Tuesday, October 11, 2011

The Gold Standard: Three Definitions

What exactly is the "gold standard?" This term refers to a system in which all forms of legal tender are based against a weight of gold. This type of monetary system uses a fixed price of gold as a comparison for currency and bank deposits. There are three different types of gold standard systems that have been used since the 18th century, which include gold specie standard, gold exchange standard and gold bullion standard. Each is slightly different and has played a different role in history.

1. The Gold Exchange Standard

With this monetary system, the less precious metal coins are used as the standard. These metals include silver. Those implementing the system have usually decided upon the exact exchange rate with any country using gold standard. Before 1900, any countries that were using silver standard began switching their currency units to the gold standard that was being used in the United States or the UK. Examples of countries that made this change include the Philippines, Japan and Mexico, who each valued their silver currency units as 50 cents per US dollar.

2. The Gold Bullion Standard

The most common form of gold standard is the one based on the price of bullion that is based on worldwide demand. Since 1925, this method has been commonly used, as the British Parliament declared the gold specie standard to be void. Because of the large volume of bullion that was shipped out of the UK after that, this gold standard was ended as well. Countries that use gold standard are somewhat insulated against having governmental inflation of prices because of excesses in paper currency. When the exchange rates are fixed, then international trade is more certain and more fair.

3. The Gold Specie Standard

This type of gold standard is related to the actual gold coins circulating worldwide. Each monetary or currency unit is based on the actual denominational value of one denomination of gold coin. Gold coins that are made from other metals mixed with gold are also considered.

Since the medieval empires, the gold specie standard has been commonly used, though not always formally recognized. The British West Indies use this system in their modern currency based on the Spanish doubloon coin. In the United States, the gold specie standard was adopted in 1873, with the Gold Eagle coin as its unit.

Unfortunately, the gold standard can sometimes affect monetary systems and policies and make them less effective when any attempt to stabilize an economy is made due to recession or slowing of economical systems. When the amount of gold determines the amount of money in the world, then the gold standard can affect international economies adversely.

What Was The Gold Standard?

The gold standard was a way fixing the price of the domestic currency against a particular amount of gold. So, when a country adopted this standard, all the money, including bank deposits and paper notes, could be converted to gold at a fixed price. England was the first country to adopt the gold standard in 1717, when Sir Isaac Newton, the master of the royal mint, ended up overvaluing the guinea against silver. However, at this time the adoption was not formal. The formal adoption of the gold standard in the United Kingdom occurred in 1819.

The United States was following a bimetallic standard, where the price of the US dollar was fixed against both gold and silver. The country shifted to the gold standard in 1834 after the US Congress passed the Gold Standard Act. The price of gold was fixed at $20.67 per ounce and this price stayed on until 1933.

During the 1870s, many other countries shifted to this standard, and the years between 1880 and 1914 were known as the classical period. This was the time the world witnessed significant economic growth clubbed with free trade.

However, when the First World War broke out, the gold standard fell apart, as countries responded by resorting to inflationary finance. Nonetheless, the standard was re-introduced for a short period, from 1925 to 1931 as the Gold Exchange Standard. In this new standard, the countries could keep reserves of gold, dollars or Sterling pounds and just the US and the UK were exempted from it, as they had reserves just in gold. But the Gold Exchange Standard broke after the UK shifted from the standard due to large outflow of gold as well as capital.

Then President Franklin Roosevelt decided to nationalize the gold that private citizens owned and also abolish contracts that paid people in gold. The US shifted to the Bretton Woods system from 1946 to 1971. Under this system, countries were allowed to settle their international debts in US dollars, while the US redeemed the dollar holdings of other central banks in gold. The price for one ounce of gold was fixed at thirty-five dollars. However, the US was facing deficits and this undermined the confidence of bankers and countries. They felt that as the US gold reserves were dwindling, the government would not have sufficient gold to redeem its currency. So, on 15 August 1971, the US President Richard Nixon took a decision that the country would no longer exchange currency for gold. This brought an end to the gold standard in the United States altogether.

However, the country faced high inflation in the latter half of the 1970s and early part of the 1980s, which prompted many economists to advocate a return to the gold standard. It is believed that whenever the inflation crosses 5 percent, there is renewed demand for return to the gold standard, as when the country was using the standard, the average inflation per year was just 0.1 percent.

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