Sunday, September 6, 2009

The gold standard

The problem of trading in different monetary units whose prices changes frequently is one of the world‘s oldest financial problems. It has been dealt with in a wide variety of ways over the centuries. One of the most successful solutions prior to the modern era centered upon gold as an international standard of value. During the 17th and 18th centuries-a period which gave birth to the Industrial Revolution and the rapid expansion of world trade-major trading nations in Western Europe made their currencies freely convertible into gold. Gold bullion and gold coins could be exported and imported from one country to another without significant restriction, and each unit of currency was defined in terms of so many grains of fine gold. Nations adopting the gold standard agreed to exchange paper money or gold coins for gold bullion in unlimited amounts at fixed, predetermined prices.
one advantage of the gold standard was that it imposed a common standard of value upon all national currencies. This brought a measure of security to international trade and investment, dampened exchange rate fluctuations, and stimulated the expansion of commerce and long-term investment abroad. A second advantage of the gold standard was economic discipline. Tying national currencies to gold regulated the growth and stability of national economies. A nation experiencing severe inflation or excessively rapid growth in consumption of imported goods and services soon found itself losing gold reserves. Exports declined, unemployment rose, and domestic prices soon began to fall. As a result, the volume of imports was curtailed, and the outflow of gold reduced. Eventually, export industries would recover and the country would begin to rebuild its gold reserves, providing a basis for further expansion of its international trade.
These advantages of security and economic discipline were offset by a number of limitations inherent in the gold standard. For one thing, the gold standard depended crucially upon free trade. Nations desiring to protect their industry and jobs from foreign competition through export or import restrictions could not do so. Moreover, the growth of a nation‘s money supply was limited by the size of its gold stock. Problems of rising unemployment or lagging economic growth might call for a stimulative monetary policy, leading to lower interest rates and rapid expansion of the domestic money supply. However, such a policy required a suspension of gold convertibility, taking the nation off the gold standard. Thus, the gold standard often conflicted with national economic goals and drastically limited the policy alternatives open to governmental authorities.

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