Additional Reading: Lecture 2
Types of Gold Standard
(With Features, Merits and Demerits) | Economics
Historically there have been different forms of gold standard. They are – 1. Gold Coin Standard 2. Gold Bullion
Standard 3. Gold Exchange Standard 4. Gold Reserve Standard 5. Gold Parity Standard.
Type-1. Gold Coin Standard:
Gold coin standard or gold currency standard or gold species standard is the oldest form of gold standard. It is
also known as orthodox gold standard or traditional gold standard. This standard was prevalent in the U.K.,
France, Germany and the U.S.A. before the World War I.
Gold coin standard is also regarded as full gold standard because under this standard full- bodies standard
coins made of gold were circulated. Other forms of money are redeemable into gold. According to Crowther –
“A currency system in which gold coins either form the whole circulation or else circulate equally with notes is
known as the full-gold standard.”
Features:
(i) Monetary unit is defined in terms of gold. For example, before World War I, sovereign was the standard coin
in the U.K. Its weight was 123.17447 grains with 11/12 purity.
(ii) Other forms of money (e.g. token coins and paper money) are also in circulation. But they are convertible
into gold.
(iii) Coinage is unlimited and free of cost.
(iv) There is free and unlimited melting of gold coins.
(v) The government buys and sells gold at fixed prices and thereby maintains parity between the face value and
intrinsic value of the standard coin.
(vi) There is free import and export of gold.
(vii) Gold is unlimited legal tender for all types of payments. All values are expressed in terms of gold.
Merits:
The gold coin system has the following advantages:
1. Public Confidence:
Since the standard coin is made of gold, it is universally acceptable. Thus, gold coin Standard enjoys full
confidence of the public.
2. Automatic Working:
It is automatic in working and needs no government intervention. Money supply depends upon the volume of
gold reserves and money supply can be changed in accordance with the changes in the volume of gold reserves.
3. Price Stability:
Since there are no frequent changes in the supply of gold, this system ensures reasonable degree of internal
price stability.
4. Exchange Stability:
Free and unrestricted import and export of gold under gold coin standard ensures stability in foreign exchange
rates. This promotes international trade.
5. Simplicity:
This is the simplest form of gold standard which can be easily understood by the common people.
Demerits:
Gold coin standard suffers from the following defects:
1. Fair-Weather Standard:
It is fair-weather standard; it operates smoothly during peace times but fails to work properly and to inspire
public confidence at the time of economic crisis.
2. Wastage of Gold:
There is great deal of wastage of gold under this standard. Circulation of gold coins suffers depreciation.
Moreover, since paper currency is fully backed by gold, gold remains idle while in reserves.
3. Not Automatic:
Gold coin standard operates automatically with the cooperation of the participating countries. After World War
I, in the absence of international cooperation, this standard ceased to be automatic in its functioning.
4. Price Stability Unreal:
Under this system, internal price stability is unreal. Various factors like discoveries of new gold mines, changes
in the techniques of production of gold, changes in imports and exports of gold, lead to changes in the price of
gold, and hence cause fluctuations in the internal prices.
5. Less Effective:
Gold currency standard is not the only standard for achieving the objective of price and exchange stability.
Critics point out that a managed currency system is more effective in ensuring stability in internal price level
and external exchange rate.
6. Deflation Oriented:
Mrs. Joan Robinson regards gold coin standard as deflation – oriented because the gold losing countries will
compulsorily reduce the currency (thus generating deflation), while the gold receiving countries generally do
not expand the currency (thus generating inflation).
Type-2. Gold Bullion Standard:
After World War I, Gold standard was revived in some countries of Europe not on gold currency basis but on
gold bullion basis. It was adopted by Great Britain in 1925. Gold bullion standard is a modified version of gold
coin standard in which there was no gold coinage and the currency is convertible into gold bullion (i.e., gold
bars).
Features:
(i) Gold coins are not in circulation. But the standard currency unit is expressed in terms of a definite quantity
of gold of a given fineness. Thus, gold does not act as a medium of exchange, but it remains a measure of value.
(ii) Coinage of gold is not allowed, i.e., people cannot get their gold converted into coins at the mint.
(iii) Other forms of money (paper money and token coins) are not fully backed by gold reserves. But the
government guarantees full convertibility of currency into gold bullion.
(iv) The government is always ready to buy and sell gold at fixed prices. For example, in England, during 1925
to 1931, the currency was exchangeable for gold bars of 400 ounces, each worth about £1560.
(v) There are no restrictions on export and import of gold.
Merits:
The gold bullion standard has the following merits:
1. Economy in the Use of Gold:
The gold bullion standard economies the use of gold. Gold coins are not in circulation and there is no wastage of
the precious metal. Moreover, there is no hundred per cent gold backing of note issue.
2. Use of Gold in Public Interest:
Since, under gold bullion standard, all gold is not kept idle in reserves, it can be properly utilised for public
purpose.
3. Automatic Working:
Like the gold currency standard, the gold bullion standard also operates automatically. If demand for money
falls people will start buying gold from the government. As a result, gold reserves, and thus the money supply,
will fall. In this way, equilibrium in the demand and supply of money will be established, and hence price
stability is ensured.
4. Exchange Stability:
Since there is unrestricted import and export of gold, stability in the exchange rate is easily maintained under
this standard.
5. Elastic Money Supply:
Since, under this system, the currency is not fully convertible the monetary authority can expand adequate
money supply by a small increase in gold reserves.
6. Public Confidence:
Since government is always ready to convert token money and paper money into gold at fixed price, the gold
bullion standard inspires public confidence.
7. Simplicity:
Gold bullion standard is easy to understand and economical in functioning.
Demerits:
Various drawbacks of gold bullion standard are given below:
1. Fair-Weather Standard:
Like gold coin standard, gold bullion standard also fails to work at the time of economic crisis. It loses public
confidence during war periods when the demand for gold increases and the government reserves are not
sufficient to meet this demand.
2. Government Intervention:
Gold bullion standard cannot function properly without government intervention. In a way, it is a managed
currency system because under this system the government manages the token money, paper money and gold
reserves.
3. Uneconomical:
Under this system, enough gold reserves are kept. They remain idle and cannot be put to productive uses.
4. Less Public Confidence:
As compared to gold coin standard, the gold bullion standard inspires less public confidence because gold coins
are not in circulation. The currency is generally converted into gold only for foreign exchange purpose and not
for domestic purpose.
Type-3. Gold Exchange Standard:
Gold exchange standard refers to a system in which there is neither a gold currency in circulation not gold
reserves held for external purposes. Under this system, the domestic currency of a country (which is composed
of token coins and paper notes) is not converted into gold for meeting internal needs, but is converted into the
currency of some foreign payments.
The external value of the domestic currency unit is determined in terms of the foreign currency. Thus, under
gold exchange standard, the domestic currency has no direct link with gold; it is linked at a fixed exchange rate
with the currency of another country which is convertible into gold. In addition to gold reserves, the monetary
authority of the country maintains sufficient amount of foreign exchange reserves for making international
payments.
Gold exchange standard is a cheaper form of gold standard particularly suitable for the underdeveloped or goldscarce countries. It was first adopted by Holland in 1877 and then by Austria, Hungary, Russia and India during
the last decade of the 19th century. India abandoned this standard in 1926 on the recommendations Of the
Hilton Young Commission.
Features:
(i) The domestic currency is made of token coins and paper money. Gold coins are not in circulation.
(ii) The domestic currency is not convertible into gold but is convertible at the fixed rate into the currency of the
other country based on the gold standard.
(iii) There is no direct link between the volume of domestic currency and the gold reserves.
(iv) Foreign exchange and foreign bills along with gold constitutes the reserve base of a country.
(v) The gold market is regulated and controlled by the government. There is no free import and export of gold.
(vi) Gold is used neither as a medium of exchange nor as a measure of value. But prices of all goods and services
are indirectly determined by the price of gold.
(vii) Foreign payments are made either in gold or in currency based on gold.
Merits:
The gold exchange standard enjoys the following advantages:
1. Economical:
Gold exchange standard is cheaper and economical.
It economies the use of gold in two ways:
(a) It avoids the wastage of gold because of non-circulation of gold coins,
(b) The government need not keep gold reserves for converting domestic currency into gold.
2. Elastic Money Supply:
Since the domestic currency is not backed by gold reserves, the monetary authority can easily, expand money
supply to meet the increasing needs of trade and industry.
3. Exchange Stability:
Under gold exchange standard, it is the responsibility of the government to maintain the stability of exchange
rate. Exchange stability is essential for the promotion of foreign trade.
4. Gains to Government:
The government of the country also gains from this standard:
(a) It earns interest on the reserves kept in the foreign country.
(b) It also keeps some margin between the buying and selling of foreign exchange.
5. Gains of Gold Standard:
All the advantages of the gold standard become available under this standard without putting gold coins in
circulation.
6. Suitable for Poor Countries:
This standard is particularly suited to the less developed countries with gold scarcity.
Demerits:
The gold exchange standard has the following drawbacks:
1. Complex:
This standard is complex in its working and is not easily understandable by the common people.
2. Less Public Confidence:
Under this standard, domestic currency is not directly linked with gold and the currency is not convertible into
gold. Therefore, it does not inspire much public confidence.
3. Not Automatic:
This standard does not work automatically and needs active government intervention. It may be more
appropriately called a managed standard.
4. Inflation-Oriented:
Under this system, money supply can be increased easily but it is very difficult to reduce money supply. Hence
it is prone to inflation.
5. Expensive:
This system is not economical. To make it work, the government has to keep many reserves which involve lot of
expenditure. It is due to its expensive nature that India abandoned this system on the recommendations of
Hilton Young Commission.
6. Monetary Dependence:
Under this standard, the monetary independence of a country cannot adopt an independent monetary policy
but has to be governed by the policy of the foreign countries.
7. External Insecurity:
Since, under this standard, the domestic currency of a country is linked with the foreign currency, the insecurity
and instability of the foreign currency makes the monetary system of the related country insecure and unstable.
Type-4. Gold Reserve Standard:
After the breakdown of gold standard, a new monetary system called gold reserve standard, was developed in
1936 mainly to ensure stability in exchange rates. In 1936, Great Britain, the U.S.A. and France entered into a
Tripartite Monetary Agreement according to which free flow of gold or foreign currency was allowed to stabilize
exchange rates and promote foreign trade without affecting the internal value of the domestic currency.
For this purpose, Exchange Equalization Funds were created. The gold reserve standard functioned successfully
for three years and came to an end with the outbreak of World War II.
Features:
The essential features of the gold reserve standard are:
1. No Link with Gold:
Under this standard, gold is used neither as a medium of exchange nor as a measure of value. The domestic
currency is made of paper money and token coins. The convertibility of domestic currency into gold is not
ensured.
2. No Free Movement of Gold:
Under this system, private individuals are not allowed to import and export gold. The government monopolises
the country’s import and export of gold. Gold is imported and exported only monetary purpose.
3. Exchange Equalisation Fund:
Under this standard, the participating countries have to setup Exchange Equalisation Fund for the purpose of
maintaining stability in exchange rates. The Exchange Equalisation Fund, which is also known as Exchange
Equalisation Account, comprises, besides local currency, foreign exchange and gold.
If the demand for foreign currency rises, the Fund will increase the supply of that foreign currency in the open
market and thus will prevent any rise in the value of that currency in terms of other currencies.
4. Strict Secrecy:
The composition and movement of reserves of the Exchange Equalisation Fund are kept strictly confidential
from the public.
5. Exchange Stability:
Under this standard, exchange rate stability is achieved without disturbing the internal economy of the member
country.
Type-5. Gold Parity Standard:
In essence, gold parity standard is the modern version of the gold standard. It came into force with the
establishment of the International Monetary Fund (IMF) in 1946. Under this standard, every member country
has to define the par value of its currency in terms of gold in order to determine the exchange rate. The gold
parity standard aims at maintaining stable exchange rates without interfering into the domestic monetary
system of the member countries.
Features:
The basic features of the gold parity standard are given below:
1. No Link with Gold:
Under this standard, gold is neither a medium exchange nor a measure of value. The domestic currency
comprises paper money and token coins of cheaper metals. The domestic currency is inconvertible into gold
coins or gold bars or foreign currency.
2. Par Value of Money:
Every member country has to define the par values of its money in terms of gold, the par values of different
currencies further determine the exchange rates for foreign transactions.
3. Exchange Rate Flexibility:
This standard allows reasonable flexibility in the exchange rates because the member nations can alter the par
values of their currencies under the regulations of the IMF.
4. Provisions of Loans:
Under this system, the IMF provides loans in foreign currencies to the member countries to ensure stability in
foreign exchange rates.
5. Independent Monetary Policy:
Under this standard, the member nations can follow independent monetary policies in their domestic affairs.
The monetary policy of one country has no direct or indirect link with the monetary policy of another country.
The End!