Chapter 2, International Financial Mgmt, Eun et al
3460.02 notes by A.P. Palasvirta, PhD
 Bronze
 Silver
 Gold
 U.S.
Dollar Standard
3460.02 gold standard notes: a.p. palasvirta, ph.d.
March 22, 2016
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 Bank


of Amsterdam (15th century)
100% reserves of gold and silver
Depositors brought gold, silver


Were given warehousing certificates for the amount of
gold, silver minus a charge
Depositors would use the warehousing certificates as
money
 Lower transactions costs
 Easier to use
3460.02 gold standard notes: a.p. palasvirta, ph.d.
March 22, 2016
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Assets
Gold
100%
3460.02 gold standard notes: a.p. palasvirta, ph.d.
Liabilities
Warehouse
receipts
March 22, 2016
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 Queen

Created the Bank of England



Elizabeth I 1563 to 1603
Held partial reserves of gold and silver
The rest were in treasury bills
This was not a strict gold standard, but a gold
exchange standard

This bank could not refund all claims for gold with gold
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March 22, 2016
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Assets
Liabilities
Gold
30 – 40%
currency
T-bills
60 – 70%

http://www.gata.org/node/104
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March 22, 2016
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 Fix

the value of the unit of account
Something immutable


Ounce of silver
Ounce of gold
 Gold


standard
Unit of account the troy ounce
Medium of exchange


Coinage
Gold certificates
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 If

the cost of mining gold increases
deflation



 If

Value of gold increases
Value of other goods remain constant
Prices decrease
the cost of mining gold decreases
Inflation



Value of gold decreases
Value of other goods remain constant
Prices increase
3460.02 gold standard notes: a.p. palasvirta, ph.d.
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1/P
Supply
Demand
Gold
3460.02 gold standard notes: a.p. palasvirta, ph.d.
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1/P
Supply
Demand
Demand
Gold
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 Two
markets for gold
official government market
 Legal unofficial private markets

 Parity
Price greater than market price
government’s price (parity) the high price
 external markets price the low price

 trader
buys low sells high
buys externally
 sells to government

3460.02 gold standard notes: a.p. palasvirta, ph.d.
March 22, 2016
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Pg
Private
Market
S2
S1
Government
Market
Par
Pg
D2
D1
Qg
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 Private
market gold supplies decrease
holders of gold will sell first to the government
 arbitrageurs will buy up stocks and sell to the
government
 excess supply will dry up bringing market price to
equal the parity price

 Government
gold supplies will increase
increases the money supply
 decrease the value of money (inflation)

3460.02 gold standard notes: a.p. palasvirta, ph.d.
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 Countries


fix parity price of gold
usd parity price = $20.67/ounce
uk parity price = 4.2474£/ounce

usd/uk£ = 4.8665$/£
 They
allow arbitrage between two markets
parity price of gold at Central Bank
 free market price of gold

 De
facto single currency the ounce of gold
many units of account
 periodic falling off of the gold standard

 Balance
gold
of Payments deficits settled with
3460.02 gold standard notes: a.p. palasvirta, ph.d.
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 Mechanism



which mitigates BOT surplus
gold is paid to pay for excess of exports to
imports
gold coming into the central bank increases
money supply
inflation in the economy


your goods now more expensive in foreign markets
foreign goods less expensive to you
 Price-specie




flow mechanism
BOP balances settled in gold
Money adjusts
Prices adjust
International prices converge
3460.02 gold standard notes: a.p. palasvirta, ph.d.
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Liabilities
Assets
cash
Gold
currency
T-bills
gold increases due
to BOT surplus
3460.02 gold standard notes: a.p. palasvirta, ph.d.
Money supply
increases
March 22, 2016
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 Gold
backs all money
 prices move relative to

excess demand for gold (economic growth)


deflation
excess supply of gold (new gold finds)

inflation
 Treasuries
have no independent monetary
policy
3460.02 gold standard notes: a.p. palasvirta, ph.d.
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 Fixed

parity price (not fixed value)
Unit of account varied with the cost of mining
gold


Often the unit of account appreciated (increased in
value) as gold supplies were harder to mine
With new gold discoveries, the unit of account
depreciated (decreased in value) as the cost of mining
gold decreased
3460.02 gold standard notes: a.p. palasvirta, ph.d.
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 All
currencies fixed to gold
 Gold is the de facto currency


single world wide currency
all international trade is denominated in gold
 No
need to hedge exchange rate volatility
since exchange rates are constant
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 When


CBs execute a monetary policy
discipline of the gold standard is gone
after WWII governments ran inflationary policies



interest rate policies
employment policies
inflation sometimes running at 200% or more
 Exchange

rates fluctuate
creating uncertainty for trade
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 Colonizers

(France, Spain, England, Portugal)
Gold standard
 Colonies

Silver standard
 Gresham’s

Law
Bad money drives out good
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 Germany
reparations heavy and denominated
in Deutsche Marks not gold


Germany inflated their currency in order to
reduce the cost of reparations
Inflation 1 trillion%
 United

France, England paid for war materials bought
from the U.S. in gold
 Stock

States had most of the gold
market crash of 1929
Led to protectionism


Sterilization polices
Depression
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 WWII
U.S. again the supplier of arms got
most of the gold in the world
 1944 end of the was the Gold Exchange
Standard

The U.S. dollar became the reserve currency


Traded at par value with all currencies part of system
Balance of payments imbalances were cleared
with U.S. dollars instead of gold


Cheaper to ship dollars instead of gold
Countries could earn interest on their foreign
exchange reserves Special Drawing Rights (SDRs)
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
Creation of the International Monetary Fund
(IMF)


International clearing house for exchange transactions
with SDRs and dollars
Special Drawing Rights
 Exchange reserves held at the IMF
 Value weighted average of basket of major
currencies


Deutsche Mark (20%), franc (12%), pound (12%), yen
(16%), us dollar (42%)
The SDR as well as the U.S. dollar became the
reserve currencies
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 U.S.
had to run a chronic BOP deficit to
supply us dollars to the worlds economies
 The fixed parities between currencies
dependent on certain assumptions for all
economies


Monetary policies aligned
Fiscal policies aligned
 Revaluations

necessary periodically
Monetary policies of many countries very
expansionary
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 US
running inflationary monetary policy to
finance Vietnamese war

US increase the dollar parity price (devalued)
twice
 DeGaulle
demanded payment of BOP surplus
with the U.S. in gold
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 January
1976
 All currencies will float with respect to each
other
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 Gold
=
 Silver =
 Platinum
 Paladium
$1,212.1
$18.411
= $1,548.7
= $462.7
3460.02 gold standard notes: a.p. palasvirta, ph.d.
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