You may be wondering what the gold standard monetary system is and what it is all about. To make you better understand this monetary system, this article will be discussing it, how it came to be and its importance.
The Gold Standard Monetary System
The gold standard system is a monetary system where a country’s government allows its currency to be converted freely into fixed gold quantities and vice versa. The exchange rate under this monetary system is normally determined by the economic difference between an ounce of gold and two currencies. This system was generally in use between 1875 and 1914 and partly during the global war era.
It was the use of the gold standard system that marked the start of the formal exchange rates. However, in those early years, the system had many flaws as many countries had to hold large gold reserves for them to keep up with the unstable nature of demand and supply of currency. After the Second World War however, a modified alternative and better version of the system – the Bretton Woods monetary system – was conceived and eventually succeeded it. Though successful in its first years, the Bretton Woods system would be abandoned in 1971 under President Nixon’s term as it too heavily depended on gold reserves.
The Gold Standard Monetary System: History
The gold standard monetary system was, in general, a commitment by participating nations to fix their domestic currency prices through specified amounts of gold. In those days, National currencies and other money forms – notes and deposits – were freely converted to gold but at a fixed price. Initially, the United States was on a bimetallic standard, using both silver and gold, but would later switch to using gold as their de facto standard in 1834 with its price standing at 20.67 dollars for each ounce where it stood until 1933.
The time between 1880 and 1914 is commonly referred to as the era of the classical gold standard. However, most of the major nations using the system adopted the system during the 1870s. During this period, a majority of these nations would adhere, in varying degrees, to this standard. It is worth noting that it is during this period that there was an unprecedented growth in economies with most countries enjoying free trade in capital, labor, and goods.
The gold standard monetary system would start to experience problems soon after World War 1 started, consequently leading to its demise. The major cause to this was that major belligerents would resort to using finance inflation tactics. The system would be reinstated, though for a brief moment – it would be in use from 1925-1931 and is when the term ‘Gold Exchange Standard’ would be coined.
The Gold Exchange Standard: 1925-1931
During this period, countries would hold dollars, pounds or gold as reserves; expect for the United Kingdom and the United States, whose reserves were made up of gold only. This version would break down in 1931 after Britain’s decision to let go of gold as a reserve in the midst of massive capital and gold outflows.
Abandoning of the gold standard
In 1933, the then serving president, Franklin D. Roosevelt would nationalize gold owned by abrogated contracts and private citizens and payments were specified in gold. From 1946 to 1971, most countries adopted the Bretton Woods System. This further modified the gold standard system leading to most nations settling their international balances in U.S$. In the bid to win favor, the U.S government vowed to buy back other nations’ central banks dollar holdings for gold at a specified fixed price of 35$ per ounce of gold.
Due to persistent balance-of-payments discrepancies, U.S gold reserves would steadily reduce. This in turn reduced confidence in the United States ability to redeem its currency as gold. In 1971, President Richard Nixon announced that his government was no longer going to redeem its currency for gold. It is this move that would lead to most abandoning the gold standard system.
Towards the end of 1970 and at the beginning of the 1980’s, there was renewed interest in the standard as widespread discontent with high inflation rates cropped up. While the interest in the gold system is not as strong today, it however seems to increase each time inflation levels move above 5%. And it all makes sense. Here is why. While the gold standard was not void of problems and issues, one thing it never had or experienced was persistent inflation. Interestingly, during the period the U.S was operating under the classical gold standard, between 1880 and 1914, inflation percentages only averaged 0.1% annually.
While the last remnants of the gold standard monetary system disappeared in 1971, the systems’ appeal is still very much alive in the hearts of many. For people who are opposed to the nation’s central bank holding discretionary powers, it’s the basic rules and the simplicity that are most attractive. Others view this monetary system as a good world price level anchor while others value its fixity of exchange rates.
However, despite such appealing attributes, the conditions that made this monetary standard successful all vanished long ago. The fact that most governments are attached to full employments shows that it is very unlikely that they will try to maintain a gold standard link and its effect, which is long-term price stability – the ultimate economic policy goal.