The gold standard

The gold standard was created by Sir Isaac Newton. The gold standard is a monetary system in which the standard economic unit of account is a fixed weight of gold. Under this system a certain amount of money is worth a certain amount of gold. Under the gold standard, currency issuers guarantee to redeem notes, upon demand, in that amount of gold. Governments that use the gold standard could also redeem their notes for gold. Such governments would be said to share a fixed-currency relationship. The gold standard is not in use by any government or central bank at present time. The type of money being used right now is called fiat currency. Fiat money is a form of money backed by the good credit of the issuing authority, which could be a government, bank, or other organization. The value of the money is based primarily on the faith that the money will remain relatively stable in value, continue to be accepted as a means of exchange, and will be accepted by creditors. Basically the money is based upon the people’s trust in the government. The history of money is made up of three major phases: commodity money, in which actual valuable objects are traded; then representative money, in which paper notes (often called 'certificates') are used to represent real valuables stored elsewhere (such as the gold standard.; and finally fiat money, in which paper notes are backed only by the traders' "full faith and credit" in the government, in particular by its acceptability for payments of debts to the government (usually taxes). Commodity money did not work because people could create hoards of stuff and have a huge advantage over other people. It does not allow the government to control the regulation of items within their domain. Gold and silver served during the representative phase. The gold standard was used in this period of money. The currency itself during the gold standard was just paper and so has no innate value, but is accepted by traders because it can be redeemed any time for the equivalent specie. A US silver certificate, for example, could be redeemed for an actual piece of silver. The gold standard prevented hyperinflation and other abuses of money, like the great depression. But the gold standard had its flaws and was gotten rid of in 1971.









Besides the fact that gold was hard to transport, and to store, one of the worst things about the gold standard was that over time it would artificially increase the value of gold. The value of all the Earth’s gold when priced at $26,000 per kilogram would only be about 3.65 trillion dollars. That’s not very much considering about 7.3 trillion dollars is in circulation in the United States alone. Also with the gold standard inflation can happen if a country finds a new gold mine causing problems. Also the United States, although it was one of the most powerful countries, was a huge source of instability to the gold standard. Its Treasury held a high percentage of world gold reserves (more than that of the three other core countries combined in 1913). Without a central bank and with a decentralized banking system, financial crises happened all too often. Far from the United States assisting Great Britain, gold often flowed from the Bank of England to the United States to satisfy increases in U.S. demand for money. There were also “rules of the gold standard game”. Central banks were supposed to reinforce, rather than moderating or ignoring, the effect of gold flows on the monetary supply.

For example maintaining a gold outflow means decreasing the total amount of gold in the country. To cope with the loss of gold the bank raise conversion prices to make sure that less money leaves. A country with a trade deficit loses gold and its money supply decreases, both automatically and by policy in accordance with the "rules of the game." Then the money income goes down and the price level falls, thereby increasing exports and decreasing imports. Vice versa a country with a preferable balance of trade gains gold, the money supply increases, money income expands, the price level rises, exports decrease and imports increase. The gold standard was credible to converting to other currencies in many different ways, here are some of them. Contracts were expressed in gold; if convertibility were abandoned, contracts would inevitably be violated -- an undesirable outcome for the government. Shocks to the domestic and world economies were infrequent and generally mild. There was basically international peace and domestic calm during this period. Lastly The London capital market was the largest, most open, most diversified in the world, and its gold market was also dominant. A high proportion of world trade was financed in sterling or silver, London was the most important reserve-currency center, and balances of payments were often settled by transferring sterling assets rather than gold. Therefore sterling was an international currency -- not just







supplemental to gold but perhaps better: a gift from above to non- center countries, because sterling involved positive, not zero, interest return and its transfer costs were much less than those of gold. Advantages to Britain were the charges for services as an international banker, differential interest returns on its financial intermediation, and the practice of countries on a sterling (gold-exchange) standard of financing payments surpluses with Britain by piling up short-term sterling assets rather than demanding Bank of England gold. Basically Brittan was pretty much in charge of the money flow throughout the world. Government policies also enhanced gold-standard stability. First, by the turn of the century South Africa -- the main world gold producer(duh) -- sold all its gold in London, either to private parties or actively to the Bank of England, with the Bank serving also as  purchaser of the gold. Thus the Bank had the means to replenish its gold reserves. Second, the orthodox- metallism ideology and the leadership of the Bank of England -- other central banks would often gear their monetary policy to that of the Bank -- kept monetary policies harmonized. Monetary discipline was maintained. In similar terms people looked up the bank of England and copied what it did. The classical gold standard was at its height at the end of 1913, ironically just before its untimely demise. The most probable cause of the breakdown of the classical gold standard was political (it’s always politics in some way shape or form, and here I was actually having fun): the advent of World War I in August 1914. However, it was the Bank of England's precarious (dangerous) liquidity position and the gold-exchange standard that were the underlying cause. With the outbreak of war, a run on sterling led Britain to impose extreme exchange control -- a postponement of both domestic and international payments -- that made the international gold standard non-operational. Convertibility was not legally suspended; but moral suasion, legalistic action, and regulation had the same effect. Almost all other gold-standard countries undertook similar policies in 1914 and 1915. The United States entered the war and ended its gold standard late, adopting restrictions on convertibility in 1917 (although in 1914 New York banks had temporarily imposed an informal embargo on gold exports). An effect of the universal removal of currency convertibility was the ineffectiveness of mint parities and inapplicability of gold points: floating exchange rates resulted. In spite of the tremendous disruption to domestic economies and the worldwide economy caused by World War I, a general return to gold took place. However, the resulting interwar gold standard differed slightly from the classical gold standard in several respects. First, the new gold standard was led not by Britain but rather by the United States. The U.S. embargo on gold exports (imposed in 1917) was removed in 1919. The gold value of the dollar rather than of the pound sterling would typically serve as the reference point around which other currencies would be aligned and stabilized. Second, it follows that the core would now have two center countries, the United Kingdom and the United States. In other words Britain moved off center stage and the U.S took its place.



Citations

Moffat, Mike. "What Was The Gold Standard?." www.about.com. 28 Feb 2008 <http://economics.about.com/cs/money/a/gold_standard_2.htm>.

Delong, Brad. "Why Not the Gold Standard?." www.j-bradford-delong.net. 8/10/1996. 28 Feb 2008 <http://www.j-bradford-delong.net/Politics/whynotthegoldstandard.html>.

Bordo, Michael. "Gold Standard." www.econlib.org. 28 Feb 2008 <http://www.econlib.org/library/Enc/GoldStandard.html>.

"What is the gold standard?." www.essortment.com. pagewise. 28 Feb 2008 <http://www.essortment.com/all/goldstandards_rgvh.htm>.