A gold standard is a monetary system in which the standard economic unit of account is based on a fixed quantity of gold. The gold standard was widely used in the 19th and early part of the 20th century. Most nations abandoned the gold standard as the basis of their monetary systems at some point in the 20th century, although many still hold substantial gold reserves.
In the 1790s, the United Kingdom suffered a silver shortage. It ceased to mint larger silver coins and instead issued "token" silver coins and overstruck foreign coins. With the end of the Napoleonic Wars, the Bank of England began the massive recoinage programme that created standard gold sovereigns, circulating crowns, half-crowns and eventually copper farthings in 1821. The recoinage of silver after a long drought produced a burst of coins. The United Kingdom struck nearly 40 million shillings between 1816 and 1820, 17 million half crowns and 1.3 million silver crowns.
By September 1931, Britain’s economic situation had deteriorated to a critical point. Foreign investors had been converting pounds into gold, depleting the country’s reserves. The Labour government, led by Prime Minister Ramsay MacDonald, responded by taking unprecedented action. After consultations with the Bank of England, the Treasury issued a statement announcing its intention to suspend the gold standard on Sunday 20 September, and parliament approved the Bill the next day.
Britain’s departure from the gold standard had immediate and lasting consequences. Almost immediately, the pound sterling experienced devaluation. This made British goods more competitively priced on international markets and provided a boost to the country’s export industries that had been suffering as a result of the Great Depression, but meant that foreign investments in Britain lost value.
The government’s decision to abandon the gold standard was soon adopted by other countries. This signalled a major shift in the nature of global economics and gave more opportunities for flexible exchange rates and increased government intervention in monetary policy. These in turn became crucial tools for managing economic crises in subsequent decades, and since 2013 there hasn’t been a single country that continues to use the gold standard.
The pound left the gold standard in 1931 and a number of currencies of countries that historically had performed a large amount of their trade in sterling were pegged to sterling instead of to gold. The Bank of England took the decision to leave the gold standard abruptly and unilaterally.
The gold specie standard ended in the United Kingdom and the rest of the British Empire at the outbreak of WW1, when Treasury notes replaced the circulation of gold sovereigns and gold half sovereigns. Legally, the gold specie standard was not repealed. The end of the gold standard was successfully effected by the Bank of England through appeals to patriotism urging citizens not to redeem paper money for gold specie. It was only in 1925, when Britain returned to the gold standard in conjunction with Australia and South Africa, that the gold specie standard was officially ended.
The British Gold Standard Act 1925 both introduced the gold bullion standard and simultaneously repealed the gold specie standard. The new standard ended the circulation of gold specie coins. Instead, the law compelled the authorities to sell gold bullion on demand at a fixed price, but "only in the form of bars containing approximately four hundred ounces troy [12 kg] of fine gold". John Maynard Keynes, citing deflationary dangers, argued against resumption of the gold standard. By fixing the price at a level which restored the pre-war exchange rate of US$4.86 per pound sterling, Churchill is argued to have made an error that led to depression, unemployment and the 1926 general strike. The decision was described by Andrew Turnbull as a "historic mistake".
Many other countries followed Britain in returning to the gold standard, leading to a period of relative stability but also deflation. This state of affairs lasted until the Great Depression (1929–1939) forced countries off the gold standard. On September 19, 1931, speculative attacks on the pound led the Bank of England to abandon the gold standard, ostensibly "temporarily". However, the ostensibly temporary departure from the gold standard had unexpectedly positive effects on the economy, leading to greater acceptance of departing from the gold standard. Loans from American and French Central Banks of £50,000,000 were insufficient and exhausted in a matter of weeks, due to large gold outflows across the Atlantic. The British benefited from this departure. They could now use monetary policy to stimulate the economy. Australia and New Zealand had already left the standard and Canada quickly followed suit.
The interwar partially-backed gold standard was inherently unstable because of the conflict between the expansion of liabilities to foreign central banks and the resulting deterioration in the Bank of England's reserve ratio. France was then attempting to make Paris a world class financial center, and it received large gold flows as well.
In May 1931 a run on Austria's largest commercial bank caused it to fail. The run spread to Germany, where the central bank also collapsed. International financial assistance was too late and in July 1931 Germany adopted exchange controls, followed by Austria in October. The Austrian and German experiences, as well as British budgetary and political difficulties, were among the factors that destroyed confidence in sterling, which occurred in mid-July 1931. Runs ensued and the Bank of England lost much of its reserves.
Economists, such as Barry Eichengreen, Peter Temin and Ben Bernanke, blame the gold standard of the 1920s for prolonging the economic depression which started in 1929 and lasted for about a decade. It has been described as the consensus view among economists. In the United States, adherence to the gold standard prevented the Federal Reserve from expanding the money supply to stimulate the economy, fund insolvent banks and fund government deficits that could "prime the pump" for an expansion. Once off the gold standard, it became free to engage in such money creation. The gold standard limited the flexibility of the central banks' monetary policy by limiting their ability to expand the money supply. In the US, the central bank was required by the Federal Reserve Act (1913) to have gold backing 40% of its demand notes.
Higher interest rates intensified the deflationary pressure on the dollar and reduced investment in U.S. banks. Commercial banks converted Federal Reserve Notes to gold in 1931, reducing its gold reserves and forcing a corresponding reduction in the amount of currency in circulation. This speculative attack created a panic in the U.S. banking system. Fearing imminent devaluation many depositors withdrew funds from U.S. banks. As bank runs grew, a reverse multiplier effect caused a contraction in the money supply (?). Additionally the New York Fed had loaned over $150 million in gold (over 240 tons) to European Central Banks. This transfer contracted the U.S. money supply. The foreign loans became questionable once Britain, Germany, Austria and other European countries went off the gold standard in 1931 and weakened confidence in the dollar (?).
The forced contraction of the money supply resulted in deflation. Even as nominal interest rates dropped, deflation-adjusted real interest rates remained high, rewarding those who held onto money instead of spending it, further slowing the economy. Recovery in the United States was slower than in Britain, in part due to Congressional reluctance to abandon the gold standard and float the U.S. currency as Britain had done.
In the early 1930s, the Federal Reserve defended the dollar by raising interest rates, trying to increase the demand for dollars. This helped attract international investors who bought foreign assets with gold.
Congress passed the Gold Reserve Act on 30 January 1934; the measure nationalized all gold by ordering Federal Reserve banks to turn over their supply to the U.S. Treasury. In return, the banks received gold certificates to be used as reserves against deposits and Federal Reserve notes. The act also authorized the president to devalue the gold dollar. Under this authority, the president, on 31 January 1934, changed the value of the dollar from $20.67 to the troy ounce to $35 to the troy ounce, a devaluation of over 40%.
Other factors in the prolongation of the Great Depression include trade wars and the reduction in international trade caused by barriers such as Smoot–Hawley Tariff in the U.S. and the Imperial Preference policies of Great Britain, the failure of central banks to act responsibly, government policies designed to prevent wages from falling, such as the Davis–Bacon Act of 1931, during the deflationary period resulting in production costs dropping slower than sales prices, thereby injuring business profits (?) and increases in taxes to reduce budget deficits and to support new programs such as Social Security. The U.S. top marginal income tax rate went from 25% to 63% in 1932 and to 79% in 1936, while the bottom rate increased over tenfold, from .375% in 1929 to 4% in 1932. The concurrent massive drought resulted in the U.S. Dust Bowl.
The Austrian School asserted that the Great Depression was the result of a credit bust. Alan Greenspan wrote that the bank failures of the 1930s were sparked by Great Britain dropping the gold standard in 1931. This act "tore asunder" any remaining confidence in the banking system. Financial historian Niall Ferguson wrote that what made the Great Depression truly 'great' was the European banking crisis of 1931. According to Fed Chairman Marriner Eccles, the root cause was the concentration of wealth resulting in a stagnating or decreasing standard of living for the poor and middle class. These classes went into debt, producing the credit explosion of the 1920s. Eventually, the debt load grew too heavy, resulting in the massive defaults and financial panics of the 1930s.
The British Gold Standard Act 1925 both introduced the gold bullion standard and simultaneously repealed the gold specie standard. The new standard ended the circulation of gold specie coins. Instead, the law compelled the authorities to sell gold bullion on demand at a fixed price, but "only in the form of bars containing approximately four hundred ounces troy [12 kg] of fine gold". John Maynard Keynes, citing deflationary dangers, argued against resumption of the gold standard. By fixing the price at a level which restored the pre-war exchange rate of US$4.86 per pound sterling, Churchill is argued to have made an error that led to depression, unemployment and the 1926 general strike. The decision was described by Andrew Turnbull as a "historic mistake".
Many other countries followed Britain in returning to the gold standard, leading to a period of relative stability but also deflation. This state of affairs lasted until the Great Depression (1929–1939) forced countries off the gold standard. On September 19, 1931, speculative attacks on the pound led the Bank of England to abandon the gold standard, ostensibly "temporarily". However, the ostensibly temporary departure from the gold standard had unexpectedly positive effects on the economy, leading to greater acceptance of departing from the gold standard. Loans from American and French Central Banks of £50,000,000 were insufficient and exhausted in a matter of weeks, due to large gold outflows across the Atlantic. The British benefited from this departure. They could now use monetary policy to stimulate the economy. Australia and New Zealand had already left the standard and Canada quickly followed suit.
The interwar partially-backed gold standard was inherently unstable because of the conflict between the expansion of liabilities to foreign central banks and the resulting deterioration in the Bank of England's reserve ratio. France was then attempting to make Paris a world class financial center, and it received large gold flows as well.
In May 1931 a run on Austria's largest commercial bank caused it to fail. The run spread to Germany, where the central bank also collapsed. International financial assistance was too late and in July 1931 Germany adopted exchange controls, followed by Austria in October. The Austrian and German experiences, as well as British budgetary and political difficulties, were among the factors that destroyed confidence in sterling, which occurred in mid-July 1931. Runs ensued and the Bank of England lost much of its reserves.
Higher interest rates intensified the deflationary pressure on the dollar and reduced investment in U.S. banks. Commercial banks converted Federal Reserve Notes to gold in 1931, reducing its gold reserves and forcing a corresponding reduction in the amount of currency in circulation. This speculative attack created a panic in the U.S. banking system. Fearing imminent devaluation many depositors withdrew funds from U.S. banks. As bank runs grew, a reverse multiplier effect caused a contraction in the money supply (?). Additionally the New York Fed had loaned over $150 million in gold (over 240 tons) to European Central Banks. This transfer contracted the U.S. money supply. The foreign loans became questionable once Britain, Germany, Austria and other European countries went off the gold standard in 1931 and weakened confidence in the dollar (?).
The forced contraction of the money supply resulted in deflation. Even as nominal interest rates dropped, deflation-adjusted real interest rates remained high, rewarding those who held onto money instead of spending it, further slowing the economy. Recovery in the United States was slower than in Britain, in part due to Congressional reluctance to abandon the gold standard and float the U.S. currency as Britain had done.
In the early 1930s, the Federal Reserve defended the dollar by raising interest rates, trying to increase the demand for dollars. This helped attract international investors who bought foreign assets with gold.
Congress passed the Gold Reserve Act on 30 January 1934; the measure nationalized all gold by ordering Federal Reserve banks to turn over their supply to the U.S. Treasury. In return, the banks received gold certificates to be used as reserves against deposits and Federal Reserve notes. The act also authorized the president to devalue the gold dollar. Under this authority, the president, on 31 January 1934, changed the value of the dollar from $20.67 to the troy ounce to $35 to the troy ounce, a devaluation of over 40%.
Other factors in the prolongation of the Great Depression include trade wars and the reduction in international trade caused by barriers such as Smoot–Hawley Tariff in the U.S. and the Imperial Preference policies of Great Britain, the failure of central banks to act responsibly, government policies designed to prevent wages from falling, such as the Davis–Bacon Act of 1931, during the deflationary period resulting in production costs dropping slower than sales prices, thereby injuring business profits (?) and increases in taxes to reduce budget deficits and to support new programs such as Social Security. The U.S. top marginal income tax rate went from 25% to 63% in 1932 and to 79% in 1936, while the bottom rate increased over tenfold, from .375% in 1929 to 4% in 1932. The concurrent massive drought resulted in the U.S. Dust Bowl.
The Austrian School asserted that the Great Depression was the result of a credit bust. Alan Greenspan wrote that the bank failures of the 1930s were sparked by Great Britain dropping the gold standard in 1931. This act "tore asunder" any remaining confidence in the banking system. Financial historian Niall Ferguson wrote that what made the Great Depression truly 'great' was the European banking crisis of 1931. According to Fed Chairman Marriner Eccles, the root cause was the concentration of wealth resulting in a stagnating or decreasing standard of living for the poor and middle class. These classes went into debt, producing the credit explosion of the 1920s. Eventually, the debt load grew too heavy, resulting in the massive defaults and financial panics of the 1930s.
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