Bimetallism

Bimetallism is a monetary standard in which the unit of account is defined by law as a fixed weight of gold and, at the same time, a fixed weight of silver. The mint accepts both metals for coinage without limit at a legal ratio of silver to gold, and coins of both metals are legal tender. Under a ratio of 15 to 1, for example, fifteen ounces of silver are treated as monetarily equal to one ounce of gold.

The system can function only while the legal ratio stays close to the ratio at which the two metals trade in the market. When the two diverge, the metal that is undervalued at the mint is exported, melted or hoarded, and the overvalued metal becomes the one actually used, so that the country drifts onto a single-metal standard in practice.

Suppose the mint ratio is 16 to 1 while the market ratio is 15 to 1. Gold is undervalued at the mint: one ounce of gold coin buys only 16 ounces of silver as money but can buy 15 ounces of silver bullion in the market. A trader can therefore melt or export gold coins, sell the gold for silver bullion abroad, bring the silver to the mint and coin it at the favorable rate, ending up with more money than at the start. This arbitrage drains gold from circulation, an example of Gresham's law, the principle that money overvalued by law drives undervalued money out of circulation.

Supporters argued that bimetallism stabilized prices because the combined stock of two metals fluctuated less than either alone, and because arbitrage by a large bimetallic country could hold the market ratio near the legal one. That compensating effect worked for long periods in the nineteenth century while France maintained the system, but it broke down when supply or demand for one metal shifted sharply.

Early practice

Metal coinage had long since freed trade from the double coincidence of wants that barter requires, and gold and silver coins circulated together for centuries, often at ratios fixed by rulers and frequently disrupted by currency debasement. In 1717 Isaac Newton, as Master of the Royal Mint, set a gold value for the guinea that overvalued gold relative to silver, which contributed to silver leaving circulation and to Britain's gradual move to the gold standard, made formal in 1816.

United States

The Coinage Act of 1792 defined the dollar in both metals at a ratio of 15 to 1. Because the market ratio rose above that level, gold tended to leave the country. The Coinage Act of 1834 changed the ratio to roughly 16 to 1, which undervalued silver, so silver coins in turn disappeared. The Coinage Act of 1873 ended the free coinage of the silver dollar, a step critics later called the Crime of '73. The free silver movement of the late nineteenth century, culminating in William Jennings Bryan's Cross of Gold speech in 1896, sought to restore unlimited silver coinage at 16 to 1. The Gold Standard Act of 1900 settled the matter in favor of gold.

France and the Latin Monetary Union

France adopted a bimetallic franc in 1803 at a ratio of 15.5 to 1. In 1865 France, Belgium, Italy and Switzerland formed the Latin Monetary Union, joined by Greece, standardizing coinage on that basis. After Germany adopted gold following its unification in 1871 and sold silver, and as new silver discoveries increased supply, the market price of silver fell. The union limited and then suspended free silver coinage in the 1870s, leaving a limping standard in which existing silver coins remained legal tender but the system was effectively anchored to gold.

By the end of the nineteenth century most industrial countries had adopted gold. Large gold discoveries, the demonetization of silver by major economies, and the network advantage of sharing a standard with Britain, then the center of world finance, all favored gold. The collapse in the gold price of silver made any return to the old ratios impractical.

Economists, including Milton Friedman, revisited the episode and argued that American bimetallism might have moderated the deflation of the late nineteenth century. Related concepts include Thiers' law, which describes how good money can drive out bad when exchange is voluntary, and modern debates over currency pegs, which face the same problem when an official rate drifts away from the market. The eventual move from metal to fiat currency removed the issue altogether, after the Bretton Woods system ended the last link between major currencies and gold.