Page 198 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

International Trade and Finance

Notes Offsetting this potential benefit of a gold standard are some drawbacks :
1. The gold standard places undesirable constraints on the use of monetary policy to fight
unemployment. In a worldwide recession, it might be desirable for all countries to expand their
money supplies jointly even if this were to raise the price of gold in terms of national currencies.
2. Tying currency values to gold ensures a stable overall price level only if the relative price of gold
and other goods and services is stable. For example, suppose the dollar price of gold is $35 per
ounce while the price of gold in terms of a typical output basket is one-third of a basket per
ounce. This implies a price level of $105 per output basket. Now suppose that there is a major
gold discovery in South America and the relative price of gold in terms of output falls to one-
fourth of a basket per ounce. With the dollar price of gold unchanged at $35 per ounce, the price
level would have to rise from $105 to $140 per basket. In fact, studies of the gold standard era
do reveal surprisingly large price level fluctuations arising from such changes in gold’s relative
price.
3. An international payments system based on gold is problematic because central banks cannot
increase their holdings of international reserves as their economies grow unless there are
continual new gold discoveries. Every central bank would need to hold some gold reserves to
fix its currency’s gold price and serve as a buffer against unforeseen economic mishaps. Central
banks might thereby bring about world unemployment as they attempted to compete for reserves
by selling domestic assets and thus shrinking their money supplies.
4. The gold standard could give countries with potentially large gold production, such as Russia
and South Africa, considerable ability to influence macroeconomic conditions throughout the
world through market sales of gold.
Because of these drawbacks, few economists favor a return to the gold standard today. While
most central banks continue to hold some gold as part of their international reserves, the price
of gold now plays no special role in influencing countries’ monetary policies.

As early as 1923, the British economist John Maynard Keynes characterized gold as
a “barbarous relic” of an earlier international monetary system.

The Bimetallic Standard
Up until the early 1870s, many countries adhered to a bimetallic standard in which the currency was
based on both silver and gold. The United States was bimetallic from 1837 until the Civil War, although
the major bimetallic power of the day was France, which abandoned bimetallism for gold in 1873.
In a bimetallic system, a country’s mint will coin specified amounts of gold or silver into the national
currency unit (typically for a fee). In the United States before the Civil War, for example, 371.25 grains
of silver (a grain being l/480th of an ounce) or 23.22 grains of gold could be turned into a silver or,
respectively, gold dollar. That mint parity made gold worth 371.25/23.22 = 16 times as much as silver.
The mint parity could differ from the market relative price of the two metals, however, and when it
did, one or the other might go out of circulation. For example, if the price of gold in terms of silver
were to rise to 20 : 1, a depreciation of silver relative to the mint parity of 16 : 1, no one would want to
turn gold into gold dollar coins at the mint. More dollars could be obtained by instead using the gold
to buy silver in the market, and then having the silver coined into dollars. As a result, gold would
tend to go out of monetary circulation when its relative market price rose above the mint relative
price, and silver coin would tend to disappear in the opposite case.
The advantage of bimetallism was that it might reduce the price level instability resulting from use of
one of the metals alone. Were gold to become scarce and expensive, cheaper and relatively abundant
silver would become the predominant form of money, thereby mitigating the deflation that a pure
gold standard would imply. Notwithstanding this advantage, by the late nineteenth century most of
the world had followed Britain, the leading industrial power of the day, onto a pure gold standard.

192 LOVELY PROFESSIONAL UNIVERSITY