The Gold Percentage

Abstract

S HORT term interest rates usually depend upon the ability of commercial banks to lend money; the position of banks, in turn, depends largely upon the gold stock of the country. Therefore, in the last analysis, the supply of gold in relation tocredit liabilities governs interest rates. It is illuminating to analyze the changes which have taken place from time to time in the gold stock, and in the credit structure erected upon the gold stock, in an effort to relate these two important forces to each other. This -relationship is ascertained through the gold percentage, arrived at by dividing the total stock of gold in the country by the sum of bank deposits plus money in circulation. Fluctuations in the gold percentage may-be caused by changes in either or both of these factors, depending upon the degree to which central bank credit policies or other artificial influences are operative at the moment. In the absence of such outside influences the volume of both credit liabilities and gold tends to move in the same direction. Sometimes there may be some delay before movements in one respond to movements in the other; and sometimes one may fluctuate less than the other. These irregularities produce the fluctuations which occur from time to time in the gold percentage. It is such changes in the gold percentage which, in the last analysis and after allowing for other lesser influences, ultimately control interest rates. Of course, there frequently is an interval of time between a reversal in the direction of movement in the gold percentage and its resulting reaction on interest rates. This is because interest rates follow more closely the position of the banks. Banks can readjust their position to changes in the stock of gold only slowly. It is one of the functions of central banks to smooth out such readjustments in the commercial banks by temporarily counterbalancing gold movements. In this manner seasonal or emergency fluctuations in the volume and cost of credit are reduced to a minimum, while cyclical and major changes are accomplished gradually and in an orderly manner. It is doubtful if any credit structure cou'ld have survived a' 20 per cent reduction in gold stock within a sDan of nine months, such as occurred in the United States between September I931 and June I932, without the assistance of a central banking system. The gold percentage is a tool with which to measure the strength or weakness of the credit structure at any given time. It also affords a check on the validity of interest rates, indicating whether or not, and to what extent, the money market is being influenced for the moment by outside forces. The gold percentage is the fundamental factor which must sooner or later be reflected in credit conditions and interest rates. These can only temporarily disregard the gold percentage, and changes in it should always be considered of the utmost significance. Gold percentages are more useful for visualizing the changes which occur in the credit structure of a given country over a period of time than they are for comparing credit conditions in one country with those in other countries at any given time. The customary or average level around which the gold percentage of any given country tends to fluctuate depends to a large extent upon banking practices and national characteristics. For example, countries like the United States and Canada, where deposit banking has been developed to a high degree, can apparently operate safely on a lower percentage of gold than can countries like France and Argentina where bank notes represent relatively a much larger proportion of total credit liabilities (Charts i and 3). Gold functions much more efficiently in the former type of credit structure than in the latter; it does more work, supports a greater volume of transactions, and is more sensitive to control. In this country there are ordinarily about eleven dollars of deposits to each dollar of nioney in circulation, and in Canada, ten to one; in France, at the other extreme, the ratio is less than two to one. In order to maintain confidence in the credit structure of a country, it appears to be necessary to keep much larger gold reserves against currency than against deposits. If the customs and habits of a country are such that the people prefer and demand bank notes, in preference to deposits, as the medium of exchange in transacting