The Gold Standard: History, Impact, and Challenges

The Gold Standard: A Historical Overview

The gold standard is a monetary system in which money is freely convertible into a fixed amount of gold. It evolved from the variety of commodity money there was before the development of paper money and fractional reserves banking. It started to function in 1871. As we know, this century was characterized by globalization and an increase in international trade. Therefore, all trade imbalances between nations were settled with gold. The main priorities of the government were to maintain gold reserves and exchange rate stability.

The Trilemma of the Open Economy

If you had the Gold Standard you had fixed exchange rates and unrestricted capital mobility but Not Monetary Autonomy. As a result, countries always had to adjust the amount of money in circulation to the balance of payments (from trade or capital flows). In order to adjust the balance of payments governments had 3 options: cut government spending, increase taxes (to have more money and more reserves) or to have a restrictive monetary policy (high interest rates which will attract foreign capital inflows of money).

Till 1914

Most of the developed nations had joined the Gold Standard and it worked very well. It was a period of international peace, liberal order made prices and wages very flexible, and coordination between central banks and government institutions was easy. But all this changed with the outbreak of the IWW. During the war, alliances changed, trade was impossible between countries, market integration was disrupted, it was difficult to have a monetary union...

Before the War

It worked really well because the UK was the main economic superpower and the center of the Gold Standard system and because there was no democracy. This implied that no one cared about the working classes and the only objective of the governments was to maintain the exchange rate.

After WWI

It was impossible to maintain the Gold Standard. First of all because the inflation caused by the war created problems as to how to fix the new mint parities and therefore the exchange rates. Second, because Britain (who was indebted with the USA) was no more the main superpower and it was replaced by the USA in a global hegemony. And third, because after the war there was a wave of democratization around the world which made it impossible to maintain Gold Standard. Moreover, it is important to say that after the IWW almost all the countries tried to return to the Gold Standard System but it was unworkable because every country chose to enter it when convenient and because every country chose its own parity and some were overvalued and others undervalued. The pound was overvalued and the franc was undervalued which led to huge amounts of gold moving from Britain towards France. But their inability to cooperate and fix the system led to Britain abandoning the system in 1931. As a consequence, after IWW it only worked effectively between 1926 when the French Franc entered and 1931 when the British Pound left it. When Britain left it, it was rapidly followed by most of the countries as Britain was at the core of this system.

Interwar Years

The volatile post-war international economy was characterized by every country creating its own currency, distorting trade and capital flows, erecting trade barriers and elaborated independent fiscal and monetary policies as well as by a huge post-war debt that diminished the possibilities of foreign borrowing, therefore becoming disintegrated. However, during the 1920s we distinguish a slow relaxation of wartime controls, there were unprecedented needs for revenue, and bank credits were expanded by immense amounts. However, the reduction of budget deficits was made difficult because of the increasing demands of trade unions for higher expenditure on social security. This period is also characterized by social unrest, which was clearly seen in the number of strikes that took place because of the reallocation of resources that was carried out after the war, which caused recession between 1920 and 1921 and consequently unemployment. Nevertheless, this period of the 1920s is known as the Roaring Twenties, because the economy overextended, there was sustained prosperity, technological advancements.