Forex: the Gold Standard

This theory holds the Gold Standard was due to a concept forwarded by David Hume that believed inflation is the cause of monetary increases. With inflation, Hume said, money (in terms of its quantity and not quality) accumulates. For this reason inflation or deflation causes business confidence to fail, leading to the weakening of trade and investments. The central purpose of establishing a gold standard is to gain business confidence by removing the uncertainty of inflation and deflation and of friction amongst currencies. The gold standard would ideally expand the market, establish a more solidity of credit and confidence.

In a full gold standard situation, the country for example has gold stock reserve that is equivalent to all its circulating money. However, such a country is a rarity.

In terms of international relations, the United States maintained a fixed exchange rate in their relation with other countries by establishing the gold standard. This put a staple on their exchange of goods and capital with other countries. However, the gold standard limited the US to expand their economy. It limited the growth of their money and credit potentiality, thus restraining inflationary pressures. In a gold standard, gold rises in terms of its value, while money and everything else drops down. This is the inevitable consequence when you place money and gold in the same weighing scale.

Moreover, the theory that was supposed to apply to the Gold Standard did not take hold for long. For the United States, yes, it did provide economic stability. But soon, gold could no longer function to be the one exception from the eternal truth of economic supply and demand. Its value had to fluctuate too, plunging the country into deep depression. For that, the US placed gold only in a subordinate role in its monetary policy. And then in a historical move, Congress approved what President Roosevelt wanted: transfer gold to the government as a reserve. This bill prohibited gold coinages to be circulated ever. Roosevelt then fixed the price of gold as a reserve at $35. Approximately $3 billion paper profit was gained by the government by making gold a national reserve. Gold reserves today are mainly used by countries as a means to defend their currency against devaluation. The United States Dollar when weakening is offset in the same way when there is strengthening of the gold prices. Central banks use gold reserve as a principal financial asset with government bonds and foreign currencies.