In the previous article, we discussed banknote was regarded as money because you can withdraw same amount of gold from bank by using banknote. It’s kind of like the simple version of gold standard. This time, we will discuss the origin of gold standard, the abandonment of gold standard and the Bretton Wood system.
What is gold standard?
The gold standard is a monetary system where paper money has a value directly linked to gold. Sounds too theoretical? OK. In short, once the gov adopt the gold standard, its central bank needs to own partial amount of gold first, then it can issue money. Mostly, it required 40% of the reserve gold and the price of gold is fixed. Hence, the gov couldn’t issue the money at will. All the money they issue get backed by gold reserve.
History of gold standard
Gold standard was first officially adopted in Britain and gradually spread to the rest of the world due to the England’s strong economic influence over the world. With Germany adopting it, gold standard was widely accepted in Europe since Germany was the leading industrial power in that time.
Gold standard was operated quite successfully for nearly a hundred years and brought a very stable global economy. However, after WW1 burst out, more and more countries got involved in the war and run out of the gold reserve in order to fund the war. The war destroyed the economy and make the unemployment rate remain in the high level. War-torn countries started to abandon gold standard to issue more money for maintaining the economic situation when they didn’t have the same amount of gold reserve.
Here Bretton Woods system comes!
During the post-war period, world needs a new financial system to stabilize the economy after abandoning gold standard. Therefore, there are 44 countries representative gathered in Bretton Woods, New Hampshire, United states to discuss the possibilities of putting the world together again.
In the Bretton Woods meeting, there are two countries playing important role: one is UK, used to be the global financial center but gradually lose the influence due to the super heavy financial burden after WW2, & another is US, a rising power owning nearly 70% of gold reserve in that time.
From UK’s perspective, the best strategy is to convince every country to abandon using gold and trade with newly-created form of currency because UK had run out of gold to fund the war. From US’s point of view, US also wants to have a currency to make countries could trade with each other again, but the currency should be US dollars.
During the discussion, every representative all agreed to create a new kind of gold-convertible currency — to revive the economy. With US delegate’s elaborate orchestration, the currency turned out to be US dollar.
Therefore, the final plan is each country keep their currencies fixed to the dollar, and the dollar was fixed to gold at $35 an ounce. US has the obligation to maintain the exchange rate between dollars and gold. And that is one of the reasons that makes US dollars so dominant in the financial world.
In the next article, I will introduce the end of gold standard and we will understand what is Fiat Money. Welcome to the modern financial game!
Reference:
NPR
Preethi Kasireddy
Investopedia
Keep reading:
Crypto series 1 — Have you ever thought what is money?
Crypto series 2 — the Evolution of Paper Money & Central Bank
Crypto series 3 — what is gold standard?
Crypto Series 4 — Fiat Money comes into existence!
