Gold standard - Meaning, Principles & Failure

Gold Standard UK
Advantages
Disadvantages

1. Gold Standard

2. Meaning Gold standard is a monetary system in which the standard unit of currency is a fixed quantity of gold or is kept at the value of a fixed quantity of gold. The currency is freely convertible at home or abroad into a fixed amount of gold per unit of currency Exchange rates between countries are fixed If 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 gold inflows or outflows occur until the rates return to the official level.

3. Principles of Gold Standard There should be free movement of gold between countries; There should be automatic expansion or contraction of currency and credit with the inflow and outflow of gold ; The governments in different countries should help facilitate the gold movements by keeping their internal price system flexible in their respective economies.

4. Background The gold standard was first put into operation in Great Britain in 1821. Prior to this time silver had been the principal world monetary metal; gold had long been used intermittently for coinage in one or another country, but never as the single reference metal, or standard, to which all other forms of money were coordinated or adjusted . For the next 50 years a bimetallic regime of gold and silver was used outside Great Britain, but in the 1870s a monometallic gold standard was adopted by Germany, France, and the United States, with many other countries following suit. This shift occurred because recent gold discoveries in western North America had made gold more plentiful. In the full gold standard that thus prevailed until 1914, gold could be bought or sold in unlimited quantities at a fixed price in convertible paper money per unit weight of the metal.

5. Advantages of Gold Standard It was an easy system to introduce and operate. It provided for a very high level of stability in exchange rates which promoted both international investments and trade. The Price Specie Adjustment Mechanism provided an in-built system for achieving trade equilibrium. It provided a fully secured system for settlement of international transactions.

6. Disadvantages of Gold Standard The cost of manufacturing gold gradually increased to levels beyond the official prices. This would result in stoppage of gold production which had an adverse effect on international liquidity . Countries with persistent trade deficit suffered from recessions resulting in reduced investments and unemployment. The system had no flexibility to adjust money supply in times of economic crisis such as natural disasters, war, recession etc. In such situations the system had to be repeatedly discontinued. To avoid the negative effects of reduced money supply, countries would break the equality between gold reserves and money supply, thereby diluting the system.

7. Reason of Failure Violation of Rules of Gold Standard Restrictions on Free Trade Inelastic Internal Price System During the inter-war period, the monetary authorities sought to maintain both exchange stability as well as price stability. This was impossible because exchange stability is generally accompanied by internal price fluctuations. Unbalanced Distribution of Gold External Indebtedness Excessive Use of Gold Exchange Standard Absence of International Monetary Centre Lack of Co-operation Political Instability Rise of Economic Nationalism