Encyclopedia of Money: Spanish Inconvertible Paper Standard

Spain stood aloof from the classical gold standard that brought monetary order to the world from the 1870s until 1914. In 1883 Spain abandoned convertibility of bank notes into precious metal and never returned to a metallic standard, even in the aftermath of World War I when most of the world’s trading partners adopted a gold exchange standard.

In 1868 Spain adopted a bimetallic standard along the lines of the Latin Monetary Union. Like the union Spain fixed the official ratio of silver to gold at 15.5 to 1. In 1874 the government conferred upon the Bank of Spain a monopoly on the issuance of bank notes. The value of silver fell as the world turned to the gold standard, raising the free market ratio of silver to gold to 18 to 1 by 1876. Gresham’s law set to work in Spain. Because gold could buy more silver abroad than in Spain, gold flowed out and silver displaced gold as domestic currency. Gold currency decreased from 1,131 million pesetas (the monetary unit of Spain) in 1874 to 736 million in 1883. Gold reserves in the Bank of Spain increased substantially until 1881, and then dropped precipitously in 1883.

The suspension of convertibility in 1883 may have been triggered by an international financial crisis, including a stock market crash in France and a deteriorating balance of trade for Spain. When Spain’s gold reserves dropped to 60 percent of their 1881 level the government suspended convertibility.

Despite abandonment of the gold standard Spain’s prices remained relatively stable; mildly deflationary during the world depression of the 1880s and early 1890s, and rising gently in the two decades before World War I. From 1883 until 1913 the Spanish wholesale price index (1913 = 100) rose from 89.5 to 100, an annual average increase substantially below 1 percent. The exchange rate of pesetas to British pounds rose significantly during the Spanish-American War, when the government ran large budget deficits, but returned to presuspension levels by the eve of World War I. Over the same time span the money supply grew at an average annual rate of 2 percent.

Spain eluded the severe monetary disorder many countries witnessed during experiments with inconvertible paper money. During the heyday of the classical gold standard Spain maintained monetary stability with inconvertible paper, providing lessons that are relevant today. Despite inconvertible paper money Spain’s government engaged in only modest deficit spending, excepting the brief episode of the Spanish-American War. Spain invariably ran a trade surplus, exporting more goods and services than importing, and the Bank of Spain accumulated gold reserves, leading speculators to expect a return to convertibility. Spain’s experience proved that monetary stability could be maintained without the much-vaunted gold standard.

Nevertheless, Spain paid a toll for not adopting the gold standard. The Bank of Spain kept interest rates in Spain above international levels, a necessary expedient to attract capital from countries considered safer because of the gold standard. Even with high interest rates Spain saw a reduction in foreign capital inflows. The higher interest rates also acted to retard domestic investment in Spain, further reducing indigenous economic growth.

Spain’s experience from 1883 to 1914 was unique because it occurred when the gold standard was heralded as the guardian of monetary stability. During the twentieth century Spain has shared many of the difficulties of other countries on inconvertible paper standards. In the 1970s Spain’s economy sank into the doldrums of stagflation, largely because the Bank of Spain issued bank notes to finance government deficits. In the 1980s Spain reformed its public finance and monetary policy, and now Spain enjoys one of the best records for monetary stability in Europe.