Gold Standard

For many years, the gold standard served the purpose of stabilizing individual economies. The international gold standard helped to facilitate global trade. A country that adopted a gold standard issued a currency backed by its gold reserves. Usually gold coins circulated in such a country, but this is not necessarily so: The medium of exchange could also be banknotes. The holder of such notes may then demand gold from the bank equivalent to the amount stated on the note. Since all holders of such notes would not exercise this right at the same time, the gold reserves required for maintaining the gold standard may be less than the amount of currency in circulation. A variant of the gold standard is the gold-exchange standard. Under this standard, gold is only exchanged among central banks, whereas the public cannot demand gold on presenting currency notes. Both standards imply a regime of fixed exchange rates.

The international gold standard was based on a free flow of gold. Economists praising the virtues of this standard argued that this free flow would automatically balance international trade. A country that attracted gold because of its positive balance of trade would experience inflationary pressures leading to a rise in prices, while countries losing gold would suffer from deflation and a fall in prices. In due course, the flow of trade and the flow of gold would be reversed, restoring an international equilibrium. This would not work, of course, if the receiving country “sterilized” gold by locking it up so as to prevent a rise in domestic prices. This was done by the United States in the 20th century with a devastating effect on the world economy, which is explained later in this entry.

The establishment of the international gold standard is attributed to Sir Isaac Newton who was master of the Royal Mint in 1717 when he fixed the value of the British currency in terms of a specific gold content. Newton did not make money by describing the law of gravity and depended on his salary as a mint master, but he did not regard this job as a sinecure. He applied his scientific mind to a study of all European currencies of his time. Newton's gold standard was a practical one maintained by the rules and regulations of the mint; it was not based on an act of Parliament. It greatly aided the expansion of the British economy in the 18th century but was upset by the Napoleonic wars when the British, in order to finance their war effort, adopted a policy of easy money. After the war, the Bullionist Controversy erupted in Britain, in which those who wished to restore the gold standard (Bullionists) were opposed by those who preferred the policy of easy money prevailing during the war. The Bullionists triumphed, and the resumption of the gold standard was based on act of Parliament of 1821. The most prominent advocates of the gold standard were economist David Ricardo and politician William Huskisson, who served as a minister of trade in the British cabinet and was convinced Britain derived benefits from the gold standard in the field of international trade. Under the British hegemony in this field, more and more European countries as well as the United States adopted the gold standard during the 19th century.

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