Gold Standard

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The gold standard is a monetary system in which the standard economics unit of account is a fixed weight of gold.

Under the gold standard, currency issuers guarantee to redeem notes, upon demand, in that amount of gold. Governments that employ such a fixed unit of account, and which will redeem their notes to other governments in gold, share a fixed-currency relationship. The gold standard is not currently used by any government or central bank, having been replaced completely by fiat currency. However, private currency backed by gold is in use.

Why gold? Due to its rarity, durability, easy divisity, and the general ease of identification through its medium, wigold as the metal of monetary reserve. Even after silver was no longer basis of currency, gold remained a base global currency until the collapse of the Bretton Woods system.

Early coinage The first metal used as a currency was silver more than 4,000 years ago, when silver ingots were used in trade. Gold coins first were used from 600 B.C. However, long before this time, gold, as per silver, was used as a store of wealth and the basis for trade contracts in Akkadia, and later in Ancient Egypt. Silver remained the most common monetary metal used in ordinary transactions until the 20th century.

The Persian Empire collected taxes in gold, and when it was conquered by Alexander the Great, this gold became the basis for the gold coinage of Alexander's Macedon. The Roman Empire mint (coin) two important gold coins: the aureus, which was ~7 grams of gold alloyed with silver, and the smaller Solidus (coin), which weighed 4.4 grams, of which 4.2 was gold. These values applied only to the early Empire. Later Roman and Byzantine coins were frequently diluted with other metals, in an attempt to expand the money supply

The dinar and dirham were gold and silver coins, respectively, originally minted by the Persians. The Caliphates in the Islamic world adopted these coins, starting with Caliph Abd al-Malik (685–705)

In 1284, the Republic of Venice coined its first solid gold coin, the ducat. Other coins, the Italian coin florin, noble (English coin), grosh, złoty, and British coin Guinea, also were introduced at this time by other European states to facilitate growing trade. Beginning with the conquest of the Aztec Empire and Inca Empires, Spain had access to stocks of new gold for coinage in addition to 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.

History of the modern gold standard The crisis of silver currency and bank notes (1750–1870) In the late 18th century, wars and trade with China, which sold many trade goods 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 1790s Britain suffered a massive shortage of silver coinage and ceased to mint larger silver coins. It issued "token" silver coins and overstruck foreign coins. With the end of the Napoleonic Wars, Britain began a massive recoinage program that created standard gold sovereigns and circulating crowns, half-crowns, and eventually copper farthings in 1821. In 1833, 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.There were 113 grain (measure) (7.32g) of gold to one pound sterling.

The US adopted a silver standard based on the "Spanish milled dollar" in July 1785. This was codified in the 1792 Coinage Act (1792). This began a long series of attempts for America to create a Bimetallism standard for the US Dollar, which would continue until the 1930s. Because of the huge debt taken on by the US Federal Government to finance the American Revolution, silver coins struck by the government left circulation, and in 1806 Thomas Jefferson suspended the minting of silver coins. The United States Department of the 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 1846, which legally separated the accounts of the Federal Government from the banking system. 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.

Establishment of the international gold standard Germany was created as a unified country following the Franco-Prussian War; it established the German gold mark. Rapidly most other nations followed suit. Gold became a transportable, universal and stable unit of valuation, and the world's dominant economy, the United Kingdom, had a longstanding commitment to the gold standard.D.Baines Economic history in the 20th century (London: London School of Economics/University of London External Programme 2003), chapter 4. See Globalization.

Dates of adoption of a gold standard:

1717: United KingdomThe UK suspended the gold standard during the Napoleonic wars. Baines, op.cit., section 4.5.1.
1854: Portugal at 1000 Portuguese real to 1.62585g gold
1871: Germany at 2790 German gold marks to 1 kg gold
1873: Latin Monetary Union (Belgium, Italy, Switzerland, France) at 31 Francs to 9g gold
1873: United States de facto at 20.67 United States dollar to 1 troy weight ounze gold
1875: Scandinavian monetary union: (Denmark, Norway and Sweden) at 2480 Krone to 1kg gold
1875: Netherlands at 1 Dutch guilder to 0.6048g gold
1876: France internally
1876: Spain at 31Spanish peseta to 9g gold
1878: Finland at 31Finnish mark to 9g gold
1879: Austria (See Austrian florin and Austrian crown)
1893: Russia at 31 Russian rouble to 36g gold
1897: Japan at 1 Japanese yen to 1.5g gold
1898: India (See Indian Rupee)
1900: United States de jure.

Throughout the decade of the 1870s deflationary and depression (economics)ary 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.

Gold standard from peak to crisis (1901–1932) Abandoning the standard to fund the war To fund operations during World War I, the United Kingdom was forced to end convertibility of Bank of England notes to gold starting in 1914. By the end of the war Britain was on a series of fiat currency regulations, which monetized Postal Money Orders and Treasury Notes (later called banknotes, not to be confused with Treasury security#Treasury note). The United States took similar measures. After the war, Germany, losing much of its gold in reparations, could no longer coin gold “Reichsmarks,” and moved to paper currency, although the Weimar Republic later introduced the “German rentenmark,” and later the gold-backed German reichsmark in an effort to control hyperinflation.

In the UK the Pound sterling was returned to the gold standard in 1925, by a somewhat reluctant Winston Churchill. 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, causing deflation throughout those countries using the Pound Sterling. 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 on September 20, 1931. Sweden abandoned the gold standard in October 1931, the US in 1933, and other nations were, to one degree or another, forced off the gold standard.

The depression and Second World War 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 US and other nations . This depletion of the UK’s reserve signalled to Winston Churchill that returning to a pre-war style gold standard was impractical. 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.

Post-war international gold standard (1946–1971) Theory The essential features of the gold standard in theory rest on the idea that inflation is caused by an increase in the Money supply, 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.

Differing definitions of gold standard 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. The 100% reserve standard is generally considered unworkable because the quantity of gold in the world is too small a quantity of money to sustain current worldwide economic activity and the "right" quantity of money (ie one that avoids either inflation or deflation) is not a fixed quantity, but varies continuously with the level of commercial activity.

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.

Perceived stability offered by gold standard The gold standard, in theory, limits the power of governments to cause price inflation by excessive issue of paper currency. It is also supposed to create certainty in international trade by providing a fixed pattern of exchange rates. 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”. At the time of the Bretton Woods agreement, it was believed that markets internally always clear (See Say’s Law). However, in practice, wages, not capital, depreciate in price first.

Mundell-Fleming model According to modern neo-classical synthesis economics, the Mundell-Fleming Model describes the behavior of currencies under a gold standard. Since the value of the currencies is fixed by the par value of each currency to gold, the remaining freedom of action is distributed between free movement of capital, and effective monetary and fiscal policy. One reason that most modern macro-economists do not support a return to gold is the fear that this remaining amount of freedom would be insufficient to combat large downturns or deflation.

Advocates and opponents of a renewed gold standard The return to the gold standard is supported by Objectivist philosophy, followers of the Austrian School, and many libertarianism.

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 money supply and in fiscal policy, because the supply of newly mined gold is finite and must be carefully husbanded and accounted for.

Few economists today advocate a return to the gold standard, other than the Austrian school and some supply-side economics. However, many prominent economists are sympathetic with a hard currency basis, and argue against fiat money, including former US Federal Reserve Chairman 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. A host of alternatives have been suggested, including energy-based currencies, market baskets of currencies or commodities; gold is merely one of these alternatives.

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 islamic gold dinar and it was defined as 4.25 grams of 24 carat (purity) (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. 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 Sharia against the charging of interest. Nonetheless, gold dinar currency has not yet materialized .

Ron Paul, a congressman from Texas and candidate for the 2008 Republican nomination for President, advocates the U.S. abolishment of the Federal Reserve and reinstitution of the gold standard.

Gold as a reserve today , still form an important currency reserve and store of private wealth.

During the 1990s 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, official 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". Approximately 25% of all above-ground gold is held in reserves by central banks.

Both gold coins and gold bars are widely traded in deeply liquid markets, and therefore still serve as a private store of wealth. Also some privately issued currencies, such as digital gold currency, are backed by gold reserves.

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.

See also

Digital gold currency
Full-reserve banking
Gold as an investment
Federal Reserve
Gold bug
International Monetary Fund
Silver standard
World Bank
Bank for International Settlements
Special Drawing Rights
United Nations Monetary and Financial Conference
Bretton Woods system

References

The Gold Standard in Theory and History, Barry Eichengreen (Editor), Marc Flandreau, 1997, ISBN 0415150612
The Gold Standard and Related Regimes : Collected Essays (Studies in Macroeconomic History), Michael D. Bordo (Editor), Forrest Capie (Editor), Angela Redish (Editor), 1999, ISBN 0521550068
A Retrospective on the Classical Gold Standard, 1821–1931 (National Bureau of Economic Research Conference Report), Michael D. Bordo (Editor), Anna J. Schwartz (Editor), 1984, ISBN 0226065901
Between the Dollar-Sterling Gold Points: Exchange Rates, Parity, and Market Behavior. Lawrence H. Officer, Cambridge University Press, 1996
Golden Fetters: The Gold Standard and the Great Depression, 1919–1939 (NBER Series on Long-Term Factors in Economic Development), Barry Eichengreen, 1996, ISBN 0195101138
Money and Politics: European Monetary Unification and the International Gold Standard (1865–1873) Luca Einaudi 2001
Keynes, the Liquidity Trap and the Gold Standard: A Possible Application of the Rational Expectations Hypothesis, Robert Marks 1995
Ideology and the Evolution of Vital Economic Institutions: Guilds, The Gold Standard, and Modern International Cooperation Earl A. Thompson, Charles R. Hickson, 2000
Gold Standard and Employment Policies between the Wars, Sidney Pollard Ed. 1970
Stability of International Exchange: Report on the Introduction of the Gold-Exchange Standard into China and Other Silver-Using Countries, Commission on International Exchange, 2001
Ken Elks' series on British Coinage
Banking in Modern Japan Research Division of the Fuji Bank, 1967
Bordo, Michael D. "Bimetallism". In The New Palgrave Encyclopedia of Money and Finance edited by Peter K. Newman, Murray Milgate and John Eatwell. New York: Stockton Press, 1992.
Gold Standard and the International Monetary System, 1900–1939, Ian M. Drummond 1983
The Gold Standard in Theory and Practice, RG Hawtrey, Longmans and Green
Glitter of Gold: France, Bimetallism, and the Emergence of the International Gold Standard, 1848–1873 Marc Flandreau 2003
Cyclopædia of Political Science, Political Economy, and the Political History of the United States by the Best American and European Writers, John Lalor, 1881
The Gold Standard, Deflation, and Financial Crisis in the Great Depression: An International Comparison Ben Bernanke, Harold James 1990
The World Currency Crisis by Murray Rothbard
The Downfall of the Gold Standard Gustav Cassel 1966
Currency Convertibility: The Gold Standard and Beyond Jorge Braga de Macedo (Editor) 1996
Deceit of the Gold Standard and of Gold Monetization, William H. Russell 1982
Gold, Prices and Wages under the Greenback Standard Wesley Clair Mitchell
Gold Standard Illusion: France, the Bank of France, and the International Gold Standard, 1914–1939 Kenneth Moure
Modern Perspectives on the Gold Standard Tamim Bayoumi (Editor), Mark P. Taylor (Editor), 1997
Keynes, John M. 1925; The Economic Consequences of Mr. Churchill (Criticism of returning to the gold standard at the pre-war level – )
A Treatise on Money, John Maynard Keynes 1930
Credibility of the Interwar Gold Standard, Uncertainty, and the Great Depression J. Peter Ferderer 1999
Monetary Standards in the Periphery: Paper, Silver and Gold,1854–1933, Pablo Martin Acena (Editor), Jaime Reis (Editor), 2000
History of the Bank of England The Bank of England updated 2004
Anatomy of an International Monetary Regime: The Classical Gold Standard, 1880–1914 Giulio M Gallarotti
Canada and the Gold Standard: Balance of Payments Adjustments under Fixed Exchange Rates 1871–1913 Trevor Dick, John E. Floyd 1992

Gold - The Once and Future Money, Nathan Lewis, John Wiley and Sons ISBN 0-470-04766-8

Articles

Actual 1933 Audio of FDR's Explanation of the Banking Crisis & Gold Confiscation
"Gold and Economic Freedom" by Alan Greenspan
The Gold Bug Variations by Paul Krugman describes the gold standard as an "economic myth".
A Gold Polaris by Jude Wanniski advocates for a return to a gold standard.
NBER on the contribution of the Gold Standard to the Great Depression
Churchill Gold and the Empire - History of Churchill's decision to return the Sterling Pound back to the Gold Standard
The Classical Gold Standard from What Has Government Done to Our Money? by Murray N. Rothbard

External links

History of the Gold Standard from EH.NET's Encyclopedia by Lawrence Officer
Gold Anti-Trust Action Committee website
The Roosevelt Gold Confiscation Order Of April 3 [1933
FDIC statement of policy regarding Public Law 93-373
Gold information for researchers
What is The Gold Standard? University of Iowa Center for International Finance and Development

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