[Editor’s notes: Footnotes in the original are omitted.]
When forced to be on a gold standard, governments promote the gold exchange standard— especially if it is the government whose currency is to be the world’s reserve currency. The gold exchange standard is a pseudo gold standard that gives the illusion and prestige of being on the gold standard without the discipline of the gold standard. Governments like the gold exchange standard because it allows them to manipulate their currency domestically. It allows the reserve currency country to export its inflation.
Greaves gives the following description of the gold exchange standard:
(1) The domestic monetary unit is legally defined as the equivalent of a certain fixed weight of gold, called the parity rate; (2) Only money-substitutes are held by individuals and used in domestic business transactions, i.e., there are no domestic gold coins; (3) The national monetary authority maintains the value of all money-substitutes at the legally set parity rate by redeeming in gold such money-substitutes as a holder desires to use abroad at the legal parity rate or at rates between the gold export and import points . . . of such parity; (4) The national monetary authority, as the only official domestic holder of gold and foreign exchange, exchanges all imports of gold and foreign exchange into domestic legal tender money substitutes at the legal parity rate or at rates between the gold export and import points of such rates.
The gold exchange standard makes it possible for the national monetary authority to keep a part of its reserves not in gold but in foreign bank balances which are redeemable in gold.After World War I, the term came “to mean a monetary system for which reserves are held in foreign currencies convertible into gold, as well as in gold itself.”
Bradford describes the gold exchange standard as follows:
Under a full gold exchange standard, the moneys of the country are not redeemed in gold coin or bullion, but in drafts payable in gold in some foreign gold standard country. As a result, although gold can be exchanged for the money of the country at a fixed price, it is impossible to turn the money into gold on the spot except by the payment of a premium equal to the cost of shipping gold from the foreign gold standard country to the country on the gold exchange standard.
The price of gold in a gold exchange standard country may vary, therefore, by an amount equal to the cost of importing the gold. Nevertheless, these limits are rigidly fixed and relatively narrow, so that it is really the value of a given weight of gold which fixes the value of the moneys of the country.Governments created the gold-exchange standard. It is a politically created system and not a product of the markets. It allows governments and their central banks to manipulate international gold flows for political reasons. The government holds the reserves of its foreign claims in gold. Most of the world’s gold ends in the vaults of a few central banks. Gold is subordinated to governmental policies and goals. Because of domestic inflation, against which it offers little resistance, the gold-exchange standard becomes unstable and dysfunctional. Although it offers little resistance to the inflation that a government can generate, it offers enough to cause governments to abandon it within a decade or two.
Under the gold exchange standard, the domestic economy operates on a fiat paper monetary system. Domestically, paper money is not redeemable in gold coin or bullion.
The only way that paper money can be converted into gold is for a foreign government, its central bank, or another approved institution to demand that the country whose currency it holds redeem it in gold. Then the government redeeming the currency has to pay the cost of shipping the gold.
Under the gold exchange standard as operated in the twentieth century, the currency of one country is declared to be the reserve currency. (During the 1920s, the reserve currency was the British pound. Between 1944 and 1971, the U.S. dollar was the reserve currency.) The reserved currency country defined its monetary unit to equal a certain weight of gold. Other countries defined their monetary unit to equal so many units of the reserve currency. In reality the gold exchange standard of the 1920s was a British pound standard. The one after World War II was really the U.S. dollar standard.
Before World War I, a few countries that were not on the gold-coin standard had adopted some form of the gold exchange standard. Among them were Austria-Hungary, Russia, Japan, Argentina, and India. They did not want to adopt a gold-coin standard. Yet they wanted the stability in foreign trade and exchange that the gold-coin standard provided. They sought this stability in the gold exchange standard.
After World War I other European countries adopted a gold exchange standard. Many countries, such as Germany, Italy, and Russia, had depleted their gold stock. They did not want to or could not acquire enough gold to maintain a gold stock sufficient to redeem their domestic currencies. An advantage identified by Robertson is that the reserve currency “can easily and speedily be released for investment in more lucrative securities, and again built again out of the proceeds of the sale of such securities, in accordance with the changing needs of the situation; whereas the trundling of gold to and from market is a relatively cumbrous and expensive proceeding.” Thus, the gold-exchange standard can be a convenient and profitable system for the government involved. It can be so convenient and profitable for governments that even countries with adequate gold stocks, such as France, turned to it.
During World War I, Great Britain had suspended the gold standard. Like the other warring countries, it paid for the war with inflation. After the war, it wanted to regain the monetary prestige that it had before the war. To do this, it believed that it had to return to the gold standard at its prewar rate, about $4.86 per ounce of gold. However, because of its wartime inflation, it could not without a significant devaluation of its currency. It did not want to devalue the pound. To avoid devaluation, Great Britain persuaded the other European countries to adopt the gold exchange standard. This was accomplished at the Genoa Conference of 1922.
In 1925, Great Britain initiated the system outlined at the Genoa Conference. During the following three years, most important countries join the gold exchange system. The notable exception was the United States. However, the Federal Reserve did conspire with the Bank of England to ensure the system would operate without formal devaluation of the pound. To prevent devaluation of the pound, the Federal Reserve had to inflate, i.e., devalue the dollar.
Rothbard described the adopted standard as follows:
Instead of each nation issuing currency directly redeemable in gold, it was to keep its reserves in the form of sterling balances in London, which in turn would undertake to redeem sterling in gold. In that way, other countries would pyramid their currencies on top of pounds, and pounds themselves were being inflated throughout the 1920s. Britain could then print pounds without worrying about the accumulated sterling balances being redeemed in gold.Great Britain could export its inflation almost without penalty. The inflation could continue as long as no country demand redemption or until the economies became so distorted that they broke down. The system finally collapsed in 1931 into the Great Depression. (The inflation caused under the gold exchange standard lead to the Great Depression.)
The gold exchanged standard adopted after World War I was a partial gold exchange standard. Countries maintained part of their reserves in gold and part in foreign currencies. “In such instances, if gold was wanted for use in the arts it could be obtained at a fixed price for that purpose. On the other hand, if the gold was needed for export, the central bank had the option of redeeming its notes in a draft payable in gold in a foreign center.” Thus, in theory at least, “the value of the gold in the money unit fixed the value of the other moneys as closely as in a gold coin or gold bullion standard country.”
In 1944 under the lead of the United States, the leading countries of the world again adopted a gold exchange standard. This system became known as the Bretton Woods international monetary system. Under this system, foreign countries fixed (pegged) their currencies in the U.S. dollar. They maintained this fixed rate of exchange by buying and selling dollars in foreign-exchange markets. The U.S. dollar was fixed (pegged) in gold at $35 per ounce of gold. “Only the United States undertook to buy and sell gold at a fixed rate of exchange in transactions with foreign monetary authorities.” Devaluation was only allowed when a country had inflated at a rate so much greater than the United States that it had depleted its dollar reserves.
The Bretton Wood system collapsed because during the 1950s and especially the 1960s the United States were inflating faster than most other countries. As a result, these countries accumulated excessive quantities of dollars. When they had accumulated too many dollars, they began to demand gold for dollars. Collapse of the system came in 1971 when the United States refused to redeem in gold the dollars for which foreign countries demanded redemption. This action ended the Bretton Wood gold exchange system. (Before 1960, the U.S. monetary gold stock exceeded the liabilities of the U.S. government. By 1971, its monetary stock was less than one-sixth of its liquid liabilities.) With the collapse of the gold exchange system, the world entered the realm of pure fiat money with floating exchange rates determined by supply and demand on foreign-exchange markets.
Under the gold exchange standard as it operated in the 1920s and under Bretton Wood, countries were not on a gold standard. They were on the British pound standard in the 1920s and the U.S. dollar standard under Bretton Wood. Their reserves were mostly British pounds and U.S. dollars, and not gold.
Furthermore, the gold exchange standard allows double counting of gold. Each ounce of gold backing the reserve currency is counted as backing the reserve currency. It is also counted as backing the currencies of foreign countries whose currencies the reserve currency backs.
Because countries fixed their currencies to the reserve currency, the gold exchange standard tied the together all their currencies. This fixed exchanged caused the prices and incomes of the difference countries to be interconnected.
Countries on the gold exchange standard do not adjust their currencies to the market valuation of gold. They adjust their currency to the reserve currency, which is based on gold. Thus, one purported advantage is that during financial crisis, these countries do not have to import gold. The crisis is resolved with the domestic currency, which has no direct dependency on gold. (If the country had been operating of the gold-coin standard, the crisis probably would not have occurred.)
Under the gold exchange standard, governments control the international movements of monetary gold. This control allows governmental leaders to conspire to coordinate their domestic inflation of paper money. They do this because only governments or their central banks can redeem the reserve currency in gold. The reserve currency country can inflate with little danger of losing gold because their currency expansion increases the reserves of other countries. This increase allows the other countries to inflate. Only when the reserve currency country begins inflating at a rate much greater than other countries does it begin to loss gold, which eventually leads to the collapse of the system.
The gold exchange standard encourages the reserve currency country to pay for its welfare-warfare state through inflation instead of taxation. Under the gold exchange standard, the reserve currency country exports much of the excess currency to buy foreign goods. Foreign governments need to obtain the reserve currency to pay for their imports. To prevent the system from collapsing, they must accumulate the excess reserve currency. Thus, domestic prices in the reserve currency country, such as the Untied States between 1944 and 1971, do not rise as high as they otherwise would.
The gold exchange standard encourages devaluation of currencies because it makes devaluation easy. A country has no gold coins to call in, i.e., to steal from the people, or outlaws as money as Roosevelt did in 1933. Gold coins do not circulate in most countries on the gold exchange standard. Thus, it allows the devaluating country to cheat its international creditors by reducing the gold that it was obliged to pay.
Individual holders of the reserve currency cannot redeem their paper money. They may be allowed to own gold and gold coins, but neither the banks nor the government will redeem either the reserve currency or its own currency in gold on demand. Only foreign governments and their central banks or other governmentally approved agencies can exchange the reserve currency for gold and then only for large bars, 400 ounces or more. This restriction on redemption takes the control the money supply from the people and gives it to those who really control the government.
A major problem with the gold exchange standard is that it gives the government the power to manipulate its currency. Of coarse, this is a major reason that governments prefer the gold exchange standard to the gold-coin standard, which greatly restricts government’s ability to manipulate the country’s money. Governments have used the gold exchange standard to carry out their inflationary monetary policies.
The gold exchanged standard relies on a country’s monetary gold being concentrated in a single institution. A central bank places the country’s gold under its control and usually in its possession. (During the gold exchange standard under Bretton Wood, the U.S. government possessed the country’s monetary gold.) Thus, central banking is a prerequisite to the gold exchange standard.
The gold exchange standard bridges the gap between the gold-coin standard of the nineteenth century and the pure fiat monetary standard of today. Under the gold-coin standard, the exchange rate of foreign currencies is fixed in the weight of gold in the coin. Under the gold exchange standard, countries fix their exchange rate in the reserve country’s currency, which in turn is fixed in gold. This system allowed a great deal of inflation until countries start redeeming the reserve currency for gold.
1. Percy L. Greaves, Jr., Mises Made Easier: A Glossary for Ludwig von Mises’ Human Action (Dobbs Ferry, New York: Free Market Books, 1974), p. 53.
2. Ibid., p. 54.
3. Frederick A. Bradford, Money and Banking (New York, New York: Longmans, Green and Co., 1938), pp. 25-26.
4. D.H. Robertson, Money (Chicago, Illinois: University of Chicago Press, 1957), p. 64.
5. Murray N. Rothbard, The Mystery of Banking (Second ed. Auburn, Alabama: Ludwig von Mises Institute, 2008), p. 244.
6. Bradford, p. 26.
7. Lawrence H. White, Competition and Currency: Essays on Free Banking and Money (New York, New York: New York University Press, 1989), p. 144.
8. Ibid., p. 145.
[Editor’s note: List of references in original is omitted.]
Copyright © 2010 by Thomas Coley Allen.
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