The Gold Standard Creates An International Economy

While international commerce has survived in one form or another since prehistoric times, a structured and robust international economy did not begin until 1815, when the Gold Standard was introduced as the world's first monetary system. By linking vastly different economies through a single medium - gold - international trade was substantially facilitated: trade evolved from bartering to the usage of a standardized methodology, thus allowing the initial building blocks of today's "global economy" to be put in place.

Essentially, the Gold Standard provided for the free circulation of gold coins between nations. As the usage of gold coins in international trade become the status quo - and as international trade began to enjoy exponential growth as a result of this - a formalized relationship between currency and gold was needed. Accordingly, the British Parliament took the first step in 1819 with the passage of the Resumption Act - an act that required the Bank of England to exchange currency notes for gold on demand at a fixed rate of 4.252 pounds per ounce of gold. Later in the nineteenth century, the majority of the industrialized world - including the US, Germany, and Japan — adopted the Gold Standard as well. Under the system, the primary responsibility of each country's central bank was to preserve the official parity between its currency and gold. The banks would achieve this stability by maintaining an adequate stock of gold reserve.

The guidelines of the system were as such: (1) each country defined their currency by a fixed amount of gold; (2) all countries allowed for coinage of gold at a mint; and (3) the importing and exporting of gold was not to be restricted (gold shipments between countries was not uncommon). These guidelines allowed for the elimination of foreign exchange risk, as the value of gold - not the value of the currency - would determine the risk exposure related to international trade.

The advantages of a gold system were its inherent stabilizing propensities. A country with a current account surplus would receive gold in payment of their exports. Such an influx of gold would raise its prices, and lower the value of that country's currency. Higher prices of goods and services would then decrease the demand for exports, thus stabilizing prices again. Essentially, the utilization of the Gold Standard allowed for supply and demand to dictate prices, thus allowing for international trade to exist in a truly economic environment.

Unfortunately, though, there were substantial disadvantages to the Gold Standard - disadvantages so powerful that they would eventually undermine the system altogether. Perhaps the premier shortcoming of the Gold Standard was that it introduced liquidity issues. The supply of money was dependent on, and limited to, the world's supply of gold. In addition, an abnormal increase in the production of gold would cause prices of goods and services to rise significantly. Thus, as the balance of supply and demand for gold became more and more uncorrelated to the balance of supply and demand for respective currencies, the Gold Standard became an unfeasible means of regulating the international economy.

Ultimately, the Gold Standard lasted until 1914, when the liquidity issues arising from a shortage of gold simply made the entire system unfeasible. What followed was the Gold Bullion Standard - a system under which countries no longer minted coins, but instead simply backed their currencies with gold bullion, essentially agreeing to buy and sell bullion at a fixed price. This system was then replaced in the 1930s by the Bretton Woods system, which lasted until 1971 — upon which it too collapsed, leaving the majority of the world to evolve to adopting a free floating currency exchange rate methodology.