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1922 U.S. gold certificate
The gold standard is a monetary system in which the
standard economic unit of account is a fixed weight of
gold and currency issuers guarantee, under specified rules, to
redeem notes in that amount of gold.
Nations that employ such a fixed unit of account, and which will
redeem their notes to other nations in gold, in principle, share a
fixed currency relationship. The intent is to create a system that is
resistant to runaway credit and debt expansion, and to enforce a
system where currency cannot be created by government fiat, and will,
therefore be safe as a store of wealth against inflation. This
is intended to remove currency uncertainty, keep the credit of the
issuing monetary authority sound, and encourage lending.
The use of gold as a monetary standard has a long and varied history,
from the period of time when coinage was the primary means for
regulating money supply, all the way through the 20th century, where
it was used to regulate international trade flows. Currently the
gold standard, despite having advocates, has fallen out of use in
almost all nations.
Due
to its rarity and durability, gold has long been used as a means of
payment. The exact nature of the evolution of
money varies significantly across time and place, though it is
believed by historians that gold's high value for its utility,
density, resistance to corrosion, uniformity, and easy divisibility
made it useful both as a store of value and as a unit of account for
stored value of other kinds in Babylon, a bushel of wheat was the
unit of account, with a weight in gold used as the token to transport
value. Early monetary systems based on grain used gold to represent
the stored value. Banking began when gold deposited in a bank could be
transferred from one bank account to another by a
giro system, or lent at interest.
When used as part of a hard-money system, the function of paper
currency is to reduce the danger of transporting gold, reduce the
possibility of
debasement of coins, and avoid the reduction in circulating medium
to hoarding and losses. The early development of paper money was
spurred originally by the unreliability of transportation and the
dangers of long voyages, as well as by the desire of governments to
control or regulate the flow of commerce within their dominion.
Money backed by a
specie is sometimes called
representative money, and the notes issued are often called
certificates, to differentiate them from other forms of paper money.
Through most of human history, however,
silver was the primary circulating medium and major monetary
metal. Gold was the metal that was used as an ultimate store of value,
and as means of payment when portability was at a premium,
particularly for payment of armies. Gold would supplant silver
as the basic unit of international trade at various times, including
the Islamic golden age, the peak of the Italian trading states during
the Renaissance, and most prominently during the 19th century. Gold
would remain the metal of monetary reserve accounting until the
collapse of the
Bretton Woods agreement in 1972, and remains an important hedge
against the actions of central banks and governments, a means of
maintaining general liquidity, and as a store of value.
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The
first metal used as a currency was
silver, before 2000 BC, when silver ingots were used in trade, and
it was not until 1500 years later that the first coinage of pure gold
was introduced. However, long before this time gold had been the
basis of trade contracts in Akkadia, and later in Egypt. Silver
remained the most common monetary metal used in ordinary transactions
through the 19th century.
The Persian Empire collected taxes in gold and, when conquered by
Alexander the Great, this gold became the basis for the gold coinage
of his empire. The paying of mercenaries and armies in gold
solidified its importance: gold became synonymous with paying for
military operations, as mentioned by Niccolς Machiavelli in The
Prince two thousand years later. The Roman Empire minted two
important gold coins: aureus, which was approximately 7 grams
of gold
alloyed with silver, and the smaller solidus, which weighed
4.4 grams, of which 4.2 was gold. The Roman mints were fantastically
active the Romans minted, and circulated, millions of coins during
the course of the Republic and the Empire.
After the collapse of the Western Roman Empire and the exhaustion of
the gold mines in Europe, the Byzantine Empire continued to mint
successor coins to the solidus called the nomisma or
bezant. They were forced to mix more and more base metal with the
gold until, by the turn of the millennium, the coinage in circulation
was only 25% gold by weight. This represented a tremendous drop in
real value from the old 95% pure Roman coins. Thus, trade was
increasingly conducted via the coinage in use in the Arabic world,
produced from African gold: the dinar.
The
dinar and dirham were gold and silver coins,
respectively, originally minted by the Persians. The Caliphates in the
Islamic world adopted these coins, but it is with Caliph Abd al-Malik
(685-705) who reformed the currency that the history of the dinar
is usually thought to begin. He removed depictions from coins,
established standard references to Allah on the coins, and fixed
ratios of silver to gold. The growth of Islamic power and trade made
the dinar the dominant coin from the Western coast of Africa to
northern India until the late 1200's, and it continued to be one of
the predominant coins for hundreds of years afterwards.
In 1284, the Republic of Venice coined their first solid gold coin,
the ducat, which was to become the standard of European coinage
for the next 600 years. Other coins, the florin, nobel, grosh,
zloty, and guinea, were also introduced at this time by
other European states to facilitate growing trade. The ducat,
because of Venice's pre-eminent role in trade with the Islamic world
and its ability to secure fresh stocks of gold, would remain the
standard against which other coins were measured.
Beginning with the conquest of the Aztec Empire and Inca Empire, Spain
had access to stocks of new gold for coinage in addition to silver.
The primary Spanish gold unit of account was the escudo, and
the basic coin the 8 "escudos" piece, or "doblσn", which was
originally set at 27.4680 grams of 22
carat (92%) gold, using current measures, and was valued at 16
times the equivalent weight of silver. The wide availability of milled
and cob gold coins made it possible for the West Indies to make gold
the only legal tender in 1704. The circulation of Spanish coins would
create the unit of account for the United States, the "dollar" based
on the Spanish silver real, and Philadelphia's currency market would
trade in Spanish colonial coins.
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The
adoption of gold standards proceeded gradually. This has led to
conflicts between different economic historians as to when the "real"
gold standard began. Sir Isaac Newton included a ratio of gold to silver in his
assay
of coinage in 1717 which created a relationship between gold coins and the
silver penny which was to be the standard unit of account in the Law
of Queen Anne; for some
historians this marks the beginning of the "gold standard" in
England. However, more generally accepted is that a full gold standard requires
that there be one source of notes and legal tender, and that this source is backed by convertibility to
gold. Since this was not the case throughout the 18th century, the generally accepted view is that England was not
on a gold standard at this time.
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To
understand the adoption of the international gold standard in the late
19th century, it is important to follow the events of the late 18th
century and early 19th. 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 amounts,
and there was a proliferation of bank and stock notes used as money.
In
the 1790's
England suffered a massive shortage of silver coinage, and ceased to
mint larger silver coins, issued "token" silver coins and overstruck
foreign coins. With the end of the Napoleonic Wars, England 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 England after a long drought produced a burst
of coins: England 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 1820's
small notes were issued by regional banks, which were finally
restricted in 1826, while the Bank of England was allowed to set up regional branches. In
1833,
however, the Bank of England notes were made legal tender, and
redemption by other banks was discouraged. In 1844 the Bank Charter
Act established
that Bank of England Notes, fully backed by gold, were the legal
standard. According to the strict interpretation of the gold standard,
this 1844 act marks the establishment of a full gold standard for
British money.
The
US adopted a silver standard based on the "Spanish milled dollar" in
1785.
This was codified in the 1792 Mint and Coinage Act, and by the Federal
Government's use of the "Bank of the United States" to hold its reserves, as well as
establishing a fixed ratio of gold to the US dollar. This was, in effect, a derivative silver standard,
since the bank was not required to keep silver to back all of its
currency. This began a long series of attempts for America to create a
bimetallic standard for the US Dollar, which would continue until the
1920's.
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 favour 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.
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 the United States this collapse was a
contributory factor in the American Civil War, and in 1861 the
US government suspended payment in gold and silver, effectively ending
the attempts to form a silver standard basis for the dollar. Through
the 18601871
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 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
evade these conditions produced periodic monetary crisis 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.
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Germany
was created as a unified country following the Franco-Prussian War; it established the
Reichsmark, went on to a strict gold standard, and used gold mined
in South Africa to expand the
money supply. Rapidly most other nations followed suit, since gold
became a transportable, universal and stable unit of valuation.
Dates of Adoption of a Gold Standard:
-
1871: Germany
-
1873: Latin Monetary Union (Belgium, Italy, Switzerland, France)
-
1873:
United States de facto
-
1875: Scandinavia by monetary Union: Denmark, Norway
and Sweden
-
1875:
Netherlands
-
1876: France internally
-
1876:
Spain
-
1879: Austria
-
1893: Russia
-
1897: Japan
-
1898: India
-
1900:
United States
de
jure.
Throughout the decade of the 1870's
deflationary and
depressionary economics created periodic demands for silver
currency. However, such attempts generally failed, and continued the
general pressure towards a gold standard. By 1879, only gold coins
were accepted through the Latin Monetary Union, composed of France, Italy, Belgium,
Switzerland and later Greece,
even though silver was, in theory, a circulating medium.
By
creating a standard unit of account which was easily redeemable,
relatively stable in quantity, and verifiable in its purity, the gold
standard ushered in a period of dramatically expanded trade between
industrializing nations, and "periphery" nations which produced
agricultural goods the so called "bread baskets". This "First Era of
Globalisation" was not, however, without its costs. One of the
most dramatic was the 'Irish Potato Famine', where even as people began to starve it was
more profitable to export
food to Britain. The result turned a blight into a humanitarian
disaster. Amartya Sen, in his work on famines,
theorized that famines are caused by an increase in the price of food,
not by food shortage itself, and hence the root cause of trade based
famines is an imbalance in wealth between the food exporter and the
food importer.
At
the same time it caused a dramatic fall in aggregate demand, and a series of long Depressions in the United
States and the United Kingdom. This should not be confused with the
failure to industrailize or a slowing of total output of goods. Thus the
attempts to produce alternate currencies include the introduction of
Postal Money Orders in Britain in 1881,
later made legal tender during World War I, and the "Greenback"
party in the US, which advocated the slowing of the retirement of
paper currency not backed by gold.
By
encouraging industrial specialization, industrializing countries grew
rapidly in population, and therefore needed sources of agricultural
goods. The need for cheap agricultural imports, in turn, further
pressured states to reduce tariffs
and other trade barriers, so as to be able to exchange with the industrial
nations for capital goods, such as factory machinery, which were
needed to industrialize in turn. Eventually this pressured taxation
systems, and pushed nations towards income and sales taxes, and away
from tariffs. It also produced a constant downward pressure on wages,
which contributed to the "agony of industrialization". The role of the
gold standard in this process remains hotly debated, with new articles
being published attempting to trace the interconnections between
monetary basis, wages and living standards.
By
the 1890's
in the United States, a reaction against the gold standard had emerged
centred in the Southwest and Great Plains. Many farmers began to view the scarcity of gold,
especially outside the banking centres of the East, as an instrument
to allow Eastern bankers to instigate credit squeezes that would force
western farmers into widespread debt, leading to a consolidation of
western property into the hands of the centralized banks. The
formation of the Populist Party in Lampasas, Texas specifically
centred around the use of "easy
money" that was not backed by gold and which could flow more easily
through regional and rural banks, providing farmers access to needed
credit. Opposition to the gold standard during this era reached its
climax with the presidential campaign of Democrat William Jennings
Bryan of Nebraska. Bryan argued against the gold standard in his
Cross of gold speech in 1896,
comparing the gold standard (and specifically its effects on western
farmers) to the crown of thorns worn by Jesus
at his crucifixion. After being defeated in 1896, Bryan ran and lost
again in 1900 and 1908, each time carrying mostly Southern and Great Plains states.
The
key change in this period was the adoption of a monetary policy to
raise interest rates in response to gold outflows, or to maintain
large stocks of gold in the reserves of the central bank. This policy
created a credibility of commitment to the gold standard. According to
Lawrence Officer and Alberto Giovanni, this can be
seen from the relationship between the Bank of England rate, and the
flow between the pound and the dollar, mark and franc. From 1889
through 1908, the pound maintained a direct bank rate rule
relationship with the dollar 99% of the time, and 92% of the time with
the mark. Thus, according to the theory of gold standard monetary
dynamics, the key to this credibility was the willingness of the Bank
of England to make adjustments to the discount rate to stabilize
sterling to other currencies in the gold, or de facto gold, standard
world, during the peak period of the gold standard composed of 360
months, the Bank of England bank rate was adjusted over 200 times in
response to gold flows, a rate of change higher than current central
banks.
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By
1900 the
need for a
lender of last resort had become clear to most major
industrialized nations. The importance of central banking to the
financial system was proven largely by examples such as the 1890
bail-out of Barings Bank by the Bank of England. Barings had been threatened
by imminent bankruptcy. Only the United States still lacked a central banking
system.
There
had been occasional panics since the end of the depressions of the
1880's
and 1890's
which some attributed to the centralization of production and banking.
The increased rate of industrialization and imperial colonization,
however, had also served to push living standards higher. Peace and
prosperity reigned through most of Europe, albeit with growing
agitation in favour of socialism and communism because of the extremely harsh conditions of early
industrialization. This
came to an abrupt halt with the outbreak of World War I. Britain was almost immediately forced to take steps that would
lead to its gradually leaving its gold standard, ending convertibility
to Bank of England notes starting in 1914.
By
the end of the war England was on a series of
fiat currency regulations, which monetized Postal Money Orders and
Treasury Notes (later called banknotes, not to be confused with US
Treasury Notes). The need for larger and larger engines of war,
including battleships and munitions, created
inflation. Nations responded by printing more money than could be
redeemed in gold, effectively betting on winning the war and redeeming
out of reparations, as Germany had in the Franco-Prussian War. The US and the UK both instituted a variety
of measures to control the movement of gold, and to reform the banking
system, but both were forced to suspend use of the gold standard by
the costs of the war. The
Treaty of Versailles instituted punitive reparations on Germany
and the defeated
Central Powers, and France hoped to use these to rebuild her
shattered economy, as much of the war had been fought on French soil.
Germany, facing the prospect of yielding much of her gold in
reparations, could no longer coin gold "Reichsmarks", and moved to
paper currency.
The series of arrangements to prop up the gold
standard in the 1920s would constitute a book length study unto
themselves, with the
Dawes Plan superseded by the
Young Plan. In effect the US, as the most persistent positive
balance of trade nation, loaned the money to Germany to pay off
France, so that France could pay off the United States. After the war,
the
Weimar Republic suffered from
hyperinflation and introduced "Rentenmarks",
an
asset currency, to halt it. These were withdrawn from circulation in favour of a restored gold
Reichsmark in 1924.
In
the UK the pound was returned to the gold standard in 1925, by
the somewhat reluctant
Chancellor of the Exchequer
Winston Churchill, on the advice of conservative economists at the
time. Although a higher gold price and significant inflation had
followed the WWI ending of the gold standard, Churchill returned to
the standard at the pre-war gold price. For five years prior to 1925
the gold price was managed downward to the pre-war level, meaning a
significant
deflation was forced onto the economy.
John Maynard Keynes was one economist who argued against the
adoption of the pre-war gold price believing that the rate of
conversion was far too high and that the monetary basis would
collapse. He called the gold standard "that barbarous relic". This
deflation reached across the remnants of the
British Empire everywhere the
Pound Sterling was still used as the primary unit of account. In
the UK the standard was again abandoned in 1931. Sweden
abandoned the gold standard in 1929, the
US in 1933,
and other nations were, to one degree or another, forced off the gold
standard.
As
part of this process, many nations, including the US, banned
private ownership of large gold stocks. Instead, citizens were
required to hold only legal tender in the form of central bank notes. While this move was argued for under national emergency, it was
controversial at the time, and there are still those who regard it as
an illegal and unconstitutional usurpation of
private property.
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In
1933 the
London Conference marked the death of the international gold
standard as it had developed to that point in time. While the United
Kingdom and the United States desired an eventual return to the Gold
Standard, with President
Franklin D. Roosevelt saying that a return to international
stability "must be based on gold" neither was willing to do so
immediately. France and Italy both sent delegations insisting on an
immediate return to a fully convertible international gold standard. A
proposal was floated to stabilize exchange rates between France,
Britain and the United States based on a system of drawing rights, but
this too collapsed.
The
central point at issue was what value the gold standard should take.
Cordell Hull, the
US Secretary of State, was instructed to require that reflation of
prices occur before returning to the Gold Standard. There was also
deep suspicion that Britain would use favourable trading arrangements
in the
Commonwealth to avoid fiscal discipline. Since the collapse of the
Gold Standard was attributed, at the time, to the US and the UK trying
to maintain an artificially low peg to gold, agreement became
impossible. Another fundamental disagreement was the role of tariffs
in the collapse of the gold standard, with the liberal government of
the United States taking the position that the actions of the previous
American Administration had exacerbated the crisis by raising tariff
barriers.
In
the years that followed nations pursued
bilateral trading agreements, and by 1935, the
economic policies of most Western nations were increasingly dominated
by the growing realization that a global conflict was highly likely,
or even inevitable. During the 1920s
the austerity measures taken to restabilize the
world financial system had cut military expenditures drastically,
but with the arming of the
Axis powers, war in Asia, and
fears of the Soviet Union exporting
communist revolution, the priority shifted toward armament, and
away from re-establishing a gold standard. The last gasp of the 19th
century gold standard came when the attempt to balance the United States Budget in
1937 led
to the "Roosevelt Recession". Even such gold advocates as Roosevelt's budget
director conceded that until it was possible to balance the budget, a
gold standard would be impossible.
Nazi Germany, as part of its pogrom
against various minorities including
homosexuals, the physically or mentally handicapped,
Slavic citizens, Gypsies,
and Jews,
used the gold looted from them to finance its war effort. Some
Swiss banks were among the international banks who ended up
handling gold deposits from this source. The gold was then deposited
with the
Reichsbank and used as the basis for notes to be issued which were
to be accepted as currency. The Reich then instituted wage and price
controls, backed by internment in prison camps, to prevent this "Mefo
financing" from producing hyper-inflation.
During the 19391942
period, Britain depleted much of its gold stock in purchases of
munitions and weaponry on a "cash and carry" basis from the US and
other nations. This depletion of Britain's reserve signalled to
Winston Churchill that returning to a pre-war style gold standard was
impractical; instead, John Maynard Keynes, who had argued against such
a gold standard, became increasingly influential: his proposals, a
more wide ranging version of the "stability pact" style gold standard,
would find expression in the
Bretton Woods Agreement.
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see
Bretton Woods system
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The
essential features of the gold standard in theory rest on the idea
that
inflation is caused by an increase in the
quantity of money, an idea advocated by
David Hume, and that uncertainty over the future purchasing power
of money depresses business confidence and leads to reduced trade and
capital investment. The central thesis of the gold standard is that
removing uncertainty, friction between kinds of currency, and possible
limitations in future trading partners will dramatically benefit an
economy, by expanding both the market for its own goods, the solidity
of its credit, and the markets from which its consumers may purchase
goods. In much of gold standard theory, the benefits of enforcing
monetary and
fiscal
discipline on the government are central to the benefits obtained,
advocates of the gold standard often believe that governments are
almost entirely destructive of economic activity, and that a gold
standard, by reducing their ability to intervene in markets, will
increase personal liberty and economic vitality.
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If
the monetary authority holds sufficient gold to convert all
circulating money, then this is known as a 100% reserve gold standard,
or a full gold standard. In some cases it is referred to as the
Gold Specie Standard to more easily separate it from the other
forms of gold standard that have existed at various times.
Some
believe there is no other form of Gold Standard other than the 100%
reserve Gold Specie Standard. This is because in any partial
gold standard there is some amount of circulating paper that is not
backed by gold, and hence it is possible for monetary issuing
authorities to attempt to use
seigniorage, and possibly
inflation. Others, such as some modern advocates of
supply-side economics contest that so long as gold is the accepted
unit of account then it is a true gold standard.
In a
national Gold Standard system, gold coins circulate as legal
tender, and all paper money is freely convertible into gold at a fixed
rate. If paper money exchanges with gold at a floating rate, then the
paper money is
fiat money and will often devalue against specie. This has
particularly been the case during wars when governments would issue
paper currency not backed by specie. Examples include
Greenbacks issued by the Union during the American Civil War, and
paper marks issued by Austria during the Napoleonic Wars. Such
episodes have traditionally lead to calls to restore "sound" money
after the war, that is a hard currency monetary system.
In an
international gold-standard system, which may exist in the absence of
any internal gold standard, gold or a currency that is convertible
into gold at a fixed price is used as a means of making international
payments. Under such a system, when 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 inflows or outflows occur until the
rates return to the official level. International gold standards often
limit which entities have the right to redeem currency for gold. Under
the Bretton Woods system, these were called "SDRs" for
Special Drawing Rights.
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The
commitment to maintain gold convertibility tightly restrains credit
creation. Credit creation by banking entities under a gold standard
threatens the convertibility of the notes they have issued, and
consequently leads to undesirable gold outflows from that bank. The
result of a failure of confidence produces a run on the specie basis,
which is generally responded to by the bankers suspending specie
payments. Hence, notes circulating in any "partial" gold standard will
either be redeemed for their
face value of gold (which would be higher than its
actual value) this constitutes a bank "run"; or the
market value of such notes will be viewed as less than a gold coin
representing the same amount.
In
the international gold standard imbalances in
international trade were rectified by requiring nations to pay
accounts in gold. A country in deficit would have to pay its debts in
gold thus depleting gold reserves and would therefore have to reduce
its money supply. This would cause prices to deflate, reducing
economic activity and, consequently, demand would fall. The resulting
fall in demand would reduce imports; thus theoretically the deficit
would be rectified when the nation was again importing less than it
exported. This led to a constant pressure to close economies in the
face of currency drains in what critics called "beggar thy neighbour"
policies. Such
zero-sum gold standard systems showed periodic imbalances which
had to be corrected by rapid falls in output.
In
practice however this could seriously destabilize the economy of
countries which ran a
trade deficit, because people tended to make a run on the bank to
retrieve their money before gold reserves were exported, thus causing
banks to collapse and wiping out savings.
Bank
runs and failures were a common feature of life during the period
when the gold standard was the established economic system. It also
created a counter-cyclical effect, as governments taxed trade, they
accumulated gold and silver coin, which reduced the monetary base for
the private economy. This paradox lead to "money droughts" and
inflation, as governments taxed, often to pay for wars, and paid in
coin, while the velocity of money decreased in the private economy as
individuals hedged against the uncertain political situation by
hoarding gold. Each attempt to introduce paper money was met, sooner
or later, with either over-printing of money and the resulting
collapse of the "fiat" money, including paper francs, continentals
printed by the pre-Constitutional US Congress and various "bubbles".
Or it would create the demand by the government to be paid only in
specie, which devalued the existing paper money.
The
gold standard, in theory, limits the power of governments to cause
price inflation by excessive issue of paper currency, although there
is evidence that before World War I monetary authorities did not
expand or contract the supply of money when the country incurred a
gold outflow. It is also supposed to create certainty in international
trade by providing a fixed pattern of exchange rates. The gold
standard in fact is deflationary, as the rate of growth of economies
generally outpaces the growth in gold reserves. This, after the
inflationary silver standards of the 1700s was regarded as a welcome
relief, and an inducement to trade. However by the late 19th century,
agitation against the gold standard drove political movements in most
industrialized nations for some form of silver, or even paper based,
currency.
Under
the classical international gold standard, disturbances in the price
level in one country would be wholly or partly offset by an automatic
balance-of-payment adjustment mechanism called the
price-specie-flow mechanism. (Specie refers to gold coins.)
The steps in this mechanism are first: when the price of a good drops,
because of oversupply, capital improvement, drop in input costs or
competition, buyers will prefer that good over others. Because the
stabilization of currencies to gold, buyers within the gold based
economies will preferentially buy the lowest priced good, and gold
will flow into the most efficient economies. This flow of gold into
the more productive economy will then increase the money supply, and
produce sufficient inflationary pressure to offset the original drop
in prices in the more productive economy, and would reduce the
circulating specie in the less productive economies, forcing prices
down until equilibrium was restored.
Central banks, in order to limit gold outflows, would reinforce this
by raising interest rates, so as to bring prices back into
international equilibrium more quickly. In theory, as long as nations
remained on the gold standard, there would be no sustained period of
either high inflation, or uncontrolled deflation. Since, at the time,
it was believed that markets internally always clear (See
Say's Law), and that deflation would alter the price of capital
first, it meant that this would reduce the price of capital, and allow
more growth as well as long term price stability.
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Thus,
the internal gold standard is supported by anti-government economists,
including extreme
monetarists,
objectivists, followers of the
Austrian School of Economics and many
libertarians. Much of the support for a gold standard is related
to a distrust of
central banks and governments, as a gold standard removes the
ability of a government to manage the value of money, even though,
historically, the establishment of a gold standard was part of
establishing a national banking system, and generally a central bank.
The
international gold standard still has advocates who wish to return to
a
Bretton Woodsstyle system, in order to reduce the volatility of
currencies, but the unworkability of Bretton Woods, due to its
government-ordained exchange ratio, has allowed the followers of
Austrian economists
Ludwig von Mises,
Friedrich Hayek and
Murray Rothbard to foster the idea of a total emancipation of the
gold price from a State-decreed rate of exchange and an end to
government monopoly on the issuance of gold currency.
Many
nations back their currencies in part with gold reserves, using these
not to redeem notes, but as a store of value to sell in case their
currency is attacked or rapidly devalues. Gold advocates claim that
this extra step would no longer be necessary since the currency itself
would have its own intrinsic store of value. A Gold Standard then is
generally promoted by those who regard a stable store of value as the
most important element to business confidence.
It is
generally opposed by the vast majority of governments and economists,
because the gold standard has frequently been shown to provide
insufficient flexibility in the
supply of money and in fiscal policy, because the supply of newly
mined gold is finite and must be carefully husbanded and accounted
for.
A
single country may also not be able to isolate its economy from
depression or inflation in the rest of the world. In addition, the
process of adjustment for a country with a payments deficit can be
long and painful whenever an increase in unemployment or decline in
the rate of economic expansion occurs.
One
of the foremost opponents of the gold standard was John Maynard Keynes
who scorned basing the money supply on "dead metal".
Keynesians argue that the gold standard creates
deflation which intensifies recessions as people are unwilling to
spend money as prices fall, thus creating a downward spiral of
economic activity. They also argue that the gold standard also removes
the ability of governments to fight recessions by increasing the money
supply to boost economic growth.
Gold
standard proponents point to the era of industrialization and
globalization of the 19th century as the proof of the viability and
supremacy of the gold standard, and point to Britain's rise to being
an imperial power, conquering nearly one quarter of the world's
population and forming a trading empire which would eventually become
the
Commonwealth of Nations as imperial provinces gained independence.
Gold
standard advocates have a strong following among commodity traders and
hedge funds with a bearish
orientation. The expectation of a global fiscal meltdown, and the
return to a hard gold standard has been central to many hedge
financial theories. More moderate
goldbugs point to gold as a hedge against commodity inflation, and
a representation of resource extraction, in their view gold is a play
against monetary policy follies of central banks, and a means of
hedging against currency fluctuations, since gold can be sold in any
currency, on a highly liquid world market, in nearly any country in
the world. For this reason they believe that eventually there will be
a return to a gold standard, since this is the only "stable" unit of
value. That monetary gold would soar to $5,000 an ounce, over 10 times
its current value, may well have something to do with some of the
advocacy of a renewed gold standard, holders of gold would stand to
make an enormous profit.
Few
economists today advocate a return to the gold standard, other than
the Austrian school and some
supply-siders. However, many prominent economists are sympathetic
with a hard currency basis, and argue against
fiat money. This school of thought includes US central banker
Alan Greenspan and macro-economist
Robert Barro. The current monetary system relies on the US Dollar
as an "anchor currency" which major transactions, such as the price of
gold itself, are measured in. Currency instabilities, inconvertibility
and credit access restriction are a few reasons why the current system
has been criticized, with a host of alternatives suggested, including
energy based currencies, market baskets of currencies or commodities.
Gold is merely one of these alternatives.
The
reason these visions are not practically pursued is based on the same
reasons that the gold standard fell apart in the first place: a fixed
rate of exchange decreed by governments has no organic relationship
between the supply and demand of gold and the supply and demand of
goods.
Thus
gold standards have a tendency to fall apart as soon as it becomes
advantageous for governments to overlook them. By itself, the gold
standard does not prevent nations from switching to a fiat currency
when there is a war or other exigency, even though gold gains in value
through such circumstances as people use it to preserve value since
fiat currency is typically introduced to allow deficit spending, which
often leads to either inflation or to rationing.
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Gold
as a reserve today
 Gold
ingots like these, from the
Bank of Sweden, still form an important currency reserve and store
of private wealth.
During the 1990's Russia
liquidated much of the former USSR's gold reserves, while several
other nations accumulated gold in preparation for the Economic and
Monetary Union. The Swiss Franc left a full gold-convertible backing. However,
gold reserves are held in significant quantity by many nations as
a means of defending their currency, and hedging against the US
Dollar, which forms the bulk of liquid currency reserves. Weakness in
the US Dollar tends to be offset by strengthening of gold prices. Gold
remains a principal financial asset of almost all central banks
alongside foreign currencies and government bonds. It is also held by
central banks as a way of hedging against loans to their own
governments as an "internal reserve".
In
addition to other
precious metals, it has several competitors as
store of value: the US dollar itself and
real estate. As with all stores of value, the basic confidence in
property rights determines the selection of which one is chosen, as
all of these have been confiscated or heavily taxed by governments. In
the view of gold investors, none of these has the stability that gold
had, thus there are occasionally calls to restore the gold standard.
Occasionally politicians emerge who call for a restoration of the gold
standard, particularly from the
libertarian right and the anti-government left. Mainstream
conservative economists such as Barro and Greenspan have admitted a
preference for some tangibly backed monetary standard, and have stated
that a gold standard is among the possible range of choices.
Some
privately issued modern notes (such as
e-gold)
are backed by gold bullion, and gold. Both coins and bullion are
widely traded in deeply liquid markets, and therefore still serve as a
private store of wealth. In effect, the holder of such currencies is
long gold, short their own currency and writing cheques on the account
of the currencies issuer.
In
1999, to protect the value of gold as a reserve,
European Central Bankers signed the "Washington Agreement", which
stated they would not allow gold leasing for speculative purposes, nor
would they "enter the market as sellers" except for sales that had
already been agreed upon. A selling band was set. This was intended to
prevent further deterioration in the price of gold.
In 2001 Malaysian Prime Minister
Mahathir bin Mohamad proposed a new currency that would be used
initially for international trade between Muslim nations. The currency
he proposed was called the gold dinar and it was defined
as 4.25 grams of 24 carat
(100%) 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. This attempt
to produce a gold currency has not materialized.
The
end of the
Great Commodities Depression has effected the price of gold as
well, gold prices rising out of a 20 year trading bracket. This has
lead to a renewed use by monetary authorities of gold to back their
currencies, but has does materially effect the use of a gold standard
as money. In fact, the reverse is the case, the more expensive gold
is, the more expensive the acquisition project to create gold standard
becomes.
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See also
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