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A monetary system in which a country's government allows its currency unit to be freely converted into fixed amounts of gold and vice versa. The exchange rate under the gold standard monetary system is determined by the economic difference for an ounce of gold between two currencies. The gold standard was mainly used from 1875 to 1914 and also during the interwar years.
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The use of the gold standard would mark the first use of formalized exchange rates in history. However, the system was flawed because countries needed to hold large gold reserves in order to keep up with the volatile nature of supply and demand for currency.
After World War II, a modified version of the gold standard monetary system, the Bretton Woods monetary system, was created as its successor. This successor system was initially successful, but because it also depended heavily on gold reserves, it was abandoned in 1971 when U.S president Nixon "closed the gold window".
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Monetary system that pegs or fixes the value of a nation's currency unit to a fixed amount of gold bullion. Paper currency in such systems is convertible freely into gold. The gold standard was introduced in Great Britain in 1821 and was the basis for the U.S. Monetary system from the 1870s to 1971, when the U.S. Treasury Department announced it would no longer back the U.S. Dollar, for foreign exchange purposes, with its gold reserves. (The Gold Act of 1934 abolished the right of U.S. Citizens to exchange paper currency for gold.) The gold standard insures a fixed rate of exchange in international trade, while limiting the amount of paper currency a central government can issue for domestic spending. Its main drawback is that it hinders the ability of a government to control the supply of money and it makes it very difficult for a country to isolate itself from depressions or inflation in the economies of its major trading partners. A country experiencing a large Balance of Payments deficit may thus find it impossible to properly address the situation without coming off the gold standard. See also Gold Exchange Standard.
For more information on gold standard, visit Britannica.com.
The gold standard is a monetary system in which gold is the standard or in which the unit of value—be it the dollar, the pound, franc, or some other unit in which prices and wages are customarily expressed and debts are usually contracted—consists of the value of a fixed quantity of gold in a free gold market.
U.S. experience with the gold standard began in the 1870s. From 1792 until the Civil War, the United States, with a few lapses during brief periods of suspended specie payments, was on a bimetallic standard. This broke down in the early days of the Civil War, and from 30 December 1861 to 2 January 1879, the country was on a depreciated paper money standard. The currency act of 1873 dropped the silver dollar from the list of legal coinage but continued the free and unlimited coinage of gold and declared the gold dollar to be the unit of value. There was a free market in the United States for gold, and gold could be exported and imported without restriction. Nonetheless, for six more years the United States continued on a de facto greenback standard. In accordance with the provisions of the Resumption Act of 1875, paper dollars became officially redeemable in gold on 2 January 1879.
Under the gold standard as it then operated, the unit of value was the gold dollar, which contained 23.22 grains of pure gold. Under free coinage, therefore, anyone could take pure gold bullion in any quantity to an American mint and have it minted into gold coins, receiving $20.67 (less certain petty charges for assaying and refining) for each ounce.
The Gold Standard Act of 1900 made legally definitive a gold-standard system that had existed de facto since 1879. This act declared that the gold dollar "shall be the standard unit of value, and all forms of money issued or coined by the United States shall be maintained at a parity of value with this standard." That meant that the value of every dollar of paper money and of silver, nickel, and copper coins and of every dollar payable by bank check was equal to the value of a gold dollar—namely, equal to the value of 23.22 grains of pure gold coined into money. Thenceforth global trends would contribute to domestic cycles of inflation and deflation. If the supply of gold thrown on the world's markets relative to the demand increased, gold depreciated and commodity prices increased in the United States and in all other gold-standard countries. If the world's demand for gold increased more rapidly than the supply of gold, gold appreciated and commodity prices in all gold-standard countries declined.
Until the Great Depression there was general agreement among economists that neither deflation nor inflation is desirable and that a stable unit of value is best. Since then, some economists have held that stable prices can be achieved only at the expense of some unemployment and that a mild inflation is preferable to such unemployment. While gold as a monetary standard during the half-century 1879–1933 was far from stable in value, it was more stable than silver, the only competing monetary metal, and its historical record was much better than that of paper money. Furthermore, its principal instability was usually felt during great wars or shortly thereafter, and at such times all other monetary standards were highly unstable.
During the late nineteenth century, the major nations of the world moved toward the more dependable gold coin standard; between 1873 and 1912 some forty nations used it. World War I swept all of them off it whether they were in the war or not. At the Genoa Conference in 1922, the major nations resolved to return to the gold standard as soon as possible (a few had already). Most major nations did so within a few years; more than forty had done so by 1931.
But not many could afford a gold coin standard. Instead, they used the gold bullion standard (the smallest "coin" was a gold ingot worth about eight thousand dollars) or the even more economical gold exchange standard, first invented in the 1870s for use in colonial dependencies. In the latter case the country would not re-deem in its own gold coin or bullion but only in drafts on the central bank of some country on the gold coin or gold bullion standard with which its treasury "banked." As operated in the 1920s, this parasitic gold standard, preferentially dependent on the central banks of Great Britain, France, and the United States, allowed credit expansion on the same reserves by two countries.
It was a hazardous system, for if the principal nation's central bank was in trouble, so were all the depositor nations. In 1931 the gold standards of Austria, Germany, and Great Britain successively collapsed, the last dragging down several nations on the gold exchange standard with it. This was the beginning of the end of the gold standard in modern times. Many of the British, notably economist J. M. Keynes, alleged that both the decline in Great Britain's foreign trade and its labor difficulties in the late 1920s had been caused by the inflexibility of the gold standard, although it had served the nation well for the previous two centuries. Others argued that Britain's problems were traceable to its refusal to devalue the depreciated pound after the war or to obsolescence in major industries. In any event, Britain showed no strong desire to return to the gold standard.
Meanwhile, in the United States the gold coin standard continued in full operation from 1879 until March 1933 except for a brief departure during the World War I embargo on gold exports. At first the panic of 1929, which ushered in the long and severe depression of the 1930s, seemed not to threaten the gold standard. Britain's departure from the gold standard in 1931 shocked Americans, and in the 1932 presidential campaign, the Democratic candidate, Franklin D. Roosevelt, was known to be influenced by those who wanted the United States to follow Britain's example. A growing number of bank failures in late 1932 severely shook public confidence in the economy, but it was not until February 1933 that a frightened public began to hoard gold. On 6 March 1933, soon after he took office, President Roosevelt declared a nationwide bank moratorium for four days to stop heavy withdrawals and forbade banks to pay out gold or to export it. On 5 April the president ordered all gold coins and gold certificates in hoards of more than a hundred dollars turned in for other money. The government took in $300 million of gold coin and $470 million of gold certificates by 10 May.
Suspension of specie payments was still regarded as temporary; dollar exchange was only a trifle below par. But the president had been listening to the advice of inflationists, and it is likely that the antihoarding order was part of a carefully laid plan. Suddenly, on 20 April, he imposed a permanent embargo on gold exports, justifying the step with the specious argument that there was not enough gold to pay all the holders of currency and of public and private debts in the gold these obligations promised. There never had been, nor was there expected to be. Dollar exchange rates fell sharply. By the Thomas Amendment to the Agricultural Adjustment Act of 12 May 1933, Congress gave Roosevelt power to reduce the gold content of the dollar as much as 50 percent. A joint resolution of Congress on 5 June abrogated the gold clauses to be found in many public and private obligations that required the debtor to repay the creditor in gold dollars of the same weight and fineness as those borrowed. In four cases the Supreme Court later upheld this abrogation.
During the autumn of 1933, the Treasury bid up the price of gold under the Gold Purchase Plan and finally set it at $35 an ounce under the Gold Reserve Act of 30 January 1934. Most of the resulting profit was subsequently used as a stabilization fund and for the retirement of national bank notes. The United States was now back on a gold standard (the free gold market was in London). But the standard was of a completely new kind, and it came to be called a "qualified gold-bullion standard." It was at best a weak gold standard, having only external, not internal, convertibility. Foreign central banks and treasuries might demand and acquire gold coin or bullion when the exchange rate was at the gold export point, but no person might obtain gold for his money, coin, or bank deposits. After France left gold as a standard in 1936, the qualified gold-bullion standard was the only gold standard left in a world of managed currencies.
Although better than none at all, the new standard was not very satisfactory. The thirty-five-dollar-an-ounce price greatly overvalued gold, stimulating gold mining all over the world and causing gold to pour into the United States. The "golden avalanche" aroused considerable criticism and created many problems. It gave banks excess reserves and placed their lending policies beyond the control of the Federal Reserve System. At the same time citizens were not permitted to draw out gold to show their distrust of the new system or for any other reason. As for its stated intent to raise the price of gold and end the Depression, the arrangement did neither. Wholesale prices rose only 13 percent between 1933 and 1937, and it took the inflation of World War II to push them up to the hoped-for 69 percent. Except for a brief recovery in 1937, the Depression lasted throughout the decade of the 1930s.
The appearance of Keynes's General Theory of Employment, Interest and Money in 1936 and his influence on the policies of the Roosevelt administration caused a revolution in economic thinking. The new economics deplored oversaving and the evils of deflation and made controlling the business cycle to achieve full employment the major goal of public policy. It advocated a more managed economy. In contrast, the classical economists had stressed capital accumulation as a key to prosperity, deplored the evils of inflation, and relied on the forces of competition to provide a self-adjusting, relatively unmanaged economy. The need to do something about the Great Depression, World War II, the Korean War, and the Cold War all served to strengthen the hands of those who wanted a strong central government and disliked the trammels of a domestically convertible gold-coin standard. The rising generation of economists and politicians held such a view. After 1940 the Republican platform ceased to advocate a return to domestic convertibility in gold. Labor leaders, formerly defenders of a stable dollar when wages clearly lagged behind prices, began to feel that a little inflation helped them. Some economists and politicians frankly urged an annual depreciation of the dollar by 2, 3, or 5 percent, allegedly to prevent depressions and to promote economic growth; at a depreciation rate of 5 percent a year, the dollar would lose half its buying power in thirteen years (as in 1939–1952), and at a rate of 2 percent a year, in thirty-four years. Such attitudes reflected a shift in economic priorities because capital seemed more plentiful than before and thus required less encouragement and protection.
There remained, however, a substantial segment of society that feared creeping inflation and advocated a return to the domestically convertible gold-coin standard. Scarcely a year passed without the introduction in Congress of at least one such gold-standard bill. These bills rarely emerged from committee, although in 1954 the Senate held extensive hearings on the Bridges-Reece bill, which was killed by administration opposition.
After World War II a new international institution complemented the gold standard of the United States. The International Monetary Fund (IMF)—agreed to at a United Nations monetary and financial conference held at Bretton Woods, New Hampshire, from 1 July to 22 July 1944 by delegates from forty-four nations—went into effect in 1947. Each member nation was assigned a quota of gold and of its own currency to pay to the IMF and might, over a period of years, borrow up to double its quota from the IMF. The purpose of the IMF was to provide stability among national currencies, all valued in gold, and at the same time to give devastated or debt-ridden nations the credit to reorganize their economies. Depending on the policy a nation adopted, losing reserves could produce either a chronic inflation or deflation, unemployment, and stagnation. Admittedly, under the IMF a nation might devalue its currency more easily than before. But a greater hazard lay in the fact that many nations kept part of their central bank reserves in dollars, which, being redeemable in gold, were regarded as being as good as gold.
For about a decade dollars were much sought after. But as almost annual U.S. deficits produced a growing supply of dollars and increasing short-term liabilities in foreign banks, general concern mounted. Some of these dollars were the reserve base on which foreign nations expanded their own credit. The world had again, but on a grander scale, the equivalent of the parasitic gold-exchange standard it had had in the 1920s. Foreign central bankers repeatedly told U.S. Treasury officials that the dollar's being a reserve currency imposed a heavy responsibility on the United States; they complained that by running deficits and increasing its money supply, the United States was enlarging its reserves and, in effect, "exporting" U.S. inflation. But Asian wars, foreign aid, welfare, and space programs produced deficits and rising prices year after year. At the same time, American industries invested heavily in Common Market nations to get behind their tariff walls and, in doing so, transmitted more dollars to those nations.
Possessing more dollars than they wanted and preferring gold, some nations—France in particular—demanded gold for dollars. American gold reserves fell from $23 billion in December 1947 to $18 billion in 1960, and anxiety grew. When gold buying on the London gold market pushed the price of gold to forty dollars an ounce in October 1960, the leading central banks took steps to allay the anxiety, quietly feeding enough of their own gold into the London market to lower the price to the normal thirty-five dollars and keep it there. When Germany and the Netherlands upvalued their currencies on 4 and 6 March 1961, respectively, their actions had somewhat the same relaxing effect for the United States as a devaluation of the dollar would have had. On 20 July 1962 President John Kennedy forbade Americans even to own gold coins abroad after 1 January 1963. But federal deficits continued, short-term liabilities abroad reaching $28.8 billion by 31 December 1964, and gold reserves were falling to $15.5 billion.
Repeatedly the Treasury took steps to discourage foreign creditors from exercising their right to demand gold for dollars. The banks felt it wise to cooperate with the Americans in saving the dollar, everyone's reserve currency. By late 1967, American gold reserves were less than $12 billion. In October 1969 Germany upvalued the mark again, and American gold reserves were officially reported at $10.4 billion. The patience of foreign creditors was wearing thin. During the first half of 1971, U.S. short-term liabilities abroad shot up from $41 billion to $53 billion, and the demand for gold rose. On 15 August 1971 President Richard M. Nixon announced that the U.S. Treasury would no longer redeem dollars in gold for any foreign treasury or central bank. This action took the nation off the gold standard beyond any lingering doubt and shattered the dollar as a reliable reserve currency. At a gathering of financial leaders of ten industrial nations at the Smithsonian Institution in Washington, D.C., on 17 to 18 December 1971, the dollar was devalued by 7.89 percent in the conversion of foreign currencies to dollars, with some exceptions. In 1972 gold hit seventy dollars an ounce on London's free market for gold, and the United States had its worst mercantile trade deficit in history.
In early 1973 another run on the dollar began. The Treasury announced a 10 percent devaluation of the dollar on 12 February, calling it "a means toward easing the world crisis" and alleging that trade concessions to the United States and greater freedom of capital movements would follow. The new official price of gold was set at $42.22, but on the London market gold soon reached $95 and went to $128.50 in Paris in mid-May. A third devaluation seemed possible but was avoided, at least outwardly. The nine Common Market nations all "floated" their currencies, and Germany and Japan announced they would no longer support the dollar. By midsummer the dollar had drifted another 9 percent downward in value. The U.S. Treasury refused to discuss any plans for a return to gold convertibility. Nevertheless the United States and all other nations held on to their gold reserves. Several European nations, notably France and Germany, were willing to return to a gold basis.
In the 1970s opponents of the gold standard insisted that the monetary gold in the world was insufficient to serve both as a reserve and as a basis for settling large balances between nations, given the rapid expansion of world trade. Supporters of the gold standard distrusted inconvertible paper money because of a strong tendency by governments, when unrestrained by the necessity to redeem paper money in gold on demand, to increase the money supply too fast and thus to cause a rise in price levels. Whereas opponents of the gold standard alleged there was insufficient monetary gold to carry on international trade—they spoke of there being insufficient "liquidity"—supporters stressed that national reserves did not have to be large for this purpose, since nations settled only their net balances in gold and not continually in the same direction.
A period of severe inflation followed the Nixon administration's decision to abandon the gold standard. Nevertheless, despite the economic turmoil of the 1970s, the United States did not return to the gold standard, choosing instead to allow the international currency markets to determine its value. In 1976 the International Monetary Fund established a permanent system of floating exchange rates, a development that made the gold standard obsolete and one that allowed the free market to determine the value of various international currencies. Consequently, as inflation weakened the American dollar, the German Mark and Japanese Yen emerged as major rivals to the dollar in international currency markets.
In the 1990s the American dollar stabilized, and, by the end of the decade, it had regained a commanding position in international currency markets. The robust global economic growth of the 1980s and 1990s appeared to vindicate further the decision to vacate the gold standard. In 2002 the European Union introduced into circulation the Euro, a single currency that replaced the national currencies of nearly a dozen European nations, including major economic powers such as Germany, France, and Italy. The Euro quickly emerged as a highly popular currency in international bond markets, second only to the dollar. Although the long-term direction of international currency markets remains unclear, it seems certain that neither the United States nor Europe will ever return to the gold standard.
Bibliography
Chandler, Lester Vernon. American Monetary Policy, 1928–1941. New York: Harper & Row, 1971.
De Cecco, Marcello. The International Gold Standard: Money and Empire. New York: St. Martin's Press, 1984.
Eichengreen, Barry J. Golden Fetters: The Gold Standard and the Great Depression, 1919–1939. New York: Oxford University Press, 1992.
Gallarotti, Giulio M. The Anatomy of an International Monetary Regime: The Classical Gold Standard, 1880–1914. New York: Oxford University Press, 1995.
Kemmerer, Edwin Walter. Gold and the Gold Standard: The Story of Gold Money, Past, Present and Future. New York: McGraw-Hill, 1944.
Mehrling, Perry G. The Money Interest and the Public Interest: American Monetary Thought, 1920–1970. Cambridge, Mass.: Harvard University Press, 1997.
Ritter, Gretchen. Goldbugs and Greenbacks: The Antimonopoly-Tradition and the Politics of Finance, 1865–1896. New York: Cambridge University Press, 1997.
Schwartz, Anna, and Michael D. Bordo, eds. A Retrospective on the Classical Gold Standard, 1821–1931. National Bureau of Economic Research. Chicago: University of Chicago Press, 1984.
A gold standard is a monetary system in which a country backs its currency with gold reserves and allows the conversion of its currency into gold. Tsarist Russia introduced the gold standard in January 1897 and maintained it until 1914. The policy was adopted both as a means of attracting foreign capital for the ambitious industrialization efforts of the late tsarist era, and to earn international respectability for the regime at a time when the world's leading economies had themselves adopted gold standards. Preparation for this move began under Russian Finance Minister Ivan Vyshnegradsky (1887 - 1892), who actively built up Russia's gold supply while restricting the supply of paper money. After a brief setback, the next finance minister, Sergei Witte (1892 - 1903), continued to amass gold reserves and restrict monetary growth through foreign borrowing and taxation. By 1896, Russian gold reserves had reached levels commensurate (in relative terms) with other major European nations on the gold standard. The gold standard proved so controversial in Russia that it had to be introduced directly by imperial decree, over the objections of the State Council (Duma). This decree was promulgated on January 2, 1897, authorizing the emission of new five-and tenruble gold coins. At this point the state bank (Gosbank) became the official bank of issue, and Russia pegged the new ruble to a fixed quantity of gold with full convertibility. This meant that the ruble could be exchanged at a stable, fixed rate with the other major gold-backed currencies of the time, which facilitated trade by eliminating foreign exchange risk.
Private foreign capital inflows increased considerably after the introduction of the gold standard, and currency stability increased as well. By World War I, Russia had been transformed from a state set somewhat apart from the international financial system to the world's largest international debtor. Proponents argue that the gold standard accelerated Russian industrialization and integration with the world economy by preventing inflation and attracting private capital (substituting for the low rate of domestic savings). They also point out that the Russian economy might not have recovered so quickly after the Russo-Japanese war and civil unrest in 1904 and 1905 without the promise of stability engendered by the gold standard. Critics, however, charge that the gold standard required excessively high foreign borrowing and tax, tariff, and interest rates to introduce. They further charge that once in place, the gold standard was deflationary, inflexible, and too preferential to foreign investment. Economist Paul Gregory argues that the entire debate may be moot, inasmuch as Russia had no choice but to adopt the gold standard in an international environment that practically required it for countries wishing to take advantage of the era's large-scale cross-border trade and investment opportunities. Russia abandoned the gold standard in 1914 under the financial pressure of World War I.
Bibliography
Drummond, Ian. (1976). "The Russian Gold Standard, 1897 - 1914." Journal of Economic History 36(4): 633 - 688.
Gerschenkron, Alexander. (1962). Economic Backwardness in Historical Perspective: A Book of Essays. Cambridge, MA: Belknap Press of Harvard University Press.
Gregory, Paul. (1994). Before Command: An Economic History of Russia from Emancipation to the First Five-Year Plan. Princeton, NJ: Princeton University Press.
Von Laue, Theodore. (1963). Sergei Witte and the Industrialization of Russia. New York: Columbia University Press.
—JULIET JOHNSON
A system in which a nation's currency has a value measured in gold and can be exchanged for gold. Most nations, including the United States, went off the gold standard in the 1930s.
The gold standard is a monetary system in which the standard economic unit of account is a fixed weight of gold.
Under the gold standard, currency issuers guarantee to redeem notes, upon demand, in that amount of gold. Governments that employ such a fixed unit of account, and which will redeem their notes to other governments in gold, share a fixed-currency relationship. The gold standard is not currently used by any government or central bank, having been replaced completely by fiat currency. However, private currency backed by gold is in use.
Due to its rarity, durability, easy divisity, and the general ease of identification through its medium, wigold as the metal of monetary reserve. Even after silver was no longer basis of currency, gold remained a base global currency until the collapse of the Bretton Woods system.
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.
The Persian Empire collected taxes in gold, and when it was conquered by Alexander the Great, this gold became the basis for the gold coinage of Alexander's empire. The Roman Empire minted two important gold coins: the aureus, which was ~7 grams of gold alloyed with silver, and the smaller solidus, which weighed 4.4 grams, of which 4.2 was gold. These values applied only to the early Empire. Later Roman and Byzantine coins were frequently diluted with other metals, in an attempt to expand the money supply
The dinar and dirham were gold and silver coins, respectively, originally minted by the Persians. The Caliphates in the Islamic world adopted these coins, starting with Caliph Abd al-Malik (685–705)
In 1284, the Republic of Venice coined its first solid gold coin, the ducat. Other coins, the florin, noble, grosh, złoty, and guinea, also were introduced at this time by other European states to facilitate growing trade. 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 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.
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 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. There were 113 grains (7.32g) of gold to one pound sterling.
The US adopted a silver standard based on the "Spanish milled dollar" in July 1785. This was codified in the 1792 Mint and Coinage Act. This began a long series of attempts for America to create a bimetallic standard for the US Dollar, which would continue until the 1930s. 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 1846, which legally separated the accounts of the Federal Government from the banking system. 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.
Germany was created as a unified country following the Franco-Prussian War; it established the mark. Rapidly most other nations followed suit. Gold became a transportable, universal and stable unit of valuation, and the world's dominant economy, the United Kingdom, had a longstanding commitment to the gold standard.[1] See Globalization.
Dates of adoption of a gold standard:
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
To fund operations during World War I, the United Kingdom was forced to end convertibility of Bank of England notes to gold starting in 1914. By the end of the war Britain 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 United States took similar measures. After the war, Germany, losing 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.
In the UK the pound 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 WWI ending of the gold standard, Churchill returned to the standard 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 using the Pound Sterling. 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 UK the standard was again abandoned on September 20, 1931. Sweden abandoned the gold standard in October 1931, the US in 1933, and other nations were, to one degree or another, forced off the 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 [citation needed]. This depletion of the UK’s reserve signalled to Winston Churchill that returning to a pre-war style gold standard was impractical. 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.
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.
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. The 100% reserve standard is generally considered unworkable because the quantity of gold in the world is too small a quantity of money to sustain current worldwide economic activity and the "right" quantity of money (ie one that avoids either inflation or deflation) is not a fixed quantity, but varies continuously with the level of commercial activity.
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.
The gold standard, in theory, limits the power of governments to cause price inflation by excessive issue of paper currency. It is also supposed to create certainty in international trade by providing a fixed pattern of exchange rates. 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”. At the time of the Bretton Woods agreement, it was believed that markets internally always clear (See Say’s Law). However, in practice, wages, not capital, depreciate in price first.
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 return to the gold standard is supported by Objectivists, followers of the Austrian School of Economics, and many libertarians.
It is generally[attribution needed] 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.[citation needed] [dubious ]
Few economists[attribution needed] 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, and argue against fiat money, including former US Federal Reserve Chairman Alan Greenspan and macro-economist Robert Barro. 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.
In 2001 Malaysian Prime Minister
Ron Paul, a congressman from Texas and candidate for the 2008 Republican nomination for President, advocates the U.S. abolishment of the Federal Reserve and reinstitution of the gold standard. [4]
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.
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 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.
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