International Monetary System 1870 - 1973 Chapter 18

Why Gold? Desirable Attributes of Commodity Money: Durable Portable Divisible Standardized

Gold Standard Money Gold Coins Bank Notes Gold Certificates

Gold Certificate

Gold Certificate

Gold Certificate This note is receivable by all national and member banks and federal reserve banks and for all taxes, customs or other public dues. It is redeemable in gold on demand at the treasury department of the U.S. in the city of Washington D.C. or in gold or lawful money at any federal reserve bank

Gold Certificate

Silver Certificate

Unbacked Currency

Central Bank Balance Sheet Under a “Pure” Gold Standard Assets Liabilities 400 Gold 400 Gold Certificates

Central Bank Balance Sheet Under a Typical Gold Standard Assets Liabilities 100 Gold 400 Gold Certificates 300 Bonds

Central Bank Balance Sheet Under a “Fiat” standard Assets Liabilities 400 Bonds 400 Currency

Policy Goals Internal balance means domestic policy goals External balance means international policy goals

Gold Standard - Mechanics System used from 1870 - 1914 US & UK agreed to fix the price of gold in terms of their currency & buy or sell gold at this price.

Gold Standard - Mechanics Guarantees the value of the home currency Fixes the exchange rate Gold is the international reserve Balance of Payments, BOP, measures the flow of gold.

Gold Standard - External balance Main policy goal was avoidance of balance of payments deficits Internal balance was secondary or ignored. Many countries took a laissez faire attitude towards the current account

Price-specie-flow mechanism This was a force pushing countries toward balance of payments (BOP) equilibrium. Suppose the US has a BOP deficit (D$ < S$) & the UK has a BOP surplus (D£ > S£) What does the US do to support the $ ? What does the UK do to support the £? What is the effect on exports, imports & the BOP?

Rules of the Game: Myth Central banks were supposed to reinforce the price specie mechanism. W/ a BOP deficit, gold was sold for M The central bank was supposed to reinforce the  in M by selling bonds for M Surplus was the mirror image

Rules of the Game: Reality Reality was not this symmetric. Deficit countries usually played by rules. Surplus countries (like UK) usually broke the rules.

Gold Standard & Price Stability Prevents inflationary monetary policy However gold discoveries brought inflation Lack of gold discoveries brought deflation

Advantages of the Gold Standard Prevents inflationary monetary policies. Responsibilities under the gold standard were somewhat symmetric.

Disadvantages of the Gold Standard Prevents use of  in M to fight recessions. Makes prices dependent on gold discovery Gives gold producing nations (like Russia & South Africa) too much power.

Wizard of Oz

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Interwar Years Three problems emerged which influenced the post WW II monetary system German hyperinflation - some countries need the monetary discipline Britain’s return to gold - an overvalued currency can do great harm The depression - tariff wars & competitive devaluations can devastate international trade

Bretton Woods & The IMF 1944 - the Allies met at Bretton Woods, NH. They set up a system of fixed exchange rates, They set up the IMF, intended to provide short term lending to countries w/ BOP deficits They agreed to move toward currency convertibility

Gold Exchange Standard Post WW II system of fixed E. $ was reserve currency The US fixed the $ price of gold Other countries fixed the $ price of their currencies Monetary discipline was provided by the threat of reserve losses.

IMF The IMF was established to help countries deal w/ BOP deficits. IMF could lend to countries w/ BOP deficits. The IMF could also adjust parities (official currency values)

Other Post WWII International Agencies World Bank provides long term project lending to LDC’s. GATT handles trade disputes & prevents tariff wars

Limited Convertibility Countries were supposed to move toward convertibility for CA transactions but not for speculation. Once in place, limited convertibility was difficult to enforce & widely evaded

The Confidence Problem Initially, foreign holdings of $ < US gold reserves Eventually, foreign holdings of $  until foreign holdings of $ > US gold reserves. If holders of $ all simultaneously lost confidence & tried to sell $, the US could not redeem them

Decline & Fall of Bretton Woods Inflationary US macro policy led to the breakdown of fixed E Johnson’s guns & butter policy caused inflation & CA deficits in the US. Even after Johnson left office, these problems continued. The US was forcing its inflation on the rest of the world & eventually the ROW resisted.