Gold Standard and The Foriegn Exchange - Essay Example

Kemmerer (1944) defines gold standard as “a monetary system where the unit of value, in terms of which prices, wages, and debts are customarily expressed and paid, consists of the value of a fixed quantity of gold in a large international market which is substantially free.” (p. 134) From mid 1870s more and more countries started to value their national currencies against gold. In the 1920s fixing a gold value for the currency ensured stable exchange rates which boosted external value of it and consequently ensured the stability of internal prices.

The gold standard period is characterized by national governments policy aimed at preserving the value of the currency (Milward 1996, p.87) Very simple in its origins gold standard was declared to support national currencies serving as an equilibrating mechanism reducing foreign exchange risk and eliminating the risk of destroying governmental policies. Each country has a domestic supply of money backed by its domestic reserves of gold. If a Treasury printed banknotes not backed by the gold standard, the result would be individual requirements to exchange the excess banknotes for gold.

(DeLong 1997) Countries which joined fixed exchange rate standard were enjoying long-run price level stability and predictability, stable and low long-run interest rates, stable exchange rates which contributed to massive capital inputs to the worlds developing countries. (Bordo and Schwartz 1996, p.11) As historically-specific institution the gold standard had been supported by all industrial-economy governments to maintain convertibility of their currency. Under the gold standard not only trade expanded but also international capital markets developed.

It allowed considerable investments into enterprises in other industrializing, mineral-rich countries which benefited greatly the economies of these countries. The gold standard ensured the entrepreneurs engaged in international trade from foreign exchange