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Gold Standard

  The gold standard is a monetary system in which the monetary units are equated by law to ounces of gold at an official exchange rate, and currency is readily exchangeable for gold. When other countries also equate their money to gold, then gold becomes an international common denominator, establishing the legal exchange rate of each currency with all others in the system. For example, if 1 ounce of gold equals 19 UK pounds and 1 ounce of gold equals 38 US dollars, then 1 pound equals 2 dollars.

When a disequilibrium occurs in the international balance of payments, the exchange value of a deficit nation\'s currency will tend to fall. Countries are most reluctant to devalue their currency (by legally fixing a larger amount of currency equal to 1 ounce of gold) in recognition of its lower value. Instead, foreign exchange reserves may be used by the deficit country in exchange for its currency held by foreigners.

The gold standard was the benchmark for exchange rates before 1914, and returned briefly to prominence in the 1920s and 1930s. Currencies were convertible into gold, at a fixed price, and international debts were transacted in gold; gold itself was then usable as a currency.

In 1914, World War I disrupted world trade and payments, and most industrialized countries left the gold standard. Along with others, the UK returned to the standard in 1925. The pound was set at its prewar parity against gold, which had not been changed since Isaac Newton set it in the 17th century. This anachronistic approach to economics forced the UK to abandon gold and devalue in 1931, floating the pound from 1931 to 1939. The gold standard broke down generally in 1930-1933, under pressure of slump and the huge cutbacks in international lending. The US suspended the dollar\'s convertibility to gold in March 1933, returning to it, with restricted convertibility, in January 1934.

After World War II, a limited form of gold standard survived, but only for the dollar. Even that was abandoned in 1971. TF

See also Bretton Woods; international monetary fund.



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