Strengths and Weaknesses of Gold Standard - Example

Strengths and Weaknesses of Gold Standard Student’s Name Institution Strengths and Weaknesses of Gold Standard Introduction The gold standard policy is a policy where the unit of account is measured by gold. The fixed weight of gold is used to determine a certain value be it of a commodity or a service. This monetary system works in a way that the government prints money which is equal to the amount of gold it has in the reserves. This standard gold monetary system entailed the following: the gold specie principle which assumes that the monetary units are directed connected to the quantity of gold coins in circulation or in subject to other coins which have less value compared to gold for example silver. Secondly, this monetary policy involves the authorities’ commitments to the principle of gold standard policy. This initiative compelled the governments to have a fixed rate of exchange of gold when dealing with foreign currencies. In other words, it means there is a fixed rate of gold that is not dependable on the nature of transactions or means of exchange involved. Finally gold bullion policy which does not involve direct circulation of gold currency in the economy but the authorities can sell gold on demand to individuals or organizations. In the late nineteenth century, most countries changed their monetary policy from paper and silver in favor of gold. The authorities were therefore forced to fix price of their currency under the convertibility principle which in essence entailed printing money in respect to the amount of gold thy have in reserve. Strengths of Gold Standard Monetary Policy Firstly, it leveled the playing ground in term of foreign exchange in the international market. With governments commitment to print money according to the units of gold they had meant that trader could not shy away from the currencies that were perceive like they will lose value. This is due to the fact that even they lose value it will not affect them because they can go back to the government reserves and buy gold. They can then use gold to purchase the currency of their choice without losing in terms of value and cost. Secondly, the policy meant that any amount of money in the economy is backed by the equal amount of fixed assets. This acted as a check and balance of the economy in terms of regulating it self. The economy could be balanced by the demand and supply of gold which directed influenced the money in circulation. This helped economies in making sure they did not spend what they did not have. The authorities’ influence of the economy was also reduced hence preventing them from abuse of monetary system. The government could not just print money without gold backup to balance. For example, even if the government secretly more money and inject to the economy people will take advantage of the money flow to buy more gold from the government. This could have devastating effects on the government reserves and the general economy (Nelson, 2007). Thirdly, one of the strongest attributes of gold standard monetary system is its ability to deal with inflation. Inflation occurs when the money in circulation exceeds the amount of goods and services available. This means the demand of goods will generally go up because of increase in purchasing power of the household. Unfortunately, this increase of demand will lead to increase of prices due to the supply and demand principle hence inflation. However, in this system this would not occur because governments could not inject money in the economy unless they had enough gold to support the cash they are injecting. The implication is that the economy will not have any excessive money which can trigger inflation. It also meant that the value of goods and services or the value of a company was real and it did not depend on speculations that have been incorporated by the current monetary system where the value of the company could evaporate with hours by the fall of shares (Rugolf, 1985). Fourthly, it boosted the economies of those countries that export more. Those exports could lead to accumulation of gold which in turn could means availability of money. The money could be injected back in the economy in terms of investments. Investments could open more opportunities like employment and innovation. This could be translated to improved standards of living which are essential for economic growth. Lastly, gold standard brought stability of the money which encouraged people to save and invest. This can be attributed to the fact that the system simply guaranteed financial assets would not be inflated at all. Since it was a world system it simply led to stability of money contracts worldwide. This led to investment in to foreign investments which boosted the world economic growth. For example, between 1880s and 1910 countries like France and Britain invested almost a third of their savings to foreign counties. Weakness of Gold Standard Gold standard was rigid which meant there is nothing countries could do to deal with challenges which faced their economies time to time. Some of these implications include the fact that the performance of the economy could only be evaluated and determined by the amount of gold they possessed. This had negative impact because of it generalization of the economy. The gold could only measure tangible assets and ignored other resources that are important to the economy like human resources. It also did not take in to consideration other things like innovations or success or the value of brands that were emerging during the industrial revolution. For example, if we analyze Coca Cola company on how its worth on the paper we will be under value due to its global iconic status of brand which has economic value in the general performance of its operation (GSDA, 1895). It also leads to countries hold on their gold instead of implementing policies that would foster growth, for example in the 1930s the United States federal bank raised interest rates in order to protect their gold reserve. This only aggravated the problem because it became even harder to raise capital for businesses. It also led to less spending by the people as they tried to save in order to leap huge interest rates. In fact most economics attributed the gold monetary policy for the cause of great depression which led to total collapse of the financial system (Schultz, 1999). With the main principle of the gold monetary system dictating governments to print money which is only equivalent to their gold capacity it led to serious challenges. This meant that at times there was little supply of money which hard some adverse effects on the economy. Firstly, it drained money needed for the investments which slowed the economy growth. It also led to goods to move slowly due to diminished purchasing power of the people which directly affected the manufacturing industry and economy on the long run (Greasley, et al, 2006) The restriction of injecting money in the economy tied the governments in terms of coming it to rescue during economic downturn. In the economic downturn the government simply prints more inject more money in the economy to foster investments which can results to creation of job. The money also boosts the spending which is the main driving force of the economy. When people spend goods and services move within the economy bringing the money flow which is translated to economic growth. The governments could not lower the interest rates which are supposed to help investor’s access cheap growth to boost their businesses. It also discourage households not to save their money due to low return and instead spend it or invest which is can have the positive impact on the economy( Waltz,1993). Reasons Why Gold Standard Was Abandoned In the First World War, most countries were involved in the war which was largely unprepared. This meant that substantial resources had to be committed to war in a short notice. The governments therefore resulted in printing more money to deal with war budget hence inflating their currencies hence suspended the gold standard. Secondly, prior to war Britain was the highest creditor but lost the position to United States after the war. The implication was Britain had lost much of the gold during the war and their attempt to go back to gold standard meant that their sterling pound was overvalued in respect to United States who had maintained their gold standard during the war. This led it to be unacceptable especially to United States who was the world largest creditors after the war. Germany on the other hand had suspended gold during the war and after the war they faced several challenges. Firstly, they were heavily fined during he treat of Versailles hence they used their gold to pay some of the reparations. Secondly, some of the debt was to be paid by raw material which affected German factories further and economy in general. Thirdly, Germany printed more money to pay workers during the occupation of Ruhr which was triggered by their default. Lastly, the country continued to print more money to pay for respirations which was still very high. The above factors led to hyperinflation and directly made in impossible for German to return to gold Standard (Frank, 2007) The great depression led to the process of abandonment of gold standard policy altogether. Most countries realized the rigidity of the system during the depression since they could not implement policies which could trigger economy. Some of polices that could not be implemented includes increased government expenditure, stimulus packages and lowering interest rates. When the depression started most countries had to suspend the gold standard policy. The collapse of the stock exchange in 1929 forced traders to result in trading with commodities and currencies. When things became worse people were forced by the circumstances to trade their dollars for gold. Many economics attributed depression to the inability of the Federal Reserve. They claim the Federal Reserve constant adherence to insufficient real bills doctrine couple by gold standard policy aggravated the economic turmoil (Eichengreen, 1992). The federal bank also resulted in raising the interest rates as a measure to discourage people from purchasing more gold in order to protect their reserve. This measure only aggravated the situation because it made it difficult for many investors to mobilize capital; leading to business bankrupt and subsequent high unemployment. The policy tied policy makers from making expansionary monetary policy, and this made the United States depression to spread across the globe. The federal could not put in place policies to control the situation. This experience made many policy makers to start formulating ways to deal with future crises. This started the steps toward formulating better policies which could give the government control of financial system (Charles, 2008). The outbreak of World War Two led to the end of depression and the countries started to ease back to their initial gold standard monetary policy. There was also the introduction of Bretton Woods’s policy which in essence valued every currency in relation to gold. In that time United States possessed most of the gold hence making most countries to simply relate their currency to dollar. This made the dollar to become world exchange currency. Bretton agreement postulated that central governments had to maintain fixed rates between their currency and the dollar. They could buy their own currency if its value became too low or sell it if it appreciated so much in relation to dollar. In the long term countries started to buy dollars instead of the gold. The demand for the dollar appreciates in value even though the size of the gold remained the same (Friedman, 1948). Change of economic dynamics is also another major factor that led to decline of the gold standard policy. The economy of the world expanded at a higher rate than the production of gold. This means more capital has been created than it was in the nineteenth century. One of the most significant aspects of gold standard is the fact that it limits money in circulation. If the system was still used today it could have major implications on the economies. With limited money supply the level of investment would be vey low because of scarcity of capital. The households could also spend less leading to slow manufacturing rate and slow circulation of money. This entire factor could have major implications on employment as any organizations could easily run bankrupt (Cuomo, 2009). Conclusion In summary, we can conclude that the gold standard policy was a success for the first six decades of its inception. Unfortunately due to its rigidity especially in time of economic recession made it hard for the governments to control the situation. This can be blamed on economic turmoil of 1930s which brought devastating effects on world economies. Although we cannot complete blame this policy as the sole cause of the problem it did contribute in the essence that the United States Federal government was forced by the circumstances to raise interest rates hence aggravating economic stagnation. The credit crunch of 2008 demonstrated the importance of the central government strategies of lowering interest rates and stimulus. It is in fact these policies such as stimulus and lowering interest rates that actually prevented the economic depression in the scale of the 1930s. References Charles, D (2008) ‘’ Depression You Say Check those Safety Nets’’. New York Times, March 23. Cuomo, M. M., Towers Productions, Inc., History (Television network), History Channel (Television network), Arts and Entertainment Network., & New Video Group. (2009). The Great Depression. New York, NY: A & E Television Networks. Ditz, G. W. (January 01, 1982). 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Rogoff, K (1985).’’The Optimal Commitment to an Intermediate Monetary Target.’’ Quarterly Journal of Economics.100 pp 1160-1190. Schultz, S (1999). Crashing Hopes: the Great Depression, American History 102: Civil War to the Present. Wisconsin: University of Wisconsin Press. Waltz H.M. (1993)). The Great Depression: America in the 1930s. Boston: Little, Brown. Read More