the gold standard

Chapter 2, International Financial Mgmt, Eun et al

3460.02 notes by A.P. Palasvirta, PhD

Bronze

Silver

Gold

U.S. Dollar Standard

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Bank of Amsterdam (15th century)100% reserves of gold and silverDepositors brought gold, silver

Were given warehousing certificates for the amount of gold, silver minus a charge

Depositors would use the warehousing certificates as moneyLower transactions costsEasier to use

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Gold 100%

Warehouse receipts

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Assets Liabilities

Queen Elizabeth I 1563 to 1603Created the Bank of England

Held partial reserves of gold and silver The rest were in treasury bills

This was not a strict gold standard, but a gold exchange standard This bank could not refund all claims for gold

with gold

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Gold30 – 40%

T-bills60 – 70%

http://www.gata.org/node/104

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currency

Assets Liabilities

Fix the value of the unit of accountSomething immutable

Ounce of silver Ounce of gold

Gold standardUnit of account the troy ounceMedium of exchange

Coinage Gold certificates

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If the cost of mining gold increasesdeflation

Value of gold increases Value of other goods remain constant Prices decrease

If the cost of mining gold decreases Inflation

Value of gold decreases Value of other goods remain constant Prices increase

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1/P

Gold

1/P

Demand

Supply

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1/P

Gold

1/P

Supply

DemandDemand

Two markets for gold official government market Legal unofficial private markets

Parity Price greater than market price government’s price (parity) the high price external markets price the low price

trader buys low sells high buys externally sells to government

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Par

D1

S1

Pg

Pg

Qg

D2

S2

GovernmentMarket

Private Market

Private market gold supplies decrease holders of gold will sell first to the government arbitrageurs will buy up stocks and sell to the

government excess supply will dry up bringing market

price to equal the parity price Government gold supplies will increase

increases the money supply decrease the value of money (inflation)

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Countries fix parity price of goldusd parity price = $20.67/ounceuk parity price = 4.2474£/ounce

usd/uk£ = 4.8665$/£ They allow arbitrage between two markets

parity price of gold at Central Bank free market price of gold

De facto single currency the ounce of gold many units of account periodic falling off of the gold standard

Balance of Payments deficits settled with gold

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Mechanism which mitigates BOT surplus gold is paid to pay for excess of exports to

imports gold coming into the central bank increases

money supply inflation in the economy

your goods now more expensive in foreign markets

foreign goods less expensive to you Price-specie flow mechanism

BOP balances settled in gold Money adjusts Prices adjust International prices converge

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Gold

T-bills

gold increases due to BOT surplus

cash

currency

Money supply increases

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Assets Liabilities

Gold backs all money prices move relative to

excess demand for gold (economic growth) deflation

excess supply of gold (new gold finds) inflation

Treasuries have no independent monetary policy

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Fixed parity price (not fixed value)Unit of account varied with the cost of

mining gold Often the unit of account appreciated (increased

in value) as gold supplies were harder to mine With new gold discoveries, the unit of account

depreciated (decreased in value) as the cost of mining gold decreased

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All currencies fixed to gold Gold is the de facto currency

single world wide currencyall international trade is denominated in

gold No need to hedge exchange rate

volatility since exchange rates are constant

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When CBs execute a monetary policydiscipline of the gold standard is goneafter WWII governments ran inflationary

policies interest rate policies employment policies inflation sometimes running at 200% or more

Exchange rates fluctuatecreating uncertainty for trade

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Colonizers (France, Spain, England, Portugal)Gold standard

ColoniesSilver standard

Gresham’s LawBad money drives out good

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Germany reparations heavy and denominated in Deutsche Marks not goldGermany inflated their currency in order to

reduce the cost of reparations Inflation 1 trillion%

United States had most of the goldFrance, England paid for war materials

bought from the U.S. in gold Stock market crash of 1929

Led to protectionism Sterilization polices Depression

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WWII U.S. again the supplier of arms got most of the gold in the world

1944 end of the was the Gold Exchange Standard

The U.S. dollar became the reserve currency Traded at par value with all currencies part of

system Balance of payments imbalances were

cleared with U.S. dollars instead of gold Cheaper to ship dollars instead of gold Countries could earn interest on their foreign

exchange reserves Special Drawing Rights (SDRs)

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Creation of the International Monetary Fund (IMF) International clearing house for exchange

transactions with SDRs and dollars Special Drawing Rights

Exchange reserves held at the IMFValue weighted average of basket of major

currencies Deutsche Mark (20%), franc (12%), pound (12%),

yen (16%), us dollar (42%)

The SDR as well as the U.S. dollar became the reserve currencies

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U.S. had to run a chronic BOP deficit to supply us dollars to the worlds economies

The fixed parities between currencies dependent on certain assumptions for all economiesMonetary policies alignedFiscal policies aligned

Revaluations necessary periodicallyMonetary policies of many countries very

expansionary

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US running inflationary monetary policy to finance Vietnamese warUS increase the dollar parity price

(devalued) twice DeGaulle demanded payment of BOP

surplus with the U.S. in gold

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January 1976 All currencies will float with respect to

each other

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Gold = $1,212.1 Silver = $18.411 Platinum = $1,548.7 Paladium = $462.7

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