Gold Standard

Topics: Great Depression, Monetary policy, Money Pages: 7 (1869 words) Published: May 3, 2015
Narges Kadirzada
Professor Mark Brady
Economics
12 April 2015
The Gold Standard
Gold, nothing can compare to this precious metal. A symbol of wealth and prosperity, it has been valuable to explorers and adventurers and a lure for conquerors. Today, Gold is vital to commerce and finance, popular in ornamentation, and is increasing importance in technology. But most importantly, gold reserves once backed the value of the dollar. Since it’s founding in 1776, the United States has governed under many different monetary systems, such as bimetallic, fiat, full gold, and partial gold. From about 1860 to 1914 the world operated under a full gold standard [1]. This research paper will explore the history of this monetary system, how it worked, and why the gold standard negatively impacted the United States and European economies. Just less than a year after the start of the civil war, the United States congress passed the Legal Tender Act to help finance the war. This act authorized the issue of the country’s first paper fiat currency. These paper bills were called “greenbacks” and were not backed by neither gold nor silver but only by the “full faith and credit” of the federal government. The Union issued almost $450 million greenbacks and $500 billion in war bonds [2][3]. During the Civil war, the dollar was inflated by up to 80% and by the end of the war; the federal government was $2.7 billion in national debt. In an attempt the move to a gold standard after the civil war, the federal government began to limit the amount of money in circulation by destroying the greenback bills [5][6]. Between 1865 and 1868 price levels in the United States fell by 25% and a national debate began about whether or not the government had a legal right to issue fiat currency. In 1837 the Fourth Coinage Act ended the exchange of silver at a fixed price, discontinued government production of silver dollars, reduced the money supply, and moved the country closer to a gold standard. On January 14, 1875 Congress passed the Specie Payment Resumption Act, which mandated that all greenbacks still in circulation be redeemable in gold [6]. Between 1879 and 1934 most major nations used the gold standard as a method for international exchange. The Gold Standard was simply a fixed-rate system. The rate was fixed to gold but in order for this system to function properly three things had to happen. First, each nation had to define its currency to gold. Second, each nation must then maintain a fixed relationship to its supply of money and its amount of actual gold. Third, the on-hand gold must be available to be exchanged freely between any nations throughout the world. With these policies successfully in place, the exchange rates of the participating countries would then be fixed to gold, therefore to each other. To successfully maintain this relationship some adjustments had to be made from time to time. For example, two countries A and B are doing international business together and A buys more of B's products than B buys of A's. Now B doesn't have enough of A's currency to pay for the excess products purchased. B now has what's called a balance of payment deficit. In order to correct this deficit the following must occur; Actual gold must now be transferred to A from B. This transfer does two things. First, it reduces B's money supply because a fixed ratio must be maintained between the actual amount of gold, and the supply of money, hence lowering B's spending, aggregate income, and aggregate employment, ultimately reducing the demand for A's products. Second, A's money supply is now increased, raising A's spending, aggregate income, and aggregate employment, ultimately raising the demand for B's products. These two events happen simultaneously stabilizing the exchange rate back to its equilibrium. From 1929 to 1931, the Great Depression took hold of the United States and the Federal Reserve was forced to pursue deflationary policy [7]. This allowed...
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