Gold (6 page)

Even so the great fleets brought a stunning treasure over the sea and up the river to Seville. In 1564 alone, 154 ships reached the port. The tide of bullion almost beggars belief. In a hundred years Europe's gold supply increased by five times. Money washed into the continent. Spain struggled to master this bonanza, and so did Europe. International trade expanded, and the story of gold in human affairs became the story of how to manage the commerce between countries. Whether the famous solution to this challenge—a system called the gold standard—bent gold to our will or bent us to gold's, is the subject of this chapter: a subject that even now, with the gold standard dead in a ditch for more than forty years, still excites rancor.

W
HEN THE SPOILS FROM
M
EXICO
and Peru came spilling into the country, Spain was not well equipped to handle the jackpot. There was no native professional class to manage money.
Spain had driven out its mercantile class in 1492, with a royal edict expelling Jews and Muslims. The merchants and bankers who replaced them were foreigners, Italians and Dutch, who favored business connections with their own countries. Much of the fresh wealth was funneled through
Spain to other destinations.
“Gold and silver merely acquired their international status in Spain,” one study said, “without being in any way connected with the Spanish economy.”

With the inflow of gold, the continental economy expanded. As commerce grew, so did the international trade fairs where much business was transacted. There was now more money. Scores of gold coins circulated in Europe, all of different value. To handle the exchange, bankers and moneychangers came to the fairs. A merchant could exchange his own money for the money that his counterparty wanted. It was a cumbersome and dangerous system, with sacks of coins carted here and there through Europe. The solution to this unwieldiness was paper money.

Merchants increased the use of bills of exchange, a system that prefigured modern checking. Like checks, the bills were contracts to pay, and bankers would redeem them in cash for a fee. Traders attending fairs did not have to bring money, but could issue paper promises.
In the late 1600s this system expanded and got easier to use when London's goldsmith bankers (goldsmiths who had branched into foreign exchange) began to accept each other's paper bills as part of a competition for customers. The use of paper spread from private commerce to public finance when countries issued paper money backed by gold or silver. The circulation of gold coins decreased until the actual exchange of metal marked only the largest transactions, such as clearing trade imbalances between countries. Finally gold's place in international affairs settled into the system called the gold standard.

The gold standard operated by binding countries to a strict agreement: the national currency supply had to match the amount of gold bullion in reserve at a stipulated ratio. If you were a foreigner accepting the banknotes of a gold-standard country, you did
so knowing that you could redeem the notes for gold. The store of gold determined exactly how much money a country could have in circulation. It could not print more notes unless it had more gold. Generally, gold-standard fans approve of this, and gold-standard opponents don't. The strict operation of the gold standard sent regular waves of misery through the world, as the vagaries of trade would drain a gold supply and lacerate an economy.
The great historian of the gold standard, Barry Eichengreen, believes that the system caused the Great Depression, by preventing the government from stimulating the economy with cash. Nevertheless, a pro-gold sentiment has returned in some quarters.

The president of the World Bank, Robert Zoellick, sent the bullion price spiking in November 2010 with remarks suggesting gold might resume some monetary role. Some central banks have started stocking up on gold after years of selling.
On the American right, advocates hark back to an imagined simpler and more upright time. But if the gold standard was simple, it was the simplicity of a war club. Some of the most ruthless passages in history have been set off by a good swing of the gold standard. What's more, even those who agreed that paper money needed the ballast of a metal to control it did not always agree on what that metal should be. Silver was a much more common money than gold, and many countries backed their paper with both.

W
HEN
S
PANISH GOLD WAS SWELLING
the European money supply, a silver penny had been circulating in Britain for eight hundred years. The British pound originated as one pound's weight of silver pennies, or 240 of them.
Similar silver coins—or even the British
coins—circulated in Europe. There was a demand for silver money, and Spain, with an abundant supply, fed the demand from deposits in Bolivia and Mexico. In the sixteenth century such silver coins as the so-called Spanish dollar oiled the wheels of international trade. (With a face value of eight reales, these were the famous “pieces of eight.”)
In 1785 the United States adopted a dollar as its currency and based it on the Spanish coin.
Congress set a silver standard in a 1792 law that spelled out how much silver the mint had to put in every dollar, half dollar, quarter, and “disme”—the old spelling of dime. But the act defined the values of gold coins too, such as the ten-dollar eagle, and specified the amount of gold each coin must contain. Defining the value of currency in terms of two metals put the United States on what is called a bimetallic system.

The challenge of bimetallism is obvious—how to fix a ratio between the two metals. Say the silver price suddenly went viral and eclipsed gold: the metal value of a silver coin could in theory overtake that of a gold coin of higher denomination. The Treasury addressed this problem by fixing the values of the metals. In the United States, the mint price of gold—what the mint would pay for it—was fixed at $19.3939 an ounce, and for silver $1.2929, a ratio of 15:1. The problem with fixing a ratio is that events can unfix it.

A declining world gold supply and a European war increased demand for gold.
In 1797 the report of a French fleet landing an invasion army in Wales caused a run on the Bank of England. The report was false, but before it could be countered Londoners rushed to cash their gold-backed banknotes into gold. Some £100,000 worth of gold was leaving the central bank every day. To keep the national reserve from evaporating, Parliament passed a law that made banknotes “deemed payments in cash.”

The French too were short of gold.
In 1803 they sold Louisiana
to the United States for $15 million—at 4 cents an acre, a good deal: it doubled the area of the United States. The Americans paid for the land with U.S. government bonds.
The bankers running the transaction sold the bonds for cash, and Napoleon got the gold he needed to pursue his war.

Inevitably the appetite for gold pushed up the price, driving it above the exchange rate set by law in the United States. An owner of gold could sell it for more in England than he could in America. In response, gold flowed out of the United States to Europe, toward the higher price. Traders used the higher gold price obtained in Europe to buy silver, took the silver back to the United States, and used it to buy more cheap gold at the established rate.
By 1834 the supply of gold in America was so low that a visiting French economist wrote, “Since I have been in the United States, I have not seen there one piece of gold money, except on the scales at the Mint. Once minted, gold is embarked for Europe and remelted.” Congress acted, setting the gold price even higher than it was in Europe. The gold-to-silver price ratio became 16:1. Now a trader could get more by buying gold in Europe and selling it in America. The gold flowed back.

The ebb and flow of gold not only described the fortunes of countries; it intensified them. A nation with a trade deficit, for example, would see its gold stock dwindle as it paid out bullion to foreign creditors cashing in their paper money. The shrinking gold stock of the deficit country would curtail domestic spending by the government. Business activity would suffer from the declining money supply.

It was not a scarcity of gold in the world at large that caused these problems. There was soon to be more gold than anyone could have conceived. It erupted into the world from a series of breathtaking discoveries—a gusher of new gold that poured into the markets and
founded the modern gold supply. Far from taming the demons of international finance, the gold invigorated them.

O
N
J
ANUARY
24, 1848, J
AMES
M
ARSHALL
panned some bright flakes from the water at Sutter's Mill, on the south fork of the American River, 130 miles northeast of San Francisco. “This day,” one of his workmen noted in a diary, “some kind of mettle was found in the tail race that looks like gold.” Within days Marshall had his crew knee-deep in the river dredging soils. They tried to keep the find secret, but word got out.
In the next seven years, 500,000 men swarmed into the Sierra from around the world.

It was the first gold rush of the modern age.
“The whole country from San Francisco to Los Angeles and from the seashore to the base of the Sierra Nevadas resounds with the sordid cry of gold, GOLD, GOLD!” the San Francisco
Californian
reported. “The field is left half planted, the house half built, and everything neglected by the manufacture of shovels and pickaxes.” They dammed the streams and sluiced the gravels, they pulled the hills apart.
“Three men using nothing but spoons dug $36,000 dollars in gold from cracks in a rock,” said one account. “A rabbit hunter poked a stick in the ground, hit rock quartz, and dug up $9,700 worth of gold in three days.” But these were the lucky few; the California gold rush didn't run on spoons. A different utensil appeared to exploit the goldfield: the mining company.

Dozens of new companies formed, attracting capital from the cities of the east coast and Europe. When silver was discovered in Nevada, the speculative boom caught fire. The dozens of companies became thousands.
The inrush of investment supported the development
of new technology, but not until later in the rush, when the most accessible deposits had been emptied out. The first equipment in the hills was rudimentary. The sluices were no different in design from the ones the Romans had used. Water washed away light soils to reveal the heavier flakes of metal left behind.
The chain pumps brought to California by Chinese miners had been known in Asia from antiquity: a treadle turned a belt that carried wooden trays: the trays scooped water out of flooded areas and fed the sluices.

Tradition bathes the California gold rush in a honeyed light. “Few events in the history of the United States have been as glamorized,” one expert on the period said. “From the nineteenth century to the present, most historians have portrayed it as both a heroic and dramatic epic and as a giant step toward the fulfillment of the nation's Manifest Destiny.” In this rousing view, a horde of enterprising men catch fortune's wind and write the founding story of the Golden State. The truth is bleaker.
Some Americans brought slaves to the mines. One researcher reckons that half the black men working in California in 1850 were slaves. Mexican miners lived in peonage, tied by debt to their
patrones.
Chinese “coolies” worked as indentured labor under a “credit-ticket system” that bound them to the middlemen who'd paid their passage. White Americans weren't slaves, but they toiled from 6:00
A.M.
in freezing water that flowed down from the melting snow at higher elevations.
A miner had to wash 160 pails of dirt a day to get an ounce of gold. “You can scarcely form any conception of what a dirty business this gold digging is,” one miner wrote. “We all live more like brutes than humans.”
Even the investors suffered, as insiders manipulated the stock market, cheated shareholders, wrested mines from weaker individuals, and drained the cash from companies into their own pockets.

But the gold billowed into the world. The satanic mill of slavery,
oppression, and fraud was a bullion spinner.
In terms of today's money, billions of dollars worth of gold flowed from the hills of California. It swelled supply with almost unimaginable speed.
Robert Whaples, a professor of economics at Wake Forest University, has calculated that from 1848 to 1857, California produced 848 tons of gold.
At the official U.S. government price of $20.67 an ounce, that single decade's production amounted to a staggering $561 million worth of gold—nearly two percent of the gross domestic product of the whole country.
New discoveries elsewhere in the world added even more production, and by 1852, only four years after the discovery at Sutter's Mill, the world's gold mines were producing 280 tons a year—forty times the volume at the end of Spain's century of plunder and 200 times the volume from before it. A cataract of gold went foaming into an eager market.

“As the creditor of the whole earth,” wrote one historian, “London got the first of this gold.” In four years the Bank of England grew its gold reserves from £12.8 million to £20 million. The Bank of France bought even more, increasing its bullion stock from £3.5 million to £23.5 million. At the time, only Britain was formally on the gold standard, with banknotes convertible to gold. But the flow of so much gold into the financial system, and Britain's place as world banker, opened a crack in the continent's facade of bimetallism.
In 1871 Germany bought £50 million worth of gold and issued a new gold-backed currency.
“We chose gold,” said Ludwig Bamberger, a German politician, “not because gold is gold, but because Britain is Britain.”

The silver dominoes began to fall. In the United States, the Coinage Act of 1873 effectively demonetized silver—the “crime of 1873,” as the silver lobby later called it. Scandinavian countries scrapped the monetary role of silver in 1874, and Holland followed one year
later. France and Spain went on the gold standard in 1876. Looking back, it can appear as if an irresistible monetary wisdom was sweeping the large trading nations into its inevitable embrace.
But some scholars think bimetallism was a better system than the gold standard, partly because the use of both metals provided the stability of a bigger money supply. The gold standard did produce periods of financial harmony, but could also suddenly reverse the fortunes of a country.