Policymakers have debated whether the US dollar’s role as the primary unit of account in international trade and commodity markets may soon be displaced by the euro or renminbi (Frankel 2011, 2013, Chiţu et al. 2014). Such transitions are fairly rare in history, and their effects on the global economy are poorly understood in part because many of them collapsed rather suddenly. However, history offers us an earlier episode when a large and economically important set of countries gradually jettisoned one unit of account in favor of another – the transition from silver and bimetallic monetary standards (cases where silver was used to fix exchange rates and both precious metals served as numeraires) to the global gold standard. As a result, the use of silver as an international price anchor gradually ended in the late 19th century as countries switched from silver and bimetallic standards to monometallic gold standards, either de jure or de facto.
Politically, the transition away from silver was far from smooth, giving support to a burgeoning populist movement at the end of the 19th century (Frieden 1997). Backed by farmers and miners, the flamboyant William Jennings Bryan embodied the resistance to gold standard adoption and ran for President in 1896 on an anti-gold standard platform. Advocates of the Free Silver Movement blamed the steady decline in the prices of agricultural commodities on the demonetisation of silver and its consequent declining price. In an obvious sense, they were right.
Figure 1 plots ten-year rolling window correlations between the price of silver and an agricultural commodity index consisting of wheat, cotton, and tea from 1870 to 1913. According to this figure, there was in fact a very close correlation between the price of silver and the prices of agricultural commodities between 1879 and 1896. The figure, however, also points to an interesting historical irony: the prior strong correlation between the price of silver and prices of agricultural commodities dissolved abruptly in 1896, precisely at the time when the controversy over Free Silver, predicated on the existence of such a correlation, reached its peak, in the Bryan-McKinley presidential campaign fought largely on the issue.
Figure 1 Correlations between the agricultural commodity index and silver prices, 1870-1913
De-anchoring of global commodity prices
In a recent study, we use the demise of silver as a metallic standard in the late 19th century to examine how global monetary standards anchor prices (Fernholz 2017). We construct a new high-frequency data set on global commodity prices and show that silver ceased functioning as a global price anchor in the mid-1890s, nearly two decades after many important countries abandoned bimetallism. In particular, the price of silver was highly correlated with agricultural commodity prices through the mid-1890s, but not so thereafter. This pattern can be seen in the rolling correlations of Figure 1.
The de-anchoring of global commodity prices shown in Figure 1 coincides with the gradual demonetisation of silver. The dynamics can be seen in Figure 2, which plots the global ratio of monetary silver to monetary gold from 1873 to 1913.
Figure 2 Global ratio of monetary silver to monetary gold, 1873-1913
In our paper, we show that the simultaneous de-anchoring of global commodity prices and demonetisation of silver in the late 19th century (Figures 1 and 2) can be understood in the context of a simple general equilibrium model based on the quantity theory of money (Friedman 1987). According to the model, the correlation between agricultural commodity prices and the price of silver is positively related to silver’s importance in the global monetary stock. Furthermore, the model predicts that, once silver becomes sufficiently demonetized, there will be an abrupt end to silver’s role as a price anchor, just like we observe in Figure 1.
The timing of the end of silver’s role as a price anchor is consistent with the gradual global transition from silver and bimetallic standards to gold. Many countries continued to use silver as a unit of account through the 1870s and 1880s, including Japan, Russia, the US, Brazil, Mexico, Peru, Spain, and China. Thereafter, global political currents continued to shift in favour of gold standards. India’s suspension of the free coinage of silver in 1893, the end of Sherman Act silver purchases, and the defeat of William Jennings Bryan in the US presidential election of 1896 left few global economies committed to silver, further weakening its role as a price anchor.
Price volatility and the end of silver
In addition to the de-anchoring of global commodity prices in the late 1890s shown in Figure 1, our data reveal that there was also a gradual decline in the volatility of agricultural commodity prices during this same time period. Figure 3 displays ten-year rolling window average coefficients of variation for wheat, tea, and cotton from 1870 to 1913. At the same time as silver’s importance in the global monetary stock was declining (Figure 2), there was also a slight decline in the volatility of commodity prices.
Figure 3 Average coefficient of variation for wheat, cotton, and tea, 1870-1913
Our research also shows that the simultaneous demonetisation of silver and decline in agricultural commodity price volatility in the late 19th century (Figures 2 and 3) can be understood in the context of our simple monetary model. Our model and the historical dynamics shown in Figure 3 contrast with Fisher (1911) and Friedman (1990), both of whom predict greater price stability under bimetallism. Crucially, however, the decline in volatility shown in Figure 3 occurs under a global bimetallic regime, in which the gold price of silver is not fixed but instead fluctuates according to the market forces of supply and demand. This distinction explains our model’s contrasting prediction for commodity price volatility and global bimetallism, and suggests that the potential benefits from greater price stability under bimetallism depend crucially on how the relative prices of gold and silver are determined.
Our results regarding price volatility and commodity monetary standards have implications for exchange-rate regimes that peg the domestic currency price of important export commodities, as proposed by Frankel (2003). Because such an exchange-rate regime functions like a commodity monetary standard, our results suggest that if two similar-sized regions of the world peg the prices of two different commodities, then this could raise the volatility of the prices of other, non-pegged commodities. This undesirable side effect of a commodity peg is supported by both the predictions of our model and the behaviour of agricultural commodity prices in the late 19th and early 20th centuries.
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