Thursday, November 24, 2022

What Is The Gold Standard

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Would We Ever Go Back Onto The Gold Standard

What is the Gold Standard?

Heres the major caveat – backers of the gold standard usually only talk about what it was like in the good old days. Few talk about the logistics of it being re-introduced today, with gold at more than AUD $2,000 an ounce, the RBA holding nearly $700 billion in assets’, and 40-odd years of free-floating currency.

The pandemic helped drive up the price by 40% to $2,049 in August . As of Nov 18, it was about $1,885. Clearly, it would be destabilising if the dollar were pegged to gold when its price swings wildly, Dr Klein said.

However, one could argue that price swings wouldnt happen, and gold wouldnt be so expensive and attractive in a time of crisis if the dollar was pegged to it.

National debt also poses a problem, especially for the United States, which ebbs and flows out of trade deficits, particularly with China. Owing money to China under a gold standard would essentially mean giving gold to China, lest they also adopt a gold-backed currency too.

For supporters of the gold standard, it appears were too far gone to return to using it.

The End Of The Gold Standard

But the onset of the First World War put the system under great strain, as high levels of inflation drove the value of paper money down well below the value of gold.

Confidence in the gold standard began to wane, though many countries continued to back it, with the British Government reaffirming its commitment in 1926.

What finished the standard off as a way to maintain the value of a currency, however, was the Great Depression of 1929 that sent the global economy into meltdown.

Britain left the gold standard in 1931 followed by the US in 1971, and instead the international monetary system came to be based on the dollar. As of 2013, there are no countries still using the practice.

But many countries do maintain the gold reserves built up during the years of the gold standard. And recent calls by leading Republicans in the US suggest that the system may not be completely resigned to the history books yet.

What Is Fiat Currency

The virtual opposite of the gold standard is fiat currency – no thats not a small Italian car. Fiat currency is basically what all currency is based on nowadays – its value is based on exchange and nothing more than the promise that the government will do its job. Any money created is essentially done so out of thin air.

In this way, fiat currency is generally more elastic, but can be at the hands of the government or central bank of the day. If government or central bank instability rocks a nation, the value of its currency can plummet: Think of Germanys Weimar Republic, Venezuela or Zimbabwe – and more recently, Turkey or Argentina.

Even in moderate examples, such as Australia, the remit of many central banks is to adjust monetary policy to affect inflation. In Australia, the Reserve Banks cash rate remains historically low, while it has also ramped up bond purchasing in order to lower interest rates, which boosts inflation and devalues the currency. Devaluing the currency makes our exports cheaper. And Australia is an export economy, mainly of iron ore, coal, and other resources. It also helps were in a trade surplus, but thats a whole other argument.

If youve ever had an annoying six year old ask But why do we use this money? or Why is this paper note WORTH something? youve probably been stumped. The gold standard, however, means currency is based on something, which can be easier for some people to wrap their head around.

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No Speculative Capital Movements

Gold standard countries should avoid large movements of capital between themselves. However, small short-term capital movements are essential to cover the international payments gap, fixing the disequilibrium in the balance of payments .

For a nation with a negative BOP, the monetary authority can increase interest rates, attracting revenue from other member nations. This approach will help the government fix its BOP status. Conversely, large capital movements due to political or economic instability can undermine the gold standards efficient functioning.

The Rules Of The Game

Gold Standard History and Facts

The rules of the game is a phrase attributed to Keynes . While the rules were not explicitly set out, governments and central banks were implicitly expected to behave in a certain manner during the period of the classical Gold Standard. In addition to setting and maintaining a fixed gold price, freely exchanging gold with other domestic money and permitting free gold imports and exports, central banks were also expected to take steps to facilitate and accelerate the operation of the standard, as described above. It was accepted that the Gold Standard could be temporarily suspended in times of crisis, such as war, but it also was expected that it would be restored again at the same parity as soon as possible afterwards.

In practice, a number of researchers have subsequently shown that central banks did not always follow the rules of the game and that gold flows were sometimes sterilised by offsetting their impact on domestic money supply by buying or selling domestic assets. Central banks could also affect gold flows by influencing the gold points. The gold points were the difference between the price at which gold could be purchased from a local mint or central bank and the cost of exporting it. They largely reflected the costs of financing, insuring and transporting the gold overseas. If the cost of exporting gold was lower than the exchange rate then it was profitable to export gold and vice versa.

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Abandonment Of The Gold Standard

The gold specie standard ended in the United Kingdom and the rest of the British Empire at the outbreak of World War I, when Treasury notes replaced the circulation of gold sovereigns and gold half sovereigns. Legally, the gold specie standard was not repealed. The end of the gold standard was successfully effected by the Bank of England through appeals to patriotism urging citizens not to redeem paper money for gold specie. It was only in 1925, when Britain returned to the gold standard in conjunction with Australia and South Africa, that the gold specie standard was officially ended.

The British Gold Standard Act 1925 both introduced the gold bullion standard and simultaneously repealed the gold specie standard. The new standard ended the circulation of gold specie coins. Instead, the law compelled the authorities to sell gold bullion on demand at a fixed price, but “only in the form of bars containing approximately four hundred ounces troy of fine gold“.John Maynard Keynes, citing deflationary dangers, argued against resumption of the gold standard. By fixing the price at a level which restored the pre-war exchange rate of US$4.86 per pound sterling, as Chancellor of the Exchequer, Churchill is argued to have made an error that led to depression, unemployment and the 1926 general strike. The decision was described by Andrew Turnbull as a “historic mistake”.

Return To The Gold Standard

In spite of the tremendous disruption to domestic economies and the worldwide economy caused by World War I, a general return to gold took place. However, the resulting interwar gold standard differed institutionally from the classical gold standard in several respects. First, the new gold standard was led not by Britain but rather by the United States. The U.S. embargo on gold exports was removed in 1919, and currency convertibility at the prewar mint price was restored in 1922. The gold value of the dollar rather than of the pound sterling would typically serve as the reference point around which other currencies would be aligned and stabilized. Second, it follows that the core would now have two center countries, the United Kingdom and the United States.

Third, for many countries there was a time lag between stabilizing a countrys currency in the foreign-exchange market and resuming currency convertibility. Given a lag, the former typically occurred first, currency stabilization operating via central-bank intervention in the foreign-exchange market . Table 2 presents the dates of exchange- rate stabilization and currency convertibility resumption for the countries on the interwar gold standard. It is fair to say that the interwar gold standard was at its height at the end of 1928, after all core countries were fully on the standard and before the Great Depression began.

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Gone But Not Forgotten

This abandonment represents a betrayal to a few distinct, but often overlapping, groups: people who believe in limited government people who interpret the American constitution literally and people who fear the power of central banks, Wall Street, and other financial institutions.

Advocates of the gold standard point to the fact that because there is no way to redeem paper dollars for gold or silver, there is no way to finally pay a debt. One common fear is that investors will stop buying US Treasury bonds, ultimately resulting in financial ruin for the country.

Their concerns can run to the hyperbolic. It is impossible to overstate the calamity that will occur when the Treasury bond collapses, stresses the homepage of the Arizona-based Gold Standard Institute, a peripheral non-profit dedicated to spreading awareness and knowledge of gold. On our current course, we will wake up one morning and find that our bank accounts are wiped out, it warns. Even if we have dollar bills in our pockets, food will not last in stores for very long, because food production and distribution depends on the banking system.

Some argue returning to the gold standard is a legal imperative.

Is A Gold Standard Practical Today

The Gold Standard, Explained

Despite the strengths of a gold standard system, there are better alternatives

On July 21, the Senate Banking Committee will vote on advancing the nomination of Judy Shelton to the full Senate for confirmation to the Federal Reserve Board of Governors. Sheltons nomination has elicited a great deal of controversy, partly owing to her record as an advocate for returning the United States to a gold standard. Although a gold standard has some highly positive attributes in the abstract, it would be immensely difficult to implement in todays world of modern central banks.

Under a gold standard, a country sets the price of a fixed unit of gold in terms of its own currency, and its currency is redeemable in gold. Since each country participating in the gold standard has fixed its own currency to gold, exchange rates between countries are fixed. In principle, a country can set its currency equal to a unit of any commodity, but historically, gold and silver have been the most notable examples. For example, in 1900, the United States set one pure ounce of gold equal to $20.67, which remained the price until 1933.

Shelton is right to desire a monetary regime that is rules-based and that brings about stability. However, a gold standard is not the only way to achieve those goals. For example, Mercatus Center scholars David Beckworth and Scott Sumner have argued that the Fed should stabilize the growth of total spending in the economy along a predetermined, level path.

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Types Of Gold Standards

Pure Coin and Mixed Standards

In theory, domestic gold standards those that do not depend on interaction with other countries are of two types: pure coin standard and mixed standard. The two systems share several properties. There is a well-defined and fixed gold content of the domestic monetary unit. For example, the dollar is defined as a specified weight of pure gold. Gold coin circulates as money with unlimited legal-tender power . Privately owned bullion is convertible into gold coin in unlimited amounts at the government mint or at the central bank, and at the mint price . Private parties have no restriction on their holding or use of gold in particular, they may melt coin into bullion. The effect is as if coin were sold to the monetary authority for bullion. It would make sense for the authority to sell gold bars directly for coin, even though not legally required, thus saving the cost of coining. Conditions and commit the monetary authority in effect to transact in coin and bullion in each direction such that the mint price, or gold content of the monetary unit, governs in the marketplace.

Table 3Structure of Money: Major-Countries Aggregatea
1885
33 99

: Triffin , Sayers for 1928 Bank of England dollar reserves .

Gold-Bullion and Gold-Exchange Standards

Gold Points and Gold Export/Import

Gold-Point Arbitrage

Gold-Point Spread

Table 4Gold-Point Estimates: Classical Gold Standard
Countries
Table 5Gold-Point Estimates: Interwar Gold Standard
Countries

Gold Has Intrinsic Value

Gold is a lot more than just a pretty asset. It is highly conductive, which makes it useful in small amounts in electronics and medical devices. Gold is used in connectors, switch and relay contacts, connection wires and other components. Tiny amounts of gold can be found in mobile phones, calculators, GPS devices and more. On the medical side of things, gold is used in dental fillings. It is also used as a drug in small doses to treat conditions such as rheumatoid arthiritis.

The theory favoured by doom and gloom types is with a healthy gold reserve, countries can stave off a disaster or zombie apocalypse. Because, even if currencies fell to hell in a handbasket, consumers could still use gold to buy their way out of trouble.

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Timely Topics: The Gold Standard

The U.S. and many other economies left the gold standard more than 40 years ago, yet advocates periodically call for its return, saying that it would curtail or prevent inflation. In this Timely Topics from the St. Louis Fed video series, David Andolfatto, a vice president and economist with the St. Louis Fed, explains the gold standard and discusses its pros and cons.

Transition To Gold Standard

What is the " Gold Standard" ?

From 1750 to 1870, wars within Europe as well as an ongoing trade deficit with China drained silver from the economies of Western Europe and the United States. Coins were struck in smaller and smaller numbers, and there was a proliferation of bank and stock notes used as money.

The gold standard became the basis for the international monetary system after 1870. According to economic historian Barry Eichengreen, “only then did countries settle on gold as the basis for their money supplies. Only then were pegged exchange rates based on the gold standard firmly established.” Adopting and maintaining a singular monetary arrangement encouraged international trade and investment by stabilizing international price relationships and facilitating foreign borrowing. The gold standard was not firmly established in non-industrial countries.

United Kingdom

In the 1790s, the United Kingdom suffered a silver shortage. It ceased to mint larger silver coins and instead issued “token” silver coins and overstruck foreign coins. With the end of the Napoleonic Wars, the Bank of England began the massive recoinage programme that created standard gold sovereigns, circulating crowns, half-crowns and eventually copper farthings in 1821. The recoinage of silver after a long drought produced a burst of coins. The United Kingdom struck nearly 40 million shillings between 1816 and 1820, 17 million half crowns and 1.3 million silver crowns.

International

Japan

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Unrestricted Movement Of Commodities

Goods and services should move without any restrictions between the gold standard countries. Under this monetary system, price variations between countries are expressed through excess of imports or exports of one country over the other. The excess of imports or exports is adjusted through gold inflow or gold outflow. Therefore, import or export restrictions disrupt the gold standards automatic functioning.

Elasticity And Flexibility Especially In Crises

History shows even countries that were most ardent supporters of the gold standard – the United States – suspended the pegging in times of crisis.

This happened in the Great Depression, but the jurys out on whether it was a direct causation.

Writing for The Conversation, Professor of International Economic Affairs at Tufts University, Dr Michael Klein, said it was odd that there are advocates for the gold standard today.

Going back to a gold standard would handcuff the Fed in its efforts to address changing economic conditions through interest rate policy. The Fed would not be able to lower interest rates in the face of a crisis like the one the world faces today, because doing so would change the value of the dollar relative to gold, Dr Klein said.

The onset of the Great Depression finally forced the U.S. and the other countries that still pegged their currencies to gold to abandon the system entirely.

Economist Barry Eichengreen has found that efforts to maintain the gold standard at the beginning of the Great Depression ended up worsening the downturn because they limited the ability of central banks like the Fed to respond to deteriorating economic conditions.

For example, while central banks today typically cut interest rates to boost a faltering economy, the gold standard required them to focus solely on keeping their currency pegged to gold.

The sharp fall in the money supply from 1930 to early 1933 was in response to the collapse of this pool.

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Sorting On Ex Ante Characteristics

The gold standard for evaluating the cross-sectional implications of recessions for earnings is the study by Guvenen et al. . Using a very large data set from the US Social Security Administration, they are able to track the earnings of individuals from 1978 to 2011, which allows analysis of four recessions. Their main data set focuses on US working-age males over this time period. Given the panel structure of the data, they are able to estimate object explicitly by sorting individuals into income bins prior to each recession and expansion.

The exact dates they use for the four recession periods are 197983, 199092, 200002, and 200710. They estimate a slight variation of object above in order to avoid problems associated with those with zero earnings. The actual function they estimate is:

Figure 13 in their study reveals the central finding with respect to recessions. In all four recessions, there is a positive relation between ex ante income and income growth from the 10th percentile of the distribution to the 70th percentile. For all recessions except for 2000 to 2002, the positive relation continues to the 90th percentile. That is, for the majority of the income distribution and for all recessions, lower income individuals suffer more during recessions as measured by income growth. Notice this effect is probably understated given that mean-reversion would bias the coefficient in the opposite direction.

Andreas Steiner, in, 2016

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