The Gold Standard

The Gold Standard

Introduction

In the pre-World War 1 era , the monetary policy of major economies was based on the amount of gold a sovereign country possessed . The concept was simple . Central banks in major economies pegged their currencies to the prevailing price of gold . For example if a 100 bill was exchanged at the American central bank , the bank will offer an equivalent sum in gold . Approximately , a 100 worth of gold weighed about 4 .5 troy ounces The same goes for the British pound . A ?100 pound note would yield

br approximately 22 troy ounces of gold

There were several theories regarding the origins of the gold standard The most common and acceptable to monetary theorists was the changes in supply with the two main metals that defined wealth - gold and silver Flandreau traced the gold standard origins to the gold standard in the defeat of France in the Franco-Prussian war and the German Empire 's use of the war indemnity to create a gold-based German national currency (Milward 87-88

The concept behind the gold standard had the philosophical underpinnings of David Hume 's specie flow . According to the theory , specie flow responded to price differentials and price changes , and produced a self balancing (Flandreau and James 7 . Gold was the logical choice during the early nineteenth century because England was dominating global trade and the gold discoveries in the 1840 's to 1850 's had built up the reserves of major economic powers (Flandreau and James 5 Politically , gold became a global currency when an ambiguous international agreement aiming for a universal international monetary system agreed to set the monetary standards based on the 25 French Franc gold coin . Liberalism had also taken its roots to initiate the steps for a more global economy (Flandreau and James 5 . An obstacle to this move was how to shift silver based economies into the new gold standard . In addition , the collapse of the price of silver forced major economies to shift to gold . In essence , the concession of the four major economies namely Britain , Germany , United States and France was essential to make the transition complete

In the ensuing sections of the , the discussion will focus on why the classical gold standard worked for pre-World War 1 economies and not for the Interwar periods . What were the factors that made the gold standard a success in the former and not in the latter

The Past Revisited

There were six rules in the international standard . First , there must be a fixed price (parity ) so that there would be ease in conversion to gold in the domestic market . Second , there should be no restriction on the export of gold . Third , banknotes and coinage were backed by gold reserves of the sovereign country . Fourth , in case of liquidity problem because egress of gold was faster than ingress , the central bank was allowed to hike interest rates . Fifth , should the first rule be suspended temporarily , the sovereign must restore the convertibility and...