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Gold Standard System "Describe, explain and evaluate the macroeconomics of the Gold Standard System. " Table of Contents: Introduction: Body: Part I Part II Part III Conclusion: Bibliography: Introduction I should start by saying that until the Franco-German War of 1870 - 1871, Europe's currencies were based on a combined gold and silver standard (BIMETALLISM). In the Versailles Peace Treaty, France had to agree to pay 5 billion Gold Francs in reparations, over the next few years. Germany partially made use of this influx by switching from the bimetallic to a pure gold standard; most other European countries followed soon. When the world's richest goldfields were found at WITWATERSRAND near Johannesburg, in the Transvaal, sufficient gold was available to keep the standard in a period of a strongly growing world economy. The Gold Standard was kept up until 1914, when, during World War I, it could no more be upheld.
In the 1920 es a number of countries, such as Great Britain and the Netherlands, tried to reintroduce it and to stick to it despite heavy problems for their respective economies; Britain gave up the gold standard in 1931. In the following essay I am going to speak about the macroeconomics of the Gold standard system. I will present various educated findings together with my personal opinion on the given matter. Body: Part I: The gold standard is a monetary system in which the standard unit of currency is a fixed weight of gold or is kept at the value of a fixed rate of gold with paper money convertible on demand into gold. Under such a system money represents gold: coins are made of the corresponding amount of gold, and / or coins and notes represent an amount of gold held in a vault somewhere. Rates of exchange between countries were fixed by their currency values in gold (Thompson, 89).
Most financially important countries were on the gold standard from 1900 until it was suspended in many nations during World War I (notably in the United States it was not suspended during the war). It was reintroduced partially in 1925 as the Gold Exchange Standard but finally abandoned in 1931. In Great Britian it was Winston Churchill in his role as Chancellor of the Exchequer that was responsible for initiating the 1925 return (Snyder, 134). In an internal gold-standard system, which implies the use of an international gold standard, gold coins circulate as legal tender or paper money is freely convertible into gold at a fixed price (More, 78). Here is the rational.
In an international gold-standard system, which may exist in the absence of any internal gold standard, gold or a currency that is convertible into gold at a fixed price is used as a means of making international payments. Under such a system, exchange rates rise above or fall below the fixed mint rate by more than the cost of shipping gold from one country to another, large inflows or outflows occur until the rates return to the official level (Rockwell, 9). If all circulating money can be represented by the appropriate amount of gold, then this is known as a 100 % reserve gold standard, or a full gold standard. Some believe there is no other form of gold standard, since on any "partial" gold standard the value of circulating representative paper in a free economy will always reflect the faith that the market has in that note being redeemable for gold (Thompson, 92). Others, such as some modern advocates of supply-side economics contest that so long as gold is the accepted unit of account then it is a true gold standard. The commitment to maintain gold convertibility tightly restrains credit creation, because doing so would be to commit fraud.
Credit creation by banking entities under a gold standard threatens the convertibility of the notes they have issued, and consequently leads to undesirable gold outflows from that bank. This is caused when people realise that the bank notes are, in a sense "oversold", and go to redeem their notes for their printed face value in gold - if they are quick enough (Snyder, 137). Hence, notes circulating in any "partial" gold standard will either be redeemed for their face value of gold (which would be higher than it's actual value) - this constitutes a bank "run"; or the market value of such notes will be viewed as less than a gold coin representing the same amount (More, 83). Part II In classical economics imbalances in international trade were rectified automatically by the gold standard. A country in deficit would have to pay its debts in gold thus depleting gold reserves and would therefore have to reduce its money supply. The resulting fall in demand would reduce imports and the lowering of prices would boost exports; thus theoretically the deficit would be rectified (Rockwell, 10).
In practice however this could seriously destabilize the economy of countries which ran a trade deficit, because people tended to make a run on the bank to retrieve their money before gold reserves were exported, thus causing banks to collapse and wiping out savings. Bank runs and failures were a common feature of life during the period when the gold standard was the established economic system (Thompson, 96). The gold standard limits the power of governments to cause price inflation by excessive issue of paper currency, although there is evidence that before World War I monetary authorities did not expand or contract the supply of money when the country incurred a gold outflow. Theoretically it also creates certainty in international trade by providing a fixed pattern of exchange rates (Snyder, 139). Thus, the gold standard is supported by many advocates of classical economics, monetarism, Objectivism, and even proponents of libertarianism (More, 88).
However, the disadvantages are that it may not provide sufficient flexibility in the supply of money, because the supply of newly mined gold is not closely related to the growing needs of the world economy for a commensurate supply of money. A single country may also not be able to isolate its economy from depression or inflation in the rest of the world. In addition, the process of adjustment for a country with a payments deficit can be long and painful whenever an increase in unemployment or decline in the rate of economic expansion occurs. Opponents of the gold standard such as Keynesianists argue that the gold standard creates deflation which intensifies recessions as people are unwilling to spend money as prices fall, thus creating a downward spiral of economic activity. The gold standard also removes the ability of governments to fight recessions by increasing the money supply to boost economic growth (Michaels, 61). Opponents of the gold standard thus argue that an expanding economy with a supply of gold that increases more slowly than the economy expands would cause a tiny, but steady, deflation.
It is believed by gold standard opponents that this gradual deflation would throw the economy into recession (Snyder, 139). No mainstream economist today advocates a return to the gold standard. However, a near century-long period of deflation has already occurred in Britain while on the Gold Standard during the 1800 s. During that century the price, in gold, of goods and services in Britain was halved. The gradual century of deflation did not cause a century of recession. Quite the contrary, the British empire during that period was the undisputed economic power of the world (Thompson, 98).
However critics of the gold standard say that this may well have been due to the fact that Britain was able to import cheap raw materials from the Empire and manufacture goods more cheaply than its competitors, allowing it to run trade surpluses (More, 93). The Sumerians, as part of their development of a standard of weights and measures, placed the royal stamp on each piece of gold to guarantee that it was the same amount as every other similarly stamped gold piece. They simply agreed that this was worth a bushel of wheat - the value was never in the gold. For each amount of gold issued by the king, a certain amount of wheat is kept in reserve in order to ensure that gold has some value. This ensures that the value of the gold with respect to wheat did not change - no inflation with respect to wheat. When the gold is returned to the king, it is redeemed with the wheat that it represented.
This, in effect, is a "wheat standard" (Snyder, 141). The problem with the idea of a gold standard is that it is similar to the creation of a "dollar standard" - creating a new currency to use, while holding a reserve of dollars in the bank to give the new currency some legitimacy. The problem is that the commodity held in reserve was merely a unit of exchange and derives its value mainly from its previous use as currency. The original backing of the currency is lost (Timmermans, 56). The gold standard was first put into operation in Great Britain in 1821.
In the full internal and international gold standard of the pre- 1914 world, gold could be exchanged for equal weights of gold coinage, coins could be melted down for their gold content, and gold coin or bullion could be exported freely (Michaels, 63). Part III Traditionally, the gold standard was not limited to one or two countries; it was an international system. With gold as money, international trade was conducted much more smoothly than it is now. With a gold standard, or indeed, with any money based on specie, traders and travellers need not constantly be concerned with losses they may suffer from exchange rate fluctuations. This also means that in a worldwide gold or specie standard, poor countries are not at the whim of international currency speculation. Those living in poor countries can instead depend, from year to year, on the value of their exports, the cost of their imports, and interest on their debts.
With a specie or gold standard, poor countries are not at the whim of the currency manipulation of governments of more wealthy nations (Thompson, 102). The reign of the full gold standard was short, lasting only from the 1870 s to the outbreak of World War I. In the post-World War I period, banknotes were issued fractionally backed by gold (i. e. gold reserves were a fixed proportion of the value of the notes in circulation). By 1928, however, both the internal and international gold standards had been virtually re-established, although gold coins were no longer in general circulation in most countries, and more extensive use was made of the gold exchange standard than before 1914.
The gold standard collapsed again during the Great Depression of the 1930 s. By 1937 not a single country remained on the gold standard (Snyder, 143). The post-World War II system agreed on at Bretton Woods was one in which most exchange rates were pegged either to the dollar or to gold. In 1958 a type of gold standard was re-established in which the major European countries provided for the free convertibility of their currencies into gold and dollars for international payments. There was no restoration of an internal gold standard (Timmermans, 59). In an international gold-standard system, gold or a currency that is convertible into gold at a fixed price is used as a medium of international payments.
Under such a system, exchange rates between countries are fixed; if exchange rates rise above or fall below the fixed mint rate by more than the cost of shipping gold from one country to another, large gold inflows or outflows occur until the rates return to the official level. These "trigger" prices are known as gold points (More, 97). The advantages of the gold standard are that (1) it limits the power of governments or banks to cause price inflation by excessive issue of paper currency, although there is evidence that even before World War I monetary authorities did not contract the supply of money when the country incurred a gold outflow; and (2) it creates certainty in international trade by providing a fixed pattern of exchange rates (Rockwell, 12). The disadvantages are that (1) it may not provide sufficient flexibility in the supply of money, because the supply of newly mined gold is not closely related to the growing needs of the world economy for a commensurate supply of money; (2) a country may not be able to isolate its economy from depression or inflation in the rest of the world; and (3) the process of adjustment for a country with a payments deficit can be long and painful whenever an increase in unemployment or a decline in the rate of economic expansion occurs (Snyder, 146). In conclusion I would like to note that Today gold is often kept as a hedge against the US dollar or other G 8 "hard currencies" (Ferdinand, 23).
In addition to other precious metals, it has three major competitors as a store of value: the US dollar itself, the Chinese yuan which is not (as of 2003) traded on markets and has similar self-sufficiency advantages as the USA did in ' 75, and real estate (which of course is dependent on property rights recognized in a country). None of these has the stability of gold had, thus there are occasionally calls to restore the gold standard, or to move to a new standard based on ecological yield of natural capital, e. g. Global Resource Banking. Given the difficulty of assessing such standards as compared to the simple weighing of gold, it seems not likely they can really take hold. Some privately issued modern currencies (such as e-gold) are backed by gold bullion.
Tantalum is also suggested as an alternative money supply standard, since even in an economy based on molecular engineering it would remain extremely difficult to forge - and remain quite easy to hide. Bibliography: Thompson, Earl, Ideology and the Evolution of Vital Economic Institutions: Guilds, the Gold Standard, and Modern International Cooperation, McGraw Hill, 2002. Snyder, Stephen, The Brewmaster's Bible: Gold Standard for Home Brewers, The, Prentice Hall, 2001. More, Kenneth, The Gold Standard Illusion: France, the Bank of France, and the International Gold Standard, 1914 - 1939, NY: Random House, 2001. Timmermans, Seen, The Gold Standard: The Challenge of Evidence-Based Medicine and Standardization in Health Care, 2000. Michaels, Walter, The Gold Standard and the Logic of Naturalism: American Literature at the Turn of the Century, Penguin books, 2000.
Rockwell, Llewellyn, The Gold Standard: An Austrian Perspective, McGraw Hill, 2002. Ferdinand, Brett, Peterson's Gold Standard McAt (Gold Standard McAt, 3 rd Ed), NY: Random House, 2001. Area, Pablo Martin, Monetary Standards in the Periphery: Paper, Silver and Gold, 1854 - 1933, McGraw Hill, 2000. Kemmerer, Edwin, Gold and the Gold Standard (International Finance), Penguin books, 2001.
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Research essay sample on Ny Random House Gold Standard
