Microsoft Word - Money, Banking, and Int Finance(scribd).docx

Money, Banking, and International Finance

Benefit 4: Gold standard restricts commercial banks and government. If banks create too
much credit, the credit expands the money supply, leading to inflation in the long run. People
would convert their currency into gold, restricting credit expansion and hence reducing inflation.
Moreover, government could print money to finance budget deficits, but this causes inflation.
Then the public counteracts the inflation by converting money into gold (Gold Standard, p. xi).
Gold standard, unfortunately, can export a country’s recession to other countries. However,
all exchange rate regimes share this problem. For example, the United States and Japan engage
in trade, and both use the gold standard. We outline the steps for a country to export a recession:

 If the United States enters a recession, the U.S. consumers reduce their demand for imports

or Japanese products. If the U.S. exports remain the same while imports fall, the U.S.

experiences a trade surplus, leading to a gold inflow from the Japan to the United States.

 Japan exports fall to the United States because lower demand causes the export industries

to contract, and they lay off workers. Furthermore, the Japanese central bank must reduce

its money supply because it had shipped gold to the United States. Consequently, the

unemployed workers buy fewer goods because they earn lower incomes and deflation

causes Japanese products to become cheaper. Furthermore, contractionary monetary policy

would raise interest rates that reduce investment. Falling investment would contract the

economy further.

 All exchange rate regimes allow one country to export a recession to another country.

Nevertheless, a flexible exchange rate allows a country to manipulate the exchange rate to

reduce a recession’s impact.

After World War II, 44 countries implemented a new international system, the Bretton
Woods System, where the delegates met at a vacation resort, Bretton Woods, in New
Hampshire. The Bretton Woods System established fixed exchange rates between nations that
lasted between 1945 and 1971. All countries except the United States fixed their exchange rates
to the U.S. dollar. Then the United States government established the official exchange rate of
$35 for 1 ounce of gold because the United States held much of the world’s gold supply. The
U.S. government accumulated gold from the sale of supplies and weapons to Europe for both
World Wars. However, the gold-dollar exchange rate applied to foreign governments because
U.S. citizens could not legally own gold between 1933 and 1974. Consequently, the Bretton
Woods System transformed the U.S. dollar into the international reserve currency
The Bretton Woods system was more flexible than the gold standard because countries
could adjust their currency exchange rates relative to the U.S. dollar. Consequently, countries
used a system resembling a gold standard, but a government can intervene with its exchange rate
to correct a balance-of-payments deficit. Then U.S. President, Richard Nixon, ended the Bretton
Woods System on August 15, 1971 because the United States experienced trade deficits that
would lead to a gold outflow.
The Bretton Woods system created two institutions: International Bank of Reconstruction
and Development, or simply World Bank and the International Monetary Fund. World Bank