Introduction
An economy that adheres to the gold standard accepts countries’ currencies’ value to be directly linked with the gold reserves that a country holds. Paper money or notes were converted into a certain fixed amount of gold, and therefore those countries that were using the gold standard had to set a fixed price through which they could sell and buy the gold. Therefore, this means that a person holding any currency at that time was able to change it into gold depending on the cost of the gold that was set at that particular time. This enables the gold to be imported and exported around the international markets without any country imposing restrictions to prevent its movement. Although the gold standard was stable owing to its universal usage, and therefore a good store of value, it was not a convenient medium of exchange because it could not be easily divided into smaller units in the same way money currency could.
Brief History of the Gold Standard
The United Kingdom established the use of gold in its monetary system in 1821 after realizing that gold was a precious metal that could be used to determine the value of the paper currency. Before the recognition of gold as the standard of measure, it was used together with other metals such as silver in making valuable coins in some countries. These silver and gold coins were by that time recognized as a medium of exchange that most countries could use to transact. It was later realized that gold was much preferred by many as compared to other metals since its supply was scarce and its value was high.
Before the preference of gold as a currency, silver was the principal monetary metal. In 1870 the monometallic gold standard was also adopted by other European countries such as Germany and France (Mitchell 42). In the same year the United State also followed the suit by adopting the gold standard monetary system, these prompted many countries around the world to do the same.
The United State was able to control and determine the price of gold at the time since there were great discoveries of gold in western North America which made gold abundantly available. The regime and the full dominancy of the Gold Standard survived in a short period until 1914 when the First World War started (Silber and Jacques 102). The war made many countries abandon the convertible paper money and they saw the need of shifting to inconvertible paper money or putting restrictions on the export of gold.
The return to paper money was occasioned by the scarcity of gold in the interwar years. Due to the export restrictions that were placed by many countries and the First World War, gold was scarce and therefore, many countries opted back to the gold exchange standard as of 1925 (Dunckenfield 72). Many countries reestablished these gold standards to supplement their central bank gold reserves with US dollars and the British pound which was by that time the currencies that were easily convertible into gold at a stable rate of exchange.
The Great Depression of the 1930s was another reason for countries abandoning the gold standard. As a result of the crisis, many countries were forced to abandon it and by 1937, it fully collapsed since no country was operating entirely only on the gold standard (Mitchell 102). After the Second World War, the United State determined the price at which gold was bought and sold by foreign countries. This prompted the brief return of the gold standard monetary system. Major European counties reestablished a type of gold standard where their currencies were freely convertible into gold and dollars for international payments as from 1958 (Dunckenfield 127). However, by this time gold had lost its place in the world market as a medium of exchange due to the growing popularity of national currencies.
Another factor that led to the collapse of the gold standard was the floatation of good reserves in the market. To prevent the risk of goods losing their value, the United States president Richard Nixon in 1972 suspended the free convertibility of dollars into gold at fixed exchange rates in the international payments (Mitchell 74). This led to most countries’ monetary systems being based on the US dollar and other stable currencies. These brought about an end of the gold standard in international trade (Duckenfield 107). These developments marked the exit of goods from the international market as a universal medium of exchange.
The Bretton Wood System
The creation of the Bretton Woods system ushered in a new era far as international commerce was concerned. After the end of World War Second, a conference held by the allied nations was held in New Hampshire, and the Bretton Wood agreement was formed in 1944 (Ghixon 1). In this agreement, countries promised to maintain a fixed exchange rate between their currencies and the US dollar. This agreement brought in a new monetary system that replaced the gold standard system that enable the recognition of the US dollar as the world currency that could determine the price of other currencies in the international market. The dominancy of America in the world economy strived since they were now given the power as the only country which was allowed to print the dollars. Bretton Agreement is what facilitated the establishment of the World Bank and the international monetary fund (IMF) which was given the mandate to monitor the world monetary system.
Components of Bretton Wood Agreement
According to the Bretton Wood agreement, in a situation where a country’s currency value declines can be compared to the dollar. These countries are allowed to purchase their currency in the foreign exchange market to reduce the circulation of that currency in the economy and this enables the price of their currency to increase (Cesarano 17). It also advocated that in a situation where a country feels that their currency value is too high, they were allowed to print more of that currency in order to increase its circulation in the world economy, therefore reducing its price as compared to the US dollar. Countries also agreed to avoid the international trade wars, but they were given an option that if they felt that the international monetary system was leading to the deterioration of their economy then they could take action to stabilize their economy.
Replacing Gold Standard with Bretton Wood Monetary System
After the Bretton Wood agreement, many countries started shifting from the gold standard to the Bretton wood monetary system which allowed them to easily convert their currency for US dollars instead of gold. Therefore, with time Bretton Wood replaced the gold standard since most countries did not have enough gold to replace what the US had, and the Bretton wood agreement allowed the slow transition from the gold standard system to the US dollar system. This made the price of the US dollar start increasing as compared to other currencies since its demand increases in the international market.
Reason Why Bretton Wood Monetary System Was Preferred Over Gold Standard
Many countries opted for the US dollar monetary system rather than the gold standard because it gave the countries the flexibility to manage their foreign currency than the gold standard which followed strict rules. Countries that were using the Bretton wood system could easily alter their currency value in case it was needed to correct the disequilibrium in the current account balance of the country. This, was a more flexible alternative compared to the gold standard, for example, when the central banks wanted to regulate the amount of currency in circulation.
The Collapse of the Bretton Wood system
Considering the high demand for the US dollar by other countries increases the price of the US dollars as compared to the value it had in the actual US gold reserve. These value discrepancies were the start of the collapse of the Bretton wood system. In 1971 United State started experiencing inflation and recession due to the increased supply of the US dollar circulating in the economy. President Nixon deflated the value dollar to gold which brought about an increase in the price of gold in the free market. This devaluation strategy backfired and many countries redeemed the US dollar to the actual gold bring an end to the Bretton wood monetary system.
Economic Performance of the Gold Standard
The Good Standard enabled price stability in the long run. Thus, when it was used the rate of inflation was at an average of 0.1% between 1880 to 1914 and 4.0% from 1946 to 2003 (Andolfaltto 1). When the gold standard was used, it was realized that the prices were unstable. This is because the gold standard was vulnerable to real and monetary shocks in the short term. Gold also gave the government minimum liberty to use monetary policies to address inflation.
Is Full Gold Standard System a Better Monetary System?
For years, there has been a discussion between politicians and economists. Most politicians suggest the return to the gold standard regime terming the argument by the economists on the adverse effect of it just a mere perception rather than a reality. The people who advocated for the return of the gold standard considered some of the following advantages.
For years, gold has retained the value that has made it to be recognized worldwide and therefore it can easily self-regulate to match the money supply in the economy. It has been observed that gold has a real value due to its beauty, usefulness, and scarcity as compared to the American paper money that does not have the real value but is only maintained on the basis of faith and credit.
The real value of gold is what made it possible for it to be used as a medium of exchange during the early centuries when it was molded in the coin form. Proponents also argued that since gold was able to maintain its value, it could therefore be used as a store of value, where people can use it to keep wealth in the form of gold. This is because owners can have confidence that their value will not decrease as compared to paper money, whose value is affected by inflation (Bordo 2). In this regard, good was preferred because of the stability of its values, making it the ideal medium in which to store wealth.
The gold standard can also be used to reduce the risk of economic crisis and recession thereby increasing the real income and reducing the unemployment rate. When America was using the gold standard, the rate of unemployment was lower as compared to the period where the Federal Reserve was printing fiat money that was not supported by the real gold value but by faith and credit. After the abandoning of the gold standard, it was realized that printing of more fiat money brought about the American economy to stumble and therefore leading to a great recession of the world economy. Therefore, considering the challenges of unemployment and inflation that are being faced across the globe some suggest that in order to solve this problem the economy should therefore go back to the gold standard.
During the time when the gold standard was being used the government’s ability to print money and create national debt anytime, it feels like was limited, since the gold standard system allowed money to be only printed if there was enough gold to back that currency. This restriction assisted in monitoring the government powers, therefore, reducing the rate of inflation which could be caused by the government printing more money in order to buy treasury bonds. This restriction also enabled people to have confidence in money as a medium of exchange and the store of value, since the money based on the value of real gold cannot be affected by inflation to a big extend.
Currently, most of the countries including America are affected by the balance of payment deficits and therefore the people advocating for the gold standard feel that it can be used to correct this problem. They realize that these deficits have been brought about by the Federal Reserve printing more money in order to finance the US deficits (Lewis 1). This will therefore reduce the value of the US dollar if other countries will start to be uncertain about the stability of the dollar in the future. In order to prevent unnecessary wars around the world, especially the ones that have been facilitated by the US government, some feel that the world economy should go back to the gold standard system. This system will help since the US government will have to reduce its spending in the military as compared to the fiat monetary system where the government can easily print money in order to keep its war policy going.
Reasons against Gold Standard Monetary System
Although some people support the return of gold standards, economists warn against it because of various reasons. Considering the scarce nature of gold, its real value can fluctuate, therefore it cannot maintain stable price stability that can be necessary for a sound economy. Therefore, if more gold is discovered, the printing of paper money may increase, therefore increasing the rate of inflation in the economy (Mitchell 102). At a time when there is a scarcity of gold, it may lead to deflation which is also not necessary for a healthy economy as witnessed in California. It is also predicted that most of the gold ore will be depleted by 2040 thereby forcing the economy to shift to another monetary system.
Economists also feel that the gold standard economy will limit government mandate in preventing and resolving economic depressions, recessions, and unemployment. In the Fiat system, the government can change the exchange rates in order to solve these economic problems. Therefore, reintroducing the gold standard will limit the government’s ability in solving these problems. Some economists also warned of the continued trend of deflation that would be brought about by the reintroduction of the gold standard. This is because more money cannot be created unless gold is obtained to back it up. Therefore, the government will not be able to print more money in order to manage the effect of deflation at the right time.
Conclusion
In summation, considering the above discussions for and against the gold standard shows that while it is stable, it is not as convenient or flexible as paper currency.
It is, therefore, necessary for governments to explore the possibility of establishing a hybrid system that uses both the gold standard and paper money. This gold system will offer extra safety against currency inflation and act as a safe store of value. On its part, the Bretton Woods System will provide a flexible means of regulating the economy through monetary policies.
Works Cited
Andolfaltto, David. “The Gold Standard and Price Inflation.” Stlouisfed, 2014. Web.
Bordo, Michael. “Gold Standard.” Econlib, 2019. Web.
Cesarano, Filippo. Monetary Theory and Bretton Woods: The Construction of an International Monetary Order. Cambridge UP, 2006.
Dunckenfield, Mark. The Monetary History of Gold: A Documentary History, 1660-1999. Routledge, 2016.
Ghizon, Sandra K. “Creation of the Bretton Woods System.” Federal Reserve History, 1994. Web.
Lewis, Nathan. “The World Gold System Will Rise Again.” Forbes, 2019. Web.
Mitchell, Kelly. Gold Wars: The Battle for the Global Economy. SCB Distributors, 2013.
Silber, William L., and Jacques Silber. When Washington shut down Wall Street: the great financial crisis of 1914 and the origins of America’s monetary supremacy. Princeton UPA, 2007.