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International Financial Management

Notes exporting of gold bullion by President Franklin Roosevelt was not sufficient to remedy the
problem.
Another problem of the system was the unrealistic expectation that countries would subordinate
their national economies to the dictates of gold as well as to external and monetary conditions.
In other words, a country with high inflation and/or trade deficit was required to reduce its
money supply and consumption, resulting in recession and unemployment. This was a strict
discipline that many nations could not force upon themselves or their population. Instead of
having sufficient courage to use unemployment to discourage imports, importing countries
simply insisted on intervention through tariffs and devaluations, instead. Nations insisted on
their rights to intervene and devalue domestic currencies in order to meet nationwide
employment objectives.

Did u know? Because of the rigidity of the system, it was a matter of time before major
countries decided to abandon the gold standard, starting with the United Kingdom in 1931
in the midst of a worldwide recession. With a 12 per cent unemployment rate, the United
Kingdom chose to abandon the gold standard rather than exacerbate the unemployment
problem. Monetary chaos followed in many countries.

2.1.2 The Inter-war Years, 1914–1944

The gold standard as an International Monetary System worked well until World War I
interrupted trade flows and disturbed the stability of exchange rates for currencies of major
countries. There was widespread fluctuation in currencies in terms of gold during World War I
and in the early 1920s. The role of Great Britain as the world’s major creditor nation also came to
an end after World War I. The United States began to assume the role of the leading creditor
nation.
As countries began to recover from the war and stabilise their economies, they made several
attempts to return to the gold standard. The United States returned to gold in 1919 and the
United Kingdom in 1925. Countries such as Switzerland, France and Scandinavian countries
restored the gold standard by 1928.
The key currency involved in the attempt to restore the international gold standard was the
pound sterling which returned to gold in 1925 at the old mint parity exchange rate of $4.87/£.
This was a great mistake since the United Kingdom had experienced considerably more inflation
than the United States and because UK had liquidated most of its foreign investment in financing
the war. The result was increased unemployment and economic stagnation in Britain.

Notes The pound’s overvaluation was not the only major problem of the restored gold
standard. Other problems included the failure of the United States to act responsibly, the
undervaluation of the French franc and a general decrease in the willingness and ability of
nations to rely on the gold standard adjustment mechanism.

In 1934, the United States returned to a modified gold standard and the US dollar was devalued
from the previous $20.67/ounce of gold to $35.00/ounce of gold. The modified gold standard
was known as the Gold Exchange Standard. Under this standard, the US traded gold only with
foreign central banks, not with private citizens. From 1934 till the end of World War II, exchange
rates were theoretically determined by each currency’s value in terms of gold. World War II also

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