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THE GOLD STANDARD SYSTEM

29 October, 2015 - 14:23

Gold has always fascinated humans. Thus, it is not surprising that the first attempts to develop an IMS used gold as the standard to which all countries linked their national currencies. Under the gold standard system national currencies were linked to gold at a fixed parity-that is, each nation defined its currency unit as equal to the value of a certain weight of pure gold. The weight of gold was determined by the number of grains. The U.S. dollar, for example, was defined as containing 23.22 grains of gold. There are 480 grains of gold in one troy ounce, so one troy ounce of gold was worth $20.67 (480/23.22).

The British pound was defined as containing 11 3 grains of gold and was equal to $4.8665 (113/23.22). This dollar amount was termed the par value of the pound.

This simple system worked remarkably well until the First World War, simply because whatever international trade took place was between the big powers and the colonies. Since most of the gold was in the hands of the colonialists, they could make the rules. In addition, the system itself was very accommodating. It provided an easy and automatic mechanism for clearing international trade balances. Since countries had to sell gold to pay for their deficits whenever export earnings were not sufficient to pay for imports, their currencies would automatically depreciate, thereby making their exports cheaper. The added currency that was earned via the increase in exports would then eliminate the deficit.

In countries where export earnings were larger than import payments, the continuous surpluses would lead to an increase in the gold stock and hence in the money supply, which would provoke a general price rise. This increase in prices would increase the price of exports, causing export volume to decline, and increase the volume of imports. The accompanying increase in the demand for foreign currency (due to increasing imports) and decline in the demand for local currency (due to decreasing exports) would lead to an automatic elimination of the surplus.