Gold Standard

 Gold Standard
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Introduction
Recent years have seen extensive debate and discussion about the gold standard. There have been renewed calls from both political and economic fronts to have the issue looked at critically. Reinstitution of the standard as part of our monetary policy was debatable during the 2011-2012 presidential primary contests, with the Republican Party calling for a commission to study it at depth. This has been buoyed by economic views that “the more gold reserves a country has, the more sovereignty it will have if there’s a cataclysm with the dollar, the euro, the pound, or any other reserve currency” (Benko, 2013). In 2010, the World Bank Group President Ambassador Robert Zoellick wrote an article in the Financial Times “The G20 must look beyond Breton Woods II” in which he stated that although contemporary views may hold gold as “old money,” markets are utilizing it as an alternative monetary asset (Benko, 2013). The Bank of England would, in 20111, publish the “Financial Stability Paper No. 13” as to vindicate the gold and gold-exchange standards that had been replaced by the fiduciary currency.
Discussions have been varied, and they have been triggered by dissatisfaction regarding the varying and high interest and inflation rates, low productivity growth, and turbulence within foreign exchange markets over the last five decades. The desire of returning to the gold standard must be preceded by informed judgment coming from a comprehension of experience (particularly as a macroeconomic policy before World War I) and an assessment of performance.

It is, therefore, important that a well-grounded and broad assessment is made of the gold standard for possible restoration as a crucial factor in potent deficit and inflation reduction and robust employment creation in the global monetary policy. This paper describes the gold standard, its historical evolution and impact on the economies it was adopted in, the reasons for its advocacy and the following benefits it had on the economies it was implemented in as fiscal policy.
Description of the Gold Standard
The gold standard represented a “commitment by participating countries to fix the prices of their domestic currencies regarding a specified amount of gold” (Bordo, 1981). These prices were maintained at these fixed prices by the willingness of the countries to purchase or sell the gold to any person at the set price. The value of the currency was linked to gold, serving as the “best practical approximation of a standard stable value” depending on the country’s gold reserves. The United States maintained a fixed price of $20.67 per ounce of gold between 1834 and 1933 while Britain kept it at £3, 17s, 10.5d between 1821 and 1914 (Bordo, 1981). These conditions meant that the exchange rates were almost fixed between the currencies of nations that relied on the gold standard, buoyed by the probability of “profitable gold arbitrage” when such rates attained the import or export points, as determined by the gold’s shipping costs and mint costs.
Gold is divisible, durable, storable, easily recognized, portable, and easily standardized, desirable features of money whose value has been recognized by humanity over centuries, retaining a stable and intrinsic value more than anything else (Schwartz, 2009). Moreover, gold is not always readily available thus has limited stock changes more so in the short run because the high production costs restrict manipulation by governments. Gold was one of the earliest models of money, used as commodity money and a standard irrespective of the product involved thus ensuring competitive market operation tending to the achievement of stability in the long term.
History of the Gold Standard
Although the use of gold as a payment mode and storage of value dates back to centuries ago, the international gold standard in the world dates properly to the nineteenth century. Britain had been on a “de facto gold standard” since 1717 and achieved its full legal status in 1816 when the country officially tied the sterling pound to a specified amount of gold upon which the British currency could be converted (Cooper, Dombusch, & Hall, 1982). In 1817, it introduced a sovereign small gold coin that was to be valued at one sterling pound. Silver was eliminated as a standard measure of value in 1873 following revisions to the coinage and mint laws, and the US sets off on an “unofficial gold standard.” Gold coins were seemingly ‘overvalued’ compared to the silver coins, and this entrenched the gold standard practice in Britain and subsequently undergoing codification into law after the Napoleonic wars that set it as the leading military and commercial power in the world. This influenced other strong economies such as Japan and Germany to adopt the gold standard that was mostly seen as the pinnacle of British success.
The gold standard was maintained by many countries in the world before World War I, and this included the proponent Great Britain and the United States, and the entire Europe. The standard was restored in 1879 in the US under the Resumption Act while the “Gold Standard Act of 1900 established gold as the ultimate standard of value” (Cooper, Dombusch, & Hall, 1982). This necessitated the US to have its fixed exchange rate maintained concerning other nations that had adopted the standard, and this necessitated capital and goods movement among the countries. Locally, the standard required the US to restrain money and credit line expansion, essentially locking inflationary pressures. The period from its legal adoption in 1821 in Britain to before World War I (1821-1914) had it referred to as the “Classical Gold Standard.” These were the heydays of the standard, characterized by virtually free trade, robust and fast economic growth, free movement of capital and labor across political boundaries, and general world tranquility. Besides, this was buoyed by a comprehensive London-centered financial network and the Bank of England’s role that led to its efficient operation
The gold standard would be suspended in the US and other countries either in full or in part so that it could not hinder war efforts. The period was characterized by upheavals in domestic and global financial markets in which the US committed to having its gold redeemed for dollars as maintaining the standard seemed to interfere with the objectives of the Federal Reserve of stabilizing the local economy. The gold standard was operated without restriction in the US alone in 1920, and this made the Federal Reserve impose a severe monetary contraction in its defense but significantly led to depression. Britain and France restored the global gold standard in the 1920s to (or “intending to”) stabilizing the world economy, and it required the Federal Reserve to choose between its local and international objectives, a view that alternated between the two. Fiduciary money was introduced after the suspension, and the restoration occurred between 1925 and 1931, called the “Gold Exchange Standard.” All countries would hold in their reserves gold and dollars or pounds, except the US and the UK that could only hold gold reserves. Britain’s exit from the standard in 1931 in the wake of massive capital and gold flows made it break down, and fiduciary money again reintroduced (Cooper, Dombusch, & Hall, 1982).
After the dollar had been devalued in 1933, the US laid in principle that the country’s objective reigned supreme and had to be considered first over the gold standard dictates. The Bretton Woods System (1946-1971) attempted to modify the gold standard through the US dollar as the key global reserve currency. All countries, except for those aligned to the sterling pound, would settle their international balances in this scheme. The gold price was fixed at $35/ounce by the US, which “maintained substantial gold reserves and settled external accounts with gold bullion payments and receipts” (Bordo, 1981). After the World War II, the positive balance-of-payments deficits that favored the US were used to finance world trade recovery following the Great Depression and the war. The continuous growth in using the US dollar by many countries as an international reserve and the endless deficits would reduce the country’s gold reserves and gold reserve ratio, and thus decreased public confidence that the state could “redeem its currency in gold” (Schawrtz, 2009). Additionally, with many countries being averse to pay “inflation tax and seigniorage” to the US led to the collapse of the system in 1971, with the US abandoning setting the price of gold. President Richard Nixon “closed the gold window” in a temporal move which however changes in 1976 when the monetary system becomes purely that of fiat money (Benko, 2013).
Benefits of the Gold Standard
The gold standard offered immense benefits to the nations that used it as a financial system, principally by asserting that fixed assets are what back the value of money as well as providing a stabilizing and self-regulating element in world economies. The history of the gold standard reveals that it helped maintain price stability during its years of operation, thus lowering inflation rates and slowing down the increase in consumer prices. Immediately the UK adopted the gold standard in 1821 and maintained the price of gold until 1914, and there was witnessed the little change to price levels, with a downward trend averaging 0.4% saw annually (Bordo, 1981). That period showed alternating periods of declining and rising prices, perfectly consistent to the commodity theory of money where prices continued to fall until the mid-1840s where the rising incomes put pressure on the limited stocks of gold. Upon discovery of gold towards the late 1840s and early 1850s, the prices took a turn-around and rose until the end of the 1860s followed by a 25-year decline of prices as more countries adopted the gold standard (Cooper, Dombusch, & Hall, 1982). This was replicated in the US following adoption of the gold standard, from whence prices declined at an average of 0.14% between 1834 and 1913. There were a lot of price instabilities after World War I when the standard was suspended, except the 1920s period when the Gold Exchange Standard was adopted, and the 1950s and 1960s upon adoption of the Bretton Woods System.
When the standard ceased to be operational, price levels in many countries continued to rise: they had “increased at an annual average rate” of 3.81% and 2.2% for the UK and the US respectively between 1914 and 1979 (Schwartz, 2009). In the US, inflation rates between 1880 and 1913 stood at 1.6%, was 3.3%in 1971, and 13.3% in 1979. Globally, the average annual inflation rate under the gold standard was 1.75% and 9.17% when not. This was served by the fact that gold has an intrinsic value thus capable of serving as a standard value of goods; and because it has storage value as new production only adds a small portion to the accumulated stock. Therefore the prices would not vary significantly even though other forms of money were introduced because the “convertibility into gold at a fixed price would force monetary authorities to avoid inflationary policies” (Schwartz, 2009). Having gold as a nation’s international reserve foreign asset makes automatic adjustments for balancing the payment surplus and deficit and therefore increasing the money supply through increased price levels leads to increased price of exports concerning imports, thus resulting in a payments deficit and gold outflow. Political manipulation is further avoided in the system, because an increase in money supply would automatically lead to lowered domestic interest rates compared to other international markets, inducing capital and more gold outflows.
The gold standard enhanced economic stability during the periods it was practiced, with countries achieving robust growth over the span of existence. Throughout the entire duration, the US was on a gold standard, economic growth averaged nearly 4% annually, plummeting to an average of 2.8% annually on average after 1971 (Schwartz, 2009). The UK and the US recorded lower unemployment rates before 1914 as compared to the post-World War I era. Unemployment in the UK was 4.3% (1888-1913) and 6.52% (1919-1979) while in the US it was 6.78% (1890-1913) and 7.46% (1919-1979). Per capita income too showed less variance during the prewar period when the gold standard was in operation, with deviations of 2.14% (1879-1913) and 3.75% (1919-1979) in the US and 6.64% (1879-1913) and 8.97% (1919-1979). These statistics exclude the period between 1941 and 1945 (Schwartz, 2009).
The gold standard ensures that innovative and productive nations are rewarded directly regarding profitability and money stability because the more the exports, the more gold is received, and thus they can print more money (Cooper, Dombusch, & Hall, 1982). It assures of a stable money supply in the long-run because the increase of gold money is proportional to the profitability of producing the gold. Countries that innovate on gold discoveries or develop technologies for mining gold would leverage on this for increased gold output. This would be leveraged upon to increase the prices of other goods produced about gold increasing their profitability and ultimately lead to a reduced gold production. The reduced purchasing power leads to shifting in demand to non-monetary utilities and thus strengthening production effects. Where technological advancements in other sectors other than gold would cause declined prices of the goods and services, increasing gold profitability and production, and ultimately increased price levels. The initially increased goal purchasing power leads to a demand shift to monetary utilities and thus strengthening the production effects. In the end, prices in the long term would be stable.
The gold standard system restricts government’s ability to print money whenever it needs to and purely requires that money can be only printed in so far as it has sufficient quantities of gold to support the same. This necessarily discourages inflation when there is too much money in the economy in comparison to the demand for goods, as well as helping governments avoid debt and budget deficits because such cannot exceed their gold supplies. Following the leaving of the gold standard by the United States in 1971, money in circulation has increased more than twenty-fold to more than $1.35 trillion dollars in 2016. The restriction on currency printing is an essential element as it helps check on the excesses of government power, and the effects can be clearly wrought from Zimbabwe where a rapidly growing money supply as a result of increasing fiscal and quasi-fiscal deficits led to inflation rates of over 1,000% (Munangagwa, 2009). The standard helps provide self-regulation for nations to match the demand and supply of money because, since it is a finite natural material with significant production cost, it is often produced at a level in tandem with the market. The standard necessitates high country spending such as of defense and military activities which can only aid in the prevention of unnecessary wars.
Apart from the enormous domestic benefits, the gold standard has had on the economies considered; it is also important to identify the contributions it had on sovereign borrowing. The standard required an automatic adjustment to respond to the balance of payments as enumerated above, and the unrestricted movement of capital and goods, thus privileging a country’s external commitments to its internal conditions (Mosley, 2002). Additionally, the dedication to the standard gave the governments access to the international capital markets in a secure manner, with gold convertibility being used as an indicator of healthy public finances and its debt servicing capacity in the future. Those who participated in the financial markets strongly viewed that committing to the gold standard insulated them from possible risks in inflation and exchange rates. Lower interest rates were paid by borrowers from participating countries as compared to those that did not implement the standard. These capital benefits offered to the governments would help shape the administration’s preferences, relying on such things as reliance on foreign capital flows and orientations towards foreign borrowing.
With the continued integration of financial markets, numerous benefits could be offered, more so to the capital-deficient or weak economies. Capital goods obtained from Britain, Germany, and France were used in compensating for the current account deficits while facilitating funding for the major infrastructure projects and smoothing of government revenue. Nearly 40% of the loans extended to Latin America between 1850 and 1875 were used to finance public works and 44% for debt refinancing (Mosley, 2002). Therefore, despite the constraints that were associated with the gold standard, countries on the periphery realized the market-based external incentives given to them upon which they either had to limit foreign borrowing thus limiting their public investments or face super-hard fixed exchange rates. Therefore, countries such as Greece, Mexico, and Argentina that had weak economies were cushioned against excessive borrowings that may have affected them in the long-run with excessive deficits. The gold standard committed policymakers to undertake to devise mechanisms of developing the local economies and thus playing a crucial role towards their “emergence and persistence” through their development endeavors.
Conclusion
The gold standard evolved as one of the single-most crucial monetary policy between the late nineteenth century and the better part of the twentieth century. In particular, the period following its adoption across Europe and the US, especially before World War I, was marked by robust economic growth with remarkably lower unemployment rates, higher per capita income, and solid price stability of goods in the market. Inflation rates were significantly lower as compared to the post-war periods, as the monetary policy shifted countries’ focus from just thinking local to thinking globally, in a manner that would motivate the countries to increase their productions for their economies to achieve stability. The gold standard encouraged positive competition, and especially helped cushion the weaker economies from excessive borrowings beyond their repayment capacity that would affect them significantly in the long-term. The gold standard offers immense benefits, from the history of the achievements during its implementation that can be relied upon in forming a solid foundational argument in the consideration for its return as a monetary policy system.
References
Benko, R. (2013). How to Go Gold. The National Interest. Retrieved, from http://nationalinterest.org/commentary/how-go-gold-8198
Bordo, M. D. (1981). The classical gold standard: some lessons for today. Review.
Cooper, R. N., Dornbusch, R., & Hall, R. E. (1982). The gold standard: historical facts and future prospects. Brookings Papers on Economic Activity, 1982(1), 1-56.
Mosley, L. (2002). “Golden Straightjacket or Golden Opportunity? Sovereign Borrowing during the Late 19th and Early 20th Centuries.” American Political Science Association Annual Meeting.
Munangagwa, C. (2009). The Economic Decline of Zimbabwe. Gettysburg Economic Review Vol. 3 Article 9.
Schwartz, A. J. (2009). Money in historical perspective. University of Chicago Press.