Gold standard

The gold standard is a monetary system in which a region's common media of exchange are paper notes that are normally freely convertible into pre-set, fixed quantities of gold. The gold standard is not currently used by any government, having been replaced completely by fiat currency, and private currencies backed by gold are rare.

Contents

History

Early gold-coin standards

See also: History of the English penny
Gold coin of Alexander the Great, ca. 330 BC

Government-minted gold and silver coins were first used in ancient Lydia in the late 7th century B.C. The burgeoning democratic city-states of Classical Greece soon thereafter introduced similar gold-coin standards, which rapidly spread Westward to most of the city-states republics, including Rome. In the heyday of the Athenian empire, the city's silver tetradrachm was the first coin to achieve "international standard" status in Mediterranean trade. Silver remained the most common monetary metal used in ordinary transactions until the 20th century.

Aureus minted in 193 by Septimius Severus

The Persian Empire collected taxes in gold and minted its own gold coin, known in the West as the dareikos δαρεικός in Greek, or daricus in Latin. When Persia was conquered by Alexander the Great, this gold became the basis for the gold coinage of Alexander's Macedon empire and those of his Diadochi. The vast gold hoard of the Persian kings was put into monetary circulation, triggering the first known "worldwide" inflation event.

Solidus of Justinian II, ca. 705

Ancient Rome minted two important gold coins: the 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. Roman and Byzantine coins were frequently alloyed with other metals of much lower value to create the seigniorage necessary for a rational system of government money.

The Roman Emperor Gallienus, who ruled from 253 to 268, introduced a monetary reform in which surface-overvalued coins were no longer accepted for tax payments, resulting in inflation: for the surface overvaluation of an emergency coinage would soon degenerate to the point where the coinage simply traded for its metallic value, thereby eliminating the ability of the senate-constrained government to collect seigniorage at critical times. Remarkably, the position was not remedied until after the fall of the Empire and the times of Justinian in the East and Theodoric the Great, the first of the Ostrogothic kings of Italy.

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).

Sequin (Venetian ducat), 1382

In 1284 the Republic of Venice coined the ducat, its first solid gold coin. Other coins, the florin, noble, grosh, złoty, and guinea, were also introduced at this time by other European states to facilitate growing trade.

Beginning with the conquest of the Aztec 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 was later to create the unit of account for the United States, the "dollar", based on the Spanish silver real, and Philadelphia's currency market was to trade in Spanish colonial coins.

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 Demand 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 113.00159 grains (7.32g) of gold to one pound sterling. The exact equivalent was that 1869 sovereigns could be minted from 40 pounds troy of crown gold (11/12 fine).

The U.S. adopted a silver standard based on the "Spanish milled dollar" in July 1785. This was codified in the 1792 Mint and Coinage Act. This began a long series of attempts for United States to create a bimetallic standard for the US Dollar, which was to continue until the 1930s. 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 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

When Germany became a unified country following the Franco-Prussian War; it established the 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.[1] See Globalization.

Gold standards should not be confused with their historical predecessor, "gold-coin standards", wherein taxes are payable in either gold coins or overvalued, government-minted and less expensive coins.

The main purpose of either government money system has historically been to provide seigniorage, or money-creation profit, to governmental leaders in order to provide them with general purchasing power during emergencies, especially those leaders who are legislatively constrained and therefore unable to raise taxes in order to execute the defense commitments that are required for the survival of their states.[2]

Gold standards replaced gold-coin standards in the 17th-19th centuries in the West as the extent of defensive warfare expanded to where the gold-coin standards were no longer sufficient to the task. A similar history generated a gold standard in China from the 9th through the early 17th century. [3]

Dates of adoption of a gold standard

Throughout the post-Civil War decade of the 1870s deflationary and depressionary economics created periodic demands for silver currency. However, attempts to introduce such currency 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)

Suspending gold payments to fund the war

As in previous major wars under its gold standard, the British government suspended the convertibility of Bank of England notes to gold in 1914 to fund military operations during World War I. By the end of the war Britain was on a series of fiat currency regulations, which monetized Postal Money Orders and Treasury Notes. The government later called these notes banknotes, which are different from US Treasury notes. The United States government took similar measures. After the war, Germany, having lost much of its gold in reparations, could no longer coin gold "Reichsmarks" and moved to paper currency, although the Weimar Republic later introduced the "rentenmark" and later the gold-backed reichsmark in an effort to control hyperinflation.

As had happened after previous major wars, the UK 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 wartime suspension, Churchill followed tradition by resuming conversion payments 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 of the British Empire and Commonwealth using the Pound Sterling. But the rise in demand for gold for conversion payments that followed the similar European resumptions from 1925 to 1928 meant a further rise in demand for gold relative to goods and therefore the need for a lower price of goods because of the fixed rate of conversion from money to goods. Because of these price declines and predictable depressionary effects, the British government finally abandoned the standard September 20, 1931. Sweden abandoned the gold standard in October 1931; and other European nations soon followed. Even the U.S. government, which possessed most of the world's gold, moved to cushion the effects of the Great Depression by raising the official price of gold (from about $20 to $35 per ounce) and thereby substantially raising the equilibrium price level in 1933-4.

Depression and World War II

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 U.S. and other nations. This depletion of the UK's reserve convinced Winston Churchill of the impracticality of returning to a pre-war style gold standard. John Maynard Keynes, who had argued against such a gold standard, became increasingly influential. Nevertheless, his theories were rejected by the 1944 Bretton Woods Agreement, which established the IMF and an international gold standard based on convertibility of the various national currencies into a U.S. dollar that was in turn convertible into gold.

Post-war international gold standard (1946–1971)

Main article: Bretton Woods system

After the Second World War, a system similar to the Gold Standard was established by the Bretton Woods Agreements. Under this system, many countries fixed their exchange rates relative to the US dollar. The US promised to fix the price of gold at $35 per ounce. Implicitly, then, all currencies pegged to the dollar also had a fixed value in terms of gold. However, under the fiscal strain of the Vietnam War, President Richard Nixon eliminated the fixed gold price in 1971, causing the system to break down.

Advantages

Without a gold standard, governments can print as much money as they want, destroying wealth through inflation. A German woman in 1924 feeding a stove with currency notes, which burned longer than the amount of firewood they could buy.

The history of money consists of three phases: commodity money, in which actual valuable objects are bartered; then representative money, in which paper notes (often called 'certificates') are used to represent real commodities stored elsewhere; and finally fiat money, in which paper notes are backed only by use of' "lawful force and legal tender laws" of the government, in particular by its acceptability for payments of debts to the government (usually taxes).

Commodity money is inconvenient to store and transport. It also does not allow the government to control or regulate the flow of commerce within their dominion with the same ease that a standardized currency does. As such, commodity money gave way to representative money, and gold and other specie were retained as its backing.

Gold was a common form of representative money due to its rarity, durability, divisibility, fungibility, and ease of identification,[6] often in conjunction with silver. Silver was typically the main circulating medium, with gold as the metal of monetary reserve.

It is difficult to manipulate a gold standard to tailor to an economy’s demand for money, giving central banks fewer options to respond to economic crises.[7]

The Gold Standard variously specified how the gold backing would be implemented, including the amount of specie per currency unit. The currency itself is just paper and so has no innate value, but is accepted by traders because it can be redeemed any time for the equivalent specie. A US silver certificate, for example, could be redeemed for an actual piece of silver.

Representative money and the Gold Standard protect citizens from hyperinflation and other abuses of monetary policy, as were seen in some countries during the Great Depression. However, they were not without their problems and critics, and so were partially abandoned via the international adoption of the Bretton Woods System. That system eventually collapsed in 1971, at which time all nations had switched to full fiat money.

Alan Greenspan, at that time the Chairman and President of Townsend-Greenspan & Co., Inc., an economic consulting firm in New York, argued in 1966, before the advent of monetarism, that

under the gold standard, a free banking system stands as the protector of an economy's stability and balanced growth… The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit… In the absence of the gold standard, there is no way to protect savings from confiscation through inflation.[8]

Disadvantages

Theory

The theory of the gold standard rests on the idea that maximal increases in governmental purchasing power during wartime emergencies require post-war deflations, which would not occur without monetary institutions like the gold standard, which insist upon return to pre-war price-levels and therefore deflationary wartime expectations.[18]

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 to sustain current worldwide economic activity and the "right" quantity of money (i.e. one that avoids either inflation or deflation) is not a fixed quantity, but varies continuously with the level of commercial activity. The currencies or banknotes having Gold standard were the old German Reichsmarks, Yugoslav dinars, Turkish liras, Brazilian cruzeiros, Croatian dinars, Polish złoty, Argentine peso leys, Angola Kwanzas reajastodos, Zairean zaires and Bolivian bolivianos.

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.

Stability offered by gold standard

The gold standard limits the power of governments to inflate prices through excessive issuance of paper currency. It may tend to create certainty in international trade by providing a fixed pattern of exchange rates. Under the classical international gold standard, disturbances in price levels 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 were always internally clear; Say's Law. However, in practice, wages, not capital, depreciate in price first.

Advocates of a renewed gold standard

The return to the gold standard is supported by many followers of the Austrian School of Economics, Objectivists and libertarians largely because they object to the role of the government in issuing fiat currency through central banks.

Few lawmakers[12] today advocate a return to the gold standard, other than adherents of the Austrian school and some supply-siders. However, many prominent economists have expressed sympathy with a hard currency basis, and have argued against fiat money, including former US Federal Reserve Chairman Alan Greenspan (himself a former Objectivist), macro-economist Robert Barro. Greenspan famously argued the case for returning to a gold standard in his 1966 paper "Gold and Economic Freedom", in which he described supporters of fiat currencies as "welfare statists" hell-bent on using monetary printing presses to finance deficit spending. He has argued that the fiat money system of today has retained the favorable properties of the gold standard because central bankers have pursued monetary policy as if a gold standard were still in place.[19] US Congressman Ron Paul argues for the reinstatement of the gold standard based on his theory of "pure strain" gold – that gold has intrinsic value separate from any economic system due to its physical properties. Furthermore, the amount of "pure strain" gold in the world is constant, heading off the problem of inflation.

The current global monetary system relies on the US dollar as a reserve currency by which major transactions, such as the price of gold itself, are measured. 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 (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 Islamic law against the charging of interest.[20] However, to date, Mahathir's proposed gold-dinar currency has failed to become an accomplished fact.

Gold as a reserve today

Main article: Official gold reserves

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, gold reserves are held in significant quantity by many nations as a means of defending their currency, and hedging against the U.S. Dollar, which forms the bulk of liquid currency reserves. Weakness in the U.S. 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 19% 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. 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 on Gold which stated that 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

References

  1. ↑ Baines, D. (1997). "Institutions that underpinned the international economy before the First World War". Economic history in the 20th century. London: University of London External Programme. ISBN 0718714377. OCLC 44837541. http://www.londonexternal.ac.uk/current_students/programme_resources/lse/lse_pdf/foundation_units/econ_hist/echist_complete.pdf. Retrieved on 2008-11-12. 
  2. ↑ Thompson, Earl A. (July/August 1974). "Taxation and National Defense". Journal of Political Economy 82 (4): 755–782. doi:10.1086/260232. http://www.jstor.org/pss/1837144. Retrieved on 2008-11-12.  See especially page 758, note 4.
  3. ↑ Shlaes, Amity (2007). The forgotten man: a new history of the Great Depression. New York City: HarperCollins. ISBN 0-06-621170-0. OCLC 74029445. 
  4. ↑ Kindleberger, Charles P. (1993). A financial history of western Europe. Oxford: Oxford University Press. pp. 60–63. ISBN 0-19-507738-5. OCLC 26258644. 
  5. ↑ The Pocket money book: a monetary chronology of the United States. Great Barrington, Massachusetts: American Institute for Economic Research. 2006. pp. 4–6. ISBN 0-913610-46-1. OCLC 75968548. 
  6. ↑ Krech, Shepard; John Robert McNeill and Carolyn Merchant (2004). Encyclopedia of world environmental history. New York City: Routledge. pp. 597. ISBN 0-415-93734-5. OCLC 174950341. 
  7. ↑ Demirgüç-Kunt, Asli; Enrica Detragiache (April 2005). "Cross-Country Empirical Studies of Systemic Bank Distress: A Survey". National Institute Economic Review 192 (1): 68–83. doi:10.1177/002795010519200108. ISSN 0027-9501. OCLC 90233776. http://ner.sagepub.com/cgi/reprint/192/1/68. Retrieved on 2008-11-12. 
  8. ↑ Greenspan, Alan (July 1966). "Gold and Economic Freedom". The Objectivist 5 (7). http://www.constitution.org/mon/greenspan_gold.htm. Retrieved on 2008-11-13. 
  9. ↑ Butterman, W. C.; Earle B. Amey III (2005). Mineral Commodity Profiles—Gold. Reston, Virginia: United States Geological Survey. OCLC 62034878. http://pubs.usgs.gov/of/2002/of02-303/OFR_02-303.pdf. Retrieved on 2008-11-12. 
  10. ↑ "Money Stock and Debt Measures". Federal Reserve Board (2008-03-13). Retrieved on 2008-03-16.
  11. ↑ 11.0 11.1 Warburton, Clark (1966). "The Monetary Disequilibrium Hypothesis". Depression, Inflation, and Monetary Policy: Selected Papers, 1945-1953. Baltimore: Johns Hopkins University Press. pp. 25–35. OCLC 736401. 
  12. ↑ 12.0 12.1 Paul, Ron; Lewis Lehrman (1982). The case for gold: a minority report of the U. S. Gold Commission. Washington, D.C.: Cato Institute. pp. 160. ISBN 0-932790-31-3. OCLC 8763972. http://www.mises.org/books/caseforgold.pdf. Retrieved on 2008-11-12. 
  13. ↑ DeLong, Brad (1996-08-10). "Why Not the Gold Standard?". Berkeley, California: University of California, Berkeley. Retrieved on 2008-09-25.
  14. ↑ Bordo, Michael D. (2008). "Gold Standard". Concise Encyclopedia of Economics. Ed. David R. Henderson. Indianapolis: Liberty Fund. ISBN 0-86597-666-X. OCLC 123350134. Retrieved on 2008-11-12. 
  15. ↑ 15.0 15.1 Hamilton, James D. (2005-12-12). "The gold standard and the Great Depression". Econbrowser. Retrieved on 2008-11-12. See also Hamilton, James D. (April 1988). "Role of the International Gold Standard in Propagating the Great Depression". Contemporary Economic Policy 6 (2): 67–89. doi:10.1111/j.1465-7287.1988.tb00286.x (inactive 2008-11-12). http://www3.interscience.wiley.com/journal/120017201/abstract. Retrieved on 2008-11-12. 
  16. ↑ Timberlake, Richard H. (August 2005). "Gold Standards and the Real Bills Doctrine in U.S. Monetary Policy". Econ Journal Watch 2 (2): 196–233. http://www.econjournalwatch.org/pdf/TimberlakeIntellectualTyrannyAugust2005.pdf. Retrieved on 2008-11-16. 
  17. ↑ McArdle, Megan (2007-09-04). "There's gold in them thar standards!", The Atlantic Monthly. Retrieved on 2008-11-12. 
  18. ↑ Thompson, Earl A. (1997). "The Gold Standard: Causes and Consequences". in David Glasner. Business cycles and depressions: an encyclopedia. New York: Garland Publishing. pp. 267–272. ISBN 0-8240-0944-4. OCLC 34651539. 
  19. ↑ Greenspan, Alan (July 1966). "Gold and Economic Freedom". The Objectivist 5 (7). http://www.constitution.org/mon/greenspan_gold.htm. Retrieved on 2008-10-16. 
  20. ↑ al-'Amraawi, Muhammad; Al-Khammar al-Baqqaali, Ahmad Saabir, Al-Hussayn ibn Haashim, Abu Sayf Kharkhaash, Mubarak Sa'doun al-Mutawwa', Malik Abu Hamza Sezgin, Abdassamad Clarke and Asadullah Yate (2001-07-01). "Declaration of 'Ulama on the Gold Dinar". Islam i Dag. Retrieved on 2008-11-14.

Further reading

External links