Kenneth R. Szulczyk
Gold standard forces fixed exchange rates, which economists call a fixed exchange rate
system. Consequently, one U.S. dollar equals 100 yen or 2 pounds. We calculate the exchange
rates in Equations 3. First, we set all currencies equal to one ounce of gold. Then we divide by
one currency’s coefficient, yielding the exchange rates, which in this case, we divide all
numbers by 2,000:
1 ounce of gold = $2,000 = 200,000 yen = 4,000 pounds ( 3 )$ = yen= poundspounds
=
yen
=$
1 100 2
2,000
4,000
2,000
200,000
2,000
2,000
A gold standard helps countries maintain a zero balance of payments. For example, the U.S.
experiences a payments deficit with Japan, where the current account plus the financial account
is negative. Consequently, U.S. dollars are flowing out of the United States and into Japan. On
the other hand, Japan accumulates U.S. dollars, and the Japanese central bank exchanges the
U.S. dollars for gold from the U.S. central bank. Then gold begins flowing out of the United
States and into Japan. Once the U.S. central bank possesses less gold, it must contract the money
supply. Remember, the money supply fixes the ratio between gold the government is holding
and the currency in circulation. When the money supply declines, the prices in the economy will
decrease, called deflation or negative inflation. Thus, U.S. products become cheaper than other
countries’ products. Then the U.S. businesses export more goods abroad while the lower U.S.
prices cause foreign products become more expensive. Hence, the U.S. consumers buy less
imported goods. U.S. exports became larger while imports smaller, increasing the current
account until it equals zero and gold stops flowing out of the United States. Exact opposite
would occur in Japan. Consequently, a gold standard automatically eliminates trade deficits and
surpluses.
Gold standard has four benefits:
Benefit 1: High inflation rates were rare under the gold standard because central banks had
little control over the money supply. If a central bank wants to increase the money supply, then
the central bank must buy gold. For example, the inflation rate averaged less than 1% in U.S.
under the gold standard. Consequently, a gold standard constrains a central bank’s ability to
expand the money supply.
Benefit 2: International investors have a lower risk because exchange rates do not fluctuate.
All exchange rates become fixed that eliminates the exchange rate risk.
Benefit 3: Gold standard greatly constrains a government’s power. For instance, central
banks have little power to influence the money supply, and hence, they cannot pursue policies to
influence their economies. Thus, gold goes hand to hand with free markets, strong property
rights, and limited government, but this benefit depends on the reader’s viewpoint because this
could be a problem (Gold Standard, pp. viii-ix). During the 2008 Financial Crisis, the Federal
Reserve granted $2 trillion for emergency loans to banks, which would be impossible under a
gold standard.