MVP ARCHIVE HISTORY | Economic : Gold Standard - A system that linked currency value to gold and supported international economic stability

MVP ARCHIVE HISTORY > Economic > Gold Standard - A system that linked currency value to gold and supported international economic stability

Gold Standard - A system that linked currency value to gold and supported international economic stability

The Gold Standard is a monetary system that links the value of a currency to a specific amount of gold.

Current Japanese yen and US dollars do not guarantee exchange for gold.
However, from the late 19th to the early 20th century, many countries supported the value of their currencies by defining "how much gold this currency is worth."

The Gold Standard supported the development of international trade and finance, but it also became a factor that constrained the policies of various countries during the Great Depression.
Its history illustrates the problem of how to balance the stability gained by fixing currency credit with the freedom to respond to economic conditions.

Linking gold and currency

Under the Gold Standard, the government sets the exchange rate between its national currency and gold.
Gold is resistant to corrosion, divisible, and easy to verify in quality. Also, it cannot be mass-produced in a short period.

Therefore, guaranteeing exchange for gold supported trust in the currency while simultaneously placing constraints on the government's issuance of currency.

While the state guaranteed the value of the currency with gold, it was a system where the state itself was also constrained by gold.

A common standard that supported international finance

The UK enacted a system in 1816 that made gold the center of its monetary system, and by the late 19th century, many countries including Germany, the United States, and Japan shifted to the gold standard.

The period from the 1870s to World War I is called the Classical Gold Standard.

Because the values of national currencies were linked through gold, exchange rates were relatively stable, making it easier for companies and banks to predict future prices for cross-border transactions, which expanded trade, investment, and lending.

The Gold Standard became one of the financial infrastructures supporting the international economy formed in the late 19th century.

Gold movement and the domestic economy

In this system, international capital movement also affects the domestic economy.
If imports or payments abroad increase, gold flows out of the country.
If gold reserves decrease, the central bank takes measures such as raising interest rates to maintain the exchange between currency and gold.

If interest rates rise, borrowing decreases, and investment and consumption are suppressed.
If economic activity shrinks and prices fall, export competitiveness increases, and the balance of payments is adjusted.

Conversely, in countries where gold flows in, it becomes easier to expand credit and money supply.
There are times when one must accept a contraction of the domestic economy to protect the value of the currency.

World War I

In 1914, when World War I began, the gold standard was severely shaken.
War requires massive funding for weapons, soldiers, transportation, food, and production facilities. Governments issued national bonds and increased the money supply.

However, because there is a limit to the amount of gold, it was difficult to maintain both large-scale currency issuance and convertibility to gold, so many countries suspended gold exchange.
World War I effectively interrupted the classical gold standard that had supported 19th-century international finance.

Post-war return

After the war ended, countries attempted to rebuild the stable international financial order of the past, but the post-war world was different from the pre-war era.

National debt had increased, and price levels had changed. The United States became a massive creditor nation, and the reparations issue remained for Germany. European finance also became heavily dependent on funds from the United States.

Nevertheless, in the 1920s, many countries returned to a currency system based on gold.
The UK also returned to the gold standard in 1925 at the same exchange rate as before the war.
However, to maintain the pre-war exchange rate, the pound had to be kept at a high level, which placed strong adjustment pressure on the UK's export industries and domestic economy.

Here, the two goals of maintaining international currency credit and stabilizing the domestic economy collided.

The Great Depression and the Gold Standard

After the Wall Street Crash of 1929, the financial crisis spread across the world.
Banks failed, credit contracted, and corporate activity declined. Unemployment surged, and governments and central banks were called upon to implement policies to support the economy.

However, countries maintaining the gold standard faced significant constraints.

If they lowered interest rates and increased the money supply to support the economy, there was a possibility that anxiety over that currency would lead to increased conversion to gold. If gold reserves flowed out, the system itself could not be maintained.

Therefore, countries were forced to make difficult choices between supporting the domestic economy and protecting convertibility to gold. Furthermore, when gold flowed out of one country, that country would try to protect its gold through interest rate hikes or monetary tightening, further suppressing domestic investment and consumption.

The gold standard, which had connected countries during stable times, became a Great Depression channel for transmitting financial contraction across borders.

Departure from the Gold Standard

In 1931, the UK abandoned the gold standard.
By stopping the exchange of pounds for gold, the constraints on maintaining gold reserves were weakened, making it easier to adopt policies to support the domestic economy, such as lowering interest rates.

In the United States as well, in 1933, the Franklin D. Roosevelt administration suspended the traditional relationship of convertibility to gold, and in 1934, changed the gold price from $20.67 to $35 per troy ounce.

The Great Depression changed not only the economy but also the international monetary system itself.

Bretton Woods and the Dollar

World War II in 1944, near its end, saw the design of a new international monetary system, the Bretton Woods System. Instead of returning to the
classical gold standard, it was a mechanism that linked the US dollar to gold and fixed other national currencies to the dollar.
※ Gold → US Dollar → National Currencies

The US dollar was exchanged for gold at $35 per troy ounce and became the center of international finance.
However, as the post-war global economy expanded, the amount of dollars used worldwide also increased. Meanwhile, there were limits to US gold reserves.

In 1971, President Richard Nixon announced the suspension of the convertibility of the dollar into gold for foreign governments and central banks, which is known as the Nixon Shock .

This caused the collapse of the Bretton Woods system, which had used gold as the ultimate standard, and major nations shifted to a floating exchange rate system.

From trust in gold to trust in institutions

Current major currencies are Fiat Money.
What supports a currency is the state, the central bank, the tax system, the financial system, economic activity, and the social trust that others will also accept that currency.

The foundation of currency has shifted from trust in a physical substance like gold to trust in institutions.
This has allowed central banks to adjust interest rates and money supply in response to financial crises or economic downturns without being directly constrained by gold reserves.

On the other hand, the boundary of gold, which physically limited currency issuance, has been lost, making it essential for central banks and governments to maintain trust in the currency itself.

Archive Point

The Gold Standard is a system that provided a common standard for domestic currency and international finance by linking currency value to a fixed amount of gold.
In the late 19th century, it supported exchange rate stability and played a significant role in the expansion of international trade and capital movement.

However, the constraints imposed by gold limited the policies of governments and central banks during crises such as the Great Depression. This is because it became impossible to reconcile monetary easing to support the domestic economy with maintaining convertibility into gold.

In the 1930s, many countries abandoned the Gold Standard, and after the post-war Bretton Woods system, the convertibility of the dollar into gold was also suspended in 1971.

The Gold Standard history leaves us with the question of not whether to choose between stability or freedom, but how to achieve both while maintaining trust.

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