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Classical Gold Standard in Brief

Classical Gold Standard is a foreign exchange regime whereby each national currency (the dollar, pound, franc, etc.) was merely a name for a certain definite weight of gold. The "dollar," for example, was defined as 1/20 of a gold ounce, the pound sterling as slightly less than 1/4 of a gold ounce, and so on. Officially, the United States began with a bimetallic standard in which both gold and silver were used to define the monetary unit. According to the first coinage act the ratio of silver to gold in a given denomination in a coin was 15 to 1. Soon the market price ratio of silver to gold moved to around 15 to 1 making silver cheaper metal. So gold was used for purchases abroad, and the coins used for domestic purposes became new mint ratio made gold cheaper California and primarily silver. In 1834, Congress moved to remedy the problem by changing the ratio to 16 to 1 by reducing the gold in gold coins. The relative to the world market price ratio. (Elwell, 2011) As a result, silver began to be exported. This became more pronounced with discoveries of gold in Australia. By 1850, silver coins had almost totally disappeared and gold became the principal coin of domestic commerce. In 1914 the mechanism for international payments dramatically collapsed. Half of world trade was financed by British credits which, with stock markets mostly shut for the duration of the war, meant bills could not be rolled over or paid with the usual ease. (Mark Harrison, 2013) Under a classic gold standard, exchange rates are fixed, and so any deviation of domestic price levels from the world gold price triggers the alarm of exports and imports of physical gold before things move too far from equilibrium. Thus, the gold-linked note issue of a country experiencing a loss of gold due to a trade deficit would be automatically contracted, depressing the price level. The deficit countrys exports would then become more attractive to foreign countries whilst imports would become more expensive thereby self-correcting the deficit. Global imbalances were automatically restrained by credit expansion in surplus countries and contractions in deficit countries. However, for the gold standard to work fully, central banks, where they existed, were supposed to play by the rules of the game. - to raise their discount rates to speed a gold inflow and to lower their discount rates to facilitate a gold outflow. (Morys) Thus, if a country was running a balance-of-payments deficit, the rules of the game required it to allow a gold outflow until the

ratio of its price level to that of its principal trading partners was restored to the par exchange rate. But there was variation in rules followed by core countries and peripheral countries. The discount rate decisions of core countries were motivated by keeping the exchange-rate within the gold points when the peripheral countries relied on high reserve levels and oriented their discount rate policy towards maintaining the reserve level. Also, countries enjoyed marginally more liberty in setting their discount rate than peripheral countries. (Mark Harrison, 2013) (Schwartz, 1984) Thus, classical gold standard of the nineteenth century was not perfect, and allowed for relatively minor booms and busts, it still provided us with by far the best monetary order the world has ever known, an order which worked, which kept business cycles from getting out of hand, and which enabled the development of free international trade, exchange, and investment. It provided an automatic market mechanism for checking the inflationary potential of government. It also provided an automatic mechanism for keeping the balance of payments of each country in equilibrium. -Prepared by: Maleeha Tarannum

Elwell, C. K. (2011). Brief History of the Gold Standard in the United States. Congressional Research Service. Mark Harrison, C. (2013, April 16 ). Did the Gold Standard Work? Economics Before and After Fiat Money. Retrieved September 5, 2013, from CFA Institute: http://blogs.cfainstitute.org/investor/2013/04/16/gold-and-international-reserve-currencies/ Morys, M. (n.d.). Monetary Policy under the Classical Gold Standard (1870-1914). University of York. Schwartz, A. (1984). A Retrospective on the Classical Gold Standard,1821-1931. University of Chicago Press.