Gold standard

In the past, before the late 1870s, many countries in existence used gold and silver as their currency. By the 1880s, the countries participating in international trade had agreed on an exchange rate system known as the “international gold standard.” Under this new arrangement, each member defined the value of its unit currency in terms of gold. The gold was precisely measured in terms of ounces with each ounce containing exactly 480 grains.

Under this method Britain defined its sterling pound gold coin to contain 113.0016 grains of pure gold and as such the price / exchange rate value of gold for Britain was fixed at 4.248 sterling pounds per ounce. Applying the same format as above, the in U.S.A set its 1 dollar gold coin to contain 23.22 grains of pure gold. Since there were 480 grains of gold per ounce of pure gold, the price of gold in terms of US dollars was given as 20.67 US dollars per ounce of gold. The mint parity between 1 sterling pound gold coin and 1 US dollar gold coin was given as 113.0016/ 23.22 which was equal to 4.87 grains. Similarly, the exchange rate between the pound and the dollar was also exactly equal to 1 pound for 4.87 US dollars. This then became the fixed exchange rate between the dollar and the pound under the gold standard system.

The same principle was used in determining the fixed exchange rates among all the other currencies issued by all the other “gold standard nations.” Under this arrangement, all the currencies had first to be converted into gold before being converted again in the other currency of choice. There was no reserve currency with gold being the only reserve requirement for all member states. As such, in the implementation of this system, each government had to have gold reserves and had committed itself to buying and selling gold at the legally stipulated weight and fixed prices/ exchange rates.

There were no institutions or written agreements / laws to enforce this fixed exchange rate system. Instead, the System was enforced through only one policy; converting one currency into gold and then back into another currency of choice. This was possible because gold was traded freely and the fact that each participating country had committed itself to buying and selling gold at the predetermined fixed prices.

This system did not operate as smoothly as earlier intended. As time passed, it became difficult for governments to sustain their gold reserves as gold became a scarce commodity and as such the fixed exchange rates had to constantly be adjusted upwards. Demand for gold became too high and the governments started to be more stringent. With the only rule being broken by the government’s refusal to sell gold freely, the system finally met its death with the advent of World War 1. After the war, some countries tried to revive the system to no avail. The major reason for this failure was the American Great depression of the 1930s.