Forex: The Gold Standard Era

The success or failure of different exchange rate regimes has depended historically on the severity of such issues with which those systems have had to cope--- in the gold standard era, for one.

Ever since 1914, the prewar gold standard has been the object of considerable nostalgia.

Both the interwar and the postwar period perceived concerted international efforts to reestablish fixed exchange rate systems, whose desirability was viewed upon by the experience of the gold standard. Among scholars, too, the 'success' of the gold standard has been widely accepted and research has focused on why, not whether, it worked so well.

The international gold standard emerged by 1870 with the help of historical accidents centering on Britain. Britain tried the pound sterling ever more closely to gold rather than silver from the late 17th century on, in part because Britain's official gold-silver value ratio was more favorable to gold than were the ratios of other countries, causing arbitrageurs to ship gold to Britain and silver, from Britain, too. The link between the pound sterling and gold proved crucial. Britain's rise to primacy in industrialization and world trade in the 19th century enhanced the prestige of the metal tied to the currency of this leading country.

As it also happened, Britain had the further advantage of not being invaded in wars, which further strengthened its image as the model of financial security and prudence. The prestige of gold was raised further by another lucky accident: the waves of gold discoveries in the middle (California, Australia) and at the end (Klondike, in South Africa) of the 19th century were small enough not to make gold too suddenly abundant to be a standard for international value.

The silver mining expansion of the 1870s and 1880s, by contrast, yielded too much silver, causing its value to plummet. With the help of such accidents the gold standard, in which each national currency was fixed in gold content, remained intact from about 1870 until World War I.

In retrospect it is clear that the success of the gold standard is explained in part by the tranquility of the prewar era. The world economy simply was not subjected to such distress as severe as World Wars I and II, the Great Depression of the 1930s, and the OPEC oil price jump of 1973-74. The gold standard looked successful in part because it was not put to a severe worldwide set.

The prewar tranquility even allowed some countries to have favorable experiences with flexible exchange rates. Several countries abandoned fixed exchange rates and gold convertibility in short-run crises. Britain itself did so during the Napoleonic war. Faced with heavy wartime financial needs, Britain suspended convertibility after the wars.