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Gold Exchange Standard

The Gold Exchange Standard^[1], as arranged in 1926, was a system first used in Holland, Austria-Hungary, Japan, India and Russia during the period between World War I and World War II. The Gold Exchange Standard was based on the recommendations at the conclusion of the Genoa Conference of 1922. In this conference, methods for the banking system to economize on gold were discussed.

Under the Gold Exchange Standard, the currency of some countries are backed by the reserves of the currencies of other nations who use the gold standard. For example, "Nations of the British Commonwealth often defined their currencies in terms of the British pound. Other nations defined their currencies in terms of the currencies of nations they were dependent on politically." - The Encyclopedia of Money By Larry Allen, P.173

Gold Bullion Standard

The Gold Bullion Standard uses circulating currency based on reserves of gold bullion, rather than coins. Under the Gold Bullion Standard, money in the form of circulating gold coins are withdrawn, and instead the currency of the country is based on a fixed quantity of gold bullion.

"With the complete breakdown of the gold exchange standard in the 1930's, the world moved toward a gold bullion standard." ...

"At the end of World War II, the world's trading partners established the Bretton Woods system, putting most nations on a gold bullion standard under the Bretton Woods system, the United States defined the value of the dollar in a fixed weight of gold. The United States agreed to buy and sell gold at a rate of $35 per ounce, and most other nations set the value of their own unit of money equal to a certain value in U.S. dollars. - The Encyclopedia of Money By Larry Allen, P.171-172

As Different from the Gold Standard

Vs. the Gold Exchange Standard

The Gold Exchange Standard, should not be confused with the Gold Standard, also known as the Gold Specie Standard. The Gold Exchange Standard is the arrangement of international currencies which are supported with a combination of reserves of a gold-backed currency and also by gold bullion.

In the first example of this arrangement, in 1926 the newly revalued British pound sterling, as well as those nations reserves of gold bullion, was used to back the currencies of various European and commonwealth countries. Countries using the gold exchange standard at the time would redeem their currency with a combination of British pounds and gold.

The Gold Standard was an internationally used currency standard used voluntarily by most nations until the beginning of World War I. However, the original Gold Standard was dropped so that governments could create unbacked paper currency to finance the war. This was the way major wars had been financed in the past. For example, during the U.S. War of Succession, bills that lacked gold backing, called "greenbacks" (backed by green), were issued to finance the war. At the end of the U.S. War of Succession all of these greenback bills were honoured in gold by the government, and were eventually bought back at face value using gold-backed currency.

Under the Gold Standard, the currency of a nation was freely exchangeable for a fixed weight of coined gold. In this way, any citizen of a country on the Gold Standard was able to go to a bank and redeem their paper bills for gold coins. Those gold coins were accepted as circulating currency alongside the bills. The banks were contractually obliged to honour any bills offered for redemption, issuing the gold that they represented. The bills of most countries were produced, engraved, and signed as if they were miniature contracts. Many bills carried inscriptions stating that the bank held the actual gold coins, and that a specific weight of gold coin will be issued upon redemption of the bill. The gold coins the banks were required to issue were sometimes quite small. This allowed most citizens to redeem their paper notes for gold coin. However, under the Gold Exchange Standard banks were not required to fulfil their obligations in the same way, allowing the banks to lessen their gold outflows by offering part of the redemption in British currency.

The money of Britain under the GES was used as a reserve currency, as with the United States Dollar. However, the Pound Sterling was no longer fully backed by nor convertible to gold coins as it had been under the Gold Standard. Consequently, the Pound Sterling was backed by either US dollars or gold bullion bars. Neither the US Dollars, nor the gold bars were legal tender of Britain or Europe, so redemption of pounds sterling would not result in the redeemer posessing a national unit of currence - as they would have before when receiving gold coins of the realm.

Gold bars are only good for amounts used in comparatively large transactions. A one-ounce bar is roughly the equivalent of 8.5 half-sovereigns, each one of which would today (2015) buy about US$150 of goods or services. Furthermore, gold bars may need to be assayed for purity before being accepted - unlike gold coins that have stamps and milling over their whole surface, so gold bars will not be freely accepted by the public in regular transactions the way gold coins may be.

The result of this was that, from the commencement of Bretton Woods, Britain redeemed pounds, not in gold coin as before World War I, but in US dollars and/or gold bars, and European nations redeemed their currencies in pounds, rather than in gold as before. Hence, the two key currencies were the dollar and the pound, with only the US dollar redeeming their currency in gold coin.

This arrangement only lasted from 1926 until 1931. After World War II, under the Bretton Woods Agreement, a different version of the Gold Bullion Standard was again picked up. This ended finally in 1971. Thus, it is well known that the Gold Bullion Standard has been dropped twice in a forty-year period of the 20th century.

Vs. the Gold Bullion Standard

In countries that adopt a Gold Bullion Standard, the primary monetary standard is still, ostensibly, gold, however, while their currencies are backed by uncoined gold bullion, this bullion was not available in a form suitable for domestic exchange. Under a gold bullion standard, most citizens would have no ability to use gold as a currency.

Under the gold bullion standard of 1934 to 1971 in the United States the private holding of gold (except for jewellery and industrial manufacture) became illegal, which prevented any lawful domestic use of gold as currency.

The Gold Exchange Standard and Post World War I Depression

It is commonly believed that the collapse of the stock market in October 1929 in the United States triggered a world-wide depression, which led to deflation and a massive increase in unemployment. However, that point of view tends to be centred on the United States, and lacks a certain amount of historical perspective and understanding. It is important to recognise the global economic context of the time.

Prior to the First World War, despite their share of economic contractions, Britain was still recognised as the most powerful economy in the world. There are important economically historical details, centred on Britain, that indicate a global environment of significant economic upheaval and decline beginning at least as early as 1914, and reaching their peak at the commencement of the Great Depression.

There appears to be unusual consensus in economic circles that worldwide depression was triggered by the costs and demands of World War I. Britain responded to the severe economic effects of war by radically altering its basis for economic exchange three times inside a 17 year period. Britain did this during a major war, and then another two times during a lengthy economic depression in a post-war environment.

Upheaval in the British economy -- the world’s strongest economy at the time -- caused interruptions to their international trade, internal economic pressures, a general strike, social discord, and rising unemployment. The upheaval also precipitated interest rate hikes in the United States and rapid fluctuations in the amount of gold stored in the French, British and United States banking systems. This turmoil led to the adoption of The Gold Bullion Standard in many European nations. Many of these nations had previously depended on the pound sterling due to its historic stability.

Gold Exchange Standard Timeline

While the Gold Exchange Standard only existed from 1925 until 1931, significant historical context is necessary to understand the subject. Resultantly this timeline begins in 1914, with the "Great War", World War I.

1914 - The Great War - Britain goes off the Gold Standard

The seeds of the adoption of the Gold Exchange Standard were planted when Britain chose to leave the Gold Standard (also known as the Gold Specie Standard). Britain had adhered to the Gold Standard since 1717 before choosing to leave it during World War I.

Before 1914, London had been the world's financial centre. When the war started in August of 1914 shipments to England of gold, silver, and goods from all over the world were immediately disrupted. The shortages put London's banks and stock exchange in crisis. To deal with the crisis they closed down for a few days. When the banks and stock exchange reopened, a debt moratorium was declared. The Bank Charter Act of 1844, fixing the bank reserve ratio, was suspended. This suspension of the Bank Charter Act put Britain unofficially off the Gold Standard.

As the war continued and the government's costs increased, the government used the suspended Bank Charter Act to pay off their war debts. They did this by simply printing more money - far in excess of gold reserves. Printing more money in this way caused considerable inflation of the pound on their domestic markets, and noteworthy inflation of the pound on international markets.

1920 - The Devalued Post-War Pound

By 1920, after the war was over, inflation had proceeded to such an extent that prices of goods in Britain had tripled, and the gold value of the British pound had fallen on world markets. The pound had dropped from 7.313 grams of gold (US$4.86) down to 6.620g of gold (US$4.40).

1922 - Genoa Monetary Conference

The Genoa Monetary Conference of 1922 proposed that central banks make a partial return to the Gold Standard by permitting central banks to keep part of their reserves in currencies that were still directly exchangeable for gold coins. Citizens, however, were not permitted to hand over their notes and receive gold coins, though the ability of citizens to do this had been an integral part of the Gold Standard.

1923 - Germany Ends Hyperinflation

To end the hyperinflation that the country had suffered for over a year, Germany adopted the Rentenmark, replacing their Papiermark. This put a sudden halt on their runaway hyperinflation.

The Rentenmark had a gold value similar to the pre-war gold mark, but was pegged to the US Dollar, which itself, at the time, was still fully backed by gold (unlike the British pound). This backing of the Rentenmark with fully gold backed US dollars was a demonstration of the implementation of the Gold Bullion Standard.

1924 - The Effect of U.S, "Easy Money” on Britain

In 1924 the US Federal Reserve adopted the "easy money" policy, making it easier than it had been to get bank loans. The decision was made in order to combat a decline in domestic business activity and to encourage international capital flows. The "easy money" policy was also expected to help Britain, which was still believed to be the economic centre of the world, to import enough gold so that they could return to a fully-backed Gold Standard the following year.

After the US easy money policy was instituted, British banks did experience significant gold inflows. This raised the likelihood of a return to the gold standard.

1925 - A Poor Gold Standard Implementation

The British economic troubles worsened after April 28, 1925, when England attempted to return to the Gold Standard, but at the artificially high pre-war rate for the pound of US$4.86. This did not take into account the larger amount of circulating British currency that was produced to fund World War I. The true, floating, or market value of the pound at the time is estimated to have been around US$3.50, 28 percent lower. Thus, the pound sterling became substantially overvalued vis-à-vis both gold and the US dollar. Keynes identified that this was an unsustainable level for the pound.

This over-valuation caused British products to suddenly appear considerably overpriced in the world markets. The immediate effect of the British revaluation was to price their goods out of the world market. For instance, U.S. importers who had been paying US$3.50 to buy a pound sterling of British wool or coal now had to pay about 40 percent more. Naturally the sudden rise in the cost of British exports led to a significant drop in demand, and a substantially negative effect on trade balances and British industry.

Greshams Law came into play on this the newly formed international money market. International entities that held British pounds prior to the revaluation now began to dump them on the market in exchange for gold from British banks. They gave up their suddenly higher purchasing pound to get a greater amount of gold than before. This action netted the seller around 40% more gold on April the 28th than it would have on the day before, and began to cause undesirable outflows from the British banks of their newly acquired gold stocks.

This sudden drop in demand for all British goods came a time when England was still very heavily dependent on exports to rebuild their post-war economy. Britain experienced imports chronically in excess of exports accompanied by persistent balance-of-payments deficits. Naturally this caused further outflows of gold reserves to pay for the trade imbalance. British banks, factories and mines were hit hard. These problems were caused by the unrealistic overvaluation of the pound by poorly implemented legal tender laws in Britain.

1926 - Britain Shows Economic Stress

The attempt to return to the gold standard at the pre-war level was clearly unrealistic, and led to unintended economic consequences. It had instantly increased the purchasing power of the pound, and hence had substantially raised the cost of British labour and exports overnight. Consequently all exporting industries, mines in particular, were in a tricky situation. Demand for mining exports had dropped sharply after the over-valuation of the pound, but the domestic costs of mining remained largely the same.

To maintain international competitiveness, or at least to keep operating, mining costs would have to drop while efficiency needed to rise. Simultaneously, historic share earnings and investor confidence somehow had to be maintained. The alternative was grim - the prospect of substantial losses in revenue and subsequent mine closures and bankruptcies in the industry. These problems would not have arisen if the value of the pound had instead been set near US$3.50 (to reflect the greater quantity of circulating British pounds), rather than attempting to return to an unrealistic pre-war US$4.85 value.

It was decided by mining industries that the wages they paid to workers would have had to be adjusted downward, and working hours also had to be increased. The situation was explained -- a drop in mining costs was necessary to account for the over-valuation of the pound in the previous year. Wages for production of exports had to be adjusted to maintain liquidity.

However, workers buy their essentials from the domestic market, not the international market, and they would see no commensurate drop in the prices they paid with their reduced income levels. Consequently these explanations fell on deaf ears, and were criticised as a feeble attempt to placate and manipulate workers. The workers, many of whom were unionised, were understandably outraged by the attempt to lower their wages by 10-15%. They resisted the proposed reduction in wages, refusing to work for less.

A Conference of Trade Union Congress met on 1st May 1926. The result of this was that a general strike was proposed to begin two days later. The action was to begin in mining and associated industry, but was planned to extend to other workers. However, this was not to be the case. Though the strike only lasted nine days, due to a lack of public support, the general strike did seriously disrupt industry and consequently produced a more urgent need for UK producers to cut costs.

Most mines were closed by this time. Many workers had to leave the workforce, and went on the dole, and many others continued to go out on strike until around August of 1926.

1925 - Other Nations and the Gold Exchange Standard

Around the same time as the revaluation of the British pound, other European nations, also following the recommendations of the Geneva Convention, moved to gold-convertible currencies. They used a monetary system known as the "Gold Exchange Standard," where currencies were pegged primarily to gold-convertible currencies rather than to gold itself.

The Gold Exchange Standard permitted the extension of credit beyond the gold reserves of individual banking institutions, relying on the purchasing power of gold-convertible currencies rather then that of the gold it held. Banking institutions were not, as had been the way under the Gold Standard, required to redeem their outstanding notes in gold coin, but were permitted to redeem their notes in a mixture of gold bullion and foreign notes.

1927 - U.S. Federal Reserve Bank Attempts to End Pound Revaluation Woes

As a result of the British pound revaluation, Britain suffered a deflationary depression for the rest of the 1920s. Moreover, to help Britain return to gold at the pre-war exchange level, the Federal Reserve had pushed down interest rates in 1924, and did so again 1927, cutting them from 4% to 3 ½%. This contributed to an inflationary boom in the U.S.

In 1927 the rate was cut partly in an attempt to help Britain to acquire sufficient gold to fully back the circulating British pounds, and thereby to solidify their attempt to return to the gold standard. However the supply of credit was eased just as a speculative boom was starting on the stock market.

1929 - The Great Depression Begins

Through 1928 and 1929 the US Federal Reserve's "easy money" policy had finally triggered a stock market boom in the US. The Federal Reserve did not take effective action to prevent the boom from getting out of control.

In July 1929 a significant tariff bill (which was to become enacted as the Smoot-Hawley Tariff Act in June 1930) was passed through congress. This bill was widely held to be severely detrimental for US businesses once enacted in late 1929, and had been anticipated by the US business community for several months. There are speculations that the passing of this bill caused a pre-emptive and significant reduction in business in the US. This pre-empting of the tariff bill may have been significant in triggering the stock market crash that followed.

On the 24th of October 1929 the New York stock market crashed. The Federal Reserve, whose easy money policy stoked the boom, suddenly tightened credit. This sudden tightening of credit had the effect of causing and then worsening a slump in the US economy, marking the beginning of the Great Depression.

Widespread bank failures and restrictions on lending by the surviving banks caused businesses of all kinds to go bankrupt. The US net national product fell by over half during the period from October 1929 until the end of 1930.

Throughout early 1931 there were many bank failures in Europe, in particular some of the major banking institutions in Germany. This resulted in the remaining German banks restricting their lending.

By September 1931 it was recognised that the United States and France held 75% of world's gold stock. During the previous 6 weeks over £200 million worth of gold (around £12 billion in 2003 money) was withdrawn from London, causing another reserve crisis for Britain.

1931 - Britain Drops the Gold Exchange Standard

Finally, on September 20, 1931, England announced that she would again suspend gold payments and go off the Gold Exchange Standard. This triggered the move from classical to Keynesian economics.

The Commonwealth (except Canada), Ireland, Scandinavia, Iraq, Portugal, Thailand, and some South American countries followed Britain off the Gold Exchange Standard in 1931.

Summary

The British monetary experiments played an important role in bringing about and prolonging the world depression of the 1930s.

Throughout these events, the resulting US Federal Reserve's monetary policy, except for very brief periods in 1929 and 1936-1937 when it turned mildly dis-inflationist, was consistently and unremittingly inflationist in the 1920s and 1930s, which indicated that the money supply during the period had been steadily been increasing since the United States Federal Reserve Bank began operating in 1913.

References

http://www.britannica.com/topic/gold-exchange-standard - Britannica gold exchange standard definition

http://www.24hgold.com/english/contributor.aspx?article=3920333806G10020&contributor=Nathan+Lewis -- Gold Exchange Standard Article

"One drawback of such a system is that you are reliant upon the target currency remaining pegged to gold. This didn't work out so well for those linked to the British pound, which was devalued in 1914, 1931, and numerous times thereafter. Or, for those linked to the U.S. dollar, which was devalued in 1933 and then in 1971."

http://www.eagletraders.com/advice/securities/gold_exchange_standard.php - Gold Exchange Standard definition Source: Encyclopedia of Banking & Finance (9h Edition) by Charles J Woelfel

http://bilbo.economicoutlook.net/blog/?p=2562 - Blog, use with caution. Use References only. "The onset of World War I interrupted the operation of the gold standard and currencies were valued by whatever the specific government wanted to set it at. The ensuing 25 odd years saw significant instability with attempts to go back to the standard in some countries proving extremely damaging in terms of gold losses and rising unemployment. The UK abandoned the gold standard in 1931 as it was facing massive losses of gold. It had tried to maintain the value of the Pound in terms the pre-WW1 parity with gold but the war severely weakened its economy and so the pound was massively over-valued in this period and trade competitiveness undermined as a consequence."

https://mises.org/library/monetary-breakdown-west - Excerpt from Rothbard. Historical breakdown. "The gold-exchange standard worked as follows: The United States remained on the classical gold standard, redeeming dollars in gold. Britain and the other countries of the West, however, returned to a pseudo-gold standard, Britain in 1926 and the other countries around the same time. British pounds and other currencies were not payable in gold coins, but only in large-sized bars, suitable only for international transactions. This prevented the ordinary citizens of Britain and other European countries from using gold in their daily life, and thus permitted a wider degree of paper and bank inflation. But furthermore, Britain redeemed pounds not merely in gold, but also in dollars; while the other countries redeemed their currencies not in gold, but in pounds. And most of these countries were induced by Britain to return to gold at overvalued parities. The result was a pyramiding of United States on gold, of British pounds on dollars, and of other European currencies on pounds — the "gold-exchange standard," with the dollar and the pound as the two "key currencies.""

https://mises.org/library/great-depression-0 - PDF book of Lionel Roberts The Great Depression. Yet to examine this PDF

http://www.nsu.ac.jp/econ/staff/komine/paper/norou.pdf - Dead, no longer found. - Wayback archive link; https://web.archive.org/web/20050219110611/http://www.nsu.ac.jp/econ/staff/komine/paper/norou.pdf

http://www.econlib.org/library/Enc/GoldStandard.html

"The gold standard broke down during World War I, as major belligerents resorted to inflationary finance, and was briefly reinstated from 1925 to 1931 as the Gold Exchange Standard. Under this standard, countries could hold gold or dollars or pounds as reserves, except for the United States and the United Kingdom, which held reserves only in gold. This version broke down in 1931 following Britain’s departure from gold in the face of massive gold and capital outflows."

^ [1] - Britannica gold exchange standard definition

[1] [1] - Britannica gold exchange standard definition

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