Gold Standard

The gold standard can be thought of as a commitment by countries  to fix the prices of their domestic currencies in terms of a specified amount of gold. The currency could then be easily converted into gold between depending upon the rates.The exchange rate under the gold standard monetary system is determined by the economic difference for a unit  of gold between two currencies.

In the Gold Standard system of currency the currency could be converted to the quantity of gold it represented. The price of gold with respect with the currencies were fixed by the Central Bank and they issued currency notes backed by gold.The new production of gold would be  only a small fraction to the stock hold by the bank and as authorities allowed convertibility of gold to currency and vice-versa the gold standard ensured that the money supply and hence the price of gold  would not vary much. In other words,the total amount of currency the bank could and would issue were quite fixed in number. However periodic surges occurred when in the world’s gold stock in case of events such as the gold discoveries in Australia and California and caused price levels to be very unstable in the short run.

The Gold Standard Currency were traded between countries at an International level.It was possible due to the fixed price of gold and their quantity.For example ,In India price for 12 kg of 24 carat gold was INR 30,000(INR2500 per Kg) and in the USA they fixed the price of a 15 kg of gold at USD 60,000(USD 4000) so the par exchange rate in terms of gold was then the exchange rate would be 1.6 USD per Rupee.

The exchange rates were fixed for all currencies around the world and hence a slight change in one economy could in effect influence prices all over the rate.So there were cases of periodic shocks all over in the economy.The greatest virtue of the gold standard was that in the long term their was assurance of price stability.Their was approx .1 to .5 of inflation during that period in comparison to present rates it is very very low.

Economies using Gold standard were so vulnerable to real and monetary shocks in the short term.The prices could suddenly fluctuate if the supply of gold was to suddenly increase in quantity.The Government and banks has very less capacity to control the money market.The other limitation would be that there could only be a fixed number of any currency under this system.Gold Standard is a thing of the history now but it still has strong appeal in terms of the fixed prices in the market until volatility.

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