AnalysisMarkets

Unpacking the gold standard monetary system and its ramifications

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By Antony Chaguruka

The World economic setup has been changing over the years. The systems of trading have been experiencing radical changes due to dynamism of world economy. Today’s currency in various countries didn’t just find itself there.

The currency has evolved from a mere exchange of commodities for commodities to gold for commodities and money for commodities. Services have also been exchanged over the years and this has complicated trade among nations.

The Bretton Wood System established in 1940s had the main objective to bring a more solid monetary and economic system. The United States had dominated the world economy due to the fact that the dollar would always be exchanged for gold.

The gold standard is a set of principles in which the value of each country’s currency is defined by the value or weight of gold and local currency is liberally convertible to gold. To enable permutability, the sum of money issued out by the central bank is strictly equivalent to the value of its gold reserves. All the international payments are settled basing on gold.

As the value of each currency is pinned to the value of a fixed weight of gold, the exchange rate between countries is constant and depicts variances in the respective of gold weights.

The establishment of Bretton Woods resulted many countries pegging their currencies to the U.S. dollar. In turn, the dollar was then fixed to the price of gold, and the United States became dominant in the world economy. The U.S. was the only nation that could print the globally accepted currency, and countries had more flexibility than they did with the old gold standard.

Before the establishment of the Bretton Woods, many countries were following the gold standard.That meant that each country’s value of currency was directly linked to gold. After Bretton Woods, members reverted to redeeming their currency to U.S. dollar, and not gold.

Why the United States dollar? The United States was at the locus of the world’s supply of gold. There was not any other currency that had enough gold reserves to back it as a replacement The United States dollar’s value by then was 1 per 35 ounces of gold.

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Through the Bretton Woods institutions, the world slowly moved from gold standard to United States dollar standard. In 1971, the United States experienced an enormous recession, a mishmash of inflation and depression, which then led to unemployment and downsized economic growth.

When the US dollar became a standard without an association to gold, its circulation in various economies increased and the then US President, Nixon started to devalue the dollar’s rate in gold. Nixon devalued the dollar to 1 per 38 ounces of gold, and then to 1 per 42 ounces.

The situation rendered the General Agreement on Tariffs and Trade (GATT) crippled. United States was not even able to convince Japan and China to open its markets to US goods.

The devaluing plan created tense pressure on the U.S gold reserves that were at Fort Knox as people scrambled to redeem quickly their devaluing dollars for gold, thus reverting. In 1971, Nixon unlocked the value of the dollar from gold altogether. Without control measures, gold quickly shot up to $120 per ounce in the free market, thus ending the Bretton Woods system.

The transition created more demand for dollars, even though it’s value and worth in gold remained the same. This discrepancy in value became the background for the collapse of the Bretton Woods system 30 years later.

The globalization of money markets and currency during the gold standard era became a serious problem particularly to GATT, in terms of management and control. According to Hobsbawm (1994), Such problems could not be anticipated by founders of GATT, therefore they just appeared leading to hurdles and difficulties in administration.

  • Chaguruka writes in his personal capacity.

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