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Gold Exchange Standard
The Gold Exchange Standard, as arranged in 1926, was a system first used in Holland, Austria-Hungary, Japan, India and Russia during the period between World War I and World War II. The Gold Exchange Standard was based on the recommendations at the conclusion of the Genoa Conference of 1922. In this conference, methods for the banking system to economize on gold were discussed.
As Different from the Gold Standard
The Gold Exchange Standard, should not be confused with the Gold Standard. The Gold Exchange Standard was a partial return to the Gold Standard. The Gold Standard was an internationally used currency standard used voluntarily by most nations until the begininning of World War I. However, the original Gold Standard was dropped so that governments could create unbacked paper currency to finance the war. This was the way major wars had been financed in the past. For example, during the Civil War of the United States of America, bills that lacked gold backing, called "greenbacks" (backed by green), were issued to finance the war. At the end of the Civil War war all of these greenback bills were honoured in gold by the government.
Under the Gold Standard, the currency of a nation was freely exchangable for a fixed weight of coined gold. In this way, any citizen of a country on the Gold Standard was able to go to a bank and redeem their paper bills for gold coins. Those gold coins were accepted as circulating currency alongside the bills. The banks were contractually obliged to honour any bills offered for redemption, issuing the gold that they represented. The bills of most countries were produced, engraved, and signed as if they were miniature contracts. Many bills carried inscriptions stating that the bank held the actual gold coins, and that a specific weight of gold coin will be issued upon redemption of the bill. The gold coins the banks were required to issue were sometimes quite small. This allowed most citizens to redeem their paper notes for gold coin. However, under the Gold Exchange Standard banks were not required to fulfil their obligations in the same way, allowing the banks to retain their gold.
In countries that adopted the Gold Exchange Standard, the primary monetary standard was still, ostensibly, gold. As far as the general citizenry of those countries were concerned, the process for redeeming their notes for gold was quite different. For many, the gold was inaccessable, and was not possible to put into circulation as currency. Under the Gold Exchange Standard most citizens had no choice but to use notes.
For nations that adopted the "Gold Exchange Standard", their national currencies were backed by United States currency, which was still backed by gold coins at $20.67 per troy ounce. Their currency was also, optionally, backed by gold bars -- but not gold coins. Neither US Dollars, nor gold bars, could easily circulate alongside non-US currencies.
The money of Britain under the GES was supposed to also be a reserve currency, as with the United States Dollar. However, the Pound Sterling was no longer fully backed by nor convertable to gold coins as it had been under the Gold Standard. Consequently, the Pound Sterling was backed by either US dollars or gold bullion bars. Neither the US Dollars, nor the gold bars were legal tender of Britain or Europe.
Gold bars are only good for amounts used in comparitively large transactions. A one ounce bar is roughly the equivalent of 8.5 half-sovereigns, each one of which would today (2005) buy about $50US of goods or services. Furthermore, gold bars, unlike coins, may need to be assayed for purity before being accepted - unlike gold coins which have stamps and milling over their whole surface, so gold bars are not freely accepted by the public in regular transactions the way gold coins were.
The result of this was that Britain redeemed pounds, not in gold coin as before, but in US dollars or gold bars, and European nations redeemed their currencies in pounds, rather than in gold as before. Hence, the two key currencies were the dollar and the pound, with only the US dollar redeeming their currency in gold coin.
This arrangement only lasted from 1926 until 1931. After World War II, under the Bretton Woods Agreement, a different version of the Gold Exchange Standard was again picked up. This ended finally in 1971. Thus, it is well known that the Gold Exchange Standard has been dropped twice in a fourty-year period of the 20th century.
The Gold Exchange Standard and Post World War I Depression
It is commonly believed that the collapse of the stockmarket in October 1929 in the United States triggered a world-wide depression, which led to deflation and a massive increase in unemployment. However, that point of view tends to be centered on the United States, and lacks a certain amount of historical perspective and understanding. It is important to recognise the global economic context of the time.
Prior to the first world war, despite their share of economic contractions, Britain was still recognised as the most powerful economy in the world. There are important economically historical details, centred on Britain, that indicate a global environment of significant economic upheaval and decline beginning at least as early as 1914, and reaching their peak at the commencement of the Great Depression.
There appears ot be unusual consensus in economic circles that worldwide depression was triggered by the costs and demands of World War I. Britain responded to the severe economic effects of war by radically altering it's basis for economic exchange three times inside a 17 year period. Britain did this during a major war, and then another two times during a lengthy economic depression in a post-war environment.
Upheaval in the British economy -- the worlds strongest economy at the time -- caused interruptions to their international trade, internal economic pressures, a general strike, social discord, and rising unemployment. The upheaval also precipitated interest rate hikes in the United States and rapid fluctuations in the amount of gold stored in the French, British and United States banking systems. This turmoil led to the adoption of The Gold Exchange standard in many European nations. Many of these nations had previously depended on the pound sterling due to it's historic stability.
Gold Exchange Standard Timeline
While the Gold exchange Standard only existed from 1925 until 1931, significant historical context is necessary to understand the subject. Resultingly this timeline begins in 1914, with the "Great War", World War I.
1914 - The Great War - Britain off the Gold Standard
The seeds of the adoption of the Gold Exchange Standard were planted when Britain chose to leave the Gold Standard. Britain had adhered to the Gold Standard, by and large, for over one hundred years before they chose to leave it during World War I.
Before 1914, London had been the world's financial center. When the war started in August of 1914 shipments to England of gold, silver, and goods from all over the world were immediately disrupted. The shortages put London's banks and stock exchange in crisis. To deal with the crisis they closed down for a few days. When the banks and stock exchange reopened, a debt moratorium was declared. The Bank Charter Act of 1844, fixing the bank reserve ratio, was suspended. This suspension of the Bank Charter Act put Britain unofficially off the gold standard.
As the war continued and the government's costs increased, the government used the suspended Bank Charter Act to pay off their war debts. They did this by simply printing more money - far in excess of gold reserves. This caused considerable inflation of the pound on their domestic markets, and noteworthy inflation of the pound on international markets.
By 1920, after the war was over, inflation had proceeded to such an extent that prices of goods in Britain had tripled, and the gold value of the British pound had fallen 10 percent on world markets. The pound had dropped from 7.313 grams of gold (US$4.86) down to 6.620g of gold (US$4.40).
1924 - The Effect of U.S, "Easy Money" on Britain
In 1924 the US Federal Reserve adopted the "easy money" policy, making it easier than it had been to get bank loans. The decision was made in order to combat a decline in domestic business activity and to encourage international capital flows. The "easy money" policy was also expected to help Britain, which was still believed to be the economic centre of the world, to import enough gold so that they could return to the gold standard the following year.
After the US easy money policy was instituted, British banks did experience significant gold inflows. This raised the likelihood of a return to the gold standard.
1925 - A Poor Gold Standard Implementation
The British economic troubles worsened after April 28, 1925, when England went back on the gold standard at the artificially high rate for the pound of US$4.86. This did not recognise the the larger amount of circulating British currency after the war. The true, or market, value of the pound at the time is estimated to have dropped to around US$3.50. Thus, the pound sterling became substantially overvalued vis-à-vis both gold and the US dollar.
This overvaluation caused British products to appear relatively overpriced in the world markets. The immediate effect of the British revaluation was to price their goods out of the world market. For instance, U.S. importers who had been paying US$3.50 to buy a pound sterling of British wool or coal now had to pay about 40 percent more. Naturally the sudden rise of British exports led to a drop in their demand.
Greshams Law came into play on this the newly formed international money market. International entities who held British pounds prior to the revaluation now began to dump them on the market in exchange for gold from British banks. This action netted the seller around 40% more gold on April the 28th than it would have on the day before, and began to cause undesirable outflows from the British banks of their newly acquired gold stocks.
This sudden drop in demand for all British goods came a time when England was still very heavily dependent on exports to rebuild their post-war economy. Britain experienced imports chronically in excess of exports accompanied by persistent balance-of-payments deficits. Naturally this caused further outflows of gold reserves to pay for the trade imbalance. British banks, factories and mines were hit hard.
These problems were not caused by the gold standard as such, but by the unrealistic overvaluation of the pound by the imposition of uneconomic legal tender laws in Britain.
1926 - Britain Shows Economic Stress
The return to the gold standard at the pre-war level was clearly unrealistic. It had increased the purchasing power of the pound, and hence had raised the cost of British labor and exports by 10 percent overnight. Consequently all exporting industries, mines in particular, were in a tricky situation. Demand for mining exports had dropped sharply after the overvaluation of the pound, but the domestic costs of mining remained largely the same.
To maintain international competitiveness, or at least to keep operating, mining costs had to drop while efficiency needed to rise. Simultaneously, historic share earnings and investor confidence somehow had to be maintained. The alternative was grim - drops in revenue and subsequent mine closures and bankruptcies in the industry. These problems would not have arisen if the value of the pound had been set at around US$3.50, rather than US$4.85.
It was decided by mining industries that the wages they were paying would have had to be adjusted downward, and working hours increased. The situation was explained -- a drop in mining costs was necessary to account for the overvaluation of the pound in the previous year, and that wages for production of exports had to be adjusted to maintain liquidity. However, workers buy their essentials from the domestic market, not the international market, and would see no drop in the prices they paid with their reduced income levels. Consequently these explainations fell on deaf ears, and were criticised as a feeble attempt to placate and manipulate workers.
The workers, many of whom were unionised, were understandably outraged by the attempt to lower their wages by 10-15%. They resisted the proposed reduction in wages, refusing to work for less.
A Conference of Trade Union Congress met on 1st May 1926. The result of this was that a general strike was proposed to begin two days later. The action was to begin in mining and associated industry, but was planned to extend to other workers. However, this was not to be the case. Due to a lack of public support this strike only lasted nine days, however the general strike did seriously disrupt industry and consequently produced a more urgent need to cut costs.
Most mines were closed by this time. Many workers had to leave the workforce, and went on the dole, and many others continued to go out on strike until around August of 1926.
1925 - Other Nations and the Gold Exchange Standard
Around the same time as the revaluation of the British pound, other European nations returned to gold-convertible currencies as well. Unfortunately they created a weak monetary system known as the "gold exchange standard," where currencies were pegged primarily to the British pound and the American dollar rather than to gold itself. The gold exchange standard created a pyramid of paper claims upon other paper claims, with gold playing a far lesser role.
1927 - U.S. Federal Reserve Bank Attempts to End Pound Revaluation Woes
As a result of the british pound revaluation, Britain suffered a deflationary depression for the rest of the 1920s. Moreover, to help Britain return to gold at the prewar exchange level, the Federal Reserve had pushed down interest rates in 1924, and did so again 1927, cutting them from 4% to 3 ½%. This ignited a fateful inflationary boom in the U.S. In 1927 the rate was cut partly in order to help Britain to stay on the gold standard. However the supply of credit was eased just as a speculative boom was starting on the stock market.
1929 - The Great Depression Begins
Through 1928 and 1929 the US Federal Reserve's "easy money" policy had finally triggered a stock market boom in the US. The Federal Reserve did not take effective action to prevent the boom from getting out of control.
On 24 October, 1929 the New York stock market crashed. The Federal Reserve, whose easy money policy stoked the boom, suddenly tightened credit. This sudden tightening of credit had the effect of causing and then worsening a slump in the US economy, marking the begining of the Great Depression.
Widespread bank failures and restrictions on lending by the surviving banks caused businesses of all kinds to go bankrupt. The US net national product fell by over half during the period from October 1929 until the end of 1930.
Throughout early 1931 there were many bank failures in Europe, in particular some of the major banking institutions in Germany. This resulted in the remaining German banks restricting their lending.
By September 1931 it was recognised that the US and France held 75% of world's gold stock. During the previous 6 weeks over £200 million worth of gold (around £12 billion in 2003 money) was withdrawn from London, causing another reserve crisis for Britain.
1931 - Britain Drops the Gold Exchange Standard
Finally, on September 20, 1931, England announced that she would again suspend gold payments and go off the gold exchange standard. The consequences were disastrous. This triggered the move from classical to Keynesian economics. The Commonwealth (except Canada), Ireland, Scandinavia, Iraq, Portugal, Thailand, and some South American countries followed Britain off the gold exchange standard in 1931.
Summary
The British monetary experiments played an important role in bringing about and prolonging the world depression of the 1930s.
Throughout these events, the resulting US Federal Reserve's monetary policy, except for very brief periods in 1929 and 1936-1937 when it turned mildly dis-inflationist, was consistently and unremittingly inflationist in the 1920s and 1930s, which indicated that the money supply during the period had been steadily been increasing since the United States Federal Reserve Bank began operating in 1913.
External Links
- http://www.mises.org/money/4s3.asp
- http://csf.colorado.edu/authors/Roper.Don/asym.html
- http://www.bbc.co.uk/history/timelines/england/ear20_general_strike.shtml