Question

In the nineteenth century, what was the gold standard? Who invented it and why? Why was its adoption in Britain harmful to workers when they were faced with the "free labor market"?

Answer 1

The gold standard is a monetary system where a country's currency or paper money has a value directly linked to gold. With the gold standard, countries agreed to convert paper money into a fixed amount of gold. A country that uses the gold standard sets a fixed price for gold and buys and sells gold at that price. That fixed price is used to determine the value of the currency. For example, if the U.S. sets the price of gold at $500 an ounce, the value of the dollar would be 1/500th of an ounce of gold.

In 1821, a new coin the sovereign was introduced, containing 95 percent of the gold in a guinea, thus making it worth exactly one pound sterling.

The international gold standard, which Newton inadvertently initiated, was one of the longest running financial institutions in history. It was successful because, being based on an equation between value and mass like an economic law of gravity, it was global and easily shared, so everyone knew where they stood.

The problem for the reconstructed gold standard was that it did not comprise similar economies with
markets that were operating in the smooth frictionless manner of textbook economics. Instead, very
dissimilar economies with different structures and different problems were combined together in a
exchange rate system which provided little room for manoeuvre. All economies suffer from shifts in
supply and demand and shocks of varying degrees of magnitude and severity. The response to such
changes can broadly take two forms: a market response or a policy response. A market response
depends on the quick, effective and painless adjustment of relative prices in response to shocks and
shifts in supply and demand. In reality, most markets rarely operate like this they are mainly slow
moving institutions and prices tend to be ‘sticky’. Some can move quickly such as financial markets
but this just makes adjustment more difficult for the slower moving product and labour markets. Take a
collapse in global demand. In response, nominal exchange rates may move very quickly but exporters will take time to reduce production, change prices and reallocate physical capital. And workers who lose
their jobs may take considerable time to find new employment and many may never succeed.

The gold standard constraint led to a tightening
of monetary policy, particularly in 1931 when the government raised interest rates in the forlorn
attempt to maintain the value of sterling. This particularly harmed interest-sensitive sectors such as
construction. As the British economy slowed, unemployment rose and this led to pressure on the
Government’s finances as tax revenue fell and expenditure on unemployment benefits increased. It lead to labour protests.

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