What Does The Gold Standard Mean

Published Date: 02 Nov 2017

Introduction

I see this question in two parts, first of all in see first part of the question is asking about what the gold standard is and I will then break the question up in to a series of questions about the gold standard ranging from why they choose gold possible advantages and disadvantages of the system and then how it works. After this is done I shall then move on to part two of my essay, where I shall examine how much the success of the gold standard caused a period of stability in international relations. Before finally drawing a conclusion on where or the gold standard did cause stability and how much of a success it could be seen as in general.

A Brief History of the Gold Standard

Throughout history different metals of been used as a store of wealth by different countries or tribes have used precious metals as from of either just as a way to make coins or through the method of that used in the gold or silver standard, where note money was banked by the banks with the view of the notes could be turned in to the metal if it was so needed these ‘Gold certificates’ as they were called in USA, Europe and other parts of the world in the half century before WW1.

What does the Gold Standard mean?

In order for a country to adopt the gold standard they must first peg their currency to gold, so for example you would set a value that you can buy and sell gold at, so for example you could say we will buy and sell gold at £10 per ounce, then through this you will have a value of your currency with all other countries on the gold standard.

This fixed value and medium of exchange was brought it as a way to provided economic stability allowing for money to hold a ‘real’ value, whilst also maintaining a lower level of inflation. This is because in order for money to be printed it needed to be back by a gold reserve held by the state so therefore as long as the supply of gold remains relatively constant then money supply should remain relatively fixed.

Why was Gold used?

Before the gold standard was seen throughout the world there was a two other metal based systems that countries used these being a silver standard or a bimetallic system, where both gold and silver were used. Both of these systems had major problems over just using gold.

The problem with the silver standard was the low value of silver meaning that in order for a country to back its currency in silver an extremely high level of silver would need to be kept this is because the gold pre ounce is and was a lot higher than that of sliver which meant for a large deal to be made in sliver a lot higher amount of the currency was needed to be stored and transferred, so then some countries needed to look for a different system of backing their currency. These troubles in the system were highlighted in chapter 2 of ‘Globalizing Capital’.

Moving on some countries then adopted a bimetallic system where a country would hold reserves of both silver and gold this allowed for small transaction could be back by silver while large movements were backed by gold. One problem that came out of this system was the fact that both gold and silver was traded at different prices in different country, meaning people would either sell or their gold or silver in order and buy the better value metal. For example in the UK according to ‘Globalizing Capital’ we see that the gold standard started in 1717 once Newton set the price of gold too low, this then lead to any silver that could be sold was as you could increase your wealth by simply buying gold for silver. Some people saw this as the first birth of the Gold standard as this was the first time a full gold standard came in during the late 18th century.

Therefore, after that gold became used as a standard as it was believed that you needed a high value single metal system in order for it to work successfully. But there were still some problems with the system, as it meant that a countries wealth was based upon the amount of gold that they had instead of how resourceful the workers are as we learn from the book ‘Globalizing Capital’.

Advantages and Disadvantages of the Gold Standard.

As I have already briefly mentioned we can see many advantages and disadvantages of gold in this section. These range from advantages about economic stability and a store of wealth as well as a universal medium of exchange. However there are also disadvantages that I have mentioned ranging from wealth being decided by the amount of gold that you had for example South Africa according to ‘Globalizing Capital’ held a very large amount of the world’s gold stock during this period of effective monetary policy in order to change the value of your currency which is ultimately why it was abandoned in 1914 at the outbreak of World War 1.

Advantages

Mike Moffatts article on about economics points some good advantages that being under the gold standard brings; the first key advantage of the gold standard is how easy it can be exchanged as it is universal as a gold bullion is the same no matter where it comes from. As well as this it is generally held in a high regard by the public, as a good store of value.

A further advantage of gold is it provides a self-regulating monetary system as money supply is directly control by the amount of gold there is no need for the central bank to do anything in terms of providing a money supply. So it does make their job sustainability easier.

As previously mentioned I see the key advantage of using gold as a standard provided a stable money supply as it is restricted by gold supply, then following the quantum theory of money there is a direct relationship between price level and money supply, so as long as money supply remains the same. However as we shall this did ultimately lead to the downfall of the gold standard in 1914.

Disadvantages

Brad DeLong states "if you do not trust a central bank to keep inflation low, why should you trust it to remain on the gold standard for generations?" This means you do not trust them to control the money supply in the economy, then how can they be trusted to stay on the gold standard. I think he is also saying that why do you have people in charge of your central bank that you do not think would be able to sensibly control your countries money supply. As removing this tool from them stops them being able to stimulate the economy by increasing the money supply in the short term (like what we are currently doing at the moment), during times of need you are unable to stimulate money, which could be needed in order to maintain a steady inflation rate.

We also saw problems with Britain having to maintain their status on the gold standard, while being lender of the last resort to back the banking sector, as it meant when according to ‘Globalizing Capital’ when the time came for the Bank of England to fulfil its role, they were unable to have the money either through print or reserves to give to the bank that was in need. This then meant that they had to seek loans from other countries on the Gold Standard in order to help the bank survive. While the Bank of England remains stable and able for fill its requirements of having gold reserves for all the money circulation.

So overall through using the gold standard you end up with a very rigid system that is purely focused on inflation and a sign of confidence, rather than overall economic performance, and also it runs on the assumption that gold has some base value when in theory this need not be the case, as if an extreme large gold reserve was found this would destroy the whole system as all this extra gold would flood the market.

How did a country transfer over to the Gold Standard

In order for a country to join the gold standard there were certain rules that it was sort that you should look to follow and although these were not formally stated according to the ‘World Gold Council Website’ by ‘Keynes’ in the 1920’s it had been used and to some extent followed by most countries on the gold standard before this period.

The rules again according to the ‘World Gold Council Website’ stated that a country must have access to gold reserved to cover the cost of any note that was looked to be cashed in. As well having a fixed price at which gold could be traded.

However as I also found on the ‘World Gold Council Website’ this system was often tampered with, through the trading of domestic assets in order to increase or decrease the money supply depending on what stat the country was in at the time. This meant that the central banks were still able to have some effect on money supply.

Was the success of the gold standard a cause or consequence of international stability?

This is a very interest question which could be argued both ways and personally I don’t see their being a simple right or wrong answer the reasons for this I belief are clear. As I see it as a situation similar to the chicken and the egg.

In order for the system to work it relied heavily on international trade in order to get gold flowing around the world, as some countries had large quantities of gold from their own mines while others did not, so in order for a country to want to sign up to the gold standard it must have good relations with some if not all of the other countries on it, or else it would not gain any of the benefits of international trade, which comes from the stable price levels and exchange rate that the gold standard was meant to provide. So this would lead us to belief that the success of the gold standard was caused by international stability.

However a counter point to this would be, in order for the success of the country it was in their best interest to continue good relation with the other countries on the gold standard, or they would quickly their economy would become isolated, and trapped by the lower levels of growth that occurred at the same time as the Gold Standard.

We also see in Findlay and O’Rourke Chapter 7 we see a great possible counter argument get argued out this teaches that during the period we are studying we went through great transport revolutions allow trade to become faster easier and cheaper with things like the Suez Canal opening in 1869 which according to the French Empress Eugine ‘brought Asia 4,000 miles nearer to Europe’, this along with many other technical advances like for example the induction of railways which in the UK began to come to force for transporting goods around the country in the later to mid-19th century which was a massive set up from the use of canal boats which would have been the main method of transport before that.

So as all these technologic advances happened around this time period made trade so much better than ever before so this could be seen as a reason why success was coming out of the already in place system, see therefore this would have had no effect of the Gold Standard being in place. This then does make you think that the gold standard was holding back the growth that you would been expecting from this second industrial revolution.

In could in fact further be argued that these growths in economic performance should have been greater and would have been greaten if their growth hadn’t been limited to the wealth of what the gold supply was at, during that point in time. But I see that there is no way of finding out where or not that would have actually been the case. So the only thing that I can think of doing in this situation would be to apply the predicable of what the gold standard should have done. This is make trade simpler and less risky for the firms and consumers under taking it, so I see it as the two should of gone hand in hand. But as it states the lectures for week 16 during this period of the gold standard we saw more of a convergence in global incomes according to the lecture notes from week 16 as through the poorer countries did improve a lot during this period it could be argue that the limiting expansionary monetary policy slowed down the potential economic growth.

Conclusion

I see the conclusion to this as being although during the period we saw a steady rate of inflation along with some per capita economic growth, the limit put on wealth by the gold standard work. Seriously limited the level of growth that the countries were experiencing. Although there is no way I can see to proof this other than by looking at the graph above. Which does in fact show a fall in the rate that economic growth was increasing during the period of time that the gold standard was in use. So this leads me to believe that although certain parts of international stability and other benefits were in fact seen. The overall lack of monetary policy being on the gold standard left you with, provided no long term benefit for a country to adopt it.