Kush gold standard


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Kush gold standard

  2. 2. CHAPTER:-1 INTRODUCTION 1.1 Meaning:- 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 rates. 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 capital. 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
  3. 3. 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
  4. 4. 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). 1.3 History:- K.E.S SHROFF COLLEGE Page 4
  5. 5. 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 Gold Sovereign. 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:- K.E.S SHROFF COLLEGE Page 5
  6. 6. 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 pound. 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 another country. 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
  7. 7. 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:- K.E.S SHROFF COLLEGE Page 7
  8. 8. 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
  9. 9. 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.  United Kingdom 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 crowns. 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.  US 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. K.E.S SHROFF COLLEGE Page 9
  10. 10. 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.  International 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.  Japan 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 markets. CHAPTER:-3 GOLD’S ROLE IN THE INTERNATIONAL MONETARY SYSTEM: PAST AND PRESENT K.E.S SHROFF COLLEGE Page 10
  11. 11. 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 appropriate. 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
  12. 12. 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
  13. 13. 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
  14. 14. 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 ended. 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 New York. 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
  15. 15. "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
  16. 16. 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
  17. 17. 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 gold. 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
  18. 18. 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 Shock"). CHAPTER:-5 ADVANTAGES AND DISADVANTAGES OF GOLD STANDARD 5.1 Advantages:-  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
  19. 19. 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 prosperity.  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
  20. 20. 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. 5.2 Disadvantages:-  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
  21. 21.  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 the market.  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 gold standard K.E.S SHROFF COLLEGE Page 21
  22. 22.  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
  23. 23. 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
  24. 24. CHAPTER:-6 COUNTRIES AND DATES ON THE GOLD STANDARD 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 Center Country Britain Coin 1774-1797b , 1821-1914 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 Western Europe 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
  25. 25. Scandinavia Denmark Coin 1872-1914 Finland Coin 1877-1914 Norway Coin 1875-1914 Sweden Coin 1873-1914 Eastern Europe Bulgaria Coin 1906-1914 Greece Coin 1885, 1910-1914 Montenegro Coin 1911-1914 Romania Coin 1890-1914 Russia Coin 1897-1914 Middle East Egypt Coin 1885-1914 Turkey (Ottoman Empire) Coin 1881m -1914 Asia 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 South America 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 Africa Eritrea Exchange (Italian lira) 1890-1914 German East Africa Exchange (German mark) 1885p -1914 Italian Somaliland Exchange (Italian lira) 1889p -1914 K.E.S SHROFF COLLEGE Page 25
  26. 26. a 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. b Or perhaps 1798. c 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. d Except August – October 1914. e Including Tunisia (from 1891) and all other colonies except Indochina. f Including Newfoundland (from 1895). g Including British East Africa, Uganda, Zanzibar, Mauritius, and Ceylon (to 1901). h Including Montenegro (to 1911). I Including Belgian Congo. j Including Netherlands East Indies. k Including colonies, except Portuguese India. l Including Greenland and Iceland. m Or perhaps 1883. n Including Korea and Taiwan. o Including Borneo. p Approximate beginning date. CHAPTER:-7 TYPES OF GOLD STANDARD K.E.S SHROFF COLLEGE Page 26
  27. 27.  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 banks. 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
  28. 28. 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 1/100th 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 1/100th 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.  Gold-Point Arbitrage:- K.E.S SHROFF COLLEGE Page 28
  29. 29. 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.  Gold-Point Spread:- 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 Standard Countries Period Gold Points (percent) Spread (percent) Method of Computation Export Import U.S./Britain 1881- 1890 0.6585 0.7141 1.3726 PA U.S./Britain 1891- 1900 0.6550 0.6274 1.2824 PA U.S./Britain 1901- 1910 0.4993 0.5999 1.0992 PA U.S./Britain 1911- 1914 0.5025 0.5915 1.0940 PA France/U.S. 1877- 1913 0.6888 0.6290 1.3178 MED Germany/U.S. 1894- 1913 0.4907 0.7123 1.2030 MED France/Britain 1877- 1913 0.4063 0.3964 0.8027 MED Germany/Britain 1877- 1913 0.3671 0.4405 0.8076 MED K.E.S SHROFF COLLEGE Page 29
  30. 30. Germany/France 1877- 1913 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 a For numerator country. b Gold-import point for denominator country. c Gold-export point for denominator country. d Gold-export point plus gold-import point. e 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 parity. Table 3 Gold-Point Estimates: Interwar Gold Standard Countries Period Gold Points (percent) Spread (percent) Method of Computation Export Import U.S./Britain 1925- 1931 0.6287 0.4466 1.0753 PA U.S./France 1926- 1928e 0.4793 0.5067 0.9860 PA U.S./France 1928- 1933f 0.5743 0.3267 0.9010 PA U.S./Germany 1926- 1931 0.8295 0.3402 1.1697 PA France/Britain 1926 0.2042 0.4302 0.6344 SE France/Britain 1929- 1933 0.2710 0.3216 0.5926 MED Germany/Britain 1925- 1933 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
  31. 31. Sweden/Britain 1926 0.3881 0.3828 0.7709 SE a For numerator country. b Gold-import point for denominator country. c Gold-export point for denominator country. d Gold-export point plus gold-import point. e To end of June 1928. French-franc exchange-rate stabilization, but absence of currency convertibility; f 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 parity. 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
  32. 32. 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
  33. 33.  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 nevertheless corrected. 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
  34. 34. 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 bimetallism). 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
  35. 35. 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 authority.  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
  36. 36. 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. K.E.S SHROFF COLLEGE Page 36
  37. 37. 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. K.E.S SHROFF COLLEGE Page 37
  38. 38. 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
  39. 39. 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
  40. 40. 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 respects. 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
  41. 41. 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
  42. 42. 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 anticipated. K.E.S SHROFF COLLEGE Page 42
  43. 43.  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. K.E.S SHROFF COLLEGE Page 43
  44. 44. 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 would imply. 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. K.E.S SHROFF COLLEGE Page 44
  45. 45. CHAPTER:-10 CONCLUSION 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
  46. 46. CHAPTER:-11 BIBLIOGRAPHY 1) www.google.com 2)www.mint.com 3)Vipul prakashan book of foreign exchange market 4)Economics Times 5)www.Wikipedia.com K.E.S SHROFF COLLEGE Page 46