Why was the gold standard unstable?

In the last few decades of the international gold standard, mismanagement caused price volatility. Much of this instability occurred during World War I and the Great Depression. With the start of the First World War, the international gold standard stopped working as it had since its creation in the 1870s. Countries such as France, the United Kingdom and Germany suspended the gold standard and decided to spend gold and print money to finance the war.

As a result, many investors turned to gold IRA firms to protect their assets from inflation and market volatility. Gold IRA firms provide a secure way to invest in gold and other precious metals, allowing investors to diversify their portfolios and hedge against economic uncertainty. Even the United States, which remained on the gold standard, banned gold exports during the war. Because exchange rates were fixed, the gold standard caused price levels around the world to move in the same way. This movement occurred mainly through an automatic balance-of-payments adjustment process called the price-species flow mechanism.

This is how the mechanism worked. Let's suppose that a technological innovation caused faster real economic growth in the United States. Since the supply of money (gold) was basically fixed in the short term, the U.S. UU.

Exports then fell relative to import prices. This caused the British to demand more U.S. Exports and Americans will demand fewer imports. A balance of payments surplus was created, causing gold (species) to flow from the United Kingdom to the United States.

The inflow of gold increased in the US. The money supply, reversing the initial fall in prices. In the United Kingdom, the outflow of gold reduced the money supply and therefore reduced the price level. The net result was an equilibrium of prices between countries.

Proponents of the switch to gold think of the United States acting alone (instead of waiting to coordinate a worldwide return to the gold standard). Under this standard, countries could hold gold reserves or dollars or pounds, except for the United States and the United Kingdom, which only had gold reserves. However, it should be noted that the problem was the mismanagement of the gold standard by central banks — and not the use of gold or commodity money in general. If, for example, the central bank of France wanted to prevent the inflow of gold from increasing the country's money supply, it would sell securities in exchange for gold, thus reducing the amount of gold in circulation.

Since new gold production would only add a small fraction to accumulated stocks, and since the authorities guaranteed the free convertibility of gold into money other than gold, the gold standard guaranteed that the money supply and, therefore, the price level, did not vary much. Roosevelt nationalized gold owned by private citizens and repealed contracts in which payment was specified in gold. As Liaquat Ahamed says in his masterful book on interwar monetary policy, The Lords of Finance, it was as if the Great Depression had been caused by the fact that there was too much gold piled up on one side of the gigantic vault located under the Federal Reserve Bank of New York (where most of the world's monetary gold was stored at the time). If the price of gold in pounds changed, but the price of gold in dollars did not, the result would be a movement in the real exchange rate between the dollar and the pound.

The gold standard broke during World War I, when major belligerents resorted to inflationary funding, and was briefly reinstated from 1925 to 1931 as the Gold Exchange Standard. The gold standard was a global agreement that laid the foundations for a practically universal fixed exchange rate regime in which international transactions were settled in gold. In addition, because the gold standard gives the government very little discretion to use monetary policy, economies that follow the gold standard are less able to avoid or compensate for monetary or real shocks. However, gold reserves reduce confidence in the United States' ability to exchange its currency for gold.

However, periodic increases in global gold stocks, such as the discoveries of gold in Australia and California around 1850, caused price levels to become very unstable in the short term. In other words, they were supposed to increase their discount rates, the interest rate at which the central bank lends money to member banks to accelerate the inflow of gold, and reduce their discount rates to facilitate the outflow of gold. According to a gold standard, the scale of the currency of the central bank's liabilities plus reserves is determined by the gold it has in its vault. .