Author’s Note September 2008: Most of this material has now been published in my article in The Statesman “Indian Inflation”, republished elsewhere here. I should add that this note written in 2007 is extremely rudimentary and was written in a few minutes; I have not altered it as it is has been a popular read, but if I rewrote it, I would say the gold exchange standard was far more complicated than I have made it out to be in this note. Please see e.g. my recent article “October 1929? Not!” in Business Standard republished elsewhere here.
“Someone at the Ron Paul Forums asked for an explanation of the gold standard etc, so I posted the following brief note on it:
Gold standard etc: Fixed versus flexible exchange rates
First published at the Ron Paul Forums and at DailyPaul.com etc
The “gold standard”, “gold exchange standard”, and “dollar exchange standard”/Bretton Woods system are examples of “fixed” exchange rate systems.
In a pure gold standard, gold is used as money, ie interchangeably with paper money and the Central Bank of a country guarantees it will exchange gold for the paper money it issues at a certain announced price. If that price changes upwards or downwards, there is devaluation or revaluation of the currency with respect to gold (depending on how you count it).
A gold exchange standard is similar except gold is not used as money and the central banks of nations guarantee the announced prices of their paper moneys with respect to gold in transactions with one another.
In the so-called dollar exchange standard (or the Bretton Woods system from 1944 to 1971), the US Government alone and uniquely undertook to guarantee the price of the dollar at $35 a troy oz of gold in transactions with all other central banks. That was the underpinning of the international financial system until President Nixon “closed the gold window” on August 15 1971 because the US had largely financed the Vietnam War through money-creation, and other countries’ central banks (eg France) had accumulated large dollar-balances.
Since then, the world has been on floating exchange rates where currencies find their own values. and gold is merely one asset among many. Obviously the price of gold at $35 an oz had become unrealistically low, and shot up at once.
Milton Friedman had argued for floating exchange rates 20 years before they came into being. Fixed exchange rate systems can lead to speculation, runs against currencies and the irresponsible international export of inflation which floating exchange rate systems tend to avoid because there will tend to be market-determined movement in the exchange-rate instead.
As I have said before here, Dr Ron Paul’s discussions about monetary economics are probably better than that of any other candidate or politician in any party but they are not robust.
Dr Subroto Roy, Kolkata, India”