Gold exchange standard
Gold exchange standard is a national monetary system under which:
- The domestic monetary unit is legally defined as the equivalent of a certain fixed weight of gold, called the parity rate;
- Only money substitutes are held by individuals and used in domestic business transactions, i.e., there are no domestic gold coins;
- The national monetary authority maintains the value of all money-substitutes at the legally set parity rate by redeeming in gold such money-substitutes as a holder desires to use abroad at the legal parity rate or at rates between the gold export and import points (see "Gold points") of such parity;
- The national monetary authority, as the only official domestic holder of gold and foreign exchange, exchanges all imports of gold and foreign exchange into domestic legal tender money substitutes at the legal parity rate or at rates between the gold export and import points of such rates.
The gold exchange standard makes it possible for the national monetary authority to keep a part of its reserves not in gold but in foreign bank balances which are redeemable in gold. It was proposed by David Ricardo in 1816 as a monetary system which he believed would function the same as the gold standard by maintaining the value of domestic money-substitutes at the gold parity and would have the added advantage of economizing on the use of gold. In practice, the rigid gold exchange standard has permitted the political manipulation of the quantity of money. This in turn has led to inflation, credit expansion and the flexible gold exchange standard, or more simply the flexible standard, under which the gold parity is subject to change, usually downward, whenever the government considers it advantageous, usually to prevent a further outflow of gold.
The gold exchange standard elevated the practice of coordinated inflation into a principle of international monetary relations. The American Fed and the Bank of England would be the central banks of the entire world (with a few exceptions, notably France). These central banks would inflate relatively slowly; but would be repaid in terms of political power. All other national central banks should keep a more or less large part of their reserves in the form of U.S. dollar notes and British pound notes and could inflate much more.
Designed from the beginning to facilitate inflation, the unstable system lasted only six years (1925-31). The Great Depression of 1929 caused a rise of protectionist policies and foreign exchange controls, that choked the international currency trade. The Bank of England could not renew its gold reserves and suspended its payments, followed by other banks. From then on currencies fluctuated freely, which lasted until the end of World War II.