From about 1870 until 1914, the international monetary system was based upon a full gold standard. A gold standard refers to a monetary system in which each unit of currency equates to a fixed quantity of gold. The currency is therefore easily converted either domestically or internationally into gold. Paper or coin money is insured by the existence of an amount of gold.

In a full gold standard, several strict requirements must be met. First, the actual gold must be payable on demand. Second, the national monetary unit must be based on a certain amount of gold of a specific purity. Third, individuals who possess the gold must be permitted to have it coined at a very small cost. Fourth, anyone who possesses gold coins must be permitted to melt them down at their pleasure. Fifth, there can be no limitations on the import or export of gold. In the full gold standard scenario, the trade between nations was backed up in gold. This stabilized trade since the value of gold could never be increased above the expense to ship it.

CS Question #1: What are the requirements of a full gold standard?

During World War I, the full gold standard collapsed. Every nation except the United States abandoned the gold standard. Most nations involved in the war found it necessary to protect their supply of gold. This meant establishing a monetary unit of paper money that could not be converted to gold. In 1928, the gold standard was reinstituted internationally. However, it was not in the same form as the prior system. Due to the relative scarcity of gold, most nations adopted a gold-exchange standard, in which they supplemented their central bank gold reserves with currencies (U.S. dollars and British pounds) that were convertible into gold at a stable rate of exchange.

During the Great Depression, the gold exchange collapsed again. In 1933, Franklin D. Roosevelt was elected president of the United States. The Great Depression had begun with a stock market crash in 1929. A great number of investors lost their money on stocks that had been inflated in value. Many banks had to close. Unemployment climbed to 25 percent. Roosevelt's most important goal was to pull the nation out of the Great Depression.

President Herbert Hoover had previously created the Smoot-Hawley Tariff Act of 1930. This act increased the duties on all items imported from foreign nations. It was designed to limit foreign competition and increase revenue for businesses in the United States. Other nations responded by increasing their taxes on products imported by the United States. U.S. exports declined rapidly. By the end of 1930, the U.S. export of farm products fell by 50 percent. In 1933, Roosevelt abandoned the full gold standard and adopted the modified gold bullion standard. The new standard outlawed the circulation of gold coins. It retained gold as the basis for monetary units and changed the dollar from 21 to 35 ounces of gold. Roosevelt hoped that devaluing the dollar would stimulate U.S. exports to other nations. These nations would find it more profitable to buy products at the new, less expensive price. Unfortunately, most nations followed suit. The United States did not exit the Great Depression until the beginning of World War II in 1942.

After World War II, the United States helped other nations to achieve new trade stability. The United States gave $45 billion in civilian aid and $100 billion in military aid. The United States also shared technology with foreign nations. The goal was to encourage global market competition. Eventually, these actions would cause the United States to lose market share to foreign nations. By the late 1960s and early 1970s, foreign competitors were gaining market share in the U.S. market of shoes, textiles, steel and other markets. An important example is automobiles. In 1966, Japan imported 63,000 cars to the American market. By 1971, Japan was importing 700,000 cars. In 1958, the United States had managed to bring a majority of the world back to the gold standard. In 1966, the United States enjoyed a $7 billion trade surplus. By 1970, the surplus had shrunk to $2.7 billion. The first of many monthly U.S. trade deficits was posted in April of 1971. The new deficits lowered international confidence in the U.S. dollar. American and foreign investors panicked. They began dumping dollars for other currencies. Hundreds of millions of dollars were dumped. The corresponding gold was shipped abroad. The U.S gold reserves were almost gone. President Richard Nixon was forced to abandon the gold standard. The American dollar was reasserted as the basis of the international monetary system.

CS Question #3: Why did Nixon abandon the gold standard?

There are several reasons to support the use of a gold standard. First, using the gold standard limits banks or governments from creating price inflation. Second, the gold standard ensures trade equality and security among nations. Third, this standard prevents nations from exceeding their budgets. However, the gold standard has many disadvantages for national economies. First, there is no guaranteed correlation between the growth of a nation's economy and how much gold will be discovered. Second, with a full gold standard nations are unable to protect themselves from international economic crises.

CS Question #4: What are the advantages of a gold standard? What are the disadvantages?

Further Thought:

1. How does the gold standard affect trade?
2. How can business cycles cause a nation to abandon the gold standard?
3. Is the gold standard necessary in today's global economy? Explain your answer.