Monetary Standard: Gold Standard, Bi-metallism and Managed Currency Standard

Recently updated on April 13th, 2023 at 05:58 pm

Various monetary standards or monetary systems have been adopted in practice from time to time.

These are:

(a) Bimetallism.

(b) Monometallism: Silver standard or Gold standard.

(c) Paper Standard.

(a) Bimetallism:

Under Bimetallism, both gold and silver coins are standard coins. A ratio is fixed by law between their values, and the ratio is maintained by the currency authority. Coins of each of the two metals are unlimited legal tender.

Merits:

Several merits are claimed for bimetallism:

(i) Ample supply of media of exchange is assured, there being two metals of which money can be minted,

(ii) The banks find it easy to keep the necessary cash reserves against liabilities, both silver and gold coins being unlimited legal tender,

(iii) The government can meet its requirements of cash more easily than would be the case under monometallism,

(iv) Bimetallism is supposed to facilitate interna­tional trade as part of exchange can be established with, all countries, whether on gold or silver,

(v) Bimetallism has been advocated in preference to universal gold standard on the ground that the stock of gold in the world will not be enough to cope with the demand for monetary purposes,

(vi) It is argued that the bimetallic standard would be more stable. A fall in the price of one metal may be counteracted by arise in that of the other.

Demerits:

People were convinced that unless adopted internationally, bimetallism had no chance of functioning successfully, and of this, there was little prospect. Adopted by a single country, bimetallism was sure to degenerate into an alternative standard (either gold or silver) through the operation of Gresham’s Law.

The world has now discovered a much cheaper medium of exchange, viz., paper, and-bimetallism is unnecessary to ensure ample supply of currency. The paper currency is as good a reserve for the banks as any. The issue of paper money also enables the Governments to tide over their financial difficulties during a period of stress and strain.

Paper being now the real medium of exchange all argument in favour of bimetallism intended to meet the shortage of supply of precious-metals has lost their force. As for stability, gold or silver monometallism has manifested much greater stability.

It has been remarked that one sober person is able to walk much more steadily than two tipsy fellows with their arms interlocked. Divergences, almost daily, between the mint ratio and the market ratio of the two metals are sure to cause confusion in trade, engender speculation and create complications in the working of the monetary system.

(b) Monometallism:

We now come to monometallism, i.e., the monetary standard being based on one metal, silver or gold and not on both as is the case in bimetallism.

Silver Standard:

Let us first take the silver standard and then the gold standard. Under a silver standard, the value of the monetary unit is fixed and maintained in terms of silver. This is usually done by the free coinage of silver into coins of a given weight and fineness. India, for instance, was on silver standard from 1835 to 1893: The rupee was freely coined and its weight was fixed at 180 grams, 11/12 fine. At present, no country in the world is on the silver standard.

Gold Standard:

Types of Gold Standard:

Although gold standard of the orthodox type ceased to function long time back, yet gold standard still retains some of its old halo. It still figures in the discussions of the monetary systems. There are several distinct phases through which gold standard Vas passed.

(i) Gold currency standard,

(ii) Gold exchange standard,

(iii) Gold bullion standard, and

(iv) The latest to appear, gold parity standard.

We shall now say a word about each of these types of gold standard. Gold Currency Standard

This is also called Full Gold Standard:

A country is on a full gold standard when gold serves not only as standard of value but also circulates as coins. It is subject to free coinage, so that its face value is equal to its intrinsic value. Before 1914, Great Britain had this type of gold standard and so had the U.S.A., France, Germany and other European countries. Gold provides for the currency a solid and frangible security. It also helps those who have to travel abroad, for they can carry their own currency and be sure of its acceptance anywhere in the world. It is called the traditional or the orthodox gold standard.

Gold Bullion Standard:

Under this system, the value of the currency is fixed in terms of gold by making such currency convertible into gold (bullion, not coin) and vice versa. But gold does not circulate as coins. In the United Kingdom, under the Gold Bullion Standard, the- Bank of England was willing to buy any amount of gold at £3 17s. 9d per ounce 11/12 fine and to sell it in minimum amounts of 400 ounces at £3 17s. 10d. This was the same rate as before 1914. Gold was allowed freely to move into or outside the country. No gold coins circulated. The idea was to make, gold available only for foreign payments.

The Gold Bullion Standard was adopted in India in 1927 on the recommendation of the Hilton Young Commission. The currency authority was placed under an obligation to buy or sell gold at rate^ announced before harm subject to a minimum of 400 ounces of gold.

The Commission claimed that it had all the advantages of full gold standard minus its disadvantages:

(i) It is economical as no gold coins have to be minted and put’ into circulation. In their daily dealings, the public use a cheap medium of exchange, either paper money or rupees.

(ii) It makes for national prestige, because gold is made freely available both for use inside the country and for exporting it abroad and not merely for exchange purposes, as under the gold exchange standard.

(iii) The paper currency, under gold bullion standard, has a more tangible and solid backing. It is convertible into gold. But, under the gold exchange standard, one token (currency note) is convertible into another token (rupee).

(iv) It is also claimed that an automatic’ mechanism for expansion and contraction of currency is maintained. The currency will be expanded when gold is sold to the currency authority, and it will be contracted when gold is purchased by the public.

(v) It is considered that gold kept as a reserve in the central bank is much more useful and gives more valuable support to the national currency than gold put into circulation.

(vi) The gold bullion standard provided for the public the facility to obtain gold and liberty to melt or export it. But these merits of the gold bullion standard are more or less theoretical; at any rate, they turned out to be so in the case of India. For the average man, the convertibility of notes into gold was a farce, for who could bring sufficient paper money to purchase 400 ounces of gold (400 ozs = 1,065 totals)? Thus, under gold bullion standard, automatic expansion and contraction of currency was not brought about. In 1931, England went off the gold standard and so did India. The gold bullion standard made an exit ‘unwept, un-honoured and unsung’.

Gold Exchange Standard:

It is a gold standard for making foreign payments only; inside the country, the people use token coins and paper notes. For making foreign payments, the external value of the home currency is fixed in terms of a foreign currency that is convertible into gold. The currency authority of the home country is ever prepared to make available the foreign currency (which is convertible into gold) in exchange for home currency.

Also, when the home country’s nationals receive payments from abroad in terms of currencies convertible into gold, the currency authority of the home country converts it into home currency.

Two reserves are kept to ensure the smooth working of this system: One reserve is kept in the form of the home currency inside the country and another reserve is kept at a foreign center in gold. When the home country has to receive payments from abroad, then gold or foreign currency convertible into gold is paid into the reserve kept at the foreign centre and, in exchange, the internal currency is issued from the home reserve.

When payments have to be made abroad, then the internal currency is paid to the currency authority within the home country and is put into the home reserve. The currency authority gives in exchange gold out of the reserve kept at the foreign centre.

The gold exchange standard was in operation in India from 1907 for about 1907 years, when during the First World War it broke down. After the war (in 1920), it was again tried [at a higher exchange rate of 2sh. (gold) instead of the pre-war 1sh. 4d.] but had to be given up. Under this system, the exchange value of the rupee was fixed in terms of British pound sterling which was on gold standard.

Defects:

(i) The gold exchange standard is too complicated and far from simple,

(ii) Such a system cannot inspire popular confidence,

(iii) It was not automatic: in its operation, it depended too much on the will of the currency authority,

(iv) Besides, it lacked elasticity,

(v) There was also unnecessary duplication of the reserves there were three reserves in India the Gold Standard Reserve, the I Paper Currency Reserve and the Government of India balances and all these three reserves had their counterparts in Britain,

(vi) Perhaps the most serious defect of the system is that is makes the currency policy of one country subservient to that of another country. Under this system, the Indian rupee became subject to all the misfortunes to which the English currency may have been subjected,

(vii) Since under it a large part of the foreign reserve is kept in a foreign country’s currency, there is always the danger of the depreciation of that foreign currency in which the reserve is kept.

Gold Parity Standard:

The latest to enter the list of gold standards is the gold parity standard. This is the type which is supposed to prevail under the aegis of the International Monetary Fund. Under this system, no gold coins are put in circulation. Gold does not serve as a medium of exchange. The internal currency consists largely of notes and some form of metallic money but certainly not of gold; nor is these notes convertible neither into coins as under the full gold standard, nor into gold bullion as under the bullion standard, nor into particular foreign currency based on gold as under the gold exchange standard.

But the only respect in which gold comes into play under this system is that the currency authority takes upon itself the obligation of maintaining the exchange rate of the domestic currency stable in terms of a certain quantity of gold. This is the type of gold standard which the member countries of the I.M.F. are supposed to have. On January 16, 1975, however, the I.M.F. decided to abolish the official price of gold. This put an end to the role that gold had played for 30 years in the international monetary system.

Advantages of Gold Standard:

(i) It is an objective system and is not subject to changing policies of the government or the currency authority.

(ii) It enables the country to maintain the purchasing power of its currency over long periods. This is so because the currency and credit structure is ultimately based on gold in the possession of the currency authority.

(iii) Exchange-rate Stability. Another important advantage claimed for the gold standard is that it preserves and maintains the external value of the currency (rate of exchange) within narrow limits. As a matter of fact, within the gold standard system, it provides fixed exchanges, which is a great boon to traders and investors. International division of labour is greatly facilitated.

(iv) It gives, in fact, all the advantages of a common international currency. It establishes an international measure of value. As Marshall pointed out, “the change to a gold basis is like a movement towards bringing the railway gauge on the side branches of the world’s railway into unison with the main lines”. This greatly facilitates foreign trade, because fluctuations in rates of exchange hamper international trade.

(v) Automatic Adjustment of Balance of Payments. It is further claimed that gold standard helps to adjust the balance of payments between countries automatically. How this happens may be illustrated by a simple example. Suppose Great Britain and the U.S.A. are both on gold standard and only trade with each other and that a balance of payments is due from Great Britain to the U.S.A. Gold will be exported from the former to the latter.

The Bank, of England, which is the Central bank of the country, will lose gold. It will contract currency in Great Britain and bring about a fall in the price level there. Price level in the U.S.A. will rise due to larger gold reserves and the resultant expansion of currency and credit. Great Britain will thus become a good’ market to buy from and a bad market to sell in.

Conversely, the U.S.A. will become a good market to sell in and a bad market to buy from. British exports will be encouraged and imports discouraged. The U.S. exports will be discouraged and imports encouraged. The balance of payments will tend to move in favour of Great Britain until equilibrium is reached. It is in this way that the movement of gold, by affecting prices and trade, keeps equilibrium among gold standard countries. More of this later.

(vi) Gold Standard inspires confidence and contributes to national prestige, for “so long as nine people out of ten in every county think the gold -standard is the best, it is the best.”

Disadvantages:

  1. Costly:

Gold Standard is costly and the cost is unnecessary. We only want a medium of exchange; why should it be made of gold? It is a luxury. ‘The yellow metal could tickle the fancy of savages only’.

  1. Not Stable:

Even the value of gold has not been found to be absolutely stable over long periods.

  1. Not Elastic:

Under the gold standard, currency cannot be expanded in response to the requirements of trade. The supply of currency depends on the supply of gold. But the supply of gold depends on the success of mining operations which may have nothing to do with the factors affecting the growth of trade and industry.

  1. Not Automatic:

Recently, even the gold standard has been a managed standard. The central banking technique has been applied deliberately to control the working of the gold standard. It is thus no longer automatic as it was claimed to be.

  1. Sacrifices Internal Stability:

Gold standard has also been charged with sacrificing internal stability to external (exchange) stability. It is the interna­tional aspect of the gold standard which has been paid more attention to.

  1. Gold Movements Affect Investments.

Another disadvantage is that “gold movements lead to changes in interest rates; so that investment is stimulated or checked solely in order to expand or reduce money income”(Benham).

  1. No Independence.

Independent policy under this system is not possi­ble. A country on a gold standard cannot follow an independent policy. In order to maintain the gold standard or to restore it (as in Great Britain after World War I), it may have to deflate its currency against its will. Deflation spells ruin to the economy of a country. It brings, in its wake, large-scale unemploy­ment, closing of works and untold suffering attendant on depression.

Working and Abandonment of the Gold Standard:

Gold standard worked, on the whole, smoothly till the war of 1914-18, because the countries concerned did play the game of the gold standard. It had to be suspended during the war and was restored in most countries when the war was over although many countries now went in not for the full-blooded gold currency standard, but for its other versions, viz., gold exchange standard or gold bullion standard. The economic environment had, however, changed so much that within a decade of its restoration, the gold standard broke down in country after country and had to be abandoned.

Why Gold Standard Broke Down:

The break-down of the gold standard is attributed to several causes:

(i) In the inter-war period, gold came to be unevenly distributed among the countries of the world, the U.S. and France monopolizing the bulk of it. The result was that the supply of gold was insufficient in other countries to enable them to maintain gold standard.

(iii) Stringent restrictions on foreign trade, especially imports, created balance of payment problems for many countries. Not having enough gold to cover the gap, they abandoned the gold standard.

(ii) Gold standard was suspended in Great Britain in 1931 when it could not stand large-scale withdrawal of gold from it by France.

(iv) The gold receiving countries, like the U.S.A., did not play the gold standard game. That is, they did not observe the rules of the gold standard by expanding their currency corresponding to the receipts of gold to avoid inflation and imports. This would have resulted in gold leaving the country for which they were not prepared.

(v) Owing to enormous growth of international indebtedness and huge amounts of interest payments and strong trade unions resisting wage-cuts, the economic structure of the various countries had become rigid. The result was that the prices no longer moved in the, direction warranted by gold movements. In these, circumstances, gold standard ceased to be workable.

(vi) Gold standard had become a ‘fair weather friend’ and collapsed when-ever there was an economic crisis. It was not considered advisable to cling to such a system.

(vii) Since gold movements (which are associated with a gold standard), caused inconvenient changes in interest rates and resulted in economic fluctuations, gold standard had become untenable.

(viii) In the inter-war period, a large volume of short-term capital moved for safety and profit from country to country. Big flows of this ‘hot money’ some-times necessitated large gold movements out of the country. Countries with slender gold reserves were unable to stand such movements and maintain the gold standard.

Future of Gold Standard:

It is unlikely that, after the experiences of the inter-war period, gold standard will be established in the conventional sense by any country of the world. The experience of the inter-war period, however, showed that the gold standard required quite a fair degree of management and still greater degree of co-operation of the gold standard countries for its smooth working.

“The gold standard will work if every nation is content to march in step with every other.” Unless the rules of the gold standard are observed, it cannot function successfully. Also, the rigidities of the economic system stood in the way of proper adjustment of price levels and costs necessary for its successful working.

Rules of Gold Standard:

These rules were as under:

(i) There should be no restrictions imposed on the free movement of goods between the countries, so that disequilibrium in the balance of payments can be adjusted mainly through the movement of goods.

(ii) Economic structure should be elastic, so that prices and wages readily respond to gold movements.

(iii) The government or the Central bank should not do anything to neutralize the effects of gold movements so that currency is allowed to expand or contract in response to gold movements.

These rules were honoured more in the breach than in their observance. The break-down of the gold standard was, therefore, inevitable. There is little hope of these rules being observed in the future. It requires a high degree of international co-operation. But with this co-operation, a managed system can be devised in which gold will not play a prominent role.

People have lost faith in the capacity of gold to maintain stability either of price level or of exchange. Gold has ceased to enjoy its old prestige; managed currency, on the other hand, has been successfully tried in several countries (e.g., the U.K.).

Towards the end of the Second World War, the world statesmen met at Bretton Woods in the U.S.A. to thrash out suitable monetary system for the postwar world. The result was the creation of the International Monetary Fund.

The fund is supposed to achieve all the advantages of a gold standard without its disadvantages by international co-operation. In it gold still played a role but not such a dominant role as it did under the gold standard. But since 1975, even that dominant role has been taken away. Thus gold standard of the old type has no future.

(c) Paper Gold Standard or the SDR Standard:

The latest to enter the list of monetary systems is the Paper Gold standard or the SDR Standard. The IMF system or the Gold Parity Standard had all the merits minus the demerits of the gold standard. It ensured exchange stability without the country having to undergo the expense of maintaining a costly currency system. The IMF also sought to provide multilateralism. It facilitated convertibility of currencies and provided adequate and convenient currency reserve (in the form of U.S. $) for the use of member countries.

However, the fast changing circumstances necessitated changes in the IMF system. In September 1967, the Board of Governors of the IMF approved a plan for a new type of international asset known as the SDRs (Special Drawing Rights). Under this Scheme, the IMF is empowered to allocate to various member countries Special Drawing Rights (SDRs) on a specified basis, which in effect amounts to raising the limit up to which a member country can draw from the IMF in time of need.

Besides, the SDRs supplement gold dollars and pounds sterling which most countries now use as monetary reserves. Thus, SDRs can be used unconditionally by the participating countries to meet their liabilities, and they are not backed by gold.

The resources of the new scheme are not a pool of currencies but simply the obligation of participating members to accept the SDRs for the settlement of obligations among themselves. Thus, SDRs serve as international money as good as other reserve currencies.

In January 1975, the IMF abolished the official price of gold and SDRs have become instead the basis of the present international monetary standard. Since the SDRs are not convertible into gold, the SDR standard may alternatively be designated as Paper Gold Standard.

Characteristics of a Sound Monetary Standard:

We are now in a position to offer remarks as to which monetary or currency standard out of those discussed above is the best. One may easily say, copying Alexander Pope: “About forms let fools contest; that which is administered best is the best.” There is no doubt that almost every system has been in operation in one country or the other at different times and with varying success.

A good system, however, should have the following characteristics:

(i) It must be simple so that people can easily understand it. The currency has to be used by all the people. If it is complicated, the people will not understand it and will not be able to work it well.

(ii) A good currency system must help to keep prices reasonably stable, thus toning down extreme fluctuations in the purchasing power of the currency. Rapid price changes are harmful to trade, industry and the people at large.

(iii) It must also maintain the external value of the currency of the country. If the ratio of the rupee with the foreign currencies is maintained stable, India’s foreign trade would flourish. Economists have, however, come to hold now that the stability of internal prices is to be preferred to the stability of foreign exchange ratio.

(iv) The system must be economical. The gold standard is a very costly standard. That is the reason why it had to be given up. A paper currency system supported by a type of standard money and money of account in which the people of the country have full confidence is an ideal system.

(v) The system should be automatically elastic so that the currency should expand when needed and contract when the need is over. Only an elastic currency can best answer the needs of trade and industry. When, as a result of rapid economic development, trade expands, the currency must expand sufficiently.

(vi) Finally, the currency system must inspire confidence. If the people have no faith in it, they will not accept it.

Indian System:

The Indian currency system as a whole commands the confidence of the people of India. It is economical and reasonably steady internally and internationally. It is also elastic. We can then safely assert that it is a good monetary standard.

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