UNIVERSITY OF LJUBLJANA

FACULTY OF ECONOMICS

International Finance Mojmir Mrak

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UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS

CONTENTS AND PURPOSE

1. The Gold Standard (Period Before World War II) 2. The Interwar Experience

purpose:
analysis of the forms of international monetary system in the period until World War II

International Finance Mojmir Mrak

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UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS

1. The Gold Standard (Period Before World War II)

first complete international monetary system based on the automatic balance-of-payments mechanism under fixed exchange rate:
classical gold standard period: from about 1870 to 1914 (beginning of World War II) managed gold standard period: from 1926 to 1931

International Finance Mojmir Mrak

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UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS

Evolution of the Gold Standard

replacement of bimetalism with gold standard in Great Britain (1816):
Greshams Law, forfeiting different shares of silver in silver coins increasing financial dependency between countries because of trading (industrial revolution)

unpromising political circumstances in Europe:

numerous countries had to give up convertibility of their currencies Germany gave up bimetalism in 1871 and set up the gold standard

International Finance Mojmir Mrak

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UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS

Evolution of the Gold Standard

chain reaction in the area of establishing gold standard:
strong interest of every country to implement the same international monetary system as their most important economic and financial partners have implemented
Country Great Britain Germany Sweden, Norway and Den mark France, Belgiu m, Switzerland, Italy and Greece Netherlands Uruguay USA Austria Chile Japan Russia Do min ican Republic Panama Mexico Year 1816 1871 1873 1874 1875 1876 1879 1892 1895 1897 1898 1901 1904 1905
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International Finance Mojmir Mrak

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UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS

The Concept and Basic Logic of the Gold Standard

rules of the game:
country defines the gold content of its currency the quantity of gold contained in one unit of domestic currency, and pledges that the central bank will buy or sell any amount of gold at that price free export and import of gold

economic agents need to be confident that the country will follow both rules of the game

International Finance Mojmir Mrak

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UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS

The Concept and Basic Logic of the Gold Standard

fixed exchange rates between currencies included in the system:
actual exchange rate could fluctuate above and below the mint parity by the transport costs actual exchange rate has to be within the gold points (gold export point and gold import point)

International Finance Mojmir Mrak

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UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS

Balance-of-Payments Adjustment Mechanism Under Gold Standard

price-specie-flow mechanism:
gold is the only form of international monetary reserves, hence a balance-of-payments deficit (surplus) causes gold outflow (inflow) country must guarantee complete back-up of domestic currency with gold there has to be price and wage flexibility

International Finance Mojmir Mrak

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UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS

Balance-of-Payments Adjustment Mechanism Under Gold Standard

Fall in prices in the USA Uchanged prices abroad

Surplus in the US balanceIncrease in US exports, fall in US imports of-payments, accompanied by net gold inflow fro m abroad Increase in the supply of money in the USA Increase in the US prices Increase in foreign exports, fall in imports Fall in the foreign supply of money Fall in foreign prices

Fall in US expo rts, increase in US imports

Balance-of-pay ments equilibriu m No more gold flow

CONTENTS

Increase in foreign exports, fall in foreign imports

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International Finance Mojmir Mrak

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UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS

Functioning of the Gold Standard and Price-Specie Flow Mechanism in Reality

following the rules of the game in practice:
gold was not the only form of international monetary reserves:
balance-of-payments disequilibria were eliminated with international capital flows foreign exchange reserves yield interest, transport costs are lower, no need to decrease the gold reserves

at least partial sterilization of the effects of the balance-ofpayments disequilibria:

reducing the severity of the balance-of-payments adjustment process

prices and wages were not completely flexible

International Finance Mojmir Mrak

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UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS

Functioning of the Gold Standard and Price-Specie Flow Mechanism in Reality

assessment of the functioning of the gold standard:
relatively successful because of fairly favorable economic circumstances fairly successful from the point of view of the world economic center

final assessment of the functioning of the gold standard:

successful before the beginning of World War I

International Finance Mojmir Mrak

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UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS

2. The Interwar Experience

With the outbreak of World War I, the classical gold standard came to an end:
exchange rate depended completely on the supply of and demand for foreign currency

extremely negative effects of the lack of agreement on the functioning of the international monetary system three trials of establishment:
Conference in Genova (1922) negotiations in 1933 three-party agreement between the USA, Great Britain and France (1936)
International Finance Mojmir Mrak Page 12

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UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS

1919 1926: Experience With Flexible Exchange Rates

entirely different economic and political circumstances at the end of World War I made quick return to stable economic circumstances realistically impossible flexible exchange rates were perceived as an exclusively temporary solution that needed to be replaced by a more permanent solution (going back to the pre-war classical gold standard) as soon as possible

International Finance Mojmir Mrak

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UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS

1919 1926: Experience With Flexible Exchange Rates

countries with hyperinflation and their return to the gold standard:
high rate of inflation caused by printing of money, that was used for financing high budget deficits an ingredient of stabilization programs was establishment of the mint parity of national currencies, or return to gold standard

return of other countries to the gold standard:

which mint parity should be used?

International Finance Mojmir Mrak

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UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS

1926 1931: Functioning of the Renewed Gold Standard Period

differences in gold standard in the interwar period and before World War I:
mint parity was established at the wrong level, resulting in continued problems in the balance-of-payments adjustments not a real gold standard, rather, a gold exchange standard:
assumption of high confidence into countries with a reserve currency to guarantee unconditional conversion of their currencies into gold

International Finance Mojmir Mrak

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UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS

1926 1931: Functioning of the Renewed Gold Standard Period

not following the rules of the game or different priorities of national economic policies :
countries started to systematically give priority to internal economic goals and relatively lower importance to balance-of-payments equilibrium sterilization economic nationalism period

changed significance of the short-run capital flows:

flows under the strong influence of lowered confidence into mint parities, which was reflected mostly in escape of capital from weak currencies
International Finance Mojmir Mrak Page 16

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UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS

1926 1931: Functioning of the Renewed Gold Standard Period

End of the gold standard:
convergence of different causes that pressured the already weak international monetary system of renewed gold standard at the end of 1920s deflation and unemployment; New York Stock Exchange crisis (1929) decreased confidence

International Finance Mojmir Mrak

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UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS

1931 1944: Period of Economic Nationalism

cannot talk about the existence of an international monetary system economic nationalism:
competitive devaluations protectionism

trade wars, international trade cut almost in half less international provision of credit and investment
International Finance Mojmir Mrak Page 18

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UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS

1931 1944: Period of Economic Nationalism

reasons for unsuccessful initiatives for the formation of a consistent international monetary system:
countries were not prepared to make and implement international agreements that would limit their freedom in leading national economic policies unresolved debt problem of some European Countries from World War I after Roosevelt became the president of the USA, the American policy focused mainly onto economic reconstruction of the USA and lowered its interest in solving global problems of the international monetary system

International Finance Mojmir Mrak

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UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS

Assessment of the Functioning of the International Monetary System During the Interwar Period
period without a consistent international monetary system with extremely negative consequences on the size of the international trade and investment:
lack of cooperation and agreement about the organization of the international monetary system has extremely negative consequences on the world economy as a whole, as well as individual countries as its components modified relationship between internal and external economic policy goals caused a significant change in international capital flows characteristics lack of willingness for cooperation in the interwar period was also a consequence of a change in the world financial center
International Finance Mojmir Mrak
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