Gold is definitely one of the most reliable, storable and easily recognizable means of exchange. For these and other virtues, this precious metal has been used as a form of money since the earliest populations, but it’s only from the late nineteenth century that gold represented an international currency essential for the needs of a world economy more and more integrated.
By fixing its national currency in terms of a specific weight of fine gold, each country could determine a unit of account in which all other forms of money are convertible, creating in this way an international system of fixed exchange rates. This leads to an important advantage (in terms of globalization): the value of a domestic currency does not depend on its demand/supply, but on the quantity of gold pegged to it, being in this way “standardized”.
Historically, the gold standard system was divided in two different periods: the classical gold standard (1870-1914) and the gold-exchange standard (1922-1930s). These systems do not differ only for chronological reasons, but also for their structure, the impact they had on the world economy and the causes that determined their failure.
Content
Introduction
The classical gold standard
The gold-exchange standard
Conclusion
References
Introduction
Gold is definitely one of the most reliable, storable and easily recognizable means of exchange. For these and other virtues, this precious metal has been used as a form of money since the earliest populations, but it’s only from the late nineteenth century that gold represented an international currency essential for the needs of a world economy more and more integrated.
By fixing its national currency in terms of a specific weight of fine gold, each country could determine a unit of account in which all other forms of money are convertible, creating in this way an international system of fixed exchange rates[1]. This leads to an important advantage (in terms of globalization): the value of a domestic currency does not depend on its demand/supply, but on the quantity of gold pegged to it, being in this way “standardized”.
Historically, the gold standard system was divided in two different periods: the classical gold standard (1870-1914) and the gold-exchange standard (1922-1930s). These systems do not differ only for chronological reasons, but also for their structure, the impact they had on the world economy and the causes that determined their failure.
The classical gold standard
Britain was both the initiator and the leader of the gold standard. In 1821, after a period of forced circulation of paper money (Napoleonic Wars), the English Parliament defined, with the measure of 113.0016 grains of pure gold, the gold pound as a standard of value.
The standardization of the currency implied that also the amount of credit issuable by the Bank of England depended on the metal, and thence, that fluctuations in the money supply (and in prices) were strictly correlated with gold-stock movements[2].
Worried for the English economic fluctuations, which seriously affected their national ones and eager to participate to the world trade competition, most European countries and the U.S. entered the gold standard in the 1870s.
As Feinstein (2008) reports, this was a period in which for technological and political reasons the world economy was undoubtedly integrated and an economic isolation was incredibly difficult.
The classical gold standard was for most of the involved countries a mixed-coin standard, namely a system in which both gold coins and paper currency circulate, being convertible one to the other at fixed established prices. This gave the possibility to governments or central banks to sterilize, within limits, gold-stock fluctuations through open market operations. Under the international gold standard, a country could prevent a gold inflow from increasing the domestic price level by selling securities on the open market, reducing in this way the liquidity circulating. On the other hand, this policy increased interest rates, damaging GDP growth, employment and the lower stata of society. Moreover, this mechanism gave more control to central-role countries, which could easily influence the price level on a global scale (it’s the case of Britain, and later of the U.S.)[3]. Keynes (1930: 274) defined the Bank of England as a “conductor of the international orchestra” to emphasize how deeply English financial decisions affected the global markets. In fact, an integrated world economy with strongly tied exchange rates implied that prices, interest rates and incomes were mostly determined worldwide.
The success of the classical gold standard could be found out in its credibility in the private sector. It essentially means that most citizens believed in their governments and in their commitment to guarantee always convertibility in gold of their liabilities (banknotes). In addition of an international climate of peaceful cooperation, this allowed most European countries to conserve an ostensible stability in the late 19th century.
The global trade balance among countries particularly jeopardized this achievement. In fact, through the gold standard, precarious equilibriums were created: a country that had incurred a trade deficit would have seen its gold reserves (and therefore part of its money supply) reduced with the risk of a recession or a deflation, requiring further capital movements to balance the system. Taking the example of England, the country was in a trade deficit with respect to USA and Canada that was offset only by returns on investments in foreign countries, such as India, Australia and Japan. Therefore, the issue was the fact that Britain should have remained on its trade deficit to preserve (domestic and international) balances.
However, the reasons of the end of the classical gold standard were political rather than economical. With the World War I, broken out in 1914, convertibility was no more possible, and most countries (especially Britain) were forced to print large quantities of uncovered paper currency.
The gold-exchange standard
In 1922 at the Conference of Genoa, again after a period of forced money circulation, most European countries decided to return to a new gold standard. The gold-exchange standard consisted in an international system in which countries could hold both gold and foreign currencies (mainly dollars and pounds) as reserves. The convertibility required was no more in gold, but in convertible-gold currencies of countries that were on the gold-coin or bullion-standard (respectively USA and England).
Different from the classical one, the bullion system implied that gold no more circulated as money in the domestic market, but that the monetary authority could sell and buy from the private sector gold bars usable only for import/export. With this new settlement, Britain and the other countries could pay out their liabilities merely in paper money.
At the end of the War, USA (the first creditor country) replaced England in its role of global leader of the gold standard. The dollar, and no more the sterling, served as a reference on which other currencies were stabilized. As a consequence, new international equilibria (or better disequilibria) were established: the treaty of Versailles (1919) decreed that Germany was obliged to pay heavy reparations to the winner countries (mainly England and France), that in turn, had been in debt to USA during the war. However, lacking of a significant trade surplus, Germany was structurally incapable of paying back its debts, not allowing France and Britain to do the same. International capital movements were in an ostensible stalemate.
According to Eichengreen (1997: 15), the credibility of the interwar standard was pretty much lower than the classical one. Whereas in the prewar period there was no doubt that convertibility and sterilizing policies were the dominant goals, in the 1920s the spread of Keynesian theories[4] and a more consciousness of the problem of unemployment made it difficult to be accepted a raise in the interest rates to control external gold flows. Therefore, the monetary authorities were no more capable of stabilizing both internal and external balances without hurting the national growth. This significantly contributed to the Great Depression of the 1930s, which later on, was the cause of the collapse of the gold exchange standard. The stock crash of 1929 carried an incredible outflow of gold in many countries, especially in Great Britain, which running out of its reserves, was forced to end the convertibility in gold in 1931. Following the example of UK, other countries left the standard for the last time in history.
[...]
[1] It’s assumed freedom both of international import/export of gold and of foreign exchange transactions.
[2] Famous gold strikes are those of California and Australia in 1849-1851, which caused a remarkable inflation in European markets.
[3] Crabbe (1989: 428).
[4] Theories about connections and responsabilities of central bank policies with the domestic economy.
- Quote paper
- Filippo Marino (Author), 2015, Similarities and differences between the Classical Gold Standard and the Gold Exchange Standard, Munich, GRIN Verlag, https://www.grin.com/document/308514
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