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Gold standard

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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, 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.

Why gold?

The history of money consists of three phases: 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 the traders' "full faith and credit" in the government.

Gold was a common form of commodity money due to its rarity, durability, easy divisibility ('fungibility'), and the general ease of identification,[1] often in conjunction with silver. Silver was typically the main circulating medium, with gold as the metal of monetary reserve.

Commodity money is troublesome and risky to transport, vulnerable to debasement, and subject to hoarding. 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 represensitive money, and gold and other specie were retained as its backing. The Gold Standard variously specified how this 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 (and still can) 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. Former US Federal Reserve Chairman Alan Greenspan 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.

Disadvantages

Beyond the difficulty in transporting, storing, and preventing the debasement of gold, one of the main disadvantages of the gold standard is that it artificially inflates its value, increasing the cost of items and industrial processes in which it is used.[2] The total amount of gold that has ever been mined is estimated at ~125,000 tonnes.[3] At the former gold price of around USD $640 per Troy ounce, or around $20,000 per kilogram, the value of this entire planetary stock would be USD $2.5 trillion, which is less than the value of currency circulating. In the U.S. alone, more than $7.3 trillion is in circulation.[4]

Under the gold standard, gold mined at a different rate than the economy grows can produce both inflation, when deposits are discovered and extracted, and deflation when they are mined to exhaustion.[5] In practice, the production of gold has usually trailed economic growth, resulting in periods of severe deflationary pressure, including events during the Great Depression.[2] Finally, using a fixed commodity as a monetary standard gives central banks substantially fewer options with which to respond to economic crises and stimulate economic growth.[6]

History

See also: History of the English penny

Early coinage

Gold coin of Alexander the Great, ca. 330 BC

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.E. 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. During the heyday of the Athenian empire, the city's silver tetradrachm was the first coin to achieve "international standard" status in Mediterranean trade. Silver remained the most common monetary metal used in ordinary transactions until the 20th century.

Aureus minted in 193 CE by Septimius Severus.

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 and those of his Diadochi. The vast gold hoard of the Persian kings was put into monetary circulation, triggering the first known "worldwide" inflation event.

Solidus of Justinian II, ca. 705 CE

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 alloyed with baser 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).

Sequin (Venetian ducat), 1382 CE

In 1284 the Republic of Venice coined the ducat, its first solid gold coin. Other coins, the florin, noble, grosh, złoty, and guinea, were also 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.

The crisis of silver currency and bank notes (1750–1870)

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 U.S. 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.

Establishment of the international gold standard

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.[7] 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 Latin Monetary Union, composed of France, Italy, Belgium, Switzerland and later Greece, even though silver was, in theory, a circulating medium.

Gold standard from peak to crisis (1901–1932)

Abandoning the standard to fund the war

The British government ended the convertibility of Bank of England notes to gold in 1914 to fund military operations during World War I. 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, 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. The British government abandoned the standard again on September 20, 1931. Sweden abandoned the gold standard in October 1931, the U.S. in 1933, and other nations were, to one degree or another, forced off the gold standard.

Depression and World War II

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. John Maynard Keynes, who had argued against such a gold standard, became increasingly influential. He proposed a more wide ranging version of the "stability pact" style gold standard, later expressed in the Bretton Woods Agreement.

Post-war international gold standard (1946–1971)

Main article: Bretton Woods system

Theory

The theory of the gold standard rests on the idea that inflation is caused by an increase in the supply of money, an idea advocated by David Hume, and that uncertainty over the future purchasing power of currency depresses business confidence and leads to reduced trade and capital investment.

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. 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 (i.e. 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.

Perceived stability offered by gold standard

The gold standard, in theory, limits the power of governments to inflate prices through excessive issuance 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 were always internally clear; Say's Law. However, in practice, wages, not capital, depreciate 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.[citation needed]

Advocates and opponents of a renewed gold standard

The return to the gold standard is supported by Objectivists, followers of the Austrian School of Economics, and many libertarians.

It is opposed by the vast majority of governments and economists,[citation needed] 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 – discuss] In theory, paper money printed based on the finite amount of gold will go up in value as it becomes rarer[citation needed].

Few economists[who?] today advocate a return to the gold standard, other than 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 and macro-economist Robert Barro. 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. In debates with US Congressman Dr. Ron Paul, Greenspan 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.

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 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.[1] However to date, Mahathir's proposed gold-dinar currency has failed to become an accomplished fact.[2][3]

Gold as a reserve today

Gold ingots like these, from the Bank of Sweden, still form an important currency reserve and store of private wealth.
Main article: Official gold reserves

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 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. 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.

See also

References

  1. ^ Krech, Shepard (2004). Encyclopedia of World Environmental History. p. 597. {{cite book}}: Unknown parameter |coauthors= ignored (|author= suggested) (help)
  2. ^ a b Warburton, C. "The Monetary Disequilibrium Hypothesis," in Depression, Inflation, and Monetary Policy, Selected papers, 1945-1953 (Johns Hopkins Press, 1966), pp. 25-35.
  3. ^ W.C. Butterman and Earle B. Amey III. Template:PDFlink
  4. ^ "U.S. Federal Reserve estimate of the M2 money supply".
  5. ^ Bordo, M. (2002) "Gold Standard" Concise Encyclopedia of Economics
  6. ^ Eichengreen, B. (1998) "Exchange Rate Stability and Financial Stability" Open Economies Review 9:1 (Springer Netherlands)
  7. ^ D.Baines Economic history in the 20th century (London: LSE/University of London External Programme 2003), chapter 4.
  8. ^ The UK suspended the gold standard during the Napoleonic wars. Baines, op.cit., section 4.5.1.
  • The Gold Standard in Theory and History, Barry Eichengreen (Editor), Marc Flandreau, 1997, ISBN 0415150612
  • The Gold Standard and Related Regimes : Collected Essays (Studies in Macroeconomic History), Michael D. Bordo (Editor), Forrest Capie (Editor), Angela Redish (Editor), 1999, ISBN 0521550068
  • A Retrospective on the Classical Gold Standard, 1821–1931 (National Bureau of Economic Research Conference Report), Michael D. Bordo (Editor), Anna J. Schwartz (Editor), 1984, ISBN 0226065901
  • Between the Dollar-Sterling Gold Points: Exchange Rates, Parity, and Market Behavior. Lawrence H. Officer, Cambridge University Press, 1996
  • Golden Fetters: The Gold Standard and the Great Depression, 1919–1939 (NBER Series on Long-Term Factors in Economic Development), Barry Eichengreen, 1996, ISBN 0195101138
  • Money and Politics: European Monetary Unification and the International Gold Standard (1865–1873) Luca Einaudi 2001
  • Keynes, the Liquidity Trap and the Gold Standard: A Possible Application of the Rational Expectations Hypothesis, Robert Marks 1995
  • Ideology and the Evolution of Vital Economic Institutions: Guilds, The Gold Standard, and Modern International Cooperation Earl A. Thompson, Charles R. Hickson, 2000
  • Gold Standard and Employment Policies between the Wars, Sidney Pollard Ed. 1970
  • Stability of International Exchange: Report on the Introduction of the Gold-Exchange Standard into China and Other Silver-Using Countries, Commission on International Exchange, 2001
  • [4] Ken Elks' series on British Coinage
  • Banking in Modern Japan Research Division of the Fuji Bank, 1967
  • Bordo, Michael D. "Bimetallism". In The New Palgrave Encyclopedia of Money and Finance edited by Peter K. Newman, Murray Milgate and John Eatwell. New York: Stockton Press, 1992.
  • Gold Standard and the International Monetary System, 1900–1939, Ian M. Drummond 1983
  • The Gold Standard in Theory and Practice, RG Hawtrey, Longmans and Green
  • Glitter of Gold: France, Bimetallism, and the Emergence of the International Gold Standard, 1848–1873 Marc Flandreau 2003
  • Cyclopædia of Political Science, Political Economy, and the Political History of the United States by the Best American and European Writers, John Lalor, 1881
  • The Gold Standard, Deflation, and Financial Crisis in the Great Depression: An International Comparison Ben Bernanke, Harold James 1990
  • The World Currency Crisis by Murray Rothbard
  • The Downfall of the Gold Standard Gustav Cassel 1966
  • Currency Convertibility: The Gold Standard and Beyond Jorge Braga de Macedo (Editor) 1996
  • Deceit of the Gold Standard and of Gold Monetization, William H. Russell 1982
  • Gold, Prices and Wages under the Greenback Standard Wesley Clair Mitchell
  • Gold Standard Illusion: France, the Bank of France, and the International Gold Standard, 1914–1939 Kenneth Moure
  • Modern Perspectives on the Gold Standard Tamim Bayoumi (Editor), Mark P. Taylor (Editor), 1997
  • Keynes, John M. 1925; The Economic Consequences of Mr. Churchill (Criticism of returning to the gold standard at the pre-war level – [5])
  • A Treatise on Money, John Maynard Keynes 1930
  • Credibility of the Interwar Gold Standard, Uncertainty, and the Great Depression J. Peter Ferderer 1999
  • Monetary Standards in the Periphery: Paper, Silver and Gold,1854–1933, Pablo Martin Acena (Editor), Jaime Reis (Editor), 2000
  • History of the Bank of England The Bank of England updated 2004
  • Anatomy of an International Monetary Regime: The Classical Gold Standard, 1880–1914 Giulio M Gallarotti
  • Canada and the Gold Standard: Balance of Payments Adjustments under Fixed Exchange Rates 1871–1913 Trevor Dick, John E. Floyd 1992
  • A.G. Kenwood & A.L. Lougheed (1992). The growth of the international economy 1820–1990. Routledge. London. ISBN 91-44-00079-0.
  • Richard Hofstadter (1996). "Free Silver and the Mind of "Coin" Harvey". The Paranoid Style in American Politics and Other Essays. Harvard University Press. Harvard. ISBN 0-674-65461-7.
  • Gold - The Once and Future Money, Nathan Lewis, John Wiley and Sons ISBN 0-470-04766-8
  • War-Time Financial Problems at Project Gutenberg

External links

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