Question

What is the classical gold standard (1821-1914)? How did the classical gold standard work in practice? When and how did it collapse?

Answer 1

Classical Gold standard was a system under which all the countries fixed their currency's value in terms of specified amount of gold or link their currency to that country which did so.And each currency was fixed in terms of gold,exchange rates between participating countries were also fixed.

Under the gold standard,a country's money supply was linked to gold.International balance payment differences were also settled in gold.Countries with balance of payment surplus would receive gold inflows,and countries with payment deficit would experinced the gold outflow. It was a self correcting balance system.A country facing defecccit balance of payment system would experience gold outflow,reduction in money supply,decline in domestic prive level,rise in competitiveness which resulted into improvement in balance of payment deficit.

Gold standard completly collapsed on 15 august 1971.It mainly collapsed due to self restricting characterstics of gold as more money needed in market, more gold is required in central bank vault.If you have to pay for imports then either balance them with your export or you will have to ship gold to other countries which result into decline in domestic money supply.

Before world war I Gold standards was widely accepted but after starting war in 1914 gold standard was abandoned due to 2 main reasons:

1.To avoid adverse balance of payments.

2.To prevent gold exports falling into the hand of enemy.

After the world war efforts made to revive gold standard but the great depression of 1929-33 ultimately led to the break down of the gold standard .The Depression ended in 1939. That allowed countries to go back on a modified gold standard.

In 1960, the United States held $19.4 billion in gold reserves, including $1.6 billion in the International Monetary Fund. That was enough to cover the $18.7 billion in foreign dollars outstanding.

But as the U.S. economy prospered, Americans bought more imported goods, paying in dollars. This large balance of payments deficit worried foreign governments that the United States would no longer back up the dollar in gold.

Also, the Soviet Union had become a large oil producer. It was accumulating U.S. dollars in its foreign reserves since oil is priced in dollars. It was afraid that the United States would seize its bank accounts as a tactic in the Cold War. So, the Soviet Union deposited its dollar reserves in European banks. These became known as eurodollars.

By 1970, the United States only held $14.5 billion in gold against foreign dollar holdings of $45.7 billion. At the same time, President Nixon's economic policies had created stagflation. This double-digit inflation reduced the eurodollar's value. More and more banks started redeeming their holdings for gold. The United States could no longer meet this growing obligation.

The gold standard ended on August 15, 1971. That's when Nixon changed the dollar/gold relationship to $38 per ounce. He no longer allowed the Fed to redeem dollars with gold. That made the gold standard meaningless.