The Global Capital Market - Example

Gold Standard was very prominent during the nineteenth century. As per Gold Standard any individual holding a paper currency of a given country could exchange the paper currency with an equal or par amount of gold by giving the same to the respective country’s government department and taking gold from the countries gold reserve. Thus the countries money was backed by an equal amount of gold reserves. Countries adapting Gold Standard thus, had a fixed international exchange rate and international trade became much easier. Thus, gold coins or heavy bullions were no longer required to do international or domestic transactions and paper currency was finally given something real and valuable to back up its worth in the future. Further, Gold Standard was adopted by powerful countries like Great Britain, United States and others, due to which even smaller countries opted to adapt the Gold Standard System in their economy as well. Gold Standard had its own strengths and weaknesses and major reason for abandonment of Gold Standard has been discussed as under. One of the biggest strengths of Gold Standard was that a country’s currency was equally backed by the gold reserves that the country possessed. Thus, it helped in controlling inflation to a greater extent which is a major problem in the recent world as the country could not flood its economy with extra currency and thus hampering its purchasing power. Paper currency was backed up by its equal worth in gold which created a sense of great relieve to people at that time (Tomz, 2001). Gold Standard helped in providing an economic stability and provided a regulating effect on the country’s economy as the respective country could only print that amount of paper currency for which it had gold reserves. Another advantage of Gold Standard was no fear of devaluation of a countries currency since there would be no exchange rates of different currencies in different countries as in today’s world which keeps on fluctuating. Thus trading at a global level was much easier as economy of a country fairly depended on its gold reserves and it kept all countries at the same floor. Gold coins or expensive heavy bullions were no longer required for trading. Gold Standard further helped in controlling government’s Budget Deficits and over piling of debts since it was regulated by the supply of gold and could not exceed beyond it. Each country adapting to Gold Standards was relieved from Budget deficits which was a serious issue even in most powerful countries of the world like The Great Britain (Martín, 2004). Productive Countries with higher gold reserves could export its gold to other countries and thus accumulate more currency and use it for further development of its economy by setting up more profitable businesses and generating more employment in their domestic economy and target a higher growth. There was no limitation in import or export of gold, which made it easier and freely transferable on a global level. Common people could easily convert their private gold into paper currency or vice versa by banks setup in their country, thus, it also created more employments in banking sectors and banks played a vital role in business activities right from nineteenth century. Countries could frame their monetary and growth policy to achieve economic stability and fight against inflations and depressions as per their gold reserves and achieve growth and stability with lower efforts, further terms like hyperinflation never existed in the dictionary during Gold Standard as in no way an economy could inflict new currency in its economy without gold reserves. Price imbalances in different countries adapting to Gold Standards would be automatically offset by one another as import of gold by the importing country would lead to decrease in the circulation of paper currency in the importing country and the same would lead to increase in the circulation of paper currency in the exporting country and decrease in the gold reserve of the exporting country by the value of gold exported by it (Martín, 2000). Thus creating an automatic balance of imports and exports internationally which further helped in balancing of payments and receipts internationally. Countries with gold mines gained greater importance whereas countries with limited supply of gold suffered a setback. The biggest advantage of Gold Standard of backing a countries currency with its gold reserves soon started creating problems and hindrance in economic policies and growth since gold reserves in every country was limited. One of the biggest weakness of Gold Standard was Economic Recession which could not be controlled by framing Monetary Policies as it is done in today’s world. Even during the time of economic slowdown and turmoil’s a country could not inflict more currency in the economy which lead to further recession and largely affect the growth of the economy. Shortage of currency was thus a concern for all countries adapting to Gold Standard. Further, countries were more pruned and focussed in saving their gold reserves which created economic fluctuations in the economy rather than framing policies for optimized utilisation of their gold reserves. Gold Standard did not guaranteed financial stability as it failed during financial panics in the economy, as invariably seen during the Great Depression fairly due to limited currency and non- capability of the country to induce fresh currency during the time of recessions. This also led to decrease in the purchasing power of the currency. There were further problems in establishing international exchange rates when needed during the Gold Standard since there was fixed exchange rate. Gold Standard helped in maintaining price stability and inflation in long term but however it failed to control inflation or rising prices or vice versa in the shorter period. There were speculative attacks during the Gold Standard period and not much could be done by countries adopting the same. To create gold as a monetary base was difficult since it is a natural resource and its availability is limited, thus in the longer run it would create problems in the economy. Gold Standard further led to real debts in the economy during the time of deflation which was one of the major causes of Big Recessions in the economy during the nineteenth century and not much could be done to regulate the same as well. It is universally accepted that when the productive capacity on an economy grows then so should the currency or money supply in that economy, but this was not the case in Gold Standard since currency was backed by a valuable metal gold, there was a restriction in the availability of gold to a certain extent which created a constraint in the economy to grow more and produce a higher capital. Whenever a country wanted to devalue its currency it showed greater and sharper changes in the economic conditions of the country, it was not a smooth process as it is in today’s world or so called the paper currency world. Any country which would show signs of weak financial stability was often suspected to be hit by major speculative attacks in the Gold Standard system. In the Gold Standard System it was difficult to actually estimate the economy’s demand for money, as demand of money should be equal to supply of the same, otherwise it shall lead to an economic imbalance in the economy and further invite inflation and deflation accordingly which if not regulated correctly might also lead to economic depressions in the economy in the longer run. Further, fluctuations such as increase in the mining of gold i.e. increasing the gold reserves of the country may lead to increase in inflation in the shorter run and similarly a decrease in the mining of gold may lead to deflation in the economy (Rodriguez, 2000). Thus, to judge the correct requirement of gold mining as per the demand of money in the respective country played an important role which many times the economists fail to do so inviting economic crisis in the country. Gold Standard worked quite well during its initial phase and was adapted by almost all countries in the world. It even worked well during the Industrial Revolution of the nineteenth century and to some extent towards the World War- 1. Till this time there was ample supply of gold in the global economy and countries worked together and traded in gold internationally quite smoothly and easily (Reis, 2000). However during the Great Depression and World War-1, gold standard started showing signs of dismay and its loopholes. There was huge need of funds by the economy for war and social programs and welfare which was not readily available as no new currency could be inflicted in the economy without gold reserves being utilised for the same. Thus it led to a shortage of money in the economy. Further in the year 1931, Gold Standard followed a setback in one of the most powerful nation of the world i.e. Great Britain (England). During the time of Great Depression, there rose a huge crisis of money and people of England literally started to panic and started exchanging their paper currency for gold from the banks. It is eventually said that there came a situation when The Bank Of England was at the verge of crisis of gold in its reserves and over flooded with paper currency. There was a complete nervous breakdown for banks and the situation went beyond control for the bank to save their gold reserves (Obstfeld, 2008). Finally, to overcome this crisis of gold shortage England decided to abandon the then present system of Gold Standard and shift to paper currency. Soon this crisis started affecting different nations one after another and smaller countries started believing and worrying that if it could affect a country so powerful like The Great Britain, it could well create huge problems in their domestic economic scenario. Finally in 1931 these speculative attacks forced England to cut off from the Gold Standard. On September 19, 1931, England left the revised Gold Standard. Further, during the Great Depression, Federal Reserve kept inflating its interest rates to make dollar a powerful currency and save its gold reserves. This had a further bad effect on the economy and the depression worsened as purchasing power declined and cost of doing even small business shoots up. Owing to this many Companies failed and had a complete shutdown and many banks failed which led to huge unemployment in the country. However, the Great Depression came to an end with the outbreak of the Second World War and Bretton-Woods System was adopted by most of the countries which fixed an exchange rate of all currencies in terms of gold. By this time United States has emerged as one of the most powerful countries in the world and hold a larger portion of World’s gold reserve, so many countries simply valued their currency in terms of Dollars than in terms of gold. Thus, this led to Dollar becoming a World Currency and even the Bretton-Woods agreement supported such an exchange further loosening the traditional system of gold exchange for currency (Helleiner, 2003). Thus Dollar becoming stronger day by day led to inflation and a deficit in the balance of payments in the United States, to control this almost double digit inflation in the United States it started deflating the value of dollar in terms of gold. During 1971 to 1973, gold was constantly reprised against U.S. dollars. Finally in 1973, United States in order to come out of this turmoil abandoned the Gold Standard completely. Soon after this the price of gold shot up and different country laid their focus on printing their own currency notes which did lead to some inflation but it led to stability in the economic growth of the countries (Vreeland, 2003). Even today, at times of recession and inflation situations investors do switch to gold to certain extent. However the old Gold Standard System of the nineteenth century is no longer followed by any country in the world. References Helleiner, E. (2003). The Making of National Money: Territorial Currencies in Historical Perspective. Ithaca: Cornell University Press, forthcoming Martín, P. (2004). Spain during the Classical Gold Standard Years, 1880-1914. In Bordo and Capie, eds., pp. 135-172 Martín, P. (2000). The Spanish Monetary Experience, 1848-1914. In Martín Aceña and Reis, eds., 112-151 Obstfeld, M. (2008). The Global Capital Market: Benefactor or Menace? The Journal of Economic Perspectives 12, 9-30 Reis, J. (2000). “The Gold Standard in Portugal, 1854-1891.” In Martín Aceña and Reis, eds., 69-111 Rodriguez, A. (2000). Chile during the Gold Standard: A Successful Paper Money Experience. In Martín Aceña and Reis, eds., pp. 174-206 Tomz, M. (2001). How Do Reputations Form? New and Seasoned Borrowers in International Capital Markets. Paper presented at the Annual Meeting of the American Political Science Association Vreeland, J. (2003). The IMF and Economic Development. New York: Cambridge University Press Read More