The gold standard was a monetary system where currency was backed by and freely convertible to a fixed amount of gold. It was first implemented in Great Britain in 1821 and later adopted by other countries in the late 19th century. The key principles were free movement of gold between countries, automatic expansion/contraction of currency with gold inflows/outflows, and flexible domestic prices. While it promoted trade and stability, the gold standard lacked flexibility and countries eventually abandoned it due to economic and political factors prior to World War 1.

1. Gold Standard

2. Meaning
• Gold standard is a monetary
system in which the standard unit
of currency is a fixed quantity of
gold or is kept at the value of a
fixed quantity of gold.
• The currency is freely convertible at
home or abroad into a fixed
amount of gold per unit of currency
• Exchange rates between countries
are fixed
• If exchange rates rise above or fall
below the fixed mint rate by more
than the cost of shipping gold from
one country to another, large gold
inflows or outflows occur until the
rates return to the official level.

3. Principles of Gold Standard
• There should be free movement of gold
between countries;
• There should be automatic expansion or
contraction of currency and credit with the
inflow and outflow of gold;
• The governments in different countries should
help facilitate the gold movements by keeping
their internal price system flexible in their
respective economies.

4. Background
• The gold standard was first put into operation in Great Britain in
1821. Prior to this time silver had been the principal world
monetary metal; gold had long been used intermittently for coinage
in one or another country, but never as the single reference metal,
or standard, to which all other forms of money were coordinated or
adjusted.
• For the next 50 years a bimetallic regime of gold and silver was used
outside Great Britain, but in the 1870s a monometallic gold
standard was adopted by Germany, France, and the United States,
with many other countries following suit.
• This shift occurred because recent gold discoveries in western
North America had made gold more plentiful. In the full gold
standard that thus prevailed until 1914, gold could be bought or
sold in unlimited quantities at a fixed price in convertible paper
money per unit weight of the metal.

5. Advantages of Gold Standard
• It was an easy system to introduce and operate.
• It provided for a very high level of stability in exchange rates
which promoted both international investments and trade.
• The Price Specie Adjustment Mechanism provided an in-built
system for achieving trade equilibrium.
• It provided a fully secured system for settlement of
international transactions.

6. Disadvantages of Gold Standard
• The cost of manufacturing gold gradually increased to levels
beyond the official prices. This would result in stoppage of
gold production which had an adverse effect on international
liquidity.
• Countries with persistent trade deficit suffered from
recessions resulting in reduced investments and
unemployment.
• The system had no flexibility to adjust money supply in times
of economic crisis such as natural disasters, war, recession etc.
In such situations the system had to be repeatedly
discontinued.
• To avoid the negative effects of reduced money supply,
countries would break the equality between gold reserves
and money supply, thereby diluting the system.

7. Reason of Failure
• Violation of Rules of Gold Standard
• Restrictions on Free Trade
• Inelastic Internal Price System
• During the inter-war period, the monetary
authorities sought to maintain both
exchange stability as well as price stability.
• This was impossible because exchange
stability is generally accompanied by
internal price fluctuations.
• Unbalanced Distribution of Gold
• External Indebtedness
• Excessive Use of Gold Exchange Standard
• Absence of International Monetary Centre
• Lack of Co-operation
• Political Instability
• Rise of Economic Nationalism