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framework established by the government. On the so-called real side of
the economy, the instruments that can be used to enclose the economic
space are the well-known mechanisms of trade protection: import tariffs,
import quotas, and outright prohibitions on trade. The corresponding
instruments on the monetary side are those associated with the ability to
create money at will, to set interest rates, and to control the exchange rate
against other currencies.
MONETARY SOVEREIGNTY AND GOLD 153
Yet all states at all times face a classic macroeconomic trilemma : it is
logically and empirically impossible simultaneously to drive local interest
rates away from the world rate, to fix the exchange rate, and to have capi-
tal flowing freely into and out of the country. Only two of these objectives
can be mutually consistent at any point in time.
What did this mean in the world of the eighteenth century? Like today,
each small piece of sovereign territory issued its own currency. Unlike to-
day, there was no international monetary system to speak of. Certainly,
there was a common element each of these countries defined the value of
its currency in terms of precious metals, silver and/or gold, which have
had universal purchasing power since time immemorial. In this sense,
these currencies could be thought of as carriers of international value
and, indeed, they did routinely move across borders. But the price of the
currencies still shifted broadly, not only across countries but also through
time, as governments tended to debase them using worthless alloys and
other devices, thus raising the price of pure gold or silver, or both, in terms
of the currencies.
Economic activities were mostly oriented inward. Trade beyond neigh-
boring territories was limited to a small number of highly risky and adven-
turous companies, many of which operated under government charters
that gave them monopolies over certain territories. These companies usu-
ally engaged in barter, and frequently fought against the people they
traded with and against each other. The most important examples were
the British East India Company, which created the British Empire in In-
dia, and the Dutch East India Company, which created the Dutch In-
donesian Empire.
Two of the main barriers constraining the growth of trade and finance
were the exchange rate risks and the difficulties involved in the settlement
of international transactions transportation of the international means
of payment, gold, was both risky and cumbersome. Like today, financial
engineering developed instruments that ameliorated these problems. Bills
of exchange were introduced at the end of the Middle Ages, and a multi-
lateral clearing system was created to deal with the settlements problem in
the fourteenth century. Forward exchange markets to manage exchange
rate risks were operating by the eighteenth century. The largest and most
efficient of these markets operated in Amsterdam and London.2 Thus,
154 MONETARY SOVEREIGNTY AND GOLD
there was a certain similarity between currency markets then and now. In
both epochs, currencies fluctuated in value against each other, and the
market developed instruments (interbank and exchange-traded derivatives
are modern counterparts to the seventeenth- and eighteenth-century for-
ward markets) to ameliorate the problems that fluctuating currency values
posed for trade and finance.3
These problems were solved in the nineteenth century through the
global adoption of a common monetary standard. Trade and finance be-
gan to grow rapidly after the Napoleonic wars, driven by the nascent In-
dustrial Revolution. Naturally, these two activities developed fastest in the
country that led industrialization, Great Britain. The industrial scale of
production exceeded the size of the British markets and demanded enor-
mous flows of imported inputs. By the 1820s, British foreign trade was
booming, and British companies were already investing in mining activi-
ties in Europe and Latin America. By 1830, manufactured goods accounted
for 91% of the country s exports.4 Along with industrialization, Britain in-
troduced a monetary innovation that facilitated its growing trade: the
gold standard. Gold had been the prime universal standard of value
throughout history: there was nothing new in this respect. What was new
was that the British committed themselves to a set of rules that linked the
British pound sterling with gold in a credible way. As other countries
came to adopt the same rules over the course of the nineteenth century,
they evolved into the foundation of the first true international monetary
system.
The standard was underpinned by four main principles. First, the cur-
rency had to be valued in terms of a certain amount of gold, underpinned
by the commitment of the monetary authorities to buy or sell any amount
of gold at a fixed price. Second, the money in domestic circulation could
consist only of gold coins with the appropriate weight, or of tokens or
banknotes fully convertible into gold. Third, people had to be free to melt
gold coins into bullion. Fourth, the government would not impede the ex-
portation of coins and bullion. These rules created a system that assured
people in a transparent way that the government would not tamper with
the value of the currency because if it did, people were free to convert
their banknotes into gold and, if they wished, export it. The system gave
government what it wanted most, a monopoly on the issuance of money,
MONETARY SOVEREIGNTY AND GOLD 155
but it also gave people the right and the means to protect their financial in-
terests, by melting down and exporting their gold, if government failed to
maintain the value of the currency against gold a standard of value for
people across the globe.
The advantage of the gold standard was that it set in motion a mecha-
nism that automatically regulated the rate of monetary creation or con-
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