The
Gold Standard is a monetary system in which the standard economic
measure of value is gold, and the currencies which are used as units
of account are specified as a weight of gold, ideally fixed and not
subject to change, and where all currency issuance is to one degree
or another regulated by the gold supply. There have been a variety
of monetary systems that have been labeled "gold standard"
since antiquity, including the classical gold standard of 1871-1914,
and the Bretton Woods System of 1945-1972 being two of the most studied
examples. A return to a gold standard is not generally thought feasible
in mainstream economics, but is still adhered to by certain schools
of thought such as the Austrian school of economics and some Monetarists,
and is used as a point of reference for monetary policy and theory.
Under the gold standard, currency is either in coins struck with a
known amount of gold or in notes that the issuers guarantee to redeem
in gold, ideally for an amount fixed in advance, called the "gold
peg". Gold standard currencies can be internal, which means that
domestic holders of notes may redeem them for specie, or international
only, where only a limited number of entities, for example central
banks, have the right to demand conversion to gold. Currencies that
are backed by fixed amounts of gold have a constant exchange rate
between each other. The purposes of a gold standard are to prevent
inflationary expansion of the money supply, to maintain a fixed value
against which other prices can be measured, and to allow wider circulation,
including clearing of transactions, with a greater degree of trust
in the stability of both the quantity and quality of money.
Gold standards of various kinds have been used in both national and
international forms, and gold standard currencies have often been
used as the monetary unit against which currencies with a less fixed
value have been measured. Gold standard currencies of the past have
included the Venetian ducat and the British pound sterling in the
late 19th century. Gold was the basis for the Bretton Woods Agreements,
which collapsed in 1971-1972.
In modern mainstream economic thought, a gold standard is considered
undesirable because it is associated with the collapse of the world
economy in the late 1920s, and that aggregate supply and demand is
a far better means of regulating interest rates, money supply and
monetary basis. However, many other theories have been advanced for
the turbulent economic conditions that existed at this time. While
the gold standard is not currently in use, it has advocates for its
resurrection and forms part of a basic theory of monetary policy as
a standard for comparison for other monetary systems. Advocates of
a variety of gold standards argue that gold is the only universal
measure of value, that gold standards prevent inflation by preventing
the creation of unlimited money supply in a fiat currency, and that
it provides the soundest theoretical basis for a monetary system.
Why gold?
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countries are responsible for 66% of the worldwide gold extraction.
Due to its rarity, durability, and the general ease of identification
through its unique color, weight, ductility and acoustic properties,
gold is a commodity that merchants and traders came to select as a
common unit of account - thus it has long been used as a form of money
and store of wealth. The exact nature of the evolution of money varies
significantly across time and place, though it is believed by historians
that gold's high value for its beauty, density, resistance to corrosion,
uniformity, and easy divisibility made it useful both as a store of
value and as a unit of account for stored value of other kinds - in
Babylon, a bushel of wheat was the unit of account, with a weight
in gold used as the token to transport value. Early monetary systems
based on grain used gold to represent the stored value. Banking began
when gold deposited in a bank could be transferred from one account
to another by a giro system, or lent at interest.
When used as part of a commodity money system, the function of paper
currency is to reduce the danger of transporting gold, reduce the
possibility of debasement of coins, and avoid the reduction in circulating
medium to hoarding and losses. The early development of paper money
was spurred originally by the unreliability of transportation and
the dangers of long voyages, as well as by the desire of governments
to control or regulate the flow of commerce within their dominion.
Money backed by a specie sometimes is called representative money,
and the notes issued often are called certificates, to differentiate
them from other forms of paper money.
Through most of human history, however, silver was the primary circulating
medium and major monetary metal. Gold was used as an ultimate store
of value, and as means of payment when portability was at a premium,
particularly for payment of armies. Gold would supplant silver as
the basic unit of international trade at various times, including
the Islamic Golden Age, the peak of the Italian trading states during
the Renaissance, and most prominently during the 19th century. Gold
would remain the metal of monetary reserve accounting until the collapse
of the Bretton Woods agreement in 1971, and it remains an important
hedge against the actions of central banks and governments, a means
of maintaining general liquidity, and as a store of value.
Early coinage
Aureus
minted in 193 by Septimius Severus to celebrate XIIII Gemina Martia
Victrix.
The first metal used as a currency was silver more than 4,000 years
ago, when silver ingots were used in trade. Gold coins first were
used from 600 B.C. However, long before this time, gold, as per silver,
was used as a store of wealth and the basis for trade contracts in
Akkadia, and later in Egypt. Silver remained the most common monetary
metal used in ordinary transactions until the 20th century. It still
circulates in certain bi-metallic coins, such as the Mexican 20-peso
coin circa 2005.
The Persian Empire collected taxes in gold, and when Alexander the
Great conquered it, this gold became the basis for the gold coinage
of Alexander's empire. The paying of mercenaries and armies in gold
solidified its importance: gold became synonymous with paying for
military operations, as mentioned by Niccolò Machiavelli in
The Prince 2,000 years later. The Roman Empire minted two important
gold coins: the aureus, which was approximately 7 grams of gold alloyed
with silver, and the smaller solidus, which weighed 4.4 grams, of
which 4.2 was gold. The Roman mints were fantastically active - the
Romans minted and circulated millions of coins during the course of
the Republic and the Empire.
After the collapse of the Western Roman Empire and the exhaustion
of the gold mines in Europe, the Byzantine Empire minted successor
coins to the solidus called the nomisma or bezant. These were of the
same weight and high purity as their Western Empire counterparts and
still are considered to be solidii. Unfortunately, the Byzantine empire
gradually degraded the purity of the coin from about the 1030s until,
by the turn of the 11th century, the coinage in circulation was only
15% gold by weight. This represented a tremendous drop in real value
from the old 95% to 98% gold Roman coins.
From the late seventh century, trade was increasingly conducted in
the dinar. The dinar was a gold coin modeled on the original Roman
solidus, having similar size and weight to the Byzantine solidus but
produced by the Arab Empire. The Byzantine solidus and the Arab dinar
circulated alongside one another for about 350 years before the solidus
began its decline.
The dinar and dirham were gold and silver coins, respectively, originally
minted by the Persians. The Caliphates in the Islamic world adopted
these coins, but it is with Caliph Abd al-Malik (685-705) who reformed
the currency (685-705) that the history of the dinar usually is thought
to begin. He removed depictions from coins, established standard references
to Allah on the coins and fixed ratios of silver to gold. The growth
of Islamic power and trade made the dinar the dominant coin from the
Western coast of Africa to northern India until the late 1200s, and
it continued to be one of the predominant coins for hundreds of years
afterward. In this way the solidus size, purity and weight of coin
- whether it was called the dinar, the bezant, or the solidus itself
- was a desired unit of account for more than 1,300 years and outlived
three global empires.
In 1284, the Republic of Venice coined its first solid gold coin,
the ducat, which was to become the standard of European coinage for
the next 600 years. Other coins, the florin, noble, grosh, zloty,
and guinea, also were introduced at this time by other European states
to facilitate growing trade. The ducat, because of Venice's pre-eminent
role in trade with the Islamic world and its ability to secure fresh
stocks of gold, would remain the standard against which other coins
were measured.
Beginning with the conquest of the Aztec and Inca empires, Spain had
access to stocks of new gold for coinage in addition to silver. The
primary Spanish gold unit of account was the escudo, and the basic
coin the 8 "escudos" piece, or "doblón",
which originally was set at 27.4680 grams of 22 carat (92%) gold,
using current measures, and was valued at 16 times the equivalent
weight of silver. The wide availability of milled and cob gold coins
made it possible for the West Indies to make gold the only legal tender
in 1704. The circulation of Spanish coins would create the unit of
account for the United States, the "dollar" based on the
Spanish silver real, and Philadelphia's currency market would trade
in Spanish colonial coins.
History of the classical and Bretton Woods gold standards
The adoption of gold standards proceeded gradually. This has led to
conflicts between different economic historians as to when the "real"
gold standard began. Sir Isaac Newton included a ratio of gold to
silver in his assay of coinage in 1717 that created a relationship
between gold coins and the silver penny, which was to be the standard
unit of account in the Law of Queen Anne; for some historians this
marks the beginning of the "gold standard" in England. However,
more generally accepted is that a full gold standard requires that
there be one source of notes and legal tender, and that this source
be backed by convertibility to gold. Since this was not the case throughout
the 18th century, the generally accepted view is that England was
not on a gold standard at this time.
The crisis of silver currency and bank notes (1750-1870)
To understand the adoption of the international gold standard in the
late 19th century, it is important to follow the events of the late
18th century and early 19th. In the late 18th century, wars and trade
with China, which sold many trade goods to Europe but had little use
for European goods, drained silver from the economies of Western Europe
and the United States. Coins were struck in smaller and smaller amounts,
and there was a proliferation of bank and stock notes used as money.
In the 1790s England suffered a massive shortage of silver coinage
and ceased to mint larger silver coins. It issued "token"
silver coins and overstruck foreign coins. With the end of the Napoleonic
Wars, England began a massive recoinage program that created standard
gold sovereigns and circulating crowns, half-crowns, and eventually
copper farthings in 1821. The recoinage of silver in England after
a long drought produced a burst of coins; England struck nearly 40
million shillings between 1816 and 1820, 17 million half-crowns and
1.3 million silver crowns. The 1819 Act for the Resumption of Cash
Payments set 1823 as the date for resumption of convertibility, reached
instead by 1821. Throughout the 1820s, small notes were issued by
regional banks, which finally were restricted in 1826, while the Bank
of England was allowed to set up regional branches. In 1833, however,
the Bank of England notes were made legal tender, and redemption by
other banks was discouraged. In 1844 the Bank Charter Act established
that Bank of England notes, fully backed by gold, were the legal standard.
According to the strict interpretation of the gold standard, this
1844 act marks the establishment of a full gold standard for British
money.
As a result, many of Britain's colonies were forced to resort to using
token coins in the 1800s. Large numbers of token coins were issued
by businesses at this time. The most famous of which is the trade
tokens of Strachan and Company, South Africa's first widely circulating
indigenous currency - first issued in East Griqualand in 1874.
The US adopted a silver standard based on the "Spanish milled
dollar" in 1785. This was codified in the 1792 Mint and Coinage
Act and by the Federal Government's use of the "Bank of the United
States" to hold its reserves, as well as establishing a fixed
ratio of gold to the US dollar. This was, in effect, a derivative
silver standard, since the bank was not required to keep silver to
back all of its currency. This began a long series of attempts for
America to create a bimetallic standard for the US Dollar, which would
continue until the 1920s. Gold and silver coins were legal tender,
including the Spanish real, a silver coin struck in the Western Hemisphere.
Because of the huge debt taken on by the US Federal Government to
finance the Revolutionary War, silver coins struck by the government
left circulation, and in 1806 President Jefferson suspended the minting
of silver coins.
The US Treasury was put on a strict "hard money" standard,
doing business only in gold or silver coin as part of the Independent
Treasury Act of 1848, which legally separated the accounts of the
Federal Government from the banking system. However, the fixed rate
of gold to silver overvalued silver in relation to the demand for
gold to trade or borrow from England. The drain of gold in favor of
silver led to the search for gold, including the "California
Gold Rush" of 1849. Following Gresham's law, silver poured into
the US, which traded with other silver nations, and gold moved out.
In 1853 the US reduced the silver weight of coins, to keep them in
circulation, and in 1857 removed legal tender status from foreign
coinage.
In 1857 the final crisis of the free banking era of international
finance began, as American banks suspended payment in silver, rippling
through the very young international financial system of central banks.
In the United States this collapse was a contributory factor in the
American Civil War, and in 1861 the US government suspended payment
in gold and silver, effectively ending the attempts to form a silver
standard for the dollar. Through the 1860-1871 period various attempts
to resurrect bi-metallic standards were made, including one based
on the gold and silver franc, however, with the rapid influx of silver
from new deposits, the expectation of scarcity of silver ended.
The interaction between central banking and currency basis formed
the primary source of monetary instability during this period. The
combination that produced economic stability was restriction of supply
of new notes, a government monopoly on the issuance of notes directly
and indirectly, a central bank, and a single unit of value. Attempts
to evade these conditions produced periodic monetary crises - as notes
devalued, or silver ceased to circulate as a store of value, or there
was a depression as governments, demanding specie as payment, drained
the circulating medium out of the economy. At the same time there
was a dramatically expanded need for credit, and large banks were
being chartered in various states, including, by 1872, Japan. The
need for a solid basis in monetary affairs would produce a rapid acceptance
of the gold standard in the period that followed.
International gold standard and the first age of globalization (1871-1901)
The previous five centuries had seen a variety of attempts in Europe
to have either a silver based currency, or a currency based on both
silver and gold with a legally fixed ratio between the two. Repeatedly
these systems had fallen prey to the varying abundance of gold and
silver, to the influxes of silver into the European economy, and out
again in trade with China, wartime suspensions of the link between
currency and specie, and with paper monies issued against silver,
where the expectation of silver abundance was built into the number
of notes issued. Monetary crisis and bank panics were common problems.
The mid-century political instabilities in Europe and the United States
were contributing factors to moving off of bimetallic standards or
silver standards and onto a single standard based solely on gold.
The soldity of these currencies against the silver and bi-metallic
currencies which preceded them gave rise to the term "gold standard"
as being the point of reference against which other, lesser, standards
were compared. Major nations not only pegged their currencies to gold,
but pursued a policy of defending the peg between their currency and
a fixed amount of gold, lest the fear that a currency was not backed
would lead to a run on gold reserves. In some cases political subdivisions
adopted a gold standard even in preference to the silver standard
of the sovereign currency-for example, Finland-or formed currency
unions with other nations in order to make clearing of notes faster
and more efficient-for example, Scandinavian Monetary Union and the
Latin Monetary Union.
Germany was created as a unified country following the Franco-Prussian
War; it established the Reichsmark, went on to a strict gold standard,
and used gold mined in South Africa to expand the money supply. Rapidly
other trading nations followed suit, since gold became a transportable,
universal and increasingly stable unit of valuation.
Throughout the decade of the 1870s, deflationary and depressionary
economics created periodic demands for silver currency. However, such
attempts generally failed, and continued the general pressure towards
a gold standard. By 1879, only gold coins were accepted through the
Latin Monetary Union, composed of France, Italy, Belgium, Switzerland
and later Greece, even though silver was, in theory, a circulating
medium. The de facto establishment of the gold standard in the US,
culminated with the ending of free coinage of the silver dollar. Silver
advocates decried this as "the Crime," but with a variety
of exceptions, the United States remained committed to a primarily
gold-backed money supply. While many montary historians have counted
this as good policy, Milton Friedman, in his monetary analysis called
the abrupt ending of silver coinage a case of "monetary mischief",
and argued that in the 1870s, though not in the 1890s, free coinage
of silver could have been made workable.
The period 1880-1913 is often called the "classical gold standard."
It featured a core of nations, centered on the Bank of England, that
adhered to a fixed gold price and continuous convertibility, with
other nations which were less strict in their adherence to convertibility
at a fixed amount of gold paying higher interest rates in gold denominated
currencies. Central banks were supposed, according to what have been
called "the rules of the game," to adjust interest rates
to maintain the fixed exchange rate between the domestic currency
and gold. Gold was used to settle accounts between nations. The price
when it became profitable to export or import gold from a country
was the "gold point" and nations which traded above or below
the "gold point" saw inflows or outflows of gold, and usually
took action to stem outflows of gold, or to convert inflows of gold
into a stable form to prevent inflation.
The gold standard of this period was not perfectly fixed; instead,
central banks had varying degrees of co-operation and competition.
On one side of the spectrum were true monetary unions where the currencies
were tightly interlocked, through loose monetary unions, to nations
whose participation in the gold standard was a matter of international
payments only. The purest monetary union was the Austro-Hungarian
Empire, which had the labor flexibility and interconnectedness to
support an almost fixed rate of exchange. The Latin and Scandinavian
monetary unions allowed co-circulation of coins, had clearing agreements
between the central banks that substituted checks for physical transfers,
and a close band of interest rates. The main gold standard of Europe
was maintained by a settlement system, centered on London. The Bank
of England adjusted interest rates to maintain the price relationship
of the pound to other major currencies. This discount rate was used
internationally to determine the amount by which trade instruments
would be adjusted between buyers and sellers.
The key change in this period was the adoption of a monetary policy
to raise interest rates in response to gold outflows, or to maintain
large stocks of gold in the reserves of the central bank. This policy
created a credibility of commitment to the gold standard. According
to Lawrence Officer and Alberto Giovanni, this can be seen from the
relationship between the Bank of England rate, and the flow between
the pound and the dollar, mark and franc. From 1889 through 1908,
the pound maintained a direct bank rate rule relationship with the
dollar 99% of the time, and 92% of the time with the mark. Thus, according
to the theory of gold standard monetary dynamics, the key to this
credibility was the willingness of the Bank of England to make adjustments
to the discount rate to stabilize sterling to other currencies in
the gold, or de facto gold, standard world, during the peak period
of the gold standard composed of 360 months, the Bank of England bank
rate was adjusted over 200 times in response to gold flows, a rate
of change higher than current central banks.
At the peripheries nations such as the United States and Russia allowed
significant internal deviations from the gold standard. The United
States issued fixed amounts of silver backed currency. Russia printed
paper money and minted coins, the paper money selling at rate between
60% and 75% of specie, until 1881 when a program to put Russia on
the gold standard internally began, including mining, exporting wheat
and importing restrictions. Russians were allowed to write contracts
in gold rubles in 1895, and in 1897 convertibility was established,
at the rate of 1.5 paper rubles for each new ruble. However, the government
reserved the right to print up to 300 million rubles not backed by
gold that were in domestic circulation.
During this period there were severe depressions punctuating periods
of strong growth, as gold-standard backed capital was freer to be
invested in a wider range of nations. The confidence in convertibility
would lead greater ability of governments to borrow funds on the world
credit markets, as they existed at that time, and to attract long-term
projects. A notable example of this is the building of railway networks
by the United States and Russia, as well as industrial development
programs. The gold standard attracted nations into it, because access
to capital was a powerful incentive to give up at least some of the
seignorage powers inherent in silver and paper based currencies. This
became a virtuous economic circle-the more nations participated in
the international gold standard, the more those who did not had greater
difficulty selling goods and obtaining credit.
One of the most observable effects of the spreading gold standard
was a marked decrease in the volatility of inflation rates. Under
the previous silver and paper systems, swift inflation could be followed
by sharp deflation, and then back to inflation in relatively short
periods of time. Beginning with the general adoption of the gold standard,
such wide swings grew smaller and smaller, and deflation replaced
inflation as the normal state of price movement. This was seen at
the time as allowing businesses to plan investment and expenses more
easily, and reduce the risk of building large industrial projects.
Alternate currencies
At the same time it caused a dramatic fall in aggregate demand, and
a series of long depressions in the United States and the United Kingdom.
This should not be confused with the failure to industrialize or a
slowing of total output of goods. Thus the attempts to produce alternate
currencies include the introduction of postal money orders in Britain
in 1881, later made legal tender during World War I, and the "Greenback"
party in the US, which advocated the slowing of the retirement of
paper currency not backed by gold. Many nations circulated limited
amounts of unbacked currency, or used postal money-redeemable for
postage rather than gold-in order to provide liquidity, particularly
in remote agricultural areas where forfaiting and forward settlement
of bills of trade were not available.
Effects on taxation
By encouraging industrial specialization, industrializing countries
grew rapidly in population, and therefore needed sources of agricultural
goods. The need for cheap agricultural imports, in turn, further pressured
states to reduce tariffs and other trade barriers, so as to be able
to exchange with the industrial nations for capital goods, such as
factory machinery, which were needed to industrialize in turn. Eventually
this pressured taxation systems, and pushed nations towards income
and sales taxes, and away from tariffs. It also produced a constant
downward pressure on wages, which contributed to the "agony of
industrialization". The role of the gold standard in this process
remains hotly debated, with new articles being published attempting
to trace the interconnections between monetary basis, wages, and living
standards.
Effects on rural communities
By the 1890s in the United States, a reaction against the gold standard
had emerged centered in the Southwest and Great Plains. Many farmers
began to view the scarcity of gold, especially outside the banking
centers of the East, as an instrument to allow Eastern bankers to
instigate credit squeezes that would force western farmers into widespread
debt, leading to a consolidation of western property into the hands
of the centralized banks. The formation of the Populist Party in Lampasas,
Texas specifically centered around the use of "easy money"
that was not backed by gold and which could flow more easily through
regional and rural banks, providing farmers access to needed credit.
Opposition to the gold standard during this era reached its climax
with the presidential campaign of Democrat William Jennings Bryan
of Nebraska. Bryan argued against the gold standard in his "Cross
of Gold" speech in 1896, comparing the gold standard (and specifically
its effects on western farmers) to the Crown of Thorns worn by Jesus
at his crucifixion. After being defeated in 1896, Bryan ran and lost
again in 1900 and 1908, each time carrying mostly Southern and Great
Plains states. The book (and, subsequently, the movie) The Wonderful
Wizard of Oz has been interpreted as a metaphor for the politics surrounding
the Gold Standard with the "Yellow Brick Road"-see Political
interpretations of The Wonderful Wizard of Oz, [1] and [2] which points
out that Dorothy returned with silver (not golden) shoes.
Gold standard from peak to crisis (1901-1932)
Pre World War One Gold Standard
By 1900 the need for a lender of last resort had become clear to most
major industrialized nations. The importance of central banking to
the financial system was proven largely by examples such as the 1890
bail out of Barings Bank by the Bank of England. Barings had been
threatened by imminent bankruptcy. Only the United States still lacked
a central banking system.
There had been occasional panics since the end of the depressions
of the 1880s and 1890s which some attributed to the centralization
of production and banking. The increased rate of industrialization
and imperial colonization, however, had also served to push living
standards higher. Peace and prosperity reigned through most of Europe,
albeit with growing agitation in favor of socialism and communism
because of the extremely harsh conditions of early industrialization.
A major part of this increase in living standards was the increase
in international trade volumes, aided by a sophisticated forfaiting
for trade by the discounting of bills of sale (See Real bills doctrine).
In this system the ability to settle a complex series of transactions
involved in the manufacture and final sale of goods was aided by having
a single value standard and single currency basis to value transactions.
This trade period is often called "The First Era of Globalization"
because of the increase in trade. This period culminated in 1913,
to be ended by the First World War. Trade volumes would not reach
the same percentage of GDP until well after the Second World War,
exactly when depending on the means used to measure. Purchase of such
bills was considered to be part of the process by which the Federal
Reserve in the United States would regulate the money supply. London's
centrality to this system was a key reason why the pound, rather than
some other gold based currency, was the anchor currency of the era.
The increase in trade expanded both industrialization and agriculture,
and provided an incentive for more developed nations to invest in
transportation and other infrastructure in less developed nations,
in order to be able to gain access to raw materials. It also provided
an incentive for the rapid development of cargo transportation by
sea, including the construction of the Suez and Panama canals.
The increasing political tensions of the first decade of the 20th
century placed pressure on monetary unions, and on governments. Severe
downturns struck most of the industrial nations at some point during
the decade, and agitation for reform of the gold standard increased.
In the United States anti-gold Democrat William Jennings Bryan ran
for the Presidency three times, and a wing of the ruling Republican
Party declared itself for silver dollars. In 1904 the Scandinavian
monetary union was dramatically renegotiated, leading to an end of
co-circulation and commission free checks between the central banks
as part of a larger political crisis. These pressures were not seen
then as leading to an end of the gold standard, but as pressure to
adopt mechanisms to manage the shocks which industrialization produced.
Another pressure was the beginning of armaments build up, particularly
the new generation of battleships, which were weapons of a size and
complexity far beyond that which had previously existed. The Russo-Japanese
War and subsequent revolution placed pressure on both Russia and Japan
monetarily, and the arms race between navies was a tremendous drain
on government holdings of gold in Great Britain and Germany.
However, trade volumes continued to increase, convertibility remained
a central monetary policy of most major nations, and the gold standard
and its economic system extended its reach farther and farther around
the globe.
The crisis of the Gold Standard (1914-1935)
This came to an abrupt halt with the outbreak of World War I. The
United Kingdom was almost immediately forced to take steps that would
lead to its gradually leaving its gold standard, ending convertibility
to Bank of England notes starting in 1914. By the end of the war England
was on a series of fiat currency regulations, which monetized postal
money orders and Treasury notes (later called banknotes, not to be
confused with US Treasury notes). The need for larger and larger engines
of war, including battleships and munitions, created inflation. Nations
responded by printing more money than could be redeemed in gold, effectively
betting on winning the war and redeeming out of reparations, as Germany
had in the Franco-Prussian War. The U.S. and the U.K. both instituted
a variety of measures to control the movement of gold, and to reform
the banking system, but both were forced to suspend use of the gold
standard by the costs of the war. The Treaty of Versailles instituted
punitive reparations on Germany and the defeated Central Powers, and
France hoped to use these to rebuild her shattered economy, as much
of the war had been fought on French soil. Germany, facing the prospect
of yielding much of her gold in reparations, could no longer coin
"Goldmark", and moved to paper currency.
At the end of the war, there was a global period of sharp inflation,
where even the winning nations faced economic dislocations. Since
high inflation had not been experienced in almost a generation in
the industrialized core, this period was seen as absolute proof that
the gold standard was a defense against inflation caused by paper
money. By 1920 there was a general belief that price stability would
only return with the reestablishment of the gold standard, a conviction
that would remain in place until the 1930s.
The series of arrangements to prop up the gold standard in the 1920s
would constitute a book length study unto themselves, with the Dawes
Plan superseded by the Young Plan. In effect the U.S., as the most
persistent positive balance of trade nation, lent the money to Germany
to pay off France, so that France could pay off the United States.
After the war, the Weimar Republic suffered from hyperinflation and
introduced "Rentenmark," an asset currency, to halt it.
This worked properly, although one more year had to pass until a new,
gold-backed Reichsmark came into circulation.
Important in the efforts to restore the gold standard were arms limitation
talks centered around restraining building of battleships in particular,
negotiations over trade barriers, and attempts to engage in deflation
to return prices to their pre-war levels. This led to both the Bank
of England and the United States Federal Reserve to "sterilize"
gold inflows. This in turn forced nations with gold outflows to deflate
more sharply in order to maintain price parity. While the United States,
as both an industrial power and exporter of oil, which was becoming
an increasingly important commodity as the world economy mechanized,
was able to weather a series of short down turns during the decade,
other nations experienced more and more economic instability.
In 1925 Winston Churchill, then Chancellor of the Exchequer, seen
as a stepping-stone to Number 10 Downing Street, attempted to return
Great Britain to the gold standard with a series of steps, which would
gradually have restored convertibility. However, it was also a goal
to reverse the price increases, which required a contraction of the
money supply. The resulting economic downturn both chased Churchill
from the fast track to power, and created a government crisis.
This was the leading edge of the global down turn now known as the
Great Depression, and with it came a seeming bind for monetary policy
and economic theory. On the one hand it seemed that suspension of
the gold system would lead to paper money and either high inflation
or hyper-inflation, and on the other hand, the mechanisms for maintaining
the gold standard-government austerity, higher taxes, monetary contraction
and higher interest rates-led directly to severe economic collapse,
unsustainably high unemployment, and agitation for communist or other
radical forms of government.
John Maynard Keynes was one economist who argued against the adoption
of the pre-war gold price believing that the rate of conversion was
far too high and that the monetary basis would collapse. He called
the gold standard "that barbarous relic." This deflation
reached across the remnants of the British Empire everywhere the Pound
Sterling was still used as the primary unit of account. In the U.K.
the standard was again abandoned in 1931. Sweden abandoned the gold
standard in 1929, the U.S. in 1933, and other nations were, to one
degree or another, forced off the gold standard.
The Great Depression and World War II (1933-1945)
The London conference
In 1933, during the Great Depression, the London conference marked
the death of the international gold standard as it had developed to
that point in time. While the United Kingdom and the United States
desired an eventual return to the Gold Standard, with President Franklin
Delano Roosevelt saying that a return to international stability "must
be based on gold"-neither was willing to do so immediately. France
and Italy both sent delegations insisting on an immediate return to
a fully convertible international gold standard. A proposal was floated
to stabilize exchange rates between France, the United Kingdom and
the United States based on a system of drawing rights, but this too
collapsed.
The central point at issue was what value the gold standard should
take. Cordell Hull, the U.S. Secretary of State, was instructed to
require that reflation of prices occur before returning to the Gold
Standard. There was also deep suspicion that the United Kingdom would
use favorable trading arrangements in the Commonwealth to avoid fiscal
discipline. Since the collapse of the Gold Standard was attributed,
at the time, to the U.S. and the U.K. trying to maintain an artificially
low peg to gold, agreement became impossible. Another fundamental
disagreement was the role of tariffs in the collapse of the gold standard,
with the liberal government of the United States taking the position
that the actions of the previous American administration had exacerbated
the crisis by raising tariff barriers.
Gold restrictions
As part of this process, many nations, including the U.S., banned
private ownership of gold either de jure or de facto. In the United
States, President Franklin Delano Roosevelt used the Trading with
the Enemy Act for statutory authority to abrogate gold and silver
clauses in U.S. Securities and impose fines of up to $100,000,000
on those who refused to do so. Over this period FDR passed two laws
prohibiting U.S. citizens and the Federal Reserve ownership of gold,
Executive Order 6102 of 1933 and the Gold Reserve Act of 1934. Jewelry,
private coin collections, and the like were exempt from this ban,
which in any case seems not to have been enforced too zealously. In
1975 all restrictions on the right of American citizens to own gold
were abolished.
Other nations suspended convertibility, prohibited exportation of
gold, and required taxes be paid in gold. When France went off the
gold standard in 1936, it ordered its citizens to turn in their privately
held gold for government notes, but attained very little compliance.
During the period of the gold ban American citizens were allowed to
hold legal tender only in the form of central bank notes. While this
move was argued for under national emergency, it was controversial
at the time. The Supreme Court upheld the Congressional action in
1934 [4], but there are still some who regard it as a usurpation of
private property.
Part of the reason for these restrictions is that the theory of the
gold standard was that nations with a net inflow of gold should allow
inflation, which would then encourage imports automatically, while
nations with a gold outflow should deflate, thus shifting effort to
exporting to obtain gold. However the United States in particular
had a policy of maintaining price stability, in response to the dramatic
inflationary spike at the end of the First World War, and "sterilized"
influxes of gold by contracting the money supply, what would now be
called "M1", in order to prevent increases in the general
level of prices. This forced nations with an outflow of gold to deflate
even farther to adjust, and helped unravel the series of loan agreements
that had been set up in the wake of the Treaty of Versailles.
From 1931 through 1936 nations left the gold standard, beginning with
Britain in 1931 after a run on the pound. France, the Netherlands
and Switzerland finally left the gold standard in 1936. In the present
the general agreement of monetary policy research is that there is
a strong correlation between leaving the gold standard and economic
recovery, as part of the monetary theory of the Great Depression.
This theory is held by both liberal and conservative economists, but
is vehemently disputed by most supporters of a renewed gold standard,
who argue the reverse: that the failure to commit to gold was the
cause of the Great Depression.
In the years that followed, nations pursued bilateral trading agreements,
and by 1935 the economic policies of most Western nations were increasingly
dominated by the growing realization that a global conflict was highly
likely, or even inevitable. During the 1920s the austerity measures
taken to restabilize the world financial system had cut military expenditures
drastically, but with the arming of the Axis powers, war in Asia,
and fears of the Soviet Union exporting communist revolution, the
priority shifted toward armament, and away from re-establishing a
gold standard. The last gasp of the nineteenth century gold standard
came when the attempt to balance the United States Budget in 1937
led to the "Roosevelt Recession." Even such gold advocates
as Roosevelt's budget director conceded that until it was possible
to balance the budget, a gold standard would be impossible.
Did the gold standard cause the Great Depression?
In modern macro-economic thought, the gold standard per se did not
"cause" the Great Depression. Instead the standard theory
is that the shock of World War I caused the "classical gold standard"
to collapse, as nations spent freely to pay for armaments, and continued
to do so after the war had ended. The gold standard, which would be
created after the war, was not of the same kind as the pre-war standard,
and the commitment to the gold standard in the face of economic shocks
was not as strong. This cooperative gold standard also faced the problem
of normalizing post-war prices with pre-war parities of currency.
According to this view the inflexibility of keeping an international
gold standard led central bankers to contract money supply in 1929,
out of the fear of inflation or a run on currency. With the German
hyperinflation, and the 1931 run on the Great British Pound, the fears
that a failure to maintain the gold standard would lead to economic
chaos seemed to be confirmed, and the "Great Contraction"
of currency was continued as a policy. According to modern macroeconomic
theory, it was this contraction that turned a credit bust, which was
of comparable size to previous over extended economic expansions,
into a very severe downturn.
While opinions on whether the gold standard could have been maintained
without severe contraction vary depending on which model is used,
there is wide agreement that the failed attempts to assert and maintain
the gold standard, and the failure to rectify structural problems
in the banking system and find flexibility in monetary policy were
the proximate causes of the Great Depression.
This line of argument stems from Friedman and Schwartz' monetary history
of the United States, as well as subsequent work by Eichengreen, Bernanke,
Bordo and other macro-economists, many of who believe that the understanding
of the Great Depression as a monetary phenomenon is the "holy
grail" of macro-economics.
Other schools of thought such as the Austrian school of economics
maintains that it was in fact a movement away from the gold standard
by the Federal Reserve that caused the Great Depression and that if
the money supply had been more heavily tied to gold, the depression
would never have manifested itself. Austrians believe that any inflation
over specie will cause a misallocation of resources whose reallocation
ends up in the "bust" phase of the business cycle.
British hesitate to return to gold standard
During the 1939-1942 period, the UK depleted much of its gold stock
in purchases of munitions and weaponry on a "cash and carry"
basis from the US and other nations. This depletion of the UK's reserve
signaled to Winston Churchill that returning to a pre-war style gold
standard was impractical; instead, John Maynard Keynes, who had argued
against such a gold standard, became increasingly influential: his
proposals, a more wide ranging version of the "stability pact"
style gold standard, would find expression in the Bretton Woods Agreement.
Post-war international gold standard (1946-1971)
Theory
The essential features of the gold standard in theory rest on the
idea that inflation is caused by an increase in the quantity of money,
an idea advocated by David Hume, and that uncertainty over the future
purchasing power of money depresses business confidence and leads
to reduced trade and capital investment. The central thesis of the
gold standard is that removing uncertainty, friction between kinds
of currency, and possible limitations in future trading partners will
dramatically benefit an economy, by expanding the market for its own
goods, the solidity of its credit, and the markets from which its
consumers may purchase goods. In much of gold standard theory, the
benefits of enforcing monetary and fiscal discipline on the government
are central to the benefits obtained; advocates of the gold standard
often believe that governments are almost entirely destructive of
economic activity, and that a gold standard, by reducing their ability
to intervene in markets, will increase personal liberty and economic
vitality.
Differing definitions of "gold standard"
If the monetary authority holds sufficient gold to convert all circulating
money, then this is known as a 100% reserve gold standard, or a full
gold standard. In some cases it is referred to as the Gold Specie
Standard to more easily separate it from the other forms of gold standard
that have existed at various times.
Some believe there is no other form of Gold Standard other than the
100% reserve Gold Specie Standard. This is because in any partial
gold standard there is some amount of circulating paper that is not
backed by gold, and hence it is possible for monetary issuing authorities
to attempt to use seigniorage, and possibly inflation. 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.
In a national Gold Standard system, gold coins circulate freely as
money, and paper money is directly convertible into gold at a market
rate (not enforced by government fiat), reflecting the value of the
paper money as a claim check giving the holder the right to a specified
amount of gold coin held by the issuer of the note.
However, where the value of paper money varies against gold, this
indicates that the paper money is fiat money and will often devalue
against specie. This has been the case during wars when governments
would issue paper currency not backed by specie. Examples include
Greenbacks issued by the Union during the American Civil War, and
paper marks issued by Austria during the Napoleonic Wars. Such episodes
have traditionally led to calls to restore sound money after the war-that
is, a hard currency monetary system.
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, when 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. International gold standards often
limit which entities have the right to redeem currency for gold. Under
the Bretton Woods system, these were called "SDRs" for Special
Drawing Rights.
What the Gold Standard is Not
"
The gold standard is not an economic system, in fact, many gold standard
economies have other currencies used by those without access to gold.
The gold standard has been practiced under many economic systems,
from statist empires, through decentralized feudal states, through
mercantile states, and various stages of capitalism.
" The gold standard is not the right of convertability. Many
gold standards have no convertability, because gold coins, not paper
notes, circulate.There is nothing to convert to. Other gold standards
do not give individuals the right to convert notes, but reserve it
for special entities, and in the case of late Bretton Woods, those
entities were discouraged from converting.
" The Gold standard does not demand that any particular currency
remain fixed in its par value in gold. Currencies which debase against
gold in a gold standard simply trade at greater and greater discounts
to currencies that maintain their peg to gold. There is still a "gold
standard" in place, because the weight of gold, and not the currency,
is used as the measure of money. Indeed, one of the motivations for
a gold system emerging as a preferred system is a mistrust of monetary
authorities, or circumstances where currencies trade far outside the
reach of those that coined or issued them. Hence a standard outside
of the control of any particular monetary authority is established,
one which is, in the case of coins, verifiable externally by the use
of Archimedes principle, and which in the case of paper currencies,
presents monetary authorities which fail to defend the value of their
notes moral hazard.
Effects of gold-backed currency
The commitment to maintain gold convertibility tightly restrains credit
creation. 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. The result of a
failure of confidence produces a run on the specie basis, which is
generally responded to by the bankers suspending specie payments.
Hence, notes circulating in any "partial" gold standard
will either be redeemed for their face value of gold (which would
be higher than its 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.
Perceived stability offered by gold standard
The gold standard, in theory, 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.
Some believe that inflation is caused by money supply and not some
other issue. It is also supposed to create certainty in international
trade by providing a fixed pattern of exchange rates. After the inflationary
silver standards of the 1700s, this was regarded as a welcome relief,
and an inducement to trade. However by the late nineteenth century,
agitation against the gold standard drove political movements in most
industrialized nations for some form of silver-based, or even paper-based,
currency.
Under the classical international gold standard, disturbances in the
price level in one country would be wholly or partly offset by an
automatic balance-of-payment adjustment mechanism called the "price-specie-flow
mechanism" ("specie" refers to gold coins). The steps
in this mechanism are first: when the price of a good drops, because
of oversupply, capital improvement, drop in input costs or competition,
buyers will prefer that good over others. Because the stabilization
of currencies to gold, buyers within the gold-based economies will
preferentially buy the lowest priced good, and gold will flow into
the most efficient economies. This flow of gold into the more productive
economy will then increase the money supply, and produce sufficient
inflationary pressure to offset the original drop in prices in the
more productive economy, and would reduce the circulating specie in
the less productive economies, forcing prices down until equilibrium
was restored.
Central banks, in order to limit gold outflows, would reinforce this
by raising interest rates, so as to bring prices back into international
equilibrium more quickly. In theory, as long as nations remained on
the gold standard, there would be no sustained period of either high
inflation, or uncontrolled deflation. Since, at the time, it was believed
that markets internally always clear (See Say's Law), and that deflation
would alter the price of capital first, it meant that this would reduce
the price of capital, and allow more growth as well as long term price
stability. However, in practice this turned out not to be the case:
it was wages, not capital, that depreciated in price first.
Mundell-Fleming model
According to modern neo-classical synthesis economics, the Mundell-Fleming
Model describes the behavior of currencies under a gold standard.
Since the value of the currencies is fixed by the par value of each
currency to gold, the remaining freedom of action is distributed between
free movement of capital, and effective monetary and fiscal policy.
One reason that most modern macro-economists do not support a return
to gold is the fear that this remaining amount of freedom would be
insufficient to combat large downturns or deflation. The theoretical
possibility of a return to a gold standard has another effect, namely,
the question of central bank credibility in a regime not based on
hard currencies. Given that major prizes are still awarded for these
questions, the gold standard eras, both the nineteenth century and
twentieth century versions, remain a baseline against which the current
floating currency monetary system is measured.
Mundell argued that it would be possible to return to an international
gold standard, or even a national one, since in an industrial economy
a great deal of capital is immobile. This would allow, in his opinion,
a central bank to have sufficient freedom of action to engage in limited
counter-cyclical actions, that is, lowering interest rates at the
onset of a downturn, raising them to prevent overheating of the economy.
This was disputed by Friedman who argued that quantity-of-money effects
would produce deflation in such a system, and that successful nations
would see less benefit than Mundell expected, since gold entering
a nation would produce internal inflation. This argument mirrors the
one made by Adam Smith and David Hume in the eighteenth century about
increasing the quantity of money not being a worthwhile objective.
Advocates of a renewed gold standard
Some monetarists, objectivists, followers of the Austrian School of
Economics, and many libertarians, support a strict version of the
internal gold standard. In Russia, Pravda has supported a gold standard
[6] in various editorials, arguing that a gold ruble would be a counterweight
to the power of the American dollar. Various Islamic groups, such
as the Hizb ut-Tahrir, support a return to a hard currency economy
with gold as a primary backer of currency. Supporters of a gold standard
often argue that fiat currency falls in purchasing power over time
and that governments cannot be trusted to regulate the money supply.
The international gold standard still has advocates who wish to return
to a Bretton Woods-style system, in order to reduce the volatility
of currencies, but the unworkability of Bretton Woods, due to its
government-ordained exchange ratio, as well as the temptation for
governments to print more money than would be backed by their reserves,
has allowed the followers of Austrian economists Ludwig von Mises,
Friedrich Hayek and Murray Rothbard to foster the idea of a total
emancipation of the gold price from a State-decreed rate of exchange
and an end to government monopoly on the issuance of gold currency.
Many nations back their economies by holding gold reserves. These
reserves are not intended to redeem notes, but are retained as a hard
liquid asset to protect against hyperinflation. Gold advocates claim
that this extra step would no longer be necessary since the currency
itself would have its own intrinsic store of value. A Gold Standard
then is generally promoted by those who regard a stable store of value
as the most important element to business confidence.
It is generally opposed by the vast majority of governments and economists,
because the gold standard has frequently been shown to provide insufficient
flexibility in the supply of money and in fiscal policy, because the
supply of newly mined gold is finite and must be carefully husbanded
and accounted for.
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.
One of the foremost opponents of the gold standard was John Maynard
Keynes who scorned basing the money supply on "dead metal."
Keynesians 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. They also argue
that the gold standard also removes the ability of governments to
fight recessions by increasing the money supply to boost economic
growth.
Gold standard proponents point to the era of industrialization and
globalization of the nineteenth century as the proof of the viability
and supremacy of the gold standard, and point to the UK's rise to
being an imperial power, ruling nearly one quarter of the world's
population and forming a trading empire which would eventually become
the Commonwealth of Nations as imperial provinces gained independence.
Moderate gold bugs point to gold as a hedge against commodity inflation,
and a representation of resource extraction. Since gold can be sold
in almost any currency, on a highly liquid world market, in nearly
any country in the world, they view gold as a play against monetary
policy follies of central banks, and a means of hedging against currency
fluctuations. For this reason they believe that eventually there will
be a return to a gold standard, since this is the only "stable"
unit of value.
Few economists today advocate a return to the gold standard, other
than the Austrian school and some supply-siders. However, many prominent
economists are sympathetic with a hard currency basis. This school
of thought includes former US Federal Reserve Chairman Alan Greenspan
and macroeconomist Robert Barro. Greenspan said in 1998
Effects of gold-backed currency
The commitment to maintain gold convertibility tightly restrains credit
creation. 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. The result of a
failure of confidence produces a run on the specie basis, which is
generally responded to by the bankers suspending specie payments.
Hence, notes circulating in any "partial" gold standard
will either be redeemed for their face value of gold (which would
be higher than its 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.
Perceived stability offered by gold standard
The gold standard, in theory, 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.
Some believe that inflation is caused by money supply and not some
other issue. It is also supposed to create certainty in international
trade by providing a fixed pattern of exchange rates. After the inflationary
silver standards of the 1700s, this was regarded as a welcome relief,
and an inducement to trade. However by the late nineteenth century,
agitation against the gold standard drove political movements in most
industrialized nations for some form of silver-based, or even paper-based,
currency.
Under the classical international gold standard, disturbances in the
price level in one country would be wholly or partly offset by an
automatic balance-of-payment adjustment mechanism called the "price-specie-flow
mechanism" ("specie" refers to gold coins). The steps
in this mechanism are first: when the price of a good drops, because
of oversupply, capital improvement, drop in input costs or competition,
buyers will prefer that good over others. Because the stabilization
of currencies to gold, buyers within the gold-based economies will
preferentially buy the lowest priced good, and gold will flow into
the most efficient economies. This flow of gold into the more productive
economy will then increase the money supply, and produce sufficient
inflationary pressure to offset the original drop in prices in the
more productive economy, and would reduce the circulating specie in
the less productive economies, forcing prices down until equilibrium
was restored.
Central banks, in order to limit gold outflows, would reinforce this
by raising interest rates, so as to bring prices back into international
equilibrium more quickly. In theory, as long as nations remained on
the gold standard, there would be no sustained period of either high
inflation, or uncontrolled deflation. Since, at the time, it was believed
that markets internally always clear (See Say's Law), and that deflation
would alter the price of capital first, it meant that this would reduce
the price of capital, and allow more growth as well as long term price
stability. However, in practice this turned out not to be the case:
it was wages, not capital, that depreciated in price first.
Mundell-Fleming model
According to modern neo-classical synthesis economics, the Mundell-Fleming
Model describes the behavior of currencies under a gold standard.
Since the value of the currencies is fixed by the par value of each
currency to gold, the remaining freedom of action is distributed between
free movement of capital, and effective monetary and fiscal policy.
One reason that most modern macro-economists do not support a return
to gold is the fear that this remaining amount of freedom would be
insufficient to combat large downturns or deflation. The theoretical
possibility of a return to a gold standard has another effect, namely,
the question of central bank credibility in a regime not based on
hard currencies. Given that major prizes are still awarded for these
questions, the gold standard eras, both the nineteenth century and
twentieth century versions, remain a baseline against which the current
floating currency monetary system is measured.
Mundell argued that it would be possible to return to an international
gold standard, or even a national one, since in an industrial economy
a great deal of capital is immobile. This would allow, in his opinion,
a central bank to have sufficient freedom of action to engage in limited
counter-cyclical actions, that is, lowering interest rates at the
onset of a downturn, raising them to prevent overheating of the economy.
This was disputed by Friedman who argued that quantity-of-money effects
would produce deflation in such a system, and that successful nations
would see less benefit than Mundell expected, since gold entering
a nation would produce internal inflation. This argument mirrors the
one made by Adam Smith and David Hume in the eighteenth century about
increasing the quantity of money not being a worthwhile objective.
Advocates of a renewed gold standard
Some monetarists, objectivists, followers of the Austrian School of
Economics, and many libertarians, support a strict version of the
internal gold standard. In Russia, Pravda has supported a gold standard
[6] in various editorials, arguing that a gold ruble would be a counterweight
to the power of the American dollar. Various Islamic groups, such
as the Hizb ut-Tahrir, support a return to a hard currency economy
with gold as a primary backer of currency. Supporters of a gold standard
often argue that fiat currency falls in purchasing power over time
and that governments cannot be trusted to regulate the money supply.
The international gold standard still has advocates who wish to return
to a Bretton Woods-style system, in order to reduce the volatility
of currencies, but the unworkability of Bretton Woods, due to its
government-ordained exchange ratio, as well as the temptation for
governments to print more money than would be backed by their reserves,
has allowed the followers of Austrian economists Ludwig von Mises,
Friedrich Hayek and Murray Rothbard to foster the idea of a total
emancipation of the gold price from a State-decreed rate of exchange
and an end to government monopoly on the issuance of gold currency.
Many nations back their economies by holding gold reserves. These
reserves are not intended to redeem notes, but are retained as a hard
liquid asset to protect against hyperinflation. Gold advocates claim
that this extra step would no longer be necessary since the currency
itself would have its own intrinsic store of value. A Gold Standard
then is generally promoted by those who regard a stable store of value
as the most important element to business confidence.
It is generally opposed by the vast majority of governments and economists,
because the gold standard has frequently been shown to provide insufficient
flexibility in the supply of money and in fiscal policy, because the
supply of newly mined gold is finite and must be carefully husbanded
and accounted for.
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.
One of the foremost opponents of the gold standard was John Maynard
Keynes who scorned basing the money supply on "dead metal."
Keynesians 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. They also argue
that the gold standard also removes the ability of governments to
fight recessions by increasing the money supply to boost economic
growth.
Gold standard proponents point to the era of industrialization and
globalization of the nineteenth century as the proof of the viability
and supremacy of the gold standard, and point to the UK's rise to
being an imperial power, ruling nearly one quarter of the world's
population and forming a trading empire which would eventually become
the Commonwealth of Nations as imperial provinces gained independence.
Moderate gold bugs point to gold as a hedge against commodity inflation,
and a representation of resource extraction. Since gold can be sold
in almost any currency, on a highly liquid world market, in nearly
any country in the world, they view gold as a play against monetary
policy follies of central banks, and a means of hedging against currency
fluctuations. For this reason they believe that eventually there will
be a return to a gold standard, since this is the only "stable"
unit of value.
Few economists today advocate a return to the gold standard, other
than the Austrian school and some supply-siders. However, many prominent
economists are sympathetic with a hard currency basis. This school
of thought includes former US Federal Reserve Chairman Alan Greenspan
and macroeconomist Robert Barro. Greenspan said in 1998: "If
you are on a gold standard or other mechanism in which the central
banks do not have discretion, then the system works automatically.
The reason there is very little support for the gold standard is the
consequences of those types of market adjustments are not considered
to be appropriate in the twentieth and twenty first century. I am
one of the rare people who have still some nostalgic view about the
old gold standard, as you know, but I must tell you, I am in a very
small minority among my colleagues on that issue."
The
current monetary system relies on the US Dollar as an "anchor
currency" which major transactions, such as the price of gold
itself, are measured in. Currency instabilities, inconvertibility
and credit access restriction are a few reasons why the current system
has been criticized. A host of alternatives have been suggested, including
energy-based currencies, market baskets of currencies or commodities;
gold is merely one of these alternatives.
The reason these visions are not practically pursued is much the same
reason the gold standard fell apart in the first place: a fixed rate
of exchange decreed by governments has no organic relationship between
the supply and demand of gold and the supply and demand of goods.
Thus gold standards have a tendency to fall apart as soon as it becomes
advantageous for governments to overlook them. By itself, the gold
standard does not prevent nations from switching to a fiat currency
when there is a war or other exigency. This happens even though gold
gains in value through such circumstances, as people use it to preserve
value; the fear is that fiat currency is typically introduced to allow
deficit spending, which often leads to either inflation or to rationing.
The practical difficulty that gold is not currently distributed according
to economic strength is also a factor: Japan, while one of the world's
largest economies, has gold reserves far less than would be required
to support that economy. Finally the quantity of gold available for
reserves, even if all of it were confiscated and used as the unit
of account, would put the value of gold upwards of 5,000 dollars an
ounce on a purchasing-parity basis. If the current holders of gold
imagine that this is the price that they will be paid for giving up
their gold, they are quite likely to be disappointed. For these practical
reasons - inefficiency, instability, misallocation, and insufficiency
of supply - the gold standard is likely to be more honored in literature
than practiced in fact.
In 1996 e-gold launched a privately issued digital gold currency system,
attempting to replicate a gold standard and create an alternative
global monetary system. Other digital gold currency systems soon followed,
such as e-Bullion and GoldMoney.
In 2001 Malaysian Prime Minister Mahathir bin Mohamad proposed a new
currency that would be used initially for international trade between
Muslim nations. The currency he proposed was called the Islamic gold
dinar and it was defined as 4.25 grams of 24-carat (100%) gold. Mahathir
Mohamad promoted the concept on the basis of its economic merits as
a stable unit of account and also as a political symbol to create
greater unity between Islamic nations. The purported purpose of this
move would be to reduce dependence on the United States dollar as
a reserve currency, and to establish a non-debt-backed currency in
accord with Islamic law against the charging of interest. [8] Nonetheless,
gold dinar currency has not yet materialized [9] [10]. However, a
digital gold currency called e-dinar has been successfully launched.
Gold as a reserve today
During
the 1990s Russia liquidated much of the former USSR's gold reserves,
while several other nations accumulated gold in preparation for the
Economic and Monetary Union. The Swiss Franc left a full gold-convertible
backing. However, gold reserves are held in significant quantity by
many nations as a means of defending their currency, and hedging against
the US Dollar, which forms the bulk of liquid currency reserves. Weakness
in the US Dollar tends to be offset by strengthening of gold prices.
Gold remains a principal financial asset of almost all central banks
alongside foreign currencies and government bonds. It is also held
by central banks as a way of hedging against loans to their own governments
as an "internal reserve". Approximately 25% of all above
ground gold is held in reserves by central banks.
In addition to other precious metals, stores of value also include
real estate. As with all stores of value, the basic confidence in
property rights determines the selection of which one is chosen, as
all of these have been confiscated or heavily taxed by governments.
In the view of gold investors, none of these has the stability that
gold had, thus there are occasionally calls to restore the gold standard.
Occasionally politicians emerge who call for a restoration of the
gold standard, particularly from libertarians and anti-government
leftists. Mainstream conservative economists such as Barro and Greenspan
have admitted a preference for some tangibly backed monetary standard,
and have stated that a gold standard is among the possible range of
choices.
Both gold coins and gold bars are widely traded in deeply liquid markets,
and therefore still serve as a private store of wealth. Also some
privately issued currencies, such as digital gold currency, are backed
by gold reserves. In effect, the holder of such currencies is long
on gold and shorton their own fiat currency, writing checks on their
account.
In 1999, to protect the value of gold as a reserve, European Central
Bankers signed the "Washington Agreement", which stated
they would not allow gold leasing for speculative purposes, nor would
they "enter the market as sellers" except for sales that
had already been agreed upon. A selling band was set. This was intended
to prevent further deterioration in the price of gold. (See Washington
Consensus)
The end of the Great Commodities Depression has affected the price
of gold as well, gold prices rising out of a 20-year trading bracket.
This has led to a renewed use by monetary authorities of gold to back
their currencies, but has not constituted adoption of a gold standard
for money. In fact, the reverse is the case-the more expensive gold
is, the more expensive the acquisition project to create a gold standard
becomes.
Courtesy
of: www.wikipedia.org