Question

1. Describe the differences between the pre-WW1 gold standard and the post-WW2 Bretton Woods monetary system, explaining the relative benefits of each approach.

Answer 1

In the Pre-World War one era, the key difference as of today is the fact that currencies were valued on the basis of gold reserves which an economy would hold and the differences in currency were also calculated on the basis of the same. The government would back its currency to the value of gold which it held and any country which had a gold surplus when compared to another country would always have a higher exchange rate. For example, if the gold of the United States was higher in volume and value as compared to China, it would always have a higher currency valuation regardless of the level of activity or productivity in both these countries.

The core advantage of this regime was that exchange rates remained fixed. The quantity of gold which each country held was known to the rest of the world and any economic transaction was backed by the fact that exchange rates would remain stable over a period of time.

The demerits however that each country could not hold excessive gold and to correct the economy by altering the supply of money was not possible as the currency had to be limited in supply depending on the valuation of the gold which a country held. Smaller countries which did not have gold reserves would never progress in such a regime.

Further, to correct the shortcomings, this policy was abolished and a policy of floating exchange rates in which the currency was pegged to the US dollar was established by the Bretton woods system. In this, the countries shifted from accumulating gold and containing their economies to a regime wherein free trade was encouraged and happened in dollars easily. Today the rapid expansion of world trade all across the globe can be credited to countries having a flexible exchange rate system where the volume of trade then defines the value of the currency and not the fact that how much gold an economy may hold. The core benefits thus including opening up the world economy and the ability to correct inflation or recession by pumping in currency or withdrawing currency from the markets.

For example, if a currency is not valued as per gold, then by decreasing the value of the currency relative to dollar, the total currency in circulation can be increased as the value is not fixed but is relative and floating in nature.

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