $1.8 trillion at the end of August 2008 and still rising despite a marked slowing of the US economy. Japan’s were $1.1 trillion.  In other words, China was lending two and a half times more to the United States in 2008 than the Marshall Plan lent to war-torn Europe in 1947. And the US is anything but war-torn, albeit it is debt infested.
Both China and Japan fail to get full benefits from their trade surpluses, because the loans to the US are denominated in dollars that the US can print at will, and because dollars are useless in China or Japan unless reconverted to yuan or yen. Trapped by dollar hegemony, Both China and Japan have to buy the dollars they earn in trade with their domestic currencies. This causes a rise in the domestic money supply to create inflation and an overheated economy. Yet both China and Japan also cannot sell dollars for yuan or yen without reducing the yuan or yen money supply, causing the Chinese and Japanese economies to contract and the yuan and yen exchange rates to rise. Selling dollars will hurt China and Japan, both heavily trade dependent, and cause them to lose export competitiveness. So the dollars that China and Japan earn from export must be invested in US Treasuries or other dollar-denominated asset.
Between 1946 and 1971, trading countries operated under the Bretton Woods regime under which countries settled their international payments balances in US dollars pegged to gold at $35 per ounce set since 1933 under a relatively fixed exchange rate system. It was a trade regime of goods and not financial instrument because cross-border flow of funds was not considered as necessary or desirable for international trade. However, persistent US balance-of-payments deficits steadily reduced US gold reserves, reducing confidence in the ability of the United States to redeem its currency in gold. It was becoming evident that capital movements across national borders, fixed exchange rates and independent national monetary policies simply could not coexist peacefully. A country can have only two of the three, as demonstrated by the Mundell-Fleming model which won the authors the 1999 Nobel Prize in Economic Sciences.

September 15, 2008 

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