The gold standard as a monetary system

What is Gold Standard? The Gold Standard is a monetary system in which the standard unit of currency is a fixed weight of gold or freely convertible into gold at a fixed price. Under the Gold Standard system, paper money which circulates as a medium of exchange is convertible into gold on demand. The exchange rate between paper or fiat money and gold is fixed. Same thing happened to the rates of exchange between national currencies, it is fixed.

The Gold Standard can be divided into two types: full Gold Standard and “partial” Gold Standard. A 100 percent reserve Gold Standard or full Gold Standard occurs when all circulating money can be represented by the appropriate amount of gold. Whilst in “partial” Gold Standard, circulating notes can be redeemed for their face value; it can be either higher than its actual value or lower.

Why gold being selected as a reserve for most countries and even for today? Many nations hold the gold reserves in significant quantity in order to defense their currency and hedge against the US dollar which forms the bulk of liquid currency reserves. Some more, the weakness of the US dollar can be offset by strengthening the gold prices. Yet, compared to other precious metals or major competitors such as US dollar and real estate, none of them has the stability as the gold as well as its rarity and durability. Gold is also used as a store of value starting from the early monetary system since it is high value enough due to its utility, density, resistance to corrosion, uniformity, and easy divisibility. As we know, banking began by depositing the gold into a bank and it could be transferred from one bank to another bank. Until today, gold remains to be a principal financial asset of almost all central banks.

By looking back at the past, before 2000 BC, the first metal that human being used as a currency in trade was silver. According to the history, we know that gold has been used as a mean of payment since long time ago. After 1500 years, the first coinage of pure gold was introduced. The adoption of Gold Standard was preceded after that. Yet, the fiat monetary system came and took over the Gold Standard system during the outbreak of World War I. This happened for most of the nations are due to the excessive public debt and the government is unable to repay all the debt in gold or silver.

IMPORTANCE OF STUDY / RESEARCH IN GOLD STANDARD

As a banking and finance student, we have to study and understand any history that regard to the field, included the topic of our assignment this time – Gold Standard. This is because people live in present and they have to plan for and worry about the future. History is the study of past. It gives the information of the past in order to anticipate what is yet to come. Understanding history is important to develop the linkages to predict the future. Yet, history also provides us abundant of information about how the Gold Standard was formed and how it operated. Understanding the operations of the Gold Standard is difficult currently since it was collapsed and we cannot be exposed ourselves to it. The current data that we have is relied on what happened into the past. By using the historical materials, we can make our own analysis on the Gold Standard and understand its weaknesses and problems.

Besides, the study of the Gold Standard can help us to understand the changes of the monetary system and how the financial world affects the global economies. From the historical information, we know when the adoption of the Gold Standard was and when the collapse of the Gold Standard was. Yet, we also know that the monetary system had been changed over time to time and which system was being created in order to take over the original system. For instance, Gold Standard was took over by Bretton Woods System and followed by Contemporary Monetary System. There is always a reason there for the changes made. This is because of the discovery of the shortages of the system. Once the deficiencies being located, the new system would be established. If there is still do not have any actions taken, it will affect the economies of the world since finance cannot be separated with the economy.

In addition, as a financial student, we have to understand about the differences between fiat money and Gold Standard. From the project we done, we know that fiat money is money that no have intrinsic value and cannot be redeemed for any commodity. The paper currencies and coins that are available in markets nowadays are considered as fiat money and the strength of the economy of the issuing nation is the determinant used to determine the value of fiat money. Mostly, inflation will follow with the enormous issuing of fiat money. Whilst, The Gold Standard is a monetary system in which the standard unit of currency is a fixed weight of gold or freely convertible into gold at a fixed price. Under the Gold Standard system, paper money which circulates as a medium of exchange is convertible into gold on demand. The exchange rate between paper or fiat money and gold is fixed.

PART II : THE GOLD STANTARD

2.1 HISTORY

2.1.1 History of Gold Standard

The first nation that officially adopted the Gold Standard system is England (also called as Great Britain) in 1821. The list below is the dates of adoption of the Gold Standard system:

1821

England

1871

Germany

1873

Latin Monetary Union

Belgium

Italy

Switzerland

France

1875

Scandinavia(Monetary Union)

Denmark

Norway

Sweden

1875

Netherlands

1876

France

1876

Spain

1879

Austria

1893

Russia

1897

Japan

1898

India

1900

United States

During that century, there was a dramatic increase in global trade and production which brought enormous discoveries of gold. The discoveries aided the Gold Standard remain intact well on the following century. As all trade imbalances between nations were settled with gold, governments had strong incentive to stockpile gold for more difficult times. The emergence of the International Gold Standard is on 1871 since the Germany also started to use the system. By 1900, most of the developed countries were linked to the Gold Standard system, but surprise that the United States was the last nation to enter. This is because there was a strong silver lobby that prevented gold from being the sole monetary standard with the U.S. throughout the 19th century.

The Gold Standard was at its pinnacle from 1871 till 1914. During the period, there were near ideal political conditions existed in the world. Governments tried to corporate nicely in order to make the Gold Standard system work, but the system was collapsed during the duration of outbreak of the Great War in 1914. In 1925, it was reestablished. But due to the relative scarcity of gold, many countries adopted a gold-exchange standard, supplementing their gold reserves with currencies convertible into gold at a stable rate of exchange. Unfortunately, the gold-exchange standard was ended during the Great Depression. The United States had set a minimum dollar price for gold in order to aid for the restoration of international gold standard after World War II. In 1971, dwindling gold reserves and unfavorable balance of payments led the U.S. to abandon the Gold Standard system.

2.1.2 Timelines of Gold Standard

1717

The Kingdom of Great Britain went on to an unofficial Gold Standard.

1816

Gold was partially displacing silver as a standard.

1821

The Gold Standard was first out into operation in Great Britain.

1873

The Coinage Act of the United States Congress came into operation on 1st April and constituted the gold one-dollar piece as the sole unit of value.

1900

Gold Standard Act was established on 14 March 1900 and gold was the only standard for redeeming paper money.

1914

The abandonment of the Gold Standard by Russia.

1925

The return of the Gold Standard.

1971

The abandonment of the Gold Standard by the United States.

2.1.3 Timelines of Fiat Money

1690

There are three types of currency according to American History:

Fiat money

Certificates based on coin or bullion

Bank notes

(Fiat money is one type of currencies that being used during the time.)

1789

France was undergoing economic downturn and due to lack of money, fiat money being used.

1862

There was a paper currency that printed upon one side in green has been created with a promise to pay – Greenbacks.

1878

An argument in favor of honest money and redeemable currency.

1896

Paper-based global economy has been collapsed.

1913

Establishment of Fed.

Fiat money became the United States legal tender.

The mercy of the fiat money system has led to the greatest debt bubble in world history.

1933

Inflation occurred.

2008

Under the fiat money system, money as debt.

2.1.4 History of Shifting Between Fiat Money and Gold Standard in U.S.

As stated as below, there were a lot of shifting between a fiat money and gold standard had been made by the United States over the past 200 years which in order to avoid hyper-inflation. Hyperinflation occurs when the confidence in money had gone and it leads to no value in the money. As mentioned as earlier, the gold standard was over due to the reason of the government was unable to repay for the excessive of public debt in gold or silver that its countries owe.

1785-1861

Fixed Gold Standard : 76 years

It was issued by American colonists for the Continent Congress in order to finance the Revolutionary War.

It was produced by the United States Federal Government.

It was authorized by the Act of March 3, 1849.

1862-1879

Floating Fiat Currency : 7 years

The fiat money of the United States above is Greenbacks.

It was created to pay for the enormous cost of the Civil War.

It was the debt of the U.S. government which could be redeemable in gold at future without any specified date.

It was circulated along with the Gold certificates.

1880-1914

Fixed Gold Standard: 34 years

It was ended due to the financial needs of World War I.

1915-1925

Floating Fiat Currency : 10 years

It was created to pay for World War I countries.

There was insufficient of gold to support the paper currency.

1926-1931

Fixed Gold Standard : 5 years

It was ended due to most of the nations tried to deposit their pounds and dollars for gold when the depression occurs.

1931-1945

Floating Fiat Currency : 14 years

It was ended due to the outbreak of World War II.

1945-1968

Fixed Gold Standard : 26 years

On 24 June 1968, a proclamation that Federal Reserve Silver Certificates could not be redeemed in silver was issued by President Johnson.

1971

Floating Fiat Currency : 5 months

It was established by President Nixon on August 1971.

1971-1973

Fixed Dollar Standard : 2 years

It was passed by the Smithsonian Agreement.

1973-today

Fiat Currency : 37 years

It was established by the Basel Accord.

2.1.5 Evolution of International Monetary Systems

International Monetary System had been undergoing several stages of evolution which are stated as below:

Bimetallism (before 1875)

A “double standard” in the sense that both gold and silver were used as money.

Some nations were on the gold standard, some on the silver standard, and some on both.

Both gold and silver were used as international means of payment and the exchange rates among currencies were determined by either their gold or silver contents.

Classical Gold Standard (1875-1914)

During this period in most major countries:

-Gold alone was assured of unrestricted coinage.

-There was two-way convertibility between gold and national currencies at a stable ratio.

-Gold could be freely exported or imported.

The exchange rate between two countries’ currency would be determined by their relative gold contents.

Highly stable exchange rates under the classical gold standard provided an environment that was conducive to international trade and investment.

Misalignment of exchange rates and international imbalances of payment were automatically corrected by the price-specie-flow mechanism.

Interwar Period (1915-1944)

Exchange rates fluctuated as countries widely used “predatory” depreciations of their currencies as a means of gaining advantage in the world export market.

Attempts were made to restore the gold standard, but participants lacked the political will to “follow the rules of the game”.

The result for international trade and investment was profoundly detrimental.

Bretton Woods System (1945-1971)

Named for a 1944 meeting of 44 nations at Bretton Woods, New Hampshire.

The purpose was to design a postwar international monetary system.

The goal was exchange rate stability without the gold standard.

The result was the creation of the IMF and the World Bank.

The system was a dollar-based gold exchange standard.

Flexible Exchange Rate System (1971-today)

The system was declared acceptable to the International Monetary Fund (IMF) members.

Central banks were allowed to intervene in the exchange rate markets.

Gold was abandoned as an international reserve asset.

Managed Float System (1973-today)

2.2 INTERNATIONAL GOLD STANDARD

2.2.1 Chronology of Gold and International Monetary System

1717

Master of the Mint, Sir Isaac Newton gave guinea statutory valuation of 21 shillings.

Commence of the United Kingdom Gold Standard.

1797

Occurrence of Napoleonic Wars.

Bank of England abandoned gold payments.

1816

Establishment of UK Coinage Act.

1844

Bank of England obliged to buy gold.

1870-1900

Except of China, most of the nation abandoned Bimetallic Standard and switched to Gold Standard.

1913

The United States system of reserve banks was established by Federal Reserve Act.

At least 40% of notes were gold-backed.

1917

U.S. prohibited gold exports.

1919

UK went off Gold Standard.

Establishment of London Gold Fixing.

1925

Return of Gold Standard in the United Kingdom.

Establishment of UK Gold Standard Act.

1931

The United Kingdom abandoned Gold Standard.

1933

Suspend of the United States convertibility.

Prohibition of exports, transactions, and holding of gold.

1934

Presidential Proclamation of making dollar convertible to gold again.

1936

Establishment of Tripartite Agreement (Countries involved: U.S., UK, and France)

1939

Close of London gold market due to the outbreak of war.

1944

Establishment of Gold Exchange Standard as a result of Bretton Woods Conference.

1945

International Monetary Fund (IMF) Articles of Agreement became effective.

1954

Reopen of London gold market after World War II.

1961

Establishment of Gold Pool (Members: Belgium, France, Germany, Italy, Netherlands, Switzerland, UK and Federal Reserve Bank of New York)

1967

Buying of gold increased due to the devaluation of sterling.

1968

Close of London market.

Abolishment of Gold Pool and establishment of 2-tier market.

Establishment of Special Drawing Right (SDR).

1971

Suspend of U.S. convertibility to gold.

Establishment of Smithsonian Agreement.

1972

Devaluation of the United States dollar.

1973

Suspend of dealing in foreign exchange markets by most of the central banks.

Adoption of floating exchange rate regime.

Abandonment of 2-tier gold market.

1975

Abolishment of restriction on citizen buying, selling or owning gold by U.S.

First U.S. gold auction on January.

Establishment of agreement between G10 countries and Switzerland on no attempt to peg the gold price.

1976

First gold auction by IMF on June.

1978

Disappear of formal role of gold in International Monetary System.

1979

Establishment of European Monetary System.

Final U.S. gold auction on November.

1980

Last 45 IMF gold auctions on May.

1982

The United States Gold Commission reported to Congress.

1985

Establishment of Plaza Agreement on currencies.

1987

Establishment of Louvre Accord on currencies.

1992

Sign of treaty on European Union at Maastricht.

1998

Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal and Spain joined Economic and Monetary Union (EMU).

1999

Began of EMU.

Announcement of Central Bank Gold Agreement (CBGA).

2004

Announcement of Second Central Bank Gold Agreement.

2.2.2 Gold Standard Went International

*The picture above the gold and silver coins that available around the world during 19th century.

From the chronology above, we know that most of the countries (except China) had abandoned their silver or bimetallic standard and went for a full gold standard between the years of 1871 to 1900. There is always a reason. German asked for “war indemnity” to be paid in gold by France right after the Franco-German War. German used this gold to finance a new gold standard in their home country. This had lead to an increase in the demand of gold and there was unload of tons of silver on the neighboring nations. Due to the fear towards silver inflation, the neighboring countries decided to follow German.

The list below is the date of first gold standard:

1871

German

1873

Belgium

1873

Italy

1873

Switzerland

1874

Scandinavia

1875

Denmark

1875

Norway

1875

Sweden

1875

Holland

1876

France

1876

Spain

1879

Austria

1893

Russia

1898

India

1900

USA

International Gold Standard existed when the following condition being fulfilled:

Gold alone is assured of unrestricted coinage.

There are two way of convertibility between gold and national currencies at a stable ratio.

Gold may be freely imported and exported.