Gold standard, as the name suggests, is a type of monetary system used for the exchange of currency (paper currency). It is the standard unit of the currency which is determined by the value of the fixed quantity of gold. It is usually used as a medium of exchange for payment globally. A country that uses this, sets a fixed gold price and it buys and sells gold at that price. Since each currency was set in terms of gold, exchange rates between participating currencies were also fixed. In the year between the 1870s to 1914, most of the countries use the Gold standard as the medium of payment, and this period and also known as the classical Gold standard period.
The Gold standard was initially implemented in the United Kingdom in 1821. Before that time, silver had been the world’s leading monetary commodity; gold had long been used occasionally for coinage in one country or another, but never as a single base metal or standard to which all other types of currency had been organized or modified. In the 1870s, the monometallic gold standard was introduced by Germany, France, and the United States, and several other countries got on board. This change happened after the discoveries of gold in western North America had made gold more abundant. Under the full gold standard that existed until 1914, gold could be purchased or sold in infinite volumes at a set price of convertible paper money per unit weight of metal. However, this reign was limited, running only from the 1870s until the start of the First World War. The declining economy coupled with the stock market crash of 1929 and the resulting series of bank defaults of 1930 and 1931 contributed to a devastating degree of deflation. The United States and other countries were not able to boost their money supply to boost the economy. Great Britain was the first to drop the gold standard in 1931. Most countries followed soon.
Get complete CFA Online Course by experts Click Here
How does it work?
Gold standard was treated as a domestic system for payment and also to regulate the quality and growth rate of a country’s money supply. It was also an international standard for assessing the worth of a nation’s currency in the currency of other nations. Most countries had legal minimum gold ratios to issued notes/currency or similar thresholds. The discrepancies in the international balance of payments were resolved in gold. Countries with a surplus balance of payments would receive gold inflows, while countries with deficits would experience gold outflows. If we talk about paper currency then it makes an obligation to pay a stated amount when presented to the government. But with the Gold standard, you can place $10 of a bill to the federal bank and get gold worth of $10. This was used when the Gold standard was in practice and with time the use of the Gold standard has been changed.
Get complete FRM Online Course by experts Click Here
- The main advantage of adopting is that it will help in reducing the power of the government to create price inflation in the economy, by lowering the printing rate of money in the economy.
- It acts as a simple tool for the monetary system and to trade internationally.
- It had also helped to maintain the stability in the exchange rate between the countries.
- It helped in increasing the income level and reducing the unemployment level by reducing the risk of economic crises and recession.
- Under the Gold standard, the money supply is not flexible because the money supply depends on the gold reserves and the gold reserves cannot be increased easily.
- This is a costly standard because the medium of exchange consists of expensive metal.
- Gold standard usually falls if war or economic crisis occurs in the economy.
A nation may not be able to distinguish its economy from deflation or inflation in the rest of the world.
The aim of this monetary policy was to avoid inflation, and furthermore deflation, and to help to facilitate a stable monetary environment. In global finance today, gold and other precious metals are peripheral, but our monetary perceptions are influenced by the Gold Standard period. Gold standards, whether real or figurative, represent systems of exchange and aspirations for peace, despite developments that challenge both.
Author: Charmi Mehta
About the Author: Charmi Mehta is currently pursuing an MBA with a specialization in Finance from the Department of Business Administration, Bhavnagar. Charmi is very much interested to work with data and its analysis and she is also fascinated by the financial markets.