CHAPTER NO. TITLE. PAGE NO.
1. INTRODUCTION 02
2. THE CRISIS OF SILVER CURRENCY AND
3. GOLD’S ROLE IN THE INTERNATIONAL
MONETARY SYSTEM:PAST AND
4. THE GOLD BULLION STANDARD AND
THE DECLINE OF THE GOLD
5. ADVANTAGES AND DISADVANTAGES
OF GOLD STANDARD
6. COUNTRIES AND DATES ON THE GOLD
7. TYPES OF GOLD STANDARD 27
8. THE CLASSICAL GOLD STANDARD 32
9. GOVERNMENT POLICIES THAT
ENHANCED GOLD STANDARD
10. CONCLUSION 46
11. BIBLIOGRAPHY 47
K.E.S SHROFF COLLEGE Page 1
The gold standard is a system in which international currencies are tied to a specific
amount of gold. Almost from the dawn of the history gold was considered as the
medium of exchange because gold was durable, storable, portable and easily
divisible. The foundation of the gold standard is that a currency's value is supported
by some weight in gold. Inherently, it makes sense to value currency by some
tangible and precious resources; otherwise, currency is just paper bills. Therefore,
by tying paper money to an amount of gold, it gives the holder of the paper money
the right to exchange the paper bills for actual gold. Ideally, this requires that paper
money be readily exchangeable for gold. If a bank does not have gold, then the
paper money has no value. But theoretically, actual gold would flow between
nations to ensure that all currencies would be supported by gold. Another reason
for considering gold as the medium of exchange was that the value of gold
remained consistent over short-run due to limited availability of gold. At the turn of
the 20th century, many major trading nations used the gold standard to adjust their
monetary supply. Under pure gold standard gold coins were traded freely and their
inherent values were considered as their market values. The pure gold standard was
used till 1870. Under the pure gold standard system, all participating currencies
were convertible based on its gold value. For example, if currency X was equal to
100 grains of gold, and currency Y was equal to 50 grains of gold, then 1X was
equal to 2Y. Under relative gold standard, gold was considered as the currency
standard and each currency was convertible into gold as a specified rate. Thus,
exchange rate between two currencies was determined by their relative convertible
The gold standard was a commitment by participating countries to fix the prices of their
domestic currencies in terms of a specified amount of gold. National money and other
forms of money (bank deposits and notes) were freely converted into gold at the fixed
price. England adopted a de facto gold standard in 1717 after the master of the mint, Sir
Isaac Newton, overvalued the guinea in terms of silver, and formally adopted the gold
standard in 1819. The United States, though formally on a bimetallic (gold and silver)
standard, switched to gold de facto in 1834 and de jure in 1900 when Congress passed the
Gold Standard Act. In 1834, the United States fixed the price of gold at $20.67 per ounce,
where it remained until 1933. Other major countries joined the gold standard in the
1870s. The period from 1880 to 1914 is known as the classical gold standard. During that
time, the majority of countries adhered (in varying degrees) to gold. It was also a period
of unprecedented ECONOMIC GROWTH with relatively FREE TRADE in goods, labor, and
The gold standard broke down during World War I, as major belligerents resorted to
inflationary finance, and was briefly reinstated from 1925 to 1931 as the Gold Exchange
Standard. Under this standard, countries could hold gold or dollars or pounds as reserves,
K.E.S SHROFF COLLEGE Page 2
except for the United States and the United Kingdom, which held reserves only in gold.
This version broke down in 1931 following Britain’s departure from gold in the face of
massive gold and capital outflows. In 1933, President Franklin D. Roosevelt nationalized
gold owned by private citizens and abrogated contracts in which payment was specified
in gold. Between 1946 and 1971, countries operated under the Bretton Woods system.
Under this further modification of the gold standard, most countries settled their
international balances in U.S. dollars, but the U.S. government promised to redeem other
central banks’ holdings of dollars for gold at a fixed rate of thirty-five dollars per ounce.
Persistent U.S. balance-of-payments deficits steadily reduced U.S. gold reserves,
however, reducing confidence in the ability of the United States to redeem its currency in
gold. Finally, on August 15, 1971, President Richard M. Nixon announced that the
United States would no longer redeem currency for gold. This was the final step in
abandoning the gold standard.
Widespread dissatisfaction with high INFLATION in the late 1970s and early 1980s
brought renewed interest in the gold standard. Although that interest is not strong today,
it seems to strengthen every time inflation moves much above 5 percent. This makes
sense: whatever other problems there were with the gold standard, persistent inflation
was not one of them. Between 1880 and 1914, the period when the United States was on
the “classical gold standard,” inflation averaged only 0.1 percent per year.
K.E.S SHROFF COLLEGE Page 3
1.2 Definition of 'Gold Standard':-
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.
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 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."
Lawrence H. Officer, University of Illinois at Chicago
The gold standard is the most famous monetary system that ever existed. The periods in
which the gold standard flourished, the groupings of countries under the gold standard,
and the dates during which individual countries adhered to this standard are delineated in
the first section. Then characteristics of the gold standard (what elements make for a gold
standard), the various types of the standard (domestic versus international, coin versus
other, legal versus effective), and implications for the money supply of a country on the
standard are outlined. The longest section is devoted to the "classical" gold standard, the
predominant monetary system that ended in 1914 (when World War I began), followed
by a section on the "interwar" gold standard, which operated between the two World
Wars (the 1920s and 1930s).
K.E.S SHROFF COLLEGE Page 4
The gold specie standard was not designed, but rather arose out of a general acceptance
that gold was useful as a universal currency.When commodities compete for the role of
money, the one that over time loses the least value, takes on the role.The use of gold as
money dates back thousands of years and the first known gold coins were minted in the
kingdom of Lydia in Asia Minor around 610 BC. The first coins minted in China are
thought to date around 600 BC.
During the Middle Ages, the Byzantine gold Solidus, commonly known as the Bezant,
circulated throughout Europe and the Mediterranean. But as the Byzantine Empire's
economic influence declined, the European world tended to see silver, rather than gold, as
the currency of choice, leading to the development of a silver standard.
Silver pennies, based on the Roman Denarius, became the staple coin of Britain around
the time of King Offa, circa AD 796, and similar coins, including Italian denari,
French deniers, and Spanish dineros circulated throughout Europe. Following the Spanish
discovery of great silver deposits at Potosí and in Mexico during the 16th century,
international trade came to depend on coins such as the Spanish dollar, Maria Theresa
thaler, and, in the 1870s, the United States Trade dollar.
In modern times the British West Indies was one of the first regions to adopt a gold
specie standard. Following Queen Anne's proclamation of 1704, the British West Indies
gold standard was a de facto gold standard based on the Spanish gold doubloon coin. In
the year 1717, master of the Royal Mint Sir Isaac Newton established a new mint ratio
between silver and gold that had the effect of driving silver out of circulation and putting
Britain on a gold standard.
However, only in 1821, following the introduction of the gold sovereign coin by the new
Royal Mint at Tower Hill in the year 1816, was the United Kingdom formally put on a
gold specie standard, the first of the great industrial powers. Soon to follow
was Canada in 1853, Newfoundland in 1865, and the USA and Germany de jure in 1873.
The USA used the Eagle as their unit, and Germany introduced the new gold mark, while
Canada adopted a dual system based on both the American Gold Eagle and the British
Australia and New Zealand adopted the British gold standard, as did the British West
Indies, while Newfoundland was the only British Empire territory to introduce its own
gold coin as a standard. Royal Mint branches were established in Sydney, New South
Wales, Melbourne, Victoria, and Perth, Western Australia for the purpose of minting gold
sovereigns from Australia's rich gold deposits.
1.4 How the Gold Standard Worked:-
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The gold standard was a domestic standard regulating the quantity and growth rate of a
country’s MONEY SUPPLY. Because new production of gold would add only a small
fraction to the accumulated stock, and because the authorities guaranteed free
convertibility of gold into nongold money, the gold standard ensured that the money
supply, and hence the price level, would not vary much. But periodic surges in the
world’s gold stock, such as the gold discoveries in Australia and California around 1850,
caused price levels to be very unstable in the short run.
The gold standard was also an international standard determining the value of a country’s
currency in terms of other countries’ currencies. Because adherents to the standard
maintained a fixed price for gold, rates of exchange between currencies tied to gold were
necessarily fixed. For example, the United States fixed the price of gold at $20.67 per
ounce, and Britain fixed the price at £3 17s. 10½ per ounce. Therefore, the exchange rate
between dollars and pounds—the “par exchange rate”—necessarily equaled $4.867 per
Because exchange rates were fixed, the gold standard caused price levels around the
world to move together. This comovement occurred mainly through an automatic
balance-of-payments adjustment process called the price-specie-flow mechanism. Here is
how the mechanism worked. Suppose that a technological INNOVATION brought about
faster real economic growth in the United States. Because the supply of money (gold)
essentially was fixed in the short run, U.S. prices fell. Prices of U.S. exports then fell
relative to the prices of imports. This caused the British to DEMAND more U.S. exports
and Americans to demand fewer imports. A U.S. balance-of-payments surplus was
created, causing gold (specie) to flow from the United Kingdom to the United States. The
gold inflow increased the U.S. money supply, reversing the initial fall in prices. In the
United Kingdom, the gold outflow reduced the money supply and, hence, lowered the
price level. The net result was balanced prices among countries.
The fixed exchange rate also caused both monetary andnonmonetary (real) shocks to be
transmitted via flows of gold and capital between countries. Therefore, a shock in one
country affected the domestic money supply, expenditure, price level, and real income in
The California gold discovery in 1848 is an example of a monetary shock. The newly
produced gold increased the U.S. money supply, which then raised domestic
expenditures, nominal income, and, ultimately, the price level. The rise in the domestic
price level made U.S. exports more expensive, causing a deficit in the U.S. BALANCE OF
PAYMENTS. For America’s trading partners, the same forces necessarily produced a
balance-of-trade surplus. The U.S. trade deficit was financed by a gold (specie) outflow
to its trading partners, reducing the monetary gold stock in the United States. In the
trading partners, the money supply increased, raising domestic expenditures, nominal
incomes, and, ultimately, the price level. Depending on the relative share of the U.S.
monetary gold stock in the world total, world prices and income rose. Although the initial
K.E.S SHROFF COLLEGE Page 6
effect of the gold discovery was to increase real output (because wages and prices did not
immediately increase), eventually the full effect was on the price level alone.
For the gold standard to work fully, central banks, where they existed, were supposed to
play by the “rules of the game.” In other words, they were supposed to raise their
discount rates—the interest rate at which the central bank lends money to member banks
—to speed a gold inflow, and to lower their discount rates to facilitate a gold outflow.
Thus, if a country was running a balance-of-payments deficit, the rules of the game
required it to allow a gold outflow until the ratio of its price level to that of its principal
trading partners was restored to the par exchange rate.
The exemplar of central bank behavior was the Bank of England, which played by the
rules over much of the period between 1870 and 1914. Whenever Great Britain faced a
balance-of-payments deficit and the Bank of England saw its gold reserves declining, it
raised its “bank rate” (discount rate). By causing other INTEREST RATES in the United
Kingdom to rise as well, the rise in the bank rate was supposed to cause the holdings of
inventories and other INVESTMENT expenditures to decrease. These reductions would
then cause a reduction in overall domestic spending and a fall in the price level. At the
same time, the rise in the bank rate would stem any short-term capital outflow and attract
short-term funds from abroad.
Most other countries on the gold standard—notably France and Belgium—did not follow
the rules of the game. They never allowed interest rates to rise enough to decrease the
domestic price level. Also, many countries frequently broke the rules by “sterilization”—
shielding the domestic money supply from external disequilibrium by buying or selling
domestic securities. If, for example, France’s central bank wished to prevent an inflow of
gold from increasing the nation’s money supply, it would sell securities for gold, thus
reducing the amount of gold circulating.
Yet the central bankers’ breaches of the rules must be put into perspective. Although
exchange rates in principal countries frequently deviated from par, governments rarely
debased their currencies or otherwise manipulated the gold standard to support domestic
economic activity. Suspension of convertibility in England (1797-1821, 1914-1925) and
the United States (1862-1879) did occur in wartime emergencies. But, as promised,
convertibility at the original parity was resumed after the emergency passed. These
resumptions fortified the credibility of the gold standard rule.
1.5 Performance of the Gold Standard:-
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As mentioned, the great virtue of the gold standard was that it assured long-term price
stability. Compare the aforementioned average annual inflation rate of 0.1 percent
between 1880 and 1914 with the average of 4.1 percent between 1946 and 2003.
(The reason for excluding the period from 1914 to 1946 is that it was neither a
period of the classical gold standard nor a period during which governments
understood how to manage MONETARY POLICY.)
But because economies under the gold standard were so vulnerable to real and monetary
shocks, prices were highly unstable in the short run. A measure of short-term price
instability is the coefficient of variation—the ratio of the standard deviation of
annual percentage changes in the price level to the average annual percentage
change. The higher the coefficient of variation, the greater the short-term
instability. For the United States between 1879 and 1913, the coefficient was 17.0,
which is quite high. Between 1946 and 1990 it was only 0.88. In the most volatile
decade of the gold standard, 1894-1904, the mean inflation rate was 0.36 and the
standard deviation was 2.1, which gives a coefficient of variation of 5.8; in the
most volatile decade of the more recent period, 1946-1956, the mean inflation rate
was 4.0, the standard deviation was 5.7, and the coefficient of variation was 1.42.
Moreover, because the gold standard gives government very little discretion to use
monetary policy, economies on the gold standard are less able to avoid or offset
either monetary or real shocks. Real output, therefore, is more variable under the
gold standard. The coefficient of variation for real output was 3.5 between 1879
and 1913, and only 0.4 between 1946 and 2003. Not coincidentally, since the
government could not have discretion over monetary policy, UNEMPLOYMENT was
higher during the gold standard years. It averaged 6.8 percent in the United States
between 1879 and 1913, and 5.9 percent between 1946 and 2003.
Finally, any consideration of the pros and cons of the gold standard must include a large
negative: the resource cost of producing gold. MILTON FRIEDMAN estimated the cost of
maintaining a full gold coin standard for the United States in 1960 to be more than 2.5
percent of GNP. In 2005, this cost would have been about $300 billion.
CHAPTER:-2 THE CRISIS OF SILVER CURRENCY AND
BANK NOTES (1750–1870)
K.E.S SHROFF COLLEGE Page 8
In the late 18th century, wars and trade with China, which sold 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 numbers, and there was a
proliferation of bank and stock notes used as money.
In the 1790s, the United Kingdom, suffering a massive shortage of silver coinage, ceased
to mint larger silver coins and issued "token" silver coins and overstruck foreign coins.
With the end of the Napoleonic Wars, United Kingdom began a massive recoinage
programme that created standard gold sovereigns and circulating crowns and half-
crowns, and eventually copper farthings in 1821. The recoinage of silver in United
Kingdom after a long drought produced a burst of coins: United Kingdom struck nearly
40 million shillings between 1816 and 1820, 17 million half crowns and 1.3 million silver
The 1819 Act for the Resumption of Cash Payments set 1823 as the date for resumption
of convertibility, reached instead by 1821. Throughout the 1820s, small notes were issued
by regional banks, which were finally restricted in 1826, while the Bank of England was
allowed to set up regional branches. In 1833, however, the Bank of England notes were
made legal tender, and redemption by other banks was discouraged. In 1844 the Bank
Charter Act established that Bank of England Notes, fully backed by gold, were the legal
standard. According to the strict interpretation of the gold standard, this 1844 act marks
the establishment of a full gold standard for British money.
The US adopted a silver standard based on the Spanish milled dollar in 1785. This was
codified in the 1792 Mint and Coinage Act, and by the Federal Government's use of the
"Bank of the United States" to hold its reserves, as well as establishing a fixed ratio of
gold to the US dollar. This was, in effect, a derivative silver standard, since the bank was
not required to keep silver to back all of its currency.
This began a long series of attempts for America to create a bi-metallic standard for the
US Dollar, which would continue until the 1920s. Gold and silver coins were legal
tender, including the Spanish real, a silver coin struck in the Western Hemisphere.
Because of the huge debt taken on by the US Federal Government to finance the
Revolutionary War, silver coins struck by the government left circulation, and in 1806
President Jefferson suspended the minting of silver coins.
The US Treasury was put on a strict hard-money standard, doing business only in gold or
silver coin as part of the Independent Treasury Act of 1848, which legally separated the
accounts of the Federal Government from the banking system. However the fixed rate of
gold to silver overvalued silver in relation to the demand for gold to trade or borrow from
England. The drain of gold in favor of silver led to the search for gold, including
the California Gold Rush of 1849. Following Gresham's law, silver poured into the US,
which traded with other silver nations, and gold moved out. In 1853, the US reduced the
silver weight of coins, to keep them in circulation, and in 1857 removed legal tender
status from foreign coinage.
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In 1857 the final crisis of the free banking era of international finance began, as
American banks suspended payment in silver, rippling through the very young
international financial system of central banks. In 1861 the US government suspended
payment in gold and silver, effectively ending the attempts to form a silver standard basis
for the dollar.
Through the 1860–1871 period, various attempts to resurrect bi-metallic standards were
made, including one based on the gold and silver franc; however, with the rapid influx of
silver from new deposits, the expectation of scarcity of silver ended.
The interaction between central banking and currency basis formed the primary source of
monetary instability during this period. The combination that produced economic
stability was a restriction of supply of new notes, a government monopoly on the
issuance of notes directly and, indirectly, a central bank and a single unit of value.
Attempts to avoid these conditions produced periodic monetary crises.
As notes devalued; or silver ceased to circulate as a store of value; or there was a
depression as governments, demanding specie as payment, drained the circulating
medium out of the economy. At the same time, there was a dramatically expanded need
for credit, and large banks were being chartered in various states, including, by 1872,
Japan. The need for a solid basis in monetary affairs would produce a rapid acceptance of
the gold standard in the period that followed.
By way of example, and following Germany's decision after the Franco-Prussian
War (1870–1871) to extract reparations to facilitate a move to the gold standard, Japan
gained the needed reserves after the Sino-Japanese War of 1894–1895. Whether the gold
standard provided a government sufficient bona fides when it sought to borrow abroad is
debated. For Japan, moving to gold was considered vital to gain access to Western capital
CHAPTER:-3 GOLD’S ROLE IN THE INTERNATIONAL
MONETARY SYSTEM: PAST AND PRESENT
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The gold standard was a system under which nearly all countries fixed the value of their
currencies in terms of a specified amount of gold, or linked their currency to that of a
country which did so. At a country level, the gold standard has been credited for a long
period of price stability which was supportive of economic growth. On an international
level, the gold standard ushered in an era of remarkable capital flows, contributing to
global trade, growth and significant global economic development. However, the strict
adherence to the gold standard has also been associated with exacerbating the Great
Depression, by contributing to extreme deflationary pressures in a time of significant
economic decline, when expansionary monetary policies may have been more
The gold exchange standard was also a period of relative stability and strong economic
growth whereby countries tied their currencies to the US dollar, which was in turn tied to
gold. Since the end of the gold exchange standard on August 15, 1971, the international
monetary system has been progressing through no official international cooperative
monetary system and gold has traded freely in the global markets. While gold no longer
plays an official role in the international monetary system, it remains a cornerstone
reserve asset accounting for 13% of total official reserves.
Furthermore, gold has been playing an increasing role among private investors, in part
supported by the ease of ownership through ETFs. Private investment has also been
supported by growing demand from emerging markets, in particular China and India.
Gold’s lack of credit or counterparty risk, coupled with the deterioration of sovereign
credit, has encouraged investors and global exchanges to increasingly use gold as a
source of high quality collateral.
3.1 The gold exchange standard (1870–1914):-
Towards the end of the 19th century, some of the remaining silver standard countries
began to peg their silver coin units to the gold standards of the United Kingdom or the
USA. In 1898, British India pegged the silver rupee to the pound sterling at a fixed rate of
K.E.S SHROFF COLLEGE Page 11
1s 4d, while in 1906, the Straits Settlements adopted a gold exchange standard against the
pound sterling with the silver Straits dollar being fixed at 2s 4d.
At the turn of the century, the Philippines pegged the silver Peso/dollar to the US dollar
at 50 cents. A similar pegging at 50 cents occurred at around the same time with the
silver Peso of Mexico and the silver Yen of Japan. When Siam adopted a gold exchange
standard in 1908, this left only China and Hong Kong on the silver standard.
Adopting the gold standard many European nations changed the name of their currency
from Daler (Sweden and Denmark) or Gulden(Austria-Hungary) to Crown, since the
former ones were traditionally associated with silver coins and the latter with gold coins.
3.2 Impact of World War I (1914–25):-
Governments faced with the need to fund high levels of expenditure, but with limited
sources of tax revenue, suspended convertibility of currency into gold on a number of
occasions in the 19th century. The British government suspended convertibility (that is to
say, it went off the gold standard) during the Napoleonic wars and the US government
K.E.S SHROFF COLLEGE Page 12
during the US Civil War. In both cases, convertibility was resumed after the war. The real
test, however, came in the form of World War I, a test "it failed utterly" according to
economist Richard Lipsey.
In order to finance the costs of war, most belligerent countries went off the gold standard
during the war, and suffered significant inflation. Because inflation levels varied between
states, when they returned to the standard after the war at price determined by themselves
(some, for example, chose to enter at pre-war prices), some countries' goods were
undervalued and some overvalued.
Ultimately, the system as it stood could not deal quickly enough with the large deficits
and surpluses created in the balance of payments; this has previously been attributed to
increasing rigidity of wages (particularly in terms of wage cuts) brought about by the
advent of unionized labor, but is now more likely to be thought of as an inherent fault
with the system which came to light under the pressures of war and rapid technological
change. In any case, prices had not reached equilibrium by the time of the Great
Depression, which served only to kill it off completely.
For example, Germany had gone off the gold standard in 1914, and could not effectively
return to it as Germany had lost much of its remaining gold reserves in reparations.
The German central bank issued unbacked marks virtually without limit to buy foreign
currency for further reparations and to support workers during the Occupation of the
Ruhr finally leading to hyperinflation in the 1920s.
CHAPTER:-4 THE GOLD BULLION STANDARD AND
THE DECLINE OF THE GOLD STANDARD (1925–31)
The gold specie standard ended in the United Kingdom and the rest of the British Empire
at the outbreak of World War I. Treasury notes replaced the circulation of the gold
K.E.S SHROFF COLLEGE Page 13
sovereigns and gold half sovereigns. However, legally, the gold specie standard was not
repealed. The end of the gold standard was successfully effected by appeals to patriotism
when somebody would request the Bank of England to redeem their paper money for
gold specie. It was only in 1925, when Britain returned to the gold standard in
conjunction with Australia and South Africa, that the gold specie standard was officially
The British Gold Standard Act 1925 both introduced the gold bullion standard and
simultaneously repealed the gold specie standard. The new gold bullion standard did not
envisage any return to the circulation of gold specie coins. Instead, the law compelled the
authorities to sell gold bullion on demand at a fixed price, but only in the form of bars
containing approximately four hundred ounces troy of fine gold. This gold bullion
standard lasted until 1931 when speculative attacks on the pound forced Britain off the
gold standard. Loans from American and French Central Banks of £50,000,000, were
insufficient and exhausted in a matter of weeks.
On September 19, 1931, the United Kingdom left the revised gold standard forced to
suspend the gold bullion standard due to large outflows of gold across the Atlantic
Ocean. The British benefited from the departure. Australia and New Zealand had already
been forced off the gold standard by the same pressures connected with the Great
Depression, and Canada quickly followed suit with the United Kingdom.
The interwar partially backed gold standard was inherently unstable, because of the
conflict between (a) the expansion of sterling and dollar liabilities to foreign central
banks, and (b) the resulting deterioration in the reserve ratio of the Bank of England, and
U.S. Treasury and Federal Reserve Banks. This instability was enhanced by gold flows
out of England, with its overvalued pound, to other countries such as France, which was
attempting to make Paris a world class financial center, in competition with London and
It was destabilizing speculation, emanating from lack of confidence in authorities'
commitment to currency convertibility that ended the interwar gold standard. In May
1931 there was a run on Austria's largest commercial bank, and the bank failed. The run
spread to Germany, where an important bank also collapsed. The countries' central banks
lost substantial reserves; international financial assistance was too late; and in July 1931
Germany adopted exchange control, followed by Austria in October. These countries
were definitively off the gold standard.
4.1 Depression and World War II (1932–46):-
Prolongation of the Great Depression
Some economic historians, such as American professor Barry Eichengreen, blame the
gold standard of the 1920s for prolonging the Great Depression. Adherence to the gold
standard prevented the Federal Reserve from expanding the money supply in order to
stimulate the economy, fund insolvent banks and fund government deficits which could
K.E.S SHROFF COLLEGE Page 14
"prime the pump" for an expansion. Once the US went off the gold standard, it became
free to engage in such money creation. The gold standard limited the flexibility of
the central banks' monetary policy by limiting their ability to expand the money supply,
and thus their ability to lower interest rates. In the US, the Federal Reserve was required
by law to have 40% gold backing of its Federal Reserve demand notes, and thus, could
not expand the money supply beyond what was allowed by the gold reserves held in their
vaults. Others including Federal Reserve Chairman Ben Bernanke and Nobel Prize
winning economist Milton Friedman place most or all of the blame for the severity of the
Great Depression at the feet of the Federal Reserve, mostly due to the deliberate
tightening of monetary policy. The US economic contraction in 1937, the last gasp of the
Great Depression, is blamed on tightening of monetary policy by the Federal Reserve
resulting in a higher cost of capital and weaker securities markets, a reduced net
government contribution to income, the undistributed profits tax, and higher labor costs.
As a result of the tighter monetary policy, the money supply peaked in March 1937, with
a trough in May 1938.
Higher interest rates intensified the deflationary pressure on the dollar and reduced
investment in U.S. banks. Commercial banks also converted Federal Reserve Notes to
gold in 1931, reducing the Federal Reserve's gold reserves, and forcing a corresponding
reduction in the amount of Federal Reserve Notes in circulation. This speculative attack
on the dollar created a panic in the U.S. banking system. Fearing imminent devaluation of
the dollar, many foreign and domestic depositors withdrew funds from U.S. banks to
convert them into gold or other assets. As people pulled money from the banking system
due to bank panics, a reverse multiplier effect caused a contraction in the money supply.
Additionally the New York Fed had loaned over $150 million (over 240 tons) to
European Central Banks to help them out with their difficulties. This transfer of gold out
of the US acted to contract the US money supply. These loans became questionable once
England, Germany, Austria and other European countries went off the gold standard in
1931 and weakened confidence in the dollar.
The forced contraction of the money supply caused by people removing funds from the
banking system during the bank panics resulted in deflation; and even as nominal interest
rates dropped, inflation-adjusted real interest rates remained high, rewarding those that
held onto money instead of spending it, causing a further slowdown in the
economy. Recovery in the United States was slower than in Britain, in part due to
Congressional reluctance to abandon the gold standard and float the U.S. currency as
Britain had done.
In the early 1930s, the Federal Reserve defended the fixed price of dollars in respect to
the gold standard by raising interest rates, trying to increase the demand for dollars. Its
commitment and adherence to the gold standard explain why the U.S. did not engage in
expansionary monetary policy. To compete in the international economy, the U.S.
maintained high interest rates. This helped attract international investors who bought
foreign assets with gold.
Congress passed the Gold Reserve Act on 30 January 1934; the measure nationalized all
gold by ordering the Federal Reserve banks to turn over their supply to the U.S. Treasury.
K.E.S SHROFF COLLEGE Page 15
In return the banks received gold certificates to be used as reserves against deposits and
Federal Reserve notes. The act also authorized the president to devalue the gold dollar so
that it would have no more than 60 percent of its existing weight. Under this authority the
president, on 31 January 1934, changed the value of the dollar from $20.67 to the troy
ounce to $35 to the troy ounce, a devaluation of over 40%.
Other factors in the prolongation of the Great Depression include trade wars and the
reduction in international trade caused by trade barriers such as Smoot-Hawley Tarriff in
the US and the Imperial Preference policies of Great Britain, the failure of central banks
to act responsibly, government policies designed to prevent wages from falling, such as
the Davis-Bacon Act of 1931, during the deflationary period resulting in production costs
dropping slower then sales prices and thereby injuring business profitability and
increases in taxes to reduce budget deficits and to support new programs such as Social
Security. The US top marginal income tax rate went from 25% to 63% in 1932 and to
79% in 1936 while the bottom rate increased over 10 fold from .375% in 1929 to 4% in
1932 Successful attacks on partially backed currencies which forced many countries off
the gold standard and reduced confidence in the financial system, and a financial system,
further damaged by the bank panics of the 1930s were also factors, as was inclement
weather such as the drought resulting in the US Dust Bowl.
Barry Eichengreen believes that the Austrian School view that the Great Depression was
the result of a credit bust has much to recommend it. Alan Greenspan wrote that the bank
failures of the 1930s were sparked by Great Britain dropping the gold standard in 1931.
This act "tore asunder" any remaining confidence in the banking system. Financial
historian Niall Ferguson writes that what made the Great Depression truly 'great' was the
European banking crisis of 1931.
4.2 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.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, 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,
K.E.S SHROFF COLLEGE Page 16
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".
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.
4.3 Post-war international gold-dollar standard (1946–1971):-
After the Second World War, a system similar to a Gold Standard and sometimes
described as a "gold exchange standard" was established by the Bretton Woods
Agreements. Under this system, many countries fixed their exchange rates relative to the
U.S. dollar. The U.S. promised to fix the price of gold at approximately $35 per ounce.
Implicitly, then, all currencies pegged to the dollar also had a fixed value in terms of
Starting under the administration of the French President Charles de Gaulle and
continuing until 1970, France reduced its dollar reserves, trading them for gold from the
K.E.S SHROFF COLLEGE Page 17
U.S. government, thereby reducing U.S. economic influence abroad. This, along with the
fiscal strain of federal expenditures for the Vietnam War and persistent balance of
payments deficits, led President Richard Nixon to end the direct convertibility of the
dollar to gold on August 15, 1971, resulting in the system's breakdown (the "Nixon
CHAPTER:-5 ADVANTAGES AND DISADVANTAGES OF
Long-term price stability has been described as the great virtue of the gold
standard. The gold standard limits the power of governments to inflate prices
through excessive issuance of paper currency. Under the gold standard, high
levels of inflation are rare, and hyperinflation is nearly impossible as the money
supply can only grow at the rate that the gold supply increases. Economy-wide
K.E.S SHROFF COLLEGE Page 18
price increases caused by ever-increasing amounts of currency chasing a constant
supply of goods are rare, as gold supply for monetary use is limited by the
available gold that can be minted into coin. High levels of inflation under a gold
standard are usually seen only when warfare destroys a large part of the economy,
reducing the production of goods, or when a major new source of gold becomes
available. In the U.S. one of those periods of warfare was the Civil War, which
destroyed the economy of the South, while the California Gold Rush made large
amounts of gold available for minting.
Proponents of the gold standard claim that its stability fosters economic
The gold standard provides fixed international exchange rates between those
countries that have adopted it, and thus reduces uncertainty in international trade.
Historically, imbalances between price levels in different countries would be
partly or wholly offset by an automatic balance-of-payment adjustment
mechanism called the "price specie flow mechanism." Gold used to pay for
imports reduces the money supply of importing nations, causing deflation and a
reduction in the general price level for goods and services, making them more
competitive, while the importation of gold by net exporters serves to increase the
money supply, causes inflation and an increase in the general price level, making
them less competitive.
The gold standard acts as a check on government deficit spending as it limits the
amount of debt that can be issued. It also prevents governments from inflating
away the real value of their already existing debt through currency devaluation. A
central bank cannot be an unlimited buyer of last resort of government debt. A
central bank could not create unlimited quantities of money at will, as there is a
limited supply of gold.
A gold standard cannot be used for what some economists call, financial
repression. Newly printed money can be used to purchase goods and services, and
to discharge debts, at no cost to the printer. This acts as a mechanism to transfer
the wealth of society to those that can print money, from everyone else. Financial
repression is most successful in liquidating debts when accompanied by a steady
dose of inflation, and it can be considered a form of taxation. In 1966 Alan
Greenspan wrote "Deficit spending is simply a scheme for the confiscation of
wealth. Gold stands in the way of this insidious process. It stands as a protector of
property rights. If one grasps this, one has no difficulty in understanding the
statists' antagonism toward the gold standard." Per John Maynard Keynes "By a
continuing process of inflation, governments can confiscate, secretly and
unobserved, an important part of the wealth of their citizens". Financial repression
negatively affects economic growth.
The gold standard benefits savers by preventing their savings from being
devalued or destroyed through inflation, and by rewarding them with higher real
(inflation adjusted) interest rates. In the US and United Kingdom, from 1945 to
K.E.S SHROFF COLLEGE Page 19
1980 negative real interest rates have cost lenders an estimated 3-4% of GDP per
year on average.
The gold standard tends to limit credit booms and the resulting boom bust cycle
because of the inelastic supply of money.
The unequal distribution of gold as a natural resource makes the gold standard
much more advantageous in terms of cost and international economic
empowerment for those countries that produce gold. In 2010 the largest producers
of gold, in order, are China, followed by Australia, the US, South Africa and
Russia. The country with the largest reserves is Australia.
K.E.S SHROFF COLLEGE Page 20
The gold standard acts as a limit on economic growth. “As an economy’s
productive capacity grows, then so should its money supply. Because a gold
standard requires that money be backed in the metal, then the scarcity of the metal
constrains the ability of the economy to produce more capital and grow.”
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. Such reason is often employed to
partially blame the gold standard for the Great Depression, citing that the Federal
Reserve couldn't expand credit enough to offset the deflationary forces at work in
Although the gold standard has brought long-run price stability, it has also
historically been associated with high short-run price volatility. It has been argued
by, among others, Anna Schwartz, that this kind of instability in short-term price
levels can lead to financial instability as lenders and borrowers become uncertain
about the value of debt.
The total amount of gold that has ever been mined has been estimated at around
142,000 metric tons and arguments have been made that this amount is too small
to serve as a monetary base. The value of this amount of gold is over 6 trillion
dollars while the monetary base of the US, with a roughly 20% share of the world
economy, stands at $2.7 trillion at the end of 2011. Murray Rothbard argues that
the amount of gold available is not a bar to a gold standard since the free market
will determine the purchasing power of gold money based on its supply.
Deflation punishes debtors. Real debt burdens therefore rise, causing borrowers to
cut spending to service their debts or to default. Lenders become wealthier, but
may choose to save some of their additional wealth rather than spending it all.
The overall amount of expenditure is therefore likely to fall.
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. Some hold the view that this
contributed to the severity and length of the Great Depression as the gold standard
forced the central banks to keep monetary policy too tight, creating deflation.
James Hamilton contended that the gold standard may be susceptible
to speculative attacks when a government's financial position appears weak,
although others contend that this very threat discourages governments' engaging
in risky policy (see Moral Hazard). For example, some believe that the United
States was forced to contract the money supply and raise interest rates in
September 1931 to defend the dollar after speculators forced Great Britain off the
K.E.S SHROFF COLLEGE Page 21
If a country wanted to devalue its currency, a gold standard would generally
produce sharper changes than the smooth declines seen in fiat currencies,
depending on the method of devaluation.
Most economists favor a low, positive rate of inflation. Partly this reflects fear of
deflationary shocks, but primarily because they believe that central banks still
have some role to play in dampening fluctuations in output and unemployment.
Central banks can more safely play that role when a positive rate of inflation gives
them room to tighten money growth without inducing price declines.
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. The demand for
money always equals the supply of money. Creation of new money reduces
interest rates and thereby increases demand for new lower cost debt, raising the
demand for money.
5.3 Advocates of a renewed gold standard:-
K.E.S SHROFF COLLEGE Page 22
The return to the gold standard is supported by many followers of the Austrian School of
Economics, Objectivists, free-market libertarians and, in the United States, by strict
constitutionalists 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.
Few politicians today advocate a return to the gold standard, other than adherents of the
Austrian school and some supply-siders. However, some prominent economists have
expressed sympathy with a hard-currency basis, and have argued against politically-
controlled fiat money, including former U.S. Federal Reserve Chairman Alan
Greenspan (himself a former Objectivist), and macro-economist Robert Barro. Greenspan
famously argued the case for returning to a 'pure' gold standard in his 1966 paper "Gold
and Economic Freedom", in which he described supporters of fiat currencies as "welfare
statists" intending to use monetary policies to finance deficit spending.
Barro argues in favor of adopting some form of "monetary constitution" that will provide
stability to monetary policy rather than allowing decisions about monetary policy to be
made on the basis of politics, but suggests that what form this constitution takes—for
example, a gold standard, some other commodity-based standard, or a fiat currency with
fixed rules for determining the quantity of money—is considerably less important. U.S.
Congressman Ron Paul has continually argued for the reinstatement of the gold standard,
but is no longer a strict advocate, instead supporting a basket of commodities that
emerges on the free markets.
For the time being, the global monetary system continues to rely on the U.S. dollar as
a reserve currency by which major transactions, such as the price of gold itself, are
measured. A host of alternatives has been suggested, including energy-based currencies,
and market baskets of currencies or commodities, gold being one of the 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 pure (24-
carat) 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. However, to date,
Mahathir's proposed gold-dinar currency has failed to take hold.
In 2011, the legislature of the state of Utah passed a bill to accept federally-issued gold
and silver coins as legal tender to pay taxes. Similar legislation is under consideration in a
number of other US states.
K.E.S SHROFF COLLEGE Page 23
CHAPTER:-6 COUNTRIES AND DATES ON THE GOLD
Countries on the gold standard and the periods (or beginning and ending dates) during
which they were on gold are listed in Tables 1 and 2 for the classical and interwar gold
standards. Types of gold standard, ambiguities of dates, and individual-country cases are
considered in later sections. The country groupings reflect the importance of countries to
establishment and maintenance of the standard. Center countries -- Britain in the classical
standard, the United Kingdom (Britain's legal name since 1922) and the United States in
the interwar period -- were indispensable to the spread and functioning of the gold
standard. Along with the other core countries -- France and Germany, and the United
States in the classical period -- they attracted other countries to adopt the gold standard,
in particular, British colonies and dominions, Western European countries, and
Scandinavia. Other countries -- and, for some purposes, also British colonies and
dominions -- were in the periphery: acted on, rather than actors, in the gold-standard eras,
and generally not as committed to the gold standard.
Table 1 Countries on Classical Gold Standard
Country Type of Gold Standard Period
Britain Coin 1774-1797b
Other Core Countries
United States Coin 1879-1917d
France Coin 1878-1914
Germany Coin 1871-1914
British Colonies and Dominions
Australia Coin 1852-1915
Canada Coin 1854-1914
Ceylon Coin 1901-1914
India Exchange (British pound) 1898-1914
Austria-Hungary Coin 1892-1914
Belgium Coin 1878-1914
Italy Coin 1884-1894
Liechtenstein Coin 1898-1914
Netherlands Coin 1875-1914
Portugal Coin 1854-1891
Switzerland Coin 1878-1914
K.E.S SHROFF COLLEGE Page 24
Denmark Coin 1872-1914
Finland Coin 1877-1914
Norway Coin 1875-1914
Sweden Coin 1873-1914
Bulgaria Coin 1906-1914
Greece Coin 1885, 1910-1914
Montenegro Coin 1911-1914
Romania Coin 1890-1914
Russia Coin 1897-1914
Egypt Coin 1885-1914
Turkey (Ottoman Empire) Coin 1881m
Japan Coin 1897-1917
Philippines Exchange (U.S. dollar) 1903-1914
Siam Exchange (British pound) 1908-1914
Straits Settlements Exchange (British pound) 1906-1914
Mexico and Central America
Costa Rica Coin 1896-1914
Mexico Coin 1905-1913
Argentina Coin 1867-1876, 1883-1885, 1900-1914
Bolivia Coin 1908-1914
Brazil Coin 1888-1889, 1906-1914
Chile Coin 1895-1898
Ecuador Coin 1898-1914
Peru Coin 1901-1914
Uruguay Coin 1876-1914
Eritrea Exchange (Italian lira) 1890-1914
German East Africa Exchange (German mark) 1885p
Italian Somaliland Exchange (Italian lira) 1889p
K.E.S SHROFF COLLEGE Page 25
Including colonies (except British Honduras) and possessions without a national
currency: New Zealand and certain other Oceanic colonies, South Africa, Guernsey,
Jersey, Malta, Gibraltar, Cyprus, Bermuda, British West Indies, British Guiana, British
Somaliland, Falkland Islands, other South and West African colonies.
Or perhaps 1798.
Including countries and territories with U.S. dollar as exclusive or predominant
currency: British Honduras (from 1894), Cuba (from 1898), Dominican Republic (from
1901), Panama (from 1904), Puerto Rico (from 1900), Alaska, Aleutian Islands, Hawaii,
Midway Islands (from 1898), Wake Island, Guam, and American Samoa.
Except August – October 1914.
Including Tunisia (from 1891) and all other colonies except Indochina.
Including Newfoundland (from 1895).
Including British East Africa, Uganda, Zanzibar, Mauritius, and Ceylon (to 1901).
Including Montenegro (to 1911).
Including Belgian Congo.
Including Netherlands East Indies.
Including colonies, except Portuguese India.
Including Greenland and Iceland.
Or perhaps 1883.
Including Korea and Taiwan.
Approximate beginning date.
CHAPTER:-7 TYPES OF GOLD STANDARD
K.E.S SHROFF COLLEGE Page 26
Pure Coin and Mixed Standards:-
In theory, "domestic" gold standards -- those that do not depend on interaction with other
countries -- are of two types: "pure coin" standard and "mixed" (meaning coin and paper,
but also called simply "coin") standard. The two systems share several properties. (1)
There is a well-defined and fixed gold content of the domestic monetary unit. For
example, the dollar is defined as a specified weight of pure gold. (2) Gold coin circulates
as money with unlimited legal-tender power (meaning it is a compulsorily acceptable
means of payment of any amount in any transaction or obligation). (3) Privately owned
bullion (gold in mass, foreign coin considered as mass, or gold in the form of bars) is
convertible into gold coin in unlimited amounts at the government mint or at the central
bank, and at the "mint price" (of gold, the inverse of the gold content of the monetary
unit). (4) Private parties have no restriction on their holding or use of gold (except
possibly that privately created coined money may be prohibited); in particular, they may
melt coin into bullion. The effect is as if coin were sold to the monetary authority (central
bank or Treasury acting as a central bank) for bullion. It would make sense for the
authority to sell gold bars directly for coin, even though not legally required, thus saving
the cost of coining. Conditions (3) and (4) commit the monetary authority in effect to
transact in coin and bullion in each direction such that the mint price, or gold content of
the monetary unit, governs in the marketplace.
Under a pure coin standard, gold is the only money. Under a mixed standard, there are
also paper currency (notes) -- issued by the government, central bank, or commercial
banks -- and demand-deposit liabilities of banks. Government or central-bank notes (and
central-bank deposit liabilities) are directly convertible into gold coin at the fixed
established price on demand. Commercial-bank notes and demand deposits might be
converted not directly into gold but rather into gold-convertible government or central-
bank currency. This indirect convertibility of commercial-bank liabilities would apply
certainly if the government or central- bank currency were legal tender but also generally
even if it were not. As legal tender, gold coin is always exchangeable for paper currency
or deposits at the mint price, and usually the monetary authority would provide gold bars
for its coin. Again, two-way transactions in unlimited amounts fix the currency price of
gold at the mint price. The credibility of the monetary-authority commitment to a fixed
price of gold is the essence of a successful, ongoing gold-standard regime.
A pure coin standard did not exist in any country during the gold-standard periods.
Indeed, over time, gold coin declined from about one-fifth of the world money supply in
1800 (2/3 for gold and silver coin together, as silver was then the predominant monetary
standard) to 17 percent in 1885 (1/3 for gold and silver, for an eleven-major-country
aggregate), 10 percent in 1913 (15 percent for gold and silver, for the major-country
aggregate), and essentially zero in 1928 for the major-country aggregate (Triffin, 1964).
The zero figure means not that gold coin did not exist, rather that its main use was as
reserves for Treasuries, central banks, and (generally to a lesser extent) commercial
An "international" gold standard, which naturally requires that more than one country be
on gold, requires in addition freedom both of international gold flows (private parties are
K.E.S SHROFF COLLEGE Page 27
permitted to import or export gold without restriction) and of foreign-exchange
transactions (an absence of exchange control). Then the fixed mint prices of any two
countries on the gold standard imply a fixed exchange rate ("mint parity") between the
countries' currencies. For example, the dollar- sterling mint parity was $4.8665635 per
pound sterling (the British pound).
Gold-Bullion and Gold-Exchange Standards:-
In principle, a country can choose among four kinds of international gold standards -- the
pure coin and mixed standards, already mentioned, a gold-bullion standard, and a gold-
exchange standard. Under a gold-bullion standard, gold coin neither circulates as money
nor is it used as commercial-bank reserves, and the government does not coin gold. The
monetary authority (Treasury or central bank) stands ready to transact with private
parties, buying or selling gold bars (usable only for import or export, not as domestic
currency) for its notes, and generally a minimum size of transaction is specified. For
example, in 1925 1931 the Bank of England was on the bullion standard and would sell
gold bars only in the minimum amount of 400 fine (pure) ounces, approximately £1699
or $8269. Finally, the monetary authority of a country on a gold-exchange standard buys
and sells not gold in any form but rather gold- convertible foreign exchange, that is, the
currency of a country that itself is on the gold coin or bullion standard.
Gold Points and Gold Export/Import:-
A fixed exchange rate (the mint parity) for two countries on the gold standard is an
oversimplification that is often made but is misleading. There are costs of importing or
exporting gold. These costs include freight, insurance, handling (packing and cartage),
interest on money committed to the transaction, risk premium (compensation for risk),
normal profit, any deviation of purchase or sale price from the mint price, possibly mint
charges, and possibly abrasion (wearing out or removal of gold content of coin -- should
the coin be sold abroad by weight or as bullion). Expressing the exporting costs as the
percent of the amount invested (or, equivalently, as percent of parity), the product of
of these costs and mint parity (the number of units of domestic currency per unit
of foreign currency) is added to mint parity to obtain the gold-export point -- the
exchange rate at which gold is exported. To obtain the gold-import point, the product of
of the importing costs and mint parity is subtracted from mint parity.
If the exchange rate is greater than the gold-export point, private-sector "gold-point
arbitrageurs" export gold, thereby obtaining foreign currency. Conversely, for the
exchange rate less than the gold-import point, gold is imported and foreign currency
relinquished. Usually the gold is, directly or indirectly, purchased from the monetary
authority of the one country and sold to the monetary authority in the other. The
domestic-currency cost of the transaction per unit of foreign currency obtained is the
gold-export point. That per unit of foreign currency sold is the gold-import point. Also,
foreign currency is sold, or purchased, at the exchange rate. Therefore arbitrageurs
receive a profit proportional to the exchange-rate/gold-point divergence.
K.E.S SHROFF COLLEGE Page 28
However, the arbitrageurs' supply of foreign currency eliminates profit by returning the
exchange rate to below the gold-export point. Therefore perfect "gold-point arbitrage"
would ensure that the exchange rate has upper limit of the gold-export point. Similarly,
the arbitrageurs' demand for foreign currency returns the exchange rate to above the gold-
import point, and perfect arbitrage ensures that the exchange rate has that point as a lower
limit. It is important to note what induces the private sector to engage in gold-point
arbitrage: (1) the profit motive; and (2) the credibility of the commitment to (a) the fixed
gold price and (b) freedom of foreign exchange and gold transactions, on the part of the
monetary authorities of both countries.
The difference between the gold points is called the (gold-point) spread. The gold points
and the spread may be expressed as percentages of parity. Estimates of gold points and
spreads involving center countries are provided for the classical and interwar gold
standards. Noteworthy is that the spread for a given country pair generally declines over
time both over the classical gold standard (evidenced by the dollar-sterling figures) and
for the interwar compared to the classical period.
Table 2 Gold-Point Estimates: Classical Gold
0.6585 0.7141 1.3726 PA
0.6550 0.6274 1.2824 PA
0.4993 0.5999 1.0992 PA
0.5025 0.5915 1.0940 PA
0.6888 0.6290 1.3178 MED
0.4907 0.7123 1.2030 MED
0.4063 0.3964 0.8027 MED
0.3671 0.4405 0.8076 MED
K.E.S SHROFF COLLEGE Page 29
0.4321 0.5556 0.9877 MED
Austria/Britain 1912 0.6453 0.6037 1.2490 SE
Netherlands/Britain 1912 0.5534 0.3552 0.9086 SE
Scandinavia /Britain 1912 0.3294 0.6067 0.9361 SE
For numerator country.
Gold-import point for denominator country.
Gold-export point for denominator country.
Gold-export point plus gold-import point.
Denmark, Sweden, and Norway.
Method of Computation: PA = period average. MED = median exchange rate form
estimate of various authorities for various dates, converted to percent deviation from
parity. SE = single exchange-rate- form estimate, converted to percent deviation from
Table 3 Gold-Point Estimates: Interwar Gold
0.6287 0.4466 1.0753 PA
1928e 0.4793 0.5067 0.9860 PA
1933f 0.5743 0.3267 0.9010 PA
0.8295 0.3402 1.1697 PA
France/Britain 1926 0.2042 0.4302 0.6344 SE
0.2710 0.3216 0.5926 MED
0.3505 0.2676 0.6181 MED
Canada/Britain 1929 0.3521 0.3465 0.6986 SE
Netherlands/Britain 1929 0.2858 0.5146 0.8004 SE
Denmark/Britain 1926 0.4432 0.4930 0.9362 SE
Norway/Britain 1926 0.6084 0.3828 0.9912 SE
K.E.S SHROFF COLLEGE Page 30
Sweden/Britain 1926 0.3881 0.3828 0.7709 SE
For numerator country.
Gold-import point for denominator country.
Gold-export point for denominator country.
Gold-export point plus gold-import point.
To end of June 1928. French-franc exchange-rate stabilization, but absence of currency
Beginning July 1928. French-franc convertibility;
Method of Computation: PA = period average. MED = median exchange rate form
estimate of various authorities for various dates, converted to percent deviation from
parity. SE = single exchange-rate- form estimate, converted to percent deviation from
CHAPTER:-8 THE CLASSICAL GOLD STANDARD
8.1 Sources of Instability of the Classical Gold Standard:-
There were three elements making for instability of the classical gold standard. First, the
use of foreign exchange as reserves increased as the gold standard progressed. Available
end-of- year data indicate that, worldwide, foreign exchange in official reserves (the
international assets of the monetary authority) increased by 36 percent from 1880 to 1899
and by 356 percent from 1899 to 1913. In comparison, gold in official reserves increased
by 160 percent from 1880 to 1903 but only by 88 percent from 1903 to 1913. (Lindert,
1969,) While in 1913 only Germany among the center countries held any measurable
amount of foreign exchange -- 15 percent of total reserves excluding silver (which was of
limited use) -- the percentage for the rest of the world was double that for Germany
(Table 6). If there were a rush to cash in foreign exchange for gold, reduction or depletion
of the gold of reserve-currency countries could place the gold standard in jeopardy.
K.E.S SHROFF COLLEGE Page 31
8.2 Rules of the Game:-
According to the "rules of the [gold-standard] game," central banks were supposed to
reinforce, rather than "sterilize" (moderate or eliminate) or ignore, the effect of gold
flows on the monetary supply. A gold outflow typically decreases the international assets
of the central bank and thence the monetary base and money supply. The central-bank's
proper response is: (1) raise its "discount rate," the central-bank interest rate for
rediscounting securities (cashing, at a further deduction from face value, a short-term
security from a financial institution that previously discounted the security), thereby
inducing commercial banks to adopt a higher reserves/deposit ratio and therefore
decreasing the money multiplier; and (2) decrease lending and sell securities, thereby
decreasing domestic assets and thence the monetary base. On both counts the money
supply is further decreased. Should the central bank rather increase its domestic assets
when it loses gold, it engages in "sterilization" of the gold flow and is decidedly not
following the "rules of the game." The converse argument (involving gold inflow and
increases in the money supply) also holds, with sterilization involving the central bank
decreasing its domestic assets when it gains gold.
K.E.S SHROFF COLLEGE Page 32
Price Specie-Flow Mechanism
A country experiencing a balance-of-payments deficit loses gold and its money supply
decreases, both automatically and by policy in accordance with the "rules of the game."
Money income contracts and the price level falls, thereby increasing exports and
decreasing imports. Similarly, a surplus country gains gold, the money supply increases,
money income expands, the price level rises, exports decrease and imports increase. In
each case, balance-of-payments equilibrium is restored via the current account. This is
called the "price specie-flow mechanism." To the extent that wages and prices are
inflexible, movements of real income in the same direction as money income occur; in
particular, the deficit country suffers unemployment but the payments imbalance is
The capital account also acts to restore balance, via interest-rate increases in the deficit
country inducing a net inflow of capital. The interest-rate increases also reduce real
investment and thence real income and imports. Similarly, interest-rate decreases in the
surplus country elicit capital outflow and increase real investment, income, and imports.
This process enhances the current-account correction of the imbalance.
One problem with the "rules of the game" is that, on "global-monetarist" theoretical
grounds, they were inconsequential. Under fixed exchange rates, gold flows simply adjust
money supply to money demand; the money supply is not determined by policy. Also,
prices, interest rates, and incomes are determined worldwide. Even core countries can
influence these variables domestically only to the extent that they help determine them in
the global marketplace. Therefore the price-specie-flow and like mechanisms cannot
occur. Historical data support this conclusion: gold flows were too small to be suggestive
of these mechanisms; and prices, incomes, and interest rates moved closely in
correspondence (rather than in the opposite directions predicted by the adjustment
mechanisms induced by the "rules of the game") -- at least among non-periphery
countries, especially the core group.
Discount Rate Rule and the Bank of England
However, the Bank of England did, in effect, manage its discount rate ("Bank Rate") in
accordance with rule (1). The Bank's primary objective was to maintain convertibility of
its notes into gold, that is, to preserve the gold standard, and its principal policy tool was
Bank Rate. When its "liquidity ratio" of gold reserves to outstanding note liabilities
decreased, it would usually increase Bank Rate. The increase in Bank Rate carried with it
market short-term increase rates, inducing a short-term capital inflow and thereby moving
the exchange rate away from the gold-export point by increasing the exchange value of
the pound. The converse also held, with a rise in the liquidity ratio involving a Bank Rate
decrease, capital outflow, and movement of the exchange rate away from the gold import
point. The Bank was constantly monitoring its liquidity ratio, and in response altered
Bank Rate almost 200 times over 1880- 1913.
While the Reichsbank (the German central bank), like the Bank of England, generally
moved its discount rate inversely to its liquidity ratio, most other central banks often
violated the rule, with changes in their discount rates of inappropriate direction, or of
K.E.S SHROFF COLLEGE Page 33
insufficient amount or frequency. The Bank of France, in particular, kept its discount rate
stable. Unlike the Bank of England, it chose to have large gold reserves (see Table 8),
with payments imbalances accommodated by fluctuations in its gold rather than financed
by short-term capital flows. The United States, lacking a central bank, had no discount
rate to use as a policy instrument.
8.3 The Stability of the Classical Gold Standard:-
The fundamental reason for the stability of the classical gold standard is that there was
always absolute private-sector credibility in the commitment to the fixed domestic-
currency price of gold on the part of the center country (Britain), two (France and
Germany) of the three remaining core countries, and certain other European countries
(Belgium, Netherlands, Switzerland, and Scandinavia). Certainly, that was true from the
late-1870s onward. (For the United States, this absolute credibility applied from about
1900.) In earlier periods, that commitment had a contingency aspect: it was recognized
that convertibility could be suspended in the event of dire emergency (such as war); but,
after normal conditions were restored, convertibility would be re-established at the pre-
existing mint price and gold contracts would again be honored. The Bank Restriction
Period is an example of the proper application of the contingency, as is the greenback
period (even though the United States, effectively on the gold standard, was legally on
Absolute Credibility Meant Zero Convertibility and Exchange Risk
The absolute credibility in countries' commitment to convertiblity at the existing mint
price implied that there was extremely low, essentially zero, convertibility risk (the
probability that Treasury or central-bank notes would not be redeemed in gold at the
K.E.S SHROFF COLLEGE Page 34
established mint price) and exchange risk (the probability that the mint parity between
two currencies would be altered, or that exchange control or prohibition of gold export
would be instituted).
8.4 Reasons Why Commitment to Convertibility Was So Credible:-
There were many reasons why the commitment to convertibility was so credible.
Contracts were expressed in gold; if convertibility were abandoned, contracts
would inevitably be violated -- an undesirable outcome for the monetary
Shocks to the domestic and world economies were infrequent and generally mild.
There was basically international peace and domestic calm.
The London capital market was the largest, most open, most diversified in the
world, and its gold market was also dominant. A high proportion of world trade
was financed in sterling, London was the most important reserve-currency center,
and balances of payments were often settled by transferring sterling assets rather
than gold. Therefore sterling was an international currency -- not merely
supplemental to gold but perhaps better: a boon to non- center countries, because
sterling involved positive, not zero, interest return and its transfer costs were
much less than those of gold. Advantages to Britain were the charges for services
as an international banker, differential interest returns on its financial
intermediation, and the practice of countries on a sterling (gold-exchange)
K.E.S SHROFF COLLEGE Page 35
standard of financing payments surpluses with Britain by piling up short-term
sterling assets rather than demanding Bank of England gold.
There was widespread ideology -- and practice -- of "orthodox metallism,"
involving authorities' commitment to an anti-inflation, balanced-budget, stable-
money policy. In particular, the ideology implied low government spending and
taxes and limited monetization of government debt (financing of budget deficits
by printing money). Therefore it was not expected that a country's price level or
inflation would get out of line with that of other countries, with resulting pressure
on the country's adherence to the gold standard.
This ideology was mirrored in, and supported by, domestic politics. Gold had won
over silver and paper, and stable-money interests (bankers, industrialists,
manufacturers, merchants, professionals, creditors, urban groups) over
inflationary interests (farmers, landowners, miners, debtors, rural groups).
There was freedom from government regulation and a competitive environment,
domestically and internationally. Therefore prices and wages were more flexible
than in other periods of human history (before and after). The core countries had
virtually no capital controls; the center country (Britain) had adopted free trade,
and the other core countries had moderate tariffs. Balance-of-payments financing
and adjustment could proceed without serious impediments.
Internal balance (domestic macroeconomic stability, at a high level of real income
and employment) was an unimportant goal of policy. Preservation of
convertibility of paper currency into gold would not be superseded as the primary
policy objective. While sterilization of gold flows was frequent (see above), the
purpose was more "meeting the needs of trade" (passive monetary policy) than
fighting unemployment (active monetary policy).
The gradual establishment of mint prices over time ensured that the implied mint
parities (exchange rates) were in line with relative price levels; so countries joined
the gold standard with exchange rates in equilibrium.
Current-account and capital-account imbalances tended to be offsetting for the
core countries, especially for Britain. A trade deficit induced a gold loss and a
higher interest rate, attracting a capital inflow and reducing capital outflow.
Indeed, the capital- exporting core countries -- Britain, France, and Germany --
could eliminate a gold loss simply by reducing lending abroad.
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8.5 The Breakdown of the Classical Gold Standard:-
The classical gold standard was at its height at the end of 1913, ironically just before it
came to an end. The proximate cause of the breakdown of the classical gold standard was
political: the advent of World War I in August 1914. However, it was the Bank of
England's precarious liquidity position and the gold-exchange standard that were the
underlying cause. With the outbreak of war, a run on sterling led Britain to impose
extreme exchange control -- a postponement of both domestic and international payments
-- that made the international gold standard non-operational. Convertibility was not
legally suspended; but moral suasion, legalistic action, and regulation had the same
effect. Gold exports were restricted by extralegal means (and by Trading with the Enemy
legislation), with the Bank of England commandeering all gold imports and applying
moral suasion to bankers and bullion brokers.
Almost all other gold-standard countries undertook similar policies in 1914 and 1915.
The United States entered the war and ended its gold standard late, adopting extralegal
restrictions on convertibility in 1917 (although in 1914 New York banks had temporarily
imposed an informal embargo on gold exports). An effect of the universal removal of
currency convertibility was the ineffectiveness of mint parities and inapplicability of gold
points: floating exchange rates resulted.
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CHAPTER:-9 GOVERNMENT POLICIES THAT
ENHANCED GOLD STANDARD STABILITY
Government policies also enhanced gold-standard stability.
First, by the turn of the century South Africa -- the main world gold producer -- sold all
its gold in London, either to private parties or actively to the Bank of England, with the
Bank serving also as residual purchaser of the gold. Thus the Bank had the means to
replenish its gold reserves.
Second, the orthodox- metallism ideology and the leadership of the Bank of England --
other central banks would often gear their monetary policy to that of the Bank -- kept
monetary policies harmonized. Monetary discipline was maintained.
Third, countries used "gold devices," primarily the manipulation of gold points, to affect
gold flows. For example, the Bank of England would foster gold imports by lowering the
foreign gold-export point (number of units of foreign currency per pound, the British
gold-import point) through interest-free loans to gold importers or raising its purchase
price for bars and foreign coin. The Bank would discourage gold exports by lowering the
foreign gold-import point (the British gold-export point) via increasing its selling prices
for gold bars and foreign coin, refusing to sell bars, or redeeming its notes in underweight
domestic gold coin. These policies were alternative to increasing Bank Rate. The Bank of
France and Reichsbank employed gold devices relative to discount-rate changes more
than Britain did. Some additional policies included converting notes into gold only in
K.E.S SHROFF COLLEGE Page 38
Paris or Berlin rather than at branches elsewhere in the country, the Bank of France
converting its notes in silver rather than gold (permitted under its "limping" gold
standard), and the Reichsbank using moral suasion to discourage the export of gold. The
U.S. Treasury followed similar policies at times. In addition to providing interest-free
loans to gold importers and changing the premium at which it would sell bars (or refusing
to sell bars outright), the Treasury condoned banking syndicates to put pressure on gold
arbitrageurs to desist from gold export in 1895 and 1896, a time when the U.S. adherence
to the gold standard was under stress.
Fourth, the monetary system was adept at conserving gold, as evidenced in Table 3. This
was important, because the increased gold required for a growing world economy could
be obtained only from mining or from nonmonetary hoards. While the money supply for
the eleven- major-country aggregate more than tripled from 1885 to 1913, the percent of
the money supply in the form of metallic money (gold and silver) more than halved. This
process did not make the gold standard unstable, because gold moved into commercial-
bank and central-bank (or Treasury) reserves: the ratio of gold in official reserves to
official plus money gold increased from 33 to 54 percent. The relative influence of the
public versus private sector in reducing the proportion of metallic money in the money
supply is an issue warranting exploration by monetary historians.
Fifth, while not regular, central-bank cooperation was not generally required in the stable
environment in which the gold standard operated. Yet this cooperation was forthcoming
when needed, that is, during financial crises. Although Britain was the center country, the
precarious liquidity position of the Bank of England meant that it was more often the
recipient than the provider of financial assistance. In crises, it would obtain loans from
the Bank of France (also on occasion from other central banks), and the Bank of France
would sometimes purchase sterling to push up that currency's exchange value. Assistance
also went from the Bank of England to other central banks, as needed. Further, the
credible commitment was so strong that private bankers did not hesitate to make loans to
central banks in difficulty.
In sum, "virtuous" two-way interactions were responsible for the stability of the gold
standard. The credible commitment to convertibility of paper money at the established
mint price, and therefore the fixed mint parities, were both a cause and a result of (1) the
stable environment in which the gold standard operated, (2) the stabilizing behavior of
arbitrageurs and speculators, and (3) the responsible policies of the authorities -- and (1),
(2), and (3), and their individual elements, also interacted positively among themselves.
K.E.S SHROFF COLLEGE Page 39
9.1 Interwar Gold Standard and Return to the Gold Standard:-
In spite of the tremendous disruption to domestic economies and the worldwide economy
caused by World War I, a general return to gold took place. However, the resulting
interwar gold standard differed institutionally from the classical gold standard in several
First, the new gold standard was led not by Britain but rather by the United States. The
U.S. embargo on gold exports (imposed in 1917) was removed in 1919, and currency
convertibility at the prewar mint price was restored in 1922. The gold value of the dollar
rather than of the pound sterling would typically serve as the reference point around
which other currencies would be aligned and stabilized.
Second, it follows that the core would now have two center countries, the United
Kingdom and the United States.
Third, for many countries there was a time lag between stabilizing a country's currency in
the foreign-exchange market (fixing the exchange rate or mint parity) and resuming
currency convertibility. Given a lag, the former typically occurred first, currency
stabilization operating via central-bank intervention in the foreign-exchange market
(transacting in the domestic currency and a reserve currency, generally sterling or the
dollar). It is fair to say that the interwar gold standard was at its height at the end of 1928,
after all core countries were fully on the standard and before the Great Depression began.
K.E.S SHROFF COLLEGE Page 40
Fourth, the contingency aspect of convertibility conversion, that required restoration of
convertibility at the mint price that existed prior to the emergency (World War I), was
broken by various countries -- even core countries. Some countries (including the United
States, United Kingdom, Denmark, Norway, Netherlands, Sweden, Switzerland,
Australia, Canada, Japan, Argentina) stabilized their currencies at the prewar mint price.
However, other countries (France, Belgium, Italy, Portugal, Finland, Bulgaria, Romania,
Greece, Chile) established a gold content of their currency that was a fraction of the
prewar level: the currency was devalued in terms of gold, the mint price was higher than
prewar. A third group of countries (Germany, Austria, Hungary) stabilized new
currencies adopted after hyperinflation. A fourth group (Czechoslovakia, Danzig, Poland,
Estonia, Latvia, Lithuania) consisted of countries that became independent or were
created following the war and that joined the interwar gold standard. A fifth group (some
Latin American countries) had been on silver or paper standards during the classical
period but went on the interwar gold standard. A sixth country group (Russia) had been
on the classical gold standard, but did not join the interwar gold standard. A seventh
group (Spain, China, Iran) joined neither gold standard.
The fifth way in which the interwar gold standard diverged from the classical experience
was the mix of gold-standard types. In particular, all four core countries had been on coin
in the classical gold standard; but, of them, only the United States was on coin interwar.
The gold-bullion standard, nonexistent prewar, was adopted by two core countries
(United Kingdom and France) as well as by two Scandinavian countries (Denmark and
Norway). Most countries were on a gold-exchange standard.
9.2 Instability of the Interwar Gold Standard:-
The features that fostered stability of the classical gold standard did not apply to the
interwar standard; instead, many forces made for instability.
The process of establishing fixed exchange rates was piecemeal and haphazard,
resulting in disequilibrium exchange rates. The United Kingdom restored
convertibility at the prewar mint price without sufficient deflation, resulting in an
overvalued currency of about ten percent. (Expressed in a common currency at
mint parity, the British price level was ten percent higher than that of its trading
partners and competitors). A depressed export sector and chronic balance-of-
payments difficulties were to result. Other overvalued currencies (in terms of mint
parity) were those of Denmark, Italy, and Norway. In contrast, France, Germany,
and Belgium had undervalued currencies.
Wages and prices were less flexible than in the prewar period. In particular,
powerful unions kept wages and unemployment high in British export industries,
hindering balance-of-payments correction.
Higher trade barriers than prewar also restrained adjustment.
The gold-exchange standard economized on total world gold via the gold of
reserve- currency countries backing their currencies in their reserves role for
countries on that standard and also for countries on a coin or bullion standard that
elected to hold part of their reserves in London or New York. (Another
K.E.S SHROFF COLLEGE Page 41
economizing element was continuation of the move of gold out of the money
supply and into banking and official reserves that began in the classical period:
for the eleven-major-country aggregate, gold declined to less than œ of one
percent of the money supply in 1928, and the ratio of official gold to official-plus-
money gold reached 99 percent -- Table 3). The gold-exchange standard was
inherently unstable, because of the conflict between (a) the expansion of sterling
and dollar liabilities to foreign central banks to expand world liquidity, and (b) the
resulting deterioration in the reserve ratio of the Bank of England, and U.S.
Treasury and Federal Reserve Banks.
In the classical period, London was the one dominant financial center; in the
interwar period it was joined by New York and, in the late 1920s, Paris. Both
private and official holdings of foreign currency could shift among the two or
three centers, as interest-rate differentials and confidence levels changed.
The problem with gold was not overall scarcity but rather maldistribution. In
1928, official reserve-currency liabilities were much more concentrated than in
1913: the United Kingdom accounted for 77 percent of world foreign-exchange
reserves and France less than two percent (versus 47 and 30 percent in 1913). Yet
the United Kingdom held only seven percent of world official gold and France 13
percent . Reflecting its undervalued currency, France also possessed 39 percent of
world official foreign exchange. Incredibly, the United States held 37 percent of
world official gold -- more than all the non-core countries together.
Britain's financial position was even more precarious than in the classical period.
In 1928, the gold and dollar reserves of the Bank of England covered only one
third of London's liquid liabilities to official foreigners, a ratio hardly greater than
in 1913 (and compared to a U.S. ratio of almost 5œ). Various elements made the
financial position difficult compared to prewar. First, U.K. liquid liabilities were
concentrated on stronger countries (France, United States), whereas its liquid
assets were predominantly in weaker countries (such as Germany). Second, there
was ongoing tension with France, that resented the sterling-dominated gold-
exchange standard and desired to cash in its sterling holding for gold to aid its
objective of achieving first-class financial status for Paris.
Internal balance was an important goal of policy, which hindered balance-of-
payments adjustment, and monetary policy was affected greatly by domestic
politics rather than geared to preservation of currency convertibility.
Especially because of (8), the credibility in authorities' commitment to the gold
standard was not absolute. Convertibility risk and exchange risk could be well
above zero, and currency speculation could be destabilizing rather than
stabilizing; so that when a country's currency approached or reached its gold-
export point, speculators might anticipate that currency convertibility would not
be maintained and the currency devalued. Hence they would sell rather than buy
the currency, which, of course, would help bring about the very outcome
K.E.S SHROFF COLLEGE Page 42
The "rules of the game" were infrequently followed and, for most countries,
violated even more often than in the classical gold standard -- Table 10.
Sterilization of gold inflows by the Bank of England can be viewed as an attempt
to correct the overvalued pound by means of deflation. However, the U.S. and
French sterilization of their persistent gold inflows reflected exclusive concern for
the domestic economy and placed the burden of adjustment on other countries in
the form of deflation.
The Bank of England did not provide a leadership role in any important way, and
central-bank cooperation was insufficient to establish credibility in the
commitment to currency convertibility.
9.3 Breakdown of the Interwar Gold Standard:-
Although Canada effectively abandoned the gold standard early in 1929, this was a
special case in two respects. First, the action was an early drastic reaction to high U.S.
interest rates established to fight the stock-market boom but that carried the threat of
unsustainable capital outflow and gold loss for other countries. Second, use of gold
devices was the technique used to restrict gold exports and informally terminate the
Canadian gold standard.
The beginning of the end of the interwar gold standard occurred with the Great
Depression. The depression began in the periphery, with low prices for exports and debt-
service requirements leading to insurmountable balance-of-payments difficulties while on
the gold standard. However, U.S. monetary policy was an important catalyst. In the
second half of 1927 the Federal Reserve pursued an easy-money policy, which supported
foreign currencies but also fed the boom in the New York stock market. Reversing policy
to fight the Wall Street boom, higher interest rates attracted monies to New York, which
weakened sterling in particular. The stock market crash in October 1929, while helpful to
sterling, was followed by a passive monetary policy that did not prevent the U.S.
depression that started shortly thereafter and that spread to the rest of the world via
declines in U.S. trade and lending. In 1929 and 1930 a number of periphery countries
either formally suspended currency convertibility or restricted it so that their currencies
went beyond the gold-export point.
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It was destabilizing speculation, emanating from lack of confidence in authorities'
commitment to currency convertibility that ended the interwar gold standard. In May
1931 there was a run on Austria's largest commercial bank, and the bank failed. The run
spread to Germany, where an important bank also collapsed. The countries' central banks
lost substantial reserves; international financial assistance was too late; and in July 1931
Germany adopted exchange control, followed by Austria in October. These countries
were definitively off the gold standard.
The Austrian and German experiences, as well as British budgetary and political
difficulties, were among the factors that destroyed confidence in sterling, which occurred
in mid-July 1931. Runs on sterling ensued, and the Bank of England lost much of its
reserves. Loans from abroad were insufficient, and in any event taken as a sign of
weakness. The gold standard was abandoned in September, and the pound quickly and
sharply depreciated on the foreign- exchange market, as overvaluation of the pound
Amazingly, there were no violations of the dollar-sterling gold points on a monthly
average basis to the very end of August 1931. In contrast, the average deviation of the
dollar-sterling exchange rate from the midpoint of the gold-point spread in 1925-1931
was more than double that in 1911-1914, by either of two measures ,suggesting less-
dominant stabilizing speculation compared to the prewar period.
Following the U.K. abandonment of the gold standard, many countries followed, some to
maintain their competitiveness via currency devaluation, others in response to
destabilizing capital flows. The United States held on until 1933, when both domestic and
foreign demands for gold, manifested in runs on U.S. commercial banks, became
intolerable. The "gold bloc" countries (France, Belgium, Netherlands, Switzerland, Italy,
Poland) and Danzig lasted even longer; but, with their currencies now overvalued and
susceptible to destabilizing speculation, these countries succumbed to the inevitable by
the end of 1936. Albania stayed on gold until occupied by Italy in 1939. As much as a
cause, the Great Depression was a consequence of the gold standard; for gold-standard
countries hesitated to inflate their economies for fear of weakening the balance of
payments, suffering loss of gold and foreign-exchange reserves, and being forced to
abandon convertibility or the gold parity. So the gold standard involved "golden fetters"
(the title of the classic work of Eichengreen, 1992) that inhibited monetary and fiscal
policy to fight the depression. Therefore, some have argued, these fetters seriously
exacerbated the severity of the Great Depression within countries (because expansionary
policy to fight unemployment was not adopted) and fostered the international
transmission of the Depression (because as a country's output decreased, its imports fell,
thus reducing exports and income of other countries).
The "international gold standard," defined as the period of time during which all four core
countries were on the gold standard, existed from 1879 to 1914 (36 years) in the classical
period and from 1926 or 1928 to 1931 (four or six years) in the interwar period. The
interwar gold standard was a dismal failure in longevity, as well as in its association with
the greatest depression the world has known.
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Although the last vestiges of the gold standard disappeared in 1971, its appeal is still
strong. Those who oppose giving discretionary powers to the central bank are attracted by
the simplicity of its basic rule. Others view it as an effective anchor for the world price
level. Still others look back longingly to the fixity of exchange rates. Despite its appeal,
however, many of the conditions that made the gold standard so successful vanished in
1914. In particular, the importance that governments attach to full employment means
that they are unlikely to make maintaining the gold standard link and its corollary, long-
run price stability, the primary goal of economic policy.
K.E.S SHROFF COLLEGE Page 45
3)Vipul prakashan book of foreign exchange market
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