Essay: The currency of gold

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  • Subject area(s): Finance essays
  • Reading time: 5 minutes
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  • Published on: November 15, 2017
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Prior to the 1870s, European countries faced challenges trying to maintain smooth financial operations under various gold, silver, and bimetallic standards. Discoveries of silver, technological advancements, and France’s loss to Germany in the Franco-Prussian war were among the factors that eventually gave way to the emergence of the Classical Gold Standard in the 1870s. After experiencing a series of numerous rapidly evolving monetary systems, countries such as Germany, the Netherlands, France, Belgium, and Switzerland became the first to commit to a monetary system regarded as the classical gold standard. The monetary authorities of these countries practiced the classical gold standard with an obligation to guarantee the value of its specified legal tender through convertibility to gold (Redish 1990). As more countries joined the gold standard, a homogenous international monetary system was born. The most notable characteristics of the classical gold standard system include the use of a standardized commodity for monetary functions, the achievement of long term price stability, trade with fixed exchange rates, and the role of central banks. Each of these elements of the classical gold standard presented countries with benefits and costs to their overarching goals of economic prosperity.
Gold emerged as an appropriate metal for a commodity standard because it possessed durability, recognizability, divisibility, and portability. Early economic writers had stressed the importance of such properties in order for money to be a suitable medium of exchange, and gold satisfied these requirements (Bordo 1981). Standardized commodity money proved beneficial for closed economies on the gold standard, especially when one considers that gold as a commodity itself could self-regulate its value, achieving its own market equilibrium price and quantity as a response to competitive market forces.

The ability of gold to respond automatically to market forces in a closed economy was beneficial for price stability, but it also brought complications. High resource costs of producing gold presented challenges to countries hoping to maintain a full commodity money standard. Often, gold production became too costly for strict adherence to the gold standard, and fiat money had to be introduced as a substitute for gold (Bordo 1981). Additionally, worries surrounding the amount of gold in circulation occasionally emerged. An instance of such concern took place in the United States in the 1890s, when the public “feared that there might come a time when the Treasury would lack the specie required to convert dollars into gold” (Eichengreen 1996). The use of a fixed, tangible commodity for currency or backing of currency was beneficial for standardizing monetary systems, though its high costs did create some of these technical concerns.

Perhaps the most widely regarded benefit of the classical gold standard was its long term price stability. The aforementioned ability of gold to self-adjust its value helped to regulate market price levels for the goods it would be used to purchase. Under the gold standard, decreases in overall price levels coincided with an increase in the purchasing power of a fixed amount of gold. Thus, the production of gold became more profitable, increasing the amount of gold in circulation to raise price levels enough to fully compensate for the initial decrease.

When people commend the gold standard’s price stabilizing abilities, however, they fail to acknowledge the severe lag in the process of price stabilization within an economy. In actual practice, it would take many years for such price adjustments to reach full effect, as each link of the chain was a response to a preceding link that had to be in practice in order for any responses to be triggered. Though they took time to become activated, these automatic price stabilizers minimized inflation. So, price stability was more achievable in the long run than it was during short term financial fluctuations.

Today, it is debated whether or not the absence of noticeable inflation during the classical gold standard was indeed optimal. Without slight inflation, consumers had little incentive to spend their money sooner, lessening the potential multiplier effects associated with consumption spending. This consequently may have hindered the ability of economies backed by the classical standard to grow to their full potential domestically. Additionally, when faced with zero inflation, some companies may have been hesitant to increase their wages (Milligan 2015). Again, this did little to stimulate GDP. These costs of the classical gold standard’s stable price levels targeted potential economic growth and should not be ignored.

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