Intl Monetary System (part 1) - The Bimetalism and Gold Standard

International Monetary System

  • Definition: Institutions and rules governing international payments, currency exchanges, and capital movements across borders.

  • Stages of Evolution: Five distinct stages since the 18th century.

    • Bimetallic System (pre-1870)

    • Gold Standard (1875-1914)

    • Interwar Period (1918-1939)

    • Bretton Woods System (1944-1971)

    • Jamaica Agreement (1976) - introduces floating exchange rate system.

Bimetallic Standard (pre-1870)

  • Usage: Both gold and silver coins were utilized as payment methods.

  • Country Variations: Some nations on gold standard, others on silver, and some on both.

  • Currency Value: Defined in terms of specific quantities of gold or silver, creating fixed exchange rates.

  • U.S. Implementation: First used in the U.S. in 1792 to control the dollar's value based on gold and silver holdings.

  • Gold/Silver Ratio: 1 ounce of gold equal to 17 ounces of silver in U.S.

    • Implication: A $10 silver coin had 15 times more silver by weight than a $10 gold coin.

  • Paper Currency: Backed by gold and silver to provide monetary stability and enhance international trade.

  • Temporary Measure: The bimetallic standard lasted until the Civil War in 1861 when silver was removed from the money supply.

Gold Standard (1875-1914)

  • Value Definition: Each currency's value was tied to a specific quantity of gold.

  • Convertibility: Full convertibility between currency and gold at central banks.

  • Free Movement of Gold: Gold could move freely globally, serving as the ultimate debt settlement method.

  • Trade Balances: Nations with trade surpluses accumulated gold, while those with deficits saw their reserves decline.

  • Money Supply: Direct link between gold holdings and money supply, allowing for economic expansion and stability.

Advantages of the Gold Standard

  1. Monetary Control: Government could not overly print currency unless backed by gold, limiting inflation.

  2. Stability: Inflation was rare; hyperinflation (50% annual rate) was virtually non-existent.

  3. Automatic Corrections: Trade imbalances corrected automatically via price specie mechanism.

Disadvantages of the Gold Standard

  • Limited Flexibility: Monetary policy flexibility was restricted, hindering central banks from adjusting interest rates during recessions.

Exchange Rate Determination During Gold Standard

  • Calculation: Gold content of currency sets the exchange rate.

    • Example: If 1 ounce of gold costs $60 in the U.S. and £15 in the UK:

      • Gold content of dollar = 1/60 ounces

      • Gold content of pound = 1/15 ounces

      • Exchange rate: 1 pound = $4 (derived from dividing gold contents or simply dividing prices).

  • Fixed Exchange Rates: Set and maintained by government-fixed gold price, promoting international trade and economic growth.

Conclusion of Gold Standard Era

  • Outcome: The classical gold standard ended with World War I, leading to fluctuations in exchange rates and the conclusion of gold convertibility.