Gold standard

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Under a gold standard, paper notes are convertible into pre-set, fixed quantities of gold.

The gold standard is a monetary system in which a region's common media of exchange are paper notes that are normally freely convertible into pre-set, fixed quantities of gold. The gold standard is not currently used by any government, having been replaced completely by fiat currency.


[edit] History

In the 1790s Britain 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, Britain began a massive recoinage program that created standard gold sovereigns and circulating crowns, half-crowns, and eventually copper farthings in 1821. In 1833, 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.[citation needed]

[edit] Establishment of the international gold standard

When Germany became a unified country following the Franco-Prussian War (19 July 1870 – 10 May 1871), it established the mark and defined its value in gold. Most other nations quickly followed suit. Gold became a transportable, universal and stable unit of valuation. The world's dominant economy at the time, the United Kingdom, already had a longstanding commitment to the gold standard.[1].

The main purpose of either government money system has historically been to provide seigniorage, or money-creation profit, to governmental leaders in order to provide them with general purchasing power during emergencies, especially those leaders who are legislatively constrained and therefore unable to raise taxes in order to execute the defense commitments that are required for the survival of their states.[2]

Gold standards replaced gold-coin standards in the 17th-19th centuries in the West as the extent of defensive warfare expanded to where the gold-coin standards were no longer sufficient to the task. A similar history generated a gold standard in China from the 9th through the early 17th century. [3]

[edit] Dates of adoption of a gold standard

Throughout the post-Civil War decade of the 1870s deflationary and depressionary economics created periodic demands for silver currency. However, attempts to introduce such currency 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.[citation needed]

[edit] Gold standard from peak to crisis (1901–1932)

[edit] Suspending gold payments to fund the war

As in previous major wars under its gold standard, the British government suspended the convertibility of Bank of England notes to gold in 1914 to fund military operations during World War I[7]. By the end of the war Britain was on a series of fiat currency regulations, which monetized Postal Money Orders and Treasury Notes. The government later called these notes banknotes, which are different from US Treasury notes. The United States government took similar measures. After the war, Germany, having lost much of its gold in reparations, could no longer coin gold "Reichsmarks" and moved to paper currency, although the Weimar Republic later introduced the "rentenmark" and later the gold-backed reichsmark in an effort to control hyperinflation.

As had happened after previous major wars, the UK was returned to the gold standard in 1925, by a somewhat reluctant Winston Churchill. Although a higher gold price and significant inflation had followed the wartime suspension, Churchill followed tradition by resuming conversion payments at the pre-war gold price. For five years prior to 1925 the gold price was managed downward to the pre-war level, causing deflation throughout those countries of the British Empire and Commonwealth using the Pound Sterling. But the rise in demand for gold for conversion payments that followed the similar European resumptions from 1925 to 1928 meant a further rise in demand for gold relative to goods and therefore the need for a lower price of goods because of the fixed rate of conversion from money to goods. In order to attract gold, Britain needed to increase the value of investing in their domestic assets. They needed to increase the demand for the pound. By doing this, Britain attracted gold from the stronger US, which decreased the US money supply as well as depressed Britain’s own economy. Because of these price declines and predictable depressionary effects, the British government finally abandoned the standard September 20, 1931. Sweden abandoned the gold standard in October 1931; and other European nations soon followed. Even the U.S. government, which possessed most of the world's gold ($175 million flowed into the U.S. in 1929, and $280 million in 1930)[8] moved to cushion the effects of the Great Depression by raising the official price of gold (from about $20 to $35 per ounce) and thereby substantially raising the equilibrium price level in 1933-4.

[edit] Depression and World War II

[edit] 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 U.S. and other nations.[citation needed] This depletion of the UK's reserve convinced Winston Churchill of the impracticality of returning to a pre-war style gold standard. To put it simply the war had bankrupted Britain. John Maynard Keynes, who had argued against such a gold standard, proposed to put the power to print money in the hands of the privately owned Bank of England. Keynes, in warning about the menaces of inflation, said "By a continuous process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method, they not only confiscate, but they confiscate arbitrarily; and while the process impoverishes many, it actually enriches some".[9] Quite possibly because of this, the 1944 Bretton Woods Agreement established the International Monetary Fund and an international monetary system based on convertibility of the various national currencies into a U.S. dollar that was in turn convertible into gold. It also prevented countries from manipulating their currency's value to gain an edge in international trade.

[edit] Post-war international gold standard (1946–1971)

After the Second World War, a system similar to the Gold Standard was established by the Bretton Woods Agreements. Under this system, many countries fixed their exchange rates relative to the US dollar. The US promised to fix the price of gold at $35 per ounce. Implicitly, then, all currencies pegged to the dollar also had a fixed value in terms of gold. Under the regime of the French President Charles de Gaulle up to 1970, France reduced its dollar reserves, trading them for gold from the U.S. government, thereby reducing US economic influence abroad. This, along with the fiscal strain of Lyndon Johnson's Great Society expenditures and the Vietnam War, led President Richard Nixon to eliminate the fixed gold price in 1971, causing the system to break down.

[edit] Theory

The history of money consists of three phases[citation needed]: commodity money, in which actual valuable objects are bartered; then representative money, in which paper notes (often called 'certificates') are used to represent real commodities stored elsewhere; and finally fiat money, in which paper notes are backed only by use of' "lawful force and legal tender laws" of the government, in particular by its acceptability for payments of debts to the government (usually taxes).

Commodity money is inconvenient to store and transport. It also does not allow the government to control or regulate the flow of commerce within their dominion with the same ease that a standardized currency does. As such, commodity money gave way to representative money, and gold and other specie were retained as its backing.

Gold was a common form of representative money due to its rarity, durability, divisibility, fungibility, and ease of identification,[10] often in conjunction with silver. Silver was typically the main circulating medium, with gold as the metal of monetary reserve.

It is difficult to manipulate a gold standard to tailor to an economy’s demand for money, providing practical constraints against the measures that central banks might otherwise use to respond to economic crises.[11]

The Gold Standard variously specified how the gold backing would be implemented, including the amount of specie per currency unit. The currency itself is 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.

Representative money and the Gold Standard protect citizens from hyperinflation and other abuses of monetary policy, as were seen in some countries during the Great Depression. However, they were not without their problems and critics, and so were partially abandoned via the international adoption of the Bretton Woods System. That system eventually collapsed in 1971, at which time all nations had switched to full fiat money.

According to later analysis, the earliness with which a country left the gold standard reliably predicted its economic recovery. For example, Great Britain and Scandinavia, which left the gold standard in 1931, recovered much earlier than France and Belgium, which remained on gold much longer. Countries such as China, which had a silver standard, almost avoided the depression entirely. The connection between leaving the gold standard as a strong predictor of that country's severity of its depression and the length of time of its recovery has been shown to be consistent for dozens of countries, including developing countries. This partly explains why the experience and length of the depression differed between national economies.[12]

[edit] Differing definitions of gold standard

A 100% reserve gold standard, or a full gold standard exists when the monetary authority holds sufficient gold to convert all circulating money into gold at the promised exchange rate. It is sometimes referred to as the Gold Specie Standard to more easily identify it from other forms of the gold standard that have existed at various times. A 100% reserve standard is generally considered[who?] difficult to implement as the quantity of gold in the world is too small to sustain current worldwide economic activity at current gold prices. Its implementation would entail a many-fold increase in the price of gold. Furthermore, the "necessary" quantity of money (i.e. one that avoids either inflation or deflation) is not a fixed quantity, but varies continuously with the level of commercial activity.[citation needed] The currencies or banknotes that were backed by the Gold standard were the old German Reichsmarks, Yugoslav dinars, Turkish liras, Brazilian cruzeiros, Croatian dinars, Polish złoty, Argentine peso leys, Angola Kwanzas reajastodos, Zairean zaires and Bolivian bolivianos.[citation needed]

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.[citation needed]

[edit] Advantages

The theory of the gold standard rests on the idea that maximal increases in governmental purchasing power during wartime emergencies require post-war deflations, which would not occur without monetary institutions like the gold standard, which insist upon return to pre-war price-levels and therefore deflationary wartime expectations.[13]

The gold standard limits the power of governments to inflate prices through excessive issuance of paper currency. It may tend to reduce uncertainty in international trade by providing a fixed pattern of international exchange rates. Under the classical international gold standard, disturbances in price levels in one country would be partly or wholly offset by an automatic balance-of-payment adjustment mechanism called the "price specie flow mechanism."

[edit] Disadvantages

Gold prices (US$ per ounce) since 1968, in nominal US$ and inflation adjusted US$.
  • The total amount of gold that has ever been mined has been estimated at around 142,000 tonnes.[14] Assuming a gold price of US$1,000 per ounce, or $32,500 per kilogram, the total value of all the gold ever mined would be around $4.5 trillion. This is less than the value of circulating money in the U.S. alone, where more than $7.6 trillion is in circulation or in deposit (M1).[15] Therefore, a return to the gold standard, if also combined with a mandated end to fractional reserve banking, would result in a significant increase in the current value of gold, which may limit its use in current applications.[16] For example, instead of using the ratio of $1,000 per ounce, the ratio can be defined as $2,000 per ounce (or $1,000 per 1/2 ounce) effectively raising the value of gold to $8 trillion. However, this is specifically a perceived disadvantage of return to the gold standard and not the efficacy of the gold standard itself. Some gold standard advocates consider this to be both acceptable and necessary[17] whilst others who are not opposed to fractional reserve banking argue that only base currency and not deposits would need to be replaced.[citation needed]The amount of such base currency (M0) is only about one tenth as much as the figure (M1) listed above.[citation needed]
  • Most mainstream economists believe that economic recessions can be largely mitigated by increasing money supply during economic downturns. Following a gold standard would mean that the amount of money would be determined by the supply of gold, and hence monetary policy could no longer be used to stabilize the economy in times of economic recession. [18]
  • Monetary policy would essentially be determined by the rate of gold production. Fluctuations in the amount of gold that is mined could cause inflation if there is an increase, or deflation if there is a decrease. [19][20] Some hold the view that this contributed to the Great Depression.[16][21]
  • Some have contended that the gold standard may be susceptible to speculative attacks when a government's financial position appears weak. For example, some believe the United States was forced to raise its interest rates in the middle of the Great Depression to defend the credibility of its currency.[21]
  • If a country wanted to devalue its currency, it would produce sharper changes, in general, than the smooth declines seen in fiat currencies, depending on the method of devaluation.[22]

[edit] Advocates of a renewed gold standard

The return to the gold standard is supported by many followers of the Austrian School of Economics, Objectivists and libertarians largely because they object to the role of the government in issuing fiat currency through central banks. A significant number of gold standard advocates also call for a mandated end to fractional reserve banking; however, this view is far from universal.

Few lawmakers[17] today advocate a return to the gold standard, other than adherents of the Austrian school and some supply-siders. However, many prominent economists have expressed sympathy with a hard currency basis, and have argued against fiat money, including former US Federal Reserve Chairman Alan Greenspan (himself a former Objectivist), and macro-economist Robert Barro.[23] Greenspan famously argued the case for returning to a gold standard in his 1966 paper "Gold and Economic Freedom", in which he described supporters of fiat currencies as "welfare statists" hell-bent on using monetary printing presses to finance deficit spending. He has argued that the fiat money system of today has retained the favorable properties of the gold standard because central bankers have pursued monetary policy as if a gold standard were still in place.[24] US Congressman Ron Paul argues for the reinstatement of the gold standard based on his theory of "pure strain" gold – that gold has intrinsic value separate from any economic system due to its physical properties. Furthermore, the amount of "pure strain" gold in the world is constant, heading off the problem of inflation.

The current global monetary system relies on the US dollar as a reserve currency by which major transactions, such as the price of gold itself, are measured. Currency instabilities, inconvertibility and credit access restriction are a few reasons why the current system has been criticized[citation needed]. A host of alternatives have been suggested, including energy-based currencies, market baskets of currencies or commodities; gold is merely one of these alternatives.

In 2001 Malaysian Prime Minister Mahathir bin Mohamad proposed a new currency that would be used initially for international trade among 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.[25] However, to date, Mahathir's proposed gold-dinar currency has failed to become an accomplished fact.

[edit] 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 U.S. Dollar, which forms the bulk of liquid currency reserves. Weakness in the U.S. 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 19% of all above-ground gold is held in reserves by central banks.[dubious ]

Both gold coins and gold bars are widely traded in deeply liquid markets, and therefore still serve as a private store of wealth. Some privately issued currencies, such as digital gold currency, are backed by gold reserves.

In 1999, to protect the value of gold as a reserve, European Central Bankers signed the Washington Agreement on Gold which stated that 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.

[edit] See also

[edit] References

  1. ^ Baines, D. (1997). "Institutions that underpinned the international economy before the First World War" (PDF). Economic history in the 20th century. London: University of London External Programme. ISBN 0718714377. OCLC 44837541. Retrieved on 2008-11-12. 
  2. ^ Thompson, Earl A. (July/August 1974). "Taxation and National Defense". Journal of Political Economy 82 (4): 755–782. doi:10.1086/260232. Retrieved on 2008-11-12.  See especially page 758, note 4.
  3. ^ Shlaes, Amity (2007). The forgotten man: a new history of the Great Depression. New York City: HarperCollins. ISBN 0-06-621170-0. OCLC 74029445. [page number needed]
  4. ^ Kindleberger, Charles P. (1993). A financial history of western Europe. Oxford: Oxford University Press. pp. 60–63. ISBN 0-19-507738-5. OCLC 26258644. 
  5. ^ Newton, Isaac, Treasury Papers, vol. ccviii. 43, Mint Office, 21 Sept. 1717
  6. ^ The Pocket money book: a monetary chronology of the United States. Great Barrington, Massachusetts: American Institute for Economic Research. 2006. pp. 4–6. ISBN 0-913610-46-1. OCLC 75968548. 
  7. ^ Snowdon, Brian; Howard R. Vane (2002). "Gold Standard". An Encyclopedia of Macroeconomics. Edward Elgar Publishing. pp. 293. ISBN 1840643870. Retrieved on 2008-12-15. 
  8. ^ Shlaes, Amity, The Forgotten Man: A History of the Great Depression (HarperCollins 2008), p. 90
  9. ^ John Maynard Keynes Economic Consequences of the Peace, 1920
  10. ^ Krech, Shepard; John Robert McNeill and Carolyn Merchant (2004). Encyclopedia of world environmental history. New York City: Routledge. pp. 597. ISBN 0-415-93734-5. OCLC 174950341. 
  11. ^ Demirgüç-Kunt, Asli; Enrica Detragiache (April 2005). "Cross-Country Empirical Studies of Systemic Bank Distress: A Survey". National Institute Economic Review 192 (1): 68–83. doi:10.1177/002795010519200108. ISSN 0027-9501. OCLC 90233776. Retrieved on 2008-11-12. 
  12. ^ Bernanke, Ben (March 2, 2004), "Remarks by Governor Ben S. Bernanke: Money, Gold and the Great Depression", At the H. Parker Willis Lecture in Economic Policy, Washington and Lee University, Lexington, Virginia
  13. ^ Thompson, Earl A. (1997). "The Gold Standard: Causes and Consequences". in David Glasner. Business cycles and depressions: an encyclopedia. New York: Garland Publishing. pp. 267–272. ISBN 0-8240-0944-4. OCLC 34651539. 
  14. ^ Butterman, W. C.; Earle B. Amey III (2005) (PDF). Mineral Commodity Profiles—Gold. Reston, Virginia: United States Geological Survey. OCLC 62034878. Retrieved on 2008-11-12. [page number needed]
  15. ^ "Money Stock and Debt Measures". Federal Reserve Board. 2008-03-13. Retrieved on 2008-03-16. 
  16. ^ a b Warburton, Clark (1966). "The Monetary Disequilibrium Hypothesis". Depression, Inflation, and Monetary Policy: Selected Papers, 1945-1953. Baltimore: Johns Hopkins University Press. pp. 25–35. OCLC 736401. 
  17. ^ a b Paul, Ron; Lewis Lehrman (1982) (PDF). The case for gold: a minority report of the U. S. Gold Commission. Washington, D.C.: Cato Institute. pp. 160. ISBN 0-932790-31-3. OCLC 8763972. Retrieved on 2008-11-12. 
  18. ^ Krugman, Paul. "The Gold Bug Variations". Retrieved on 2009-02-13. 
  19. ^ DeLong, Brad (1996-08-10). "Why Not the Gold Standard?". written at Berkeley, California. University of California, Berkeley. Retrieved on 2008-09-25. 
  20. ^ Bordo, Michael D. (2008). "Gold Standard". in David R. Henderson. Concise Encyclopedia of Economics. Indianapolis: Liberty Fund. ISBN 0-86597-666-X. OCLC 123350134. Retrieved on 2008-11-12. 
  21. ^ a b Hamilton, James D. (2005-12-12). "The gold standard and the Great Depression". Econbrowser. Retrieved on 2008-11-12.  See also Hamilton, James D. (April 1988). "Role of the International Gold Standard in Propagating the Great Depression". Contemporary Economic Policy 6 (2): 67–89. doi:10.1111/j.1465-7287.1988.tb00286.x (inactive 2008-11-12). Retrieved on 2008-11-12. 
  22. ^ McArdle, Megan (2007-09-04). "There's gold in them thar standards!". The Atlantic Monthly. Retrieved on 2008-11-12. 
  23. ^ Salerno, Joseph T. (1982-9-9). "The Gold Standard: An Analysis of Some Recent Proposals". Cato Policy Analysis. Cato Institute. Retrieved on 2009-03-23. 
  24. ^ Greenspan, Alan (July 1966). "Gold and Economic Freedom". The Objectivist 5 (7). Retrieved on 2008-10-16. 
  25. ^ al-'Amraawi, Muhammad; Al-Khammar al-Baqqaali, Ahmad Saabir, Al-Hussayn ibn Haashim, Abu Sayf Kharkhaash, Mubarak Sa'doun al-Mutawwa', Malik Abu Hamza Sezgin, Abdassamad Clarke and Asadullah Yate (2001-07-01). "Declaration of 'Ulama on the Gold Dinar". Islam i Dag. Retrieved on 2008-11-14. 

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